Lazy theorizing and useless macroeconomics

15 September, 2016 at 15:03 | Posted in Economics | 6 Comments

In a new, extremely well-written, brave, and interesting article, Paul Romer goes to frontal attack on the theories that has put macroeconomics on a path of ‘intellectual regress’ for three decades now:

Macroeconomists got comfortable with the idea that fluctuations in macroeconomic aggregates are caused by imaginary shocks, instead of actions that people take, after Kydland and Prescott (1982) launched the real business cycle (RBC) model …

67477738In response to the observation that the shocks are imaginary, a standard defence invokes Milton Friedman’s (1953) methodological assertion from unnamed authority that “the more significant the theory, the more unrealistic the assumptions.” More recently, “all models are false” seems to have become the universal hand-wave for dismissing any fact that does not conform to the model that is the current favourite.

The noncommittal relationship with the truth revealed by these methodological evasions and the “less than totally convinced …” dismissal of fact goes so far beyond post-modern irony that it deserves its own label. I suggest “post-real.”

Paul Romer

There are many kinds of useless ‘post-realeconomics held in high regard within mainstream economics establishment today. Few — if any — are less deserved than the macroeconomic theory/method — mostly connected with Nobel laureates Finn Kydland, Robert Lucas, Edward Prescott and Thomas Sargent — called calibration.

fraud-kit

Paul Romer and yours truly are certainly not the only ones having doubts about the scientific value of calibration. In Journal of Economic Perspective (1996, vol. 10) Nobel laureates Lars Peter Hansen and James J. Heckman writes:

It is only under very special circumstances that a micro parameter such as the inter-temporal elasticity of substitution or even a marginal propensity to consume out of income can be ‘plugged into’ a representative consumer model to produce an empirically concordant aggregate model … What credibility should we attach to numbers produced from their ‘computational experiments’, and why should we use their ‘calibrated models’ as a basis for serious quantitative policy evaluation? … There is no filing cabinet full of robust micro estimats ready to use in calibrating dynamic stochastic equilibrium models … The justification for what is called ‘calibration’ is vague and confusing.

Mathematical statistician Aris Spanos — in  Error and Inference (Mayo & Spanos, 2010, p. 240) — is no less critical:

Given that “calibration” purposefully foresakes error probabilities and provides no way to assess the reliability of inference, how does one assess the adequacy of the calibrated model? …

The idea that it should suffice that a theory “is not obscenely at variance with the data” (Sargent, 1976, p. 233) is to disregard the work that statistical inference can perform in favor of some discretional subjective appraisal … it hardly recommends itself as an empirical methodology that lives up to the standards of scientific objectivity

In physics it may possibly not be straining credulity too much to model processes as ergodic – where time and history do not really matter – but in social and historical sciences it is obviously ridiculous. If societies and economies were ergodic worlds, why do econometricians fervently discuss things such as structural breaks and regime shifts? That they do is an indication of the unrealisticness of treating open systems as analyzable with ergodic concepts.

The future is not reducible to a known set of prospects. It is not like sitting at the roulette table and calculating what the future outcomes of spinning the wheel will be. Reading Lucas, Sargent, Prescott, Kydland and other calibrationists one comes to think of Robert Clower’s apt remark that

much economics is so far removed from anything that remotely resembles the real world that it’s often difficult for economists to take their own subject seriously.

As Romer says:

Math cannot establish the truth value of a fact. Never has. Never will.

So instead of assuming calibration and rational expectations to be right, one ought to confront the hypothesis with the available evidence. It is not enough to construct models. Anyone can construct models. To be seriously interesting, models have to come with an aim. They have to have an intended use. If the intention of calibration and rational expectations  is to help us explain real economies, it has to be evaluated from that perspective. A model or hypothesis without a specific applicability is not really deserving our interest.

To say, as Edward Prescott that

one can only test if some theory, whether it incorporates rational expectations or, for that matter, irrational expectations, is or is not consistent with observations

is not enough. Without strong evidence all kinds of absurd claims and nonsense may pretend to be science. We have to demand more of a justification than this rather watered-down version of “anything goes” when it comes to rationality postulates. If one proposes rational expectations one also has to support its underlying assumptions. None is given, which makes it rather puzzling how rational expectations has become the standard modeling assumption made in much of modern macroeconomics. Perhaps the reason is that economists often mistake mathematical beauty for truth.

But I think Prescott’s view is also the reason why calibration economists are not particularly interested in empirical examinations of how real choices and decisions are made in real economies. In the hands of Lucas, Prescott and Sargent, rational expectations has been transformed from an – in principle – testable hypothesis to an irrefutable proposition. Believing in a set of irrefutable propositions may be comfortable – like religious convictions or ideological dogmas – but it is not  science.

So where does this all lead us? What is the trouble ahead for economics? Putting a sticky-price DSGE lipstick on the RBC pig sure won’t do. Neither will — as Paul Romer notices — just looking the other way and pretend it’s raining:

The trouble is not so much that macroeconomists say things that are inconsistent with the facts. The real trouble is that other economists do not care that the macroeconomists do not care about the facts. An indifferent tolerance of obvious error is even more corrosive to science than committed advocacy of error.

6 Comments »

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  1. Math cannot establish the truth value of a fact. Never has. Never will.

    I’m not crazy about Romer’s precise formulation, but “Amen!” to the spirit of the point. And yet there is a cottage industry in so-called “robustness analysis” of models in economic theory that assumes, astonishingly, the exact opposite.

  2. More recently, “all models are false” seems to have become the universal hand-wave for dismissing any fact that does not conform to the model that is the current favorite.

    Another obvious statement remarkable for being made by a mainstream economist. “The universal hand-wave” indeed.

  3. Every hypothesis which is consistent with observation is a member of the set of hypotheses consistent with observation.

    Science isn’t about adding hypotheses to the set with more cleverness. Science is about removing hypotheses from the set with more observation.

  4. We’re not going to get anywhere until we produce a full real-time simulator. Those who think they are too difficult need to spend a bit of time playing multi-player computer games in simulated worlds until the penny drops.

    A simulator is the Large Hadron Collider of economics. Without it you can’t possibly know what the effect of policies are, or see what happens if you remove the straitjacket of mainstream economics from central bank policy and the like.

    A spreadsheet with half a dozen simultaneous equations demonstrates nothing. You need much more than that.

  5. I find the most disturbing thing that Romer says in his paper is on page 20 in the last paragraph.

    He says: “This price is lower for me because I am no longer an academic.”

    Pages could be written about this.

    It makes you wonder about intellectual integrity of the academic class.

    He implies in the next few sentences that access to professional journals and receipt of professional honours is tied to towing the line.


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