What’s Wrong With Modern Macro?

After 15 posts, 17,795 words, and about 9 months, my series of posts on the problems with modern macro is finally complete. If anyone cares, here is the list of all the posts in order.

Part 1: Before Modern Macro – Keynesian Economics

Part 2: The Death of Keynesian Economics: The Lucas Critique, Microfoundations, and Rational Expectations

Part 3: Real Business Cycle and the Birth of DSGE Models

Part 4: How Did a “Measure of our Ignorance” Become the Cause of Business Cycles?

Part 5: Filtering Away All Our Problems

Part 6: The Illusion of Microfoundations I: The Aggregate Production Function

Part 7: The Illusion of Microfoundations II: The Representative Agent

Part 8: Rational Expectations Aren’t so Rational

Part 9: Carrying on the Torch of the Market Socialists

Part 10: All Models are Wrong, Except When We Pretend They Are Right

Part 11: Building on a Broken Foundation

Part 12: Models and Theories

Part 13: No Other Game in Town

Part 14: A Pretense of Knowledge in Macroeconomics

Part 15: Where Do We Go From Here?

If you made it through all of them I’m not sure if I should congratulate you or feel sorry for you, but either way thanks for reading.

Why I’m a Libertarian

In a previous post I noted that libertarian ideas seem to be frequently misunderstood, that libertarians are sometimes labeled selfish, materialistic, and uncaring. In this post I hope to show that a libertarian worldview can come from a more virtuous principle: humility. Note that the title of this post is not “why you should be a libertarian.” I doubt it will convince anybody that is not already highly sympathetic to libertarian ideas, but I hope it can show that that (at least some) libertarians have good intentions. That I may be wrong, but I’m not evil.

A widely cited joke about Ayn Rand’s famous novel Atlas Shrugged goes something like this (I believe the original source was John Rogers here):

“There are two novels that can change a bookish fourteen-year old’s life: The Lord of the Rings and Atlas Shrugged. One is a childish fantasy that often engenders a lifelong obsession with its unbelievable heroes, leading to an emotionally stunted, socially crippled adulthood, unable to deal with the real world. The other, of course, involves orcs.”

It’s a good joke, but I worry that many outside of libertarian circles take its message a bit too seriously. Libertarians live in a fantasy world where everyone shares our ideals and we never think about real issues, about real people. And it is perhaps unfortunate that Rand’s view, one which believes in an objectively correct morality, that aims to tell you that there is a right way to live and she knows it, has been associated so closely with libertarian thought more broadly.

I’m a libertarian because I don’t believe there’s a correct way to live.

Family is the most important part of my life. Others might place a higher weight on different relationships, with their friends, their students, their coworkers. Some may find their strongest bond comes from a higher being, so they let religion or spirituality take precedence over earthly concerns. Another priority could be helping those they don’t know, simply because they are less fortunate or in need of help. Devotion to their jobs, to their hobbies, to the pursuit of knowledge, to any other activity that they find fulfilling – each can also drive a person’s behavior. And of course, pure material pleasures occupy a place on everybody’s scale of value. All of these considerations play a part in deciding the actions that lead to a life worth living.

I’m a libertarian because I don’t want to tell you what’s most important.

A Harvard educated liberal from Massachusetts wants to convince you to support abortion because a woman has a right to her own body. An evangelical Christian from Texas says that killing a fetus is no different than killing a child. Neither can be proven right or wrong. Each wants to impose their values on the other. Drugs are immoral. Alcohol is immoral. Gay marriage is immoral. I disagree and I’ll try to convince anyone that believes otherwise to join my side. But I’ll respect your right to believe what you want as long as you recognize mine.

A person’s moral worth is determined by how much they produce for society. No, it’s determined by what percentage of their wealth they give to charity. Or maybe it’s how much they do for their family. How devout they are in their prayers. Everyone lives by a different code. How comfortable are you in saying that your code is the right one?

I’m a libertarian because you have as much right to your values as I have to mine.

In the 2012 Republican primary debates, the moderators asked Ron Paul if a libertarian society would let a person without insurance die (for the record, he said no). It seems like an easy question – of course we can’t let them die. Let’s ask a harder question. A cancer patient has six months to live. They can extend their life for an additional 5 years, but the procedure costs $5 million in addition to a significant amount of time from doctors who could be working on helping others. They don’t have insurance. Should they be allowed to die? What if they can only extend their life 6 months? 1 day? Where do we draw the line? And who draws it?

Global warming is real. It’s almost certainly caused by humans. It could very well cause catastrophic changes in the future. Our use of fossil fuels could be the source of substantial problems for future generations. But if we stopped using fossil fuels now, we definitely cause substantial problems for the current generation. How can we determine which is worse? How do we weigh the life of an individual against the lives of their descendants?

I’m a libertarian because everything is a tradeoff and I can’t value the costs and benefits.

We all want equality of opportunity. It’s a nice slogan. What does it mean? Some say it means education should be free for everyone – that it’s a basic human right. How much? What kind? Who pays? Some people excel in a standard classroom setup. They love to learn, they can sit down with a book and study. Others can’t. And that’s ok. To think that we can create equality of opportunity by placing everybody in the exact same environment may be pure in its intention, but it’s incredibly dangerous in its execution. We weren’t all created equal and that’s a great thing. Our differences are not something to be squashed out, but embraced.

I’m a libertarian because everybody has different strengths and weaknesses, because everybody has different needs.

Markets always fail. The conditions of perfect competition laid out in a standard economics textbook never hold in reality. Every firm has some monopoly power. Every good causes some externality. Collective action problems, public goods, asymmetric information – all pervasive issues that throw a wrench into the workings of a perfectly competitive economy. Couldn’t a government fix some of these problems? Doesn’t a planner have the ability to take a big picture approach and do what’s best for society instead of what’s best for each individual? It’s possible, but where does the knowledge come from? Where do we set the prices for the monopolist? How high is the optimal tax to prevent the externality? Can we design a mechanism to improve upon the free market outcome? Even in an economic model where everybody has identical preferences and production technologies are fixed the answers are not always clear. In the real world – good luck.

Someone made you king of the world. You want to make it better. So you call in teams of experts, the best from every field. You build supercomputers capable of running an unimaginable number of calculations every second. A coordinated, planned society led by the brightest minds available – how could the chaotic workings of the free market stand any chance? But soon you realize that even the simplest questions – like how much toilet paper to produce – turn out to be nearly impossible to answer. So you give up on your unified plan and try to just fix a few obvious problems. And yet each leak sealed opens up several more – the experts and their fancy computers do their best to predict people’s behavior, but there is simply too much left unknown. Without an overarching plan the ad hoc solutions continue to multiply and the end result is a convoluted, bureaucratic mess.

I’m a libertarian because knowledge is dispersed and I can’t think of a better way of collecting it than through the market process.

Liberty is not magic. It’s not a solution to any of the problems I’ve touched on above. But that’s exactly the point. When the questions facing society are this challenging it would be incredibly arrogant to assume that any one mind or group of minds could divine an appropriate solution. A society of liberty sidesteps these questions entirely. It allows individuals – with their unique perspectives and values, with their knowledge of their own specific time and place – to attempt to find solutions for their own much smaller problems. Most of these attempts fail, but a free market rewards those that work, letting the best rise to the top, creating a better world for all.

Maybe I’m wrong. Maybe individuals making decisions for themselves results in outcomes that are worse for everybody. Maybe governments are better at weighing the total costs and benefits to society than individuals acting on their own. Maybe a coordinated plan can figure out better answers to the questions facing our society than the spontaneous order of a free market. Maybe. And I’m happy to have those debates. But never say that I haven’t thought about these issues. Never say that I’m not worried about poverty, or the environment, or the thousands of other important problems that affect this world every day. Never question my intentions.

And never say that I’m a libertarian because I don’t care.

I’m a libertarian because I don’t know.


It’s Not Your Fault

Note: Although this post is my longest so far, 1500 words is not nearly enough to form a full argument on a topic as big as free will. I’m also not a philosopher so this post is very much outside my area of expertise. I don’t expect the words here to convince anybody, but they are what I believe and I hope they give some idea of the philosophy that drives much of my thinking on economics and politics.

I used to believe in free will. In fact, I hardly considered the idea that there was any other possibility. Success, I thought, was built entirely on making good choices, failure on making poor ones. And perhaps it was because I had been relatively successful that I was so averse to believing those choices came from anything other than my own free will. I chose to work hard, chose to stay out of trouble, chose to be respectful to others. Those choices led to good grades, good relationships, and a good life. Most importantly, those choices were mine.

Nobody can say I’ve never changed my mind.

“I don’t believe in free will.” I don’t remember how the conversation got to that point, but I do remember my feeling of disbelief when I heard a friend say those words at dinner one night in the Umass dining hall. My initial thought was to throw my fork at him, to flip over my plate of food, to do something so unpredictable that he would be forced to admit that the only explanation was that I did it of my own free will. Of course, I didn’t do any of those things. I did spend the next hour arguing with him and several hours after that furiously googling to find evidence that free will was real. What I found instead was that Einstein believed “everything is determined, the beginning as well as the end, by forces over which we have no control” and that neuroscience has offered evidence that free will is nothing but an illusion. The debate over free will vs determinism is complex and has not been settled, but in reading the various arguments, I consistently found myself drawn more to those that opposed free will. It was time to admit I was wrong.

Think about anything you’ve ever done, any choice you’ve ever made. Now try to think about the reason that you made the decision in the way that you did. I can’t think of any action I’ve ever taken that wasn’t fully shaped by my past experiences. For me, free will means that if I could repeat the exact same situation twice, I would make a different choice each time. But why would that be? The choices I make are the ones I believe to be optimal (broadly defined) at any given point in time and what I believe to be optimal can only come from what I have learned in the past. I was lucky enough to be born into a stable family in the richest country in the world. If I were an orphan growing up in inner-city Boston, would I be where I am today? Unlikely. If I were born in Kenya? Not a chance. The opposite thought experiment is also revealing. If somebody else lived through my life in exactly the same way I have until this point, wouldn’t they just be me? Why would they make any choice differently from the ones I make?

Take away all the people you’ve met in your life. Take away all of the books you’ve ever read, all the movies you’ve ever seen, all the websites you’ve ever visited. Take away your genetics. You didn’t have control over any of those things, so they can’t be the result of your free will. But without them, what is left? Are you anything more than everything you have ever experienced? I’m not so sure.

Imagine that you could see your future, not only the one that actually occurs, but every possible future based on every possible action you could ever take. In this case, it should be clear that there is only one set of choices that make sense, the ones that lead to the best life (again defining best in the broadest possible way – I am not saying that people have to be “rational” in the usual economic sense of the word). Adding uncertainty complicates the problem, but it doesn’t change the basic principle. Every decision has to have a reason for being made, regardless of whether that reason is based on a complicated calculation, a simple heuristic, or pure instinct. If I knew everything about you, from your memories to your genetics, from your predictions of the future to your emotional state, I claim that I would have enough information to predict exactly what you would do next because I would be able to observe exactly the thought process that led you to make the decision.

Although determinism seems like a scary idea – your path is already set before you make your choice – the alternative is actually worse. There is only one way out I can see, one hope for “free will,” and that’s pure randomness. Again consider the situation where you live the same life in the exact same way up to a decision point. There are only two options. Either you make the same decision each time, which is then by definition a decision that could be predicted given full information, or you make a different decision given the same circumstances, which means there must be randomness involved. It can’t be randomness like flipping a coin – knowing the speed at which your thumb moves, the air resistance, the weight of the coin, and every other factor means the result is fully determined before the coin lands. Quantum mechanics appears to offer the possibility of true randomness, where only the probabilities of an event can ever be predicted, and some have used this phenomenon as an argument against determinism. But decisions being driven by pure randomness does not really support free will either, at least not in the way most people would think about it. In this version of the story, your path may not be fully determined, but now it’s completely random. Either way, your choices have nothing to do with you.

Now you might be a bit confused. The previous argument is starting to sound something like “you didn’t build that,” a rallying cry for democrats like Obama and Elizabeth Warren to justify taxing the rich. And there is some logic to that connection. If you aren’t the source of your own actions, why should you be responsible for their consequences? Sure, most rich people worked pretty hard to make their money, but even that hard work only came because they had good influences pushing them in the right direction. Other individuals and institutions (yes, even the government) deserve much of the credit for their success and it therefore seems natural to redistribute some of the rewards. So how do I reconcile determinism with libertarianism? Why is my blog dedicated to Hayek rather than Karl Marx?

It’s all about incentives.

If people’s choices are entirely determined by outside forces, then the institutions and laws that define the environment in which they live become especially important. Without free will, taxing the rich is no longer a question of fairness, but without the reward, why should an entrepreneur take the risks required to start a new business? Why should a manager put in the work required to make that business run well? Why should a worker do any more than the bare minimum to avoid getting fired? Conceding that all people had help in achieving success is not an argument against allowing them to keep all of the benefits of that success, because those benefits are themselves one of the most important factors in pushing them to make good decisions.

In other words, I’m not a libertarian because it’s right. I’m a libertarian because it works. Free will doesn’t exist, but acting as if it does ensures that incentives push people to act in ways most would consider desirable.

So why should we care? If we are better off pretending free will exists even if it doesn’t, why bother with this discussion at all? I think it has to do with perspective. Next time somebody does something you disagree with, remember that they come from a very different place than you do. They didn’t have your parents, your teachers, or your friends and therefore they could never have developed the same set of values you have. It doesn’t excuse immoral actions, but it does shift the blame. Rather than hating people that do bad things, rather than strive for vengeance, or for harsh punishments, the goal should always be to change the environment that caused those actions in the first place.

But more importantly, rejecting free will can give you a better perspective on your own life. Every person’s life will be filled with success and failure, and it’s easy to take these results personally, to admire your own achievements and blame yourself for your flaws. These feelings are important – they drive you to become a better person. But I’ve found that recognizing the influence others have had on your life can remind you to never get too high or low. When you succeed, stay humble. And when you fail, remember that it’s not your fault.