"The Rebel Economist Who Blew Up Macroeconomics"
"It's Time to Junk the Flawed Economic Models That Make the World a Dangerous Place"
And who can forget:
"Famous Economist Paul Romer Says Macroeconomics is All Bullshit"
Paul has some rules for bloggers writing about his stuff. These are:
1. If you are interested in a paper, read it.I've taken these to heart, and have indeed read the paper thoroughly. Comprehension, of course, is another matter altogether.
2. If you want to blog about what is in a paper, read it.
Paul's conclusions are pretty clear. From his abstract:
For more than three decades, macroeconomics has gone backwards...A parallel with string theory from physics hints at a general failure mode of science that is triggered when respect for highly regarded leaders evolves into a deference to authority that displaces objective fact from its position as the ultimate determinant of scientific truth.So, those are strong charges:
1. The current stock of macroeconomists knows less than did the stock of macroeconomists practicing in 1986 or earlier.
2. A primary reason for this retrogression is that junior macroeconomists are unabashed butt-kissers. They can't bear to criticize their senior colleagues.
If you are a macroeconomist, one question that might occur to you at this point is how Romer views his role in all this macro bullshit. As we know, Romer's early work was highly influential. It's hard to say where the endogenous growth research program would be without him. This paper and this one have more than 22,000 Google scholar citations each. That's enormous. In order to collect that many citations, those papers had to be on many PhD macro reading lists, had to be read carefully, and had to form the basis for much subsequent published research. It's not for nothing that NYU, in the manner of various obituary writers, has a blurb ready to go should Paul ever collect a Nobel. Thus, it would appear that Paul singlehandedly shaped a large piece of modern macroeconomics as we know it, and should take credit for some of the bullshit he claims we are mired in. But, apparently he thinks it was someone else's fault.
A key part of Paul's paper has to do with what he views as flaws in the approach to identification in some modern macroeconomics, which he thinks yields bizarre results:
Macro models now use incredible identifying assumptions to reach bewildering conclusions.He then sets up a straw man:
To appreciate how strange these conclusions can be, consider this observation, from a paper published in 2010, by a leading macroeconomist: "... although in the interest of disclosure, I must admit that I am myself less than totally convinced of the importance of money outside the case of large inflations."In a paper that aims to debunk modern macro as pseudoscience, Romer here commits his first sin. Where's the citation, so we can check this quote? Of course, through the miracles of modern search engines, it's not hard to find the paper in question. It's this one, by Jesus Fernandez-Villaverde. Jesus is indeed a "leading macroeconomist," and I highly recommend his paper, if you want to learn something about the technical aspects of modern DSGE modeling.
It's useful to see the quote from Jesus's paper in context. Here's most of the paragraph in which it is contained:
At least since David Hume, economists have believed that they have identified a monetary transmission mechanism from increases in money to short-run fluctuations caused by some form or another of price stickiness. It takes much courage, and more aplomb, to dismiss two and a half centuries of a tradition linking Hume to Woodford and going through Marshall, Keynes, and Friedman. Even those with less of a Burkean mind than mine should feel reluctant to proceed in such a perilous manner. Moreover, after one finishes reading Friedman and Schwartz's (1971) A Monetary History of the U.S. or slogging through the mountain of Vector Autoregressions (VARs) estimated over 25 years, it must be admitted that those who see money as an important factor in business cycles fluctuations have an impressive empirical case to rely on. Here is not the place to evaluate all these claims (although in the interest of disclosure, I must admit that I am myself less than totally convinced of the importance of money outside the case of large inflations). Suffice it to say that the previous arguments of intellectual tradition and data were a motivation compelling enough for the large number of economists who jumped into the possibility of combining the beauty of DSGE models with the importance of money documented by empirical studies.Paul wants us to think that the view expressed in the quote - that monetary factors are relatively unimportant for aggregate economic activity - is: (i) a mainstream view; (ii) a standard implication of "DSGE" models; (iii) total nonsense. First, the full paragraph makes clear that, as Jesus says, there is "an impressive empirical case" that supports the view that money is important. Jesus's parenthetical remark (the quote) states his skepticism, without getting into the reasons. Surely Paul should approve, as he thinks we're all too deferential to authority. Second, the New Keynesian research program is primarily engaged with the question of how and why monetary policy matters. We may quarrel about their mechanisms and the conclusions, but surely Mike Woodford can't be accused of arguing that monetary policy is irrelevant.
On the third point, that Jesus's skepticism is nonsense, Paul looks at some data from the Volcker disinflation. Volcker, as we all know, was Fed chair during the disinflationary period during the early 1980s. Here are Paul's conclusions:
The data displayed in Figure 2 suggest a simple causal explanation for the events that is consistent with what the Fed insiders predicted:So, that's a standard narrative that we hear about the Volcker era. What's wrong with it? First, it's incorrect to say that the Fed was "aiming" for a fed funds rate target at the time. It's quite interesting to read the FOMC transcripts from the Volcker era, in the context of modern monetary policy implementation. Volcker and his FOMC colleagues were operating on quantity theory principles. They aimed to reduce inflation by reducing the rate of money growth, without regard for the path of the fed funds rate, and you can see that in the data. Here's the fed funds rate during Volcker's time as Fed chair:
1. The Fed aimed for a nominal Fed Funds rate that was roughly 500 basis points higher than the prevailing inflation rate, departing from this goal only during the first recession.
2. High real interest rates decreased output and increased unemployment.
3. The rate of inflation fell, either because the combination of higher unemployment and a bigger output gap caused it to fall or because the Fed’s actions changed expectations.
Paul's point #3 above reflects a Phillips curve view of the world - a higher "output gap" causes lower inflation, and lower expected inflation causes lower inflation. Though that story may appear to fit the Volcker experience, Phillips curves are notoriously unreliable. Just ask the people who keep predicting that low interest rates will make inflation take off. A more reliable guide is the Fisher effect, which fits this episode nicely. This is a scatter plot of the inflation rate vs. the fed funds rate, from the peak in the fed funds rate in June 1981 until the end of Volcker's term, with the observations connected in temporal sequence: Neo-Fisherism 101. Indeed, most of our models have neo-Fisherian properties, even when they have Phillips curve relations built in, as in New Keynesian models.
What's the conclusion? None of what Paul claims to be obvious concerning the effects of monetary policy during the Volcker era is actually obvious. Many hours have been spent, and many papers and books have been written by economists about the macroeconomic effects of monetary policy. But, given all that work, Jesus is not being unscientific in his skepticism about the importance of monetary factors for aggregate economic activity. It's widely accepted that central banks can and should control inflation, but there is wide dispersion - for good reasons - in views about the quantitative real effects of monetary policy.
So much for the case that modern macro leads to obviously false conclusions. What else does Paul have to say?
1. Paul doesn't like the notion of modeling business cycles as being driven by what he calls "imaginary shocks." Of course, economics is rife with such "imaginary shocks," otherwise known as stochastic disturbances. In macro, one approach - and an arguably very productive one - to constructing models that can be used to to understand the world and allow us to formulate policy, is to construct structural models (based on behavior, optimization, and market interaction) that are stochastically disturbed in ways that we can analyze and compute. Such models can produce aggregate fluctuations that look like what we actually observe. There are other approaches. For example, we can construct models with intrinsic rather than extrinsic aggregate uncertainty - models with multiple sunspot equilibria. Roger Farmer, for example, is very fond of models with self-fulfilling volatility. These models were popular for a time, particularly in the 1990s, but never caught on with the policy people. With respect to business cycle models with exogenous shocks, I can understand some of Paul's concerns. If I can't measure total factor productivity (TFP) directly, what good does it do to tell me that TFP is causing business cycles? If I have a model with 17 shocks and various ad-hoc bells and whistles - adjustment costs, habit persistence, etc. - is this any better than what Lawrence Klein was doing in the 1960s? But, and I hate to say this again, but economics is hard. In contrast to what Paul thinks, I think we have learned a lot in the last 30+ years. If he thinks these models are so bad, he should offer an alternative.
2. Paul thinks that identification - in part through the use of Bayesian econometrics - in modern macro models, is obfuscation. I might have been inclined to agree, but if you read Jesus's paper, he has some nice arguments in support of the Bayesian approach. Again, I recommend reading his paper.
3. The remaining sections of the paper, 6 through 10, are mostly free of substance. Paul asserts that macroeconomists are badly behaved in various ways. We're overly self-confident, monolithic, religious rather than scientific, we ignore parallel research programs and evidence that contradicts our theories. He seems to have it in for Lucas, Sargent, and Prescott, who apparently are engaged in some mutual fraudulent conspiracy. My favorite section is #9, "A Meta Model of Me." This paragraph sums that up:
When the person who says something that seems wrong is a revered leader of a group ... there is a price associated with open disagreement. This price is lower for me because I am no longer an academic. I am a practitioner, by which I mean that I want to put useful knowledge to work. I care little about whether I ever publish again in leading economics journals or receive any professional honor because neither will be of much help to me in achieving my goals. As a result, the standard threats ... do not apply.This is supposed to convince us that Paul is being up front and honest - he's got nothing to lose, and what could he possibly gain from bad-mouthing the profession? Well, by the same logic, Brian Bazay had nothing to lose and nothing to gain by pushing me down in the school yard. But he did it anyway. In my experience, there is a positive payoff to demonstrating the weakness of another economist's arguments in public - and the bigger the economist, the bigger the payoff. If macroeconomists were actually as wimpy as Paul says we are, I wouldn't want to belong to this group. In general, economists are an argumentative lot - that's what we're known for. As Paul says, he's not an academic any more. Maybe he's been away so long he's forgotten how it works.
So, this is a pseudoscientific paper purporting to be about the pseudoscientific nature of modern macro. It makes bold assertions, and offers little or no evidence to back those assertions up. There's a name for that, but fear of shunning keeps me from going there. :)