The arguments about “macroeconomic methodology”

There has been a series of posts by people discussing a new book, “Big Ideas in Macroeconomics“.  Ryan Decker points out a good post by Steven Williamson that has links to other posts.  I haven’t read the book, in fact I haven’t ordered it yet (but intend to) – but I don’t really intend to talk about the book, so I think I’ll be ok.  Instead, I am going to discuss the posts – as I’ve been reading them as they have come out.

The first post was over at Uneasy Money, a blog I really enjoy if you don’t already read it :)

Here the book was discussed, and although David Glasner was uncomfortable with elements of it he found it interesting.  This is cool.  From his description of the book I immediately decided I wanted to buy it, there were two reasons for this:

  1. David notes that the book was strongly tied to GE/representative agent theory, which is a standard starting point macro.  I wanted to see how this was delivered “in words”.
  2. David notes that co-ordination failure concepts were generally put to the side.  I would like to see why, given I find the argument for activist monetary policy as a type of co-ordination failure argument.

So this was all gravy, at this point there is nothing about trying to undermine some mythical macroeconomic methodology.  Then John Quiggin came along.  I had a lot of issues with his post.

As a starting point, I get frustrated when people say “macroeconomics began with Keynes”.  Keynes was extending on contemporary concepts (in a way he wanted to sell as a type of revolution – go marketing), and even a number of ideas that are seen as archetypically Keynesian were already being discussed at the time (this type of historical context is part of the reason why I like David Glasner’s blog so much).  Keynes tied together ideas about inflation and interest rates (coming from thinkers as diverse as Hume and Fisher) with the debate between Ricardo and Malthus regarding unemployment.  In the General Theory I got the impression that a) Keynes liked to badmouth contempories and b) he saw himself as extending Malthus’s argument.

Activist monetary policy as a concept existed before Keynes, and outside of economics.  Activist fiscal policy was more novel, but was already taking place in countries like Sweden before Keynes released the General Theory.  Now don’t get me wrong, Keynes was amazing and contributed a lot to the discipline – but treating him like some touchstone messiah that splits good economics from bad is a mixture of historic revisionism and dis-ingenuity.

Sidenote:  When I was 14 my brother gave me my second book on economics (the first being a brief loan of Das Kapital by my English teacher) it was “Keynes for beginners”.  I did my speech that year for school on Keynesian economics, and won, so yah.  The books conclusion was that we’ve forgotten Keynesian economics and it is “due for a comeback” in 1992.  Nowadays I’m glad I don’t have a copy of my old speech, and I realise that people simply use these “names” to create easy good and evil narratives to argue about.

It is in this environment that John writes about the book, and honestly as a criticism of “macroeconomics” he is well off point – many of the ideas he attacks as irrelevant are important for understanding the “macroeconomy” and should be part of a mainstream research program.

He has a comment below his post which I am a lot closer to agreeing with:

 I am interested in general equilibrium theory and think that, viewed with an appropriate scepticism, it yields some useful insights. I’ve even had a go at it myself

But the idea of using Walrasian GE to understand either the Great or Lesser Depression seems to me to be self-evidently silly.

Indeed, if we want to understand what happens with a particularly large shock, we may need to use a different set of tools.  In this context if he had said “I think this book has too little on analyzing what happens in the face of large economic shocks (the type where assumptions about log-linearization become too strong)” that would be fine – instead he attacks all of macroeconomics.

We are starting to get to something here.  Do we actually have different definitions of macroeconomics floating around?

Noah Smith then goes on to discuss how it appears the book is more about macroeconomic method, than economic history/hypotheses.  I wouldn’t really find that terribly surprising in a book that is about explaining the method macroeconomists do – however, I do see his point that macroeconomists in turn need to explain “why” they do it.  Again, we need to define what we mean by “macroeconomists” here, and things are left just vague enough for me to have little to say.

Stephen Williamson then comes out and is not happy with the negative comments, specifically from Quiggin and Smith.  He notes that even if we focus on just the crisis, the methods discussed in the book allow us to actually have testable hypotheses about the crisis, and to figure out what went wrong and how we can improve policy and institutions.  Quiggin’s comments degrading the use of tools such as “mechanism design” come off as incredibly inappropriate under Williamson’s definition of macroeconomics – as mechanism design is a central tool for understanding how we can improve policies and make institutions function better (or be more robust where appropriate).

Most importantly, macroeconomics is not a “finished field” with a set of “known answers for all states of the world” – we are researching and trying to create knowledge.

I agree with Williamson’s view.  A lot of the “criticism” of macroeconomics seems to stem from loose definitions and an annoyance that they couldn’t persuade policy makers during the GFC.  Your inability to persuade someone is not a reason to degrade a scientific research programme – instead you should look more carefully at why you can’t seem to persuade people.

What is macroeconomics?

There is a kicker here as well – no-one seems willing to define macroeconomics in of itself.  It is the study of “aggregates” rather than individual markets, sure.  But we know there is a relation between aggregates and individual choices – and so we need to think through this issue in more detail before we could really define a scope for the discipline!

It turns out that different views about this relation, and about the scope of macroeconomics that comes out of it, lead to different views on what is “good macroeconomics”.

Macroeconomics, science, methodology – what the hell do those things have in common?

I’m glad you asked.  In macroeconomics, just like in other economic, social, and physical disciplines, we use the scientific method.  That’s nice.  But in terms of the relation between methods, and thereby what is “scientific” in macroeconomics there are two broad areas to think about:

  1. Reductionism:  Can we reduce macroeconomic phenomenon (aggregates, their trends and movements) into microeconomic arguments given perfect data.
  2. How close can we get to “perfect data”.

In Kevin Hoover’s “Is Macroeconomics for real” he discusses the fact that reductionism of aggregates may not be possible (in fact there is a lot of literature to suggest that already as I note in this document), and the “synthetic” aggregates we do measure do not bear a relation to our perfect data. [I would note here that measurement issues, and the lack of unique identification of causal mechanisms, are issues that exist within microeconomics - and in fact in pretty much everything]

However, this is not a call to just compare aggregates to each other and leave it at that without causal relationships!  Macroeconomic events are still the result of microeconomic choices, we just may not be able to identify them uniquely – but macroeconomic variables still supervene upon microeconomic ones.  We still need to understand the structure of causal relationships in order to understand POLICY – and this is why the Lucas Critique still holds firm.

Now as I also note in this document at the start, representative agent models do not fully satisfy the Lucas Critique – in fact we can’t make anything that does “fully satisfy it” due to data limitations (although the types of assumptions we make play a role, and should be discussed).  In that context, understanding that our knowledge of effects are conditional and partial is important.  Attacking “macroeconomists” because they are taking this into account and not just making sweeping generalisations and following universal laws isn’t a good idea.

Conclusion

The Lucas Critique remains important as a call to understand policy by actually understanding cause-and-effect in some manner.  As Mas-Colell (1989) states with regards to GE and capital markets, the fact we can’t a prori come up with tendencies that will always hold is a call for modesty and the use of empirical evidence.  That is exactly what the modern macroeconomists are trying to do – create conditional slices of knowledge.

If economists are answering the “wrong” questions, and statisticians are measuring the “wrong” things, then we should chat about that – and we should ask why incentives are aligned the way they are.  In fact, I am convinced that this is exactly what thinkers like Krugman and Smith are considering when they discuss these issues – and it is in this way that this comment on Smith’s post (which he tweeted approvingly) is interesting.  Update:  Kling seems to think it is the wrong methods as well as wrong questions – I am still not convinced.

However, acting like we have universal laws (which is how Quiggin’s expression of Keynes in his post comes across), and that people that disagree are idiots (which is a common theme from a number of bloggers), may get people attention in public.  But it is bad form for economists.

Disclaimer:  I actually think all the above authors will agree with the sentiments I have here about methodology in a large part – but they view the discipline as more partisan than I do, and perhaps also believe that their evidence is “self evidently” more persuasive than I may.  I also think that they all discuss interesting ideas, and I am in no way dismissive of their actual work – I am just disappointed at the rhetoric they are using to discuss the discipline, a negative rhetoric I think is undeserved.

Update:  Interesting comments from Chris House.

  • JohnQuiggin

    If you’re going to nitpick a quote, you should really read it in context first. The point about macro beginning with Keynes was in the same spirit as “econ began with Adam Smith” – I attached a footnote that “That is not to say that no one before Keynes paid attention to the economic issues
    with which macroeconomics is concerned: the business cycle, inflation, and unemployment.
    On the contrary, serious empirical research into the business cycle began in the early twentieth
    century, most notably by the National Bureau of Economic Research, established in
    the United States. Important theoretical contributions came from economists such as Irving
    Fisher. And, as discussed below, the great economists of the Austrian School, F. A. Hayek
    and Ludwig Mises, produced an analysis of the business cycle that remains relevant today.
    But neither Fisher nor the Austrians took the final steps needed to create a theory of
    macroeconomics.”

    On your more seriosu response, I’d pick out this point “indeed, if we want to understand what happens with a particularly large
    shock, we may need to use a different set of tools. In this context if
    he had said “I think this book has too little on analyzing what happens
    in the face of large economic shocks (the type where assumptions about
    log-linearization become too strong)”

    Well, yes. Macro matters precisely when there are large shocks, and since this is one of those times, I’m unimpressed that people are still pursuing a research agenda designed in and for the Great Moderation.

    If I read a book that claimed to be a guide to medicine and it consisted entirely of theoretical
    models of healthy people, i’d have the same reaction as I have here.

    • http://tvhe.co.nz/ Matt Nolan

      Your quote on Keynes was at the start of your post, I took this as the context for what was appropriate. You clearly defined it as a “pre-Keynes bad” vs “Keynes good” argument from early in the post just so you could fit a narrative that played into that when discussing the book.

      However, I think the core of our disagreement is in the second part – as you say.

      This comes back to definition for me. You are defining macro solely as the policy prescription we’d give in the fact of a large shock, given we can observe a large shock.

      I would say that macro is viewed as much larger than that by a lot of the discipline, and as a result “big ideas in macro” should discuss the understanding and expression of policy during “normal” times.

      Now, if the critique is specifically about appropriate macro tools in the face of a shock then we need to ask:

      1) Can we observe the shock in real time

      2) Do we understand the treatment for the shock, if we can observe it

      Which one we’ve “failed” at is an important question – one is a failing of data and identification, another is a failing of theory.

      The medical analogy is an apt one. However, we can’t just pick out the idea of “treating someone when they are measurably sick” and comparing that to economics. We have the issues of identifying illness. The issues of appropriate treatment. The issues of subjective wellbeing which is unobservable to the doctor.

      There are significant moral and ethic arguments in medicine even now – and in the past (both they could do significant randomised trails) it was argued that doctors very often did more harm than good. As a result, doctors focused on the idea of “first do no harm” – a very conservative principle.

      Economics is an even more complicated science in many ways than medicine. And we don’t have the advantage of randomised trials. So by that very example, we should be very conservative about policy.

      “If I read a book that claimed to be a guide to medicine and it consisted entirely of theoretical models of healthy people, i’d have the same reaction as I have here.”

      Now if I take your exact analogy, rather than just medicine, then I view your analogy as out of place. I would expect a book on medicine to discuss a large number of COMMON illnesses, and also explain medical issues we understand. You seem to be presuming that such a book would only focus on rare illnesses we hardly understand, which would seem fairly beside the point no?

      The rare and very costly condition is something it is worthwhile to invest to understand, and that is why it may be a “question we need to focus on”. But that is an entirely different issue.