The foxy Fed

A few days ago, the Fed released its workhorse model of the macroeconomy - the FRB/US model - to the public. The model had been only semi-private before, since the Fed would send it to interested researchers, and revealed some information about it to the general public. But now the model is fully public. How should we interpret that action?

Why didn't the Fed fully reveal FRB/US model before now? It always seemed to me that it was basically because of - for lack of a better word - embarrassment. Academic macroeconomists haven't used or studied this type of model in decades (having abandoned everything else in favor of DSGE). In 2010, Chris Sims appeared to call models like FRB/US "something close to a spreadsheet". Since most Fed employees are drawn from the same pool of people as academic macro (and interact with academic macroeconomists quite frequently), the fact that they use something like FRB/US must have seemed a bit awkward. In fact, I've heard academic macroeconomists make fun of FRB/US a number of times.

So if my guess is right, the Fed's publication of FRB/US indicates that whatever embarrassment existed is now essentially gone. That is kind of interesting.

After all, FRB/US flies in the face of two key developments in academic macro. Since FRB/US has a huge number of parameters, all of which are assumed to be structural, it is a lot harder for this model to pass the intuitive test known as the "Lucas Critique". Basically, more "structural" parameters = more assumptions = more chance to get some of the assumptions wrong = easier for any given economist to wrinkle his nose at the model.

Second, FRB/US does not force its users to use Rational Expectations (which the Fed more aptly calls "Model Consistent Expectations" or "MCE"). The model has an option that allows you to use it with MCE. But it also has an option to allow you to use it with non-model-consistent expectations. That flies in the face of what Robert Lucas told economists to do, and what most academic macroeconomists do in fact do.

(Also, FRB/US uses more heterogeneity than most academic DSGE-type models use.)

Lucas and his followers (and "his followers" include almost 100% of academic macroeconomists working after 1980, to a greater or lesser degree) hoped and expected that DSGE models, which have a relatively small number of parameters and generally only consider the MCE case, would fully replace models like FRB/US at central banks. But that has not happened, despite decades of arguments by academics. The Fed and other central banks do indeed use DSGE models, but they continue to use things like FRB/US as well. Where academic macro is hedgehoggy, central banks are stubbornly foxy.

And I say "stubbornly" because instead of becoming more and more shy about their continued deviation from academia, the Fed now seems to be getting more bold about it. In their notes on the public release of FRB/US, they very explicitly show how the model is used not just for unconditional forecasting, but for policy analysis - exactly the thing that Robert Lucas told us that we shouldn't do with this kind of model.

That's my (non-insider) takeaway from the public release of FRB/US - the Fed seems less embarrassed about its continued split with academic macro.

(Note: I'm definitely not calling the Fed cowards for not releasing FRB/US before now; in fact, the opposite. It takes lots of guts to keep using a diverse array of models when some of the world's smartest hedgehogs are yelling at you to use only one kind! Instead, I think it's the academics who might want to pause and think about why even central banks, their main audience, aren't totally sold on their approach even after more than three decades...)

Update: Steve Williamson has more. He's not a fan of FRB/US, but he agrees with me that the main takeaway from its continued existence is that the Fed has not fully bought into the ideas of Robert Lucas.