Noah Smith catches the Demand-Denialist Bug

I like Noah Smith, but his scientific-skepticism meme-immune system appears to be very weak.  The latest case in point is Noah’s post defending the use of Search Theory in Macroeconomics against John Quiggin who is rightly pointing out that Search Theory is incapable of explaining cyclical unemployment.  I’m not really going to add to what Quiggin wrote, instead I’m only interested in Noah’s response.  Before I go on, I should link to Noah’s excellent critique of Kartik Arthreya’s Big Ideas in Macroeconomics to which Quiggin is responding.

Conceding that Search Theory doesn’t explain all the employment patterns, Noah goes on to criticize “demand” explanations:

This is a simple answer… Economists are used to thinking in terms of supply and demand, so the AD-AS model comes naturally to mind… so we look at the economy and say “it’s a demand problem”.

But on a deeper level, that’s unsatisfying – to me, at least.

…what causes aggregate demand curves to shift?…how does aggregate demand affect unemployment? The usual explanation for this isdownward-sticky nominal wages. But why are nominal wages downward-sticky? There are a number of explanations, and again, these differences will have practical consequences.

… is an AD-AS model really a good way of modeling the macroeconomy?… The idea of abandoning the friendly old X of supply-and-demand is scary, I know, but maybe it just isn’t the best descriptor of booms and recessions,..

… I’m not really satisfied by the practice of putting “demand in the gaps”. If “demand” is not to be just another form of economic phlogiston, we need a consistent, predictive characterization of how it behaves…

Wow is that a lot of BS jammed into a short space.   Noah is a strong proponent of a more empirical and predictive macroeconomics, which I agree with!  but this post suggests that Noah doesn’t understand the other side of the problem, model selection and Okkam’s razor.

How do you know which model is the correct one?  You can’t just say that it’s the model that survived empirical tests because there are an infinite number of possible models at any given time which have survived those tests.   All that data you’ve collected tells you exactly nothing until you figure out which of those continuum of possible models you should treat as the preferred one.   Okkam’s razor plays the keystone role in scientific methodology as the selection criterion.   (If you were a philosopher of science you’d spend a lot of time trying to justify Okkam’s razor…Karl Popper believed it gave the most easily falsified model among the alternative… but as a practical scientist you can just accept it.)

Now that we’ve all accepted that Okkam’s razor must be used to winnow our choice of models, we should spend some time thinking about how to use Okkam’s razor to do this in practice.   That would require a post in itself, so instead let me just mention one particular criterion I use:  At any given time, who is the claimant?   In science, the burden of proof is always on the claimant because the claimant’s model at any given time  is almost always less simple than the accepted model given the field’s accepted information set.

As a heuristic, the claimant’s model generally does not pass Okkam’s razor’s test until new information is found and added to the field’s information set.   It’s possible (and does happen) that a heretofore unknown or unnoticed model is simpler than the accepted one, but that’s rarer than you might think and not generally how science proceeds.

With all that out of the way, what’s my problem with Noah’s post?  Two things:

1)  Demand is not phlogiston

For those not in the know, phlogiston was an hypothetical substance which made up fire.  The theory was rendered obsolete by the discovery of combustion.

Basically what Noah is saying here is that maybe demand, like phlogiston, is a hypothetical piece of a theory and that piece may be unnecessary.   Now science certainly does produce phlogiston-like theories from time to time, these theories tend to be the result of trying to tweak systemic models:   you have a theory of elements (at the time of phlogiston a sort of proto-elemental atomic theory) and a substance (fire) which you can’t explain.  So add an element to you model to explain the substance.

The first thing to point out is that demand is a reductionist phenomenon in the strictest sense.   The smallest unit of a macroeconomy (the atom, if you will) is the transaction.  But a single transaction has a well-defined demand:  how much the buyer is willing to trade for the item being transacted.   So the neoclassicals are the claimants here:  they’re saying that there is an emergent phenomenon in which demand becomes irrelevant for the macroeconomy.   They are using an updated version of  Say’s Law to argue that demand goes away, not that it never existed–that would be crazy.

Show me the evidence that it doesn’t exist, then we can talk.   Yes, that’s hard.   Tough… you’re the one making an outlandish claim, now live with it.

The second thing to notice is that phlogiston isn’t even phlogiston as Noah means it… rather phlogiston is a perfectly reasonable and testable scientific hypothesis, the study of which led to our understanding of oxidation.

2)  You don’t need sticky prices to get demand curves

You don’t need sticky prices to get aggregate demand, rather sticky prices are the simplest (in modeling terms) way to get rid of Say’s law while otherwise keeping the market clearing assumption intact.  Now market clearing is not necessarily a good assumption, but even more than the sticky prices are, it is a standard one.

Of course, no microeconomist worth half his or her salt would ever think market clearing is necessary because market clearing doesn’t always happen in the real world (look around).  Store shelves are rarely bare, there are usually tables empty (or people waiting in line) at restaurants and some people pay outlandish prices for tickets to sporting events from scalpers even as some seats go unfilled.   You can talk all you want about how sticky prices are a bad assumption, but the real problem here is that it’s silly that macroeconomists insist on market clearing.

This is a long winded way of saying that anything which breaks Say’s Law can substitute for the sticky-price assumption: 1) nominal debt not indexed to inflation, 2) demand for financial assests, or 3) non-stantionarity and knightian uncertainties.   I’m sure I’m missing some other possibilities.

These are all “reductionist” explanations and once again, that’s my point.   It is the neoclassicist demand-deniers who are flipping the script here and insisting on a systemic explanation for why demand should disappear in the aggregate.

I can go on, but this post is already getting too long.  For my take on AS/AD in particular, see this.  I think that answers Noah’s implicit objection.