RBC theory — willfully silly obscurantism

2 August, 2015 at 21:30 | Posted in Economics | 10 Comments

Lucas and his school … went even further down the equilibrium rabbit hole, notably with real business cycle theory. And here is where the kind of willful obscurantism Romer is after became the norm. I wrote last year about the remarkable failure of RBC theorists ever to offer an intuitive explanation of how their models work, which I at least hinted was willful:

“But the RBC theorists never seem to go there; it’s right into calibration and statistical moments, with never a break for intuition. And because they never do the simple version, they don’t realize (or at any rate don’t admit to themselves) how fundamentally silly the whole thing sounds, how much it’s at odds with lived experience.”

Paul Krugman

Yours truly, of course, totally agrees with Paul on Lucas’ rabbit hole freshwater school.

And so does Truman F. Bewley:

unemployed-thumbLucas and Rapping (1969) claim that cyclical increases in unemployment occur when workers quit their jobs because wages or salaries fall below expectations …

According to this explanation, when wages are unusually low, people become unemployed in order to enjoy free time, substituting leisure for income at a time when they lose the least income …

According to the theory, quits into unemployment increase during recessions, whereas historically quits decrease sharply and roughly half of unremployed workers become jobless because they are laid off … During the recession I studied, people were even afraid to change jobs because new ones might prove unstable and lead to unemployment …

If wages and salaries hardly ever fall, the intertemporal substitution theory is widely applicable only if the unemployed prefer jobless leisure to continued employment at their old pay. However, the attitude and circumstances of the unemployed are not consistent with their having made this choice …

In real business cycle theory, unemployment is interpreted as leisure optimally selected by workers, as in the Lucas-Rapping model. It has proved difficult to construct business cycle models consistent with this assumption and with real wage fluctuations as small as they are in reality, relative to fluctuations in employment.

This is, of course, only what you would expect of New Classical Chicago economists.

So, what’s the problem?

The problem is that sadly enough this extraterrestial view of unemployment is actually shared by so called New Keynesians — a school of which Krugman considers himself a member — whose microfounded dynamic stochastic general equilibrium models cannot even incorporate such a basic fact of reality as involuntary unemployment!

Of course, working with microfunded representative agent models, this should come as no surprise. If one representative agent is employed, all representative agents are. The kind of unemployment that occurs is voluntary, since it is only adjustments of the hours of work that these optimizing agents make to maximize their utility.

In the basic DSGE models used by most ‘New Keynesians’, the labour market is always cleared – responding to a changing interest rate, expected life time incomes, or real wages, the representative agent maximizes the utility function by varying her labour supply, money holding and consumption over time. Most importantly – if the real wage somehow deviates from its “equilibrium value,” the representative agent adjust her labour supply, so that when the real wage is higher than its “equilibrium value,” labour supply is increased, and when the real wage is below its “equilibrium value,” labour supply is decreased.

In this model world, unemployment is always an optimal choice to changes in the labour market conditions. Hence, unemployment is totally voluntary. To be unemployed is something one optimally chooses to be.

The final court of appeal for macroeconomic models is the real world.

If substantive questions about the real world are being posed, it is the formalistic-mathematical representations utilized to analyze them that have to match reality, not the other way around.

To Keynes this was self-evident. But obviously not so to New Classical and ‘New Keynesian’ economists.

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  1. “If substantive questions about the real world are being posed, it is the formalistic-mathematical representations utilized to analyze them that have to match reality, not the other way around.”

    Well said, and that means working like an historical investigator. That would mean eschewing a lot of nonsensical models. In any case, no model should not be used to organise your analysis – the known facts should.

    I would add, Romer goes on about ‘mathiness’ by the Freshwater School. But for the sorts of reasons you outline here, I find it is New-Keynesianism which is the more convoluted, hypocritical and dishonest. Methodologically they are at their core doing the same thing, just not being honest about it.

    • “That would mean eschewing a lot of nonsensical models.”

      Love it.

      I would go farther and say it is better teaching what is correct than even teaching the mistakes to avoid. Its easier on the half asleep students.

  2. Dynamics is more common then equilibrium. Equilibrium is most often a mathematical assumption in economics.

    Here is my experience with RBC. I tried almost every thing following the equations and the books logic to get a cyclic solution to the equations in my book. (It was Oliver Blanchard’s book.) I could not. I put numbers in, made graphs from equations, etc.

    Why? Every movement or change was from outside the equations! The RBC equations in my book could never produce a cycle because the equations never explicately included time, t, as an independent variable. And, they were not differential equations. In math,science, and engineering ordinary differential equations are what you use to model dynamic things! Including things that cycle. And, if system reaches an equilibrium after being dynamic the solutions to the dynamic equations will reach equilibrium.

    Blanchard’s book’s RBC equations are like twisting the knobs on an etch a sketch. The machine produces nothing but what the user inputs. It was nothing like swinging on a swing or a mass on a spring going up and down with out input! Nothing, like a planet going around the sun because of its momentum and attraction of gravity.

    As an engineer we can do dynamic modeling of real things. One of the simplest experimental and mathematical dynamic examples is a weight on a spring going up and down. Or, sideways on a fiction-less table.

    The differential equation is this:
    X”(t)=-k/m*X(t) where k is the spring constant (stiffness) and m is the mass of the weight.

    And a solution could be:
    X(t) is the position at time t.
    X(t)=sin(t) if k=m=1

    A differential equation is hard the first time! They can be numerically solved in a spread sheet program.

    Online there are videos such as:
    Spray Paint Oscillator
    spring oscillator

    It is simpler for you to try a pendulum. Or, go to a play ground. The length of the pendulum sets the frequency or period of oscillation.

    The videos you want to see first are the actual demonstrations not the math. Then say to your self, “Equilibrium assumption is usually bunk!”

  3. Neither real nor cyclic. Just a theory.

    • Correction:
      “Real Business Cycle” theory is neither, real, nor cyclic. Just a verbal theory.

      Here is data of cyclic swings but they are not regular nor at the same frequency.

      https://research.stlouisfed.org/fred2/graph/?id=EMRATIO

      And it is not in equilibrium. Hardly ever!

      • Thanks Uncycle. It disturbs me that people like Blanchard who are pedalling such nonsense and are trained and train to think in such an absurd, uncritical and a-historical manner have a huge influence through their positions in the IMF on the welfare of the populations of many countries – particularly the vulnerable ones.

  4. I’ll do some thing cool for you and provide good info on the Goodwin model.
    .
    Here is a really good paper on the Goodwin growth cycle with correct unmessaged data for Germany.
    http://www.systemdynamics.org/conferences/2005/proceed/papers/WEBER196.pdf
    .
    And, I will provide with you with data for the US. If you want it for other countries you can do the same but request time series with the country name.
    https://research.stlouisfed.org/fred2/graph/?g=1Ao1
    X-Y graph like the Goodwin model is graphed!:
    https://research.stlouisfed.org/fred2/graph/?g=1Ao1
    You can expand it by pulling the bottom right corner.
    .
    Information on the derivation of some of the time series.
    https://research.stlouisfed.org/fred2/release/tables?rid=53&eid=42509&od=2014-01-01#heid_42498
    .
    Notice both the German data in the paper and the American data both have a common feature with the mathematical Goodwin model!
    .
    They all rotate in the same directions with relation to the wage share axis and the employment population ratio axis. That is if wage share is on the vertical and employment ration on the horizontal they rotate counter clockwise. If the axis were flipped (switched) or viewed from the back it would be clockwise.
    Please see figures 4, 10, and16 in the paper and the data linked above.

  5. http://www.digplanet.com/wiki/Goodwin_model_%28economics%29
    I just plotted the data from here as XY.

  6. Correction:
    The xy graph link should be:
    https://research.stlouisfed.org/fred2/graph/?g=1Aox

  7. Now, compared to static economic models, that is impressive to capture some of the dynamic.


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