I like Wolfgang Munchau’s columns on the Eurozone crisis a lot. But this one on claiming that macroeconomists need new tools is serious overreach. Anyone actually building, solving or just reading others’ models, will see that it isn’t right, not even a little bit, on a single point it makes. This is not to say macro doesn’t have challenges to answer, or may indeed need ‘new tools’. But these are not for any of the reasons given in Wolfgang’s columns.
Error one. That ‘their system of equations is linear’. Well, this is true, except for the thousands that are not. And those that are linear are approximated as such. I dare say some don’t do this as advisedly as they should. But most will know what they are doing, and when it works and when it does not. But the importance of not making them linear is THE WHOLE POINT of many papers, in fact of many macroeconomists WHOLE LIVES.
I’m not at the forefront of this research, but I did teach a 5 hour workshop of various different methods for solving these models. Check it out. And in that time I could barely skim the surface of what’s been done. Or take a look at this textbook by Ken Judd. It contains lots of ‘new tools’. In a 1992 book! And tools that were around for a lot longer before that in paper form before they became lecture notes and then his textbook. Popular topics now are the macroeconomics of borrowing constraints and the zero lower bound. Both of which require non-linear methods, which are embraced, in fact positively revelled in by the practitioners.
Error two. Macro restricts itself to single equilibria. Or ignores ‘chronic instability’. Nope. Multiplicity is everywhere. Some, admittedly, get embarrassed about it, and hide it away. There’s an amusing interview with William Brock where he explains how some liked to conceal multiple equilibria in footnotes. [Can’t find it now, but I’ll update with a link when I do]. But I think most either address this head on and demand a lot of explanation from authors that seek to sidestep it. Roger Farmer made much of his career out of multiplicity. The New Keynesians – often bearing the brunt of this ‘failure of macro’ waffle – have spilled lots and lots of ink over the issue of what kinds of policies and environments generate multiplicity of equilibria and what don’t. [Anyone who doubts this can try a quick google. I’d suggest terms like ‘multiple equilibria, multiplicity, equilibrium, macroeconomy, monetary, stability’.]
One example [but there are hundreds] of a paper that embraces both issues, nonlinearity and multiplicity. Benhabib and Schmitt-Grohe on the ‘perils of Taylor rules’. This is solved non-linearly, in the presence of the zero bound. And it explains how there are 2 steady states. One with inflation at target. And one with nominal interest rates perpetually trapped at the zero bound.
Error 3. Secular stagnation is hard to capture in modern macro models. A little more debatable. For a start, this started out life as a bit of verbal reasoning by one of the great minds in our profession no longer building models. It’s a conjecture, not a fact. So even if it was hard to build into a model, that would not necessarily be a bad thing. But, in fact it is. Eggertson and Mehrotra have done it, for one. Whether they have done it convincingly is up for debate. But it is done. And so has Greg Thwaites. I would not like to trivialise what they did by calling it ‘easy’. But I think it’s fair to say of both pieces of work that they are not pieces of technical virtuoso. They use bread and butter tools, and the contribution is in the insight and the economics. The difficulties they had don’t speak to some problem in macro. They may well speak to a problem with the hypothesis, conjured creatively but speculatively out of a few charts.
Error 4. Well, I’m not actually sure what is meant here. But Munchau starts out saying that there is ‘an assumption of limitless space. That wherever you stand, you can go further.’ This is so vague, it’s not easy to know if it’s wrong or not. But, some examples: microfounded models assume budget and economy wide resource constraints. So, in that sense, the ‘space’ is extremely limited. And usually there is the invocation that the space that variables live in is bounded. Munchau writes ‘No go zones like a zero bound are technical minefields in a model.’ Well, not really. I teach my MSc students how to deal with it in 2 hours. They are a clever lot, for sure. But they are also busy and exhausted and have 25 other things to revise. Yet they still get it.
The implication is ‘ooh, look at this really obvious real world thingy that economists just can’t deal with’. But actually, they can and do, and it’s embraced by 100s of papers now, since Krugman wrote the first modern one in 1998.
Munchau identifies, therefore a false ‘consensus’. And hopes that ‘new tools’ will come along to help people challenge it. Not realising that these tools have been in use by mainstream macro people since the mid 1980s. I hope that Munchau’s penetrating writing on other topics don’t lead peope to take him seriously on this one.