Ideology and Falsification in Macroeconomics

                This is a response to two posts, one by Stephen Williamson and another two by Noah Smith. Both are linked to a Paul Krugman post, which commented on, and had the same broad message, as one of my own. See also Mark Thoma here.

                Both Paul Krugman and I argued that the reason for the apparent disputative nature of macro lay in politics and ideology. To paraphrase my own take, the antagonism to a Keynesian reading of events since to financial crisis has ideological roots, based on a distrust of government intervention. This distrust is most apparent in the austerity versus stimulus debate on fiscal policy.

                Underneath Stephen Williamson’s obvious personal dislike for what Krugman is doing, there is a serious challenge to this view.  He writes

“Modern macroeconomics has been much more concerned with science than with politics. Robert Solow, David Cass, Tjalling Koopmans, Len Mirman, and Buzz Brock were not thinking about politics when they developed the theory that Kydland and Prescott used in their early work. I don't think Kydland and Prescott had politics on their mind in 1982, nor was Mike Woodford thinking about politics when he adapted Kydland and Prescott's work to come up with New Keynesian theory.”

Details aside, I think this will strike a chord with many academic macroeconomists. They are just trying to advance the discipline, and are certainly not trying to defend some ideological viewpoint. There are lots of interesting new ideas being explored in modern macro, producing high quality work with important implications. Most importantly, this work can be appreciated by most mainstream fellow researchers. Unlike the days of old, where members of different schools of thought talked across each other, we now have a shared language as a result of the microfoundation of macro.

I agree with everything in the previous paragraph, which is perhaps where I differ from some other Keynesians.[1] But I also obviously agree with what I wrote on ideology and macro. So how can I square this circle? The first, and probably critical, point to make is that when I and most others talk about antagonistic macroeconomic debates, we are referring to debates over current macroeconomic policy rather than the details of some macroeconomic research. The second point is that New Keynesian theory builds on Real Business Cycle foundations, and is therefore in theoretical terms not an alternative to it.

So, for example, I have no problem appreciating a seminar where the presenter explores a flex price DSGE model where fluctuations are only caused by productivity shocks, but where some relevant feature of the real world (some ‘friction’) is being added to earlier models. I might learn something about how to model this new feature, and what its macroeconomic implications might be. It could be the case that these techniques and results are completely negated once you added sticky prices into the model, but normally this is not the case. However, when it comes to looking at the impact of contractionary fiscal policy on the macroeconomy today, I will select a quite different model: sticky prices are essential, because we need to work in a world where we have demand deficiency.

The current reversion of macro back into schools of thought relates to policy advice. It’s about which models we select, and which we reject, when telling governments what to do. So the interesting question that arises is how this selection process takes place. Why do I insist we need to focus on aggregate demand to understand what is happening today, while others take a different view?

In the idealised Popperian description of scientific progress, it is evidence that provides this selection process. The moment that a piece of evidence is found that contradicts a theory or model, that theory will be rejected, and a new theory will emerge that is consistent with all known evidence. What is missing in macro, says Noah Smith, is this falsification process. I think the late and great Mark Blaug would wholeheartedly agree.

Now I could at this stage talk about the limits to falsificationism, and how it particularly fails to apply to economics. But I think Noah is essentially right. For a number of reasons I’ve talked about elsewhere, the microfoundation of macro and DSGE modelling downplays the role of evidence. More specifically, it allows modellers to be selective about which evidence they focus on (the ‘puzzle’). This may be fine for writing papers, but when it comes to model selection to tackle policy problems it is weak. And this weakness lets in the ideological factors I talked about.

So that is how I can be both supportive of current academic macro, and believe that macroeconomic policy advice is contaminated by ideology. I want to add one additional thought. Noah talked about this problem as one involving broken institutions, and I found that strange at first. But let’s go back to my fictional seminar involving a model where cycles are generated by productivity shocks. Even though the model is missing what I believe causes most business cycles, I can still learn something from the seminar, so it would be quite inappropriate for me to denounce the paper and storm out in disgust. Equally, academics should be free to choose what they think are interesting avenues to explore. The problem comes when the policy maker has to choose between models. But how and where exactly should evidence be exerting a greater influence? Is the problem in the selection processes of journals? Should there be more econometric analysis of structural macro relationships in journals, or do VARs tell us all we need to know? If nothing is missing from the academic journals, should policy making institutions employ more staff to do this kind of work? If you think that ideology plays too large a role in macro policy, but refuse to believe that this must always be so, these are interesting questions.        

               

               

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[1] This is a different question about whether modern macro has advanced our understanding of the current crisis. Here I agree that old fashioned tools (be they 1970s macro – see Robert Gordon for example - or the General Theory itself) have proved their worth, but I also suspect that in time a more complete understanding will include more modern (and as yet undeveloped) elements.