Was Newtonian Physics refuted?

John Quiggin is loving the attention he’s getting for his series of posts labeled “refuted economic dogmas”. These refutations have left me unconvinced. Often, when I know a little about the “dogma” being refuted, I find myself suspecting Prof. Quiggin doesn’t really appreciate the nuances. For example, in his refutation of central bank independence, he conflated independence with inflation targeting and independence with the lack of cooperation between governments and central banks.

Another example: Quiggin argues New Keynesian Macroeconomics has been refuted by recent events. He defines New Keynesian Macroeconomics as the analysis of small deviations from Adam Smith’s ideal economy. This is not New Keynesian Macro. NK macro models a number of serious deviations from the ideal: imperfect goods markets, imperfect labor markets, sticky prices and sticky wages are standard features of these models. Its interesting that these serious deviations from Smithian ideal result, by construction, in a place being found for policy to improve macro outcomes but despite these deviations, the effect of policy is minor.

The problem of these models is that they can only analyze small deviations from these Keynesian economies. Shocks to the system are assumed to be small and “small” isn’t defined. It could be, in theory at least, the kinds of shocks experienced in the actual economy are bigger than the small shocks analyzed in the model. This would mean the results from the model don’t tell us much about the real economy.

In particular, it could be the shocks experienced to the economy in the current recession are too big to correspond to the implications of NK models. I agree, then, that this feature of these models is troubling. However, we can’t know if the shocks are too big. To use these models, we assume they’re not.

The standard rebuttal to this argument against using NK models, then, is that without an alternative framework of analysis — one that does at least as good a job of replicating key facts about the economy — we can’t do better than NK models. Yes, they’re not a perfect fit to reality, but they’re the best we’ve got. And until we have an alternative, this rebuttal seems persuasive to me.

BTW, Delong says that because NK models don’t tell us everything, they tell us nothing. This argument is just silly. Really very silly.

8 thoughts on “Was Newtonian Physics refuted?”

  1. Quiggin said NK “has not been refuted so much as rendered obsolete by events”. Maybe not obsolete, but I don’t think sticky wages or prices was the problem this time – they’re less sticky than they’ve ever been, historically. The unions are gone, prices can be changed with a few keystrokes – Reis had a podcast pushing sticky information, I kinda don’t see that either.

    NK models may be the best we’ve got, at least by the current standards of macro (i.e. they match selected moments and impulse responses better) but that’s not good in an absolute sense. Use them since we have nothing else, but the on the questions I want to answer (e.g. was the housing/credit boom unsustainable? Do we need to prop up the banks? Are we going to have inflation or deflation?) the models, NK or otherwise, are silent.

  2. I think those questions aren’t very well formed. What do you mean by unsustainable? What does prop up mean? These questions can be reformulated into something NK models can tackle. I suspect the second question will be a hot topic in coming years… there’s at least two grad students at Davis who are looking into credit channel effects of policy. Asset bubbles will get more attention too. And the point is that these things can be studied in the NK framework.

    Also, sticky information is a great topic because its one of those areas that micro data can be brought to bare on macro topics. Last week I saw Yuriy Gorodnichenko talk about this neat paper: http://www.econ.berkeley.edu/~ygorodni/CoibionGorodnichenko.pdf

  3. “Often, when I know a little about the “dogma” being refuted, I find myself suspecting Prof. Quiggin doesn’t really appreciate the nuances. For example, in his refutation of central bank independence, he conflated independence with inflation targeting and independence with the lack of cooperation between governments and central banks.”

    This seems to suggest that I conflated independence and inflation targeting because I was unaware that they were different things. In fact, I wrote “The shift to independent central banking was closely associated with the adoption (implicit or explicit) of inflation targets as the primary focus of monetary policy, and with interest rates as the primary tool.” It seems as if you missed the nuances here.

    I agree that my post treated co-operation between governments and central banks as being inconsistent with central bank independence. If you disagree, maybe you could spell out how co-operative but independent monetary policy is supposed to work.

    BTW, the descriptions you impute to me are taken straight from Akerlof and Shiller, who specifically state that looking only at sticky wages and prices is not adequate. All I did was point to NK as an example of the kinds of approach they state that they pursued in the past and are now discarding in favor of “animal spirits”.

  4. Its possible Akerlof and Shiller weren’t defining New Keynesianism, but were talking about RBC or something (aside: neither of these is taught in the textbooks, at least at the undergrad level, so I’m really not sure what they were talking about). I don’t have their book in front of me so I’m not able to look up the section you quote from.

    Regarding independence: recent coordinated activities make it harder, but they don’t make the doctrine unattainable. Cooperative but independent monetary policy is able to tell the fiscal authority no when needed. The real test of the Fed’s independence will be if it can increase interest rates when growth picks up to prevent inflation. The Congress and the President will be railing against this policy (as they want to be reelected), so they’re be a lot of political pressure not to do the right thing.

  5. I will admit that I am not convinced by the NK model, but neither are some New Keynesians. For example, Mankiw and Reis are now emphasizing the role of “sticky information.”

    Of course, there are also the credit channel folks like Gertler and Gilchrist, who should really have a lot to say about the current situation. (I would suggest that those who are not familiar with this approach, but are interested to read their article with Bernanke on the financial accelerator and the flight to quality.)

    Also, Farmer’s model that incorporates search is intriguing.

    I could go on for quite some time, but what I find discouraging (and this is not a criticism of Quiggin, but rather the debate more generally) is that there are a lot of criticisms of individual theories that seem to parade as refutations of macro generally. However, in reality, there is a great deal of diversity in macroeconomic thought. Perhaps we are not doing enough to communicate this point…

  6. I’ll take a look at the farmer model.

    It seems like we need to disseminate two ideas. First, theories aren’t refuted, they’re just superseded by new theories that explain more. Second, macroeconomics is a toolkit not a sequence of “dogmas” or whatever. With modern techniques, one can produce models with a variety of normative implications. The way to pick good models is to see which is in best correspondence with the data.

    These are very basic ideas, but I get the sense that macro didn’t always work like this. “Old” macro didn’t have a unified toolkit so there wasn’t a way to compare models. I don’t know much about this intellectual history; I’m kinda reverse engineering from comments made by older economists that were trained several decades ago and not familiar with new macro (e.g. Kling). Anyway, I wonder what innovations in macro led to a unified toolkit. Micro foundations?

  7. A minor correction. I’ve used the term “doctrine” which has connotations rather different from those of “dogma”.

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