For those who don't know the history involved, let me give a condensed version.
1. Before Robert Lucas, macroeconomists used mostly "aggregate" models - stick labor and capital and money etc. into some equations, and out pop GDP and inflation, or something like that.
2. Then Robert Lucas came along and said "These equations might look like they fit the data, but as soon as you try to actually use the equations to make policy, people will see what you're doing and change how they behave. And then your equations will stop working completely." Some people resisted this idea, but eventually it won, and people stopped using the old style of models. (Lucas got a Nobel for this, and for insisting that people use "rational expectations" models...see #3.)
3. People asked Lucas, "OK, so what do we do instead?" Lucas said "Your models have to be based on things that won't be changed by policy. What people want to consume, for example, or the technology that we use to produce things. Those things can't be changed by the government, right?" And everyone said "Uhhh, no, guess not." So Lucas said "OK, base all your models on those things, and you'll be OK. Also, you should assume that people have 'rational expectations'." To which the world replied "Uhhh, OK." Of course, this sort of modeling required the use of microfoundations.
4. The first to take up this challenge was Lucas' friend Ed Prescott. He made a model where the business cycle was caused by changes in technology - if we invent more stuff than usual we get a boom, if we invent less than usual we get a recession. Also, he allowed for business cycles to be caused by changes in people's desire to work - if people suddenly got lazy, we could have a recession. Lucas gave this model his unofficial stamp of approval. (Prescott's model, called the "RBC" model, won him a Nobel.)
5. However, some people came along and said "Wait a second, Prescott's model doesn't fit the facts. In this model, a recession is basically just a big shortage of everything; in a shortage, inflation should go up. But in the past, especially the Great Depression, inflation often goes down in a recession. Recessions must be caused by some kind of general glut, not a general shortage. In other words, there must be some kind of 'aggregate demand shock'." To which the RBC people replied: "Oh yeah? Let's see you put that in math!"
6. So the people who wanted to model aggregate demand shocks thought of some plausible ways that a "general glut" could happen. Greg Mankiw, for example, came up with the idea that "menu costs" could keep people from changing prices. Other people focused on contract theory, money illusion, and other "frictions" that could cause general gluts. But these ideas, though probably pretty realistic, were all very very hard to put into the type of model that Prescott had used (called a "DSGE" model).
7. Then came along a guy named Guillermo Calvo, who thought of a fix: Just assume that some magical force (the "Calvo fairy") keeps people from changing their prices, and voila! Aggregate demand shortage! This mechanism, although obviously a fantasy, was very easy to put into DSGE models. So a bunch of people started doing that. Mike Woodford, for example, used the idea to make models of how monetary policy could stabilize the economy, canceling out shocks to aggregate demand while also guarding against inflation. These models came to be known as "New Keynesian" models, since Keynes had also argued that aggregate demand was what caused recessions. They were also called "saltwater" models, because they were made primarily by people on the coasts, especially at Harvard.
8. The RBC people, who were also called "New Classicals" or "freshwater" (since many worked at the University of Minnesota and the University of Chicago), fought back, deriding the New Keynesians, or saying that the new Calvo-based models didn't satisfy the Lucas Critique.
And here we are today. Wow, OK, that took slightly longer than I thought, but anyway, let's go on.
The 2006 paper by Mankiw about "scientists vs. engineers" should be seen in this historical context, as an attempt to make peace between New Classicals and New Keynesians. If you read it, especially after reading the earlier Robert Barro "good guys and bad guys" diss paper, you'll see it's a very political document. It's basically saying "Look, you New Classical guys are like scientists; you're trying to understand how the world works on a deep level. We New Keynesians are more like engineers; our models may not match what's really going on at the micro level, but they fit the big macro facts, so they're useful for policymaking." Very politic...remember, scientists are generally thought to be smarter than engineers. In fact, Mankiw's distinction reminds me very much of Stephen Jay Gould's attempt to get anti-evolution folks off his back by dividing science and religion into "separate magisteria".
By defending New Keynesian models as "engineering", Mankiw was - I think - essentially admitting that the New Keynesian movement had not really satisfied the Lucas Critique. The DSGE structure of the models was a head-fake in the direction of microfoundations, but by including things like Calvo pricing, the New Keynesian models were really more in the spirit of the old, pre-Lucas "aggregate" models. But the "scientists vs. engineers" idea was also a kind of defense of that old "aggregate" approach - it said "For the purposes of short-term policy making, all you really need is a model that fits the macro data; you don't need something that really represents what's going on at a deep level." In other words, it was very, very similar to the stuff that Simon Wren-Lewis writes on his blog all the time.
But I do not like Mankiw's "scientists vs. engineers" distinction, because although I think it gets the "engineers" part right, I don't really think what the New Classical folks do is especially similar to what actual scientists do. (Mankiw is trying to be a nice guy, a uniter instead of a divider. I am a different sort of guy, for whom dissent and argument are a natural part of the truth-finding process. So don't be surprised if I am less politic than he.)
The whole idea and the whole appeal of New Classical models is that they are microfounded on things that don't change with respect to policy - human tastes and preferences, and technology. The New Classical macroeconomists do often try to match the parameters of these microfoundations to micro data (this is called "calibration"). But rarely if ever do they bother to see if the equations themselves are an accurate description of how economic agents behave. As a result, as I argue in these old posts (Post 1, Post 2), the microfoundations in RBC-type models are almost certainly terribly misspecified descriptions of microeconomic behavior and markets.
As my advisor (and Greg Mankiw's advisee) Miles Kimball tweeted today when we discussed this topic: "the 'micro foundations [used by New Classicals are] usually not very serious, they're often more like imaginary engineering than science."
Note that if the microfoundations are misspecified, it doesn't matter whether a model satisfies the Lucas Critique or not. Even if "tastes and technology" really are policy-invariant things, if tastes and technology don't really work the way the model says they work, the model will not give you useful advice about policy.
Now, terrible microfoundations might not lead to a terrible model. But if by some lucky happenstance, crappy microfoundations produce a model that matches the macro facts, then it might as well be one of those "aggregate-only" models that Greg Mankiw labels "engineering". In this case, RBC has no theoretical advantage over a New Keyneisan model.
So basically, I charge that the New Classical/RBC/freshwater macroeconomics paradigm is not really science, and not really like science...not yet, anyway. In science, evidence rules all; if a model doesn't fit the evidence you toss it out. And I don't think the microfoundations we have seen in freshwater models pass muster (yet). Until they do, I think that "engineering" - the aggregate models of VARs, or the Calvo-pricing New Keynesian models, etc. - are all we've got.
Thanks for going into the history.
ReplyDelete"In science, evidence rules all; if a model doesn't fit the evidence you toss it out."
ReplyDeleteOr you toss out the evidence, this seems to be a not uncommon occurrence in the practice of science ;-).
Whether or not something is science, it seems, is more dependent on the attitude of those pursuing a particular enterprise than anything else: evidence of intellectual curiosity is all we have to make that judgement.
Therefore if that was the distinction Mankiw was driving at it seems more that he simply capitulated for the intimidation tactics by the Saltwater school(s) than anything else.
I would not quickly dismiss New Keynesian literature as unscientific or 'mere' engineering. If you try to figure out how the world works, even if you cannot model it perfectly, then you're doing science. Some could say that they're asking the wrong questions, others might say that the answers are wrong, but the entire criticism is premised on the idea that the parties are engaged in the same enterprise. I simply don't buy the distinction.
Therefore if that was the distinction Mankiw was driving at it seems more that he simply capitulated for the intimidation tactics by the Saltwater school(s) than anything else.
ReplyDeleteMankiw IS part of the "saltwater" school. One of its founders, in fact.
I would not quickly dismiss New Keynesian literature as unscientific or 'mere' engineering.
And neither would I!
If you try to figure out how the world works, even if you cannot model it perfectly, then you're doing science.
Well, I prefer to make a distinction between different methods that are used to figure out how the world works...for example, I'd make a distinction between "history" and "science", i.e. that history doesn't require ergodicity. But you know, sure, it's just vocabulary, and not that important.
Did I write saltwater? I meant freshwater, sorry, my bad. Freshwater are the lakes right, with Chicago and Minnesota, the New Classicals, whilst Saltwater are the New Keynesians?
ReplyDeleteAs for the vocabulary: there seems to be a curious obsession about what is considered "science", in English anyway, and what's not. In German for example, history or Geschichtswissenschaften, is a science ("science" translates to German as "Wissenschaft"). History in German therefore does not have as easily the stigma of being "unscientific" as it does in English, simply because its method is a different one than that of the natural and social sciences, or the "hard" and the "soft" sciences as some would like to call them respectively ;).
History in the German language is therefore also still part of the scientific enterprise of finding things out about the world. By categorizing whether or not something is "science" by method, what you're saying is that a change in method would quickly render an enterprise "unscientific", even if the change in method would be an appropriate one.
I am not sure how many "scientists" would like to see their work labeled as "unscientific" or "not science" by simply switching method; and I wouldn't be surprised if this obsession about method and "scienceness" has something to do with the debate in macro.
Freshwater are the lakes right, with Chicago and Minnesota, the New Classicals, whilst Saltwater are the New Keynesians?
DeleteYep!
I am not sure how many "scientists" would like to see their work labeled as "unscientific" or "not science" by simply switching method; and I wouldn't be surprised if this obsession about method and "scienceness" has something to do with the debate in macro.
Maybe so. But how should we label disciplines that just make up stuff about the world and declare it to be true, without checking it against any evidence?
Maybe so. But how should we label disciplines that just make up stuff about the world and declare it to be true, without checking it against any evidence?
DeleteHow about imaginative fiction?
Economics ;).
DeleteIn all seriousness though, historians don't make stuff up about the world, they too actually do try to find out what happened and do look at the historical record or 'evidence'. However due to the limitation of the narrative some facts are often left out that are not deemed important to the story. In this however history is not unique, economists do that, physicists do that etc.
All this 'scientific vs unscientific' does is to exclude certain narratives and certain forms of evidence in favor of other narratives and other forms of evidence. It's an argument from authority. What matters is attitude, you can't test for that, but you know it when you see it. This view - I'd say - is pretty much implicit in "just make up stuff about the world and declare it to be true, without checking it against any evidence".
In all seriousness though, historians don't make stuff up about the world, they too actually do try to find out what happened and do look at the historical record or 'evidence'. However due to the limitation of the narrative some facts are often left out that are not deemed important to the story. In this however history is not unique, economists do that, physicists do that etc.
DeleteBut I don't see this as the key distinction between history and science. History only happens once; science allows for controlled experimentation ("empirics", as done in economics, is somewhere in between). That doesn't mean science is "better" than history, but it does seem to me to be a real difference. This is meant to be a classification scheme, not a hierarchy of prestige.
It's an argument from authority.
No, it's not...I am no authority. I'm just trying my best to observe the methods that different groups of people are using to study, understand, and predict the world, and classify those methods in the most useful way possible. That doesn't make me an authority.
Noah, I did not mean to imply that you were the authority, what I meant was that calling something "scientific" or "unscientific" is an appeal to the authority of "science" in the English language.
DeleteThe argument seems to run somewhat like this and I'll use the German words here: X is the method of the Naturwissenschaften and the Sozialwissenschaften, Y is the method of the Geschichtwissenschaften, and therefore Geschichtswissenschaften are not a Wissenschaft.
Clearly in German this argument is nonsense as they use a different taxonomy: they consider history to be a "science". For to be a science in German, method is not the distinguishing characteristic.
If you accept with me that the taxonomy in English is not really universal and more of the result of a use of language, then I hope you see with me that the classification scheme can also be very much about prestige. When people classify they might not care about status, but when they talk to one another it matters greatly.
Whether something is "scientific" or "unscientific" is not just about method, it's also about status. Or when was the last time you heard someone say: 'I want to figure out this problem so I'll switch to an unscientific method'? This is the rhetoric of microfoundations and Mankiw seems to buy it.
'But how should we label disciplines that just make up stuff about the world and declare it to be true, without checking it against any evidence?'
DeleteA discipline that declares ANYTHING to be true is called a religion.
Science in its first stage is a conjecture. Then someone comes and checks the evidence and two things can happen. Either the conjecture withstands the checks and remain as a conjecture (until the next test), or it does not and we learn how far off the truth it is. Then we build a new conjecture. But there is one thing that can NEVER happen. A conjecture can never be shown to be true unless it is a tautology (like a mathematical theorem). The truth value of a scientific theory can never be 'TRUE', it can only be 'FALSE' or 'MAYBE'. Science is nothing more than a very big conjecture waiting to be proved wrong.
The true difference between engineers and scientists is that engineers are magicians that make wishes come true, whereas scientists explain why the world will not bend to let you have what you want. The equivalent of engineering in macroeconomics is economic policy, a field that build systems to make the wish of being rich come true. Thus if macroeconomists want to be scientists, they have to stop making policy recommendations. And it is true for all of them, freshwater and saltwater alike.
Noah,
ReplyDeleteThis is an absolutely wonderful article. I commend you!
Have you ever read the works of Pragmatism like Peirce, James, etc. I think you'd like them. Best regards.
Noah - you do write beautifully. I wish I had half your grace and clarity in expressing myself.
DeleteVery nice post. I totally agree of course. I have two comments on intellectual history
ReplyDelete1) Lucas did not make any claim of originality. He supported his claim that there was nothing original in "Econometric Policy Evaluation: A Critique" with a long lists of cites of exactly that argument made by old Keynesians. It was prominently featured in Samuelson and Solow (1960) on the Phillips curve. The critique of this paper won two economists Nobel prizes, but it is a critique of the legend to figure 2 taken out of context.
http://www.angrybearblog.com/2012/05/did-samuelson-and-solow-claim-that.html
Macroeconomists knew they had a problem and hoped their models would be useful anyway (then as now).
2) The first model following Lucas's adoption of the old critique was based on the Lucas supply function*. This model failed spectacularly and people decided that it was a silly idea to begin with. Lucas's reputation was not damaged at all. That episode seems to have been sent down the memory hole
The Lucas model survives in New Keynesian models which are Lucas supply plus sticky prices. In the original model prices aren't sticky, but agents don't know the price level and mistake an increases in the price level as an increase in the relative price they are offered (a better explanation is cut and pasted below). So output and inflation are correlated even though output and expected inflation aren't correlated. The problems are that it doesn't fit the data, also estimates of the CPI are published monthly so how can rational people be so dumb, also there can only be a recession if people don't know there is a recession (if they did they would know the price level had fallen so not be tricked into supplying less).
You too are too kind to the freshwater school. Yes they are out of touch with reality, but they did not discover the appealing theoretical arguments they claim as their own. Lucas is a very good lawyer. He has managed to convince people that a demonstrably unoriginal statement was earthshattering and paradign shifting. He has made up a straw old Keynesian and convinced most macro-economists that this figment of his imagination dominated the profession until he came along.
* earlier described by Muth and even earlier discussed in The General Theory of Employment Interest and Money Chapter 20. Keynes explained how there could be fluctuations at what he considered full employment. Muth and Lucas just takes Keynes observation that fluctuations don't show there is room for Keynesian demand stimulus and pretended that their quotation from Keynes was a critique of Keynes.
OK the promised better explanation cut and pasted from "The General Theory ..." chapter 20
(1) For a time at least, rising prices may delude entrepreneurs into increasing employment beyond the level which maximises their individual profits measured in terms of the product. For they are so accustomed to regard rising sale-proceeds in terms of money as a signal for expanding production, that they may continue to do so when this policy has in fact ceased to be to their best advantage; i.e. they may underestimate their marginal user cost in the new price environment.
see http://www.angrybearblog.com/2010/10/what-keynes-wrote-about-phillips-curve.html
Fair enough. I may have given Lucas too much credit. But I don't feel especially guilty for doing so, since I then call the research program initiated by Lucas and Prescott a giant boondoggle... ;)
Deletequote
ReplyDeleteIn science, evidence rules all; if a model doesn't fit the evidence you toss it out.
well, yes and no, but rather simplistic, cause the data isn't always clear or right.
and even when the data are clean, numerous and compelling, it works a lot better if it fits a theory
to put it another way, this is a long , literate post that makes clear a lot of complex work..but it is not a post dominated by data on how people act; it is dominated by theory and theoreticians: we hear only as a slight aside that the models don't fit the world; we don't hear,as prominent, the people who go out and measure how humans react and how the macro models should be changed on that.
I find this over emphasis on theory a little depressing; a scientist would say something like this
empirical studies (ref) have shown that people change their behaviour as predicted by lucas (ref)...
its sublte, but that form of writing puts the data first; in this column, as in virtually all economics blogs, the data is 3rd place
"However, some people came along and said "Wait a second, Prescott's model doesn't fit the facts. In this model, a recession is basically just a big shortage of everything; in a shortage, inflation should go up. But in the past, especially the Great Depression, inflation often goes down in a recession. Recessions must be caused by some kind of general glut, not a general shortage. In other words, there must be some kind of 'aggregate demand shock'."
ReplyDeleteTo which the scientists replied, "Oh, right!"
OK Noah,
ReplyDeleteI'm going to push in another direction here.
My problem with rational expectations, is that there is no agreed model of how the economy works, so the effects of government policy are uncertain. So how can rational expectations fully offset unknown effects. You should call it instead rational uncertainty. And this uncertainty is what drives the fluctuations in the macro economy, not directly, but because the uncertainty LEVEL also fluctuates and that inhibits (or slows) action. Like I said a couple of posts ago - it is time that economists made risk and uncertainty endogenous. The way that Minsky suggested, perhaps.
There is no one engineering application which is not based on the hard sciences or contradicts observations. One can not invent engineering without scientific backgroud. The scientific and engineering community is likely offended when compared with any economic model or tool.
ReplyDeleteAs with the Nobel prize, the economic community just borrows the other people fame.
Engineers do sometimes use mathematically nonsensical shortcuts, though.
DeleteWhen the uncertainty of the applied method does not go beyond the limits of the desired reliability. For an aircraft, a boundary element (or any other mathematical approach) method creates a discrete model with an eccuracy still providing .99999... reliability.
DeleteI would divide economists into optimistic and pessimistic dreamers. The former are "scientists"and the latter - "engineers", but both visionaries.
I'm not going to argue with you because as you can guess from my name, I agree.
Delete"There is no one engineering application which is not based on the hard sciences"
DeleteSimply not true. There was no sound scientific understanding of the nature of water when Roman's developed aqueducts and plumbing. All they had was observations of how water seemed to behave.
Hard scientific knowledge wasn't required for ballistics, gunpowder, hot-air balloons, John Snow's solution to Cholera, the plough, the knife, the spinning jenny, the water-mill, the hand-mill, the compass, ceramics, the weighing scale, the water jug, the.....
you get the idea.
"or contradicts observations."
I'm not sure what this could mean of an engineering application. Do you mean there is no engineering application that does something impossible? Agreed.
Economics as engineering: The Gale-Shapley matching algorithm, the varying auction mechanisms, contract design, using elasticities to set taxes and subsidies(comparable to using Hooke's laws for civil engineering), printing money to create inflation (don't understand exactly how it works but have a good idea), the solution of public goods problems.
These engines are still crude. They are based on empirical observations and theoretical considerations about the world. We have a very crude understanding. We do not fully understand our atom (individuals) and we do not understand dynamics very well, and, well all kinds of things. The fact remains that rough understanding and approximate imprecise science has been used to develop many useful tools and engineering applications in human history.
We are trying to improve it from both an engineering and scientific stand point. The problem is that the science of economics is just much more difficult than simple subjects like Physics. If people have genuine contributions that's great but don't just sit in front of your computer screen bashing it.
Economic modelling is not yet a science, and may never be a true science because of the unpredictability/nonlinearity/weirdness of human behaviour (at least compared, as Newton did, to celestial motion).
ReplyDeleteThe most scientific thing economists do is collect and map data. Prognostication and statements about causation beyond that is guesswork to various degrees. May I call that the economic uncertainty principle... "We can never be certain, but if we support our conclusions with enough data we can have a damn good stab at being right"
So as Keynes said it is better to be roughly right than precisely wrong.
Hey, that is correct and I like the Keynes quote too, but, in fall fairness, isn't collecting data and theorizing about why they are what they are and why they behave as they do what other scientists do, too? I suppose one difference between economics and other sciences is that, although you can have some experiments, you probably can't have experiments on the scale on which you can have in, say, Physics or Chemistry or whatever.
DeleteComputer programmers like to say, "Garbage In. Garbage Out!"
ReplyDeleteMany models have assumptions that simply are not correct or "irrational". For example, the assumption that unemployment has a "natural rate" and that unemployment always returns to its "natural rate" is simply wrong. It overlooks the fact that governments always and everywhere for the past 5,000 years have wrestled with the issue of "excess labor" and have found ways to productively employ the excess labor.
The assumption that markets alone will offer everyone a living wage simply flies in the face of the historical evidence.
I have an expectation that employment is dynamic and cyclical and that BigG will find a use for excess labor during periods of slack private demand for goods and services. BigG has some control over demand and I expect BigG to exercise its control. My expectation is rational.
Model That!
-jonny bakho
ok i understand what you try to explanted ..analysis up to analysis NEW KEYNES doesnt have nothing new than OLD K economy is economy +science +numbers...we can not wolk just about theory ...
ReplyDeletethank you
Reminds me of something Keynes wrote in Essays in Persuasion:
ReplyDelete"f economists could manage to get themselves thought of as humble, competent people on a level with dentists, that would be splendid."
Still working on it, aren't we?
I have a problem with the "Lucas critique."
ReplyDeleteIt is not clear that it is possible to pick policy-independent parameters.
For example, do you think it is in any way possible to model the North Korean economy without considering government policy in virtually everything you do? Therefore, here is an economy that cannot be modeled using the Lucas critique.
Now, how do you pick anything that isn't effected by government policy? Likes and tastes? What happens when the government tells you that eating nothing but meat is bad for you? Does this not change "likes and tastes". To me trying to model economics in a policy-independent fashion is like trying to do physics while denying Heisenberg. It can't be done. So what? You understand that your policy choices will effect behavior (duh!) and model away. Isn't that what differential equations are for?
The thing that makes me ill is that many economists don't seem to think that you have to correlate your theory with data. I'd much rather have a bad theory that explains lots of data than a "good" theory that explains no data. How could you have such a theory? Why you just redefine what "good" means.
You guys need to man up and start correlating crap.
Good luck
Conesnail
It is not clear that it is possible to pick policy-independent parameters.
DeleteAgree.
"do you think it is in any way possible to model the North Korean economy without considering government policy in virtually everything you do?"
DeleteI think that misunderstands the Lucas critique. Lucas says that you should have a model based on fundamental human nature where government policy is an exogenous variable. Insert a description of your economy, including government policy, and a useful prediction pops out. The model should not only work for modern America and modern North Korea, it also has to work for ancient Greece, etc. That is what it means to have a model that meets the Lucas critique (IMHO).
Absalon,
DeleteAnon and Noah get that, but they (and I) simply do not think it is possible.
Also see:
Deletehttp://noahpinionblog.blogspot.com/2012/07/the-lucas-critique-and-hard-money.html
"It is not clear that it is possible to pick policy-independent parameters."
DeleteThis is a big sticking point for me. As far as I can tell, everything about technology and preferences is influenced by policy.
The technology argument is easy. Government funds the research that supports innovation, subsidizes advances in certain industries (i.e. solar energy or defense), mandates innovation through regulation (i.e. fuel standards), creates the patent system, etc.
Human preferences are largely determined by community and marketing, and there's no way to disentangle policy from these. Governments do campaigns to change preferences directly (eat more vegetables, conserve water). Corn subsidies make certain food processes more attractive to suppliers and so affect what gets marketed most aggressively. Governments subsidize and give special treatment to everything from football stadiums to churches. Even when you get down to fundamental things like sex and love, there are government policies surrounding sexual orientation, marriage and children. Much as we like to think of ourselves as unique, free thinking agents, our preferences are profoundly influenced by the forces shaping our communities.
"Science.. ..cannot create ends and, even less, instill them in human beings; science, at most, can supply the means by which to attain certain ends. But the ends themselves are conceived by personalities with lofty ethical ideals and—if these ends are not stillborn, but vital and vigorous—are adopted and carried forward by those many human beings who, half unconsciously, determine the slow evolution of society. Source: Albert Einstein, Why Socialism http://monthlyreview.org/2009/05/01/why-socialism
ReplyDeleteShouldn't Rochester be included in your list of places that put the fresh into freshwater? I'm thinking here, e.g., of King, Long, Plosser, etc.
ReplyDeleteI love your little potted histories of economic thought - they are quite helpful to us outsiders. But I can't help but think you can probably do more to express the freshwater point of view. I mean, "proof by contradiction" is a commonly accepted form of mathematical proof:
ReplyDelete1. Assume some joint hypothesis H.
2. Rigorously derive two contradictory implications of H using math.
3. Conclude that, therefore, not H.
In your telling, the freshwater guys seem to have gone off the rails at step 3., something like:
3. Hey, if we assume H, we can also derive this really cool theorem T. Using math! So if you forget that not H part for a second, T!
There has got to be more to the story.
Noah Smith: "Then Robert Lucas came along and said "These equations might look like they fit the data, but as soon as you try to actually use the equations to make policy, people will see what you're doing and change how they behave."
ReplyDeleteExcellent! Lucas identified a negative feedback mechanism. You can see how a scientific research program could flow from that. First, show that such a mechanism exists. Then, determine the degree to which it nullifies policy, the differing conditions which affect its action, and how they work.
Lucas (paraphrased by Smith): "And then your equations will stop working completely. . . .Your models have to be based on things that won't be changed by policy."
WTF! Where is the science in that? Simply make the extreme assumption that the negative feedback will completely negate the effects of policy? Incredible!
Min,
DeleteI think you misunderstood. The estimates of the equations will be useless, policy may or may not be completely nagated. When it is, the negation is not imposed, it arises endogenously. Here is an example.
It is reasonable to assume that a firm decides on how many workers to hire by comparing the wage it has to pay versus the price it can get for the product these workers produce. According to the logic of the traditional Phillips curve, following an expansionary monetary policy demand for goods and services rises. Firms respond by raising prices, but despite the increase in the cost of living workers cannot raise wages because they are bind by contracts. Firms thus find it profitable to hire more workers, so employment goes up until workers are able to re-negotiate their contracts. Once they do so wages rise to match the new prices, so things go back to the previous status quo. But then monetary authorities can pursue another wave of expansion, raise prices and reduce unemployment again. So, the story goes, central banks can maintain a lower unemployment rate forever by continuously raising prices (pursuing inflation). Moreover, the more agressive the expansion, the bigger the drop in unemployment. So some Keynesian economists suggested that we estimate this relationship, and use the equation to target the desired level of unemployment by targeting the appropriate rate of inflation.
Lucas's idea is that, if people are forward looking, such an attempt is useless. If we estimate the Phillips curve in an environment where prices have been stable, we will get a strong positive relationship between inflation and unemployment because people are caught by surprise. However, once workers realize what the central bank is doing they will take into account its behavior when setting their wage, and the relationship will become much weaker, and can in fact turn negative. Therefore, our estimates become useless. This is a valid critique! It suggests that any estimated relationships will be useful to policy-makers only if their attempt to exploit them does not cause the nature of these relationships to change.
Correction, the relationship between unemployment and inflation is negative in the Phillips curve, and under the Lucas critique it can turn to positive.
DeleteCA: "Lucas's idea is that, if people are forward looking, such an attempt is useless. If we estimate the Phillips curve in an environment where prices have been stable, we will get a strong positive relationship between inflation and unemployment because people are caught by surprise. However, once workers realize what the central bank is doing they will take into account its behavior when setting their wage, and the relationship will become much weaker, and can in fact turn negative. Therefore, our estimates become useless. This is a valid critique!"
DeleteYes, and where is the science? I see some interesting and plausible hypotheses. The science is to investigate them, not just accept them at face value.
From "The Art of Scientific Investigation" by Beveridge, pp. 96 - 7:
"When some rabbits from the market were brought into Claude Bernard's laboratory one day, he noticed that the urine which they passed on the table was clear and acid instead of turbid and alkaline as is usual with herbivorous animals. Bernard reasoned that perhaps they were in the nutritional condition of carnivora from having fasted and drawn on their own tissues for sustenance. This he confirmed by alternately feeding and starving them, a process which he found altered the reaction of their urine as he had anticipated. This was a nice observation and would have satisfied most investigators, but not Bernard. He required a " counterproof ", and so fed rabbits on meat. This resulted in an acid urine as expected, and to complete the experiment he carried out an autopsy on the rabbits."
Now, of course, economics, like a number of other sciences, is only partially experimental. But note Bernand's thoroughness. He formed a hypothesis that was almost certainly correct, given the knowledge of biology at the time. But still he tested it. Then, when "most investigators" would have stopped, he continued his investigations, not just one more step, but going so far as to look at the rabbits' innards. (This last step led to further discoveries.) I do not mean to be unfair, but it seems to me that in the story as given by Noah Smith, the Lucas Critique was tested by disputation rather than empirical investigation. Where is the science in that?
Beveridge again, p. 89:
"People in most other walks of life can allow themselves the indulgence of fixed ideas and prejudices which make thinking so much easier, and for all of us it is a practical necessity to hold definite opinions on many issues in everyday life, but the research worker must try to keep his mind malleable and avoid holding set ideas in science. We have to strive to keep our mind receptive and to examine suggestions made by others fairly and on their own merits, seeking arguments for as well as against them. We must be critical, certainly, but beware lest ideas be rejected because an automatic reaction causes us to see only the arguments against them. We tend especially to resist ideas competing with our own.
"A useful habit for scientists to develop is that of not trusting ideas based on reason only."
Underline that last statement. :)
Min,
Deletehere is Lucas's attempt to test his own theory:
http://www.aeaweb.org/aer/top20/63.3.326-334.pdf
I don't know why you use such strong language when you don't know the literature. Every mainstream economist agrees with your last statement.
"I don't know why you use such strong language when you don't know the literature. Every mainstream economist agrees with your last statement."
DeleteStrong language? I ask, Where is the science?
I am not the one presenting narratives to the public that fail to mention empirical testing.
And thank you very much for the reference. :)
Noah, I don't agree that Mankiw is identifying New Classicals with science and New Keynesians with engineering. In fact, one of his main thesis is that neither school has done much to improve engineering, since old Keynesianism seems to be much more useful in thinking about economic policy. I do agree, however, that New Classicals do not have an advantage in scientific work over New Keynesians. If anything, the reverse is true.
ReplyDeleteI remember the surprise of a senior economist at the New York Fed a couple of years ago, when I told him "We are all New Keynsians now". I don't know why people seem to think that New Classisism is prevalent; it is not.
I don't know why people seem to think that New Classisism is prevalent; it is not.
DeleteBut it is prevalent in first-year grad macro courses, which is all the macro that most PhD economists ever learn... ;)
Hmm, I used David Romer's book and I remember all students covering efficiency wages, staggered price adjustments, liquidity constraints, and the like. In my opinion New Classisism is like a concrete slab. It shows how the world would look like if there were no transaction costs, people were perfectly informed, etc. Then you start adding bricks, sheetrock, and so on, and you get very different results. The problem is with those who mistakenly think that the slab is the dwelling and not simply something to build on. So maybe graduate schools should do a better work at explaining this! :)
DeleteWell, first of all, your curriculum may have been different...I learned all of that stuff, but only in my second-year field course, not in the first-year macro sequence. Professors at other universities have said the same when I asked them about their curricula...so you seem to be a bit of an outlier if you got all that in your first term.
DeleteNew Classisism is like a concrete slab. It shows how the world would look like if there were no transaction costs, people were perfectly informed, etc. Then you start adding bricks, sheetrock, and so on, and you get very different results.
I think this is the typical viewpoint, which is why they call departures from the New Classical model "frictions". But what if the slab itself is not solid? What if the New Classical models bear no relation to what an economy would look like without the "frictions"?
Perhaps a closer dichotomy would be theorists and experimentalists (or empiricists) with the problems of not addressing reality and not advancing theory respectively. I do wonder how macro can make sense without money or how demand for money could possibly be independent of policy.
ReplyDeleteAs an engineer who has spent time among PHD academic economists, I came to the opinion that economics is largely a cargo cult. Basically, bull5#!t disguised behind complicated math.
ReplyDeleteAs a PHD academic economists who has spend time among engineers, I came to the opinion that engineers have limited intellectial capacity. Once the objects of interests become concious actors, their ability to translate math into ideas is greatly diminished. Basically they are little dictators who think that they can arrange people in a the same way they would arrange columns to achieve the outcome they deem desirable.
DeleteAnd yes, I am aware of all my typos, I was writing in a hurry.
Delete#nerdfights
DeleteAs a non-economist I would like to offer an additional point. The Great Depression repudiated the classical school of economics and provided an opening for Keynes who provided a plausible explanation and seem confirmed by the Great Moderation of the 1950's-1968 era. Stagflation undermined Keynes and offered an opening for rational expectations. The Great Recession suggested the inadequacy of rational expectations and of the implausible of its theoretical explanations. As argued in Thomas Kuhn's The Structure of Scientific Revolutions, this type of real world disconfirmation plays an important role in the rise and fall of theoretical approaches. Certainly not the whole story by any means but I think it at least is worthy of mention.
ReplyDeleteAs a non-economist, I have a hard time imagining any parameters that aren't responsive to policy.
ReplyDeleteAdam, another way of putting it might be that some are highly responsive, and responsive in the short term; others are less so.
ReplyDeletenice post.
ReplyDeleteThe Lucas approach also breaks down because there is no such thing as one representative consumer. If you try to model even a limited number of interacting consumers with distinct preferences, you get a crazy mishmash. Grandmont was showing this more than a decade ago.
ReplyDeleteLeaving scientists and engineers aside, can we agree that "New Classical" is a really unfortunate name for this school? Firstly because "Classical" is already quite ambiguous (I take the Chicagoans as saying they've resurrected economics as it stood with Marshall, in a direct stab at Keynes and his use of "Classical"). Secondly because it sounds so much like "neoclassical", which was already an ambiguous and loaded term. Even in choosing a name, they muddied the waters rather than adding clarity...
ReplyDeleteWhen I took macro from Greg Mankiw (Winter 1986), he used the phrase "New Clasical" to refer specifically to a kind of model that was based on imperfect information (e.g. the Lucas model of aggregate supply), which was distinct from "Real Business Cycle" models, which were driven by shocks to preferences and technology. I'm not sure how idiosyncratic his usage was or how much it has changed since then. I think it rapidly became clear (and had already been clear for a while by the time Greg taught that) that the models Greg called "New Classical" didn't make sense because, in order to explain anything important, they required people to be ignorant of things that were public information (e.g. the aggregate price level, about which information is easily available with a one-month lag).
ReplyDeletesome quality engineering saltwater economics produce... let's see some evidence of accurate macroeconomic forecasting especially in the presence of policy changes.
ReplyDeleteSeems to me your argument really comes down to : neither freshwater nor saltwater have the theory down right, but saltwater had admitted that and given up, content to match previous data, make flawed forecasts, and not try to capture the underlying forces, resting smugly on their cynicism.
nobody in freshwater uses prescott’s initial models anymore, we are improving them, adding on fictions backed up by evidence and testing them against data.
Thank u for such a nice post. However, i am not convinced by this statement:
ReplyDelete[Lucas said "Your models have to be based on things that won't be changed by policy. What people want to consume, for example, or the technology that we use to produce things. Those things can't be changed by the government, right?" ]
I think government policy can change everything. My preference or what i want to consume. Through taxation and subsidies, government can can change our tastes, preference. For example, whether i should use petrol or CNG/LPG (Liquefied Petroleum Gas) cars depend upon price structure. If government wants use of more environment friendly cars when people use petrol products then it can, through taxation and subsidy, change our choice. And also technology.
It is absolutely clear that government policy can change preferences and technology. It's equally clear that advertising can change preferences.
DeleteI really do think a theory of economics with advertising as the central, or core, component would be very very interesting. It would describe our current world pretty well.
Really good write-up, Noah. I especially liked the history review in the beginning.
ReplyDelete