Thursday, May 30, 2013

Contra the Renegade Noah Smith

Get off of my lawn.

update: No not you Thomists.  Also more here
Please click this link.

Noah Smith has something nice to say about a DSGE model.

I get really really cranky in comments.  this post is pure curmuggeon therapy and not worth reading.  the story is a DSGE model plus the financial accelerator due to Bernanke Gertler and Gilchrist (1999) fits the data from the great recession OK:

I comment.

Wow you were impressed ! I am feeling very very cranky, partly as i feel abandoned on anti-DSGE Island.  I haven't read the paper, so my comment isn't worth reading.

That said, I will now imagine a superficially convincing but invalid article with that title and abstract.

1) Recall the absolutely key fundamental insight  "making predictions is difficult, especially about the future" Yogi Berra  [update spelling corrected thanks to anonymous -- I'm a worse speller than the average angrybear booboo].  What we have is 4 years after the event a working paper in which a DSGE model manages to fit the now long known data.  Fitting is not forecasting.  It is easy to be wise after the fact.

2) I claim DSGE models generally need one arbitrary constant per phenominon to explain.  In this case it is the correlation between a quality premium and subsequent output growth.  Scientific success occurs when the number of stylized facts fit or correct predictions made exceeds the number of degrees of freedom.  A failed approach is neck and neck with the data.  DSGE seems not to have pulled away with this paper.

3. The number of exogenous unexplained random variables keeps growing.  2008 was extraordinary, because a large but not post WWII unprecedented downturn was associated with huge huge yield spreads.  I am pretty sure that they are ascribed to something unobservable.  In Bernanke Gertler Gilchrist 1999 quality premia change endogenously with GDP.  Ascribing 2008 to a financial shock will not shock anyone.  The question is whether we can predict such financial events.  A model with exogenous shifts is the variance of ability across entrepreneurs does not do this.

4)is there anything added by the D or the GE ?

In Bernanke Gertler Gilchrist 1999 the effect of investment decisions by other firms on sales by this firm and so the interest rate it must pay to borrow are modelled.  There is something genuinely general equilibrium there.  I concede that it is a good paper in the (fairly recent) theoretical macro literature (I think this may be my only such concession except for related papers by over-lapping sets of authors).

But you can get a good fit to recent investment with an accelerator and an even better fit if you toss in "loan officer report on lending conditions"

Consumption is always well modelled as a backward looking smoothed series of aggregate disposable income.  Real output is well modelled as aggregate demand.  I think inflation is well modelled with an adaptive expectations augmented Phillips curve.

Models which are, by now, ancient, fit the data very well certainly needing no more fiddling than the DSGE model which fits OK.

What is the point of DSGE ?  The idea is that a micro founded model makes useful predictions following extraordinary events (so just looking what happened last time isn't OK).  That sure didn't work for DSGE in 2009.  Or also that they work across changes in policy regimes.

So a multiplier accelerator Phillips curve model would make the same predictions whether or not the FED were attempting extreme non standard monetary policy.   Uh it did. and it fit the data.  Fancier models made it possible to fantasize about manipulating expectated inflation and therefore getting higher investment than one would guess with an accelerator.  The linked study [update: the Goldman-Sachs study cited by Menzie Chin at econobrowser] shows that this was a step away from reality.


Anonymous said...

That's "Yogi".

Rich C said...


What's the "linked study" you refer to in the last paragraph? There doesn't seem to be a link in the body of the post that i can see.

paine said...

i like this post

u arrogant bastard !