Macro Models Aren't Useful Now, And That Is Perfectly Fine Brian Romanchuk

There has been a small flurry of publications by neoclassical economists attempting to fit a pandemic into standard frameworks. This is what to be expected, as neoclassical models are frameworks designed to maximise the amount of publications over time. However, aggregated models are not particularly useful right now. This is true both for neoclassical as well as traditional heterodox macro models. The reason is that they do not offer much insight into either forecasting, nor are they useful for policymakers. That will change, but we are not there yet.

I will quickly discuss the two main justifications for looking at macro models....

Bond Economics

Macro Models Aren't Useful Now, And That Is Perfectly Fine

Brian Romanchuk

REVIEW ESSAY–The Reformation in Economics: A Deconstruction and Reconstruction of Economic Theory by Philip Pilkington Marc Morgan

Book review.

American Affairs

REVIEW ESSAY–The Reformation in Economics: A Deconstruction and Reconstruction of Economic Theory by Philip Pilkington

Marc Morgan | research economist at the World Inequality Lab of the Paris School of Economics.

Tim Wallace — Inflation is getting harder to understand, central banker warns

No, inflation is not getting harder to "understand." Central banks are just using models that don't fit the case, for example, confusing special case model with general models, or using models that are mis-specified. 

The message is to review the assumptions, including methodological ones, and revise them as appropriate. Then compare the model with the real world.

What's so difficult to understand about that? This is what scientists do.

Difficult, you say? That's what you are getting paid for. If you don't have the chops, then resign and do something you can handle. 

Maybe others have a better handle on it. Give them a shot.

The Telegraph
Inflation is getting harder to understand, central banker warns

Tim Wallace

Lars P. Syll — DeLong, Summers & Krugman on models

Larry Summers, Brad DeLong, and Paul Kugman are having an extended discussion on the role of models in economics on their blogs this week.

That’s good. Since the model is the message in economics today, that is actually the most important discussion possible to have in economics.…

Lars P. Syll’s Blog
DeLong, Summers & Krugman on models
Lars P. Syll | Professor, Malmo University

Neil Wilson — How Not to Model Human Behaviour

Human beings are not atoms, or amoeba, either.

3spoken
How Not to Model Human Behaviour
Neil Wilson

Ken Houghton — Quote of the Day Last Thirty Years of Economics

From, naturally, Robert Waldmann, chez DeLong, pointing out that the Emperor not only has no clothes, but has been deliberately strutting his lack of stuff since the late 1970s….

Angry Bear
Quote of the Day Last Thirty Years of Economics
Ken Houghton

David F. Ruccio — The fetishism of mathematics

As usual David Ruccio nails it (IMHO). Paul Romer hoist with his own petard.

Occasional Links & Commentary
The fetishism of mathematics
David F. Ruccio | Professor of Economics University of Notre Dame Notre Dame

Marco Del Negro, Raiden Hasegawa, and Frank Schorfheide — Combining Models for Forecasting and Policy Analysis

As we noted before, the ideal model combination is the one that puts all the weight on the model that has the most accurate projection. The problem is, you know which one that is only afterwards. A measure of success is the extent to which your real-time combination produces a forecast that is as accurate as possible to that of the best model. The chart shows that the forecast accuracy of the dynamic pools approach is quite close to that of the best model most of the time, and in particular during the Great Recession. This confirms that the bucket tilted early enough in the game and shifted the weight toward the model with financial frictions. We show in the paper that, because of this timeliness, our procedure does generally better than the competition in terms of out-of-sample forecasting performance. 

Now, imagine you are a policymaker and are contemplating the implementation of a given policy. Consider also that this policy achieves the desired outcome in one model, but not in the other. Clearly the decision of whether to implement the policy depends on which model is the right one. You do not quite know that, but you do know the weights. Using them to come up with an assessment of the pros and cons of a given policy is the topic of our next post.

FRBNY — Liberty Street Economics
Combining Models for Forecasting and Policy Analysis
Marco Del Negro, Raiden Hasegawa, and Frank Schorfheide

Mark Buchanan — Arrow-Debreu Derangement Syndrome

Imagine you had never read any textbook economics, or studied any academic research papers. You didn't know the THEORIES of economics, especially in their mathematical form. But suppose you did know some mathematics, and were also generally well informed about the realities and complexities of real world economies. Now, suppose a demon sat you down and made you read and study the famous theorems concerning the existence of a competitive economic equilibrium as developed in the 1950s by Ken Arrow and Gerard Debreu. What would you think? 

My belief is that you would quickly conclude that these theorems probably held little or no importance for understanding any real world economic system. If the demon tried to tell you that these theorems were at the very core of today's theoretical approach to (much of) economics, you'd think he or she was joking. If the demon insisted, you'd suspect you were dealing with an insane demon; and if you discovered the demon was right, you suspect the economics profession of being deranged. At least I would...

I've never yet been able to understand why the economics profession was/is so impressed by the Arrow-Debreu results. They establish that in an extremely abstract model of an economy, there exists a unique equilibrium with certain properties. The assumptions required to obtain the result make this economy utterly unlike anything in the real world. In effect, it tells us nothing at all. So why pay any attention to it? The attention, I suspect, must come from some prior fascination with the idea of competitive equilibrium, and a desire to see the world through that lens, a desire that is more powerful than the desire to understand the real world itself. This fascination really does hold a kind of deranging power over economic theorists, so powerful that they lose the ability to think in even minimally logical terms; they fail to distinguish necessary from sufficient conditions, and manage to overlook the issue of the stability of equilibria.

The Physics of Finance
Arrow-Debreu Derangement Syndrome

Mark Buchanan

Brian Romanchuk — If r < g, DSGE Model Assumptions Break Down

The relationship between interest rates and the growth rate of the economy is critical for government fiscal dynamics. In the literature for Dynamic Stochastic General Equilibrium (DSGE) models, the discussion of the governmental budget constraint appears to have an embedded assumption that the real interest rate on government debt is greater than the economic growth rate (“r>g”). However, there is no reason that this has to be true, and the mathematics of the budget constraint fails if the condition does not hold. This poses a problem for the constraint, as a true mathematical constraint is something that is always true. Once this constraint is dropped, a good portion of the recent academic literature discussing fiscal policy becomes irrelevant. (Despite my opportunistic use of “r” and “g” in the title of this article – in order to capitalise on the popularity of a recent book – it has nothing to do with inequality.)

Bond Economics
If r < g, DSGE Model Assumptions Break Down
Brian Romanchuk

Philip Pilkington — Shadow-boxing with DSGE Models

This is what mainstream economics is turned into. Economists bicker amongst themselves over models that are obvious nonsense. They will use criteria to prove or falsify such models that when turned around on beliefs they hold in common would demolish these too. It is a bizarre show.

It is a group of people vying for the Throne of Macro all the while secretly terrified that anyone will push the scientific criteria they claim to uphold too far and expose the fact that the Emperor is naked. How long can this carnival last? Well, if we look back on the last time such a discourse was firmly entrenched — that is, during the Scholastic era in the Middle Ages — we can be confident that it will last as long as those in power put up with it. But with regards to mainstream economics that day might well be coming to an end.

Fixing the Economists
Shadow-boxing with DSGE Models
Philip Pilkington

Peter Radford — Quote of the day #3

Why econometric modeling of general equilibrium is bonkers.

Real-World Economics Review Blog
Quote of the day #3
Peter Radford

Lars Syll — Microfounded DSGE models are not only unrealistic — they are also plainly wrong

The DSGE model is a model in which output is determined in the labour market as in New Classical models and in which aggregate demand plays only a very secondary role, even in the short run.

In addition, given the fundamental philosophical problems presented for the use of DSGE models for policy simulation, namely the fact that a number of parameters used have completely implausible magnitudes and that the degree of freedom for different parameters is so large that DSGE models with fundamentally different parametrization (and therefore different policy conclusions) equally well produce time series which fit the real-world data, it is also very hard to understand why DSGE models have reached such a prominence in economic science in general. — Sebastian Dullien

Microfounded DSGE models are not only unrealistic — they are also plainly wrong
Lars P. Syll | Professor, Malmo University

Philip Pilkington — An Excellent Guide to Using Gretl

For those that don’t know Gretl is a freeware econometrics package. Despite not costing anything I’ve found it to be a very useful econometrics program that can do pretty much anything — or, at least, anything that I’ve ever wanted it to do.

Gretl can be a bit daunting to use, however. This especially so given it’s ‘stripped down’ presentational format (which I rather like, but others may not). Anyway, the author Hishamh over at the Economics Malaysia blog has put together a series of post that guides the user through all the major uses of Gretl. The posts, complete with screenshots, are indispensable and I will here run quickly through what they show

Fixing the Economists
An Excellent Guide to Using Gretl
Philip Pilkington

Lars P. Syll —Do people have rational expectations?

If we want to have anything of interest to say on real economies, financial crisis and the decisions and choices real people make [in a non-ergodic world not amenable to stochastic modeling], it is high time to replace the rational expectations hypothesis with more relevant and realistic assumptions concerning economic agents and their expectations.

The post shows why.

Do people have rational expectations?
Lars P. Syll | Professor, Malmö University