16.8.14

DO INCENTIVES MATTER?

John Cochrane is truly a grumpy economist, as he contemplates the recent state of macroeconomic analysis.
Quantitative, scientific discipline? Explicit statistical descriptions of economic behavior? Reliance of government officials on technical economic expertise?  The use of mathematical control theory to manage an economy? All that has vanished.

The sub-basements of central banks have big [dynamic stochastic general equilibrium] models, or combined models where you can turn Lucas and Sargent on and off. But I think it's fair to say nobody takes the results very seriously. Policy -- our stimulus, for example -- is based on back of the envelope multipliers and the authority and expertise, if you're charitable, or the unvarnished, verbal, opinions if you're not, of administration officials.

There are some large-scale empirical DSGE models left in academia too. But the vast bulk of policy analysis does not use them, as they did, say, the models of 1972. At conferences and in papers, academic work uses small scale toy models and a lot of words. Models do not seem to be cumulative. Each paper adds a little twist ignoring all the previous little twists.

A complete split occurred. "Equilibrium" models, in which I include new-Keynesian DSGE models, took over academia. The policy world stuck with simple ISLM logic -- not "models" in the quantitative scientific tradition Lucas and Sargent praised -- despite Lucas and Sargent's devastating criticism.
Yes, in the policy world what matters is coming up with a forecast that's reasonably close to accurate rapidly enough so as to be able to get re-elected, or perhaps to roll out the right mix of upscale and downscale products.  In the academic world what matters is creating a minimal-publishable-unit that is also a contribution before someone else does, and going on to create sufficient such units to earn tenure or promotion.  And everyone recognizes what the Hot Ideas are: there was one session of interviews I participated in, years ago, when my department was searching for a macroeconomist, and I heard a lot of "Lucas critique" and more than a few "unit roots" in those thesis summaries.  Empirical failures in the policy world might have been secondary.  Failure to acknowledge the state of the art, though, is a career-killer. "Rightly or wrongly, all subsequent models had to have these two elements present within them (RE and microfoundaions), or they would be dismissed."

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