Solow on the irrelevance of the Ramsey model

23 June, 2015 at 19:16 | Posted in Economics | Leave a comment

4703325-2So in what sense is this “dynamic stochastic general equilibrium” model firmly grounded in the principles of economic theory? I do not want to be misunderstood. Friends have reminded me that much of the effort of “modern macro” goes into the incorporation of important deviations from the Panglossian assumptions that underlie the simplistic application of the Ramsey model to positive macroeconomics. Research focuses on the implications of wage and price stickiness, gaps and asymmetries of information, long-term contracts, imperfect competition, search, bargaining and other forms of strategic behavior, and so on. That is indeed so, and it is how progress is made.

But this diversity only intensifies my uncomfortable feeling that something is being put over on us, by ourselves. Why do so many of those research papers begin with a bow to the Ramsey model and cling to the basic outline? Every one of the deviations that I just mentioned was being studied by macroeconomists before the “modern” approach took over. That research was dismissed as “lacking microfoundations.” My point is precisely that attaching a realistic or behavioral deviation to the Ramsey model does not confer microfoundational legitimacy on the combination. Quite the contrary: a story loses legitimacy and credibility when it is spliced to a simple, extreme, and on the face of it, irrelevant special case. This is the core of my objection: adding some realistic frictions does not make it any more plausible that an observed economy is acting out the desires of a single, consistent, forward-looking intelligence …

For completeness, I suppose it could also be true that the bow to the Ramsey model is like wearing the school colors or singing the Notre Dame fight song: a harmless way of providing some apparent intellectual unity, and maybe even a minimal commonality of approach. That seems hardly worthy of grown-ups, especially because there is always a danger that some of the in-group come to believe the slogans, and it distorts their work …

There has always been a purist streak in economics that wants everything to follow neatly from greed, rationality, and equilibrium, with no ifs, ands, or buts. Most of us have felt that tug. Here is a theory that gives you just that, and this
time “everything” means everything: macro, not micro. The theory is neat, learnable, not terribly difficult, but just technical enough to feel like “science.”

Robert Solow

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