Thursday, December 4, 2014

What's wrong with macro?

Reflecting on my overly grumpy last post, as well as many recent Krugman columns, I think there is really a fundamental consensus here.

There is, in fact, a sharp divide between macroeconomics used in the top levels of policy circles, and that used in academia.


Static ISLM / ASAD modeling and thinking really did pretty much disappear from academic research economics around 1980. You won't find it taught in any PhD programs, you won't find it at any conferences (except the occasional lunchtime "keynote speech" where an Important Person from the policy world comes in to enlighten us), you won't find it in any academic journals (AER, JPE, QJE, Econometrica, etc. etc.).  "New-Keynesian" DSGE (Dynamic Stochastic General Equilibrium) models are much in vogue, but have really nothing to do with static Keynesian ISLM modeling. Many authors would like it to be so, but when you read the equations you will find these are just utterly different models.

Static ISLM thinking pervades the upper reaches of the policy world. "Thinking" as, sadly, quantitative modeling of that thought disappeared in the mid-1970s. But if you read the analysis guiding policy at the IMF, the Fed, the OECD, the CBO; and the larger policy debate in the pages of the Economist, New York Times, and quite often even the Wall Street Journal, policy analysis is pretty much unchanged from the Keynesian ISLM, ASAD, analysis I learned from Dornbush and Fisher's textbook, taught in Bob Solow's undergraduate Macro class at MIT about 1978.   The staffs at these agencies write nice academic general equilibrium papers, but only in their "research" activities.

Thus, if you read Krugman's columns, you will see him occasionally crowing about how Keynesian economics won, and how the disciples of Stan Fisher at MIT have spread out to run the world. He's right. Then you see him complaining about how nobody in academia understands Keynesian economics. He's right again.

Perhaps academic research ran off the rails for 40 years producing nothing of value. Social sciences can do that. Perhaps our policy makers are stuck with simple stories they learned as undergraduates; and, as has happened countless times before, new ideas will percolate up when the generation trained in the 1980s makes their way to to top of policy circles.

I think we can agree on something. If one wants to write about "what's wrong with economics," such a huge divide between academic research ideas and the ideas running our policy establishment is not a good situation.

The right way to address this is with models -- written down, objective models, not pundit prognostications -- and data. What accounts, quantitatively, for our experience?  I see old-fashioned Keynesianism losing because, having dramatically failed that test once, its advocates are unwilling to do so again, preferring a campaign of personal attack in the popular press. Models confront data in the pages of the AER, the JPE, the QJE, and Econometrica. If old-time Keynesianism really does account for the data, write it down and let's see.

26 comments:

  1. Don't see it John. Mike Mussa (CEA, RES at IMF) found Bernanke -Gertler to be remarkably similar to ISLM-ASAD. When I was giving advice to Volker (early 80s) I used exactly the same models I was publishing with Garber in the JPE. This is not quite the bigs, but go to the Chi Fed and have this discussion with the guys there. My experience is that the discussion is at a very high level. There is surely noise inserted by other influences at the implementation level, but that happens in everything.

    ReplyDelete
  2. Gali on Wages and Employment writes:

    "All things considered, the findings of the present paper suggest that the
    effectiveness of wage cuts in fighting unemployment and, more generally, the
    desirability of more wage flexibility are propositions that one should not take for
    granted. That lesson, central to Keynes’s General Theory, remains valid when examined
    in the context of the New Keynesian framework."

    http://crei.cat/people/gali/jg2013_jeea.pdf

    ReplyDelete
  3. I think this is exactly right. The water is muddies because not only the same institutions, but often the same individuals, are engaged in both kinds of economics. But as intellectual projects they are entirely distinct.

    ReplyDelete
  4. I tend to agree with some other comments that you were a overly harsh on Blinder in your last post. I often disagree with his conclusions but I've generally found him to be a serious and thoughtful analyst. In this case, it looks like he's guilty of repeating a quote that someone else took out of context. He was definitely being a little sloppy here, but he doesn't belong in the same category as someone like Krugman who is purposely misleads his readers by creating bogus straw man arguments and completely distorting other people's opinions.

    ReplyDelete
  5. I agree, John. NK-general equilibrium models are quite different from IS-LM models. Take for instance Woodfords equilibrium in a recession, where changes in fiscal policy through taxes can have a positive or negative marginal effect on output, depending on wether the change in taxes is applied to corporations vs individuals. This is widely different from the predictions of an IS-LM model.

    Furthermore, even in the cases under which IS-LM logic might lead to the same recommendation as DSGE models, the causal relationships seldom are the same.

    Out of curiosity, how would you recommend macroeconomics should be taught at an undergraduate level? I remember my biggest frustration as a graduate student was learning "new" macroeconomics, since most of my training had been under static reasoning. However, the level of technical expertise required for DSGE models is unavailable to beginner and intermediate macro undergraduate students....

    ReplyDelete
  6. I'm not surprised in the least that IS/LM pervades in the fiscal side of the economy, but it would be strange to see that it happens at the FED, IMF, OR OECD - which are run mainly by trained economist.

    ReplyDelete
    Replies
    1. Where I work, at the St. Louis Fed, using an IS/LM model would invite ridicule. But the Board's FRB/US model is indeed an expanded IS/LM model - without the LM curve.

      Delete
    2. "If old-time Keynesianism really does account for the data, write it down and let's see." I did write it down John. Don't take PK's account of Old Keynesian Economics as gospel. Try expanding your horizon by reading this.

      Delete
    3. I haven't read the book, but other writing of yours that I have read is very innovative novel economics, not good old time Keynesianism! Why not just call it macroeconomics, rather than tie it to an 80 year old long book?

      Delete
    4. This sounds like a "no True Scotsman" argument. Farmer, or Krugman, or Woodford, or Diamond, or Sims, or Tobin, or many others, may see themselves as working in the Keynesian tradition, but they are wrong by definition. Keynesian economics is defined as the obsolete macro of the 1930s (or sometimes the obsolete big model macro of the 1960s), no modern macro could possibly be Keynesian.

      Delete
    5. "Keynesian economics is defined as the obsolete macro of the 1930s...."

      Tendentious much? Any sensible definition should reflect the way the term is actually used. Wikipedia's effort is not too bad: "the view that in the short run...economic output is strongly influenced by aggregate demand." Of course that's incomplete; we need to explain what we mean by AD. More sophisticated discussion would tease out where Keynesian economics differs from Walrasian theory, monetarism of various kinds, etc. You're not furthering the discussion be defining a school of thought as obsolete.

      Delete
    6. Kevin,

      You misunderstand. Maybe you don't know that a "no true Scotsman" argument is a type of fallacious, circular argument?

      I'm not stating my own definition of Keynesian economics. Instead I'm accusing Cochrane of making a circular argument: "proving" that there are no current Keynesians, by implicitly defining Keynesian economics as 1930s macro and nothing else.

      "I practice Keynesian economics!" says Farmer (right on this thread), and Krugman, and Sims, and Woodford, etc. "But not the True Keynesian economics," replies Cochrane.

      Delete
    7. Everyone seems to be hung up on the word "Keynsian." I think John's main point is to attack the notion that during a recession, Gov spending of "any kind and of significant enough magnitude(whatever that means)" is enough to course correct us back to full employment and growth. This view - that PK and others keep spoon feeding to the public - is NOT taught in any graduate program and that's why he lampooned it.

      Delete
    8. Ragout,
      Yes, I misunderstood; thought you were telling Roger Farmer that he's wrong to see himself as working in the Keynesian tradition, rather than responding to John Cochrane's comment along those lines.

      Delete
    9. "Where I work, at the St. Louis Fed, using an IS/LM model would invite ridicule. But the Board's FRB/US model is indeed an expanded IS/LM model - without the LM curve."

      Not trying to say one model is better than the other here, but just assume the ISLM model gave consistently better predictions, would it still invite more ridicule than a DSGE model?

      Delete
  7. Did you hear about Kansas? (o-o) Tax department economists blew the income tax forecast by -$330 million after Brownback's tax cuts. They blamed it on the ATRA of 2012 pulling forward capital gains (at $330M/4.9% top tax rate = 6.7 billion in capital gains pulled forward). Never knew sunflowers paid so well (they don't and it's untrue that this was the cause). Maybe the truth is Art Laffer help them with their forecast.

    http://www.nytimes.com/2014/10/23/upshot/kansas-faces-additional-revenue-shortfalls-after-tax-cuts.html

    Brownback is just plum shocked, blaming the legislature for the cuts he signed. Let's watch though, because Art Laffer, and I presume you, are predicting a turn-around in the short-run in Kansas's under-performing economy. Or maybe the long-run.

    http://kcur.org/post/kansas-slashes-revenue-forecast

    This is kind of interesting: Russian cash registers are RINGING thanks to the devaluation of the ruble (or is that rubble) and credible threats of inflation...
    http://www.cnbc.com/id/102240080?trknav=homestack:topnews:1

    Krugman, to his credit today is thinking about the oil issue on-line, which will be helpful to our country and economists, like even in Kansas.



    ReplyDelete
    Replies
    1. 1. I could be wrong, but I don't recall ever seeing Prof. Cochrane make any predictions about Kansas so I'm not really sure what your point is.

      2. If politicians in Kansas were immediately expecting some sort of massive supply-side response to a 1.6 percentage point cut in the top marginal rate, then they were wrong.

      3. As Scott Sumner has pointed out, Kansas has a relatively large government sector compared to other states in the region. Perhaps their real budget issue is more about spending than revenues.

      http://www.themoneyillusion.com/?p=27773

      4. The current unemployment rate in Kansas is 4.4%.

      Delete
  8. Slightly off topic but here's a John Taylor post from a few years ago about Keynesians, New Keynesians and "anti-Keynesians."

    http://economicsone.com/2011/07/20/what-does-anti-keynesian-mean/

    ReplyDelete
  9. Have you considered changing your avatar to you yelling at the NYT not the WSJ?

    ReplyDelete
  10. Economic theory is to some extent performative. Wall St economists are surely trained in Keynesian economists judging by their pronouncements, then it seems likely that Keynesian theory is the most relevant for how the private sector thinks about macroeconomics, even if DSGE modeling is the preferred mode of academics.

    ReplyDelete
  11. "New-Keynesian" DSGE (Dynamic Stochastic General Equilibrium) models are much in vogue, but have really nothing to do with static Keynesian ISLM modeling. Many authors would like it to be so, but when you read the equations you will find these are just utterly different models.

    This, to my mind, is where you're wrong. I've read the equations and I see strong similarities between them. Now, you can say that's just me, but if I wanted to I could dig up many quotations from economics professors saying much the same thing. If Krugman annoys you too much, take a look at what Simon Wren-Lewis has to say; or you can find a paper by Benassy in which he uses a monetary OLG model to present IS/LM in a modern guise.

    ReplyDelete
    Replies
    1. I'd have added the following link (PDF file) to the Benassy paper I had in mind if I'd realized it was available online. And, pretty please, can the comment form stop insisting I prove I'm not a robot?

      https://hal.inria.fr/file/index/docid/590513/filename/wp200614.pdf

      Delete
  12. Cochrane is a typical Classical - talks about methodology and not about explaining the basic facts. Big deal that the DSGEs are fancier than the ISLMs. What are the tools in the Classical toolkit - market clearing, super agents, well functioning markets with no liquidity constraints, choosing leisure etc....- to explain the world in depression? Huh? And if I am choosing leisure I wouldn't be in the labor force so I couldn't be unemployed. - John H

    ReplyDelete
  13. I'm surprised no one has pointed out yet that ISLM isn't even Keynes - it's Hicks. ISLM doesn't appear in the Keynes' "80 year old book"; it's Hicks' stylized summary of part of it. And Hicks was well aware that ISLM had serious limitations; in his 1980 reflective piece in the JPKE (www.jstor.org/stable/4537583) he says that the "applied economist, who uses such methods" needs to be aware of these or ISLM will have no use beyond that of "a classroom gadget" (pp. 152-53).

    Maybe, John, you should be talking about "Hicksian macro" or, even better, "Hicksian ISLM". Then there's an interesting discussion to be had about a tool that many in academia think of as primarily as "a classroom gadget" but that seems to be used a lot by Hicks' "applied economists" working in the policy world. But identifying ISLM with "Keynesian economics" is a "No True Scotsman" fallacy, as Ragout rightly observes. Or, maybe even better, an example of Humpty Dumpty Economics. "When I use a word," Humpty Dumpty said, in rather a scornful tone, "it means just what I choose it to mean—neither more nor less."

    ReplyDelete
  14. " If old-time Keynesianism really does account for the data, write it down and let's see."

    It really does. IS-LM (as Mark pointed out, not a radical model but a fairly classical interpretation of Keynes or, from a technical point of view, simply a short-run general equilibrium model of the money, bonds and output market which takes as given that GDP is below long-run potential) has been tested empirically during the last years in Europe and contractionary fiscal policy did turn out to be contractionary. As there are (thankfully) rarely such radical political-economical experiments we rarely get such extremely clear cut results.

    ReplyDelete

Comments are welcome. Keep it short, polite, and on topic.

Thanks to a few abusers I am now moderating comments. I welcome thoughtful disagreement. I will block comments with insulting or abusive language. I'm also blocking totally inane comments. Try to make some sense. I am much more likely to allow critical comments if you have the honesty and courage to use your real name.