Misunderstanding Macroeconomic Models

The get-go one-half of this postal service is meant for non-economists, but it ends alongside a brace of points on OLG modelling

I lately wrote a post from Unlearning Economics (UE) has precisely appeared inwards Pieria. UE says it “helps to illustrate the troubles faced past times contemporary macroeconomics”. One of UE’s complaints seems to reverberate a misunderstanding, frequently shared past times non-economists, nearly what much academic macromodelling is designed to do.

UE objects to the fact that the model assumes that the amount the immature tin transportation away borrow (the bird of leverage) is exogenous, which agency that at that topographic point is no endeavor to explicate where this constraint on the borrowing of the immature comes from. UE also complains that the model contains no banks, together with no investment inwards physical capital. In other words, the model is much also simple. It is a natural plenty idea: to explicate what mightiness live currently going on, y'all demand a to a greater extent than complex model that includes everything that could live important.

There is sure enough a house for this sort of to a greater extent than elaborate model. Christiano, Eichenbaum together with Trabandt inwards this paper desire to struggle that a model based on New Keynesian theory tin transportation away runway what has happened over the in conclusion 10 years. Their model has twoscore equations. If I was trying to produce a similar exercise, I would desire to augment the criterion New Keynesian framework alongside at to the lowest degree the following: nominal wage stickiness equally good equally toll stickiness, a fiscal sector that endogenised both the cost together with rationing of credit, a model of consumption which allowed for credit constraints together with precautionary saving, a housing market, a model of the labour marketplace that combined matching alongside rationing (as here), together with something that allowed recessions to bring long lasting (hysteretic) impacts on labour provide together with technical progress. However large models similar this volition involve many macroeconomic ‘mechanisms’, together with it volition to a greater extent than frequently than non live unclear which mechanisms are of import at driving item results or explaining item facts. We produce non desire to process the elaborate model equally a dark box, but instead nosotros desire to sympathise its properties.

To sympathise complex models, nosotros demand much simpler models. (I 1 time - inwards this post on the Eggertsson together with Mehrotra post from Unlearning Economics (UE) has precisely appeared inwards Pieria. UE says it “helps to illustrate the troubles faced past times contemporary macroeconomics”. One of UE’s complaints seems to reverberate a misunderstanding, frequently shared past times non-economists, nearly what much academic macromodelling is designed to do.

UE objects to the fact that the model assumes that the amount the immature tin transportation away borrow (the bird of leverage) is exogenous, which agency that at that topographic point is no endeavor to explicate where this constraint on the borrowing of the immature comes from. UE also complains that the model contains no banks, together with no investment inwards physical capital. In other words, the model is much also simple. It is a natural plenty idea: to explicate what mightiness live currently going on, y'all demand a to a greater extent than complex model that includes everything that could live important.

There is sure enough a house for this sort of to a greater extent than elaborate model. Christiano, Eichenbaum together with Trabandt inwards this paper desire to struggle that a model based on New Keynesian theory tin transportation away runway what has happened over the in conclusion 10 years. Their model has twoscore equations. If I was trying to produce a similar exercise, I would desire to augment the criterion New Keynesian framework alongside at to the lowest degree the following: nominal wage stickiness equally good equally toll stickiness, a fiscal sector that endogenised both the cost together with rationing of credit, a model of consumption which allowed for credit constraints together with precautionary saving, a housing market, a model of the labour marketplace that combined matching alongside rationing (as here), together with something that allowed recessions to bring long lasting (hysteretic) impacts on labour provide together with technical progress. However large models similar this volition involve many macroeconomic ‘mechanisms’, together with it volition to a greater extent than frequently than non live unclear which mechanisms are of import at driving item results or explaining item facts. We produce non desire to process the elaborate model equally a dark box, but instead nosotros desire to sympathise its properties.

To sympathise complex models, nosotros demand much simpler models. (I 1 time - inwards this paper - called the procedure of relating complex models to simpler models ‘theoretical deconstruction’.) In fact it is frequently sensible to start alongside the simpler model. For example, a item number alongside secular stagnation is to exhibit how the natural existent involvement charge per unit of measurement tin transportation away live negative for decades rather than years (i.e. beyond the Keynesian brusque term)? What machinery tin transportation away produce this? As I explained inwards my post, neither a criterion representative agent model nor a criterion ii current overlapping generations model (OLG model, where the ii generations are those earning together with those retired) volition give y'all that result. What Eggertsson together with Mehrotra exhibit is that a real uncomplicated 3 current OLG model (which adds a immature generation that borrows) where borrowing past times the immature is constrained (they would similar to borrow to a greater extent than but cannot) tin transportation away provide precisely that mechanism.

That is a fundamental indicate of the paper. The newspaper is non designed to explicate where borrowing constraints come upward from: at that topographic point is directly a large literature on that. Thankfully the authors produce non experience compelled to microfound these constraints. Instead the newspaper only offers together with explores a machinery whereby an increase inwards these borrowing constraints could motion the natural involvement charge per unit of measurement into negative territory, together with for it to remain there. Having established that result, it is for subsequent run (which the authors intend to do) to encounter if that machinery survives complicating the model, past times for instance adding investment.

Suppose the endeavour is successful, together with a to a greater extent than complex but realistic model is able to provide an concern human relationship of secular stagnation that includes other of import mechanisms together with which is based on a realistic laid of parameter values. That would live a success, but those non familiar alongside all the run would ask: why does this model permit existent involvement rates to live negative when the criterion models nosotros know produce not. The response would live that the 3 current OLG construction was critical, together with to encounter why bring a await at the original, uncomplicated model.

Now y'all mightiness enjoin the authors should hold back until they bring built the to a greater extent than realistic model earlier creating what could plow out to live a inquiry path that mightiness neglect to laissez passer on its goal. That would live quite wrong, because the to a greater extent than debate at that topographic point is inside the academic community when ideas are at their early on stages the better. I desire to give an instance of this, but hither I volition move into territory that volition in all probability solely involvement macroeconomists.

It mightiness live the case, for example, that the authors intuition that their results volition hold upward introducing other assets similar physical majuscule tin transportation away live shown to live incorrect real quickly. Indeed, Nick Rowe has already made such a claim, post from Unlearning Economics (UE) has precisely appeared inwards Pieria. UE says it “helps to illustrate the troubles faced past times contemporary macroeconomics”. One of UE’s complaints seems to reverberate a misunderstanding, frequently shared past times non-economists, nearly what much academic macromodelling is designed to do.

UE objects to the fact that the model assumes that the amount the immature tin transportation away borrow (the bird of leverage) is exogenous, which agency that at that topographic point is no endeavor to explicate where this constraint on the borrowing of the immature comes from. UE also complains that the model contains no banks, together with no investment inwards physical capital. In other words, the model is much also simple. It is a natural plenty idea: to explicate what mightiness live currently going on, y'all demand a to a greater extent than complex model that includes everything that could live important.

There is sure enough a house for this sort of to a greater extent than elaborate model. Christiano, Eichenbaum together with Trabandt inwards this paper desire to struggle that a model based on New Keynesian theory tin transportation away runway what has happened over the in conclusion 10 years. Their model has twoscore equations. If I was trying to produce a similar exercise, I would desire to augment the criterion New Keynesian framework alongside at to the lowest degree the following: nominal wage stickiness equally good equally toll stickiness, a fiscal sector that endogenised both the cost together with rationing of credit, a model of consumption which allowed for credit constraints together with precautionary saving, a housing market, a model of the labour marketplace that combined matching alongside rationing (as here), together with something that allowed recessions to bring long lasting (hysteretic) impacts on labour provide together with technical progress. However large models similar this volition involve many macroeconomic ‘mechanisms’, together with it volition to a greater extent than frequently than non live unclear which mechanisms are of import at driving item results or explaining item facts. We produce non desire to process the elaborate model equally a dark box, but instead nosotros desire to sympathise its properties.

To sympathise complex models, nosotros demand much simpler models. (I 1 time - inwards this arguing that the presence of dry reason equally an property ensures a positive existent involvement rate. If Nick was correct this could live plenty to kill the inquiry programme, without whatever to a greater extent than fourth dimension existence wasted. Whether he is correct is about other matter: this paper past times Rhee may live relevant inwards that respect.

Here I precisely desire to add together a in conclusion thought. Within an OLG framework, it may non live necessary to found the existence of a steady dry reason alongside negative existent involvement rates. The typical current inwards an OLG model lasts ii or to a greater extent than decades. So if the dynamics of such a model involved about overshooting, it mightiness live possible to generate prolonged periods (in years) of negative involvement rates fifty-fifty if the steady dry reason existent involvement charge per unit of measurement was positive. To live honest I’m non sure what mightiness give ascent to overshooting of this kind, but that may precisely reverberate my inadequate imagination.