OK, since my body clock still thinks I’m in Australia, I (TP) think it’s OK to violate our no-posting-in-the-US rule for just this once, to follow up on my earlier post on the debt ceiling.

The question here is, how did my little model do? The answer is, good not great. There are a couple of issues here. The outcome–a near complete capitulation by the Ds to the Rs–is not my final prediction, so that’s not good. But there are several reasons why a little model might not predict reality.

• The model is wrong somehow. I don’t think is it. For what I intended the model to do, I think it stands up very well in explaining the essential logic of the debt ceiling crisis. The logic of the positions is correct, from what I can tell. It’s just that the Rs stood firmer than I anticipated, a prediction which only comes out informally at the very end of my discussion.
• The model makes technical simplifications. This is part of it: due to the fact that I’m not any good at math I only entertained a 2×2 game structure with discrete strategies (vote yes or no), and clearly any actual debt ceiling negotiations involved negotiations allowing for continuous strategies. The model sacrifices reality to be more tractable, with obvious consequences.
• Actual events are random draws from a distribution of possible outcomes. Maybe relevant too. This is what ever good poker player knows, and most critics of formal theories of politics forget. Think about it this way: if you’re playing no limit Hold ‘Em and find yourself raising pre-flop with pocket aces, but get beat by someone who flops a boat, you probably didn’t make a mistake by raising pre-flop, you just got a bad beat.
• People aren’t rational. Possible. I think in the case of Obama himself, there’s evidence that he is not responding to incentives and new information about his opponents in a way that a rational Bayesian learner would. He seems to believe things about the Rs’ willingness to compromise that don’t seem compatible with reality. [ed.–Would love MGr’s and MGl’s reactions to this claim.] Beyond that, everyone else seems pretty rational to me.
• Games are nested. I think that this the real issue. We can’t forget that the final debt ceiling crisis is part of a much larger game between the Ds and the Rs, and a lot of the relevant considerations for players calculating optimal strategies are external to the specific vote on whether or not to raise the debt ceiling and the small number of parameters I’ve included. I’ve long thought that the very fact that we had a debt ceiling crisis at all means that the Ds had already lost the ability to make and defend coherent economic policy positions. I just thought that they would stand firm.

The good news, as I mentioned before, is that in capturing the essence of the interactions between Ds and Rs over the debt ceiling, and understanding why the crisis looked the way that it did and lasted as long as it did, my exposition does well.

The real news now though is the market reaction (not great) and the subsequent economic data which has been released (very discouraging). What is striking to me now is a point to which I alluded earlier: the complete and utter refusal of US politicians to advocate for a coherent policy response based on basic economy theory. We used to know that when interest rates were really low but banks still weren’t lending and the economy was still stalled, governments should spend. Today, no politician–not a D, not an R, not a president–is willing to take this position. Instead, Washington is obsessed with debt and tax cuts. The reason why no politician will explain to you precisely why cutting taxes and decreasing spending over the next 20 years will help the US economy over the next 5 is because, well, it won’t.

There are various reasons for our politicians’ current ignorance. One is the really terrible state of economic literacy among the Americans. Lots of people study business in college, fewer study macroeconomics. The really smart ones who do study macroeconomics work in the financial sector, not politics, and they are screaming for more government spending right now. One is that macroeconomics is difficult, and that leads people to try to look for analogies in how you run a national economy in how they run their household or their small business, which create a huge fallacy of composition (if your household is almost bankrupt you should stop borrowing, and that is not necessarily true if you’re a national economy). One is possibly naked greed, but I don’t think that that is it really, because a greedy person would be willing to trade a higher tax bracket for a much higher income (which a good economy will give you), and that doesn’t seem to describe the nature of the debate right now.

But there also might be something in the way that leaders lead. I think that this is important, and not something amenable to game theoretic analysis. I can pick on Obama, but it’s not just his fault, it’s a general problem among the Ds, the party that would have the ability to advocate a classic Keynesian response to the current crisis. They seems unwilling or unable to stand up and recite the lessons of Econ 101.

UPDATE: Another obstacle to embracing a coherent policy response to our current economic maladies might come from academic economics, in the form of real business cycle theory. For better or for worse, RBCT enjoyed great prestige in the 1980s especially, and its intellectual champions remain active and influential. Simplifying greatly, RBCT starts with the assumption that all markets for goods, labor, and capital clear, which means that the business cycle–that is, the variation around the trend in how economies perform over the long term–must be explained by random shocks (yes, literally) to the economy. You get terms like “adverse technology shocks” to explain why recessions occur (Noah Smith discusses the logical implications of this sort of view applied to the current crisis).  Sneakily, then, economists who follow this line of thinking don’t have to think carefully about the origins of recessions, because they are unanticipated and unpredictable, or else they wouldn’t be random. One additional consequence of this line of thinking is that government action (monetary policy or fiscal policy) can at best do nothing to redress the business cycle. Here is an early, devastating critique from Larry Summers.

What makes this relevant for my discussion is that this sort of thinking is currently popular among many of the libertarian types of economists who tend to have blogs and lots of readers. The internet and libertarians go together like PB and J. It’s unlikely that many of these people strictly believe that RBCT is a good model; rather, they like the implication that government action can never be useful, and they sort of latch onto RBCT from time to time because that’s one of the things that  RBCT says. Blog readers usually don’t know that ins and outs of the models that produce these predictions but my sense is that they are still influential among the commentariat.