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Thursday, September 25, 2014

The usual comment on Wren-Lewis

Simon Wren-Lewis has a very thoughtful post on what went wrong in Macroeconomics. I wrote the same thing I always do (see below). I also tried to answer his questions.

I will write a second comment. I will try to respond to your questions. I wasn't an economist in the 70s so (as usual) I don't know what I am talking about.

"So why didn’t this happen? Why did we have a revolution which overturned an existing methodology and temporarily banished Keynesian theory, rather than an adaptation and augmentation of what was then mainstream?"

"Was the attraction of overturning orthodoxy too strong, as it is for a minority of heterodox economists today? "

I think this attraction was very strong. There is something else. A couple of Economists from U Minnesota mentioned Harvard for no clear reason -- I think there was and is an element of Midwestern pride (neither of the economists is originally from the USA). In particular a distasteful aspect of appeals to common sense or judgment is that they are and must be assertions of intellectual authority. Math has the appealing feature that a proof is a proof and does not rely on the authority of the person stating it.

" Did an ideological imperative of dismissing Keynesian ideas play a role?" I think it definitely did. Friedman, Lucas, Prescott and Barro are very ideological. The models change but the policy proposals remain the same. Views on methodology change (Sargent asserted that Lucas and Prescott were all in favor of testing models as null hypothesis until he rejected their favored models).

"To what extent was the hostile reaction of many in the macroeconomic establishment to eminently sensible ideas like rational expectations responsible? "

I think the extremely hostile reaction played an important role (of course, I don't think that rational expectations is a sensible idea).

"Was the attraction of a methodology where at least you could be sure you were consistent too enticing, ? "

Here I would say that mathematics was enticing. Writing papers that look like Physics except the variables have different meanings is enticing.

"perhaps encouraged by increasing segmentation between theoretical and empirical macro? "

I'm quite sure this came later. In the 70s and early 80s new Classicals developed new empirical tools and did a lot of empirical work. I think theoretical macro separated from empirical macro when the data kept saying that new Classical models were not good approximations to reality.

So far, I have made no progress towards understanding how a few departments were so influential. Here I think that hard work and the passion due to fanaticism were important. The general rightward political shift also must have mattered. I think that the loony left managed to cast discredit on Republican Keynesians somehow. But I really don't understand how and why it happened.

I have two other thoughts.

If macro theory (or non theory or ad hoc models or whatever) were about as good as it is would ever be in 1973, PhD candidates and junior faculty would still have to present something new. In fields which aren't progressing a new and crazy original contribution is preferable to an unoriginal contribution. Here I think the trouble is that some questions in macro are too simple and have for decades been answered well enough to serve. I think it is very easy to fit consumption and investment without theory -- 1960s equations fit well out of sample.

If aggregates depend on expectations which are not rational nor adaptive nor anything which can feasibly be modelled, then the problems of stabilizing output and even of forecasting can't be solved. If so the only reasonble thing to do is to try something and if it fails badly try something completely different.

I think many of the questions are too easy and have been answered (but young researchers can't afford to accept this) and the unanswered questions are too hard (I fear unanswerable).

Now my usual boring pointless comment

Here I am again more certain than ever that this comment serves no useful purpose. You support an eclectic approach and not the utter rejection of all of the past 40 years of theoretical macroeconomics. I guess this must seem obviously reasonable to you and to basically everyone. However, while you have very often stated this view, I don't recall much in the way of argument, evidence or even examples.

"Microfounded models could have shown the kind of errors that can arise in more empirically based models when theory is ignored or only applied piecemeal, "

for example ? To be sure such errors can arise, one should point to examples of such errors arising. The classic example is the 1960s era Keynesian ad hoc assumption that the Phillips curve is a structural relationship. This error never happened. It may well be that going to the data armed only with common sense and verbal arguments leads to errors which would have been avoided if one used formal theory. But to claim that such errors occured, one should cite them with authors, dates, titles, Journal titles volume and page numbers.

"However I also think the new ideas that came with that revolution were progressive. I have defended rational expectations, I think intertemporal theory is the right place to start in thinking about consumption, and exploring the implications of time inconsistency is very important to macro policy, as well as many other areas of economics. I also think, along with nearly all macroeconomists, that the microfoundations approach to macro (DSGE models) is a progressive research strategy."

I note that the word "progressive" appears twice. I think it is very useful, too useful. To argue that something is progressive, one need not point to achievements. The word is consistent with the claim that the approach will in the future yield valuable fruits. I recall reading in 1982 Sargent expressing the hope that realistic micro founded models which could be taken seriously and confronted with the data would be developed in the following 30 years. I say time is up.

I also note "to start". Now the claim that something is the right place to start can't be disproven. The claim is that something good will happen. I know of no evidence against the view "(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." Keynes 1936 chapter 8 section II.

I have 2 3 final questions.

1. What evidence could possibly convince you that intertemporal theory is not the right place to start in thinking about consumption ?

2. What evidence could possibly convince you that DSGE isn't a prgressive research program ?

3. What could the data do which they have failed to do in the past 40 years ?


Luis Enrique said...

I tend to make the same comment in these discussion too (my one about the consequences of focusing on exogenous shocks as the source of fluctuations and neglecting models endogenous crises.)

But I never get any traction. I am always hoping Simon or someone will pat me on the head and say, yes you're right, that is important.

I am perplexed. It seems to me that it *is* important - most critics of mainstream economics do seem to want it to predict crises, or at least have something to say about how they come about and how to prevent them, and it seems obvious to me that mainstream macro just hasn't been in that game.

But in all the very many discussions of the failings of mainstream macro I read, this point never seems to come up and it's all about the shortcomings of intertemporal optimization, representative agents. Now I suppose they might expect the reader to make the connection for themselves that these approaches make it difficult to model endogenous crises and such like, but why not go directly to the point?

Am I missing something?

Larry said...

I think the point he's trying to make is that your three questions sound like word salad to him.

Dan said...

A devastating question:
What could the data do which they have failed to do in the past 40 years ?

To have followed by this:
"the unanswered questions are too hard (I fear unanswerable)."

Oh well.

I don't think the ananswered questions are unanswerable, I think they are the wrong questions.

No one asks an architect to predict what his new building will look like by surveying (even with great mathematical rigor) all extant buildings. We ask architects to build us the building we want exploiting the knowledge that was gained in building all past buildings.

Economics would be far less dismal if it dreamed about how to make the economy we like rather drearily examining what has been as evidence of what must be.

why so dismal?

Robert said...

I note the word "unanswered" in the second bit you quote. Those questions are
1) how do people really form exectations ?
2) what's going to happen ?

In contrast, I think some questions have been answered.

I think they include
1) is the Permanent income Hypothesis true ?
As originally stated it is false. To argue that it should be considered a model not a hypothesis is to argue that Milton Friedman was totally wrong. He not I called it a hypothesis

2) is an intertemporal optimizing consumer a good place to start when modelling aggregate consumption and savings ? I think the answer is clearly no. It is widely agreed that it isn't a good place to end, but I think the approach contributes no useful insights at all. I have challenged Wren-Lewis to describe one such useful insight. His response was "very thin gruel." -- P Krugman
and didn't address aggregate consumption at all.

3) Is a model of shareholder value maximization considering installation costs a good place to start when modelling investment ? Here I note that it has been abandoned in the state of the art DSGE models. The accelerator fits the data well.

well things like that.

The kind of questions we can answer are
1) is this hypothesis rejected by the data
2) Is this model a useful approximation to the data
3) Do more recent models outperform 40 year old models ?

The question which is not answered is "OK so if the answers to are no, no, and no, then what are we supposed to do to understand macroecomics and achieve good macroeconomic outcomes.

I think your comment proves that you can't grasp the possibility that some questions have been answered and some questions have not been answered. I see no other explanation for your chose to ignore my qualifier " unanswered"

Anonymous said...

I tend to think that there is a strong tendency in economics and business schools to align themselves with the wealthy. It's something that was prevalent in the 19th Century and the Great Depression was the break in that alignment. However, it was always a strong feeling to suggest wealth must have been earned. Also, the simplicity of a Newtonian type clockwork of a free market without government is a seductively neat way of viewing the world. And so, any deviation must be the fault of an interventionist government.

Anonymous said...

Fortunately for the world no one cares about your opinion.