Why The Microfoundations Hegemony Holds Dorsum Macroeconomic Progress

When David Vines asked me to contribute to a OXREP (Oxford Review of Economic Policy) issue on “Rebuilding Macroeconomic Theory”, I recall what he hoped I would write on how the center macro model needed to alter to reverberate macro developments since the crisis amongst a item center to modelling the behave upon of financial policy. That would locomote an interesting newspaper to write, but I decided fairly chop-chop that I wanted to tell something that I idea was much to a greater extent than important.

In my thought the biggest obstruction to the advance of macroeconomics is the hegemony of microfoundations. I wanted at to the lowest degree 1 of the papers inwards the collection to inquiry this hegemony. It turned out that I was non alone, together with a few papers did the same. I was peculiarly encouraged when Olivier Blanchard, inwards spider web log posts reflecting his thoughts earlier writing his contribution, was thinking along the same lines.

I volition speak close the other papers when to a greater extent than people conduct maintain had a run a jeopardy to read them. Here I volition focus on my ain contribution. I conduct maintain been pushing a similar job inwards spider web log posts for unopen to time, together with that sense suggests to me that most macroeconomists working inside the hegemony conduct maintain a uncomplicated mental block when they recall close option modelling approaches. Let me run across if I tin intermission that block here.

Imagine a DSGE model, ‘estimated’ yesteryear Baynesian techniques. To locomote specific, suppose it contains a measure intertemporal consumption function. Now suppose mortal adds a term into the model, tell unemployment into the consumption function, together with thereby significantly improves the jibe of the model. It is non difficult to recall why the jibe significantly improves: unemployment could locomote a proxy for the uncertainty of labour income, for example. The fundamental inquiry becomes which is the improve model amongst which to examine macroeconomic policy: the DSGE or the augmented model?

A microfoundations macroeconomist volition tend to tell without doubtfulness the master copy DSGE model, because only that model is known to locomote theoretically consistent. (They mightiness instead tell that only that model satisfies the Lucas critique, but internal consistency is the to a greater extent than general concept.) But an as valid reply is to tell that the master copy DSGE model volition give wrong policy responses because it misses an of import link betwixt unemployment together with consumption, together with so the augmented model is preferred.

There is absolutely aught that says that internal consistency is to a greater extent than of import than (relative) misspecification. In my experience, when confronted amongst this fact, unopen to DSGE modellers resort to 2 diversionary tactics. The first, which is to tell that all models are misspecified, is non worthy of discussion. The minute is that neither model is satisfactory, together with inquiry is needed to comprise the unemployment outcome inwards a consistent way.

I conduct maintain no job amongst that reply inwards itself, together with for that argue I conduct maintain no job amongst the microfoundations projection as one way to create macroeconomic modelling. But inwards this item context it is a dodge. There volition never be, at to the lowest degree inwards my lifetime, a DSGE model that cannot locomote improved yesteryear adding plausible but potentially inconsistent effects similar unemployment influencing consumption. Which agency that, if y'all recall models that are significantly improve at plumbing fixtures the information are to locomote preferred to the DSGE models from whence they came, so these augmented models volition e'er crunch the DSGE model as a way of modelling policy.

What this inquiry tells y'all is that at that spot is an option methodology for edifice macroeconomic models that is non inferior to the microfoundations approach. This starts amongst unopen to theoretical specification, which could locomote a DSGE model as inwards the example, together with so extends it inwards ways that are theoretically plausible together with which likewise significantly improve the model’s fit, but which are non formally derived from micofoundations. I telephone phone that an instance inside the Structural Econometric Model (SEM) class, together with Blanchard calls it a Policy Model.

An of import signal I brand inwards my newspaper is that these are non competing methodologies, but instead they are complementary. SEMs as I depict them hither begin from microfounded theory. (Of course of written report SEMs tin likewise begin from non-microfounded theory, but the pros together with cons of that is a dissimilar combat I desire to avoid here.) As a finished production they render many inquiry agendas for microfoundation modelling. So DSGE modelling tin render the starting signal for builders of SEMs or Policy Models, together with these models when completed render a inquiry agenda for DSGE modellers.

Once y'all run across this complementarity, y'all tin run across why I recall macroeconomics would railroad train much to a greater extent than rapidly if academics were involved inwards edifice SEMs as good as edifice DSGE models. The fault the New Classical Counter Revolution made was to dismiss previous ways of modelling the economy, instead of augmenting these ways amongst additional approaches. Each methodology on its ain volition railroad train much to a greater extent than slow than the 2 combined. Another way of putting it is that inquiry based on SEMs is to a greater extent than efficient than the puzzle resolution approach used today. 

In the paper, I travail to imagine what would conduct maintain happened if the microfoundations projection had only augmented the macroeconomics of the fourth dimension (which was SEM modelling), rather than dismissing it out of hand. I recall nosotros conduct maintain skilful evidence that active complementarity betwixt SEM together with microfoundations modelling would conduct maintain investigated inwards depth links betwixt the financial together with existent sectors before the financial crisis. The microfoundations hegemony chose the wrong puzzles to await at, deflecting macroeconomics from the to a greater extent than of import empirical issues. The same affair may hap 1 time to a greater extent than if the microfoundations hegemony continues.