Sunday, October 16, 2011

The Structure of Macroeconomic Revolutions?

Macroeconomics sometimes appears to be a somewhat confusing swirl of models and "schools of thought." This can be a somewhat off-putting feature to students (though for some of us it is also part of what makes macroeconomics more interesting than microeconomics).  When I introduce it to my students, I make a nod to Thomas Kuhn's "Structure of Scientific Revolutions" framework, which provides a way of putting some structure on the development of macroeconomics that is more sophisticated than framing it as a series of "debates" between "sides" (i.e., "classical" vs. "Keynesian", "saltwater" vs. "freshwater", etc.).

So I liked this post by Matthew Yglesias, where he invokes Kuhn and draws an analogy between macroeconomics and the Copernican revolution in astronomy.  He recounts how Copernican (Earth revolves around the sun) astronomy eventually supplanted Ptolemaic (Earth is center of universe), but initially the Ptolemaic system made much better predictions, and concludes:
My view, with both all due respect and all due derision, is that the Robert Lucas types are like the early Copernicans here. There’s something admirable in their insistence that it ought to all work out to an easily modeled system grounded in compelling theoretically considerations. The New Keynesian model is a mess, like late-Ptolemaic astronomy, thrown together to account for observed reality. But you don’t fly to a moon with an elegant model that delivers mistaken predictions about where the moon’s going to be. And what we actually need is a Kepler to give us an elegant model that actually predicts the phenomena, and then a Newton who can explain what that model means. 
Hmmm... I'm more inclined to place the users of old Keynesian models, including the IS-LM-based macroeconometric models used by policymakers, in the "late-Ptolemaic" role, but, in any case, the Kuhninan approach helps explain why I simultaneously agree with Brad DeLong, Paul Krugman and Greg Mankiw that the IS-LM model remains a very useful tool, while being a little more optimistic than Krugman about the state of macroeconomics.

Also, I'm not sure that Lucas and others (including new Nobel laureate Tom Sargent) who have pushed macroeconomics towards "structural" or "micro-founded" models are leading us to an "easily modeled system." What counts for "elegance" in modern macro is consistency between the macroeconomic model and micro-economically optimal behavior on the part of consumers and firms (I suppose the obvious retort to that is to invoke Emerson: "A foolish consistency is the hobgoblin of little minds").


Anonymous said...

Given "What counts for "elegance" in modern macro is consistency between the macroeconomic model and micro-economically optimal behavior on the part of consumers and firms," any thoughts on the Sociology & Anthropology based observations about the poor quality of the underlying assumptions of micro-economic behavior (ultimatium game, barter involving personel debt/favor trading?)

Bill C said...

Hmmmm....That's a fair point; I know there's quite a bit of work going on under the heading of "behavioral economics" that gets at some of those issues.

Also, George Akerlof had an interesting presidential address to the American Economic Assoc. a few years ago called "The Missing Motivation in Economics" which dealt with social norms. So economists definitely are aware... but I'm not sure how soon (or successfully) it will filter into "mainstream" macro models.

I think for macroeconomics, the main problem is to build it in a way that doesn't imply that there is a deviation from "rationality" that can be systematically exploited. I'm thinking of "adaptive expectations" which is actually probably a more plausible story than "rational expectations" (which is what we use), but if you have adaptive expectations in a macro model, it can imply that the central bank can systematically and repeatedly fool people with inflation "surprises" and accelerating inflation can keep the unemployment rate below its "natural" (long-run equilibrium level).

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Anonymous said...

Thanks for pointing me to "The Missing Motivation" address. I wonder if some deviations from "rationality" would be explained by the concept of declining marginal utility of income/wealth and its implications for substitution of social goods/norms for income/wealth? It seems that ultimatium game outcomes would be wildly different if you could move participants along their income/wealth utility function? It would take quite the grant to test subjects' rationality toward greedy offers of an amount of money large enough to impact their income/wealth utility function.

How could the central bank be sure that suprise and accelerating inflation & above NLRU employment is the only outcome for cental bank shanagans? Couldn't asset bubbles and liquidity traps/fetishes also be possible outcomes for too much money (it becomes capital, not consumption/employment?)

The Arthurian said...

Hi Bill.

In regard to swirls of models and schools of thought, perhaps you will find Zen Babu's Macro Cube of interest.

Bill C said...

Frank: The phillips curve/adaptive expectations example I had in mind was a simple one where we assume the monetary authority can choose the inflation rate (which it could if the quantity theory held exactly... but you're right that there are other possible consequences of "loose" monetary policy).

Art: Interesting! Thanks for passing that along.

Anonymous said...

So your point was that the model has to have a "whirligig" to counter cheap money as a way of running the economy above its natural equilibrium (nature abhors an over-pressure just as much as a vacuum.) You feel the whiriligig is best expressed as an "adaptive expectation." This expectation is acted on by the banks/bond market/speculators or do you expect to see the behavior change among households?