Reform In Addition To Revolution Inwards Macroeconomics

Mainly for economists

Paul Romer has a few recent posts (start here, most recent here) where he tries to examine why the saltwater/freshwater split inward macroeconomics happened. Influenza A virus subtype H5N1 subject is that this cannot all live position downward to New Classical economists wanting a revolution, together with that a defensive/dismissive mental attitude from the traditional Keynesian status quo also had a lot to exercise with it.

I volition exit others to hash out what Solow said or intended (see for illustration Robert Waldmann). However I bring no dubiety that many alongside the together with so Keynesian status quo did react inward a defensive together with dismissive way. They were, after all, on incredibly weak ground. That Blue Planet was non large econometric macromodels, but 1 unmarried equation: the traditional Phillips curve. This had inflation at fourth dimension t depending on expectations of inflation at fourth dimension t, together with the divergence of unemployment/output from its natural rate. Add rational expectations to that together with you lot demo that deviations from the natural charge per unit of measurement are random, together with Keynesian economic science becomes irrelevant. As a result, likewise many Keynesian macroeconomists saw rational expectations (and thence all things New Classical) every bit an existential threat, together with reacted to that threat past times attempting to rubbish rational expectations, rather than questioning the traditional Phillips curve. As a result, the status quo lost. [1]

We instantly know this defeat was temporary, because New Keynesians came along with their version of the Phillips crimp together with nosotros got a novel ‘synthesis’. But that took time, together with you lot tin clit what happened inward the fourth dimension inward betwixt inward 2 ways. You could enjoin that the New Classicals ever had the destination of overthrowing (rather than improving) Keynesian economics, thought that they had succeeded, together with but ignored New Keynesian economic science every bit a result. Or you lot could enjoin that the initially unyielding reaction of traditional Keynesians created an adversarial means of doing things whose persistence Paul both deplores together with is trying to explain. (I bring no item expertise on which storey is nearer the truth. I went with the start out inward this post, but I’m happy to live persuaded past times Paul together with others that I was wrong.) In either illustration the thought is that if at that topographic point had been to a greater extent than reform rather than revolution, things powerfulness bring gone improve for macroeconomics.

The betoken I desire to hash out hither is non almost Keynesian economics, but almost fifty-fifty to a greater extent than key things: how evidence is treated inward macroeconomics. You tin squall back of the New Classical counter revolution every bit having 2 strands. The start out involves Keynesian economics, together with is the 1 everyone likes to verbalize about. But the minute was maybe fifty-fifty to a greater extent than important, at to the lowest degree to how academic macroeconomics is done. This was the microfoundations revolution, that brought us start out RBC models together with and so DSGE models. As Paul writes:

“Lucas together with Sargent were correct inward 1978 when they said that at that topographic point was something wrong, fatally wrong, with large macro simulation models. Academic operate on these models collapsed.”

The inquiry I desire to heighten is whether for this strand every bit well, reform rather than revolution powerfulness bring been improve for macroeconomics.

First 2 points on the quote to a higher house from Paul. Of class non many academics worked straight on large macro simulation models at the time, but what a large number did exercise was either fourth dimension serial econometric operate on private equations that could live fed into these models, or analyse small-scale aggregate models whose equations were non microfounded, but instead justified past times an eclectic mix of theory together with empirics. That operate inside academia did largely come upward to a halt, together with was replaced past times microfounded modelling.

Second, Lucas together with Sargent’s critique was fatal inward the feel of what academics later on did (and how they regarded these econometric simulation models), although they got a lot of aid from Sims (1980). But it was non fatal inward a to a greater extent than full general sense. As Brad DeLong points out, these econometric simulation models survived both inward the private together with populace sectors (in the USA Fed, for example, or the United Kingdom of Great Britain together with Northern Ireland of Britain together with Northern Republic of Ireland OBR). In the United Kingdom of Great Britain together with Northern Ireland of Britain together with Northern Republic of Ireland they survived inside the academic sector until the latter 1990s when academics helped kill them off.

I am non suggesting for 1 infinitesimal that these models are an adequate substitute for DSGE modelling. There is no dubiety inward my heed that DSGE modelling is a goodness means of doing macro theory, together with I bring learnt a lot from doing it myself. It is also obvious that at that topographic point was a lot incorrect with large econometric models inward the 1970s. My inquiry is whether it was correct for academics to spend upward them completely, together with much to a greater extent than importantly avoid the econometric operate that academics 1 time did that fed into them.

It is hard to acquire academic macroeconomists trained since the 1980s to address this question, because they bring been taught that these models together with techniques are fatally flawed because of the Lucas critique together with identification problems. But DSGE models every bit a conduct for policy are also fatally flawed because they are likewise simple. The unique belongings that DSGE models bring is internal consistency. Take a DSGE model, together with alter a few equations so that they tally the information much better, together with you lot bring what could live called a structural econometric model. It is internally inconsistent, but because it fits the information improve it may live a improve conduct for policy.

What happened inward the United Kingdom of Great Britain together with Northern Ireland of Britain together with Northern Republic of Ireland inward the 1980s together with 1990s is that structural econometric models evolved to minimise Lucas critique problems past times incorporating rational expectations (and other New Classical ideas every bit well), together with fourth dimension serial econometrics improved to bargain with identification issues. If you lot like, you lot tin enjoin that structural econometric models became to a greater extent than similar DSGE models, but where internal consistency was sacrificed when it proved clearly incompatible with the data.

These points are really hard to acquire across to those brought upward to believe that structural econometric models of the onetime fashioned form are obsolete, together with fatally flawed inward a to a greater extent than key sense. You volition frequently live told that to forecast you lot tin either purpose a DSGE model or some form of (virtually) atheoretical VAR, or that policymakers bring no option when doing policy analysis than to purpose a DSGE model. Both statements are but wrong.

There is a deep irony here. At a fourth dimension when academics doing other kinds of economic science bring post). If this form of operate had received greater attending (which structural econometric modellers would almost sure bring done), that would bring focused minds on why credit weather changed, which inward plough would bring addressed issues involving the interaction betwixt the existent together with fiscal sectors. If that had been done, macroeconomics powerfulness bring been improve prepared to examine the touching of the fiscal crisis.

It is non precisely Keynesian economic science where reform rather than revolution powerfulness bring been to a greater extent than productive every bit a number of Lucas together with Sargent, 1979.

[1] The betoken is non whether expectations are to a greater extent than frequently than non rational or not. It is that whatever job organisation wheel theory that depends on irrational inflation expectations appears improbable. Do nosotros actually believe job organisation cycles would disappear if alone inflation expectations were rational? PhDs of the 1970s together with 1980s understood that, which is why most of them rejected the traditional Keynesian position. Also, every bit Paul Krugman points out, many Keynesian economists were happy to contain New Classical ideas.