Economists could calculate error bars that would say how closely the calculated aggregate figures approximate their exact values according to definitions. This is normally not done, and as Morgenstern noted in the book discussed elsewhere in the thread, the results would be quite embarrassing, since they’d show that economists regularly talk about changes in the second, third, or even fourth significant digit of numbers whose error bars are well into double-digit percentages.
However, when it comes to the more essential point I’ve been making, error bars wouldn’t make any sense, since the problem is that there is no true value out there in the first place, just different arbitrary conventions that yield different results, neither of which is more “true” than the others.
Economists could calculate error bars that would say how closely the aggregate figures approximate the exact value as defined. This is normally not done, and as Morgenstern noted in the book discussed elsewhere in the thread, the results would be quite embarrassing, since they’d show that economists regularly talk about changes in the second, third, or even fourth significant digit of numbers whose error bars are well into double-digit percentages.
There’s an old joke: “How can you tell macroeconomists have a sense of humour? They use decimal points.” I’ll admit spurious precision is a problem with a quite a bit of economic reporting. Remember that these statistics are produced by governments, not academics and politicians can have trouble grokking error bars.
the problem is that there is no true value out there in the first place, just different arbitrary conventions that yield different results, neither of which is more “true” than the others.
Actually, that’s not really the case. There is an ideal, it’s just you can’t do it. If you knew everyone’s preferences and information and endowments of income, you could work out how people’s consumption would change as real incomes and relative prices changed so you could figure out what the right basket of goods is to use for the index at every point in time (the right bundle is whatever bundle consumers would actually pick in a given situation).
But in practice you can’t get the information you’d need to do this, and that information would be constantly changing anyway. In practice what statistical agencies do is develop a basket of goods based on current consumption and review it every decade or so. This means the index overestimates inflation (the estimates I’ve seen put it at about 1 percentage point per year) because when prices rise, people change their consumption patterns and we can’t predict how until it’s already happened.
This is a flawed procedure, but it’s not arbitrary, its an honest effort to approximate the ideal price index as well as we can, given the resources at our disposal.
There is an ideal, it’s just you can’t do it. If you knew everyone’s preferences and information and endowments of income, you could work out how people’s consumption would change as real incomes and relative prices changed so you could figure out what the right basket of goods is to use for the index at every point in time (the right bundle is whatever bundle consumers would actually pick in a given situation). But in practice you can’t get the information you’d need to do this, and that information would be constantly changing anyway.
To the best of my understanding, what you write above seems to concede that even under the assumption of omniscience, when we consider different times and/or places, with different prices, incomes, and preferences of individuals—and different sets of goods available on the market, though this can be modeled by assigning infinite prices to unavailable goods—there is, after all, no unique objectively correct way to define equivalent baskets of goods. You could calculate the baskets that would actually be consumed at each time and place, but not the ratio of their true values (whatever that might mean), which would be necessary for their use as the basis for a true and objective price index.
Am I wrong in this conclusion, and if I am, would you be so kind to explain how?
In practice what statistical agencies do is develop a basket of goods based on current consumption and review it every decade or so. [...] This is a flawed procedure, but it’s not arbitrary, its an honest effort to approximate the ideal price index as well as we can, given the resources at our disposal.
I would be really grateful if you could spell out what exactly you mean by “the ideal price index” when it comes to comparing different times and places, given my above observation. Also, you ignore the question of how exactly baskets are “reviewed,” which is a step that requires an arbitrary choice of the new basket that will be declared as equivalent to the old.
Moreover, different kinds of “honest efforts” apparently produce very different figures. The procedures for calculating official price indexes have been changed several times in recent decades in ways that make the numbers look very different compared to what the older methods would yield. (And curiously, the numbers according to the new procedures somehow always end up looking better.) Would you say, realistically, that this is purely because we’ve been moving closer to the truth thanks to our increasing knowledge and insight?
You could calculate the baskets that would actually be consumed at each time and place, but not the ratio of their true values (whatever that might mean), which would be necessary for their use as the basis for a true and objective price index.
The concept of “true value” is incoherent, at least in my model of reality. The correct price to attach to a good at any time is its market price at that time. If you had the set of information I listed in my last comment, you’d have the market prices, since they’re implied by the other stuff.
Also, you ignore the question of how exactly baskets are “reviewed,” which is a step that requires an arbitrary choice of the new basket that will be declared as equivalent to the old.
I think we’re using different definitions of arbitrary. To me, arbitrary means that there is no correct answer, and all options are equally valid. I don’t accept that as a legitimate description of the process, there are judgement calls, but ambiguity is inevitable in the social sciences, you either get used to it, or find something else to study. Now if you’re using arbitrary in the way I’m using ambiguous, then I don’t think we disagree, except that I think it’s less problematic than I think you do, since as soon as you start dealing with people things get so complex that ambiguity is inevitable.
And curiously, the numbers according to the new procedures somehow always end up looking better.
Now, here you have a point. The Laspeyres Index is biased up, it may be an honest effort, but not one that’s Bayes correct. But Bayesian rationality has not penetrated through the discipline at this time, and as such a biased estimate is allowed to remain, primarily because there’s no methodologically clean way to remove the bias (you’d need to be able to predict things like quality changes and how people change their spending patterns in response to price changes) and without a background in Bayesian probability theory I think most economists would baulk at adding a fudge factor into the calculation.
The concept of “true value” is incoherent, at least in my model of reality. The correct price to attach to a good at any time is its market price at that time. If you had the set of information I listed in my last comment, you’d have the market prices, since they’re implied by the other stuff.
It might be valuable to talk about a “true value” of a given good to a given agent. Yes, the correct price to buy or sell a good at is always the market price; but whether I want to sell at that price or buy at that price depends on how much I want the good. If I sell, then the “true value” of the good to me is less than the current market price; and if I buy, then the “true value” of the good to me is greater than the current market price. In general, the “true value” of a given good to a given agent is the price such that, if the market were trading at that price, that agent would be indifferent regarding whether to buy or sell that good.
The concept of “true value” is incoherent, at least in my model of reality.
I heartily agree—but what is a price index, other than an attempt at answering the question of what the “true value” of a unit of currency is? What are the fabled “real” values other than attempts at coming up with a coherent concept of “true value”?
The correct price to attach to a good at any time is its market price at that time. If you had the set of information I listed in my last comment, you’d have the market prices, since they’re implied by the other stuff.
Yes, but even given perfect knowledge of all market prices and individual preferences at every time and place, as well as unlimited computing power, I still don’t see how this solves the problem. We can find out the average basket consumed per individual (or household or whatever) and its price at each time and place, but what next? How do we establish the relative values of these baskets, whose composition will be different both quantitatively and qualitatively?
To clarify things further, I’d like to ask you a different question. Suppose the moon Europa is inhabited by intelligent jellyfish-like creatures floating in its inner ocean. The Europan economy is complex, technologically advanced, and money-based, but it doesn’t have any goods or services in common with humans, except for a few inevitable ones like e.g. some basic chemical substances, and there is no trade whatsoever between Earth and Europa due to insurmountable distances. Would it make sense to define a price index that would allow us to compare the “real” values of various aggregate variables in the U.S. and on Europa?
If not, what makes the U.S./Europa situation essentially different from comparing different places and epochs on Earth? Or does the meaningfulness of price indexes somehow gradually fall as differences accumulate? But then how exactly do we establish the threshold, and make sure that the differences across decades and continents here on Earth don’t exceed it?
I think we’re using different definitions of arbitrary. To me, arbitrary means that there is no correct answer, and all options are equally valid. I don’t accept that as a legitimate description of the process, there are judgement calls, but ambiguity is inevitable in the social sciences, you either get used to it, or find something else to study.
Well, if macroeconomists and other social scientists were just harmless and benign philosophers, I’d be happy to leave them to ponder their ambiguities in peace!
Trouble is, to paraphrase Trotsky’s famous apocryphal quote, you may not be interested in social science, but social science is interested in you. In the present Western political system, whatever passes for reputable high-profile social science will be used as basis for policies of government and various powerful entities on its periphery, which can have catastrophic consequences for all of us if these ideas are too distant from reality. (And arguably already has.) Macroeconomics is especially critical in this regard.
but what is a price index, other than an attempt at answering the question of what the “true value” of a unit of currency is? What are the fabled “real” values other than attempts at coming up with a coherent concept of “true value”?
No, no. A price index is an attempt to work out how much things cost relative to what they used to cost. Real GDP is an attempt to measure how much stuff is being produced relative to how much stuff was being produced. GDP is not an attempt to determine what that stuff is worth in a metaphysical or personal sense, the production is merely valued at its market price (adjusted for inflation, in the case of real GDP). To a pacifist, the portion of GDP spent on the military is worth less than nothing, but it’s still part of GDP because it was stuff that was produced.
Or does the meaningfulness of price indexes somehow gradually fall as differences accumulate?
Yes, the closer the consumption patters of the two economies being compared, the more useful the comparison is. If there were no common goods between two economies it would be impossible to compare them meaningfully. As to where to draw the line, well I wish I had a good answer for you, but I don’t. All I can say is that the value of the comparison decays over “distance” (meaning differences in consumption patterns).
Some economists have created more specialised indices for long-run comparisons; William Nordhaus created a price index for light (based on hours of work per candela-hour) from the stone age to modern times. This is a little unusual at the moment since macroeconomists don’t usually do comparisons over long time periods (it’s fiendishly hard to get data going back before the 20th Century on most indicators), but it shows you that we are aware of the limitations of our tools, including price indices.
In the present Western political system, whatever passes for reputable social science will be used as basis for policies of government and various powerful entities on its periphery, which can have catastrophic consequences for all of us if these ideas are too distant from reality. Macroeconomics is especially critical in this regard.
I agree wholeheartedly, good quality policy advice is something I take very seriously. The social science we have has significant limitations, but right now, we don’t have anything better. I very much doubt the quality of our policy would improve if politicians paid less attention to their advisers than they do at the moment. So we do what we can, help thing along as much as our knowledge and the institutional frameworks decisions are made will permit. What else can you do?
Some economists have created more specialised indices for long-run comparisons; William Nordhaus created a price index for light (based on hours of work per candela-hour) from the stone age to modern times. This is a little unusual at the moment since macroeconomists don’t usually do comparisons over long time periods (it’s fiendishly hard to get data going back before the 20th Century on most indicators), but it shows you that we are aware of the limitations of our tools, including price indices.
That’s a very interesting paper (available here), thanks for the pointer!
As with nearly all papers addressing such topics, parts of it look as if they were purposefully written to invite ridicule, as when he presents estimates of 19th century prices calculated to six significant digits. (Sorry for being snide, but what was that about spurious precision in economics being the fault of politicians?) However, the rest of it presents some very interesting ideas. Here are a few interesting bits I got from skimming it:
The mathematical discussion in Section 1.3.2. seems to imply (or rather assume) that even assuming omniscience, a “true price index” (Nordhaus’s term) can be defined only for a population of identical individuals with unchanging utility functions. This seems to support my criticisms, especially considering that the very notion of a human utility function is a giant spherical cow.
The discussion in the introduction basically says that the way price indexes are done in practice makes them meaningless over periods of significant technological change. But why do we then get all this supposedly scientific research that uses them nonchalantly, not to mention government policy based on them? Nordhaus is, unsurprisingly, reluctant to draw some obvious implications here.
Nordhaus considers only the fact that price indexes fail to account for the benefits of technological development, so he keeps insisting that the situation is more optimistic than what they say. But he fails to notice that the past was not necessarily worse in every respect. In many places, for example, it is much less affordable than a few decades ago to live in a conveniently located low-crime neighborhood, and this goal will suck up a very significant percentage of income of all but the wealthiest folks. Moreover, as people’s preferences change with time, many things that today’s folks value positively would have been valued negatively by previous generations. How to account for that?
More to the same point, unless I missed the part where he discusses it, Nordhaus seems oblivious to the fact that much consumption is due to signaling and status competition, not utility derived from inherent qualities of goods. I’m hardly an anti-capitalist leftie, but any realistic picture of human behavior must admit that much of the benefit from economic and technological development ultimately gets sucked up by zero-sum status games. Capturing that vitally important information in a price index is a task that it would be insulting to Don Quixote to call quixotic.
Finally, I can’t help but notice that in the quest for an objective measure of the price of light, Nordhaus seems to have reinvented the labor theory of value! Talk about things coming back full circle.
Overall, I would ask: can you imagine a paper like this being published in physics or some other natural science, which would convincingly argue that widely used methodologies on which major parts of the existing body of research rest in fact produce spurious numbers—with the result that everyone acknowledges that the author has a point, and keeps on doing things the same as before?
As with nearly all papers addressing such topics, parts of it look as if they were purposefully written to invite ridicule, as when he presents estimates of 19th century prices calculated to six significant digits. (Sorry for being snide, but what was that about spurious precision in economics being the fault of politicians?)
[facepalm] OK, I’m not making any excuse for that. Given the magnitude of his findings he doesn’t even need them to make his point.
The mathematical discussion in Section 1.3.2. seems to imply (or rather assume) that even assuming omniscience, a “true price index” (Nordhaus’s term) can be defined only for a population of identical individuals with unchanging utility functions. This seems to support my criticisms, especially considering that the very notion of a human utility function is a giant spherical cow.
Yes, you can’t produce a true price index. But less-than-true price indices can still be useful.
Nordhaus considers only the fact that price indexes fail to account for the benefits of technological development, so he keeps insisting that the situation is more optimistic than what they say. But he fails to notice that the past was not necessarily worse in every respect. In many places, for example, it is much less affordable than a few decades ago to live in a conveniently located low-crime neighborhood, and this goal will suck up a very significant percentage of income of all but the wealthiest folks.
But houses keep getting bigger and you have to account for that too. Besides which, housing is no more than a third of most people’s income, at least it is in my country. That is a significant percentage, but it’s still less than half. And things keep getting better (or no worse) in the remaining two thirds.
More to the same point, unless I missed the part where he discusses it, Nordhaus seems oblivious to the fact that much consumption is due to signalling and status competition, not utility derived from inherent qualities of goods.
Assuming it’s even possible to adjust for that, I’d really want to apply the adjustment to GDP, not prices. Signalling isn’t a matter of cost but rather value.
Finally, I can’t help but notice that in the quest for an objective measure of the price of light, Nordhaus seems to have reinvented the labor theory of value! Talk about things coming back full circle.
No, you’re confusing cost and value. The labour theory of value is the theory that the value of a good derives from the labour taken to produce it. If Nordhaus were using this theory he’d be arguing that the value of light keeps falling. Measuring cost with labour is another thing entirely.
Overall, I would ask: can you imagine a paper like this being published in physics or some other natural science, which would convincingly argue that widely used methodologies on which major parts of the existing body of research rest in fact produce spurious numbers—with the result that everyone acknowledges that the author has a point, and keeps on doing things the same as before?
No. I recognise this is a problem. I can only imagine they thing it’s too had to correct for technological change robustly, but that’s not really an excuse. If you can’t do it well, it’s generally still better to do it badly than not at all. And I didn’t realise the research was that old (I’ve actually never read the paper, I read a summary in a much more recent book). Apparently macroeconomists have more catch-up to do than I thought.
This sentence of yours probably captures the heart of our disagreement:
If you can’t do it well, it’s generally still better to do it badly than not at all.
We don’t seem to disagree that much about the limitations of knowledge in this whole area, epistemologically speaking. Where we really part ways is that I believe that historically, the whole edifice of spurious expertise produced by macroeconomists and perpetuated by gargantuan bureaucracies has been an active force giving impetus for bad (and sometimes disastrous) policies, and that it’s overall been a step away from reality compared to the earlier much simpler, but ultimately more realistic conventional wisdom. Whereas you don’t accept this judgment.
Given what’s already been said, I think this would be a good time to conclude our discussion. Thanks for your input; your comments have, at the very least, made me learn some interesting facts and rethink my opinions on the subject, even if I didn’t change them substantially at the end.
(Oh, and you’re right that I confused cost and value in that point from my above comment. I was indeed trying to be a bit too much of a smartass there.)
This sentence of yours probably captures the heart of our disagreement:
If you can’t do it well, it’s generally still better to do it badly than not at all.
Yes, I think so. It’s not that I think that macroecoonmics has covered its self in glory, it hasn’t. But this really is literally the only way to learn for those guys. And I believe it’s worth it in the short run, though I’m less sure of that, than I was before we started this. Maybe those macro guys should go try micro or something.
Given what’s already been said, I think this would be a good time to conclude our discussion. Thanks for your input; your comments have, at the very least, made me learn some interesting facts and rethink my opinions on the subject, even if I didn’t change them substantially at the end.
Heh. Yeah, I’m going to go out on a limb and guess that Nordhaus didn’t subtract off the previously-free sunlight lost to global dimming and the attenuation of natural sources of nightlight due to interference from artificial light.
This is NOT to say I’m endorsing some kind of greenie move toward a pre-industrial time just so we can see the undimmed sky or have less “light pollution”. I’m just saying that ignoring natural and informal sources of wealth is a bad habit to get into.
A price index is an attempt to work out how much things cost relative to what they used to cost. Real GDP is an attempt to measure how much stuff is being produced relative to how much stuff was being produced. GDP is not an attempt to determine what that stuff is worth in a metaphysical or personal sense, the production is merely valued at its market price (adjusted for inflation, in the case of real GDP). To a pacifist, the portion of GDP spent on the military is worth less than nothing, but it’s still part of GDP because it was stuff that was produced.
But now we’re back to square one. Since different things are produced in different times and places, to produce these “real” figures for comparison, we need to come up with a way to compare apples and oranges (sometimes literally!). Now, if economists just said that they would consider an apple equivalent to an orange for some simple Fermi problem calculation, I’d have no problem with that.
However, what economists use in practice are profoundly complicated methodologies that will tell us that an orange is presently equivalent to 1.138 of an apple, and then we get subtle arguments and policy prescriptions based on the finding that this means an increase in the orange-apple index of 2.31% relative to last year. Here we enter the realm of pure nebulosity, where the indexes and “real” figures stop being vague heuristics where even the order of magnitude is just barely meaningful, and acquire a metaphysical existence of their own, as “real” variables to be calculated to multiple digits of precision, fed into complex mathematical models and policy guidelines, and used to measure reified true, objective value.
Yes, the closer the consumption patters of the two economies being compared, the more useful the comparison is. If there were no common goods between two economies it would be impossible to compare them meaningfully. As to where to draw the line, well I wish I had a good answer for you, but I don’t. All I can say is that the value of the comparison decays over “distance” (meaning differences in consumption patterns).
So, here is a straightforward question then: how do we know that it is meaningful to do comparison across, say, between the U.S. in 2010 and the U.S. in 1960 or 1910? What argument supports the assumption that the differences between them are small enough?
The social science we have has significant limitations, but right now, we don’t have anything better. [...] So we do what we can, help thing along as much as our knowledge and the institutional frameworks decisions are made will permit. What else can you do?
Sometimes it’s safer to just leave things alone if you don’t know what you’re doing. Presenting dubious conclusions and questionable expertise as scientific insight leads to the equivalent of dilettante surgery being performed on entire countries by their governments, sometimes with awful consequences, and with even worse ones threatening in the future. (Prominent macroeconomists will in fact agree with me, it’s just that they’ll claim that their professional rivals are the dilettantes, and only they are true experts who should be listened to.)
Here we enter the realm of pure nebulosity, where the indexes and “real” figures stop being vague heuristics where even the order of magnitude is just barely meaningful, and acquire a metaphysical existence of their own, as “real” variables to be calculated to multiple digits of precision, fed into complex mathematical models and policy guidelines, and used to measure reified true, objective value.
So, here is a straightforward question then: how do we know that it is meaningful to do comparison across, say, between the U.S. in 2010 and the U.S. in 1960 or 1910? What argument supports the assumption that the differences between them are small enough?
I would be careful about using a price index over that kind of time frame, I don’t actually know how macroeconomists treat it, but I have read books that point out the inherent difficulty of making comparisons over long time periods (where long means more than about 20 years), and that if you’re trying to capture differences in standard of living over a long period one should try to account for differences in product quality and product mix over time. Of course that’s incredibly hard to do, and I don’t know how seriously this issue is treated in macroeconomics, but it should be taken seriously.
Sometimes it’s safer to just leave things alone if you don’t know what you’re doing.
I strongly agree. However, there are two limiting factors when applying to this logic to policy advice:
1) If you don’t give a politician any advice, their reaction won’t be to do nothing, it will be to do whatever they think is a good idea. The average macroeconomist may not know a lot, but they know enough that their advice will probably help a little. I do think that macroeconomists should be less willing to offer active advice, as opposed to “we don’t understand this problem, the best thing to do here is nothing”, but politicians have a strong aversion to doing nothing in the face of a crisis, and if their advisers keep telling them to do politically unpalatable things, they’ll find advisers that will tell them what to hear.
2) You can’t run experiments in macroeconomics, the only way to acquire data on how well an intervention works is to try it (multiple times in multiple countries) and find out how it goes, and even then you end up arguing what would have happened if you did nothing. That means that if you don’t try to fix and/or prevent macroeconomic problems you don’t get any better information on how to fix future ones. Maybe that’s an acceptable trade off, but I’m sure you can see why macroeconomists don’t think so. Also bear in mind that what brought macro into its own as a discipline was the Great Depression. Maybe it’s worth risking some bumps in the road to try to work out how to stop something like that happening again.
Prominent macroeconomists will in fact agree with me, it’s just that they’ll claim that their professional rivals are the dilettantes, and only they are true experts who should be listened to.
Yes, it’s depressing how much a macroeconomists’ opinion on what caused the recent troubles matches up with their political ideology. But it’s a function of the low quality of evidence available, in Bayesian terms when you only have access to weak evidence, your prior matters more than when the evidence is strong. The inevitable influence politics has on the discipline doesn’t help either. Politicians are all too keen to build up economists who are telling them to do things they want to do anyway.
Would error bars be a bad thing?
Economists could calculate error bars that would say how closely the calculated aggregate figures approximate their exact values according to definitions. This is normally not done, and as Morgenstern noted in the book discussed elsewhere in the thread, the results would be quite embarrassing, since they’d show that economists regularly talk about changes in the second, third, or even fourth significant digit of numbers whose error bars are well into double-digit percentages.
However, when it comes to the more essential point I’ve been making, error bars wouldn’t make any sense, since the problem is that there is no true value out there in the first place, just different arbitrary conventions that yield different results, neither of which is more “true” than the others.
There’s an old joke: “How can you tell macroeconomists have a sense of humour? They use decimal points.” I’ll admit spurious precision is a problem with a quite a bit of economic reporting. Remember that these statistics are produced by governments, not academics and politicians can have trouble grokking error bars.
Actually, that’s not really the case. There is an ideal, it’s just you can’t do it. If you knew everyone’s preferences and information and endowments of income, you could work out how people’s consumption would change as real incomes and relative prices changed so you could figure out what the right basket of goods is to use for the index at every point in time (the right bundle is whatever bundle consumers would actually pick in a given situation).
But in practice you can’t get the information you’d need to do this, and that information would be constantly changing anyway. In practice what statistical agencies do is develop a basket of goods based on current consumption and review it every decade or so. This means the index overestimates inflation (the estimates I’ve seen put it at about 1 percentage point per year) because when prices rise, people change their consumption patterns and we can’t predict how until it’s already happened.
This is a flawed procedure, but it’s not arbitrary, its an honest effort to approximate the ideal price index as well as we can, given the resources at our disposal.
James_K:
To the best of my understanding, what you write above seems to concede that even under the assumption of omniscience, when we consider different times and/or places, with different prices, incomes, and preferences of individuals—and different sets of goods available on the market, though this can be modeled by assigning infinite prices to unavailable goods—there is, after all, no unique objectively correct way to define equivalent baskets of goods. You could calculate the baskets that would actually be consumed at each time and place, but not the ratio of their true values (whatever that might mean), which would be necessary for their use as the basis for a true and objective price index.
Am I wrong in this conclusion, and if I am, would you be so kind to explain how?
I would be really grateful if you could spell out what exactly you mean by “the ideal price index” when it comes to comparing different times and places, given my above observation. Also, you ignore the question of how exactly baskets are “reviewed,” which is a step that requires an arbitrary choice of the new basket that will be declared as equivalent to the old.
Moreover, different kinds of “honest efforts” apparently produce very different figures. The procedures for calculating official price indexes have been changed several times in recent decades in ways that make the numbers look very different compared to what the older methods would yield. (And curiously, the numbers according to the new procedures somehow always end up looking better.) Would you say, realistically, that this is purely because we’ve been moving closer to the truth thanks to our increasing knowledge and insight?
The concept of “true value” is incoherent, at least in my model of reality. The correct price to attach to a good at any time is its market price at that time. If you had the set of information I listed in my last comment, you’d have the market prices, since they’re implied by the other stuff.
I think we’re using different definitions of arbitrary. To me, arbitrary means that there is no correct answer, and all options are equally valid. I don’t accept that as a legitimate description of the process, there are judgement calls, but ambiguity is inevitable in the social sciences, you either get used to it, or find something else to study. Now if you’re using arbitrary in the way I’m using ambiguous, then I don’t think we disagree, except that I think it’s less problematic than I think you do, since as soon as you start dealing with people things get so complex that ambiguity is inevitable.
Now, here you have a point. The Laspeyres Index is biased up, it may be an honest effort, but not one that’s Bayes correct. But Bayesian rationality has not penetrated through the discipline at this time, and as such a biased estimate is allowed to remain, primarily because there’s no methodologically clean way to remove the bias (you’d need to be able to predict things like quality changes and how people change their spending patterns in response to price changes) and without a background in Bayesian probability theory I think most economists would baulk at adding a fudge factor into the calculation.
It might be valuable to talk about a “true value” of a given good to a given agent. Yes, the correct price to buy or sell a good at is always the market price; but whether I want to sell at that price or buy at that price depends on how much I want the good. If I sell, then the “true value” of the good to me is less than the current market price; and if I buy, then the “true value” of the good to me is greater than the current market price. In general, the “true value” of a given good to a given agent is the price such that, if the market were trading at that price, that agent would be indifferent regarding whether to buy or sell that good.
Yes that is a coherent definition of true value. It’s not a concept that maps well to price indices though.
James_K:
I heartily agree—but what is a price index, other than an attempt at answering the question of what the “true value” of a unit of currency is? What are the fabled “real” values other than attempts at coming up with a coherent concept of “true value”?
Yes, but even given perfect knowledge of all market prices and individual preferences at every time and place, as well as unlimited computing power, I still don’t see how this solves the problem. We can find out the average basket consumed per individual (or household or whatever) and its price at each time and place, but what next? How do we establish the relative values of these baskets, whose composition will be different both quantitatively and qualitatively?
To clarify things further, I’d like to ask you a different question. Suppose the moon Europa is inhabited by intelligent jellyfish-like creatures floating in its inner ocean. The Europan economy is complex, technologically advanced, and money-based, but it doesn’t have any goods or services in common with humans, except for a few inevitable ones like e.g. some basic chemical substances, and there is no trade whatsoever between Earth and Europa due to insurmountable distances. Would it make sense to define a price index that would allow us to compare the “real” values of various aggregate variables in the U.S. and on Europa?
If not, what makes the U.S./Europa situation essentially different from comparing different places and epochs on Earth? Or does the meaningfulness of price indexes somehow gradually fall as differences accumulate? But then how exactly do we establish the threshold, and make sure that the differences across decades and continents here on Earth don’t exceed it?
Well, if macroeconomists and other social scientists were just harmless and benign philosophers, I’d be happy to leave them to ponder their ambiguities in peace!
Trouble is, to paraphrase Trotsky’s famous apocryphal quote, you may not be interested in social science, but social science is interested in you. In the present Western political system, whatever passes for reputable high-profile social science will be used as basis for policies of government and various powerful entities on its periphery, which can have catastrophic consequences for all of us if these ideas are too distant from reality. (And arguably already has.) Macroeconomics is especially critical in this regard.
No, no. A price index is an attempt to work out how much things cost relative to what they used to cost. Real GDP is an attempt to measure how much stuff is being produced relative to how much stuff was being produced. GDP is not an attempt to determine what that stuff is worth in a metaphysical or personal sense, the production is merely valued at its market price (adjusted for inflation, in the case of real GDP). To a pacifist, the portion of GDP spent on the military is worth less than nothing, but it’s still part of GDP because it was stuff that was produced.
Yes, the closer the consumption patters of the two economies being compared, the more useful the comparison is. If there were no common goods between two economies it would be impossible to compare them meaningfully. As to where to draw the line, well I wish I had a good answer for you, but I don’t. All I can say is that the value of the comparison decays over “distance” (meaning differences in consumption patterns).
Some economists have created more specialised indices for long-run comparisons; William Nordhaus created a price index for light (based on hours of work per candela-hour) from the stone age to modern times. This is a little unusual at the moment since macroeconomists don’t usually do comparisons over long time periods (it’s fiendishly hard to get data going back before the 20th Century on most indicators), but it shows you that we are aware of the limitations of our tools, including price indices.
I agree wholeheartedly, good quality policy advice is something I take very seriously. The social science we have has significant limitations, but right now, we don’t have anything better. I very much doubt the quality of our policy would improve if politicians paid less attention to their advisers than they do at the moment. So we do what we can, help thing along as much as our knowledge and the institutional frameworks decisions are made will permit. What else can you do?
James_K:
That’s a very interesting paper (available here), thanks for the pointer!
As with nearly all papers addressing such topics, parts of it look as if they were purposefully written to invite ridicule, as when he presents estimates of 19th century prices calculated to six significant digits. (Sorry for being snide, but what was that about spurious precision in economics being the fault of politicians?) However, the rest of it presents some very interesting ideas. Here are a few interesting bits I got from skimming it:
The mathematical discussion in Section 1.3.2. seems to imply (or rather assume) that even assuming omniscience, a “true price index” (Nordhaus’s term) can be defined only for a population of identical individuals with unchanging utility functions. This seems to support my criticisms, especially considering that the very notion of a human utility function is a giant spherical cow.
The discussion in the introduction basically says that the way price indexes are done in practice makes them meaningless over periods of significant technological change. But why do we then get all this supposedly scientific research that uses them nonchalantly, not to mention government policy based on them? Nordhaus is, unsurprisingly, reluctant to draw some obvious implications here.
Nordhaus considers only the fact that price indexes fail to account for the benefits of technological development, so he keeps insisting that the situation is more optimistic than what they say. But he fails to notice that the past was not necessarily worse in every respect. In many places, for example, it is much less affordable than a few decades ago to live in a conveniently located low-crime neighborhood, and this goal will suck up a very significant percentage of income of all but the wealthiest folks. Moreover, as people’s preferences change with time, many things that today’s folks value positively would have been valued negatively by previous generations. How to account for that?
More to the same point, unless I missed the part where he discusses it, Nordhaus seems oblivious to the fact that much consumption is due to signaling and status competition, not utility derived from inherent qualities of goods. I’m hardly an anti-capitalist leftie, but any realistic picture of human behavior must admit that much of the benefit from economic and technological development ultimately gets sucked up by zero-sum status games. Capturing that vitally important information in a price index is a task that it would be insulting to Don Quixote to call quixotic.
Finally, I can’t help but notice that in the quest for an objective measure of the price of light, Nordhaus seems to have reinvented the labor theory of value! Talk about things coming back full circle.
Overall, I would ask: can you imagine a paper like this being published in physics or some other natural science, which would convincingly argue that widely used methodologies on which major parts of the existing body of research rest in fact produce spurious numbers—with the result that everyone acknowledges that the author has a point, and keeps on doing things the same as before?
[facepalm] OK, I’m not making any excuse for that. Given the magnitude of his findings he doesn’t even need them to make his point.
Yes, you can’t produce a true price index. But less-than-true price indices can still be useful.
But houses keep getting bigger and you have to account for that too. Besides which, housing is no more than a third of most people’s income, at least it is in my country. That is a significant percentage, but it’s still less than half. And things keep getting better (or no worse) in the remaining two thirds.
Assuming it’s even possible to adjust for that, I’d really want to apply the adjustment to GDP, not prices. Signalling isn’t a matter of cost but rather value.
No, you’re confusing cost and value. The labour theory of value is the theory that the value of a good derives from the labour taken to produce it. If Nordhaus were using this theory he’d be arguing that the value of light keeps falling. Measuring cost with labour is another thing entirely.
No. I recognise this is a problem. I can only imagine they thing it’s too had to correct for technological change robustly, but that’s not really an excuse. If you can’t do it well, it’s generally still better to do it badly than not at all. And I didn’t realise the research was that old (I’ve actually never read the paper, I read a summary in a much more recent book). Apparently macroeconomists have more catch-up to do than I thought.
This sentence of yours probably captures the heart of our disagreement:
We don’t seem to disagree that much about the limitations of knowledge in this whole area, epistemologically speaking. Where we really part ways is that I believe that historically, the whole edifice of spurious expertise produced by macroeconomists and perpetuated by gargantuan bureaucracies has been an active force giving impetus for bad (and sometimes disastrous) policies, and that it’s overall been a step away from reality compared to the earlier much simpler, but ultimately more realistic conventional wisdom. Whereas you don’t accept this judgment.
Given what’s already been said, I think this would be a good time to conclude our discussion. Thanks for your input; your comments have, at the very least, made me learn some interesting facts and rethink my opinions on the subject, even if I didn’t change them substantially at the end.
(Oh, and you’re right that I confused cost and value in that point from my above comment. I was indeed trying to be a bit too much of a smartass there.)
Yes, I think so. It’s not that I think that macroecoonmics has covered its self in glory, it hasn’t. But this really is literally the only way to learn for those guys. And I believe it’s worth it in the short run, though I’m less sure of that, than I was before we started this. Maybe those macro guys should go try micro or something.
Same here, it’s been fun.
How much did it cost a cave man to walk outside? Or are we including the time he spent digging renovations to put the sky-light in his roof?
Heh. Yeah, I’m going to go out on a limb and guess that Nordhaus didn’t subtract off the previously-free sunlight lost to global dimming and the attenuation of natural sources of nightlight due to interference from artificial light.
This is NOT to say I’m endorsing some kind of greenie move toward a pre-industrial time just so we can see the undimmed sky or have less “light pollution”. I’m just saying that ignoring natural and informal sources of wealth is a bad habit to get into.
Reading paper to see if I can guess them right...
ETA: Ohhhhhh! Can I call ’em or what?
James_K:
But now we’re back to square one. Since different things are produced in different times and places, to produce these “real” figures for comparison, we need to come up with a way to compare apples and oranges (sometimes literally!). Now, if economists just said that they would consider an apple equivalent to an orange for some simple Fermi problem calculation, I’d have no problem with that.
However, what economists use in practice are profoundly complicated methodologies that will tell us that an orange is presently equivalent to 1.138 of an apple, and then we get subtle arguments and policy prescriptions based on the finding that this means an increase in the orange-apple index of 2.31% relative to last year. Here we enter the realm of pure nebulosity, where the indexes and “real” figures stop being vague heuristics where even the order of magnitude is just barely meaningful, and acquire a metaphysical existence of their own, as “real” variables to be calculated to multiple digits of precision, fed into complex mathematical models and policy guidelines, and used to measure reified true, objective value.
So, here is a straightforward question then: how do we know that it is meaningful to do comparison across, say, between the U.S. in 2010 and the U.S. in 1960 or 1910? What argument supports the assumption that the differences between them are small enough?
Sometimes it’s safer to just leave things alone if you don’t know what you’re doing. Presenting dubious conclusions and questionable expertise as scientific insight leads to the equivalent of dilettante surgery being performed on entire countries by their governments, sometimes with awful consequences, and with even worse ones threatening in the future. (Prominent macroeconomists will in fact agree with me, it’s just that they’ll claim that their professional rivals are the dilettantes, and only they are true experts who should be listened to.)
I happen to agree that macroeconomists are overdoing it on the level of precision they can provide. Arnold Kilng (himself a macroeconomist) made this same point in a blog post last year: http://econlog.econlib.org/archives/2009/03/paragraphs_to_p.html
I would be careful about using a price index over that kind of time frame, I don’t actually know how macroeconomists treat it, but I have read books that point out the inherent difficulty of making comparisons over long time periods (where long means more than about 20 years), and that if you’re trying to capture differences in standard of living over a long period one should try to account for differences in product quality and product mix over time. Of course that’s incredibly hard to do, and I don’t know how seriously this issue is treated in macroeconomics, but it should be taken seriously.
I strongly agree. However, there are two limiting factors when applying to this logic to policy advice: 1) If you don’t give a politician any advice, their reaction won’t be to do nothing, it will be to do whatever they think is a good idea. The average macroeconomist may not know a lot, but they know enough that their advice will probably help a little. I do think that macroeconomists should be less willing to offer active advice, as opposed to “we don’t understand this problem, the best thing to do here is nothing”, but politicians have a strong aversion to doing nothing in the face of a crisis, and if their advisers keep telling them to do politically unpalatable things, they’ll find advisers that will tell them what to hear.
2) You can’t run experiments in macroeconomics, the only way to acquire data on how well an intervention works is to try it (multiple times in multiple countries) and find out how it goes, and even then you end up arguing what would have happened if you did nothing. That means that if you don’t try to fix and/or prevent macroeconomic problems you don’t get any better information on how to fix future ones. Maybe that’s an acceptable trade off, but I’m sure you can see why macroeconomists don’t think so. Also bear in mind that what brought macro into its own as a discipline was the Great Depression. Maybe it’s worth risking some bumps in the road to try to work out how to stop something like that happening again.
Yes, it’s depressing how much a macroeconomists’ opinion on what caused the recent troubles matches up with their political ideology. But it’s a function of the low quality of evidence available, in Bayesian terms when you only have access to weak evidence, your prior matters more than when the evidence is strong. The inevitable influence politics has on the discipline doesn’t help either. Politicians are all too keen to build up economists who are telling them to do things they want to do anyway.