Must-Read: JEC: Houdini’s Straightjacket

Must-Read: JEC: Houdini’s Straightjacket:

Escape artistry… probably wouldn’t be anyone’s first choice as a model for the conduct of social science.  Yet, bizarrely, it has become the prevailing paradigm in macroeconomics….

How so? Consider the macroeconomist.  She constructs a rigorously micro-founded model, grounded purely in representative agents solving intertemporal dynamic optimization problems in a context of strict rational expectations.  Then, in a dazzling display of mathematical sophistication, theoretical acuity, and showmanship (some things never change), she derives results and policy implications that are exactly what the IS-LM model has been telling us all along. Crowd–such as it is–goes wild. And let’s be clear:  not even the most enthusiastic players of the macroeconomics game imagine that representative agents or rational expectations are, in any sense, empirical realities. They are conventions, “rules of the game”…. arbitrary difficulties we impose on ourselves in order to demonstrate our superior cleverness in being able to escape them. They are, in a word, Houdini’s straightjacket….

[This] modelling approach made arriving at sound policy recommendations unnecessarily difficult. For example, George Evans at the University of Oregon writes:

[T]he profession as a whole seemed to many of us slow to appreciate the implications of the NK model for policy during and following the financial crisis… because many macro economists using NK models in 2007-8 did not fully appreciate the Keynesian mechanisms present in the model.

Now, if after thirty years of study economists failed to “fully appreciate the Keynesian mechanisms present in the model,” one might wonder exactly what such models have to recommend themselves. What is the advantage of an intellectually demanding and mathematically complex modelling approach that makes it harder to actually get the job done? The answer, I suspect, is that “intellectually demanding and mathematically complex” has become an end in itself…. Which is fine as long as the goal is entertainment…