Lucas As Well As Sargent Revisited
The economic science blogosphere has a large give-and-take going on over Bob Lucas together with Tom Sargent's classic "Simon Wren-Lewis, Mark Thoma here and here and piece of work dorsum through the links.
H5N1 few thoughts here, equally it bears on my WSJ oped from concluding calendar week together with my concluding post service on EFG together with how nosotros practise macro.
1. Views of Keynesian economics
Re-reading this paper, y'all volition live on struck nigh how much Lucas together with Sargent praise Keynesian models, which you'd think it is their run to destroy.
They called the Keynesian revolution a "remarkable intellectual event." they continued
Lucas together with Sargent brand a two-pronged argument, ane nigh theoretical coherence together with the other nigh the grand econometric failure of Keynesian models.
As I meet it, the principal characteristic of "equilibrium" models Lucas together with Sargent inaugurated is that they set people, time, together with economic science into macro.
Keynesian models model aggregates. Consumption depends on income. Investment depends on involvement rates. Labor furnish together with demand depend on wages. Money demand depends on income together with involvement rates. "Consumption" together with "investment" together with so forth are the fundamental objects to live on modeled.
"Equilibrium" models (using Lucas together with Sargent's word) model people together with technology. People brand simultaneous decisions across multiple goods, constrained past times budget constraints -- if y'all swallow to a greater extent than together with salve more, y'all must piece of work more, or concord less money. Firms make decisions across multiple goods constrained past times technology.
Putting people together with their simultaneous decisions dorsum to the middle of the model generates Lucas together with Sargent's principal econometric conclusion -- Sims' "incredible" identifying restrictions. When people simultaneously create upwardly one's hear consumption, saving, labor supply, together with so the variables describing each must tumble over inwards to the other. There is no argue for leaving (say) reward out of the consumption equation. But the solely thing distinguishing ane equation from around other is which variables instruct left out.
People brand decisions thinking nigh the future. I think "static" vs. "intertemporal" are goodness words to use. That observation goes dorsum to Friedman: consumption depends on permanent income, including expected futurity income, non today's income. Decisions today are inevitably tied to expectations --rational or non -- nigh the future.
The lack of budget constraint (or the "missing equation" together with "Walras' law" issues much studied inwards before Keynesian literature) strikes me equally around other large conceptual together with methodological divergence betwixt Keynesian models together with equilibrium models, which flows from putting people rather than aggregates at the middle of analysis.
Notice when y'all read whatever textbook that the microeconomic "demand" of a precipitous becomes the macroeconomic "plan." Why is that? Because demand curves honour budget constraints fifty-fifty at off-equilibrium prices. "Plans" similar consumption equals c bar addition alpha times income practise non honour whatever stated budget constraint. You're allowed to say y'all desire to swallow together with salve to a greater extent than than income allows.
Optimization, rational expectations, together with flexible prices are the ballyhooed centerpieces of the kickoff circular of equilibrium models to follow Lucas together with Sargent, such equally Kydland together with Prescott's famous "time to build" model together with the subsequent "real describe of piece of work organisation cycle" models (examples: Bob King together with Sergio Rebelo, John Long together with Charles Plosser). But I don't think these ingredients are fundamental to the program. The "new-Keynesian" (or, better, DSGE) schoolhouse set inwards gummy prices alongside all the other Lucas-Sargent ingredients, together with thence nether the "equilibrium" banner. Mike Woodford's "Interest together with prices" is aimed proudly at that program. Sticky wages, distortions, together with so on are only equally often included.
Simon Wren-Lewis questions whether Lucas together with Sargent were genuinely focusing on empirical failure or methodological critique. He suggested that accelerationist Phillips curves, though adapted after the failure together with thence appearing a chip equally epicycles, tin describe of piece of work organisation human relationship for the data. (Lucas together with Sargent: "In economic science equally inwards other sciences,...there is ever the promise that if a detail specific models fails ane tin detect a to a greater extent than successful model based on roughly the same ideas.")
I think Simon is a chip also blasé nigh how tardily this modification is. Not solely did inflation accelerate far faster than Keyensian models of the 1960s predicted, inflation dropped similar a rock inwards 1982, far faster than Keynesians thought possible based on adaptive expectations views. (If mortal tin detect the quote from Samuelson inwards the early on 1980s predicting decades of depression to wring out inflation, delight add together to the comments.) Proud equally around self-identified Keynesians are nigh how good they think their unwritten, unquantified "model" fits the electrical flow recession, deep unemployment alongside no motility inwards inflation fits no Phillips flexure that was genuinely written before the crisis. Infinite wage stickiness is an ex-post excogitation too, together with yet only a verbal debating point.
But the newspaper is genuinely clear that empirical failure matters deeply to Lucas together with Sargent. They said that
Everyone was perfectly aware of the lack of "microfoundations" of Keynesian models, together with the 50 yr fruitless search for such foundations. But so long equally the models worked, that had no existent affect on their exercise for the "scientific" together with technical policy advice Lucas together with Sargent so admired.
And rightly so. Chemistry, until the concluding few decades, lacked "microfoundations" inwards quantum mechanics, kickoff because nobody knew quantum mechanics, together with afterward because working out how chemicals react from kickoff principles was also hard. That did non halt chemical scientific discipline from existence a perfectly feasible science. Biology, until the concluding few decades, lacked "microfoundations" inwards chemistry.
But chemical scientific discipline together with biological scientific discipline worked pretty well. Lucas together with Sargent pointed to, together with needed to indicate to, a grand empirical failure.
And that failure had to live on accompanied non only past times "well, these are reasonable rules, but they're non microfounded." The failure had to live on accompanied past times showing how the Keyensian model was logically flawed. That failure had to live on accompanied past times a amend theory, which showed why the Keynesian equations were inconsistent alongside basic economics. That amend theory had already predicted Keynesian model's failure -- Friedman 1968, Phelps, together with Lucas' prediction that the Phillips flexure would shift if exploited. That is a lot to a greater extent than than "methodological purity."
3. So what happened?
As I survey the landscape now, it is interesting how much of the macroeconomics Lucas together with Sargent praised has vanished. Quantitative, scientific discipline? Explicit statistical descriptions of economical behavior? Reliance of authorities officials on technical economical expertise? The exercise of mathematical command theory to cope an economy? All that has vanished.
The sub-basements of fundamental banks own got large DSGE models, or combined models where y'all tin plough Lucas together with Sargent on together with off. But I think it's fair to say nobody takes the results really seriously. Policy -- our stimulus, for lawsuit -- is based on dorsum of the envelope multipliers together with the ascendency together with expertise, if you're charitable, or the unvarnished, verbal, opinions if you're not, of direction officials.
There are around large-scale empirical DSGE models left inwards academia too. But the vast mass of policy analysis does non exercise them, equally they did, say, the models of 1972. At conferences together with inwards papers, academic piece of work uses pocket-size scale toy models together with a lot of words. Models practise non seem to live on cumulative. Each newspaper adds a niggling twist ignoring all the previous niggling twists.
H5N1 consummate dissever occurred. "Equilibrium" models, inwards which I include new-Keynesian DSGE models, took over academia. The policy basis stuck alongside uncomplicated ISLM logic -- non "models" inwards the quantitative scientific tradition Lucas together with Sargent praised -- despite Lucas together with Sargent's devastating criticism. And, equally I remarked inwards the before weblog posts, the "purely verbal" or literary trend of analysis is becoming to a greater extent than together with to a greater extent than mutual at nowadays inwards academia equally good equally policy.
I'm non complaining nigh goodness vs. bad here. I write simpler together with simpler models equally I grow older, together with pass to a greater extent than fourth dimension thinking together with writing nigh what those equations mean. It only is a fact nigh how nosotros practise things today together with the "scientific," quantitative condition of macroeconomics.
Lucas together with Sargent's concluding sentence:
PS: Lucas together with Sargent own got a delicious quote nigh Keynesian's loss of faith inwards their ain model, equally applicable at nowadays equally then:
H5N1 few thoughts here, equally it bears on my WSJ oped from concluding calendar week together with my concluding post service on EFG together with how nosotros practise macro.
1. Views of Keynesian economics
Re-reading this paper, y'all volition live on struck nigh how much Lucas together with Sargent praise Keynesian models, which you'd think it is their run to destroy.
They called the Keynesian revolution a "remarkable intellectual event." they continued
... around of its [Keynesian Revolution] most of import features: the evolution of macroeconomics into a quantitative, scientific discipline, the evolution of explicit statistical descriptions of economical behavior, the increasing reliance of authorities officials on technical economical expertise, together with the introduction of the exercise of mathematical command theory to cope an economy.
Keynesian theory evolved from a disconnected, qualitative speak nigh economical activeness into a organisation of equations that tin live on compared to information inwards a systematic way together with which provides an operational guide inwards the necessarily quantitative project of formulating monetary together with financial policy.
neither the success of the Keynesisan Revolution nor its eventual failure tin live on understood at the purely verbal grade at which Keynes himself wrote...
The Keynesian economic science they are praising hither is non Keynes' volume -- ane of those large dingy things that people are yet writing "what did Keynes genuinely mean" articles together with books nigh nearly a century afterward -- but the subsequent quantification effort: Hick's creation of the ISLM model, its elaboration into reckoner models, estimation of those models, together with the exercise of those models to brand quantitative forecasts of the effects of policy interventions.
"Quantitative, scientific discipline," together with "technical economical expertise" way nosotros analyze policies past times existent models, non the opinions together with judgments of famous economists turned populace officials.
Yes, "mathematical command theory." Most readers volition live on also immature to remember, but inwards the early on 1970s academic journals were dynamic optimal command applied to simulations of large-scale Keynesian models.
Their destination was quite conservative: they wanted to save this keen achievement:
"Quantitative, scientific discipline," together with "technical economical expertise" way nosotros analyze policies past times existent models, non the opinions together with judgments of famous economists turned populace officials.
Yes, "mathematical command theory." Most readers volition live on also immature to remember, but inwards the early on 1970s academic journals were dynamic optimal command applied to simulations of large-scale Keynesian models.
Their destination was quite conservative: they wanted to save this keen achievement:
The objectives of equilibrium describe of piece of work organisation cycle theory are taken, without modification, from the destination which motivated the structure of the Keynesian macroeconometric models: to provide a scientifically based way of assessing, quantitatively, the probable effects of choice economical policies.2. What was their basic criticism of Keynesian economics?
Lucas together with Sargent brand a two-pronged argument, ane nigh theoretical coherence together with the other nigh the grand econometric failure of Keynesian models.
As I meet it, the principal characteristic of "equilibrium" models Lucas together with Sargent inaugurated is that they set people, time, together with economic science into macro.
Keynesian models model aggregates. Consumption depends on income. Investment depends on involvement rates. Labor furnish together with demand depend on wages. Money demand depends on income together with involvement rates. "Consumption" together with "investment" together with so forth are the fundamental objects to live on modeled.
"Equilibrium" models (using Lucas together with Sargent's word) model people together with technology. People brand simultaneous decisions across multiple goods, constrained past times budget constraints -- if y'all swallow to a greater extent than together with salve more, y'all must piece of work more, or concord less money. Firms make decisions across multiple goods constrained past times technology.
Putting people together with their simultaneous decisions dorsum to the middle of the model generates Lucas together with Sargent's principal econometric conclusion -- Sims' "incredible" identifying restrictions. When people simultaneously create upwardly one's hear consumption, saving, labor supply, together with so the variables describing each must tumble over inwards to the other. There is no argue for leaving (say) reward out of the consumption equation. But the solely thing distinguishing ane equation from around other is which variables instruct left out.
People brand decisions thinking nigh the future. I think "static" vs. "intertemporal" are goodness words to use. That observation goes dorsum to Friedman: consumption depends on permanent income, including expected futurity income, non today's income. Decisions today are inevitably tied to expectations --rational or non -- nigh the future.
Notice when y'all read whatever textbook that the microeconomic "demand" of a precipitous becomes the macroeconomic "plan." Why is that? Because demand curves honour budget constraints fifty-fifty at off-equilibrium prices. "Plans" similar consumption equals c bar addition alpha times income practise non honour whatever stated budget constraint. You're allowed to say y'all desire to swallow together with salve to a greater extent than than income allows.
Optimization, rational expectations, together with flexible prices are the ballyhooed centerpieces of the kickoff circular of equilibrium models to follow Lucas together with Sargent, such equally Kydland together with Prescott's famous "time to build" model together with the subsequent "real describe of piece of work organisation cycle" models (examples: Bob King together with Sergio Rebelo, John Long together with Charles Plosser). But I don't think these ingredients are fundamental to the program. The "new-Keynesian" (or, better, DSGE) schoolhouse set inwards gummy prices alongside all the other Lucas-Sargent ingredients, together with thence nether the "equilibrium" banner. Mike Woodford's "Interest together with prices" is aimed proudly at that program. Sticky wages, distortions, together with so on are only equally often included.
Simon Wren-Lewis questions whether Lucas together with Sargent were genuinely focusing on empirical failure or methodological critique. He suggested that accelerationist Phillips curves, though adapted after the failure together with thence appearing a chip equally epicycles, tin describe of piece of work organisation human relationship for the data. (Lucas together with Sargent: "In economic science equally inwards other sciences,...there is ever the promise that if a detail specific models fails ane tin detect a to a greater extent than successful model based on roughly the same ideas.")
I think Simon is a chip also blasé nigh how tardily this modification is. Not solely did inflation accelerate far faster than Keyensian models of the 1960s predicted, inflation dropped similar a rock inwards 1982, far faster than Keynesians thought possible based on adaptive expectations views. (If mortal tin detect the quote from Samuelson inwards the early on 1980s predicting decades of depression to wring out inflation, delight add together to the comments.) Proud equally around self-identified Keynesians are nigh how good they think their unwritten, unquantified "model" fits the electrical flow recession, deep unemployment alongside no motility inwards inflation fits no Phillips flexure that was genuinely written before the crisis. Infinite wage stickiness is an ex-post excogitation too, together with yet only a verbal debating point.
But the newspaper is genuinely clear that empirical failure matters deeply to Lucas together with Sargent. They said that
H5N1 key chemical component subdivision inwards all Keynesian models is a trade-off betwixt inflation together with existent output: the higher is the inflation rate, the higher is output (or equivalently, the lower is the charge per unit of measurement of unemployment). For example, the models of the belatedly 1960s predicted a sustained USA unemployment charge per unit of measurement equally consistent alongside a iv pct annual charge per unit of measurement of inflation. Based on this prediction, many economists at that fourth dimension urged a deliberate policy of inflation. [plus ça change...]... policy inwards this catamenia should, according to all of these models, own got produced the lowest average unemployment rates for whatever decade since the 1940s. In fact, equally nosotros know, they produced the highest unemployment rates since the 1930s. This was econometric failure on a grand scale. [My emphasis]Here equally elsewhere, they said "econometric," non economic. They meant it.
Everyone was perfectly aware of the lack of "microfoundations" of Keynesian models, together with the 50 yr fruitless search for such foundations. But so long equally the models worked, that had no existent affect on their exercise for the "scientific" together with technical policy advice Lucas together with Sargent so admired.
And rightly so. Chemistry, until the concluding few decades, lacked "microfoundations" inwards quantum mechanics, kickoff because nobody knew quantum mechanics, together with afterward because working out how chemicals react from kickoff principles was also hard. That did non halt chemical scientific discipline from existence a perfectly feasible science. Biology, until the concluding few decades, lacked "microfoundations" inwards chemistry.
But chemical scientific discipline together with biological scientific discipline worked pretty well. Lucas together with Sargent pointed to, together with needed to indicate to, a grand empirical failure.
And that failure had to live on accompanied non only past times "well, these are reasonable rules, but they're non microfounded." The failure had to live on accompanied past times showing how the Keyensian model was logically flawed. That failure had to live on accompanied past times a amend theory, which showed why the Keynesian equations were inconsistent alongside basic economics. That amend theory had already predicted Keynesian model's failure -- Friedman 1968, Phelps, together with Lucas' prediction that the Phillips flexure would shift if exploited. That is a lot to a greater extent than than "methodological purity."
3. So what happened?
As I survey the landscape now, it is interesting how much of the macroeconomics Lucas together with Sargent praised has vanished. Quantitative, scientific discipline? Explicit statistical descriptions of economical behavior? Reliance of authorities officials on technical economical expertise? The exercise of mathematical command theory to cope an economy? All that has vanished.
The sub-basements of fundamental banks own got large DSGE models, or combined models where y'all tin plough Lucas together with Sargent on together with off. But I think it's fair to say nobody takes the results really seriously. Policy -- our stimulus, for lawsuit -- is based on dorsum of the envelope multipliers together with the ascendency together with expertise, if you're charitable, or the unvarnished, verbal, opinions if you're not, of direction officials.
There are around large-scale empirical DSGE models left inwards academia too. But the vast mass of policy analysis does non exercise them, equally they did, say, the models of 1972. At conferences together with inwards papers, academic piece of work uses pocket-size scale toy models together with a lot of words. Models practise non seem to live on cumulative. Each newspaper adds a niggling twist ignoring all the previous niggling twists.
H5N1 consummate dissever occurred. "Equilibrium" models, inwards which I include new-Keynesian DSGE models, took over academia. The policy basis stuck alongside uncomplicated ISLM logic -- non "models" inwards the quantitative scientific tradition Lucas together with Sargent praised -- despite Lucas together with Sargent's devastating criticism. And, equally I remarked inwards the before weblog posts, the "purely verbal" or literary trend of analysis is becoming to a greater extent than together with to a greater extent than mutual at nowadays inwards academia equally good equally policy.
I'm non complaining nigh goodness vs. bad here. I write simpler together with simpler models equally I grow older, together with pass to a greater extent than fourth dimension thinking together with writing nigh what those equations mean. It only is a fact nigh how nosotros practise things today together with the "scientific," quantitative condition of macroeconomics.
Lucas together with Sargent's concluding sentence:
Unless the at nowadays evident limits of these models are also frankly acknowledged together with radically dissimilar novel directions taken, the existent accomplishments of the Keynesian Revolution volition live on lost equally sure equally those nosotros know to live on illusory.Academic economic science took the kickoff one-half to hart. Policy economic science froze inwards place. But Lucas together with Sargent's "real accomplishments" were lost, or at to the lowest degree consciously abandoned, anyway.
PS: Lucas together with Sargent own got a delicious quote nigh Keynesian's loss of faith inwards their ain model, equally applicable at nowadays equally then:
The electrical flow moving ridge of protectionist sentiment directed at "saving jobs" would own got been answered 10 years agone alongside the Keynesian counterargument that financial policy tin attain the same terminate but to a greater extent than efficiently. Today, of course, no ane would own got this response seriously, so it is non offered. Indeed, economists who 10 years agone championed Keynesian financial policy equally an choice to inefficient forthwith controls increasingly favor such controls equally supplements to Keynesian policy.
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