Macrovelution

How I would have loved to have been at this conference on the future of macroeconomics.

The essential gist:

Joseph Stiglitz reiterated the sharp divergence between representative agent models and reality...James Galbraith went the even more aggressive route by suggesting that REH (rational expectations hypothesis), EMH (efficient markets hypothesis), RAM (representative agent models), and DSGE (dynamic stochastic general equilibrium models) be buried beneath a bed of garlic below Keynes' quarters with guards standing atop the burial site. (This was not a direct quote but very close.)...

So what's the next step? What will it take to move macroeconomic theory and policy in a truly innovative and novel direction? I don't know; but I do see two issues that will likely drag the process.

Problem #1: the financial crisis has rendered much empirical and theoretical research obsolete; clearly, this is a solid chunk of what I refer to as the “aggregate Curriculum Vitae”. There's a host of refereed and published literature with now documented spurious results, or entire literature reviews citing papers with theses that tread water at best.

It's going to take time to break through the concrete wall of neo-classical macroeconomic denial (among other types of denials). This is the “old boys club”, where careers and prestige are on the line. It's the true sense of economics as a falsifiable science: some disproved and obsolete macro theory remains ingrained in the profession as some academics, some policymakers, and some politicians cling to their reputations. This “enables” bad economic policy.

Exactly right.

For those who haven't already heard me repeat it a thousand times, the "neoclassical" villains include Nobel Prize winners Ed Prescott and Bob Lucas, as well as prominent economists Gene Fama, Robert Barro, and John Cochrane (as well as hosts of less well-known people). These are the people who still insist that the most extreme ridiculous forms of current macro theory (known ironically as "RBC", or "real business cycle" models) are beautiful and correct. They generally say this either because A) their careers, which are based on those models, have already essentially finished, or B) Republican types continue to pay them to promote these silly models.

But in addition to these willful reality-deniers are a host of more reasonable economists who have spent the last 25 years developing ever-so-slightly more realistic alternatives to the retarded RBC crap, but still sticking within the DSGE/REH/RAM framework*. These good people had the misfortune to arrive on the scene at a time when the neoclassical/RBC shmucks had succeeded in convincing everyone that only their chosen mathematical approach was legit; they toiled and slaved to bend that approach to make a slightly better alternative to RBC, and then along comes reality and proves that the entire approach was hooey. If economists as a whole admit the truth, it's going to smash a lot of careers that don't deserve to be smashed. Which is why, even as we search frantically for more realistic models and methods, a lot of good people are going to continue to work in the not-very-useful DSGE/REH/RAM framework. Doh. Institutional momentum is a bitch...


* DSGE = Dynamic Stochastic General Equilibrium. These are models where the macroeconomy is the sum of the decisions and actions of a bunch of individual agents. These are unwieldy - imagine trying to biology by modeling the physics of all the particles in a human body...
REH = Rational Expectations Hypothesis. This basically says that people all know and understand how the economy works. This is just flat-out wrong.
RAM = Representative Agent Models. These models treat the entire economy as if it were one giant person. This is just utterly retarded, and doesn't work at all, but it's the easiest way to make a DSGE model so people use it.