T C A Srinivasa-Raghavan: Numbers in search of concepts

OKONOMOS

"Economists must accept that much of what they have been writing and saying about fiscal policy has been an exercise in linguistics, not economics."

For several years now, I have been arguing that macroeconomics is a lot of hot air. For instance, I have maintained: don't exaggerate the importance of the fiscal deficit because exaggeration is the method that the IMF devised in the 1980s for preventing a sudden devaluation of the exchange rate. But the truth is countries which don't depend on foreign savings need to worry less about the deficit than those that do.

Not many have taken this seriously. It is, therefore, heartening to see many distinguished economists coming to similar conclusions about modern macroeconomics.

Last week, this column had described the views of Gregory Mankiw of Harvard who says "The sad truth is that the macroeconomic research of the past three decades has had only minor impact on the practical analysis of monetary or fiscal policy."

Now comes another paper*, this time by Laurence J Kotlikoff and Jerry Green saying "Economists must accept and acknowledge that much of what they have been writing and saying about fiscal policy has been an exercise in linguistics, not economics."

Their basic premise is that "standard fiscal measures, including deficits, taxes, and transfer payments, depend on one's reference point/reporting procedure/language/labels." The authors say that these measures "represent numbers in search of concepts that provide the illusion of meaning where none exists."

This is a devastating critique but Kotlikoff and Green manage to substantiate it adequately. Their paper provides mathematical proof that standard and routinely used fiscal measures are badly defined, with the result that there is a great deal of "arbitrary labeling of underlying fiscal conditions".

If you use these and measures derived from them, such as disposable income, private assets, and personal saving, you will get a lot of high sounding gobbledegook that is of little practical use. Such analysis "constitutes the perusal of nomenclature, not the application of economics."

Back in 1986, Kotlikoff had suggested that any fiscal policy can be described by a series of numbers placed against deficits, taxes, and transfer payments. But "these measures are, economically speaking, content-free" (which, one must say, is nice way of saying rubbish). What happens is real life is very different.

"A competitive, contingent claims economy can accommodate uncertainty, information asymmetries, distortions, externalities, public goods, time inconsistent policy, imperfect credit markets, and incomplete/segmented markets." In other words, don't get your knickers in a twist over the numbers. They mean less than what you think they do.

Kotlikoff and Green also point out that it is possible to "construct an infinite number of equally meaningless time series of government debt, deficits, taxes, transfer payments, private assets, private saving, and disposable income." How would you say one analysis is better than the other? The linguistic over-reach also has an impact on theoretical research, which has become less valuable.

What this sort of thing has led to, say Kotlikoff and Green, is to encourage the notion of equivalent policies. "No doubt someone will someday write a paper arguing that a tax hike policy and a tax cut policy are equivalent" whereas, in fact "there are no equivalent policies in neo-classical economics."

It is best quoted. "Policies are unique. What's different is simply the words we use to describe the same underlying policy." There is a sharp lesson for India's economists here because almost all of them have blindly accepted American categories of analysis, unmindful of the fact that the two economies have different structures and operate under different implicit and explicit rules. The latter are especially important in the macroeconomic context.

Recently, I got into an argument with some colleagues over government debt, who think it is "bad". Kotlikoff and Green say it has become an article of faith that "government debt grow, in the long run, no faster than the economy's return on capital and the presumption that economies that violate such conditions are dynamically inefficient." The fact is that the size of the debt tells you nothing about the efficiency of economic agents. Debt may be bad, but not for the reasons you think.

* On the General Relativity of Fiscal Language, NBER Working Paper No. 12344 June 2006