Thursday, September 3, 2009

Ketchup economists

Paul Krugman has an interesting column in the NYT with the title "How Did Economists Get It So Wrong?" (registration required). There are lots of quotable sentences (silly, absurd, crazy), but the short story is that many economists went wrong because they assumed that people always were rational and the market was efficient. He argues both elegantly and convincingly - and it is well worth a read - but it will not be earth shattering news to those who have followed the debate.

However, buried in the article are also some quotes about economists and their relationship with evidence that deserve to be repeated. First:

But there was something else going on: a general belief that bubbles just don’t happen. What’s striking, when you reread Greenspan’s assurances, is that they weren’t based on evidence — they were based on the a priori assertion that there simply can’t be a bubble in housing.

However, he also writes, more interestingly, that:

To be fair, finance theorists didn’t accept the efficient-market hypothesis merely because it was elegant, convenient and lucrative. They also produced a great deal of statistical evidence, which at first seemed strongly supportive. But this evidence was of an oddly limited form. Finance economists rarely asked the seemingly obvious (though not easily answered) question of whether asset prices made sense given real-world fundamentals like earnings. Instead, they asked only whether asset prices made sense given other asset prices. Larry Summers, now the top economic adviser in the Obama administration, once mocked finance professors with a parable about “ketchup economists” who “have shown that two-quart bottles of ketchup invariably sell for exactly twice as much as one-quart bottles of ketchup,” and conclude from this that the ketchup market is perfectly efficient.

Ketchup economists! The real problem was not that they did not use empirical evidence, but that only a certain type of evidence was admitted. This is different and it raises the question of why only some types of evidence were accepted? Ideology? Ease of quantification?

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