Thursday, 24 January 2013

Misinterpreting the history of macroeconomic thought

An attractive way to give a broad sweep over the history of macroeconomic ideas is to talk about a series of reactions to crises (see Matthew Klein and Noah Smith). However it is too simple, and misleads as a result. The Great Depression led to Keynesian economics. So far so good. The inflation of the 1970s led to ? Monetarism - well maybe in terms of a few brief policy experiments in the early 1980s, but Monetarist-Keynesian debates were going strong before the 1970s. The New Classical revolution? Well rational expectations can be helpful in adapting the Phillips curve to explain what happened in the 1970s, but I’m not sure that was the main reason why the idea was so rapidly adopted. The New Classical revolution was much more than rational expectations.

The attempt gets really off beam if we try and suggest that the rise of RBC models was a response to the inflation of the 1970s. I guess you could argue that the policy failures of the 1970s were an example of the Lucas critique, and that to avoid similar mistakes macroeconomists needed to develop microfounded models. But if explaining the last crisis really was the prime motivation, would you develop models in which there was no Phillips curve, and which made no attempt to explain the inflation of the 1970s (or indeed, the previous crisis - the Great Depression)?

What the ‘macroeconomic ideas develop as a response to crises’ story leaves out is the rest of economics, and ideology. The Keynesian revolution (by which I mean macroeconomics after the second world war) can be seen as a methodological revolution. Models were informed by theory, but their equations were built to explain the data. Time series econometrics played an essential role. However this appeared to be different from how other areas of the discipline worked. In these other areas of economics, explaining behaviour in terms of optimisation by individual agents was all important. This created a tension, and a major divide within economics as a whole. Macro appeared quite different from micro.

A particular manifestation of this was the constant question: where is the source of the market failure that gives rise to the business cycle. Most macroeconomists replied sticky prices, but this prompted the follow up question: why do rational firms or workers choose not to change their prices? The way most macroeconomists at the time chose to answer this was that expectations were slow to adjust. It was a disastrous choice, but I suspect one that had very little to do with the nature of Keynesian theory, and rather more to do with the analytical convenience of adaptive expectations. Anyhow, that is another story.

The New Classical revolution was in part a response to that tension. In methodological terms it was a counter revolution, trying to take macroeconomics away from the econometricians, and bring it back to something microeconomists could understand. Of course it could point to policy in the 1970s as justification, but I doubt that was the driving force. I also think it is difficult to fully understand the New Classical revolution, and the development of RBC models, without adding in some ideology. 


Does this have anything to tell us about how macroeconomics will respond to the Great Recession? I think it does. If you bought the ‘responding to the last crisis’ narrative, you would expect to see some sea change, akin to Keynesian economics or the New Classical revolution. I suspect you would be disappointed. While I see plenty of financial frictions being added to DSGE models, I do not see any significant body of macroeconomists wanting to ply their trade in a radically different way. If this crisis is going to generate a new revolution in macroeconomics, where are the revolutionaries? However, if you read the history of macro thought the way I do, then macro crises are neither necessary nor sufficient for revolutions in macro thought. Perhaps there was only one real revolution, and we have been adjusting to the tensions that created ever since.  

9 comments:

  1. A lot of empirical work suggests that optimisation (at least as defined by Samuelson) is not actually how consumers act, e.g. Sippel (1997). We need a revolution not in macro so much as in the microfoundations themselves. Steve Keen is one of many revolutionaries who are ripping up these either falsified or unfalsifiable Walrasian and Samuelsonian assumptions and starting again. Empirical work in behavioural economics is providing a new framework for how individual agents actually behave. Walrasians who ignore this incipient revolution will end up looking irrelevant.

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  2. Well, this still leaves my main question unanswered...Why aren't macroeconomists dissatisfied with our actual inability to tell which models work when (and thus which to use when)?

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    1. Noah - I agree, but my point was that it was not always so. When central banks used models based on time series econometrics, the idea was to explain the data as far as possible. Good empirical work attempted to encompass previous findings. Before RBC, even people writing theory papers would appeal to time series evidence as well as theory in justifying the relationships they used, and there were many more attempts in the literature to estimate consumption functions, investment functions and the like.

      Now this did not stop macro making big mistakes, as the 1970s showed. But the current attitude to models and evidence is the result of a particular methodology, and is absolutely not inherent to macro.

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  3. @ Noah Smith24 January 2013 21:25

    The answer is simply that they don't know and don't care - besides as most Economists depend on public money, they don't want to upset the mainstream and their 'meal-ticket'.

    Economics is all FRAUD where Economic Theory equals Political Expedience ONLY. Where GDP and CPI are manipulative Frauds perpetrated by political expediency. Economics can not and will not stand up to the light of scrutiny, it needs and gets support through blind consensual prattle of the Economists; the Banker's "True Believer" Priests. Yes, Economics is a cult and at best an Institutional Religion of Dogma.

    There are over 30 Main Schools of Economic Theory and none of them would stand any element of scientific scrutiny.

    Ho hum

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    1. I neglect to say that the whole Cathedral of Economics need to be burnt to the ground so as to give birth to something that resembles a dynamic comprehensive approach to human behaviours, founded in Integrity and Scientific Procedure.

      Prior to that, all the exotic terms used by Economists need to be transparently defined; something that is earnestly and desperately hidden from view, in today's World as the Global Economic Collapses.

      While we are at in, we must justify, and explain, why it is that the Bankers rule the whole world, including education and commit pervasive fraud with impunity, and why this is acceptable to our so-called modern Economists.

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    2. Looks a bit overpessimistic.
      -Start with using realistic assumptions and assumptions when coming from another field supported by that other field (political science come to mind) and not make them up. Politics react differently from what 14 year olds think so donot use the assumptions 14 year olds would use, but the ones based in science (be it a soft science).
      -Start with decent definitions and use these in a consistent way.
      -As it is a soft science look at other ways to see if conclusions are correct, not simply apply a formula and that is it (as is often done).
      -A lot of economist simply are not up for the job, eliminate these jokes as far as possible from the public domain, they give the field, like with all soft sciences, a bad name.
      -stay out of political discussions as far as possible (no max social benefit stuff an so on, let politics decide on that). The moment you get into politics at least half the population will sincerely doubt your credibility and your academic work.

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  4. Concerning the "tension" in economics during the 70s your view matches my memories: There was Leijonhufvud's "Life among the Econ" and all the discussions about the divide between micro and macro. After Clower's "Keynesian Counterrevolution - a theoretical appraisal" the neo-walrasian disequilibrium approach (Benassy, Drèze, Malinvaud) was on vogue, though not in the US.

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  5. In the introduction to the second (or was it the third?) edition of Capitalism and Democracy, Milton Friedman remarks that he had been preaching the same principles for many years before they became popular. In other words, the seeds of monetarism already existed before the crisis of inflation, and only came into favor after it. I think that crises rarely spark new innovation-- rather they swing emphasis from one already developed field to another. In this sense swings are very much ideological--when bad things happen the party in office is voted out. (owe much of this opinion to Mark Blyth's Great Transformations)

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  6. Developments in sociobiological understanding are now guiding us to a fundamental rethink of political and economic ideology in the sense that because human nature is ambivalent it is a "variable" and as such has to form the foundation of our thinking for any ideological development. It has to do so because a variable will have us hunting for an "area of stability" because a state of pure equilibrium is a chimera. "Hunting" is of course another term for "seeking balance." This strongly reflects itself in the Sectoral Balances work of Wynne Godley, Modern Money Theory and the dynamic modelling work of Steve Keen.

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