Solow kicking Lucas and Sargent in the pants
from Lars Syll
In opening the conference, Frank Morris mentioned his disappointment or disillusionment – which many others share – that the analytical success of the 1960s didn’t survive that decade. I think we all knew, even back in the 1960s, that as Geof put it, “inflation doesn’t wait for full employment.” These days inflation doesn’t even seem to care if full employment is going along on the trip … The question is: what are the possible responses that economists and economics can make to those events?
One possible response is that of Professors Lucas and Sargent. They describe what happened in the 1970s in a very strong way with a polemical vocabulary reminiscent of Spiro Agnew. Let me quote some phrases that I culled from thepaper: “wildly incorrect,” “fundamentally flawed,” “wreckage,” “failure,” “fatal,” “of no value,” “dire implications,” “failure on a grand scale,” “spectacular recent failure,” “no hope” … I think that Professors Lucas and Sargent really seem to be serious in what they say, and in turn they have a proposal for constructive research that I find hard to talk about sympathetically. They call it equilibrium business cycle theory, and they say very firmly that it is based on two terribly important postulates — optimizing behavior and perpetual market clearing. When you read closely, they seem to regard the postulate of optimizing behavior as self-evident and the postulate of market-clearing behavior as essentially meaningless. I think they are too optimistic, since the one that they think is self-evident I regard as meaningless and the one that they think is meaningless, I regard as false. The assumption that everyone optimizes implies only weak and uninteresting consistency conditions on their behavior. Anything useful has to come from knowing what they optimize, and what constraints they perceive. Lucas and Sargent’s casual assumptions have no special claim to attention …
It is plain as the nose on my face that the labor market and many markets for produced goods do not clear in any meaningful sense. Professors Lucas and Sargent say after all there is no evidence that labor markets do not clear, just the unemployment survey. That seems to me to be evidence. Suppose an unemployed worker says to you “Yes, I would be glad to take a job like the one I have already proved I can do because I had it six months ago or three or four months ago. And I will be glad to work at exactly the same wage that is being paid to those exactly like myself who used to be working at that job and happen to be lucky enough still to be working at it.” Then I’m inclined to label that a case of excess supply of labor and I’m not inclined to make up an elaborate story of search or misinformation or anything of the sort. By the way I find the misinformation story another gross implausibility. I would like to see direct evidence that the unemployed are more misinformed than the employed, as I presume would have to be the case if everybody is on his or her supply curve of employment.
The purported strength of New Classical macroeconomics is that it has firm anchorage in preference-based microeconomics, and especially the decisions taken by inter-temporal utility maximizing “forward-loooking” individuals.
To some of us, however, this has come at too high a price. The almost quasi-religious insistence that macroeconomics has to have microfoundations – without ever presenting neither ontological nor epistemological justifications for this claim – has put a blind eye to the weakness of the whole enterprise of trying to depict a complex economy based on an all-embracing representative actor equipped with superhuman knowledge, forecasting abilities and forward-looking rational expectations. It is as if – after having swallowed the sour grapes of the Sonnenschein-Mantel-Debreu-theorem – these economists want to resurrect the omniscient walrasian auctioneer in the form of all-knowing representative actors equipped with rational expectations and assumed to somehow know the true structure of our model of the world.
Methodologically Lucas and Sargent builds their whole approach on the utopian idea that there are some ‘deep structural constants’ that never change in the economy. To most other economists it is self-evident that economic structures change over time. That was one of the main points in Keynes’ critique of Tinbergen’s econometrics. Economic parameters do not remain constant over long periods. If there is anything we know, it is that structural changes take place (something that ought to be pretty obvious if one took the ‘Lucas critique’ seriously …)
The Lucas-Sargent Holy Grail of a ‘true economic structure’ being constant even in the long run, is from a realist perspective simply ludicrous. That anyone outside of Chicago should take the Lucas-Sargent kind of stuff seriously is totally incomprehensible. As Solow has it:
Suppose someone sits down where you are sitting right now and announces to me that he is Napoleon Bonaparte. The last thing I want to do with him is to get involved in a technical discussion of cavalry tactics at the battle of Austerlitz. If I do that, I’m getting tacitly drawn into the game that he is Napoleon. Now, Bob Lucas and Tom Sargent like nothing better than to get drawn into technical discussions, because then you have tacitly gone along with their fundamental assumptions; your attention is attracted away from the basic weakness of the whole story. Since I find that fundamental framework ludicrous, I respond by treating it as ludicrous – that is, by laughing at it – so as not to fall into the trap of taking it seriously and passing on to matters of technique.