Thursday, January 19, 2017

Olivier Blanchard — The Need for Different Classes of Macroeconomic Models

So what should be done? My suggestion is that the two classes should go their separate ways.
DSGE modelers should accept the fact that theoretical models cannot, and thus should not, fit reality closely. The models should capture what we believe are the macro-essential characteristics of the behavior of firms and people, and not try to capture all relevant dynamics. Only then can they serve their purpose, remain simple enough, and provide a platform for theoretical discussions.
Policy modelers should accept the fact that equations that truly fit the data can have only a loose theoretical justification. In that, the early macroeconomic models had it right: The permanent income theory, the life cycle theory, the Q theory provided guidance for the specification of consumption and investment behavior, but the data then determined the final specification.
Both classes should clearly interact and benefit from each other. To use an expression suggested by Ricardo Reis, there should be scientific cointegration. But the goal of full integration has, I believe, proven counterproductive. No model can be all things to all people.
Like I have been saying. Separate theoretical from practical inquiry. They are separate fields, just as theoretical physics is separate from the various branches of engineering as applied physics.

However, engineers also require other knowledge and skill, such as materials science, and they must also take cost into account. Good design often includes aesthetics. Architecture is a combination of design and engineering.

Engineers are not interested in "the perfect bridge," but rather the bridge that will meet the design specifications most economically and reliably. Engineers realize that building in redundancy for safety is not inefficient, although it may appear to be "wasteful" duplication.

Theoretical economics requires specialization in applied math. Political economy requires knowledge of  systems dynamics, political science, sociology, history in addition to economics, accounting, and statistics.

There is nothing wrong with departments of theoretical economics looking like departments of theoretical physics or applied math. But departments of political economy should look more like business schools and engineering departments, which are oriented toward application and data-centric.

Peterson Institute for International Economics
The Need for Different Classes of Macroeconomic Models
Olivier Blanchard | Professor and Senior Fellow at the Peterson Institute for International Economics, and former chief economist at the International Monetary Fund
ht Lambert Strether at Naked Capitalism



Ralph Musgrave said...

Oliver Blanchard: former chief economist at the organization (the IMF) which was preaching "consolidation", i.e. austerity, in the middle of the recent recession. And second, the article is published by the Peterson Institute.

Two excellent reasons for ignoring the article!!!!

circuit said...

Actually, he made the case against austerity...