Theory is dead; long live theory [Summer silly season]

In a typically entertaining and provocative recent blog post, Noah Smith pronounced ‘the death of theory’, and then proceeded to offer a post-mortem.  Paul Krugman thought he had exaggerated a little, but still accepted the basic premise, and then offered his own diagnosis of the cause of death, in his fields of macro and trade.

Looking around at the fields I either participate in, consume, or read about in literature surveys, I find the notion that theory is dead completely mystifying.  I guess the word ‘dead’ applied as a metaphor to describe academic disciplines, is, unlike in biology, somewhat subjective, so there is room for disagreement.

Here are some developments in macro theory that I guess Noah and Paul would take to be intellectual rigor-mortis, but I take as signs of healthy life.

– The struggle to incorporate financial frictions into real business cycle models [Kiyotaki, Moore, Allen, Gale, Bernanke, Gertler, Gilchrist]

– The incorporation of sticky prices and wages into real business cycle models [Blanchard, Kiyotaki, Christiano, Eichenbaum, Evans]

– The fleshing out of international real business cycle theory, its puzzles, and the possible resolutions [Bacchus, Kydland, Kehoe, Stockman, Tesar, Obstfeld, Rogoff…]

– The exploration of the implications of rational expectations and sticky prices for monetary and fiscal policy and the study of attendant credibility problems [McCallum, Nelson, Rotemburg, Woodford, Gali, Gertler]

– The development of ‘new monetarist economics’, explanations for the emergence of and value of money [Kiyotaki, Wright, Williamson, Lagos…]

– Explorations of the implications of non-rational expectations for business cycles, inflation dynamics, asset pricing, and policy, [in the work of Sargent, Evans, Honkapohja, Sims, Mankiw, Reiss and many others]

– Sargent’s work with co-authors on robust policymaking, and the implications for asset pricing of robust behaviour by agents

– The development of heterogeneous agent rational expectations macroeconomic models, [through the work of Bewley, Aiyagari, Huggett, Krussel and Smith, Rios-Rull, Den Haan, Heathcote and many others.]

– The merging of macro and finance, the identification of associated asset pricing and business cycle puzzles, and various resolutions [Mehra, Prescott, Bansal, Yaron, Cochrane, Campbell, Epstein, Zin…]

I could go on.  The statistics that Noah present, showing increases in the proportions of papers described as empirical, are intriguing.   Looking at my own field I can see anecdotal evidence of a vibrant empirical literature too.  For example, the emergence of new datasets on price-setting at the firm or good level.  Or the emergence of very high frequency financial data.  Or regulatory data sets on banks and their customers.

But this empirical work seems to have spurred theoretical work, not superseded it.  For example, work on micro data on price setting has energised the controversy over whether prices are sticky or not.  Yan see this in the debate over the significance of discounted sales prices – are they signs of flexibility, or temporary departures from a sticky price?  Or in the observation that micro data invalidate early New Keynesian models previously fitted only to macroeconomic time series (eg in respect of their being no indexation in prices, typically, or in the observation that the longer a price has been fixed, the more likely it is not to be changed next period).

And much of the empirical work I see around me has a life that depends on the theoretical work that preceded it.  The enormous field contrasting the properties of business cycle models with the data, and working out what can and can’t be inferred from this contrast, is one example of that.  Theory has produced a rich set of hypotheses that empirical researchers can get tenure falsifying.

If this is theoretical ‘death’, then long may macroeconomic theory remaind dead.

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3 Responses to Theory is dead; long live theory [Summer silly season]

  1. Noah Smith says:

    I think you do have a good point, at least when it comes to macro.

  2. daniels says:

    The distinction between theory and empirics is actually not so clear cut in many of the examples you mention. A lot of it is quantitative theory: using a structural model with either calibrated parameters (semi-formal method of moments) or in many cases more formal estimation. I guess what’s true is that there’s a lot more work of this sort, that’s not just pure theory anymore as in the heyday of pure general equilibrium theory or the initial development of game theory. Same thing in industrial organisation and some parts of labour economics. And this was the intent of people like Lucas and Prescott all along: that economists should use theory to explore more applied hypotheses that could not be proved necessarily in the most general purely theoretical form, but could be explored for plausible parametrisations on a computer using numerical methods (Ken Judd has a similar point I think about the switch towards less pure theory in one of his more methodological papers on the importance of numerical methods in economics).

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