Home > New vs. Old Paradigm Economics, The Economics Profession > On relevance and rigour in macroeconomics

On relevance and rigour in macroeconomics

from Lars Syll

be-relevant

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

Empirical evidence only plays a minor role in neoclassical mainstream economic theory, where models largely function as a substitute for empirical evidence.

One might have hoped that humbled by the manifest failure of its theoretical pretences during the latest economic-financial crisis, 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. That has, so far, not happened. 

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

For many years now, the main alternative to Real Business Cycle Theory has been a somewhat loose cluster of models given the label of New Keynesian theory. 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. The “New Keynesian” label refers back to the “rigid wages” brand of Keynesian theory of 40 or 50 years ago. Except for this stress on inflexibilities this brand of contemporary macroeconomic theory has basically nothing Keynesian about it …

I conclude that dynamic stochastic general equilibrium theory has shown itself an intellectually bankrupt enterprise. But this does not mean that we should revert to the old Keynesian theory that preceded it (or adopt the New Keynesian theory that has tried to compete with it). What we need to learn from Keynes … are about how to view our responsibilities and how to approach our subject.

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 behaviour and the behaviour 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. Using DSGE models only confirms Robert Gordon‘s  dictum that today

rigor competes with relevance in macroeconomic and monetary theory, and in some lines of development macro and monetary theorists, like many of their colleagues in micro theory, seem to consider relevance to be more or less irrelevant.

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  1. Garrett Connelly
    December 18, 2013 at 9:18 pm | #1

    I became an applied economist when I discovered the $5 per square foot house that pays the residents to live in itself. What kind of economy is that? And what does the rest of economics have to say about anything that actually matters to real people? Like Sanitation, water, health, education and shelter.

  2. Newtownian
    December 20, 2013 at 4:27 am | #2

    Last year I attended the International Risk Analysis Society’s Congress. Lots of models on display and some scary science – artificial life (bacterial cells) for example made to order.

    But virtually no economists! There was one but the presentation was relatively obtuse (though full marks for him attending/presenting). It seems economics modellers want to be seen as scientists but aren’t willing to appear on the same multidisciplinary stage by in large (or they are so advanced they have no need? or so retarded they wouldn’t be able to follow the discourse).

    Though disappointing, this apparent exclusivism/unwillingness of economists to air their dirty underwear to scientists who might have laughed their methods out of the lecture rooms wasn’t altogether unsurprising.

    A month before I’d been invited to give a small presentation to an @Risk semi-industry conference (for those unfamiliar – a suite of spread-sheet wizards which allow UNCERTAINTY and VARIABILITY to be incorporated into the Excel modelling workbooks designed for high powered economic modellers and low grade environmental science risk modellers like myself.

    On that occasion there were some economics experts and their sessions were quite informative if a bit puzzling. Most notable was one keynote guy who explained that amazingly the financial crisis had revealed there was more to risk estimation than the Gaussian/Normal distribution which showed clearly that once you move beyond the mean the likelihood of problems becomes infinitely small. (had he been reading Taleb in an airport lounge?).

    I was quite boggled by this, after inhabiting the real world where Murphy’s Law rules (i.e. shit happens). Routinely normal risk analysis focuses on hazardous events which can make probability density functions multimodal. But apparently economics modelling doesn’t seem to conceive this. I can only think that economics modellers are overly in love with the Central Limit Theorem to the point where earthquakes meteors climate change and most of existential reality are not on their theoretical radar.

    Declaration – I have no direct link or gain any benefit from association with Palisade who make @Risk other than the free drinks they provided one evening.

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