ISSN (Print) - 0012-9976 | ISSN (Online) - 2349-8846

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Economists Speak

Inside the Economist's Mind: Conversations with Eminent Economists edited by Paul Samuelson and William Barnett;

Russia after a trip there: “One sees it in the appearance of solid well-being of the people on the streets, the close-to-murderous traffic, the incredible exfoliation of apartment houses, and the general aspect of restaurants, theatres and shops... Partly, the Russian system succeeds, because, in contrast with the western industrial economies, it makes full use of its manpower.”

However, when the Fed tried strict money supply-based rules in the early 1980s, it was unsuccessful – the short-run relationship between the money supply and the economy was too unstable for the rules to be a good guide to monetary policy. Stanford University economist John Taylor

– who shows up in this book as the interviewer of Friedman – helped devise “a simple and practical rule” to guide the conduct of monetary policy and also give observers a benchmark against which to measure the central bank’s performance [Loungani 2008]. Over time, the use of so-called Taylor rules, and the adoption in many countries of explicit or implicit inflation targeting regimes, has helped to improve the conduct of monetary policy.

How will monetary regimes evolve? The economists interviewed here take a range of views. Volcker states that he expects that 5

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BOOK REVIEWEconomic Political Weekly EPW july 19, 200833concept of rational expectations, which assumes that people’s expectations of, say, inflation, are consistent with the model that the economist writes down to explain inflation. So if inflation depends on some aggregate demand and supply factors, people’s expectations of inflation should depend on their predictions of those factors. While this is a logically elegant way of describing how expectations are formed, many of the economists interviewed here express doubts about the realism of rational expectations, particularly over the short run. Friedman agrees that rational expec-tations is correct to assume that “people try to predict what is going to happen tomor-row”, but in practice “there is always going to be a lag in expectations catching up”. Samuelson says that he tends to agree with only a weak form of rational expectations: “Fool me once. Shame on you. Fool me twice. Shame on me.” Shiller argues that “there ought to be more recognition of the limited ability of people to calculate [and] their tendency to use rules of thumb ...”.Aumann provides some of the most interesting discussion of the role of ration-ality in economics. He argues for what he calls “rule rationality”: “the basic premise is that people grope around. They learn what is a good way of behaving. When they make mistakes they adjust their behaviour to avoid those mistakes. It is a learning process, not an explicit optimisa-tion procedure…Rule rationality means that people evolve rules of behaviour by which they usually act, and they optimise these rules. They don’t optimise every single decision”. At the same time, Aumann is dismissive of behavioural economics, which he feels goes too far in challenging the notion that people behave rationally and respond to incentives. He says that the laboratory set-tings used in reaching these conclusions of-ten do not replicate the repeated real-world interactions that people go through in life. He then adds words that will be music to any economist who has played around withreal-world data: “...true behavioural economics does in fact exist; it is called empirical economics. This really is behav-ioural economics. In empirical economics, you go and see how people behave in real life, in situations to which they are used. Things they do every day...Empirical economics shows that people do respond very precisely to economic incentives”.Aumann concludes with the important distinction that what economists study isnot necessarily what they advocate: “…studying selfishness is not the same as advocating selfishness…Game theory says nothing about whether the ‘rational’ way is morally or ethically right… If we want a better world, we had better pay attention to where rational incentives lead.” Elements of EminenceThe interviews reveal some common traits among these eminent economists. One superficial one is that they are all white males. Those seeking to hear from or about economists of the other gender and other hues will have to wait until the planned second volume of these interviews or look in other sources. An interesting set of profiles of eminent Indian economists – Jagdish Bhagwati, Manmohan Singh, I G Patel, Krishna Raj, and others – canbe found in Deena Khatkhate’s recently pub-lished book,Ruminations of a Gadfly. Looking beyond the superficial, three other traits stand out. First, many of these economists have over the course of their professional lives been able to strike a balance between working on fairly abstract problems and very practical ones. The practical problem-solving often came about because many of the older econo-mists helped their defense establishments during the second world war and the cold war. Aumann, for instance, worked on the abstract mathematical problems, but also used game theory for very practical matters like how best to defend a city from a squadron of aircraft, most of which were decoys but a small percentage carried weapons. He was also one of a group of game theorists involved in the arms control negotiations with the Soviet Union in the 1960s – this followed the Cuban missile crisis during which, Aumann says,US president Kennedy was influenced by the game-theoretic school in international re-lations, which was prominent at the time. Modigliani provides a wonderful illus-tration of a peacetime use of economics to solve a practical problem. In 1975, in the middle of the oil crisis, the Italian labour demanded a new type of cost-of-living adjustment “in which an x % increase in prices would entitle a worker to an in-crease in wages not of x %of his wage but of x % of the average wage – the same numberofliras for everyone! And the high-wageemployers went along with glee!”Modigliani wrote a couple of in-dignantarticles trying to explain the folly of this policy and helped to eventually roll it back, though not before its use caused several years of economic turmoil. Among the younger economists, Shiller stands out as one who has contributed to both theory and practice. He helped launch the field of behavioural finance [Loungani 2004] but has also run a success-ful business, Case-Shiller-Weiss, which provides sophisticated house prices indices that are proving useful in tracking the course of the present housing crisis. Shiller thinks that “for an academic economist, it is a good thing to run a business”, adding that he would “encourage more economists to do practical things, like write patents”, rather than proposals for academic grants.Truth and ModestyA second common feature that emerges is integrity – these economists have conduct-ed their work to seek the truth rather than from a desire to be interesting, provoca-tive or prove ideological points. Samuel-son says that “my aim is not to be interest-ing but rather, as best as I can, not to be wrong”. Lucas, when asked if his famous result that the welfare costs of business cycles is small was merely an attempt to be provocative, responds: “I don’t write things I don’t believe in just to be provoca-tive! Those estimates may be too small, but if so, it is an honest mistake.” And even Milton Friedman, often portrayed as rigid in his views, forswears that those views were formed by his reading of the evi-dence: “I believe that I can honestly say that I never reached a judgment about monetary or fiscal policy because of my belief in free markets … If fiscal policy had deserved to play a much larger role, that would have shown up in the data.” These interviews thus show, in Shiller’s words, that “our profession indeed includes a lot of open-minded people, who really look at the evidence, even though their own published work may not make obvious to readers the breadth of their understanding and personal desire to pursue the truth”.

2004 Economics Nobel: The Two Insights of Kydland and Prescott’, Economic Political Weekly, October 30.

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