“We Always Thanked Robert Lucas for Giving Us a… Monopoly” Over Valuable Macroeconomics
The extremely sharp Paul Romer gets something, I think, very very wrong in paragraph 3 of his latest weblog post. Paul is, I think, the captive of a folk story about the economy and economics that only survives–that could only survive–only within the epistemically-closed scholastic hothouse that is the post-Friedman Chicago School:
: Solow’s Choice: “Robert Solow’s had a choice about how to respond…
…He chose sarcastic denial over serious engagement. His optimistic assessment of the prospects for the simulation models, a grade of B or B- but nothing ‘in that record that suggests suicide,’ is hard to reconcile with the decision by virtually all macroeconomists to abandon work on them…
Ummm…
That seem to me to be pretty completely wrong.
Consider Macro Advisers. Macro Advisors makes a very good living today selling its simulation models:
: Model Services: “We released a major update of our structural macro model, MA/US in December 2012…
…We are proud to share our modeling with clients who want to make their own forecasts, conduct their own policy analysis and develop their own alternative scenarios. Clients interested in developing their own model-based forecasts understand that model building and forecasting is a team sport, requiring vast resources. By subscribing to MA’s Model Service, these clients have access to MA’s structural econometric model of the U.S. economy, MA/US, and receive extensive support from the MA team… clients are able to produce their own forecasts, perform policy analysis, and construct alternative scenarios…
And MA’s founder Laurence Meyer still finds his structural model very useful–and believes that it would be an error to require it impose rational expectations everywhere:
: What I Learned at the Fed: “Bond markets are fiercely forward-looking and have to be modelled as such…
…Rational expectations also appears to be important in explaining the effect of a productivity acceleration, specifically in terms of capturing the effect on equity valuations of forward-looking expectations of earnings growth and the effect on consumer spending of forward-looking expectations of the growth of wage income. On the other hand, I don’t find rational expectations as compelling when it comes to inflation dynamics. With respect to understanding the effects of monetary policy, it is forward-looking behaviour in the bond market that is especially important…
Larry Meyer gives his assessment of all of the impact of Lucas and the rest of Chicago macro thus:
John Cassidy (1996): The Decline of Economics: “Meyer… “In our firm…
…we always thanked Robert Lucas for giving us a virtual monopoly. Because of Lucas and others, for two decades no graduate students are trained who were capable of competing with us by building econometric models that had a hope of explaining short-run output and price dynamics. [Academic economics Ph.D. programs] educated a lot of macroeconomists who were trained to do only two things–teach macroeconomics to graduate students, and publish in the journals.
Cassidy continues:
Meyer also pointed out that the large-scale Keynesian models that Lucas criticized have actually tracked the economy pretty accurately… when… modified….
People who have spent their lives doing macroeconomic forecasting and policy analysis know that over the last twenty-five years the Phillips curve has been the single most reliable tool in their tool kit…
And:
Meyer dismissed Lucas’s followers as practitioners of what he terms closed-blind economics, saying mockingly:
When you close the blinds, you don’t look out of your window and you don’t care what’s happening out there. You don’t try to build models which are consistent with the real world. With the blinds closed, it’s hard to see anything…
It is not just private-sector clients who are going to make investment decisions that depend on having a good macroeconomic forecast who are willing to pay handsomely for the output of the simulation models Romer scorns. The same holds true for central bankers as well:
Greg Mankiw: The Macroeconomist as Scientist and Engineer: “Laurence Meyer… left his job as an economics professor at Washington University…
…and as a prominent economic consultant to serve for six years as a Governor of the Federal Reserve. His book… leaves the reader with one clear impression: recent developments in business cycle theory, promulgated by both new classicals and new Keynesians, have had close to zero impact on practical policymaking. Meyer’s analysis of economic fluctuations and monetary policy is intelligent and nuanced, but it shows no traces of modern macroeconomic theory. It would seem almost completely familiar to someone who was schooled in the neoclassical-Keynesian synthesis that prevailed around 1970 and has ignored the scholarly literature ever since. Meyer’s worldview would be easy to dismiss as outdated if it were idiosyncratic, but it’s not. It is typical of economists who have held top positions in the world’s central banks…
Mankiw concludes:
Greg Mankiw: The Macroeconomist as Scientist and Engineer: “A new consensus has emerged about the best way to understand economic fluctuations…
…The heart of this new synthesis–a dynamic general equilibrium system with nominal rigidities–is precisely what one finds in the early Keynesian models. Hicks proposed the IS-LM model, for example, in an attempt at putting the ideas of Keynes into a general equilibrium setting. (Recall that Hicks won the 1972 Nobel Prize jointly with Kenneth Arrow for contributions to general equilibrium theory.) Klein, Modigliani, and the other [structural simulation] model builders were attempting to bring that general equilibrium system to the data to devise better policy. To a large extent, the new synthesis picks up the research agenda that the profession abandoned, at the behest of the new classicals, in the 1970s….
The new classical economists promised more than they could deliver. Their stated aim was to discard Keynesian theorizing and replace it with market-clearing models that could be convincingly brought to the data and then used for policy analysis…. The movement failed…. Their analytic tools that are now being used to develop another generation of models that assume sticky prices and that, in many ways, resemble the models that the new classicals were campaigning against.
The new Keynesians can claim a degree of vindication here. The new synthesis discards the market-clearing assumption that Solow called “foolishly restrictive”and that the new Keynesian research on sticky prices aimed to undermine. Yet the new Keynesians can be criticized for having taken the new classicals’ bait and, as a result, pursuing a research program that turned out to be too abstract and insufficiently practical…