Wren-Lewis on economic methodology

30 Jul, 2014 at 17:09 | Posted in Economics | 3 Comments

Simon Wren-Lewis has a post up today discussing why the New Classical Counterrevolution (NCCR) was successful in replacing older theories, despite the fact that the New Classical models weren’t able to explain what happened to output and inflation in the 1970s and 1980s:

The new theoretical ideas New Classical economists brought to the table were impressive, particularly to those just schooled in graduate micro. Rational expectations is the clearest example …

However, once the basics of New Keynesian theory had been established, it was quite possible to incorporate concepts like rational expectations or Ricardian Eqivalence into a traditional structural econometric model (SEM) …

The real problem with any attempt at synthesis is that a SEM is always going to be vulnerable to the key criticism in Lucas and Sargent, 1979: without a completely consistent microfounded theoretical base, there was the near certainty of inconsistency brought about by inappropriate identification restrictions …

So why does this matter? … If mainstream academic macroeconomists were seduced by anything, it was a methodology – a way of doing the subject which appeared closer to what at least some of their microeconomic colleagues were doing at the time, and which was very different to the methodology of macroeconomics before the NCCR. The old methodology was eclectic and messy, juggling the competing claims of data and theory. The new methodology was rigorous!

Wren-Lewis seems to be überimpressed by the “rigour” brought to macroeconomics by the New Classical counterrevolution and its rational expectations, microfoundations and ‘Lucas Critique’.

I fail to see why.

Contrary to what Wren-Lewis seems to argue, I would say the recent economic crisis and the fact that New Classical economics has had next to nothing to contribute in understanding it, shows that New Classical economics is a degenerative research program in dire need of replacement.

The predominant strategy in mainstream macroeconomics today is to build models and make things happen in these “analogue-economy models.” But although macro-econometrics may have supplied economists with rigorous replicas of real economies, if the goal of theory is to be able to make accurate forecasts or explain what happens in real economies, this ability to — ad nauseam — construct toy models, does not give much leverage.

“Rigorous” and “precise” New Classical models cannot be considered anything else than unsubstantiated conjectures as long as they aren’t supported by evidence from outside the theory or model. To my knowledge no in any way decisive empirical evidence has been presented.

And — applying a “Lucas critique” on New Classical models, it is obvious that they too fail. Changing “policy rules” cannot just be presumed not to influence investment and consumption behavior and a fortiori technology, thereby contradicting the invariance assumption. Technology and tastes cannot live up to the status of an economy’s deep and structurally stable Holy Grail. They too are part and parcel of an ever-changing and open economy. Lucas hope of being able to model the economy as “a FORTRAN program” and “gain some confidence that the component parts of the program are in some sense reliable prior to running it” therefore seems – from an ontological point of view – totally misdirected. The failure in the attempt to anchor the analysis in the alleged stable deep parameters “tastes” and “technology” shows that if you neglect ontological considerations pertaining to the target system, ultimately reality gets its revenge when at last questions of bridging and exportation of model exercises are laid on the table.

No matter how precise and rigorous the analysis is, and no matter how hard one tries to cast the argument in modern mathematical form, they do not push economic science forwards one millimeter if they do not stand the acid test of relevance to the target. No matter how clear, precise, rigorous or certain the inferences delivered inside these models are, they do not per se say anything about real world economies.

keynes-right-and-wrong

3 Comments

  1. Lars, Could I ask you how well do these “analogue-economies” models fit in micro- (not macro-) economics? From Steve Keen’s book, I get the impression that microeconomics also has problems in making these models conform to the target-system of individuals’ and firms’ behavior in the marketplace.

    If that’s the case, the story could be even worse than macroeconomists became enamored of a research programme that only fruitful in micro, since the microeconomics itself would have already had very tenuous links to what it purported to model.

    Is the difference simply that in macro the mismatch between model and target-system makes the situation desperate, rather than merely serious, as it might be in micro?

  2. To this layperson, it would be extremely helpful to have a map of what to ignore and what remains. If I know New Classical has fatal ontological flaws, what gets crossed off the list of worthwhile academic pursuits? Is this everything out of Chicago? Does Pikkety rely on any of the same assumptions?

    DeLong and Krugman seem aware of these problems. Do they successfully avoid them?

    It’s like knowing that lead is poison, but not knowing which pipes contain lead.

  3. Well, there is also the reverse perspective. If the theories and models do not fit the reality, then perhaps the structure of reality is misunderstood. If the models are ‘rules of the game’ then it should be simple to prove the model’s validity. Shouldn’t we discussing application?


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