Gittins and economic dyspepsia

Economists are wont to criticise habits as a sign of irrationality, but they're often a sensible rule of thumb that stops us doing other things we'll later regret.

A case in point: over the years, I've developed the habit of not reading Ross Gittins. Last week I broke that habit, and the experience reminded me of how sensible that habit was.

The reason for breaking with habit was that Ross's headline had a certain resonance for me. He was musing about things he had learnt as he approaches 65, and since I approach a similar if smaller milestone myself soon (60), I was curious to see what his musing were.

Figure 1: The story caption in the SMH

Then I saw that one of them was musing about "What Keynes Really Meant" in his comment that "in the long run we are all dead."

"Scholars argue over what Keynes meant by that aphorism. Like many such quotes, people use it to mean whatever suits them. I've always taken it to mean we should focus on managing the short-run fluctuations in demand (spending) and not worry about the supply (production) side of the economy, which neo-classical economics teaches can change only in the long run," Gittins said in the February 13 article More to life than going along with big bosses.

"If that's what Keynes meant then he WAS wrong. As he well knew, the long run of economic theory isn't long enough for many of us to have died. But if you ignore the supply side for long enough it starts to malfunction, and this inevitably makes it harder to manage the demand side and keep unemployment and inflation low."

Oh blather. There's no mystery at all to what Keynes meant: he was taking a swipe at the tendency of economists to think in terms of equilibrium about an economic system that is never at rest. The single sentence – which can seem mysterious if that's all you've ever read– sits in the middle of a paragraph in chapter three of Keynes 1923 book A Tract on Monetary Reform that makes its meaning bleedingly obvious:

"The long run is a misleading guide to current affairs. In the long run we are all dead. Economists set themselves too easy, too useless a task if in tempestuous seasons they can only tell us that when the storm is past the ocean is flat again."

Today the quote can be found by a simple Google search. With that, its meaning is obvious: Keynes was criticising the practice of the conventional economists of his day, of modelling the economy as if it is in continuous equilibrium, and as if 'exogenous storms' are the only explanation for its tempestuous behavior.

Keynes's critique is even more valid now than it was 90 years ago when he first wrote those words. Today, the dominant school of economists still model the economy as if it has an innate tendency towards equilibrium – which is why they at perplexed when it behaves as it has since 2007/08 when the economic crisis began. "Why won't you go back to equilibrium, like a good economy?" they muse – if they muse at all.

Keynes had a right to be exasperated with this behaviour in his day, but there's a right to be truly outraged by it now. The excuses economists of Keynes' day had for pretending that the economy was in continuous equilibrium are long gone. Back then, it was generally too difficult to model a system out of equilibrium. These days, with modern computer software, it's a cinch: engineers, meteorologists, biologists and physicists do it all the time. Only economists prattle on about 'general equilibrium'. Modern science is 'general dynamics', and economics by comparison is not 'The Queen of the Social Sciences', as its dominant practitioners would like to believe, but a pathetic relic of a bygone age.

Keynes was prescient too in choosing the ocean as his analogy to what economics had to model and explain – and not a fabled 'in the long run' equilibrium, but the continuous cyclical behaviour of the here and now – because the behaviour of a fluid subject to a source of heat was the subject that gave rise to modern dynamics back in the mid-1960s.

The meteorologist Edward Lorenz was dissatisfied with the then common practice of modelling the weather – you guessed it – as if it was in equilibrium. He developed a simple non-linear dynamic model of fluid flow in a 'slice' of water. Here's his model – as simulated in my dynamic modelling program "Minsky" – when it starts precisely in one of its three equilibrium positions:

Figure 2: Lorenz's Weather Model in equilibrium

Exciting, isn't it? Now here's how it looks if it starts a tiny distance away from equilibrium:

Figure 3: Lorenz's weather model starting slightly away from equilibrium

Ever heard of "the butterfly effect"? Now you know where the expression comes from. (You can download the program yourself from here, and run this model on it to see it for yourself. Right-click and choose "Save As” if you get XML gobbledygook turning up in your browser instead).

Lorenz's model ushered in the modern study of chaos and complexity, which has revolutionised sciences but completely failed to penetrate economics – because economists continue to believe that they not only can but must model the complex, unstable, far from equilibrium beast that an economy is as if it is actually in equilibrium.

Economists could get away with that drivel before the economic crisis, because it was possible to look at this dynamic, volatile system and see smooth progress along an equilibrium time path. Then the crisis hit, and that smooth upward trend took a sudden roller-coaster turn down. But amazingly, the crisis hasn't stopped them doing precisely the same thing – and still arguing that there is no other way. The blog Unlearning Economics recently uncovered an example of this belief (by French economist Gilles Saint-Paul), and pilloried the article for all it was worth:

"I recently stumbled upon a reddit post called ‘A collection of links every critic of economics should read.‘ One of the weaker links is a defence of economists post-crisis by Gilles Saint-Paul. It doesn't argue that economists actually did a good job foreseeing the crisis; nor does it argue they have made substantial changes since the crisis. It argues that the crisis is irrelevant. It is, frankly, an exercise in confirmation bias and special pleading, and must be fisked in the name of all that is good and holy."

So economists haven't embraced the reality that the economy is a dynamic, far from equilibrium beast. With some notable and honourable exceptions, the majority continue to not only model the economy as if it tends to equilibrium, but continue to assert that there is no other way to model.

That is also drivel. Genuine sciences like engineering and meteorology have developed techniques for modelling general dynamic systems rather than 'general equilibrium'. Even though economics can never achieve their level of precision, there is also no excuse for being so precisely wrong by imposing equilibrium thinking on a dynamic phenomenon.

This is why I am developing a tool for dynamic monetary modelling, which I'm calling "Minsky". The aim is that hopefully, one day, economics will break away from equilibrium and become at least moderately useful, rather than downright dangerous to society.

Not to mention individuals: I had better go now, and take some antacid tablets. You can see why I shouldn't read Gittins. Clearly, at my age, it's bad for my health.

Steve Keen is Professor of Economics & Finance at the University of Western Sydney and author of Debunking Economics and the blog Debtwatch. His Minsky Kickstarter page is here.