Modern macro models are falsifiable

To be honest, I’m having a hard time parsing this post by Arnold Kling. He talks about issues with “structural models” in macroeconomics, but I’m not sure to what he’s referring. Of course models reflect how somebody thinks the economy works. The key is whether or not you can falsify that model. Kling goes on to make is statistical power critique (I think), but I think this misses the point.

Models in modern macro are falsifiable. I know this because I’ve seen some falsified in the literature (this is the whole game!), I’ve been in seminars where a new model is dismissed by some in the audience because it “explains too much” and macroeconomists have developed clear criteria for evaluating models.

A model needs to reproduce time-series data that have statistical properties similar to data generated by the real economy. This often means standard deviations of income, consumption, investment, etc generated by the models match standard deviations in real data. Macro folks also look at how the model reproduces correlations between these data.

An example from recent literature might help. So there’s these new Keynesian models with sticky prices and imperfect competition that predict inflation will spike as soon as a technology shock happens and then peters out over time. The problem with this prediction is that inflation doesn’t react this way to technology shocks in the real economy. A number of empirical studies with a number of different so-called identification assumptions (maybe this is what Kling has problems with?) have found that inflation doesn’t spike right away after a shock. It takes a few quarters for inflation to hit its peak before it then peters out. Macro people affectionately call this “hump shaped” inflation.

This as seen as falsifying the simply new Keynesian model ((Falsifying in the same way the motion of Mercury falsified Newtonian physics. Newtonian physics still does a pretty good job; I’m mindful of walking under trees dropping their fruit. Relativity just explains more facts than Newtonian physics does.)) . And people have been working on alternative models that generate hump shaped inflation. (If you ask me, the issue was successfully resolved in this paper by one of my former teachers.)

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