Phlogiston Economics

Richard Thaler wants to bring back the old word “aether” that used to refer to the (non-existent) medium through which waves of light pass, the way sound waves pass through air:

Aether variables are extremely common in my own field of economics. Utility is the thing you must be maximizing in order to render your choice rational.

Both risk and risk aversion are concepts that were once well defined, but are now in danger of becoming Aetherized. Stocks that earn surprisingly high returns are labeled as risky, because in the theory, excess returns must be accompanied by higher risk. If, inconveniently, the traditional measures of risk such as variance or covariance with the market are not high, then the Aetherists tell us there must be some other risk; we just don’t know what it is.

Similarly, traditionally the concept of risk aversion was taken to be a primitive; each person had a parameter, gamma, that measured her degree of risk aversion. Now risk aversion is allowed to be time varying, and Aetherists can say with a straight face that the market crashes of 2001 and 2008 were caused by sudden increases in risk aversion.

I think I’d prefer the use of the term “phlogiston” for these purposes, but I think it’s a good point. In Kuhnian terms, we’re at a point where the prevailing academic approach in macroeconomics is accumulating more problematic anomalies but behaviorist critics haven’t really produced a workable alternative paradigm. Consequently, actual practical policymakers are relying a lot on economic history, intuition, etc.