Home > Uncategorized > Economic Depression: A commentary on Paul Romer’s The Trouble With Macroeconomics

Economic Depression: A commentary on Paul Romer’s The Trouble With Macroeconomics

By David Orrell

In a previous article for this newsletter, I wrote about the rather long and withdrawn grief process that the economics profession is working through, as it comes to terms with its role in what has become known as the Great Financial Crisis. Initial denial was followed by anger towards critics, which in turn was followed by a bargaining stage. The latter (I used Dani Rodrik’s book Economics Rules as an example) involved claims that there is nothing seriously wrong with economic models, it was just that the wrong ones were used. According to this view, critics are just attacking a simplified straw man. (We will stop attacking the straw man when it stops threatening to blow up the world financial system.)

Signs that we may be proceeding to the next stage of the grief process, depression, are evident in the recent working paper (available online) by Paul Romer, The Trouble With Macroeconomics. The first sentence of the abstract announces that “For more than three decades, macroeconomics has gone backwards.” It goes on to describe the author’s “pessimistic assessment of regression into pseudoscience.” It mentions the “serious failure” of economists such as Robert Lucas, who announced in 2003, a little prematurely, that the “central problem of depression prevention has been solved.” Decidedly non-upbeat section titles include “Post-Real Models”, “Loyalty Can Corrode The Norms of Science”, “Back to Square One”, and “The Trouble Ahead For All of Economics”.

The paper is based on a lecture given in January 2016, and is forthcoming in The American Economist. Just to be clear, this is not a magazine bent on overthrowing the status quo; indeed its web site has an entire section devoted to “Articles from Nobel Laureate Authors”. Typical paper titles are more like “My Life Philosophy” (Paul Samuelson) and “How I Work” (Paul Krugman) and “Some Gleanings From My Mind” (I made that up). So this appears to represent a significant stylistic departure. And as Paul Mason observed in The Guardian, Romer’s paper is important exactly because he is not an outsider or a rebel, but “a doyen of the profession, and from the heart of the US academic mainstream.”

The paper’s title is modelled on that of Lee Smolin’s 2006 book The Trouble With Physics. In the same way that elegant but unfalsifiable string theory has taken over high-energy physics, so mainstream economics has increasingly emphasised elegant but unfalsifiable mathematical models over experimental reality. Romer for example notes that many economic models suffer from the problem that they have more parameters than can be determined from the data. Economists therefore resort to making up imaginary inputs which give the desired answers. In string theory these are called supersymmetric particles, and have names like selectrons, squarks, and winos; Romer gives the equivalent economics versions names such as phlogiston, trolls, gremlins, aether, and caloric.

However the problems are as much sociological as they are mathematical. Just as string theory is characterised by what Smolin described as “groupthink” about the correct way to approach problems, so some economists see it as “an extremely serious violation of some honor code for anyone to criticize openly a revered authority figure … neither facts that are false, nor predictions that are wrong, nor models that make no sense matter enough to worry about.”

(It is interesting to compare that with the self-image that many economists enjoy of being open to criticism. As one wrote, while commenting on one of my books: “Economists welcome criticism. In the academy, we are well-known, if not infamous, for being direct, abrupt, and rude in criticizing each other (and others). There is a very healthy discussion about methodology. Bring it on.”)

Striving for acceptance

The paper is written with commendable honesty, along with a good dose of sarcasm, and an obvious concern for the state of economics. As Romer writes: “science and the spirit of the enlightenment are the most important human accomplishments. They matter more than the feelings of any of us.” And it makes a nice change from the usual, rather self-congratulatory commentary that “celebrates steady progress” as Romer describes.

However, while readers of The American Economist may be shocked by the paper’s content, it will be less surprising to those people who never bought into the orthodoxy in the first place, or have found themselves on the other side of groupthink. The comparison with string theory (to which I would add a shared fascination with a certain type of aesthetics) is apt, but it would have been nice to supplement quotes from dissident physicists with something from the dissident economists who have been saying the same things for decades. Instead, the focus is on spats between various Nobel-winners and other leading insiders.

For example, one of Romer’s main criticisms of mainstream theory is that it ignores or downplays the role of money. Models typically say (or assume) that the money supply plays only an incremental role in the economy. But as Romer points out, citing some Volcker-era data: “If the Fed can cause a 500 basis point change in interest rates, it is absurd to wonder if monetary policy is important.”

It is certainly refreshing to read this, since the discussion of money as anything other than a passive medium of exchange seems to be almost taboo in proper economics circles (see my review of Rodrik’s book). But again, there is no acknowledgement that these issues have long been debated outside of the mainstream.

The reason this is important is not just to give credit where credit is due (we’re well past that point); it is because this deafness to other voices is at the root of the “trouble with economics.”

Of course, depression is a state of mind that involves turning inwards. But for an area as insular as mainstream economics, the final stage of the grief process – acceptance – will only come when it finally opens up to new ideas – or even the old ideas that have been there all along.

From: p.p.10-11 of World Economics Association Newsletter 6(5), October 2016

Download WEA newsletter Volume 6, Issue No. 5, October 2016 ›

  1. antireifier
    November 9, 2016 at 3:20 am

    Funny that there are often criticisms here about economic models but the model of grief is just that. A model. There are other grief models.

    • November 10, 2016 at 9:44 am

      Yes, indeed. Models of development have evolved over the last 100 years. No social scientist from the 40s would recognize these models today. Similar with psychological models, such as Piaget’s childhood development stages. And the model of general evolution of species has evolved and become more specific over the last 50 years. Economic models, on the other hand have become more confused and less specific, and much more difficult to match to observable events than models in any other social science. Why this happened is an important research topic. The impacts of such models on events in the world beyond economics is an even more important topic for research.

  2. David Chester
    November 9, 2016 at 7:48 am

    If the model has to meet the following criteria, then there is only one. It should be as simple as possible without being oversimplified (Einstein). It should cover the whole of our social system. It should be comparatively easy to understand so that it is useful and can be used. It should permit the introduction of numerical values so that problems are identified with numbers and that adjustment or policy decisions can follow and be simulated.

    The only model which achieves these requirements is mine, see SSRN 2600103. The reasoning behind it is in my recent book and in a new paper I have not quite completed.

  3. November 9, 2016 at 10:28 am

    To say that money is unimportant in economies is equivalent to saying blood is unimportant in humans or electricity is unimportant in the operation of a television set. What it physically is may be unimportant and even variable; it is important because of its ability to carry information to where that can release or inhibit power, or direct action.

    • November 10, 2016 at 10:07 am

      Economics is a social science concerned chiefly with description and analysis of the production, distribution, and consumption of goods and services. Money or money surrogates are important for certain economic transactions. In the type of economy that exists today money is the tool, the device used to complete transactions. But there remains in most western-Christian strong feelings opposing the idolatry of money. And money is not essential to the production, distribution, or consumption of goods and services. If necessary these transactions can be completed without money, just more slowly and with greater inconvenience. So, I can’t agree that money is like the blood in the body or the electricity for a TV. The body dies without blood. The TV cannot operate without electricity. There are no effective substitutes. But there are many effective substitutes for money. My Lakota friends remind me constantly, for example that the traditional Lakota gift economy does not require money at all. As to power, if you mean influence over people’s actions such influence can be gained with money, sometimes. But it can be gained other ways as well. For example, religious beliefs, morals about duty and obligations, and appeals to the common good come to mind.

  4. November 10, 2016 at 11:30 am

    I have two basic questions. At least I think they’re basic. First, based on your reading or Romer, you say the macro models rely on identifying assumptions that are not just opaque but also not credible. How did Romer and how ought we to determine the opaqueness, and particularly the credibility of the identifying assumptions of these models? And how did Romer and how ought we to determine they’re “too” opaque and “not” credible? Second, you contend that in economics there may be a norm making “… it is an extremely serious violation of some honor code for anyone to criticize openly a revered authority figure – and that neither facts that are false, nor predictions that are wrong, nor models that make no sense matter enough to worry about?” My question is since science is a community and a community requires a minimal level of cooperation and trust to function, how can this need be reconciled with the repudiation and embarrassment of “revered authority figures,” failed predictions, and factual errors in nonsensical models you say is necessary for a science to be scientific?

  5. Larry Motuz
    November 11, 2016 at 2:18 am

    First, I think that any so-called science that equates exchange-value with use-value, saying in effect that market prices equal use-values, and that also ignores the import of incomes distribution on presumptive ‘aggregate demand’ for particular products or markets as a whole, is simply not credible. Indeed, demand price stability without stability in incomes distribution is simply unheard of/impossible, just as is the idea of a ‘representative’ consumer.

    In short, what the edifice economics has constructed describes is absolutely nothing real. Human beings have welfare, gain welfare, or lose welfare–in terms of actual benefits received or lost–whether or not they have the ability to pay that defines what economists call a consumer able to enjoy a welfare gain or loss in any transaction.

    Second, given that the real world is occupied by human beings –and not algorithms purporting to describe an impossible human behavior, ‘maximizing preferences’ instead of realizing goals attached to specific uses of various goods, then authorities must be challenged as pseudo-scientific, regardless of their skills with math or logic. A community based on not challenging authorities is medieval in its outlook and noumenal gestalt, pre-scientific at best and merely ideological :: based upon beliefs rather than evidence :: at its worst.

    • David Chester
      November 11, 2016 at 3:36 pm

      So Larry, what happens to the extra money coming to the producer or seller that exceeds the corresponding cost? Some people regard it as profit but regardless of its name, who gets it? And what is it used for, since idle money is not earning any interest.

      The answer is that this so called profit is part of the dividend which passes to share-holders in the public limited liability firm that produces the goods. In the case of a private company, it is still regarded as dividend. As a result of growing dividends the share prices will soon rise so that in terms of newly invested money the gain is about the same as for other kinds of investments.

      When it comes to allowing for this change in the model of the whole system, there is no difficulty, the value of the shares simply goes up or down and the more steady interest on shares in aggregate does not vary very much. There is no difficulty in modelling this change, provided one does not use an incomplete model, where the various gains and losses etc., are wrongly assumed to be unaltered.

      I think your difficulty with this kind of situation is a failure to consider only macroeconomics effects, and to cease including the microeconomics ones along with them.

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