Why do markets not share MPC’s views about future interest rates?

Mark Carney, Governor of the Bank of England, spoke yesterday to try to convince markets that interest rates will stay lower for longer than they expect.  Assuming that was the intention, it wasn’t very succesful.

Why don’t markets share the expectations of Governor Carney and the MPC?  There are many possibilities.  Some possibilities Carney dealt with in his speech, but not all.

1) Markets don’t believe that the economy will pan out the way the MPC think it will.  For example, they may not buy the analysis in the Inflation Report that the heating up of demand indicators over the last 3 months or so was precisely matched by an expansion of supply capacity, and therefore won’t affect the outlook for inflation.  Or perhaps they don’t believe that the natural rate of unemployment is as low as the MPC thinks it is, and so they guess that the ‘inflation knockout’ will ‘knockout’ the commitment.  Some participants in the market might (like me) put weight on the event that the stability of inflation itself over the last several years is evidence that the unemployment rate is closer to its natural rate than MPC appear to believe.  Or, perhaps markets are unnerved by MPC’s silence on the topic of how they have grappled with issue of how to estimate the impact of a very prolonged period of fixed interest rates?  As pointed out in previous posts (and before that by other writers) the MPC’s model (like all those it descended from) is extremely unreliable in this regard, and so the MPC is forced more than usual to rely on guesswork.

Unfortunately, Carney didn’t do much to try to address this problem.  He did re-emphasise that 7% was a ‘staging post’ not a trigger, in case that was the source of the disagreement.  He also noted that pre-crisis unemployment rates fell to 5%, hinting that the natural rate may be much lower than the staging post of 7%.  But that period may have simply been an unustainable low;  and post crisis, after long-term unemployment has entrenched itself, the natural rate could be much higher.  If you think markets are overestimating the natural rate, it is pretty unpersuasive simply to point to these pre-crisis rates.  MPC could start by telling us what they think the natural rate is, or will be, rather than keeping us guessing.   And in general they could be greatly more transparent about the model and judgements that construct the forecast, so that participants can take it to pieces and reassemble, getting a better sense of where MPC are coming from.  The August Inflation Report took steps in that regard (a fan chart for unemployment, for example), but only baby steps.  There are some reasons to keep back information.  MPC might worry that in the hands of mischievous or ignorant outsiders (like me) this information would be put to nefarious or damaging uses.  But the cost is that some suspect that the reason for not being clearer is to create wiggle room for future changes of policy:  wiggle-room that can be used to disguise a change of mind as consistent with the commitment already made.

2) A second reason why markets don’t share MPC’s forecast for future rates is that they don’t believe that the MPC believes its own forecast.  (Governor Carney didn’t cover this reason in his speech!)  What do I mean by that?  Surely the MPC wouldn’t publish a forecast it didn’t believe in?  What I mean is that the MPC is a heterogenous committee of 9 persons, and the mapping from the views of those 9 persons and the one published forecast is completely opaque.  (And has been since the Halcyon days of ‘Table 6b’, where the separate forecasts of Wadwhani/Julius/Allsopp were recorded).  Up to the point where the forward guidance was announced, there was a clear division of views between those who wanted to inject more stimulus, and those who did not.  This was reflected in some difference of view about how variables the MPC cared about would evolve under different paths for interest rates and asset purchases.  It’s not clear how those two (if it is only two) sets of forecasts have changed since Carney’s arrival, and therefore not clear what to make of the collective forecast published in August.  Perhaps markets put some weight on this disagreement persisting, hidden from view in the collective, ambiguously weighted Inflation Report projection, but likely to resurface and make itself felt later.

Carney didn’t do much to illuminate us on this, and neither did the minutes of the August MPC meeting.  Before the agreement on forward guidance was struck, the first forecast round for the MPC was looking from the outside like a car-crash.  Carney had made public remarks before taking office that he believed in FG, because it provided a way of injecting extra stimulus, yet the majority of the MPC not only presumably did not support FG (otherwise why their silence or disapproval on the subject up to that point) but didn’t want more stimulus.  Magically, agreement was struck.  Carney described FG as making monetary policy ‘more effective’ at the Inflation Report press conference, careful not to say ‘more stimulatory’, but actually drawing a distinction without a difference.  The hawks so far register no protest, so perhaps for them it is a distinction with a difference.

What are markets to make of this?  The magic that might unite the MPC behind the need for more stimulus could be the unwanted tightening of the yield curve around the time the first talk of ‘tapering’ emerged from the Fed, combined with the view that the distinct warming of the data at the same time was inflation-neutral (as remarked above, conveniently accompanied by an exactly matching improvement in supply).  But this stretches credulity for me, and perhaps for markets too.  For one thing, there have been many wiggles in the yield curve in the life of MPC, but none seem to have so decisively altered the consensus on MPC about the stance of current policy as this one.  For another, if this was what swung the hawks into line, why has there not been a clear focus on explaining and articulating it?  This is surely THE key conundrum about recent MPC behaviour, but it scarcely receives a mention.  It’s as if MPC wiped the slate clean and started over, pretending that all differences in view had evaporated.  Hence I called it Fudged Guidance.  For some, a plausible interpretation is that the hawks simply decided to set aside their independent vote for a while, as a kind of golden hello to the new Governor.  Many in the media write as if the Governor is the Committee (just as he was in Canada), ignoring the painstaking attention to individual accountability that MPC members give.  By not paying more attention to the task of articulating whether the course has changed, and, if so, why, MPC are naively running the risk of fuelling this lay view of a committee dominated by its charismatic new chair.

Not adequately explaining past changes of course is particularly hazardous in the new game MPC is playing.  The whole point of forward guidance is to convince observers that there will be no such changes of course in the future, thus influencing expectations now, thus generating more stimulus now.  So to start out on forward guidance by appearing to change course inexplicably is not only ironic but potentially self-defeating.

3) This leads me to mention (again) the third obvious possibility.  Even if markets believed that the MPC were united in their views about the economy, they don’t believe that MPC will necessarily follow through with forward guidance.  I and many others have written about this before, but forward guidance is bluff, inherently non-credible.  Once the stimulus from lower expected future rates is pocketed, there is every incentive to renege and tighten.  The MPC turns over slowly, after all, so the agreement struck now could easily be set aside if newer members don’t concur.  The cost is that MPC has egg on its face.  But the benefit might be preventing another asset price bubble and ensuing bust.  This would come back to haunt MPC if there were another zero bound episode, but, what the hell, perhaps the calculation is that there won’t be another one until everyone has forgotten?

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Paul Krugman vs Roger Farmer

Recently Roger Farmer published an open letter criticising Krugman’s commentary on modern macro.  He points out that Krugman frequently alludes to the fact that the Great Recession is due to self-fulfilling prophecies, without citing Roger’s prior work.  Krugman replied, explaining that he hadn’t read Farmer.  He’d tried, but found it too difficult to understand.  Steve Williamson characterised this as ‘show me your trailer or I won’t watch your movie’.  [And then proceeds to write a good trailer for Roger’s movie himself].

To all this, I add a few remarks.

1.  It’s not necessarily the job of scholars to perfect the marketing of their own work for the busy reader.  The incentives for many are simply to get it to the point where journal referees understand what’s been done and why.  Don’t blame scholars for not doing this, blame the market for their talents in which they are selling them.  Many lay readers will side with Krugman for not reading stuff that seems difficult, thinking it perverse or incompetent of an academic not to write things that are easy.  But those readers won’t appreciate that everyone has their own specialism, and scholars have their work cut out just formulating coherent macro models and testing them, pretty much the sole thing their academic market value will rest.

2.  It’s not good enough to plead that you haven’t read Roger (or anyone like him) IF you set yourself up as an authoritative mouthpiece on macro developments, and on developments in macro research (exactly what Krugman does).  Consequently, if you don’t read him, don’t write as though you are sure you have something original or watertight to say, because the implication is that you haven’t been keeping up.  It’s ok to drop Pynchon’s Gravity’s Rainbow, if you are an economics writer, [I confess I did], but not if you are an oracle on American Literature.

3.  It’s striking that PK says he tried and gave up.  It’s not that hard to grasp the basic points, even for those on the lower ranks of the academic food chain [eg me].  And it must have been clear to PK that Roger was writing about exactly what PK was thinking about.  So surely his curiosity was piqued?  Surely an alarm bell must have gone off that this was exactly the kind of macro work he should get to the bottom of?  After all it sought to bring the same house down that he had been trying to bring down latterly with his journalism?  Why didn’t PK drop Roger an email if he got stuck?  If he is stopped by such modest obstacles as these, even with his own evidently prodigious talents, on a topic squarely at the focus of his own writing, how much effort does he put into reading further away from his concerns?  What else hasn’t he read that’s hard?

Why it’s harder to build new houses in the UK than France

This is a brief response to Allister Heath, of CityAM, who has been writing and tweeting about how desirable it would be to build more new houses in the UK, and how meagre new building is in the UK compared to new building in France.

My response (tweeted here) was to note that population density is much higher in the UK than France.  We have roughly the same population as France, but 1/5 of the land mass.  Allister’s reply was to note (amongst other points) that actually an incredibly small amount of land is ‘concreted over’ (around 2 per cent) and that on the face of it a great deal more could be built on.  On this view, population density should not be a barrier to more new building.

I think the two of us are talking at cross purposes.  Allister makes a normative point, that more houses would be desirable, despite the larger population density.  He sees the planning restrictions as welfare-reducing.   My reply is a positive one;  I speculate that the tighter planning restrictions have at their root the higher population density, whether they are or are not socially desirable.

If Allister is right, that more building would make us all better off, then there are two positive explanations for the status quo.  One is that people simply don’t know what’s good for them.  For these people, it’s almost tautological to observe that density is the route of their objections to new building.   They don’t want new building because it increases the number of buildings near them!  Density comes into it in other ways too.  The planning restrictions that society (on this view, irrationally) dislikes need enforcing.  And enforcement is easier when density is higher:  ultimately it boils down to the number of cops you have per field!

A second explanation for the status quo in planning is that there is a small, influential group of people powerful enough to enforce it, even though on balance most people would prefer new building.  Enforcing ones will over the majority would also seem to me to be harder in less densely populated areas.  If the majority are spread out over a large territory, it will be more expensive for the minority to try to thwart their desire to build and enforce planning regulations they don’t like.

Although I think we were talking at cross purposes, I could take Allister on and question whether more building would be socially desirable.  How would we figure this out anyway?  New building is surely not going to make everyone happier (see above).  At least not the people living next door.  And those who have their own house [either by owning one, or having enough income to guarantee to be able to rent one] are probably in the majority.  So to conclude that more building is socially beneficial means we depart from majoritarian schemes for deciding and to something like a utilitarian one.  Perhaps the unhappiness of the few without a house more than outweighs the mild displeasure those with one would experience if another house was built in front of their thus far unrestricted view of arable farmland.  Perhaps.

There must also be some socially optimal level of population density.  (Allister concedes this, he just thinks we have not yet reached it).  Noting, as Allister does, that only a small percentage of land is ‘concreted over’ is, however, not necessarily conclusive proof that we have not yet got to that optimal level of density.  For example, it would be easy to destroy all the remaining open wilderness in the world by adding only fractionally to that ‘concreted over’ percentage, ensuring that wherever you looked there was at least some man-made structure.  The proportion of land that is concreted over is not that informative about where we are relative to the optimum.

Moreover, there is some good in having a system that makes it hard to take steps to increase the density of buildings.  The optimal density of buildings is probably slowly time-varying, as demographics, and the economics of production and social interaction evolve over time.  [It’s entirely conceivable that the population will fall at some point.  Or the desire to get away from it all will rise.]  Since land once built on is harder to restore to its ‘original’ state, being cautious about new building is a crude way of protecting the interests of those that will follow us and want to make their own choices about the same question.

[PS a quick glance at Wikipedia showed me that I was way off with my guess at relative densities in the UK and France.  Population density seems to be about 2.5 times greater in the UK than France, not 5 times greater, as I asserted in my tweet.]

Krugman on history of recent macro thought

Increasingly, I find Paul Krugman’s [PK] forays into macroeconomics (or rather, the history and sociology of macroeonomic thought) bizarre, highly selective (selected in order to back his own view that unlimited stimulus obtained anyhow is great) and ridiculous.  This post responds to this article by PK, but there are many more in the last few years that I could pick.

Steve Williamson wrote at length rebutting previous claims by PK that debate at the forefront of macroeconomics was ideological, and not scientific.  This claim is repeated implicitly in the post I am responding to, but Steve’s rebuttal can’t be bettered or added to greatly.  I think it would be fair to point out that most economists, being human, find themselves prey to the weakness of trying once in a while to focus on the plus points of a piece of research, (if you don’t join the others in this, they will beat you), or to defend a previously held position for too long.  But I don’t think that ideology has played a part in any seminar I have attended.  (Unless you want to call a basic acceptance of the capitalist system with quantitative analysis of government intervention ‘ideological’.)

On to two specific points in PK’s column.

1  ‘The original idea that money had real effects because people were surprised by monetary shocks fell apart in the face of evidence of business cycle persistence’.

Where does this come from?  Here is what I would recognise:  when researchers took simple real business cycle models and made prices sticky, they found that monetary shocks had real effects.  However, because these effects were not persistent enough on their own to generate long-lasting effects that were computed for (what was hoped were) comparable effects (of identified monetary shocks) in the data, it was recognised that something else had to be added to the model to account for it.  The profession converged on adding various other frictions, like slowly moving consumption, investment, price and wage ‘indexation’.  These additions don’t mean the original observation that it is monetary shocks causing business cycles (at least in part) ‘falls apart’;  it is intact, it’s just that one needs a model with richer propagation.

2 ‘the real business cycle view that nominal shocks didn’t actually matter after all was refuted by decisive evidence (pdf) that, in fact, it did. Yet there was no backing off on this approach. On the contrary, it actually increased its hold on the profession.’

It’s selective to view this notion as ‘decisively rejected’.  The sharp way to test it is to try to find monetary shocks in the data and compute their effects.  There is a huge volume of papers trying various methods to do this.  On the assumption that these shocks exist and on the assumption that the methods accurately recover what we are trying to find, then it’s fair to say that the weight of evidence favours the view that monetary (policy) shocks have real effects.  However, both assumptions are questionable.  Policymakers don’t accept that they are injecting significant monetary shocks (after all, why would they).  And all methods for recovering these shocks (even if they are there to be found) have their problems.  Rejecting the notion of monetary policy neutrality on the basis of these two problematic assumptions hardly qualifies as ‘decisive’ in my view.

I also don’t get the comment that ‘there was no backing off on this approach’.  Actually, I think the view that monetary policy shocks have real effects was ‘decisively’ accepted by central bank economists,  [eg, it’s embodied in the Fed’s model, and models at the BoC, ECB, BoE, BoJ, RBA, RBNZ, and many more], and accepted by at least half of the macroeconomists working with real business cycle models or those descended from them.

The point of successful economics scholars migrating to journalism ought to be to bridge the divide between research and non economists who want to decide what to think about what their governments are doing or not doing.  But PK’s columns don’t do that any more.   They don’t even reinforce the divide, which would be less harmful.  They are filling non economists’ heads with stories of a cult of crazed mathematician-politicians that have lost their way, but could solve all problems if they simply thought through the old AS/AD/IS/LM diagrams in his macro textbooks.

Fudged Guidance, and the guess

Two more thoughts on the Fudged Guidance, which I think more accurately describes the launch of the new framework than ‘Forward Guidance’.  Both are repeats.   The first rants about the ‘Fudge’, in the Guidance.  The second is about the unusual amount of guesswork that must have gone on to work out the effect on unemployment and inflation of a prolonged period of fixed interest rates.

The fudge, of course, is over whether the new state-contingent commitment to keep rates at 0.5 per cent should be considered a policy loosening or not.  In the Inflation Report press conference Mark Carney was careful to avoid saying in his prepared remarks that this is a loosening of policy.  Likewise, when pressed to clarify whether it was or was not in questions, he stressed that FG was about making the stimulus already applied ‘more effective’.  The Inflation Report takes the same care;  no words on whether the overall stance of policy (considering all the instruments, and guidance on them) should be considered tighter or looser.  One is led naturally, though the text is careful not to say it explicitly, that the stance of policy is about the same as before.  Yet there is also text using those words in Carney’s press conference and subsequent interview remarks ‘more effective’.

Here is one interpretation [based on conversations with other BoE watchers].  Carney wanted looser policy, did not believe in delivering it via QE, but wanted to deliver it instead via forward guidance.  However, the majority on the MPC did not want looser policy, delivered through whatever means.  At least two MPC members (Ben Broadbent and Spencer Dale) had gone on record coming out sceptical of forward guidance.  The others one might presume must have thought about it and discarded this in favour of using QE instead.  However, rather than simply face the new Governor down, a compromise was struck.  Carney, who wanted looser policy, could find what he wanted in describing the existing stimulus as now being ‘more effective’ (ie more powerful, likely to stimulate demand, asset prices and jobs to a greater extent).  The other MPC members were happy with the new framework provided it omitted explicitly mentioning that policy was now looser, and presumably were happy with the ‘more effective’ language, since this could be interpreted not just as ‘more powerful’, but something like ‘more skilfully done’.   The compromise must have been made more fragile by the rising temperature of data over the last two to three months.   The compromise is problematic for both, however.  Carney, who wants looser policy, would struggle to come up with an economically meaningful reason why he did not describe it as ‘more stimulus’, and must regret the obfuscation.  And the Hawks [for want of a better word]:  all the communication subsequent to the launch has emphasised that this is about trying to encourage more spending (and presumably attendant inflation) through underpinning confidence and reducing uncertainty.  How could an MPC member content with the previous level of monetary stimulus find the ‘more effective’ be happy with that?

In this sense this was Fudged Guidance.  A text that tiptoes around the key question of whether policy has loosened or not, allowing two presumably opposed factions to strike an agreement, but leaving both uncomfortable.

There is another interpretation.  We take all the communication at face value.  The majority of the MPC voted to stimulate the economy further by making the existing stimulus ‘more effective’.  But, as I said in a previous post, why did those who were not voting for more stimulus (under the old rules where you could only do this with today’s Bank Rate or QE) change their minds from the previous vote?  And if they did change their minds, why were they not content to make it clear that their guidance should be taken to be a loosening of policy?  Why risk being seen to have Fudged the issue?

If this was a compromise, it was unnecessary.  The previous Governor voted many times in the minority, and his ability to perform his role as chair of the MPC was not visibly affected by that.  The cost of compromising was to put at risk the effectiveness of the new communications policy.  It was also not terribly successful, (yet). Markets brought forward their expected date of a first rise in Bank Rate, when that first date was already before the MPC expect to raise rates.  So markets didn’t see it as a loosening, or at least, if they did, they considered it one MPC would think better of later.  But the economics press did, and presumed that Carney had bent the rest of the MPC to his will.

Onto the forecast and the commitment itself.  What MPC did not tell you, either in Carney’s verbal communications, or in the Inflation Report, is the following.  In trying to predict the effect of a prolonged period of fixed interest rates the MPC are in the realms of pure guesswork, and much more so than in normal times.  This is going to get nerdy, but it’s important, because it is a key part of the overall picture in forming a judgement about how MPC have handled FG.  The model that the MPC uses to articulate their forecast and compute the effects of such policies is being stretched to its absolute limits.  And in two senses:  first, because the economy is (as the MPC see it) far away from its resting place, and second, because of the need to forecast under a protracted period of fixed interest rates.

Let’s deal with these two problems in turn.  If the MPC is right that there is a large margin of spare capacity, the model is operating far away from its resting place.  But the further away from its resting place, the less accurate a model it is.  [Even presuming its the right model in the first place, which is another story].  A key feature of macro models like the one the Bank uses is that it presumes that prices are sticky.  If they were not, the MPC would have no real job, and certainly no influence over real things like activity and unemployment.  Dumping the right amount of money on the economy to achieve a constant k per cent would suffice.  A simplifying assumption made is that there is a fixed chance that firms change prices each period.  But so far away from the model’s resting point, such an assumption becomes highly dubious.  Research by Peter Karadi at the ECB gives an example of how unreliable this assumption can be.  Hit by a big enough depressing shock, the economy starts to become very like an economy with flexible prices, as all firms find it worthwhile changing prices.  The appropriate policy in  a model that veers from being a basically sticky price economy to being a flex price one is very different from the right policy in a model like the BoE uses.

Now onto the second problem, to do with projecting under fixed interest rates.  This is dealt with in various papers, (eg papers by Gali, Blake) but most vividly by  Carlstrom et al.  They highlight the weirdness of these sticky price models by looking at what happens as interest rates are kept fixed for more and more periods.  At some point, the inflation response to an extra period becomes explosive.  And then further out, it can even change sign.  This is not to say that the real world is anything like this, and we should worry about the 3 year promise to keep rates fixed causing an explosion or an oscillation in inflation.  [Though if you were a New Keynesian literalist this is what you would worry about].  But it is a strong hint that there is something deeply amiss with the model, and that it is an extremely unreliable tool for speaking to the appropriate policy response to a shock that takes the economy down to the zero bound for a long period.  Now, the MPC have always explained that they are careful not to take the steer from models literally, and apply their judgement based on their immersion in economics or the real world more generally.  But they have not explained to us that the tools they are using are revealed by today’s circumstances to be much more fragile than we guessed before, and that they are going on judgement [which could be drawing in profiles overwriting the model, or carefully selecting the model] more than previously.  Although MPC communications don’t mention this problem, one presumes that they must be aware of it.  One can guess that they chose not to mention it for fear of reducing confidence in the policy measure.  But this course of action is a gamble, and it rather goes against the overall grain of the new framework for FG, [aside from the Fudge], which is to emphasise transparency.

Forward guidance to make existing stimulus ‘more effective’, ie more powerful?

The key question at the heart of the revelation of the new framework for the implementation of monetary policy is whether it constitutes a loosening of monetary policy, relative to what was envisaged before.

It seems inconceivable that there could have been a majority for a loosening of monetary policy:  i) such a majority did not exist before Carney’s arrival, ii) the data firmed substantially since that point.  To justify a loosening, MPC members would surely have had to put aside their obligation to vote individually, in favour of another objective to smooth the succession of the new Governor, perhaps worried that by not doing the credibility of his leadership, and so the MPC as a whole, would be threatened.

However.

When asked at the Press Conference by Faisal Islam of Channel 4 news to clarify whether or not forward guidance was a loosening of policy, or just a clarification, although Carney chose to point out that it was primarily the latter, in doing this he emphasised that by so doing the existing stimulus would be made ‘more effective’.  Most people would take that to mean ‘more powerful’.  A stimulus of the same size, but which had the same effect as more stimulus of the old kind (applied without forward guidance).  Hence it seems Carney at least expects the new framework to exert more stimulus, and given the convention that the Governor confines himself to speaking for the majority at the Press Conference, one would presume that the other MPC members also think this.  But if that’s the case, how does one reconcile those MPC members’ previous votes.  What has happened since those votes to convince them that they needed to make the stimulus they voted for previously ‘more effective’, ie ‘more powerful’?

[Added]:  Moreover, later on Carney observed that the new forward guidance did not constitute a ‘change in the reaction function’.  How does that square with previous MPC votes?   What news could have prompted MPC members, following a given reaction function, to wish for more stimulus (a ‘more effective’ existing stimulus)?  This latter comment is pretty hard to read.  It implies, taken literally, that MPC members have been articulating their decisions about rates in terms of this forward guidance privately, or perhaps inside their heads, and have simply chosen now to disclose it.  Surely that cannot be what he meant.  But if he did not mean that, (which is what most people who know what reaction function means would have taken him to mean), what did he mean?

[Added]:  That Carney had to be pushed on this key question, and that he wasn’t entirely clear about it in his answer, is unfortunate.   One presumes that this comparison (between the overall stance of policy before and after forward guidance) has been discussed on the Committee, and that there is an answer.  In which case, why was this not the lead message today?  It’s ironic that this was ommitted, since today was meant to be about launching a new, more transparent era for monetary policy implementation.

The next UK MPC minutes are going to make for interesting reading!

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.