Thursday, September 16, 2010

What's wrong with macro?

Peter Boettke shares some good Congressional testimony from David Colander here, and invites people to read and react.

There are some pluses and minuses in this testimony. A lot of the message is that old song and dance that economics is over-mathematized. To a certain extent, I agree with this. But how much is too much? Some people balk at a little calculus so this is always hard to judge. My concern is that it's precisely when you dump the math that people stop thinking clearly about correlation vs. causality, proper identification of a problem, endogeneity, etc. So that's one problem I would put a spotlight on. Words aren't as clear as functions - it's a simple as that. I can point your to one of Mattheus's posts yesterday where we chased each other back and forth over what "wealth" is. That would not be an issue if we introduced a little math.

I think Colander also somewhat overstates the limitations of standard macro models. He laments the absence of forward looking agents, multiple equilibria, non-linearities, etc.. There's only one problem - these things are in all kinds of macro models. Recently, Mark Thomas shared this video of George Evans presenting the dynamics of a New Keynesian model where all the elements Colander was concerned about are considered:

One of the things Colander mentions is that economists look at what their math lets them look at, and not what is important to look at. That accusation bears no resemblance to what Evans presents here - this is clearly relevant to what we're going through now. He didn't just pick this because this is what he could do mathematically. This is also should not be too technical for anyone trained in economics to understand. You may not have been able to figure it out. You may not be able to lecture on it yourself - but I don't think there should be major obstacles to understanding it.

So are there limits? Sure. Should we be cognizant of problems that may be less amenable to modeling? Well of course! I take Colander's points to be in the right spirit, but somewhat overstated.

- In this vein I also want to share this CESinfo conference I found from last year on "what's wrong with modern macroeconomics?". I haven't looked at it in detail, but they link to a lot of papers.

- Russ Roberts shares a less insightful answer to my title question, where the answer is essentially "Keynesianism". Right now, it's not worth getting into how ignorant this one reads. Needless to say - if you're time is limited, read the Colander link rather than this one.

I see, in ten or fifteen years, some revised New Keynesian models. This downturn, like the Great Depression, has rightfully brought Keynes to the forefront. Immediately after the Great Depression we had a lot of "crude Keynesianism" - and understandably so. It was new stuff and a brave new world. When that faltered, a lot of people assumed Keynesianism needed to be abandoned. The smart ones realized it needed to be improved. We're not going to enter the post-Great Recession period with the same rose-tinted glasses that the crude Keynesians had. You see people talking about incorporating the right Old Keynesian principles into New Keynesian models. Nobody is abandoning the good stuff in the Rational Expectations revolution. Friedman has made his mark. Phelps has made his mark. We're going to get a better Keynesianism after all this and we're going to think about how Keynesian thinking relates to periods of weak and strong demand. (Hopefully) we're not going to go into another Dark Age where we assume that to explain periods of strong demand we have to reembrace classicism. But we're going to come through this with more Keynesianism rather than less. This is going to disturb a lot of people who for some insane reason think the current downturn was the death knell for Keynes.

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