Thursday, August 20, 2009

Macroeconomics as convoluted fiction

One successful strategy in microeconomics is to search for something that seems stupid, ignorant, misguided, etc. and dream up some implausible, ridiculous story that explains it as actually being sophisticated, subtle optimization. The explanation is linked very loosely to the real world by linking selected assumptions and effects to anecdotes or stylized facts, and if someone says it is all nonsense you can retreat to the “as-if” defence. Since you can “explain” it through your convoluted Alice-in-Wonderland model, you can then claim that the phenomena in question is “no longer a challenge to standard rational choice theory.”

Personally, I became aware of this through my PhD work on rational addiction theory. A 1988 note from University of California, Berkeley Professor Jeffrey A. Frankel that was recently linked to in Krugman’s blog points to the same thing in macroeconomics.

Stockman comments on how everything can be made consistent with dynamic stochastic general equilibrium models based on indiviudal optimization (the “equilibrium view”). When economists thought purchasing power parity held, this was interpreted as evidence in favor of the equilibrium view. When they thought it didn’t… well, this was evidence in favor of the equilibrium view. So when a dataset doesn’t allow you to reject the null hypothesis that real exchange rate follows a random walk, this:

[…] is […] interpreted as evidence in favor of the equilibrium theory, even though the latter has no more testable implications for the real exchange rate than does the proposition that 9 is a prime number.

He notes evidence that would seem to favor sticky-price theory, and shows how “equilibrium” theorists work out convoluted, bizarre models to “explain” this within their framework.

Such explanations are clever, and make for good
journal articles that are popular among academic economists. But that doesn't make them true.

Speaking of "agents," spy novels are a good analogy for stories that are clever and make entertaining reading, but have little to do with the truth. Datum: a few minutes ago, I got up from my chair next to Alan Stockman on the stage, and walked over to take my place here at the podium. Hypothesis 1: I am a spy for a foreign power, Alan is a CIA counterspy who was about to assassinate me, and so I got up to move out of range. This hypothesis is "consistent with the facts" in the sense that, if true, it would explain them; but it is convoluted and not very plausible. Hypothesis 2: John Le Carre was in British intelligence before he
began his second career as a novelist. This hypothesis is  interesting to speculate about. I have no idea whether it is true or not. It is also "consistent with the facts" in the weak sense that it does not contradict the datum. But it seems no more relevant than the statement that 9 is a prime number, the proposition that agents dynamically optimize, or the hundreds of other hypotheses that I "fail to reject" every morning in the shower. Hypothesis 3: I came up to the podium for the simple reason that AEI invited me here to comment on Alan's paper. While not as clever as the other propositions, this hypothesis is simple, plausible, and
consistent with the facts in the strong sense that it would explain them while most other hypotheses would
not. (I will leave it to you to decide which hypothesis is the correct one.)

He also has some fun comments on the flip to a state where the goal of macroeconomics became to find nothing (no explanation, no relevant causal variables etc.):

The word "nothing" will play a key role in my comments.
["We know nothing, therefore we should do nothing."] The word does not often appear explicitly in the writings of equilibrium theorists. The popular phrase in the econometric writings is "random walk." [The usual conclusion is stated as "I have found that such-and-such a variable follows a random walk." Or, at
best, "I cannot reject the hypothesis that this variable follows a random walk." You seldom hear someone say, "After studying this variable for 6 months, I have absolutely nothing to say that would help to predict its movements." But the statements mean the same thing.] In Stockman's paper, the phrase is "in the current
state of knowledge:" "In the current state of rates and the current account should play little role...[in the conduct of monetary policy]"

No comments:

Post a Comment