Return to the Macro Methodological Morass
In a recent post, Olivier Blanchard attempted the heroic: to find a common path forward for the various critics of post-1980s macroeconomics. Steve Keen almost immediately wrote a post criticizing Blanchard’s approach because it didn’t allow for the possibility that the macro-economy was a complex nonlinear system that was best understood without reference to its micro-underpinnings. Roger Farmer wrote his own post, explaining to Keen that a group of well-known dynamic economic theorists had decided in 1985 that there was insufficient macroeconomic data to distinguish nonlinear from linear models, and so (based on Occam’s Razor) had abandoned nonlinear models. But Farmer also notes that he’s no fan of New Keynesian models and so (one presumes) not drawn to Blanchard’s attempted consensus.
In what follows, I comment on all three of these recent posts.
With respect to Blanchard: I thought that this piece was extremely useful. I broadly agree with what Blanchard writes until he poses the question, “Can we write down a basic model …” that we could all treat as foundational? I’m not convinced that this should be a goal at this stage. (Perhaps Keen and Farmer have convinced Blanchard of this too!). There are so many unknowns out there:
along with many others. With all those unknowns on the table, I’d be loath to aim for the next IS-LM synthesis in the near term. Given the data limitations that confront the field, I think we’d be better off developing a number of approaches and developing more flexible methods that address questions using multiple approaches.
Hopefully, this sounds pretty reasonable. Given that, I should point out that it is quite different from how much macro proceeds nowadays. The main goal for most research projects in macroeconomics is to get to a computer program that converges to a single number. This focus tends to rule out many features of possible interest (like multiple equilibria or nonlinearities).
With respect to Keen: I read him as making two substantive points. First, the world might well feature extraordinarily complex nonlinear dynamics (especially with respect to debt) that are simply excluded from mainstream macroeconomic models. Second, the focus on micro-foundations is misguided. I agree with him on the first point, and view it as important. I’ll say more about that agreement in a moment.
I disagree with him on the second point. Just to cite one issue that should resonate with him: surely we’ve learned that the distribution of debt/net worth across, say, financial institutions could matter materially for macroeconomic outcomes? Understanding the determinants evolution of that distribution would require more than merely aggregate models …
With respect to Farmer: His response to Keen is a wonderful illustration of how mainstream macroeconomics excludes potentially interesting modeling approaches. (I found Farmer's response to be somewhat somewhat ironic, because I’ve heard many macroeconomists use that same kind of response to argue against Farmer’s own very interesting research agenda.)
Here’s how the mainstream remains the mainstream:
1. Mainstream consists of a class of models C.
2. Someone proposes new class of models C’. It is clear to most that the answers to many questions of interest will be different if C’ is true rather than C.
3. It’s argued (usually by a theorist!) that we can’t readily distinguish C’ from C using existing data.
4. One response to (3) is: let’s figure out, and undertake, a class of (possibly very expensive!) experiments that would allow us to distinguish C’ from C. I don’t know much about the hard sciences but this response seems common there.
5. The standard approach to (3) in macro is: let’s abandon C’ and keep C. Since (3) is a common issue, C tends to remain the mainstream.
I’m not comfortable with (5) myself, but it is how macro typically proceeds.
In terms of the specifics of Keen’s chaotic models: the connection that he and others stress between nonlinear dynamics and financial imbalances was not explored carefully back then. To be clear: I’m not convinced that the connection is a valid one. But these nonlinear models might well lead to fundamentally different answers to macro policy questions of import. As such, this class of models represents a potentially important deviation from existing modeling that deserves more exploration.
N. Kocherlakota
Rochester, NY
October 5, 2016