Microfounded macromodels, aka DSGE models, hold a dominant
position in academic macro, and their influence in central banks is increasing.
(The Bank of England’s core model is DSGE, but the approach has not yet quite achieved
a similar dominance in the Fed or elsewhere.) At the risk of gross
oversimplification, you can class the critics of this situation into two
groups: the reformers and revolutionaries. The reformers (like myself) see DSGE
analysis as always forming a central part of macro, but want greater diversity,
with in particular more analysis using time series econometrics. The
revolutionaries want to confine DSGE analysis to a much more minor role, if not
the bin.
In a sense debate between these critics is a bit pointless.
We are standing on the same train platform, agreed on the direction of travel,
but at the moment the train shows no sign of moving. There is a danger that we
spend too much time arguing about when the train should stop, and not thinking
enough about how to get it going in the first place. Nevertheless I think it is
worth having the debate, if only because of tactics. Those DSGE modellers who
are sympathetic to reform can easily become defenders of the status quo in the
face of more extreme attacks.
So let me give one argument for reform rather than
revolution that I have only made implicitly before. When I studied macro and
then began working as a macroeconomist, mainstream macro was divided into schools
of thought. In an environment where both inflation and unemployment were
high, you had monetarists saying that you just needed to control the money
supply, some Keynesians arguing that we should focus on unemployment because it
had nothing to do with inflation, and New Classicals saying unemployment was
not even a problem. Each school had its models, and each claimed empirical
backing. Econometric analysis was not strong enough to discriminate between
schools. Different schools tended to talk across each other, and anyone trying
to look for common ground or ultimate sources of disagreement had a hard time,
and ended up writing lists. For a policymaker or student it must have seemed like a
nightmare, and no wonder many chose which school to follow based on its
ideological associations.
In my view microfoundations brought some order to this chaos
(see this
from here).
Now for heterodox economists who think the microfoundation approach is
fundamentally flawed, this is a problem: we are looking at alternatives through
the wrong lens. But for those who think that, for at least some problems, basic
micro reasoning is a good place to start, microfoundations provided a common
language with which to discuss and appreciate different points of view. Note
that this is not an argument for complete synthesis, but just a shared
language.
As Diane Coyle noted
about the conference we both recently attended, the UK’s social science funding
agency (the ESRC) is considering what kind of research in macro is needed
post crisis, and therefore what funding initiatives might be appropriate. Here
I want to present a cautionary tale. Macro is dominated by US economists of
course, but one area where the UK was strong was in the building and empirical
evaluation of econometric macromodels. This reflected strength in time series
economics (David Hendry, Hashem Pesaran,
Andrew
Harvey to name just three), but was embodied in the ESRC
Macroeconomic Modelling Bureau, directed by Ken
Wallis from 1983 to 1999. However with the intellectual tide moving ever
more strongly in favour of calibrated DSGE models, macro papers by those
involved with this area were not hitting the top journals. Partly as a result,
the ESRC (which really means the academic and other macroeconomists advising
the ESRC) decided to discontinue funding for the centre.[1]
I thought that was a huge mistake at the time, and that
conviction has been reinforced by recent events.[2]
What the Bureau did was bring modellers from policy institutions and academics together
around the concrete endeavour of comparing the models used by those
institutions. At the very least, modellers became aware of alternative
perspectives, and models used by policymakers were subject to critique.
This has now been lost. The moral I draw
from this mistake is that it is dangerous to sacrifice strengths to fashion.
The UK retains strengths in time series macro: one of the strongest papers at
the conference was presented by John Muelbauer,
whose work on financial liberalisation and consumption I have discussed
before. However the UK also has a number of economists producing strong work in
the DSGE tradition, and this should also be encouraged. What the UK really
lacks (and the key message from the report Diane cites)
is academic macroeconomists, and the reason for that is for another post.
[1] The Centre was co-funded by the Treasury and the Bank of England, and the absence of strong support from these institutions may also have been important in this decision. Both institutions were of course subject to the same intellectual tide, and may have had mixed feelings about being open to external critique.
[2] Unfortunately this was not the first time lack of support from the ESRC killed off a very innovative and productive macro research team. Many of the issues involved in optimal policy analysis in rational expectations models were first investigated by David Currie and Paul Levine in the 1980s, but funding support for this team was not renewed by the academics advising the ESRC.
[2] Unfortunately this was not the first time lack of support from the ESRC killed off a very innovative and productive macro research team. Many of the issues involved in optimal policy analysis in rational expectations models were first investigated by David Currie and Paul Levine in the 1980s, but funding support for this team was not renewed by the academics advising the ESRC.
