I have to confess that I have long been torn between the
intellectual pursuit of academic economics and the uselessness of much of the
output. Part of the appeal of economic theory is that it attempts to address
problems in a rigorous manner. Of course, that is also its Achilles Heel: the
intellectual underpinnings of much that passes for current state of the art
thinking are simply bogus. For that reason papers such as the one by Paul
Romer, chief economist at the World Bank, entitled ‘The Trouble with
Macroeconomics’ (here),
always strike a chord. In many ways, this is a subversive read for macro
economists and makes a number of serious, but in my view substantiated,
allegations regarding the state of economics today.
Romer’s key thesis is that the “identification problem” in
economics has essentially taken us round in a circle back to where we started
in the 1970s. I hope readers will forgive a little digression at this point so
that we can more easily understand the nature of the problem which Romer sets
out. The identification problem requires, as Chris Sims noted in a famous 1980
paper, that we must be able to identify “observationally distinct patterns of
behaviour” for a given model. This is both a philosophical and empirical
argument. Philosophically, it requires us to specify very carefully how our
economic system works. In an empirical sense, it means we must construct models
in which unique values for each of the model parameters can be derived from
other variables in the system. This in turn allows us to clearly identify how
economic linkages operate.
As it happens most empirical macro models in use in 1980
were over-identified: It was possible to explain each variable in the model by various
different combinations of other variables. Consequently, we were unable to determine
precisely how the macroeconomy worked. In his 1980 paper entitled ‘Macroeconomics
and Reality’ (a title which, when I first read the paper, seemed to be most
inappropriate) Sims noted that such models could only be made to work by
applying “incredible” identifying restrictions.
This identification problem is the key to understanding Romer’s
critique of much modern macroeconomic theory. In his view, by trying to get
away from imposing such “incredible” restrictions, macroeconomists have ended
up devising models which themselves are increasingly divorced from reality. Romer
starts by taking direct aim at Real Business Cycle (RBC) models which were a
direct response to many of the criticisms of the over-identified macro models of
the 1970s. He argues that they make a hugely simplifying assumption that cyclical
fluctuations in output are solely the result of shocks. The question Romer
poses is "what are these imaginary shocks?" Is there really no role
for monetary policy, as much of thinking in this field suggests? If that is
true, we should all pack up and go home – and the Fed, ECB, BoE et al should
abandon attempts to stabilise the economic cycle.
He then aims his blunderbuss at the DSGE models which followed
from this, arguing in effect that they are a post-truth way of looking at the
world because they rely less on data and more on a series of assumptions about
how the world works. (I posted on this topic here).
Indeed, such is Romer’s apparent contempt for some of this analysis that he
states “the noncommittal relationship
with the truth revealed by these methodological evasions [and] dismissal of
fact goes so far beyond post-modern irony that it deserves its own label. I
suggest ‘post-real’.”
Even worse, in his view, is that many of the proponents of modern
macroeconomics have tended to band together and reinforced each other’s views
rather than challenging them. This unwillingness to challenge belief systems
has, in Romer’s opinion, promoted a stagnant culture which has slowed the
advancement of new ideas in economics.
Faced with such a nihilistic view of economics, you may wonder
what is the point of it all? I share Romer’s criticisms of many of the ideas which
have found their way into the economic mainstream. But I also adhere to the
George Box school of thought that whilst all models are wrong, some are useful.
There is thus nothing inherently wrong with the idea of going in the direction
of RBC or DSGE models – it is just that they have captured the high
intellectual ground and have proven difficult to shift. And like it or
not, many of the competing theories have not proven up to scratch either.
What is also interesting is that whilst many economists
passionately advocate a particular school of thought, few people of my
acquaintance argue in public in such terms. So either this debate is a
particularly American academic thing or it is confined to those pushing hard to
get their material into the journals (and failing). And finally, I have long
argued that the financial crisis will act as an efficient way of winnowing out
many of the worst ideas in macroeconomics. Just as the Great Depression of the 1930s
produced the ideas of Keynes and his acolytes, so the current crisis in the western
word may yet lead to a more fruitful approach to many economic issues. So chin
up, Mr Romer. The darkest hour comes just before dawn.
No comments:
Post a Comment