Knowing and Making

Paul Krugman in " Bourbon Economics " (and his commenter Peter von zur Muehlen ) complain that we've had new ideas for decades in macroeconomics, but they don't take hold. By 1988, it was already obvious that equilibrium business cycle theory had failed. Shiller had already circulated his devastating demonstration that asset prices were much too volatile to be explained by fundamentals...nothing happened. Real business cycle theory continued to prosper, developing an increasing stranglehold over the professional journals. Behavioral finance stayed on the margins. The equilibrium guys had learned nothing and forgotten nothing... Our problem, in short, isn’t lack of nifty new ideas; it’s the refusal of too many economists to face up to the fact that some of their preferred theories don’t work I sympathise - as an adherent and practitioner of behavioural finance, I could hardly not. But it's too easy to blame this on the establishment for not listening. And really, ...

Two articles this evening lead me to ask the question: how do we predict GDP growth? Before reading on, why not ask yourself this question: what do you expect next quarter's GDP growth figures to be? How about the next 12 months? And why? I'd be interested to see some of your answers in the comments to this post - please also say which particular GDP figures you're predicting (personally I'm most familiar with the UK and US figures, but would be interested in comments from the eurozone and other regions too)*. I'm not going to test you on the accuracy of your forecasts: I'm more interested in the prediction itself, and your reasoning, than whether it turns out to be right. My prompts for thinking about this are: a paper Roger Farmer sent me this evening, introducing the concept of a belief function  describing what people expect next year's growth and inflation figures to be David Smith's blog excerpt of his Sunday Times column today , in which h...

Roger Farmer likes unorthodox monetary policy. At the turn of the year he proposed that central banks should buy and sell equities , targeting a stock price index as a method of controlling asset prices. My own version of this proposal was slightly different . Now he's suggesting that they use quantitative easing as a monetary tool , independently of interest rates. The idea is that even once central banks have started to raise interest rates to control inflation, they should separately adjust their balance sheet, changing the composition of the stock of savings in the economy, to combat unemployment. If QE is a useful tool now to help raise economic output, why shouldn't it be useful later, when inflation is taking off? Now admittedly I'm not a trained monetary economist, but I have a bad feeling about this idea. Aren't interest rate targets and QE both different manifestations of the central bank's ability to control the money supply? Crudely speaking: if money is...