Jan Tinbergen: pioneer of economic modeling

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Jan Tinbergen (1903-1994) is an influential economist known for building economic models and helping pioneer econometrics. He was also the recipient of the first Nobel Prize in Economics in 1969. The Concise Encyclopedia of Economics says,

"Along with Frisch and others Tinbergen developed the field of econometrics, the use of statistical tools to test economic hypotheses. Tinbergen was one of the first economists to create multiequation models of economies. He produced a twenty-seven-equation econometric model of the Dutch economy, and his 1939 book, Business Cycles in the United States, 1919–1932, includes a forty-eight-equation model of the American economy that explains investment activity and models American business cycles."

John Maynard Keynes questions the usefulness of Tinbergen's economic modeling,

"[Tinbergen's] method is neither of discovery nor of criticism. It is a means of giving quantitative precision to what, in qualitative terms, we know already as the result of a complete theoretical analysis." (Tinbergen's work: Change and continuity by Kol and Wolffe)

Keynes also said,

"No one could be more frank, more painstaking, more free from subjective bias or parti pris than professor Tinbergen... But Newton, Boyle and Locke all played with alchemy. So let him continue." (Tinbergen's work: Change and continuity by Kol and Wolffe)

The rest of this post is some quotes from Tinbergen.

How to build an economic model

"First of all I want to remind you of the essential features of models. In my opinion they are: (i) drawing up a list of the variables to be considered; (ii) drawing up a list of the equations or relations the variables have to obey and (iii) testing the validity of the equations, which implies the estimation of their coefficients, if any. As a consequence of especially (iii) we may have to revise (i) and (ii) so as to arrive at a satisfactory degree of realism of the theory embodied in the model." (The Use of Models: Experience, 1969)

Mathematical economics

"Models constitute a framework or a skeleton and the flesh and blood will have to be added by a lot of common sense and knowledge of details." (The Use of Models: Experience, 1969)

"As a boundary science, econometrics is younger than the adjacent regions, which fact likewise has advantages and disadvantages. As a disadvantage, the lack of an established doctrine, and also the lack of established textbooks, can be felt; as an advantage is the fresh enthusiasm, with which its students work." (Econometrics, 1951)

Support for a world government

"Mankind’s problems can no longer be solved by national governments. What is needed is a World Government. This can best be achieved by strengthening the United Nations system." (Human Development Report 1994 by the United Nations)

"Some of the most important new institutions would be financial- a World Treasury and a World Central Bank. Just as each nation has a system of income redistribution, so there should be a corresponding ‘World Financial Policy’ to be implemented by the World Bank and the World Central Bank." (Human Development Report 1994 by the United Nations)

Ragnar Frisch's critique of macro econometrics

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Ragnar Frisch (1895-1973) was an influential economist and is sometimes regarded as the father of econometrics. Frisch helped establish the Econometrics Society in 1930 and the economic journal Econometrica in 1933. He also received the first Nobel Prize in Economics in 1969. Wikipedia says,

"[Frisch] made a number of significant advances in the field of economics and coined a number of new words including econometrics and macroeconomics. His 1926 paper on consumer theory helped set up Neo-Walrasian research." (Wikipedia: Ragnar Frisch, 8.12.21 UTC 22:44)

The rest of this post is some quotes from Frisch.

What is econometrics?

"Econometrics has as its aim to subject abstract laws of theoretical political economy or 'pure' economics to experimental and numerical verification, and thus to turn pure economics, as far as possible, into a science in the strict sense of the word." (On a Problem in Pure Eco­nomics, 1926)

"I believe that economic theory has arrived at a point in its development where the appeal to quantitative empirical data has become more necessary than ever. At the same time its analyses have reached a degree of complexity that require the application of a more refined scientific method than that employed by the classical economists." (Quoted in Ragnar Frisch 1895-1995 by O. Bjerkholt)

Is macroeconomics unpredictable?

"The majority of the economic oscillations which we encounter seem to be explained most plausibly as free oscillations." (Propagation problems and impulse problems in dynamic economics, 1933)

"Deep in the human nature there is an almost irresistible tendency to concentrate physical and mental energy on attempts at solving problems that seem to be unsolvable." (From Utopian Theory to Practical Applications, 1970)

"Questions of convergence under an infinite time horizon will depend so much on epsilontic refinements in the system of assumptions - and on the infinite constancy of these refinements - that we are humanly speaking absolutely certain of getting infinite time horizon results which have no relevance to concrete reality. And in particular we are absolutely certain of getting irrelevant results if such epsilontic exercises are made under the assumption of a constant technology." (Econometrics in the World of Today, 1970)

What is bad econometrics?

"In this feverish world of ours, where one wants the economic analyses to produce easily understandable results quickly and at the least possible cost, some of us have fallen into the habit of assuming for simplicity that the hundreds sometimes thousands of variables that enter into the analyses are linked together by very simple relationships." (Theory of Production, 1964)

"I have insisted that econometrics must have relevance to concrete realities, otherwise it degenerates into something which is not worthy of the name econometrics, but ought rather to be called playometrics." (Quoted in The Concise Encyclopedia of Economics)

"We may perhaps start by throwing all kinds of production into one variable, all consumption into another, and so on, imagining that the notions 'production', 'consumption', and so on, can be measured by some sort of total indices. At present certain examples of micro-dynamic analyses have been worked out, but as far as I know no determinate macro-dynamic analysis is yet to be found in the literature." (Propagation problems and impulse problems in dynamic economics, 1933)

Support for General Equilibrium models

"An important object of the Journal should be the publication of papers dealing with attempts at statistical verification of the laws of economic theory, and further the publication of papers dealing with the purely abstract problems of quantitative economics, such as problems in the quantitative definition of the fundamental concepts of economics and problems in the theory of economic equilibrium. The term equilibrium theory is here interpreted as including both the classical equilibrium theory proceeding on the lines of Walras, Pareto, and Marshall, and the more general equilibrium theory which is now beginning to grow out of the classical equilibrium theory, partly through the influence of the modern study of economic statistics." (A Dynamic Approach to Economic Theory, 1927)

Milton Friedman and free markets

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Milton Friedman (1912-2006) was a famous economist best known for his support of free markets and libertarian views. He is also famous for his analysis of monetary policy. Friedman is arguably the most influential economist of the 20th century. Economist Paul Krugman said,

"Milton Friedman may well be the world's best-known economist. He has turned his unprepossessing stature and manner into a trademark persona; a feisty conservative David battling the Goliath of Big Government. But his influence is not merely a matter of skill at propaganda. It rests on the long campaign that he waged against the ideas of Keynesian economics, a campaign that eventually bore fruit in radical changes in both economic ideology and real-world economic policy." (Peddling Prosperity, 1994)

Former Chairman of the Federal Reserve Alan Greenspan said,

"His views have had as much, if not more, impact on the way we think about monetary policy and many other important economic issues as those of any person in the last half of the twentieth century." (Federal Reserve Board Speech, 1997)

The rest of this post is some quotes from Friedman.

What should the government provide?

"We need government to enforce the rules of the game. By prosecuting anti-trust violations, for instance. We need a government to maintain a system of courts that will uphold contracts and rule on compensation for damages. We need a government to ensure the safety of its citizens–to provide police protection." (Playboy Interview with Milton Friedman, 1973)

"The proper role of government is exactly what John Stuart Mill said in the middle of the 19th century in On Liberty. The proper role of government is to prevent other people from harming an individual." (America's Drug Forum Interview, 1991)

Taxation

"I am in favor of cutting taxes under any circumstances and for any excuse, for any reason, whenever it's possible... because I believe the big problem is not taxes, the big problem is spending. I believe our government is too large and intrusive, that we do not get our money's worth..." (Quoted in Conservatives Betrayed, 2006)

"If I spend somebody else’s money on somebody else, I’m not concerned about how much it is, and I’m not concerned about what I get. And that’s government." (Interview on Fox News, 2004)

"What are the least bad taxes? In my opinion the least bad tax is the property tax on the unimproved value of land, the Henry George argument of many, many years ago." (Quoted in The Times Herald, Norristown, Pennsylvania, 1978)

Free markets

"The only effective cure is to reduce the scope of government - get government out of the business." (YouTube: Big Business, Big Government)

"The unions might be good for the people who are in the unions but it doesn't do a thing for the people who are unemployed. Because the union keeps down the number of jobs, it doesn't do a thing for them." (Interview with Brian Lamb, 2000)

"The price system works so well, so efficiently, that we are not aware of it most of the time. We never realize how well it functions until it is prevented from functioning, and even then we seldom recognize the source of the trouble." (Free to Choose, 1980)

Monetary policy

"Inflation is always and everywhere a monetary phenomenon in the sense that it is and can be produced only by a more rapid increase in the quantity of money than in output." (The Counter-Revolution in Monetary Theory, 1970)

"I know of no severe depression, in any country or any time, that was not accompanied by a sharp decline in the stock of money and equally of no sharp decline in the stock of money that was not accompanied by a severe depression." (Money Masters, 1995)

"The Federal Reserve definitely caused the Great Depression by contracting the amount of money in circulation by one-third from 1929 to 1933." (National Public Radio Interview, 1995)

"The use of quantity of money as a target has not been a success. I'm not sure that I would as of today push it as hard as I once did." (Quoted in the Financial Times, 2003)

"Over short periods, the relation between growth in money and growth in nominal income is often hard to see." (Money Mischief, 1992)

Libertarianism

"The problem in this world is to avoid concentration of power - we must have a dispersion of power." (YouTube: Big Business, Big Government)

"I say thank God for government waste. If government is doing bad things, it's only the waste that prevents the harm from being greater." (Interview with Richard Heffner on The Open Mind , 1975)

"Governments never learn. Only people learn." (The Cynic's Lexicon : A Dictionary Of Amoral Advice‎, 1984)

"Society doesn't have values. People have values." (Free to Choose television series, 1980)

"Because we live in a largely free society, we tend to forget how limited is the span of time and the part of the globe for which there has ever been anything like political freedom: the typical state of mankind is tyranny, servitude, and misery." (Capitalism and Freedom, 1962)

Economic theories

"If we are to use effectively these abstract models and this descriptive material, we must have a comparable exploration of the criteria for determining what abstract model it is best to use for particular kinds of problems, what entities in the abstract model are to be identified with what observable entities, and what features of the problem or of the circumstances have the greatest effect on the accuracy of the predictions yielded by a particular model or theory." (The Methodology of Positive Economics, 1953)

"The construction of hypotheses is a creative act of inspiration, intuition, invention; its essence is the vision of something new in familiar material. The process must be discussed in psychological, not logical, categories; studied in autobiographies and biographies, not treatises on scientific method; and promoted by maxim and example, not syllogism or theorem." (The Methodology of Positive Economics, 1953)

Thomas Robert Malthus and the population problem

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Thomas Robert Malthus (1766-1834) is a famous economist best known his analysis of the population problem. Malthus believed that population naturally increases faster than economic production, therefore human living conditions cannot improve in the long run. Wikipedia says,

"In his 1798 book, An Essay on the Principle of Population, Malthus observed that an increase in a nations's food production improve the well-being of the populace, but the improvement was temporary because it led to population growth, which in turn restored the original per capita production level." (Wikipedia: Robert Thomas Malthus, 8.4.21 UTC 13:52)

The rest of this post is some quotes from Malthus.

Population problem

"Population, when unchecked, increases in a geometrical ratio, Subsistence, increases only in an arithmetical ratio." (An Essay on the Principle of Population, 1798)

"The perpetual tendency of the race of man to increase beyond the means of subsistence is one of the general laws of animated nature, which we can have no reason to expect to change." (An Essay on the Principle of Population, 1798)

Support for government spending

"When Hume and Adam Smith prophesied that a little increase of national debt beyond the then amount of it, would probably occasion bankruptcy; the main cause of their error was the natural one, of not being able to see the vast increase of productive power to which the nation would subsequently obtain." (An Essay on the Principle of Population 2nd Edition, 1836)

"The employment of the poor in roads and public works, and a tendency among landlords and persons of property to build, to improve and beautify their grounds, and to employ workmen and menial servants, are the means most within our power and most directly calculated to remedy the evils arising from that disturbance in the balance of produce and consumption." (An Essay on the Principle of Population 2nd Edition, 1836)

Against the Poor Laws

"To remedy the frequent distresses of the common people, the poor laws of England have been instituted; but it is to be feared that though they may have alleviated a little the intensity of individual misfortune, they have spread the general evil over a much larger surface." (An Essay on the Principle of Population, 1798)

"The laboring poor, to use a vulgar expression, seem always to live from hand to mouth. Their present wants employ their whole attention, and they seldom think of the future. Even when they have an opportunity of saving they seldom exercise it, but all that is beyond their present necessities goes, generally speaking, to the ale house." (An Essay on the Principle of Population, 1798)

What is political economy?

"The science of political economy is essentially practical, and applicable to the common business of human life. There are few branches of human knowledge where false views may do more harm, or just views more good." (An Essay on the Principle of Population 2nd Edition, 1836)

"It has been said, and perhaps with truth, that the conclusions of Political Economy partake more of the certainty of the stricter sciences than those of most of the other branches of human knowledge." (An Essay on the Principle of Population 2nd Edition, 1836)

Philosophy of science

"It is an acknowledged truth in philosophy that a just theory will always be confirmed by experiment." (An Essay on the Principle of Population, 1798)

"To minds of a certain cast there is nothing so captivating as simplification and generalization. (An Essay on the Principle of Population 2nd Edition, 1836)

"The finest minds seem to be formed rather by efforts at original thinking, by endeavors to form new combinations, and to discover new truths, than by passively receiving the impressions of other men's ideas." (An Essay on the Principle of Population, 1798 revised 1826)

"The first business of philosophy is to account for things as they are; and till our theories will do this, they ought not to be the ground of any practical conclusion." (An Essay on the Principle of Population 2nd Edition, 1836)

How to predict a financial crisis

I believe economists would benefit from reading The Big Short by Michael Lewis. The book describes the story of how hedge fund manager Michael Burry was able to predict the subprime mortgage financial crisis long before anyone else, while mainstream economists and institutions were largely blind to it. In 2013, Nobel prize recipient economist, Lars Peter Hansen said,

"I believe that the recent financial crisis exposed gaps in our knowledge... [Central banks] have a mandate to monitor systemic risk, but we don't have great trustworthy models to do precisely that." (Interview with Nobel Laureate Lars Hansen, 2013)

If economists are interested in identifying the next financial crisis, I believe they should take note of Burry's research style. I'm not saying this style is right for all economists, but I believe this type of research would be useful for predicting a financial crisis. The rest of this post is a collection of quotes from the book describing Burry's research style.

Analyzing subprime mortgage prospectuses

"In early 2004 another stock market investor, Michael Burry immersed himself for the first time in the bond market... He just sat alone in his office, in San Jose, California and read books and articles and financial filings. He wanted to know, especially how subprime mortgage bonds worked." (The Big Short, 2010)

"He read dozens of prospectuses and scoured hundreds more, looking for the dodgiest pools of mortgages, and was still pretty certain even then (and dead certain later) that he was the only human being on earth who read them, apart from the lawyers who drafted them." (The Big Short, 2010)

"He analyzed the relative importance of the loan-to-value ratios of the home loans, of second liens on the homes, of the location of the homes, of the absence of loan documentation and proof of income of the borrower, and a dozen or so other factors to determine the likelihood that a home loan made in America circa 2005 would go bad." (The Big Short, 2010)

Michael Burry the analyst

"Burry had a gift for finding and analyzing information on the subjects that interested him intensely." (The Big Short, 2010)

"Burry said, 'I have always believed that a single talented analyst, working very hard, can cover an amazing amount of investment landscape, and this belief remains unchallenged in my mind.'" (The Big Short, 2010)

"Burry said, 'I was in a state of perpetual disbelief. I would have thought that someone would have recognized what was coming before June 2007. If it really took that June remit data to cause a sudden realization, well, it makes me wonder what a 'Wall Street analyst' really does all day.'" (The Big Short, 2010)

Paul Krugman and economic theories

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Paul Krugman is an influential economist best known for his contributions to trade theory and his support for liberal economic policies. Economist Paul Samuelson said,

"I am proud of my generation of policy economists. You know their names: Walter Heller, Milton Friedman, John Kenneth Galbraith, Arthur Okun, Herbert Stein, Peter Drucker, and many more. But, as some sage has said, science progresses funeral by funeral. Paul Krugman is the rising star of this century and the next, and the world beats a path to his door." (Forward to Krugman's The Age of Diminished Expectations, 1990)

The rest of this post is some quotes from Krugman.

Critique of mainstream economics

"As I see it, the economics profession went astray because economists, as a group, mistook beauty, clad in impressive-looking mathematics, for truth." (How Did Economists Get It So Wrong? 2009)

"Few economists saw our current crisis coming, but this predictive failure was the least of the field’s problems. More important was the profession’s blindness to the very possibility of catastrophic failures in a market economy." (How Did Economists Get It So Wrong? 2009)

"We’re living in a Dark Age of macroeconomics. Remember, what defined the Dark Ages wasn’t the fact that they were primitive — the Bronze Age was primitive, too. What made the Dark Ages dark was the fact that so much knowledge had been lost, that so much known to the Greeks and Romans had been forgotten by the barbarian kingdoms that followed." (A Dark Age of Macroeconomics, 2009)

"When it comes to the all-too-human problem of recessions and depressions, economists need to abandon the neat but wrong solution of assuming that everyone is rational and markets work perfectly." (Economics 4th edition, 2015)

"Economics is harder than physics; luckily it is not quite as hard as sociology." (Peddling Prosperity, 1994)

Support for formal economic analysis

"I do not mean to say that formal economic analysis is worthless, and that anybody's opinion on economic matters is as good as anyone else's. On the contrary! I am a strong believer in the importance of models, which are to our minds what spear-throwers were to stone age arms: they greatly extend the power and range of our insight." (How I Work, 1993)

"Many of the stories economists tell take the form of models—for whatever else they are, economic models are stories about how the world works." (Economics 4th edition, 2015)

How to make a good economic theory

"Here, then, is a revised version of Marshall's rules: (1) Figure out what you think about an issue, working back and forth among verbal intuition, evidence, and as much math as you need. (2) Stay with it till you are done. (3) Publish the intuition, the math, and the evidence - all three - in an economics journal. (4) But also try to find a way of expressing the idea without the formal apparatus. (5) If you can, publish that where it can do the world some good." (Two Cheers for Formalism, 1998)

"The strategy is: always try to express your ideas in the simplest possible model. The act of stripping down to this minimalist model will force you to get to the essence of what you are trying to say (and will also make obvious to you those situations in which you actually have nothing to say). And this minimalist model will then be easy to explain to other economists as well." (How I Work, 1993)

"If you want a simple model for predicting the unemployment rate in the United States over the next few years, here it is: It will be what Greenspan wants it to be, plus or minus a random error reflecting the fact that he is not quite God." (What should trade negotiators negotiate about? 1997)

William Stanley Jevons and the calculus of pleasure and pain

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William Stanley Jevons (1835-1882) was an English economist best known for utility theory and promoting mathematical economics. As a major figure in the marginal revolution, Jevons helped lay the foundations for utility analysis in economics which is still used today in neoclassical economics. Wikipedia says,

"[Jevons] made the case that economics as a science concerned with quantities is necessarily mathematical. In so doing, it expounded upon the 'final' (marginal) utility theory of value. Jevon's work, along with similar discoveries made by Carl Menger (1871) in Vienna and by Leon Walras (1874), marked the opening of a new period in the history of economic thought." (Wikipedia: William Stanley Jevons, 7.12.21 UTC 23:23)

The rest of this post is some quotes from William Stanley Jevons.

Support for mathematical economics

"It is clear that economics, if it is to be a science at all, must be a mathematical science." (The Theory of Political Economy, 1871)

"You will perceive that economy, scientifically speaking, is a very contracted science; it is in fact a sort of vague mathematics which calculates the causes and effects of man's industry, and shows how it may be best applied." (Letter to Henrietta Jevons, 1858)

Calculus of pleasure and pain

"In this work I have attempted to treat economy as a calculus of pleasure and pain, and have sketched out, almost irrespective of previous opinions, the form which the science, as it seems to me, must ultimately take." (The Theory of Political Economy, 1871)

"Pleasure and pain are undoubtedly the ultimate objects of the calculus of economics. To satisfy our wants to the utmost with the least effort - to procure the greatest amount of what is desirable at the expense of the least that is undesirable - in other words, to maximize pleasure, is the problem of economics." (The Theory of Political Economy, 1871)

"My principal work now lies in tracing out the exact nature and conditions of utility. It seems strange indeed that economists have not bestowed more minute attention on a subject which doubtless furnishes the true key to the problems of economics." (The Theory of Political Economy, 1871)

"Repeated reflection and inquiry have led me to the somewhat novel opinion, that value depends entirely upon utility." (The Theory of Political Economy, 1871)

Critique of classical economics

"The conclusion to which I am ever more clearly coming is that the only hope of attaining a true system of economics is to fling aside, once and forever, the mazy and preposterous assumptions of the Ricardian school. Our English economists have been living in a fool's paradise." (The Theory of Political Economy, 1871)

"I protest against deference to any man, whether John Stuart Mill, or Adam Smith, or Aristotle, being allowed to check inquiry. Our science has become far too much a stagnant one, in which opinions rather than experience and reason are appealed to." (The Theory of Political Economy, 1871)

"Among minor alterations, I may mention the substitution for the name political economy of the single convenient term economics. I cannot help thinking that it would be well to discard, as quickly as possible, the old troublesome double-worded name of our science." (The Theory of Political Economy, 1871)