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What do we mean when we say that Macroeconomics is broken?

Hi friends (but mostly Nikita and Alli because this might be something we want to consider),

First, please excuse the stream of consciousness (I promise I tried to keep this organized).

Second, when I refer to modern macro as being “broken” I’m referring to it being broken with regards to its ability to predict/explain behavior and to inform policy decisions, not its ability to teach principles/intermediate students.

Anyway, I did some thinking (gasp) after last class and I think I have an important question with which we need to grapple when we try to define “broken.” That is, I think we need to draw a distinction between two different types of “broken”-ness.

Popperian Broken means that mainstream macro models were unable to explain or predict important phenomena (i.e. the Great Recession). A hard science example of this might be like how existing theories of biology/aerodynamics can’t explain why a bumble bee is able to fly or how physics can’t understand what glass is. They’re important questions, but it’s probably safe to say that we don’t need to radically overhaul these disciplines to understand them, we probably just need to make some revisions.

I think that Popperian Brokenness means macro as a discipline isn’t truly *broken*, but rather that it just needs some polishing. So far, we’ve really only pointed out ways that macro suffers from Popperian Brokenness – DSGE models are oversimplified, don’t have a financial sector, etc. All of these could probably be fixed by adding more and more equations into the models as computing power gets stronger and none of them necessarily imply that we need to overhaul our understanding of macro.

Kuhnian Broken means that mainstream macro models are paradigmatically wrong and macroeconomists are headed in completely the wrong direction. The hard science equivalent of this would be the geocentric models of the universe – our explanations are totally wrong.

I’m still trying to establish a threshold for considering macro to be Kuhnian Broken. The best I can come up with would be a fundamental upending of the micro-founded assumptions of modern macro models – i.e. that consumers don’t seek to maximize utility, firms don’t try to maximize profits, etc. I’m also not sure whether information failures (people act rationally based on incomplete information) count as Kuhnian or Popperian Brokenness, but I think that it depends in part on whether those information failures can be solved by adding equations.

Of course, I also realize that these two probably aren’t mutually exclusive – Popperian Brokenness can be a symptom of Kuhnian Brokenness. Retrograde planets could be considered Popperian Broken but they ended up proving that the geocentric model of the universe was Kuhnian Broken. That said, this still raises the question of how we would know whether macro suffers from Kuhnian Brokenness or just a few instances of Popperian Brokenness, which seems tricky. Loathe as I am to concede Alli’s point that economics is a soft-science, she has a point that it’s hard to make a definitive argument in macroeconomics. Astronomers can point a telescope into space and say “this planet is here” to disprove the geocentric model of the universe (OK maybe not that simple, but I only took 100-level astronomy). Economists rarely have access to good experimental data, especially in the study of macroeconomics. Instead we have to interpret regression results using often imperfect variables and proxies.

I thought Alli made a pretty insightful counter-point to this whole discussion yesterday. She said that in order for macro to be “broken” it had to have worked at some point – Classical Economics worked until the Depression, Keynesian models worked until Stagflation in the 1970s, etc. This point would imply that Popperian Brokenness is the only type of broken that we should consider because if we found that macro was Kuhnian Broken (and that macro never really worked), then that would just mean that macroeconomics is a pseudo-science and was never worth pursuing in the first place.

Finally, I realize that this whole meta-rant might have been better suited for the very beginning of the class, but this just now came to me in a semi-coherent form. Looking forward to hearing others’ thoughts on this

What is a conceptual framework?

My first instinct after reading Campbell’s blog post “Conceptual Frameworks: some thoughts” was to try to define the conceptual framework of Econ488. I found this was tricky because Campbell explicitly separated the idea of having “conceptual framework” from having “a set of standards, or learning outcomes … or prescriptive enumeration of skills.” (It might just be me but) the lack of clarity on how conceptual frameworks are distinct from these skills was my biggest frustration with the post, because I think my initial understanding of the conceptual framework for this class was that we would explore certain themes – i.e. whether the economy rests at (or eventually comes to) an equilibrium, whether contemporary macroeconomics can adequately explain crises, whether macroeconomics can rest on micro-foundations or is something intrinsically distinct – all of which could easily fall into the categories latter, more trivial categories. Despite my uncertainty regarding whether exploration of these themes constitute a conceptual framework, they remain my most satisfying definition of the conceptual framework for this class.

I then tried to go more general – is the class trying to teach us how to be better oral/written communicators of macroeconomic ideas? Or is Econ488 intended simply to introduce us to the dilemmas facing contemporary macroeconomists? My problem with these definitions is that they seem far too general. Most economics classes serve these purposes, if only at a different level than our seminar. After all, the Principles of Macro/Micro classes teach students how to use simplified models that form the basis of the models we’re currently learning in our seminar. Would it be more useful to speak in terms of a conceptual framework for the economics major?

Also, I enjoyed the shout-out to Bryan Alexander, bamboozler of Fsems everywhere.

Do DSGE models have a future?

Oliver Blanchard of the Peterson Institute for International Economics had an interesting hot take on the future of DSGE models. In essence, his argument was that while DSGE models have a number of unappealing features (they’re based on shaky assumptions, estimation as a system makes it difficult to pinpoint flaws in the models, they don’t provide sufficient analysis of distributional effects for contemporary economic problems, and they are bad at communicating results to a lay audience), DSGE models are ultimately redeemable. As such, Dr. Blanchard lays out two proposals to revitalize the use of DSGE models: (1) DSGE models need to incorporate the work of other sub-disciplines (such as behavioral economics, big data, etc.) instead of relying simply on micro-foundations and (2) DSGE models are not a one-size-fits-all tool and economists must recognize their limitations.

While I agree with many of Dr. Blanchard’s diagnoses, I am not so sure about his proposed solutions. Moving away from exclusive reliance on micro-foundations certainly sounds desirable in theory, but it seems to me that adding the work of other disciplines would increase, rather than decrease, the complexity of DSGE models which would (1) make it more difficult to solve these models equation-by-equation and (2) raise the barriers to entry for understanding the assumptions of any given DSGE model.

Internal Model of the Economy

My internal model of the economy is probably best captured by Marshall’s scissor model displaying aggregate demand and aggregate supply. In this model I think of quantity as determined by the function Y = C + I + G + (Ex – Im). If any of these quantities change – say consumption drops – then aggregate demand will shift. Price is also endogenous in this model and it can be understood in terms of the money supply. Demand for U.S. dollars for example, comes from both the U.S. and foreign markets.