The Permanent Income Hypothesis and Why Mark Sadowski is a Typical Macroeconomist

     Not to pick on Mark-with whom I've buried the hatchet and I basically like. Also I don't think Tom Brown could take me having problems with Mark again. However, I did think of him here in a piece Richard Waldmann wrote about Milton Friedman's Permanent Income Hypothesis. 

     "To begin at the beginning, the Permanent Income Hypothesis is the conjecture that it is useful to model consumption savings choices by treating consumption at different times as consumption of different goods and imagining an agent who maximizes an inter-temporal utility function subject to an inter temporal budget constraint. I add that I think of it as including the assumption that it is useful to model aggregate consumption as the decisions of a representative consumer. The PIH as introduced by Friedman did not include the assumption that the consumer has rational expectations and thus did not imply that the resulting choices were optimal. However current usage of the phrase now implies, at least, that the assumption of rational expectations is a good approximation."

     "So far even with a representative consumer with rational expectations, there isn’t enough there to justify the word hypothesis. That is to say the assumptions have no implications at all without some further assumptions about the utility function. The key standard assumption which gives content to the PIH is that utility is the sum of pleasure from consumption and a function of everything else we care about (that the utility function is additively separable in consumption and everything else). This is a very standard assumption in main stream macroeconomics. It is often relaxed if the aim is to test the PIH and to avoid rejecting it (yes I am asserting that this research program starts from the conclusion). But, as far as I know, the assumption is almost always made and used when the PIH is used (rather than protected from the data)."

     "These assumptions are enough to get a falsifiable hypothesis as is demonstrated by the fact that the PIH with separability is rejected by the data. Predictable changes in income should not be associated with changes in consumption and they are. The typical macroeconomist’s reaction (as always) is to shrug his or her shoulders and say that models are false by definition and the Permanent Income Model (PIM) is useful, because it captures some aspects of the data, that is provides explanations for some otherwise puzzling patterns."

   - See more at: http://angrybearblog.com/2014/01/is-the-permanent-income-hypothesis-glass-half-full.html#more-21221

     I'm thinking about the part about the reaction of 'they typical macroeconomist shrugging their shoulders and saying all models are false anyway what matters is how useful they are.' I seem to remember Mark making this argument somewhere-I don't have the quote though if I had to I could probably dig it up. I think it was regarding Granger Causality showing that the increase in the monetary base since 2008 has helped the recovery. 

     Waldman's post-which is not about Mark Sadowski-is very interesting as it looks at the PIH and he's very skeptical. The PIH is just one of those things that you almost feel like you're spitting into the wind regarding it as while we can certainly argue whether it's true or not-or whether for that matter it's useful or not-it's hard not to wonder if it will make any difference at all at least in terms of how mainstream Macro is done. The real story is not whether it's true or not-I think a strong case can be made it's netierh true or useful-but that Macro believes it true and its hard to see what might pry this from it's cold dead hands. Just like its hard to see what would pry say Rational Expectations, DSGE or the need for microfoundations-the Lucas Critique-or Long Run Monetary Neutrality from its cold dead hands. 

     To speak of 'typical macroeconomists' of which Sadowski evidently is-but I for one aren't, which is why Sumner thinks I have no right to an opinon on economic issues at all-is to speak of soemone who believes in all these things as much as they believe the sun will come up tomorrow or that 2+2=4. Indeed, this is not a bad place to evoke Sumner's hero Richard Rorty here who believed that even in supposed sciences-even 'hard sciences' rather than squishy social sciences like economics, no matter what it wants to believe-there is still a social consensus around 'truth' discourse and 'truth' statements. Rorty argued that social consensus is everything in any kind of truth discourse-he saw Winston's fate in 1984 as pretty much out of luck as there was nowhere for him to appeal against Orwellian society. 

    Nevertheless, I still am very untested in debates that do quest6ion these Macro verities. In his latest piece questioning PIH Waldmann appeals to what I consider a pretty impressive authority himself-Keynes in the General Theory. 

    "Keynes dismissed the PIH (well before it re-emerged) as follows when discussing consumption in Chapter 8 of The General Theory …

(6) Changes in expectations of the relation between the present and the future level of income. — We must catalogue this factor for the sake of formal completeness. But, whilst it may affect considerably a particular individual’s propensity to consume, it is likely to average out for the community as a whole. Moreover, it is a matter about which there is, as a rule, too much uncertainty for it to exert much influence.

    - See more at: http://angrybearblog.com/2014/01/is-the-permanent-income-glass-half-full-ii.html#sthash.LuF1TFq7.dpuf

      This was a pretty stark position on PIH by Keynes-that whatever this means at the individual level, it averages out for the community as a whole and so doesn't matter for macroeconomics. In other words, it's not only untrue-as supposedly all models are-but it's not interesting either. 

      P.S. Not to be too graphic but I'm wiping my face off as the wind just blew my spit back into my face. 

      P.S.S The Rortian point is that while I or Waldmann or Warren Mosler, or maybe you the reader, may disagree with PIH, Rational Expectations, or Long Run Monetary Neutrality, mainstream-who are the only ones that matter-macroeconoimsts do. Those who don't are dismissed like you or I might dismiss a man declaring himself to be Napoleon or God's Thumb. Remember the angst Bertrand Russell had about how there has to be more reason to prove a man is not a poached egg than that the govt doesn't agree with him. Rorty's argument is basically, no there isn't. 

    P.S.S.S My point is not to discourage, just trying to make it clear what's at stake. Zizek thinks there's virtue in the Lost Cause. 

    http://www.amazon.com/Defense-Lost-Causes-Slavoj-Zizek-ebook/dp/B004GKMBIO/ref=sr_1_1?s=books&ie=UTF8&qid=1390752000&sr=1-1&keywords=zizek+in+defense+of+lost+causes

   I'm not a Zizekean to be sure but that's a conversation another day. 

    UPDATE: I like this quote by Waldmann

    "My way of putting this is to consider the PIH an alternative hypothesis to the Keynesian null that intertemporal budget constraints can be neglected when modeling aggregate consumption"

  . - See more at: http://angrybearblog.com/2014/01/is-the-permanent-income-hypothesis-glass-half-full.html#more-21221