The trouble with macro

Diane Coyle, writing in an FT blog, says

 “There are two tribes of economists, the macro and the micro. I’m one of the latter group. We have our empirical controversies, of course – much of our applied research concerns public policy choices in areas such as education and health, so vigorous disagreement is inevitable. But I think it’s fair to say that few of the micro disagreements compare in intensity to the all-out war of words between different macroeconomists about the effects of fiscal stimulus or austerity.”

She goes on to say that it is macroeconomists’ “certainty that’s astonishing”. Her comments could be summarised as asking why macroeconomists are so sure and shrill compared to their micro colleagues.

Now it could be that there is something odd about those who choose macro rather than other types of economics, but I’m not sure I’ve noticed any character traits more evident in macro people. (But who am I to judge - an open invitation for microeconomists to comment!?) It could be something to do with the nature of the theory and empirics involved, but since macro became microfounded that seems unlikely. I think the problem is in a way much more straightforward.

I think you only need to look at the recent UK election to understand the problem. One of the central themes of the Conservative’s attack on Labour involved their alleged incompetence at running the macroeconomy when they were in power. For whatever reason, macro rather than micro policy issues become central in political debates. That makes macro unusual for various reasons.

One immediate consequence is that many beyond the tribe of macroeconomists think they can write with authority of macroeconomic issues. As a recent example of a shrill macro debate Diane cites Krugman vs Ferguson. But this is not to compare like with like. On one side you have an economics Nobel Prize winner who has made important contributions to macroeconomics, and as a result is careful about what he writes. Both data and theory are respected. On the other side … well I’ve said what I think in an earlier post.

To take another politically charged topic, I have seen plenty of debates between climate change scientists and deniers who are not scientists. Often the scientist will go into detail to get the facts straight, and say how uncertain everything is, while their opponent by contrast will be confident and clear. A scientist will not be fooled by this confidence, but many others will be. When one side argues out of conviction or ideology or political bias rather than knowledge, it is difficult for someone who does have that knowledge not to respond in kind if they want to be convincing.

There is a deeper reason for shrillness, however. The debate over austerity is not a normal academic discussion about the likely size of parameter values. Here Diane is mistaken in saying that the key issue is whether the multiplier (the size of the impact of cuts in government spending on output) is greater or less than one. In talking about UK austerity, I have typically quoted OBR figures which assume a multiplier below one, which gives me the £4000 per average household cost of UK austerity. My own best guess would be that the multiplier has been larger than one, which gives me significantly higher costs, but I have never suggested that I know with certainty what the size of the multiplier has actually been. However there has, to my knowledge, been no public debate on these terms.

Instead supporters of austerity typically want to suggest that the multiplier is close to zero. They want to suggest that sacking nurses and cutting back on flood defences will be very rapidly met by an increase in private sector labour demand and investment. Although theoretically possible via various different mechanisms, the evidence and recent experience overwhelmingly suggests this does not normally happen in the kind of situation we are currently in. For much of the time those arguing for the virtues of current austerity seem to be doing so from a position of faith or political convenience rather than evidence.

Why is it important to recognise this? Because there is a danger that microeconomists may misdiagnose the problem, and suggest that macro contains some fundamental flaw which undermines eighty years of intellectual endeavour. This provides useful cover to those who have an ideological or political agenda, and want policymakers to ignore the bits of the discipline that clearly work. Sometimes microeconomists seem to think that if only they could disassociate themselves from macro, economics would become a better and more respectable subject. That is an illusion: the ideological and political forces that cause such problems for macro are not unique to it.

So I’m not sure that academic macroeconomists suffer from an excess of certainty compared to their micro colleagues. Instead I think the trouble with macro is that it is prone to ideological and political influence: like all economics, but just more so.

What microeconomists think about macroeconomics

                There is a lot that is interesting in Diane Coyle’s 2012 Tanner lectures. What I want to respond to here is an associated post, where she expresses some of the frustrations that I know many microeconomists have with macroeconomics. These can be summed up rather crudely as: why do we disagree all the time, and yet appear so sure we are right, and don’t we realise we are bringing the whole discipline into disrepute? Diane says that “macroeconomists simply do not realise how low their stock has sunk in the eyes of their microeconomist colleagues”. This may be an exaggeration, but who knows what is said when we are out of earshot. Because I (and pretty well all macroeconomists) do have great respect for our microeconomic colleagues, we have some explaining to do. (Jonathan Portes has an excellent post responding to some of the more specific comments Diane makes in this post.)

                What I want to say in summary is this. Microeconomists are right in many of their criticisms, but what they often fail to see is the root cause of the problem. This is that macroeconomic policy is highly political, with strong ideological implications. Ideology and politics distort macroeconomics as a science. Yet despite this, there is – and for many years has been – a substantial body of analysis that most macroeconomics would sign up to, and which has sound empirical backing.

                What is this substantial body of analysis? It is what used to be called the new neoclassical synthesis (Goodfriend and King (1997) – see here for more background and references). For a closed economy, its details are well represented in Romer’s graduate textbook, for example. This body of analysis has important gaps and omissions, of course, such as a naive and simplistic view of the financial sector. However, as I argued recently, the financial crisis itself showed up this incompleteness, but did not invalidate most of what was in the synthesis. Indeed, events since the crisis have provided significant empirical support for the Keynesian elements of that synthesis. (Of course, there are caveats, some of which I have discussed in earlier posts, and which I will return to below.)

                So why the appearance of constant disagreement among macroeconomists? The first point to make is that the disagreement tends to focus on one part of the synthesis, which is short term macroeconomic fluctuations: their causes and cures. This is not the only part of the synthesis which has the potential for political and ideological controversy, but it is where there is constant popular and media interest. The second point, however, is that politics alone is not sufficient to explain controversy within a scientific discipline. Here I might give climate change is an example: despite strong pecuniary temptations, climate change science is pretty united, and typically dissenting views come from outside the discipline.

                The reason, I would suggest, why many macroeconomists do not sign up to the new neoclassical synthesis is that its Keynesian component conflicts with an ideological view which uses economics as part of its intellectual foundation. That view is that markets generally work well when left free from political interference and that government intervention is almost always bad. Now most microeconomists will immediately point out that microeconomic theory as a whole does not support this ideological view. Much microeconomic analysis is all about market imperfections. But that misses the point. Those attracted to this ideological position use a very partial take on economics for support, and are naturally attracted to that part of the discipline.

                Keynesian analysis is all about the consequences of one particular market imperfection. Conventionally this is seen as the externalities that arise from sticky prices. (I personally am increasing drawn to describe them as the consequences of the existence of money, but that is a different story.) It implies in general the need for constant involvement of one arm of the state – the central bank – in stabilising the economy, and in some circumstances the involvement of fiscal policy to do the same. I have argued that this analysis leaves those with the ideological view that free markets are good and government intervention bad feeling very uncomfortable, so they will try and find ways of avoiding and disputing this part of the synthesis.

                Now nothing I have said so far makes macroeconomics unique in attracting ideologically driven controversy. There are areas of microeconomics which are equally controversial for similar reasons. I would suggest the debate over minimum wages is an example. An outsider looking at this debate might well conclude that labour economists are as equally disputatious as macroeconomists on this issue. Another example from my youth I always like to use is the ‘Cambridge controversies’ over ‘reswitching’. This was a highly technical theoretical dispute, but its ideological implications were such that views on this technical debate were highly correlated with political beliefs.

                I think there is one factor that is peculiar to macroeconomics, and that is the role of ‘city’ economists. There are two elements here. One is that city economists work in an environment which has a strong vested interest in promoting the free market ideological view. The other is that part of the name of the game for these guys is to differentiate the product. These are of course tendencies: there are many excellent city economists who go with the evidence rather than with ideological conviction.

                Why is it important to say all this? First, because the influence of ideology on economics is not confined to macroeconomics. It is also not confined to the political right, so there is no simple bias, but recognition rather than denial is important. Second, the cure – if there is one – is evidence. As Jonathan points out, the recent evidence is clearly with those who accept Keynesian views, but I think there is an underlying problem. The way empirical evidence is marshalled in the microfoundations methodology associated with DSGE modelling makes it too easy for those who hold ideologically based priors to retain and defend those priors, which is one reason why I have tried to suggest that it should not be the only way serious macroeconomic analysis is done.