Who’s the Boss? On the Usefulness of Economics

MM: Baron Byron, I know that we economists follow the Queen of Social Sciences and are extraordinarily smart when compared to… you know whom. Are we sometimes too smart for our own good? The other day, I spoke with a fellow economist about the shortage of servers in restaurants in my city. He said the solution was simple and that they should raise the wages. Is that simple? Why didn’t the restaurant owners do that already? Don’t economists always assume that people maximize utility given the constraint? What is the point of economists being smart ass and telling people to do this or that?

BB: Master Ming, I have something similar going on in my little town too. As an economist who is a bit more humble (or timid), I try not to tell people what to do but try rather to understand what is going on. Things happen for a reason, and there must be something behind restaurants looking for workers. Similarly, we do see people line up for food at restaurants. Why don’t they just raise the price then?

MM: There are variables besides prices, and constraints in the real world are never obvious. The good restaurants I know only hire good servers. Bad servers give managers headache and the restaurants bad reputation.

BB: And business owners know a lot more about those constraints than we do.

MM: Really? (Mouth opened in shock!) So how useful are we? John Muth, who inspired Robert Lucas and the school of rational expectation, said that businesses must be operating with a model as good as those developed by economists, or else they would have hired a lot of economists! For many years, economists mostly work at the governments, central banks, and think tanks.

BB: Businesses need to know more than economists or they would not have survived! The fact that some businesses exist mean that they are doing something right, by accident or not.

MM: But things are changing. The tech industry has begun to fall in love with economists. Take Uber for example.

BB: Now the world has changed! They are all over the place at tech companies.

MM: What is your take? Why were economists not used by the private sector until the last couple of years? Have we become “smarter” than businesses? Or do businesses get “smarter” and know how to use economists?

BB: I still think economists are hired not because they know how to do business. Economists are useful as they know how to work with data, lots and lots of data. They are able to identify patterns, and such businesses gain by exploiting these patterns. Those restaurants you mentioned earlier probably do not have much data to exploit.

MM: You mean economists are more like accountants in the big data era? Accountants do not run businesses, but businesses need accountants. Accountants can be inventive with numbers on a balance sheet; economists can be inventive with numbers on a spreadsheet.

BB: Yeah, so try not to say you do econometrics, and say that you use machine learning to work with big data!

MM: With big data, the traditional foundation of statistics is shaken. William Gosset’s problem was a small sample problem. Now tech firms have close to the universe of data. What’s more? They can do immediate experiment with tweaking the prices, etc. in real time.

BB: Yes, and there are economies of scale here. More customers mean more data, and more data mean more reliable understanding. More customers also mean more room for experiment as you mentioned.

MM: In other words, it’s not that the superior intelligence of economists is finally appreciated. Rather, just like most interesting economic phenomena: a matter of chance!

MMT 101

BB: Hey, have you heard of this thing called MMT? It’s all over the media. Is it something important that we need to know about?

MM: I have never heard of this idea until recently. Isn’t the economic adviser of Bernie Sanders, Stephanie Kelton, an advocate? It’s a strange time. Both inflation and unemployment rates are low; it’s debatable whether the Fed is doing their job well, or that something else is at work. Somehow from both the left and the right people think the Fed can do more for whatever.

BB: From the left, I guess the consensus is that the government can spend more to achieve some social goals. Reducing inequality, protecting the environment, or something along that line. It is where MMT fits in: from what I have read so far, MMT is all about not needing to worry too much about government debt. Since the federal government is the only entity that can print money, and debt is written in terms of that printed money, the government can always just print its way out.

MM: Then, what is their principle for monetary policy? I am not one who likes to cry “Inflation! Inflation!”, but it does sound like advocating seigniorage to me. Am I missing something?

BB: First of all, monetary policy will play a secondary role. It is only there to print money out for whatever the government sees fit to spend. If there is a bit too much inflation, the government can again step in and do the opposite: increase taxes to “soak up” the extra money out there. Fiscal policy will have a really big role to play!

MM: This reminds me of a paper by William Poole on how certain monetary policy instrument can accommodate certain type (IS or LM) of shocks. If fiscal policy takes the lead, monetary policy will act accordingly. I suppose MMT assumes a fluid mechanism to adjust the tax rate? But how does it work since federal income tax returns are filed once a year?

BB: Just tax the rich? I am not sure about what new taxes the MMT supporters are thinking of, or just how frequently the tax rates are changed. It seems that MMT is placing a lot of faith on the flexibility of fiscal policy.

MM: Mainstream macro theory is accused of turning a blind eye on the financial market. MMT does not seem to deal with that issue while at the same time undermining the role of monetary policy. By the way, why don’t they call it MFT since the M for money is not that important?

BB: No idea. Actually, I am not 100% true if what we just talked about is the true MMT. There is no “official” model for MMT and we just have to read here and there for bits of ideas.

MM: Oh yeah, Noah Smith talked about that. I don’t think a formal model is always necessary, though I wary about anything that is too good to be true.

BB: By the way, is there empirical evidence on this? I only know about countries that spent and printed themselves to disasters.

MM: The United States had high inflation in the 70s, but nothing at the par of Zimbabwe in 2015 or the current Venezuela… OK, I have changed my mind, I am going to buy gold now.

BB: Gold … now you are getting into another myth that I have a hard time understanding. Let’s deal with that another time!

We all want to sleep on a pile of gold.