The Ambrosini Critique

One more on macro from Kocherlakota. Everything on his list seems right to me. As I’ve pointed out before, he notes that macro folks (at least those that got their PhD since 1990) have studied heterogeneity, frictions, bounded rationality and government intervention and they’ve done so at the core of their research agendas. He points out that the salt/fresh water divide doesn’t exist these days. He admits, though, there’s been little study of financial frictions, but its worth pointing out that few macro models assume complete financial markets.

Two of his observations are very close to what I was saying a while ago. In a post called “the extent of our knowledge“, I talked about how macro models hide what we don’t know in so-called exogenous shocks. If you want to know what a macro model isn’t telling you, you look at the shocks and Cogley and Nason taught me that lots of stuff can be hiding in those shocks. Kocherlakota says,

The sources of disturbances in macroeconomic models are (to my taste) patently unrealistic. Perhaps most famously, most models in macroeconomics rely on some form of large quarterly movements in the technological frontier. Some have collective shocks to the marginal utility of leisure. Other models have large quarterly shocks to the depreciation rate in the capital stock (in order to generate high asset price volatilities). None of these disturbances seem compelling, to put it mildly. Macroeconomists use them only as convenient short-cuts to generate the requisite levels of volatility in endogenous variables.

Second, he points out that macroeconomists are a technical sort of people and they don’t talk much. This is bad for me because, while I like to geek out, I’m more of a talker. Its also bad for the profession because it means we do a bad job at communicating our ideas to lay people and to other economists. Early in the crisis, when everyone went all Keynesian, I was lamenting that the best ideas in modern macro aren’t in the text books.

One of his throw away lines: “some departments have shockingly few young tenured scholars in this important field (including large departments like Harvard and Princeton [and Berkeley]).” And this may explain why Krugman (and Delong) have a hard time appreciating the current state of macroeconomics. They don’t know any modern macroeconomists.

I confess. I don’t get Gordon’s critique of modern macro.

Questions for Prof. Gordon:

• If you think other things should be modeled, like volatile investment, why don’t you add them to the model?
• Why should we scrap a modelling technique because you don’t think the right things were modeled? We don’t throw out hammers because they haven’t built the tallest building.
• Did you know that DSGE models were the battle field for a discussion on how forward/backward inflation expectations are?
• Did you know Cambell and Mankiw’s dumb agents have been incorporated into DSGE models? Also, many of the other “missing” features of DSGE you mention have actually been incorporated into that framework.
• Shouldn’t we reject models because they can’t reproduce important features of the data, NOT because they don’t tell satisfying stories?
• What features of the data do ALL models written in the DSGE framework fail to replicate?

He notes “much of Keynesian economics and what I call here “1978‐era macroeconomics” was designed to explain the set of impulses and propagation mechanisms that created and amplified the Great Depression”. I don’t get why we should develop a science around explaining one (or two) data points.

If you’re tired of Sumner (how would that even be possible?) and you suspect Krugman is blowing smoke (totally possible), then read this Altig post about the problems with modern macro (which he calls New Keynesian hence Krugman’s smoke).

Altig works for the Fed so he’s tainted, of course, because “real criticism of the central bank has become a career liability”. Real criticism like this and this and this got those guys fired! Oh wait.

(Seriously, read the Sumner piece, too. It compliments the Altig’s piece in a combination that’s a way more serious critique of macro than Krugman’s.)

A worm took over the blog and was messing with the permalinks. I had to update wordpress and delete all the old user names. You shouldn’t need a user name to comment on the blog, though.

Because I stopped reading it at about the third paragraph where he starts listing all the things that macroeconomists do but claims they don’t do (e.g. financial channels, model robustness, unemployment), can someone explain to me the argument Krugman makes?

From Sumner’s critique it sounds like Krugman wants to go back to old school Keynesian modeling. Cool. If we can test those models and they have more to say than our current models, I’m down. Anyway, I gather from Sumner’s post that Krugman says we should make this move because modern macroeconomics has nothing to say about about depressions and deflations and the zero lower bound.

How does he get from the failure of models to understand once in three generation events to the failure of models in between those events? I mean couldn’t we have two theories? One for the 95% of the time where the lower bound doesn’t hold and another for when it does?

I’m probably wrong because I can’t make heads or tails out of the General Theory, but confusing this point — thinking Keynes’ policy prescriptions for getting out of the Depression applied outside moments of depression — led to the failure of post-war macroeconomics. It lead to terrible monetary policy and the mistaken idea that Feds could fine-tune the economy.

A story:

Fred is driving a car down a deserted highway in the middle of the night. His friend Sam is in the passenger seat. Fred reaches down to pick up something he dropped, taking his eyes off the road¹. When he lifts his gaze back to the road, a deer has appeared.

What should Fred do? What should Sam do?

Clearly Fred should make a measured jerk of the wheel and swerve out of the way of the deer and Sam should do nothing. If Fred doesn’t swerve out of the way, he is responsible for the resulting crash. If Sam yanks on the wheel causing the car to go out of control and slam into a guard rail, he’s responsible for making the crash much worse.

The deer in the road is ultimately the cause for the crash, but as a force of nature he can’t be blamed for it. It is the actions or inactions of the people in the car that determine culpability. Because their actions determine whether or not the crash occurs and its severity, their culpability may not limited to not preventing the crash but for making it worse.

Friedman and Swartz found that Fred was at fault for the crash because he didn’t swerve when he should have. Ohanian has conjectured and has found some support in the data for the idea that Sam is at fault for making the crash worse because he jerked on the wheel.

But in the historical example, didn’t Sam jerk the wheel again after the car hit the guard rail? Yes, but jerks on wheels can, by luck, right out-of-control cars. Luckily for Sam, Eggertsson has found this was the case in the historical example. In that case, a jerk on wheel in the right direction happened to be productive.

Notice this doesn’t mean wildly jerking the wheel and sending cars out of control is a good idea. Also, the lucky productivity of the second jerk on the wheel doesn’t mean the first wasn’t bad.

1. or maybe he doesn’t know he’s driving [↩]