037: Noah Smith on Austrian Theory Being a ‘Bad Joke’, Heterodox Models and Efficient Markets

Noah Smith is Assistant Professor of Finance at Stony Brook University, New York where he is also a member of the Center for Behavioral Finance research team. Noah’s research Interests include Experimental Finance, Behavioral Finance and Macroeconomics Noah was panel discussant for the Institute for New Economic Thinking Task Force and has received numerous research awards and fellowships. 

Noah is a regular contributor to Bloomberg View where he writes extensively on economics and finance related topics. He also writes at his fantastic economics blog Noahpinion.

Noah received his PhD in economics from the University of Michigan, graduating in 2012. His dissertation examined expectation formation in financial markets. Noah majored in physics as an undergraduate at Stanford University, and spent three years working in Japan, where he still returns from time to time to do research.

Everyone who meets in the public sphere, unless you’re extremely dry and technical, is going to piss people off. Econ is one of those fields where everyone has their own opinion and position and their models that they like. Traditionally, it was this very closed discipline. Econ was for economists and they didn’t often interface with the outside world except through official policy advice and the occasional op-ed. People start talking in the public sphere and I think that disturbs a lot of people. So all the blogs are bad boys really – Noah Smith.

Economics:

GDP, inflation, Central Bank, consumption, microeconomics, macroeconomics, behavioral economics, DSGE, game theory, decision theory, supply, demand, time series, interest rates, linear regression, forecasting, Quantitative Easing, money, gold, Federal Reserve, efficient markets hypothesis, extrapolative expectations, hedge funds, adverse selection, random walk, fat tails and volatility.

Economists:

Paul Samuelson, Brad DeLong, Steve Keen, Greg Mankiw, John H. Cochrane, Jack Schwager, Josh Angrist, Steve Pischke, Ed Phelps, Robert Lucas, Ed Prescott, Paul Volcker, Ludwig von Mises, Friedrich Hayek, Hyman Minsky, Andrei Schleifer, Alok Kumar, Kelly Schuh,  Jonathan Burke, Burton Malkiel, Marcus Brunnermeier, Mark Thoma, Tyler Cowen and Alex Tabarrok.

Find out:

• whether economists suffer from ‘Physics Envy’.

• if we should remove mathematics from economics.

• how math took over economics.

• if there is a connection between economics and physics.

• how economics is becoming a more data-driven field.

• about the micro foundations to macro theory and why these models don’t work.

• why theory and math-focused economics papers are waning in the academic publishing field.

• how to approach teaching micro and macro when the theoretical models may not explain much.

• about whether Economics is moving away from the orthodox method of teaching toward a heterodox method.

• about the difference between Heterodox and Orthodox teaching in Economics.

• why Noah considers Austrian Economics to be a bad joke.

• where Noah falls within the economic spectrum.

• why Noah believes that heterodox economics is not the future.

• Noah’s recommended economics blogs to follow.

• why the Efficient Market Hypothesis is a good starting model for finance students to understand.

• and much much more

Physics Envy and the Mathematisation of Economics:

At one point economics was a literary discipline. It was philosophical. It was people writing down verbal description of how they thought things worked. Then people started writing down equations. At first it was just a couple of people doing it who were obscure and then, with Paul Samuelson, they really started putting everything in terms of equations and mathematising everything. It was at that point people started to mention that economists had ‘Physics Envy’ because physicists write everything in equations. Maybe that was true as Samuelson had also studied Physics. This was probably a misnomer.

There were new mathematical tools and people were just trying to apply them to things. Math really took over economics and the style of math they did was sometimes similar to physics. Mathematicians are very rigorous. They start with axioms and they have this really formal proof structure. A physicists approach to working with equations is a lot more ad hoc and informal. So in economics, you see both styles. Noah doesn’t think there’s a lot of connection between economics and physics. He also doesn’t believe there is any particular pieces of math in economics that were inspired by physics.

Math helps you organise your thoughts. It makes your economic theory more internally consistent because math always has to work out perfectly and all the logic has to work out. But in practice it rarely does that. What usually happens is that people usually end up sticking in the assumptions they need to get the conclusions they want to see in the theories. So there’s essentially no discipline provided by math on theory, but math is useful when you want to get actual numbers.

Economics is becoming a more and more data-driven field. Now that we have information technology, we have so much data. We have macro data and industry-level data that we can keep track of with electronic records. Government can easily keep track of statistics on all kinds of variables on the economy. We have a lot more financial data. It is easier to get people surveyed so you have a lot more survey data. So you have huge amounts of data that is easily transferable and easily manipulatable in statistics programs. Economists are basically rolling in data. What we’ve seen from that is that data and empirics has become so much central  to the economics field in recent years. The number of published papers that are data and empiric-focused has soared, whereas the percent that is just theory and math-focused has gone down in the last twenty years.

On Teaching Micro and Macro When Theoretical Models Fail:

Economics is not data-free. You can use data to help you teach. But in terms of giving students a hands-on thing where they can predict some outcome something, well for lower-level students, there’s not much you can do. But for upper-level students there are some things you can do with linear regression that help you make a prediction or forecast. Certainly with graduate-level students you can do things with time series econometrics. Then you can have them make forecasts and see how well their forecasts come out. There’s things you can do but it doesn’t work as beautifully as it does in Physics – Noah Smith

Noah Smith on Why He Considers Austrian Economics to be a Bad Joke and Why Heterodox Economics is Not the Future:

The idea that economics is substantially divided between the orthodox and the heterodox is wrong. That’s just not the way it is. There’s only a very few people in the world who call themselves heterodox. For any science you’re going to get some people somewhere who are doing something totally different. There’s probably somebody out there using physics models that look nothing like quantum mechanics or Newton’s Laws or any of the core physics models we think of as real physics. There’s probably someone out there doing some model of a type you and I never heard of and will never hear of. And that’s basically what the heterodox economics guys are.

The people who call themselves heterodox in economics, include some people who are nakedly political. All they really are is political, well I could say hacks but they’re not paid by parties, but they’re trying to make economics into a politicised discipline. So, the most prominent group of these is people who call themselves Austrians.

There were these guys, called the Austrians, who wrote some ideas down. All of those ideas were later taken up by the mathematical economists and put into math language. Most were tested in some way. They were developed further on. But then what happened was there was a tribe of people who declared that all the mathematical economics was bullshit and that what we had to do was pay attention to the wisdom of the ‘Old Masters’. So they spend a lot of time reading the old wisdom of Mises and Hayek and those guys. And the only way this group could survive when economics itself had moved on was to take donations from political people who agree with their politics.

So they politicise themselves in order to survive. And in the wilderness where they deserve to be, their method of analysis they use are a joke. A lot of mainstream normal economics might also be a joke but the Austrian stuff is definitely a joke. And the problem is with the addition of politics to the mix, it really becomes a bad joke.

Most of what they do is advocating through their version of free markets or advocating for various conservative policies and politics. And that’s what they spend most of their time doing. It’s clear that what they really want to do is just turn economics into a mouthpiece for conservative ideas.

I haven’t spent hundreds of hours reading Mises because that would be robbing me of many many valuable hours of my life-span and I’m mortal and my life-span is ticking away and I can’t spend my time reading Mises. I’ve read a little bit. It was obviously silly. It was like reading Jacques Derrida.

It’s so dense and confusing and self-referential and full of neologisms and just, frankly, badly written that what it descends into this infinite recursion where you have people who read the ‘Old Master’ and write some interpretation of the ‘Old Master’ and then someone reads what that person wrote and mis-interprets that and then writes their own interpretation of that. Then you just have this infinite recurring commentary where nobody really knows what the hell anyone else is talking about and they all just sort of talk about their own distorted, twisted perception of what these other people talk about. It gives no insight and no understanding. People ‘parrot’ the words of the ‘Old Masters’ without understanding what the ‘Old Masters ‘ were necessarily meant or what those ideas would even imply.

If you criticise the ‘Old Masters’ or criticise this paradigm of relying on the ‘Old Masters’, They say “Oh, you have to go read everything the ‘Old Masters’ wrote before you are qualified to comment on this. How dare you comment on this when you haven’t read this and this and this. I’ve spent time reading this.” What do you say to that. That’s not scientific. That’s scholastic.

Sometimes you look at Minsky and you look at Hayek and you say these guys aren’t saying such different things after all actually. But the thing is you have the right-wingers in the modern day who think that Hayek and Mises are gods and left-wing guys who think Minsky is a god and they fight like cats and dogs.

The mere fact of these kind of battles is one thing that convinces me that so-called heterodox economics is not the future at all.

Austrians have a lot of blogs. They have a big mouth-piece; much bigger than their academic footprint. Austrians took a huge hit in 2011 and 2012. Those are absolute critical years for this sort of ‘pop-Austrianism’ that has become very popular on sites like zerohedge. All the Austrians are saying is the Fed is printing all this money doing Quantitative Easing. There’s going to be big inflation. And this never happened. That was like a thunderbolt that really discredited Austrians. They were saying things were going to happen by gold now. There was a gold bubble and gold is quite a bit off its peak. A lot of people lost some of their savings on that. People are not happy to lose their savings. If you bought gold collectibles in 2011, well you were a sad puppy when it crashed. That’s God’s punishment. That’s the market’s punishment anyway. It’s the markets punishment for making bets on silliness.

Where does Noah Fall within the Economic Spectrum:

I really don’t know. I suspect something that would look like demand is responsible for most recessions. And I suspect something that they call a limit cycle is going on where something in a boom actually causes a bust to become more likely. So booms lead to busts. Austrians said that, absolutely. The ‘Old Masters’ definitely said that and Minsky said that too – Noah Smith

Recommended Blogs:

• Economists’ View by Mark Thoma
• Marginal Revolution by Tyler Cowen and Alex Tabarrok
• Grasping Reality by Brad DeLong

Recommended Book:

• The Myth of the Rational Market by Justin Fox

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