Macroeconomic quackery

20 Jul, 2014 at 13:41 | Posted in Economics | 2 Comments

In a recent interview Chicago übereconomist  Robert Lucas said

the evidence on postwar recessions … overwhelmingly supports the dominant importance of real shocks.

So, according to Lucas, changes in tastes and technologies should be able to explain the main fluctuations in e.g. the unemployment that we have seen during the last six or seven decades. But really — not even a Nobel laureate could in his wildest imagination come up with any warranted and justified explanation solely based on changes in tastes and technologies.

How do we protect ourselves from this kind of scientific nonsense? In The Scientific Illusion in Empirical Macroeconomics Larry Summers has a suggestion well worth considering:

Modern scientific macroeconomics sees a (the?) crucial role of theory as the development of pseudo worlds or in Lucas’s (1980b) phrase the “provision of fully articulated, artificial economic systems that can serve as laboratories in which policies that would be prohibitively expensive to experiment with in actual economies can be tested out at much lower cost” and explicitly rejects the view that “theory is a collection of assertions about the actual economy” …

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A great deal of the theoretical macroeconomics done by those professing to strive for rigor and generality, neither starts from empirical observation nor concludes with empirically verifiable prediction …

The typical approach is to write down a set of assumptions that seem in some sense reasonable, but are not subject to empirical test … and then derive their implications and report them as a conclusion. Since it is usually admitted that many considerations are omitted, the conclusion is rarely treated as a prediction …

However, an infinity of models can be created to justify any particular set of empirical predictions … What then do these exercises teach us about the world? … If empirical testing is ruled out, and persuasion is not attempted, in the end I am not sure these theoretical exercises teach us anything at all about the world we live in …

Reliance on deductive reasoning rather than theory based on empirical evidence is particularly pernicious when economists insist that the only meaningful questions are the ones their most recent models are designed to address. Serious economists who respond to questions about how today’s policies will affect tomorrow’s economy by taking refuge in technobabble about how the question is meaningless in a dynamic games context abdicate the field to those who are less timid. No small part of our current economic difficulties can be traced to ignorant zealots who gained influence by providing answers to questions that others labeled as meaningless or difficult. Sound theory based on evidence is surely our best protection against such quackery.

Added 23:00 GMT: Commenting on this post, Brad DeLong writes:

What is Lucas talking about?

If you go to Robert Lucas’s Nobel Prize Lecture, there is an admission that his own theory that monetary (and other demand) shocks drove business cycles because unanticipated monetary expansions and contractions caused people to become confused about the real prices they faced simply did not work:

Robert Lucas (1995): Monetary Neutrality:
“Anticipated monetary expansions … are not associated with the kind of stimulus to employment and production that Hume described. Unanticipated monetary expansions, on the other hand, can stimulate production as, symmetrically, unanticipated contractions can induce depression. The importance of this distinction between anticipated and unanticipated monetary changes is an implication of every one of the many different models, all using rational expectations, that were developed during the 1970s to account for short-term trade-offs…. The discovery of the central role of the distinction between anticipated and unanticipated money shocks resulted from the attempts, on the part of many researchers, to formulate mathematically explicit models that were capable of addressing the issues raised by Hume. But I think it is clear that none of the specific models that captured this distinction in the 1970s can now be viewed as a satisfactory theory of business cycles”

And Lucas explicitly links that analytical failure to the rise of attempts to identify real-side causes:

“Perhaps in part as a response to the difficulties with the monetary-based business cycle models of the 1970s, much recent research has followed the lead of Kydland and Prescott (1982) and emphasized the effects of purely real forces on employ- ment and production. This research has shown how general equilibrium reasoning can add discipline to the study of an economy’s distributed lag response to shocks, as well as to the study of the nature of the shocks themselves…. Progress will result from the continued effort to formulate explicit theories that fit the facts, and that the best and most practical macroeconomics will make use of developments in basic economic theory.”

But these real-side theories do not appear to me to “fit the facts” at all.

And yet Lucas’s overall conclusion is:

“In a period like the post-World War II years in the United States, real output fluctuations are modest enough to be attributable, possibly, to real sources. There is no need to appeal to money shocks to account for these movements”

It would make sense to say that there is “no need to appeal to money shocks” only if there were a well-developed theory and models by which pre-2008 post-WWII business-cycle fluctuations are modeled as and explained by identified real shocks. But there isn’t. All Lucas will say is that post-WWII pre-2008 business-cycle fluctuations are “possibly” “attributable… to real shocks” because they are “modest enough”. And he says this even though:

“An event like the Great Depression of 1929-1933 is far beyond anything that can be attributed to shocks to tastes and technology. One needs some other possibilities. Monetary contractions are attractive as the key shocks in the 1929-1933 years, and in other severe depressions, because there do not seem to be any other candidates”

as if 2008-2009 were clearly of a different order of magnitude with a profoundly different signature in the time series than, say, 1979-1982.

Why does he think any of these things?

Yes, indeed, how could any person think any of those things …

2 Comments

  1. Let me fill in the […] part from Lucas that you accidentally left out:

    “(up to but not including the one we are now in)”

  2. The term equilibrium implies stability but it is an idea that is part of a dream world. If political policies do not follow a realistic pattern but economists insist on following a equilibrium justification for decisions related to policies, then both aspects of government are dreaming. For example, not only does the FRB fail to supervise banks during the pre-1929 crisis but the government also shuts down immigration thus cutting off labor expansion. The ‘shock’ was a natural event, the dust-bowl drought, which should have been anticipated by installing an irrigation system. Clearly, a dream world future had taken hold of the ruling class, er, investors, who thought that stock market investing and a constant labor source would lead to equilibrium, er, stability.

    In post WW2, not only is Germany and Japan defanged, destabilizing traditionally occupied areas, the US also dismisses the bulk of its forces and a Cold War ensues with an imminent nuclear war threatening. This is not equilibrium or stability in a meaningful sense. Therefore, the question looms as to what was the basis for policy decisions during this period and up to today where the concepts of equilibrium, stability, or even balance obviously does not work because it involves the suppression of the questioning of the structure of reality. (Reminds of the restriction on ordnance issues just before TET in ’68!) An econometric model that is not confirmed by induction is useless!


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