Financial Sense University ~ King of the Mathletes by C. J. Maloney 11/28/2004

The economy changes in ways that tend to limit
the relevance of historical observations for policymaking.
- Fed Vice Chairman Ferguson, 10/29/2004

I stumbled across Dr. Sargent’s The Conquest of American Inflation because like most who work in the financial world I am always looking for information. A colleague of mine was giving a lecture on TIPS (Treasury Inflation Protected Securities) and since I own some in my portfolio he asked me look at his notes beforehand. Seeing this book cited in one of his footnotes, the title alone had me in buying mode.

Give Dr. Sargent his due, it takes some courage to release a book with a title like this – you set yourself up to be quickly relegated to the bargain bin with other titles such as Dow 50,000 and Courtney Love’s Book of Etiquette for Young Girls. Then again, judging by the inexplicable success of his fellow Stanford professor Dr. Paul Ehrlich - who has made quite a career out of being ridiculously, consistently inept - maybe Dr. Sargent feels assured of a mulligan.

The book jacket states that The Conquest of American Inflation is “a groundbreaking analysis of the rise and fall of U.S. inflation after 1960” though I have no idea where the person who wrote the jacket’s blurb got that idea. He obviously didn’t read the book because the subject covered is anything but an analysis of U.S. inflation. Instead, it’s a less than riveting blow-by-blow account of Dr. Sargent playing with “econometric” models.[1] This book has surely made him quite the celebrity amongst the Mathletes.

Dr. Sargent explains in the book that inflation has been licked (well, maybe) and “proves” so by citing two causes: the use of models showing “the natural-rate hypothesis joined to the Lucas critique and a more traditional econometric policy evaluation modified to include adaptive expectations and learning”. Sitting in my favorite chair with a bottle of No-Doze at my side, while reading this book it became clear to me that I really need to get out more.

I did not investigate this book past its title before I splurged four dollars to buy it on line, and I must admit the book is not quite what I was looking for. You would figure that in a book such as this the author would at least give a chapter or two explaining to the reader the cause of inflation. Not here. The only hint the good doctor gives is a brief “adherence to the gold standard…gave the U.S. low inflation and low expectations of inflation”. In addition, we get a cute “if we take for granted that inflation is under the control of the Federal Reserve”, as if some other body in the U.S. creates money.[2] That’s it, then on to oodles and oodles of graphs and mathematical formulas.

Inflation came about due to bad, misguided econometric models, according to the good doctor. Dr. Sargent posits that in the early 1960s Dr. Samuelson and Dr. Solow “taught that the Phillips curve was exploitable and urged raising inflation to reduce unemployment” but this is a complete crock. Dr. Keynes, the patron saint of Big Meddling Government, “taught” that misguided foolishness in his General Theory three decades prior. And Keynes got the idea from the Birmingham School, Silvio Gesell, and all the Inflationists of earlier centuries. Samuelson, Solow, and Keynes were not economists, they were crackpots who gave pseudo-intellectual varnish to the idiotic theory that one needs not create wealth to bring prosperity, one needs only to print pieces of paper with numbers on them.[3]

Dr. Sargent notes that “to everyone’s dismay, over time the Phillips Curve shifted adversely” so, like Superman (but better at math) he has flown in, calculator and spreadsheet at the ready, to cram reality onto his zippy new model. One could easily get the impression that Dr. Sargent believes the models are the reason inflation has purportedly gone the way of the dodo bird. The author claims that he takes “an important idea…an adaptive model allows a government to learn from past attempts to exploit the Phillips Curve and to discover a version of the natural-rate hypothesis that instructs it to reduce inflation.”

The problem with the Phillips Curve is that nobody has the slightest idea how to accurately measure it, and by the time the data is in, it’s already changed again - it being a constantly moving target. The Phillips Curve is the supposed trade off between unemployment and inflation. How to explain then the late 1970s, when everyone noticed the robust inflation because their unemployed selves had plenty of time to sit around and read about it? So besides being completely immeasurable, the Phillips Curve was discredited three decades ago - except in the minds of whiz kids who worship the idol of Math. It’s not a bad theory, they say, it just “shifted adversely” on them, much like that iceberg shifted adversely into the path of the unsinkable Titanic.

How can one use mathematical formulas to “manage” the economy when – and even the Mathletes will admit this – those formulas consist entirely of variables? Dr. Sargent notes Dr. Lucas’ critique that “typical economist forecasting practice…frequently adjust(ed) constant terms in important equations” (italics added). The use of mathematical formulas to predict the economic future based on past outcomes makes about as much sense as the use of mathematical formulas to estimate how insane a mental patient is and how he will respond when you take away his favorite axe. Math has its uses, but like Grady Little at a Red Sox fanfest, there are some places where it just doesn’t belong.

The author also states that, “the remainder of the essay explores alternative modifications of the basic model that might produce the observed outcome history (italics added). I…economize on free parameters. I embrace minimalism to discipline my venture into the wilderness of bounded rationality”.[4] So he “economizes”, “embraces minimalism”, and “ventures into the wilderness of bounded rationality”, cramming, assuming, and jamming his econometric model onto the known historical data to “produce the observed historical outcome”. And this teaches us what, besides how to back test formulas? How does this help us to “predict” the economic future? Bottom line, it doesn’t. Life is nothing if not change (except for the perennially inept Mets front office) and soon enough some other Mathlete will knock Dr. Sargent’s model off its pedestal.

As far as the laws of mathematics refer to reality, they are not certain;
and as far as they are certain, they do not refer to reality.
-Albert Einstein

The meat of this book is gobs and gobs of mathematical formulas; it’s chock full of drifting coefficients, self-confirming equilibria, least squares learners, and recursive learning algorithms. I don’t know how gifted an economist Dr. Sargent is but, take it from me, he is very, very, very good at math. When all is said (well…calculated) and done, this book, which is purportedly about economics, is about nothing of the sort – it is a math book.

So if you’re looking for an explanation of the rise and fall of American inflation from 1960 onward, you won’t get it here. If you’re in need of a refresher course in advanced mathematics then this is your book. Dr. Sargent gives no explanation for the seeming conquest of inflation other than a lame sigh that “we hope that policy makers somehow have learned a correct rational expectations version of the natural rate hypothesis and have found devices to commit themselves to low inflation”. In other words, buy from Dr. Sargent’s Econo-models R Us.

Dr. Sargent, like Dr. Keynes, is a Court Economist. (This book was written in part using funds from the National Science Foundation and the National Bureau of Economic Research.) He is in favor with the power structure because he whispers in the ear of the powerful that yes, it is possible to manage the workers’ affairs better than they could do it themselves. He gives power hungry reactionaries the ammunition, in the form of useless mathematics, to fool the workers into believing that groups of “experts” encumbered with doctorates should usurp decision making from the masses, that twelve old men in a conference room can use their Mathlete ability to “steer” the economy better than millions of free men making individual choices ever could. If nothing else, The Conquest of American Inflation proves the central planning mentality that wrecked the Soviet Union is alive and well.

In the end, Dr. Sargent and the rest of the Mathletes who somehow have taken over the study of economics are much like the Star Trek dorks that have taught themselves Vulcan. They all sit in the corner, pontificating haughtily to each other in a language that nobody understands. Unfortunately, because of their slavish devotion to the State, the Mathletes have taken over the helm from Sulu; they are piloting the Enterprise using their ridiculous econometric models for a map. If the laws of economics are any guide, the policies of central planning which these Ph.D. encumbered Mathletes champion are going to sail our economy right into an iceberg.[5]

[1] Econometric models are the drug of choice for those who practice “positive” economics. Positive economists believe that mankind and his behavior can be accurately predicted through the use of mathematical formulas…sometimes…but not always…and with exceptions. From what I can gather, positive economists aren’t really positive about anything at all.

[2] Though admittedly my Uncle Louis was a pretty well known counterfeiter in 1930s New York City, I doubt Dr. Sargent has him in mind.

[3] My dear Uncle Louis died penniless in a Florida trailer home, and let that be a lesson to him.

[4] I think he is plagiarizing Robert Frost here.

[5] As a Vulcan would say, “Itisha choshonai!” (It will not work!)

The opinions of FSU contributors do not necessarily reflect those of Financial Sense.