A similar thing has already been shown by Steve Keen. First, he shows that if firms optimize by attempting to set the total derivative of profits to zero, they behave like monopolies. Second, he uses a simple model in which firms randomly raise or lower prices, then revert if they lost money, and shows they converge to behaving like monopolies.
He also points out that many fundamental economic principles are flawed, and have been proven to be flawed for years, but economists lack rigor, and would rather live in their "supply meets demand, actors are rational, and the market is in equilibrium" fantasy-land.
Oh, and in about 2006, he warned that there'd be a recession caused by a debt-deflation, just like in 1929. He warned that the government would continually underestimate its impact. He also thinks that the best way to "reset" the system is with a "modern jubilee" - the government engage in massive quantitative easing (which they won't, because they don't realise what's causing the crisis, and how bad it is), and should hand out the free money to tax-payers rather than giving it to banks, as the banks have lost their appetite for risk and won't create new money even if you feed them.
But mainstream economists only study basic calculus, linear algebra, and statistics, not ODEs, and don't believe anything they don't understand. A 50 year old professor (or central banker) isn't going to go back to school and sit in a class with sophomore engineers, just to be able to understand what "complexity theorists" and "econophysists" are talking about, so they just pretend that it doesn't exist. There's no conspiracy, they just don't read or teach anything more mathematically advanced than IS-LM (which is stone age). Their journals don't accept non-mainstream papers for "methodological reasons" (they don't understand basic differential equations), or because it "doesn't sit well with the current theory" (it proves them wrong) and since there's tens of thousands of them they tend to dominate the field.
"... There's no conspiracy, they just don't read or teach anything more mathematically advanced than IS-LM ..."
I aked Steve about this exact problem, [0] the mismatch of decision making using at best questionable economic modelling and the reply was along the lines you suggest. It starts right at University level theory where nobody questions the accepted orthodox theory. What I don't understand is why more mathematicians don't call mainstream economists bluff?
It's basic agency theory - the economists who can't handle complexity take over dumb institutions (like most universities and governments), then insulate themselves against having to learn anything they aren't comfortable with. I guess the smarter ones work for Goldman Sachs, or work in university research departments, writing obscure papers that are never going to be compulsory reading because undergrad economics courses don't require hard-core math.
> ... but economists lack rigor, and would rather live in their "supply meets demand, actors are rational, and the market is in equilibrium" fantasy-land.
No, that's not why economics is in the state it's in. The reason economics is full of theorems that only hold in highly stylized worlds is that economics is hard.
Betrand Roehner provides an insightful classification of problems in the natural and social sciences by their level of complexity.[1] Two-body problems (like most of those in classical mechanics) are the least complex. N-body problems in which the interactions are local and the bodies are homogenous (like many problems in statistical mechanics) occupy the next level. At the third level of complexity are homogenous N-body problems with long-range interactions. And at the fourth level are heterogeneous N-body problems; these include lots of hard problems, like regulation of gene expression, morphogenesis ... and pretty much all interesting problems in economics and the social sciences.
Yes, I just said economics is harder than physics. (Well, it's harder than the physics physicists have been able to figure out so far.) And the difficultly of the problems is compounded by the difficultly of doing experiments in economics and the social sciences; you can't measure and tinker with a self-contained version of society in a lab somewhere. Is it any surprise then that most of economics doesn't really tell us anything directly applicable to the real world?
> ... mainstream economists only study basic calculus, linear algebra, and statistics, not ODEs, and don't believe anything they don't understand. A 50 year old professor (or central banker) isn't going to go back to school and sit in a class with sophomore engineers, just to be able to understand what "complexity theorists" and "econophysists" are talking about, so they just pretend that it doesn't exist. There's no conspiracy, they just don't read or teach anything more mathematically advanced than IS-LM (which is stone age).
You could not be more wrong. Economists, at least those from good programs, have great quantitative training. Pick up any copy of Econometrica if you don't believe me.[2] The mathematical tools used by financial economists, in particular, are largely the same as those used by statistical physicists, which is why so many physics PhDs end up working in finance. (Brownian motion, power-law distributions, etc. were all first described in an economic context.) Informed criticisms of the profession usually comes from the other side, e.g., that top economics journals are full of mathematical fireworks and devoid of reference to the real world.
And IS-LM has not been a part of mainstream macroeconomics since at least the early 1970s. It is still taught in some intro undergrad macro courses (precisely because it requires no mathematical sophistication to understand, I suppose), but it is not a part of the graduate curriculum or a part of the way macroeconomists comprehend the workings of the economy. Your citing it illustrates how little you know of what you speak.[3]
> Yes, I just said economics is harder than physics.
I'm saying that too.
> You could not be more wrong. Economists, at least those from good programs, have great quantitative training.
Which programs? Is this Ivy League PhD, econometrics stream? Or undergrad? First year physics students learn special relativity. They won't learn the advanced stuff until 3rd year, or maybe 4th, but it's still taught.
But most economics students struggle with "econometrics", which is glorified linear algebra. There's theoreticians who do understand complexity, but none of their work is likely to be widely read. There'll be a few ivory tower academics doing really hard stuff, but it doesn't enter the general body of knowledge.
It's like saying that computer programmers don't understand algorithms. Of course some do, and there's research out there if you want to find it, but generally just they kind of know that O(n) is good, and O(2^n) is bad.
And while economists are pretty good at statistics (at least, the good ones are), very few use differential equations. It's not covered in undergraduate classes, and by postgrad classes it's too late.
And while IS-LM is going out of fashion, it's just being replaced with DSGE. I can't see any appendix on differential equations in the TOC of that textbook you mention, is that because everyone already understands them, or because despite the model being called "Dynamic", it's not? I quote Solow, the guy who kind of invented it:
> I do not think that the currently popular DSGE models pass the smell test. They take it for granted that the whole economy can be thought about as if it were a single, consistent person or dynasty carrying out a rationally designed, long-term plan, occasionally disturbed by unexpected shocks, but adapting to them in a rational, consistent way. I do not think that this picture passes the smell test. The protagonists of this idea make a claim to respectability by asserting that it is founded on what we know about microeconomic behavior, but I think that this claim is generally phony. The advocates no doubt believe what they say, but they seem to have stopped sniffing or to have lost their sense of smell altogether.
Yes, economics is hard. Yes, there's smart people working on it. But by the time it filters down to teaching undergraduates or setting policy, the general attitude is "we'll assume rational behavior and a market at equilibrium, so nothing we say is going to be too controversial".
(trollish rant ahead)
I wonder what to ration of neo-classicals to quants is on Wall Street (where people actually have to make the right calls) compared to the Federal Reserve and the Treasury?
It's basic agency theory - the economists who can't handle complexity take over dumb institutions (like most universities and governments), then insulate themselves against having to learn anything they aren't comfortable with.
i realise this is a discussion about economics not finance - but i think this little story sheds some light on this. early into a job on wall street i found that the companies default risk model could be improved (against the 'training'/regression data they had already spent ages cleaning) by adding a neural network that was trained to predict the error in the model.
did they use it? no. why not? because they felt it was important that they fully understand the forces at play that cause the default rates to move in that direction. you could say that they were worried about models overfitting the data - sure, that's kinda it. but the point is the entire nature of the market can change overnight and kind of go into a different state.
so what does that have to do with economics? well i guess maybe some of the same reasoning is at stake - people who think "we're proved wrong so often we need to retreat back to just those few things we can really rely on being true" and are worried about being "too clever" with all this math stuff.
now its true that cargo cult like application of mathematical formula has been (imho) part cause for many truly dreadful economic theories. but still, they are wrong. if you don't understand the nature of far from equilibrium, complex systems, you'll never even begin to understand the forces that drive the economics of the real world.
Current mainstream economic theories underfit like crazy, that's their virtue. The problem is, they aren't based on knowledge of what actually happens, but on either a 19th century armchair philosopher's guess at what happens, or principles which have been chosen in order to create an under-fitting model.
So while they don't overfit, they also are't based on any real knowledge of the system.
It seems the other extreme is elaborate overfitting models.
Steve Keen uses fairly simple models, but tries to base them on actual reality (i.e. broad money is created by the banks, not the government, while Ben Bernanke's explanation of the Great Depression apparently focuses on M0, as he accuses the government of not minting enough coins with the gold they had in reserves, with the implicit assumption that the money would be multiplied if the government would only print it. In reality, the money was not multiplied, because the banks didn't feel like lending.)
He also points out that many fundamental economic principles are flawed, and have been proven to be flawed for years, but economists lack rigor, and would rather live in their "supply meets demand, actors are rational, and the market is in equilibrium" fantasy-land.
Oh, and in about 2006, he warned that there'd be a recession caused by a debt-deflation, just like in 1929. He warned that the government would continually underestimate its impact. He also thinks that the best way to "reset" the system is with a "modern jubilee" - the government engage in massive quantitative easing (which they won't, because they don't realise what's causing the crisis, and how bad it is), and should hand out the free money to tax-payers rather than giving it to banks, as the banks have lost their appetite for risk and won't create new money even if you feed them.
But mainstream economists only study basic calculus, linear algebra, and statistics, not ODEs, and don't believe anything they don't understand. A 50 year old professor (or central banker) isn't going to go back to school and sit in a class with sophomore engineers, just to be able to understand what "complexity theorists" and "econophysists" are talking about, so they just pretend that it doesn't exist. There's no conspiracy, they just don't read or teach anything more mathematically advanced than IS-LM (which is stone age). Their journals don't accept non-mainstream papers for "methodological reasons" (they don't understand basic differential equations), or because it "doesn't sit well with the current theory" (it proves them wrong) and since there's tens of thousands of them they tend to dominate the field.