There have been several blog posts commenting on Kartik Athreya’s book, Big ideas in Macroeconomics: A nontechnical view and I wanted to make a couple of passing remarks pertaining to the blog posts I’ve read. I haven’t read the book yet, and to be completely honest, I’m not sure I will ever get to it given the huge pile of work I have. I will not discuss the book itself. Instead I’ll focus on some of the noteworthy remarks made by bloggers.
Overall, there seems to be lots of misplaced DSGE hand-wringing going on. I think one of the main reasons that some economists dislike DSGE models is that they place limitations on our ability to engage in hand-waiving theorizing. “Microfoundations” is really just code for saying that we want you to be specific and clear. Researchers who try to brush by important parts of their business cycle theories will have a really tough time if they cannot provide the details that accompany their hand waiving. As soon as a researcher appeals to some arbitrary relationship which comes out of thin air, they will immediately feel pressure to back up that component of their theory. Unlike many macroeconomists, I am willing to let people make use of plausible ad hoc theoretical relationships provided that they come with an acknowledgement that this is unfinished work which needs to be filled in later. In the past, wise old economists could get by making sweeping statements about the nature of business cycles and the correct policy cocktail which he or she thought would save the day without having to spell out what they really meant. Today, macroeconomists are typically not granted this latitude.
In his comment, Noah Smith argues that many macroeconomists are “in love with modern macro methodology.” I think Noah is partially correct. It’s true that there are many economists (not just macro guys) who focus far too much on the tools we use to analyze problems rather than the problems themselves. In the end, tools are only valuable if they are put to good use. My own view is that grad students need to have a solid grasp of fundamental / basic tools so they can get started. But, after learning these basic tools, they should not go out of their way to learn more advanced tools unless they have a specific need to do so. There are other people who feel quite differently and I can appreciate this alternate view even if I don’t ultimately agree with it. On the other hand, I’m not so sure I know what Noah means by “macro methodology.” The techniques used by macroeconomists are for the most part used in every area of economics. Dynamic programming is used in labor and IO as well as macro. Bayesian estimation, maximum likelihood techniques and so on are used by most fields. General equilibrium analysis is again used throughout economics. There are some tools which are used almost solely by macroeconomics (the Blanchard-Kahn decomposition comes to mind) but I don’t think this is what he has in mind. Perhaps it is the conjunction of so many common elements that he associates with DSGE models. For instance, there is a good deal of “boilerplate” which shows up in DSGE models (the representative agent, the production function, the capital accumulation equation, and so on). It might be interesting to hear exactly what he views as techniques which are primarily in the domain of DSGE research which he questions.
John Quiggin takes the opportunity to Eulogize some of the modern research which he feels met its end during the financial crisis. He writes that “(t)he crisis that erupted in 2008 destroyed (the) spurious consensus (in macroeconomics).” There might be some truth to this statement as well though I’m not entirely sure what class of theories he has in mind. I suspect that he thinks that the crisis undercut real business cycle models or perhaps rational expectations models more generally. I don’t think this is the case. The productivity shocks at the heart of standard real business cycle models have not been viewed as plausible sources of business cycles fluctuations for quite a while and rational expectations theories are most likely here to stay. If there is a model that really got taken to the woodshed during the financial crisis it was the New Keynesian model which had, until then, occupied a clearly dominant position in policy discussions and academic research. The “New Old Keynesians” as he calls them aren’t having a much better time. They also don’t have a good framework for understanding the financial crisis (there is no meaningful financial sector in the traditional IS/LM model) and their versions of the supply-side of the models aren’t doing very well at all. Quiggin might be referring to the absence of Keynesian demand channels in many DSGE models. Here he might have more of a case. Getting traditional Keynesian demand models to work the way they ought to is not easy. Again, the mechanics of the DSGE approach might be limiting us. There are lots of background assumptions made in most DSGE models which play important roles in how the models function and which likely prevent Keynesian swings in aggregate demand from occuring (though Roger Farmer’s work is overtly pushing in this direction). The basic Walrasian supply and demand framework is surely one of the key features of DSGE models which limit Keynesian channels. A worker who cannot find employment can simply lower his wage. A firm that cannot sell its goods can simply lower the price if it needs to sell. Of course, sticky prices and sticky wages are the standard refrain but this now ties the model to observations in which recessions should be accompanied by deflation (which really didn’t happen during the great recession). I personally have some faith in the basic Keynesian demand story but we don’t really have a good useable version of it at the moment.
Paul Krugman also weighs in with a short comment. He makes two remarks which are noteworthy. First he says that DSGE models are “basically, the particular form of modeling that is more or less the only thing one can publish in journals these days).” This is simply not true. Second, his closing remark is (to me) somewhat cryptic:
I think, that somebody is going to end up in the dustbin of history. I wonder who?
I confess, I really don’t know who or what he is talking about when he writes this.
More to come I’m sure …