This post is prompted by a twitter exchange some time ago between Adam Posen, Noah Smith and myself over the ‘merit’ of microfoundations. [Here’s a storify recap]. And that in turn by the fall-out from the events at the Federal Reserve Bank of Minneapolis, where Naranya Kocherlakota [former microfounding whizz] has begun to push out senior advisors and research economists, including Pat Kehoe and Ellen McGratten. But this debate will be familiar to those following econ blogs for longer than that. It’s tangentially related to the controversy in the UK over how economics should be taught, fuelled by the student campaign group at Manchester University, and by the initiative led by Wendy Carlin at UCL to reform the curriculum. And it probably surfaces whenever a few economists have a beer and talk shop.
In this twitter exchange, Adam Posen said ‘microfoundations are without merit’. Noah challenged me to substantiate my claim that they do have merit.
The merit in any economic thinking or knowledge must lie in it at some point producing an insight, a prediction, a prediction of the consequence of a policy action, that helps someone, or a government, or a society to make their lives better.
Microfounded models are models which tell an explicit story about what the people, firms, and large agents in a model do, and why. What do they want to achieve, what constraints do they face in going about it? My own position is that these are the ONLY models that have anything genuinely economic to say about anything. It’s contestable whether they have any merit or not.
The early microfoundations project was about pointing out the unreliability of pre-microfoundations models, sometimes known as ‘Cowles Commission’ models, after one of the research centres that sponsored such a model. These were models that were long lists of equations for economic aggregates built out of stories economists had that linked some of these aggregates together [like ‘people tend to consume something, plus something else times disposable income’ – the consumption function]. This contribution [crystallised in Lucas’ 1976 ‘Critique’] was to note that if policy was based on statistical estimates of these guessed-at relationships, when that policy changed, those relationships may change too, invalidating the original policy choice. So the contribution was negative. It was about warning that another way of doing economics did not have as much merit as first thought, and might in fact entail substantial economic costs.
It seems likely to me that this early contribution ‘had merit’. To me, it seems highly probable that major policy mistakes, informed, for example, by the belief that permanently higher inflation might buy permanently lower unemployment, were avoided. I can’t prove it. But there are dozens of empirical papers exploring this same point, in the light of what Lucas said. The evidence there is not entirely on one side. How could it be? But I would say it was decisively tilted in favour of Lucas/Phelps/Friedman’s warning that higher inflation doesn’t get you lower unemployment forever. Here is an example of recent empirical work on this by Luca Benati that concludes that high inflation doesn’t buy permanently lower unemployment.
Pointing at the Lucas Critique doesn’t establish without doubt that microfounded modelling leads to a better world. It suggests that it might. Revealing that there is some probability that high inflation policies will not work, when previously this probability was discounted, has merit. Lucas showed that if the world behaved according to the postulates of a particular micro-founded model, and you didn’t bother with microfoundations, then you would mistakenly infer that you had found causal and stable statistical connections between your instrument and your goal variable, when these would mutate once you used them to inform policy. You might doubt that a microfounded laboratory is a legitimate tool to discover anything. If you don’t accept microfounded models as an interesting laboratory to test out any thought experiment, then you might not care about the Lucas Critique.
Caring about it requires that you accept that something that is true in a possible world (the model) may be informative about the actual one. I think it’s impossible to refute this, unless you know how the real world works. In which case you would of course not bother with the model. To refute it, you’d need to represent the real world, somehow, and show that acting on something that was true in the false word was useless in the real one.
The discussion about how to do macro often neglects that there are serious people trying to work out the details of how to do policy when you don’t understand how the world works. Or how the world looks when it’s packed full of agents who doubt their own representations of how the world works. Tom Sargent and Lars Hansen, now both Nobel laureates, have spent the last 15 years exploring these topics, sharpening discussions that used to and still go on inside central banks.
I would not try to claim that microfounded modelling is the ONLY way of doing macro that has merit. Sims explained one of the other ways. Form systems of statistical equations linking variables you care about. Where you regress everything on everything else lagged. Then you can forecast things if you like. To get further, you have to start using economics. Further meaning trying to measure the effects of a policy, for example, so that you can work out what good policy would look like. Identifying policy shocks need not use microfounded economic logic. For example, you could study the runes of history and declare that it was self-evident that some policy change was exogenous and not related to the things the policymaker cared about (despite the obvious quandary – discussed in the last blog post, since policy changes should surely only be motivated by care about something). An example of this approach in the past is the use of military spending changes to measure fiscal policy shocks. These being a result of decisions to go to war, or ideological shifts in government, or both, not business cycle policy.
Another kind of non-microfounded thinking I would accept is thinking that has been shown in a microfounded context to work. So, for example, Sims and Zha talked of ‘modest policy interventions’. These are small enough changes to the way policymakers have typically gone about things for it to be conjectured that the Lucas Critique won’t matter. If you don’t mess around with policy too much, the statistical relationships you have estimated won’t change much either. This isn’t a cast-iron guarantee, however. Because to get even this far you need to write down a possible economic world (a microfounded one), and show that the statistical relationships it generates don’t move much for a given type of policy change that you want to contemplate. And in writing down that world you are going to assume some things that are false. And have to keep in the back of your mind that anything you deduce using it might be false too.
Another kind of non-micro-founded thinking I think is valuable is knowledge building exercises like solving non-micro-founded rational expectations models. [The Bank of England had a model like this until just a couple of years ago]. Without going through the motion of solving a model like this, you won’t know how to solve a micro-founded one. And some insights can be got about how forward-looking behaviour manifests itself in time series. Of course, the assumption of rational expectations may often be very unrealistic. But if there are circumstances when it’s useful, and you need to figure out how to go about building a microfounded RE model, then building a non-micro-founded RE model might be a useful learning step.
A final possibility is that there is no alternative but to proceed in non-micro-founded way. Yet some business has to be done – some policy decision, or some investment based on a forecast. In these circumstances, it’s ok to take a stab at the decision rules or laws of motions for aggregates in an economy might look like if you could micro-found what you are concerned with, and move on. Perhaps doing so will shed light on how to do it properly. Or at least give you some insight into how to set policy. Actually many so called microfounded models probably only have this status; guesses at what something would look like if only you could do it properly.
Adam Posen dismissed my many examples of microfounded economic thinking that I thought had changed the face of economics and policy. [See the storify collection for some examples]. He said that the merit in examples of microfounded models lies in the ‘intuition’ behind the ‘one line idea’. In my tweets I explained my position on this. This statement is highly perplexing to me. Economic ideas are claims about what people and firms and governments do, and why, and what unfolds as a consequence. The models are the ideas. ‘Intuition’, the verbal counterpart to the models, are not separate things, the origins of the models. They are utterances to ourselves that arise from us comprehending the logical object of the model, in the same way that our account to ourselves of an equation arises from the model. One could make an argument for the separateness of ‘intuition’ at best, I think, as classifying it in some cases to be a conjecture about what a possible economic world [a microfounded model] would look like. Intuition as story-telling to oneself can sometimes be a good check on whether what we have done is nonsense. But not always. Lots of results are not immediately intuitive. That’s not a reason to dismiss it. (Just like most of modern physics is not intuitive.) Just a reason to have another think and read through your code carefully.
Let’s google Adam and take an example from his written or spoken work. I agree with almost all that Adam says about everything. I think he’s super smart and almost polymathic in his grip on all kinds of different economic issues and problems. But, I vehemently disagree with his claim about microfounded models, and I also think he himself is the great improvising microfounder of our times.
Adam said or was reported to have said [and I agree with him 100% on the substance in this example]:
‘If they [Germany] had resolved and done more transfers to southern Europe in the form of writing off more of the bad loans they gave to southern Europe. If they had pushed for a monetary policy that was more expansionary instead of blocking expansionary monetary policy, and if they had invested at home and in their own public and in their own people, these global balances and the imbalances in Europe would be reduced.’
As someone who thinks microfounded models have merit, but knowing that Adam claims to think they don’t, this is a tricky paragraph to grasp as one that still ‘has merit’. What on earth is he saying? [And marvel at the confidence with which it is said]. I read it as a good account of what would happen in a two-country sticky-price RBC model with rational expectations, and possibly other partially forward-looking models for expectations, of the sort you can find in Obstfeld and Rogoff’s textbook from 1995, modified to encode issues of sovereign default and financial frictions. Or rather, since neither of us (and perhaps nobody, I haven’t checked) has actually worked out a model with all these details, I should say that reads like a conjecture about what such a model would say, based on having seen previous ones like it.
There are other ways to read it [and as something that nevertheless ‘has merit’]. For example it could be read as having meant ‘based on past historical correlations, I predict that if debt had been forgiven, and monetary policy looser, imbalances would have been reduced, and the world would have been a better place.’ But to make such a claim, Adam would have had to develop a sharp econometric procedure to isolate a kind of natural experiment from the historical time series that enables him to replay it now in his head. Or to be referring to others who had. Without isolating these experiments, you can’t confidently claim from past episodes what was due to policy, and what was due to things that were perhaps prompting a particular policy. Worse still, although in principle there are ways to identify these shocks without using microfounded economic theory, they are pretty controversial. The runes of history or military spending approaches are contestable. [How can we know what was in the heads of the policymakers?] And for monetary policy these approaches are very tricky. You can’t help but rely in part on identification schemes that rely on microfounded models. Such schemes might include the following: ‘for any microfounded model I can think of, a monetary policy contraction surely does not boost output, surely raises interest rates, and surely lowers inflation’. Or ‘in the long run monetary policy should be neutral on real variables.’
Aside from these two ways of characterising Adam’s statement, there are no other scientific ways to put it. You might read those words, agree with them, and think to yourself: ‘surely all he’s saying is that looser fiscal policy would put money in German consumers’ pockets, and the looser monetary policy would lower real rates and make German firms want to invest more, and they would buy more foreign goods, and this would provide the missing demand for Greek exports….’. The trouble, is, this claim is empty and baseless without it making reference to one or both of the literatures that I have pointed to above. It can’t be a claim about the real world. On what basis would Adam claim to know about that? [We are excluding econometrics now, remember]. Perhaps if we had surveyed all the households in Germany and outside, and asked them what they would do in certain situations, (and also asked them how happy they would be if certain things happened, since there is an implicit welfare claim in Adam’s statement), then we could interpet Adam’s statement as being useful. [‘With merit’]. Then we could claim that we really knew something about what the world looked like. But we know that no such survey has been done. So this leaves us basing Adam’s utterance either in a conjecture about what a possible microfounded but false economic world would look like (and hedging our statements about it more cautiously than Adam did in that soundbite, a slightly unfair point since it’s possible that the hedging was stripped out of the interview report, or was implicit). Or a statement about the consequences of identified fiscal shocks. If we ground it in the latter, however, we can’t say anything about whether such an outcome would be better. To do that we need to have a model in which we compute how people feel about stuff and in which such a shock can be replicated, to see if they feel better when Adam’s suggested loosening is tried out. In other words, we are stuck with the microfounded but false way of thinking again.
This is not to say that all microfounded thinking is flawless. Much of it is highly dubious. The freshwater lot groan to see all the rigidities built into New Keynesian models partly because they suspect that the micofoundations for them are baseless; that they are put in because they make the models fit aggregate time series better. The particular mechanism for price stickiness widely used is a case in point. One of the most popular devices is Calvo’s: this assumes that prices roll a dice each period and get to change prices with some probability. And they get to never ever change prices until the end of time with some probability too. This makes the model behave very oddly in some circumstances. And is responsible for generating welfare costs of inflation instability that dwarf everything else in New Keynesian models. Calvo price stickiness makes the model tractable and fits certain aspects of the data better than the model without it. [For example, monetary policy shocks have effects on the real economy]. But no-one thinks this is anything like what happens in real firms. But it is an approximation that might well be helpful in lots of circumstances. Example: in such models, rules like Taylor Rules (in which interest rates respond more than one for one with inflation, but also to the output gap) do a pretty good job. And during periods when central banks actually followed them, performance was usually pretty good. I deduce from this that with some probability the false microfounded model has taught us something useful about good monetary policy design. [Almost all policymakers in central banks accept this too, as you can tell from the minutes of their meetings, or the documents explaining their monetary frameworks].
There’s something irksome about defending micro-founded macro from the attack that it is ‘without merit’. A voice inside me says: if they aren’t doing macro, by which I mean, generating new empirical or theoretical work themselves, who are they to go about proclaiming whether something has merit or not, or how macro should be done? [I’m not singling out Adam here. Lots are at it.] And why should anyone care what they say?
Three concerns make it hard to resist attempting a defence, however. First, there is the concern that the macro project at large gets tarred with the same brush as the microfounders who insist almost religiously that prices are flexible and markets are efficient. So it’s worth trying to disentangle the defence of the project as a whole from defending those substantive positions. Second, there’s the concern that someone with some influence might take Adam or others who say these things seriously. Third, there’s the concern that if people inside macro don’t respond to challenge, no matter how high-handed and ill thought through, there’s the risk that we come to seem like a cult bent on disengaging, concerned to interact with those outside the cult only so far as is necessary to squeeze them for the money we need to continue playing with our toys. [Perhaps that day has already come?!]
In my time in central banks one definitely encountered a breed of policymaker that behaved as if they were above actually doing macro, but yet seemed to know all the answers for sure, and know how macro should be done [of course by someone else, not them]. It seemed to many of us who observed them as though they had fallen victim to the illusion that since they had done so well in life, their gut feelings about stuff must really be valuable, and that perhaps that’s where macroeconomic truth lay, in what they as great individuals felt and said. Many can tell stories of attempting to advise them, and being met with the condescending twinkle in the eye that translates as ‘Ah, so that’s what’s true in your silly little toy world, is it, tee hee, how quaint that you think such things worth repeating, well, I can only hope that one day you glimmer the real source of truth, namely, the instinctive knowledge of the chosen’. If the meme that microfounded macro has ‘no merit’ were to gain any more traction, I assert that great danger would lie ahead!: theorising that is incomplete and ‘accidental’ [in the sense meant by Krugman]; policy promises that are unverifiable; discretion untamable; and a search for new economic knowledge that is empty and futile (since the truth is already felt by the great policymakers, and the only way to divine it is to draw the few charts they ask us to plot, and sit around and wait until the charts work their inner magic and they are kind enough to write it down in speeches for us).
[Includes edits for typos and minor stylistic changes not in original].
to what extent are you repeating “fraudulent intellectual history” here?
I don’t really understand your comment, so you’ll have to recapitulate it in your own words.
oh, just the same thing as Herman is on about below really – reading your post, one might get the impression you’re claiming that until microfounded models came along economists believed in a permanent unemployment/inflation trade off, and we have microfounded models to thank for avoiding major policy mistakes. This – not important to your wider argument – is what Waldmann calls the “fraudulent intellectual history” that macroeconomists tell themselves – in fact the “probability that high inflation policies will not work” had already been raised without the benefit of microfoundations. Although whether it took Lucas to get those warnings taken seriously, so in that sense maybe we do have microfounded models to thank for avoiding major policy mistakes, I don’t know.
but this is nit picking intellectual history and as you say to herman, in some respects not terribly interesting (that’s a matter of taste).
If I was to try to respond to your main point, perhaps Adam Posen could respond by saying that existing microfounded models just aren’t nearly good enough and hence invariably mislead those who would take lessons from them about the real world, hence lack any merit in practice, whereas “thinking carefully about how the world works, looking carefully at the data, studying history and using verbal reasoning etc.”, which is presumably something like what he’d claim to be doing, gets thing less wrong.
I appreciate that formal model free approach can descend into competing accounts of “the instinctive knowledge of the chosen” (worse than the swamps of dsge despair?) and your point about what makes anybody think they know the truth in order to claim that micro-founded models are systematically misleading. Although I presume Adam Posen would have some answers to that. Maybe he would cite one of your previous posts saying that our models say we should have deflation if we have an output gap, and we don’t have deflation hence we don’t have an output gap! [okay okay I know that’s mischaracterising your views terribly]
OK, I follow now.
I’m not well versed enough on the origins of the Lucas Critique, or the Samuelson-Solow-Friedman debate about the Philips Curve to pronounce on that. It’s a shame if the appropriate credit has not been given by history. And my own prior was different to this account, but I won’t contest what you say. It’s not really pertinent, as you concede.
Microfounded models certainly are bad in many respects. But I would just not accept ‘thinking carefully about how the world works, looking carefully at the data, studying history and using verbal reasoning’ as an adequate response. Certainly I would hope that all economists do this. But this is part of forming sharp hypotheses whose distance from the real world can be measured, and whose usefulness can be investigated. Verbal reasoning is fine, but it has to be following one of the acceptable research strategies laid out in the post [and in dictat by sargent/sims/lucas], and requires checking. If it’s correct, it’s really not verbal reasoning, just the utterances of people who are clever enough to do maths silently to themselves in an instant. A lot of people do it. And I think Adam is one of them. If you tried to push him on one of his verbally reasoned statements, I bet he would retort using mathematical arguments, even if they were expressed in words.
On deflation and the output gap. Well, you might have deflation soon, is one response. Core inflation has been drifting down slowly in the US.
The other is: you can make modifications to the DSGE model to incorporate financial frictions that impair the supply side, and explain roughly constant inflation. Constant inflation and distressingly high non employment are foreceful rejoinders to the NK model with sticky prices only as the single distortion, for the reason you suggest. But having digested that we can go away and improve the model. Such models with supply-side impaired credit frictions would predict roles for government intervention to improve bank balance sheets, amongst other things. Gertler and Karadi and others explore these kind of questions.
Thank you for convincing me that Adam Posen et. al. are right. The microfoundations project is indeed without merit.
The Lucas critique was not an original contribution of Lucas. In fact Lucas is explicit about this. That someone thinks that it was, is a pretty clear indication that he has not read the Lucas paper.
Cowles Commission people, particularly Tinbergen and Marschak were well aware of the ‘Lucas critique’ — in fact, they were the originators. Their view was that of all the possible causes of parameter instability, the ‘Lucas critique’ was not the most important, and in any case, there was no credible way around it. They were right. Nothing empirical, absolutely nothing, from Lucas or his followers suggest otherwise.
“Pointing at the Lucas Critique doesn’t establish without doubt that microfounded modelling leads to a better world. ”
This is seriously misleading. Forget about establishing this beyond doubt, the Lucas critique doesn’t suggest this *at all*. The ‘Lucas critique’ defence of microfoundations is completely circular. It runs something like this:
If a particular microfounded model with rational expectations is the One True Model that completely and correctly specifies the behaviour of the actual economy, then that model will not be subject to the Lucas critique.
To state this argument, is I think, enough to make clear its absurdity as a defence for the existing microfoundations.
Also, Tom Sargent(2005):
“Lucas used evidence of coefficient drift and add factors to bash the Keynesians, but as I read his paper, at least, he didn’t claim to offer an explanation for the observed drift. His three examples are each time-invariant structures. Data from them would not have coefficient drift even if you fit one of those misspecified Keynesian models. So the connection of the first part of his paper to the second was weak.”
“… the belief that permanently higher inflation might buy permanently lower unemployment, …”
This is a myth. Samuelson and Solow (1960), are very clear that they do not believe in a permanent trade-off. Yes, James Tobin believed it, but as he himself admitted (Tobin 1972, AEA Presidential lecture), he was in a minority.
Gardner Ackley (member, and later head of the CEA in the 1960s):
“However, the notion that there was a *stable* Phillips curve tradeoff did not capture the support of the economists most closely associated with formulating monetary and fiscal policies, at least in the United States. The writer believes that a careful study of the Annual Reports of the Council of Economic Advisers for the years 1961-1968 will discover no reference to any such stable trade-off.”
There is also the curious fact that claims about a stable trade-off actually post-date Friedman (1968), not pre-date it.
Forder, James, “Economists on Samuelson and Solow on the Phillips Curve”, University of Oxford Department of Economics DISCUSSION PAPER SERIES, No. 516, December 2010.
“Microfounded models are models which tell an explicit story about what the people, firms, and large agents in a model do, and why”
This would be a credible argument if the stories were, in fact, true. They are not.
“We know these stories aren’t true. There is no K, there is no P, there is no C. There are no infinitesimal monopolistically competitive firms. Individuals do not respond instantly, continuously and rationally to the macroeconomic state. And that these things are all myths matters for how the data behave.”
Thanks for writing. You seem to have totally missed the point.
1. Who cares who originated the Lucas Critique? That’s a different argument, and not a very interesting one. The point is whether the ideas contained in it support the case that microfoundations ‘have merit’.
2. Likewise who cares what Samuelson or Solow did or did not think? The point is whether we can show that non-microfounded Philips Curves with a long run slope, and their shifts around over time, can be rationalised by way of a microfounded model.
3. The logic of the Lucas Critique is not at all circular. It simply observes a pathology of ignoring microfoundations in a possible world. As I said in my post, if you think that possible world uninteresting, then Lucas’ paper won’t shift the probabilities that you will attach to outcomes that result from different policies. It is false that the logic applies to one particular microfounded model; and it is also false that it only applies to rational expectations models. You are right to note that Lucas’ model (and the hundreds of others that would give the same message) are false. But false models may nonetheless be useful, as other macroeconomists (and probably micro too) have been thinking through. Indeed, dismissing the insights from a model on the grounds of its falsehood will leave you empty handed, because no model in that sense is ‘true’.
4. Your quote from Sims in response to my noting that microfounded models ‘tell and explicit story’… is also completely inappropriate. He is extremely hard-line in support of the twin statistical/theoretic approach advocated in my post. You don’t seem to have followed the post at all in this regard. The point is to explain that microfounded models establish properties of a possible world. Non-microfounded theoretical models do not. They are at best unverified guesses at what such a possible world might look like. At worst, they are misleading hoaxes that try to convince you they are saying something economic, but aren’t. Non-microfounded statistical models are useful in ways explained in the post, and can be used to answer some limited questions of interest to policy if you can find credible identification. The whole point of the ‘stories’ in microfounded models is that they are false. If they were not, it would be impossible to enumerate, construct and manipulate them to discern their properties.
1. The question of who originated the Lucas critique is irrelevant to its validity. I agree. My point was that you’ve got a basic point wrong which suggests you haven’t actually read the paper. I am not questioning the validity of the Lucas critique, only its importance. Particularly its role in justifying the existing microfoundations.
2. Samuelson-Solow : Again my point was, as Luis Enrique above puts it, that you are presenting a “fraudulent intellectual history”.
3. I never said the logic of the Lucas critique is circular. What is circular is Lucas’s and your defence of microfoundations relying on the Lucas critique.
4. Sims : I disagree strongly with many views of Sims, but still I hold him in high regard. I actually have read the paper and strongly disagree with him when he says Bayesian DSGEs are “credible probability models of the data”. This, IMHO, is nonsense. In macro there is no such thing as a credible probability model of the data in general. The point of the SIms quote was to point out that even someone like Sims, contrary to your claim, admits such a model is not true in terms of the stories it tells.
” The point is to explain that microfounded models establish properties of a possible world. Non-microfounded theoretical models do not. ”
Scientifically speaking, this is just nonsense. We are not interested in the properties of an arbitrary world. We are interested in, and only in, properties of the world that we inhabit. There is no good reason to believe that properties of your imaginary world accurately reflect properties of the real world. And since they do not, but only create such an illusion in the minds of the naive, the brainwashed and the scientifically illiterate, they are actually worse than useless: They are actively dangerous.
” [Non microfounded models] are at best unverified guesses at what such a possible world might look like.”
Ideally, they are supposed to be guesses about the world we live in, not some arbitrary, imaginary world. All scientific hypothesis start of as unverified guesses. We accept, reject or modify them based on out of sample performance, and their external validity.
1. I didn’t get any point wrong. I described the idea of the Lucas Critique accurately. I didn’t make any statements about originality. I have read the paper many times. Unlike you, I understood it! You seemed oblivious to what it applied to (ie not just the example contained therein, hence the thousands of citations since).
2. I was not presenting any history at all. I was describing the idea that shifting long run philips curves can be rationalised by a microfounded model. That’s not history. That’s a statement about a mathematical object. [Not an interesting object for you]. It’s also one amongst thousands of possible examples in the literature that make the same point, as you ought to know.
3. This is infantile and uncivil blog behaviour: if you don’t put your comments civilly I won’t accept them. To turn to your point, there’s no circularity. Lucas shows that in a possible world, bad things happen if you ignore how that world behaves. I concede that if you don’t think that possible world contains any lessons for the real world, you can ignore it. But its falsehood is not a grounds for ignoring it, because you don’t have any option if you want to create a conception of the world in which you can replay history or conduct policy experiments. Abstractions (falsehoods) are necessary for this. Other literatures [robust control] provide explorations of how to make use of false possible worlds as a policymaker.
4. You didn’t process any of my claims. No one suggests these models are true. What some claim is that they are useful. Sims, like all in the microfounded camp, accept their falsehood, and embrace it. But defend their usefulness.
5. I agree that non microfounded models and microfounded models are guesses about the world we live in. But non microfounded models are incomplete guesses, and are not coherent accounts of any economy; they are just equations linking time series. They may forecast well. [As do many microfounded models]. They are just as arbitary and imaginary and false as microfounded models, only they are empty of any hypotheses about what people in an economy are doing, or firms are doing, that can be verified as false, or judged to be false but not far off, or whatever.
@ Tony Yates
You are right. Unfortunately parts of my comments are indeed uncivil. Irritation seems to have got the better of me. Apologies
On substantive matters we seem to be pretty far apart. Perhaps later someday we might be able to have a more fruitful discussion.
Herman disagrees with Sims. Thanks Herman, for letting us know that the infinitely more successful and influential Chris Sims should be aware of your disagreements, as I’m sure your genius has simply been overlooked. You also seem hopelessly ill-informed and, frankly, not all that bright.
Caring about it requires that you accept that something that is true in a possible world (the model) may be informative about the actual one.
No. The Lucas Critique is NOT A MODEL.
? Correct, the Lucas Critique is not a model. It’s an observation about a model.
the false microfounded model
That is fairly precious. To recognize that Calvo pricing is patently unrealistic (which it is), but then to just accept or pretend that the consumer’s problem and firm’s problem in an RBC model are any better, you have to be chugging the Freshwater Kool-Aid at the rate of several liters a day.
I think Calvo pricing is a step further into the abyss. Proper Ss rules for pricing are another matter. But these are neglected to make the maths easier. Or were until recently, with the work of Golosov, Lucas [yes same one], Midrigan, Karadi.
What about the assumptions of the search model in Lagos-Wright 2005, that underlie all of the “new monetarism” stuff? How is that any less magical than Calvo pricing?
A voice inside me says: if they aren’t doing macro, by which I mean, generating new empirical or theoretical work themselves, who are they to go about proclaiming whether something has merit or not, or how macro should be done?
We are the people who PAY you.
There are precious few people, if any, making microfounded DSGE models for private industry. The people who spend their days making microfounded DSGE models are paid by tax money (or alumni contribution money). So of course we want to know what we’re getting for our money.
Sure [I acknowledge this a few sentences later]. That gives a right to know how the money is being spent. But that doesn’t establish your right [ie you as a finance professor] to pass judgement. After all, you may be trying to grab my money to play with your toys. Nor does it establish the right of Adam to pass one line judgement while he is sipping Cappucino. [He, after all, may be trying to grab money to fund more one line economics papers].
Look, if only the people who are engaged in an enterprise are qualified to judge its worth, then we’ll always get overestimates, since the practitioners’ human capital is already invested in the enterprise.
So we need outside critics, to avoid institutional capture.
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I like Kevin Hoover’s perspective a lot. The representative agent point is a complete red herring though; micro-founded macro doesn’t mean representative agent macro. First Aiyagari and Huggett, Townsend, then later den Haan, Krussel and Smith, and more recently Heathcote, Violante, Perri, and in fact dozens of others have been revisiting questions first examined in representative agent business cycle models using heterogeneous agent models. And even agent-based models, which combine this approach with an eclectic mix of other non standard assumptions including dropping optimising behaviour and even market clearing, are micro-founded. Representative-agent assumptions have to be used with care, like all falsehoods in macro.
“The merit in any economic thinking or knowledge must lie in it at some point producing an insight, a prediction, a prediction of the consequence of a policy action, that helps someone, or a government, or a society to make their lives better.”
Keynes is an obvious example of this, and in his time he was regarded as a ‘good thinker’. Yet you seem to set up a dichotomy between naïve statistical extrapolation and reductionist micro-foundations as the only possible ‘scientific’ approaches. It seems to me that the main insight that we need is something like Keynes’, when he argues against your ‘scientific’ dichotomy. Thus it may be that the kind of knowledge that we need is something more like Russell’s ‘Human Knowledge’ than scientism masquerading as science.
I’m not setting up this dichotomy; this is the one I have learned from Sims, Sargent, Lucas and Prescott.
I don’t see how he could have argued against this dichotomy, because when he was alive, this had not been advanced as a prescription for how to do macro [this didn’t come until the 1970s].
You can see his work as demonstrating that you don’t necessarily need any kind of formalism at all.
But none of the adversaries [Noah Smith, Simon Wren Lewis, Adam Posen, Krugman] in this debate are arguing that a return to Keynes’ methods is what is needed.
This debate is about different brands of formalism, not formalism vs informalism.
Keynes was a genius, and made great strides from where he found the subject.
His informalism is, I surmise, only apparent, since he was often able to describe very precise results in his head, and in prose. Lesser minds probably couldn’t manage this feat.
To take the subject further from where he left it, I think exhausted what informalism alone could do. Hence that’s why economics [and micro too] went where it did.
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One of the (empirical and conceptual more succesful) alternatives to so micro founded (not!) models: input output analysis, which enables us to answer questions which can’t even be asked using the micro founded (not!) models http://rwer.wordpress.com/2014/01/04/input-output-analysis-as-an-alternative-to-micro-founded-not-models/
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