Mainstream macroeconomics — rigorously irrelevant

2 Jul, 2020 at 16:57 | Posted in Economics | 7 Comments

be-relevantThere is something about the way macroeconomists construct their models nowadays that obviously doesn’t sit right.

One might have hoped that humbled by the manifest failure of its theoretical pretenses during the latest economic-financial crises, the one-sided, almost religious, insistence on axiomatic-deductivist modeling as the only scientific activity worthy of pursuing in economics would give way to methodological pluralism based on ontological considerations rather than formalistic tractability. But — empirical evidence still only plays a minor role in mainstream economic theory, where models largely function as a substitute for empirical evidence.

Fortunately — when you’ve got tired of the kind of macroeconomic apologetics produced by ‘New Keynesian’ macroeconomists and other DSGE modelers — there are still some real Keynesian macroeconomists to read. One of them — Axel Leijonhufvud — writes:

New Keynesians adhere on the whole to the same DSGE modeling technology as RBC macroeconomists but differ in the extent to which they emphasise inflexibilities of prices or other contract terms as sources of shortterm adjustment problems in the economy … Except for this stress on inflexibilities this brand of contemporary macroeconomic theory has basically nothing Keynesian about it … Dynamic stochastic general equilibrium theory has shown itself an intellectually bankrupt enterprise.

If macroeconomic models – no matter of what ilk –  build on microfoundational assumptions of representative actors, rational expectations, market clearing, and equilibrium, and we know that real people and markets cannot be expected to obey these assumptions, the warrants for supposing that conclusions or hypotheses of causally relevant mechanisms or regularities can be bridged, are obviously non-justifiable. Incompatibility between actual behavior and the behavior in macroeconomic models building on representative actors and rational expectations microfoundations is not a symptom of ‘irrationality.’ It rather shows the futility of trying to represent real-world target systems with models flagrantly at odds with reality.

A gadget is just a gadget – and no matter how brilliantly silly DSGE models you come up with, they do not help us working with the fundamental issues of modern economies.

7 Comments

  1. Leijonhufvud and Prof. Syll make devastating critisms of “New Classical” and “New Keynesian” DSGE models.
    However, it is now, and always was, a mistake to regard Mainstream Economics as DSGE modelling.
    Even in 2008 (the date of the above Leijonhufvud quote) DSGE models were only a minor specialised component of “Mainstream Economics”.
    Today DSGE models are of little interest to the majority of Mainstream Economists.
    .
    “By the early 1990s, the New Classical revolution had played itself out; most economists recognized that general equilibrium could not be applied directly to the economy. New Keynesian models incorporated farsighted rationality, but they were primarily partial equilibrium models. Neither New Classical nor New Keynesian models were especially insightful and, in the 1990s, the theoretical focus of attention in macro shifted to growth. Practical and macro modeling was returned to the real-world practitioners, and applied macroeconomics returned to
    pragmatic, ad hoc modeling.”
    David Collander
    Journal of the History of Economic Thought, Volume 22, Number 2, 2000
    https://www.sci-hub.tw/10.1080/10427710050025330

    • Collander is an economist that yours truly greatly enjoys reading. But if his judgment here were true, we should immediately inform all economics journal editors and textbook authors that those models they publish and write about “are of little interest”. I wish Collander were right, but even a fast perusal of the contemporary economics publications shows him — unfortunately — wrong.

      • Information dissemination via market based incentives preclude such rigor – see covid.

  2. Lars,
    .
    “….there are still some real Keynesian macroeconomists to read. One of them — Axel Leijonhufvud…”
    .
    I can’t see why you continue to describe Leijonhufvud as a Keynesian economist.
    .
    He might have high regard for Keynes as an original thinker but he has very little regard for the GT.
    .

  3. ‘This “equilibrium” graph (Figure 3) and the ideas behind it have been re-iterated so many times in the past half-century that many observes assume they represent one of the few firmly proven facts in economics. Not at all. There is no empirical evidence whatsoever that demand equals supply in any market and that, indeed, markets work in the way this story narrates.
    We know this by simply paying attention to the details of the narrative presented. The innocuous assumptions briefly mentioned at the outset are in fact necessary joint conditions in order for the result of equilibrium to be obtained. There are at least eight of these result-critical necessary assumptions: Firstly, all market participants have to have “perfect information”, aware of all existing information (thus not needing lecture rooms, books, television or the internet to gather information in a time-consuming manner; there are no lawyers, consultants or estate agents in the economy). Secondly, there are markets trading everything (and their grandmother). Thirdly, all markets are characterized by millions of small firms that compete fiercely so that there are no profits at all in the corporate sector (and certainly there are no oligopolies or monopolies; computer software is produced by so many firms, one hardly knows what operating system to choose…). Fourthly, prices change all the time, even during the course of each day, to reflect changed circumstances (no labels are to be found on the wares offered in supermarkets as a result, except in LCD-form). Fifthly, there are no transaction costs (it costs no petrol to drive to the supermarket, stock brokers charge no commission, estate agents work for free – actually, don’t exist, due to perfect information!). Sixthly, everyone has an infinite amount of time and lives infinitely long lives. Seventhly, market participants are solely interested in increasing their own material benefit and do not care for others (so there are no babies, human reproduction has stopped – since babies have all died of neglect; this is where the eternal life of the grown-ups helps). Eighthly, nobody can be influenced by others in any way (so trillion-dollar advertising industry does not exist, just like the legal services and estate agent industries).
    It is only in this theoretical dreamworld defined by this conflagration of wholly unrealistic assumptions that markets can be expected to clear, delivering equilibrium and rendering prices the important variable in the economy – including the price of money as the key variable in the macroeconomy. This is the origin of the idea that interest rates are the key variable driving the economy: it is the price of money that determines economic outcomes, since quantities fall into place.’

    https://professorwerner.org/shifting-from-central-planning-to-a-decentralised-economy-do-we-need-central-banks/

  4. I am sympathetic with most of the article. But to be honest, there is now a wave of new models still in general equilibrium framework that have less and less in common with standard dsge. They take into account heterogeneity and credit system, uncertainty and imperfect competition, behavioural biases. This followed some heavy hits that new Keynesians and neoclassical suffered because of the increasing relevance of rigorous empirical testing.

  5. We in developing countries feel that we have wasted time in teaching and studying new classical rational expectations type theories and their faith in uncontrolled market forces.Fortunately, heterodox macro economics is still there in the course contents. It is very hard to convince students such unrealistic selfish virtues like rational expectations since we here are born and brought up in an altruistic family and community set up


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