The economic science blogosphere has a large give-and-take going on over Bob Lucas in addition to Tom Sargent's classic "Simon Wren-Lewis, Mark Thoma here and here and travel dorsum through the links.
Influenza A virus subtype H5N1 few thoughts here, every bit it bears on my WSJ oped from final calendar week in addition to my final postal service on EFG in addition to how nosotros practise macro.
1. Views of Keynesian economics
Re-reading this paper, you lot volition live on struck nigh how much Lucas in addition to Sargent praise Keynesian models, which you'd think it is their role to destroy.
They called the Keynesian revolution a "remarkable intellectual event." they continued
Lucas in addition to Sargent brand a two-pronged argument, 1 nigh theoretical coherence in addition to the other nigh the grand econometric failure of Keynesian models.
As I run into it, the master copy characteristic of "equilibrium" models Lucas in addition to Sargent inaugurated is that they pose people, time, in addition to economic science into macro.
Keynesian models model aggregates. Consumption depends on income. Investment depends on involvement rates. Labor render in addition to demand depend on wages. Money demand depends on income in addition to involvement rates. "Consumption" in addition to "investment" in addition to so forth are the fundamental objects to live on modeled.
"Equilibrium" models (using Lucas in addition to Sargent's word) model people in addition to technology. People brand simultaneous decisions across multiple goods, constrained past times budget constraints -- if you lot eat to a greater extent than in addition to salve more, you lot must travel more, or concord less money. Firms make decisions across multiple goods constrained past times technology.
Putting people in addition to their simultaneous decisions dorsum to the see of the model generates Lucas in addition to Sargent's master copy econometric conclusion -- Sims' "incredible" identifying restrictions. When people simultaneously create upward one's heed consumption, saving, labor supply, so the variables describing each must tumble over inwards to the other. There is no argue for leaving (say) reward out of the consumption equation. But the alone thing distinguishing 1 equation from merely about other is which variables larn left out.
People brand decisions thinking nigh the future. I think "static" vs. "intertemporal" are goodness words to use. That observation goes dorsum to Friedman: consumption depends on permanent income, including expected hereafter income, non today's income. Decisions today are inevitably tied to expectations --rational or non -- nigh the future.
The lack of budget constraint (or the "missing equation" in addition to "Walras' law" issues much studied inwards before Keynesian literature) strikes me every bit merely about other large conceptual in addition to methodological divergence betwixt Keynesian models in addition to equilibrium models, which flows from putting people rather than aggregates at the see of analysis.
Notice when you lot read whatsoever textbook that the microeconomic "demand" all of a abrupt becomes the macroeconomic "plan." Why is that? Because demand curves honour budget constraints fifty-fifty at off-equilibrium prices. "Plans" similar consumption equals c bar addition alpha times income practise non honour whatsoever stated budget constraint. You're allowed to say you lot desire to eat in addition to salve to a greater extent than than income allows.
Optimization, rational expectations, in addition to flexible prices are the ballyhooed centerpieces of the outset circular of equilibrium models to follow Lucas in addition to Sargent, such every bit Kydland in addition to Prescott's famous "time to build" model in addition to the subsequent "real trouble organisation cycle" models (examples: Bob King in addition to Sergio Rebelo, John Long in addition to Charles Plosser). But I don't think these ingredients are fundamental to the program. The "new-Keynesian" (or, better, DSGE) schoolhouse pose inwards mucilaginous prices amongst all the other Lucas-Sargent ingredients, in addition to therefore nether the "equilibrium" banner. Mike Woodford's "Interest in addition to prices" is aimed proudly at that program. Sticky wages, distortions, in addition to so on are merely every bit often included.
Simon Wren-Lewis questions whether Lucas in addition to Sargent were genuinely focusing on empirical failure or methodological critique. He suggested that accelerationist Phillips curves, though adapted after the failure in addition to therefore appearing a fighting every bit epicycles, tin trouble organisation human relationship for the data. (Lucas in addition to Sargent: "In economic science every bit inwards other sciences,...there is e'er the promise that if a detail specific models fails 1 tin discovery a to a greater extent than successful model based on roughly the same ideas.")
I think Simon is a fighting besides blasé nigh how slow this modification is. Not alone did inflation accelerate far faster than Keyensian models of the 1960s predicted, inflation dropped similar a rock inwards 1982, far faster than Keynesians thought possible based on adaptive expectations views. (If mortal tin discovery the quote from Samuelson inwards the early on 1980s predicting decades of depression to wring out inflation, delight add together to the comments.) Proud every bit merely about self-identified Keynesians are nigh how good they think their unwritten, unquantified "model" fits the electrical flow recession, deep unemployment amongst no motility inwards inflation fits no Phillips flexure that was genuinely written before the crisis. Infinite wage stickiness is an ex-post project design too, in addition to nonetheless merely a verbal debating point.
But the newspaper is genuinely clear that empirical failure matters deeply to Lucas in addition to Sargent. They said that
Everyone was perfectly aware of the lack of "microfoundations" of Keynesian models, in addition to the 50 twelvemonth fruitless search for such foundations. But so long every bit the models worked, that had no existent comport upon on their occupation for the "scientific" in addition to technical policy advice Lucas in addition to Sargent so admired.
And rightly so. Chemistry, until the final few decades, lacked "microfoundations" inwards quantum mechanics, outset because nobody knew quantum mechanics, in addition to afterward because working out how chemicals react from outset principles was besides hard. That did non halt chemical scientific discipline from existence a perfectly feasible science. Biology, until the final few decades, lacked "microfoundations" inwards chemistry.
But chemical scientific discipline in addition to biological scientific discipline worked pretty well. Lucas in addition to Sargent pointed to, in addition to needed to indicate to, a grand empirical failure.
And that failure had to live on accompanied non merely past times "well, these are reasonable rules, but they're non microfounded." The failure had to live on accompanied past times showing how the Keyensian model was logically flawed. That failure had to live on accompanied past times a amend theory, which showed why the Keynesian equations were inconsistent amongst basic economics. That amend theory had already predicted Keynesian model's failure -- Friedman 1968, Phelps, in addition to Lucas' prediction that the Phillips flexure would shift if exploited. That is a lot to a greater extent than than "methodological purity."
3. So what happened?
As I survey the landscape now, it is interesting how much of the macroeconomics Lucas in addition to Sargent praised has vanished. Quantitative, scientific discipline? Explicit statistical descriptions of economical behavior? Reliance of authorities officials on technical economical expertise? The occupation of mathematical command theory to create out an economy? All that has vanished.
The sub-basements of fundamental banks possess got large DSGE models, or combined models where you lot tin plow Lucas in addition to Sargent on in addition to off. But I think it's fair to say nobody takes the results real seriously. Policy -- our stimulus, for trial -- is based on dorsum of the envelope multipliers in addition to the authorisation in addition to expertise, if you're charitable, or the unvarnished, verbal, opinions if you're not, of direction officials.
There are merely about large-scale empirical DSGE models left inwards academia too. But the vast mass of policy analysis does non occupation them, every bit they did, say, the models of 1972. At conferences in addition to inwards papers, academic travel uses small-scale scale toy models in addition to a lot of words. Models practise non seem to live on cumulative. Each newspaper adds a niggling twist ignoring all the previous niggling twists.
Influenza A virus subtype H5N1 consummate carve upward occurred. "Equilibrium" models, inwards which I include new-Keynesian DSGE models, took over academia. The policy footing stuck amongst uncomplicated ISLM logic -- non "models" inwards the quantitative scientific tradition Lucas in addition to Sargent praised -- despite Lucas in addition to Sargent's devastating criticism. And, every bit I remarked inwards the before weblog posts, the "purely verbal" or literary trend of analysis is becoming to a greater extent than in addition to to a greater extent than mutual forthwith inwards academia every bit good every bit policy.
I'm non complaining nigh goodness vs. bad here. I write simpler in addition to simpler models every bit I grow older, in addition to pass to a greater extent than fourth dimension thinking in addition to writing nigh what those equations mean. It merely is a fact nigh how nosotros practise things today in addition to the "scientific," quantitative condition of macroeconomics.
Lucas in addition to Sargent's final sentence:
PS: Lucas in addition to Sargent possess got a delicious quote nigh Keynesian's loss of religious belief inwards their ain model, every bit applicable forthwith every bit then:
Influenza A virus subtype H5N1 few thoughts here, every bit it bears on my WSJ oped from final calendar week in addition to my final postal service on EFG in addition to how nosotros practise macro.
1. Views of Keynesian economics
Re-reading this paper, you lot volition live on struck nigh how much Lucas in addition to Sargent praise Keynesian models, which you'd think it is their role to destroy.
They called the Keynesian revolution a "remarkable intellectual event." they continued
... merely about of its [Keynesian Revolution] most of import features: the evolution of macroeconomics into a quantitative, scientific discipline, the evolution of explicit statistical descriptions of economical behavior, the increasing reliance of authorities officials on technical economical expertise, in addition to the introduction of the occupation of mathematical command theory to create out an economy.
Keynesian theory evolved from a disconnected, qualitative beak nigh economical action into a organisation of equations that tin live on compared to information inwards a systematic way in addition to which provides an operational guide inwards the necessarily quantitative project of formulating monetary in addition to financial policy.
neither the success of the Keynesisan Revolution nor its eventual failure tin live on understood at the purely verbal degree at which Keynes himself wrote...
The Keynesian economic science they are praising hither is non Keynes' volume -- 1 of those large dingy things that people are nonetheless writing "what did Keynes genuinely mean" articles in addition to books nigh nearly a century afterward -- but the subsequent quantification effort: Hick's creation of the ISLM model, its elaboration into figurer models, estimation of those models, in addition to the occupation of those models to brand quantitative forecasts of the effects of policy interventions.
"Quantitative, scientific discipline," in addition to "technical economical expertise" agency nosotros analyze policies past times existent models, non the opinions in addition to judgments of famous economists turned populace officials.
Yes, "mathematical command theory." Most readers volition live on besides immature to remember, but inwards the early on 1970s academic journals were dynamic optimal command applied to simulations of large-scale Keynesian models.
Their finish was quite conservative: they wanted to save this peachy achievement:
"Quantitative, scientific discipline," in addition to "technical economical expertise" agency nosotros analyze policies past times existent models, non the opinions in addition to judgments of famous economists turned populace officials.
Yes, "mathematical command theory." Most readers volition live on besides immature to remember, but inwards the early on 1970s academic journals were dynamic optimal command applied to simulations of large-scale Keynesian models.
Their finish was quite conservative: they wanted to save this peachy achievement:
The objectives of equilibrium trouble organisation wheel theory are taken, without modification, from the finish which motivated the structure of the Keynesian macroeconometric models: to provide a scientifically based agency of assessing, quantitatively, the probable effects of option economical policies.2. What was their basic criticism of Keynesian economics?
Lucas in addition to Sargent brand a two-pronged argument, 1 nigh theoretical coherence in addition to the other nigh the grand econometric failure of Keynesian models.
As I run into it, the master copy characteristic of "equilibrium" models Lucas in addition to Sargent inaugurated is that they pose people, time, in addition to economic science into macro.
Keynesian models model aggregates. Consumption depends on income. Investment depends on involvement rates. Labor render in addition to demand depend on wages. Money demand depends on income in addition to involvement rates. "Consumption" in addition to "investment" in addition to so forth are the fundamental objects to live on modeled.
"Equilibrium" models (using Lucas in addition to Sargent's word) model people in addition to technology. People brand simultaneous decisions across multiple goods, constrained past times budget constraints -- if you lot eat to a greater extent than in addition to salve more, you lot must travel more, or concord less money. Firms make decisions across multiple goods constrained past times technology.
Putting people in addition to their simultaneous decisions dorsum to the see of the model generates Lucas in addition to Sargent's master copy econometric conclusion -- Sims' "incredible" identifying restrictions. When people simultaneously create upward one's heed consumption, saving, labor supply, so the variables describing each must tumble over inwards to the other. There is no argue for leaving (say) reward out of the consumption equation. But the alone thing distinguishing 1 equation from merely about other is which variables larn left out.
People brand decisions thinking nigh the future. I think "static" vs. "intertemporal" are goodness words to use. That observation goes dorsum to Friedman: consumption depends on permanent income, including expected hereafter income, non today's income. Decisions today are inevitably tied to expectations --rational or non -- nigh the future.
Notice when you lot read whatsoever textbook that the microeconomic "demand" all of a abrupt becomes the macroeconomic "plan." Why is that? Because demand curves honour budget constraints fifty-fifty at off-equilibrium prices. "Plans" similar consumption equals c bar addition alpha times income practise non honour whatsoever stated budget constraint. You're allowed to say you lot desire to eat in addition to salve to a greater extent than than income allows.
Optimization, rational expectations, in addition to flexible prices are the ballyhooed centerpieces of the outset circular of equilibrium models to follow Lucas in addition to Sargent, such every bit Kydland in addition to Prescott's famous "time to build" model in addition to the subsequent "real trouble organisation cycle" models (examples: Bob King in addition to Sergio Rebelo, John Long in addition to Charles Plosser). But I don't think these ingredients are fundamental to the program. The "new-Keynesian" (or, better, DSGE) schoolhouse pose inwards mucilaginous prices amongst all the other Lucas-Sargent ingredients, in addition to therefore nether the "equilibrium" banner. Mike Woodford's "Interest in addition to prices" is aimed proudly at that program. Sticky wages, distortions, in addition to so on are merely every bit often included.
Simon Wren-Lewis questions whether Lucas in addition to Sargent were genuinely focusing on empirical failure or methodological critique. He suggested that accelerationist Phillips curves, though adapted after the failure in addition to therefore appearing a fighting every bit epicycles, tin trouble organisation human relationship for the data. (Lucas in addition to Sargent: "In economic science every bit inwards other sciences,...there is e'er the promise that if a detail specific models fails 1 tin discovery a to a greater extent than successful model based on roughly the same ideas.")
I think Simon is a fighting besides blasé nigh how slow this modification is. Not alone did inflation accelerate far faster than Keyensian models of the 1960s predicted, inflation dropped similar a rock inwards 1982, far faster than Keynesians thought possible based on adaptive expectations views. (If mortal tin discovery the quote from Samuelson inwards the early on 1980s predicting decades of depression to wring out inflation, delight add together to the comments.) Proud every bit merely about self-identified Keynesians are nigh how good they think their unwritten, unquantified "model" fits the electrical flow recession, deep unemployment amongst no motility inwards inflation fits no Phillips flexure that was genuinely written before the crisis. Infinite wage stickiness is an ex-post project design too, in addition to nonetheless merely a verbal debating point.
But the newspaper is genuinely clear that empirical failure matters deeply to Lucas in addition to Sargent. They said that
Influenza A virus subtype H5N1 key chemical factor inwards all Keynesian models is a trade-off betwixt inflation in addition to existent output: the higher is the inflation rate, the higher is output (or equivalently, the lower is the charge per unit of measurement of unemployment). For example, the models of the belatedly 1960s predicted a sustained the US unemployment charge per unit of measurement every bit consistent amongst a four part annual charge per unit of measurement of inflation. Based on this prediction, many economists at that fourth dimension urged a deliberate policy of inflation. [plus ça change...]... policy inwards this menstruation should, according to all of these models, possess got produced the lowest average unemployment rates for whatsoever decade since the 1940s. In fact, every bit nosotros know, they produced the highest unemployment rates since the 1930s. This was econometric failure on a grand scale. [My emphasis]Here every bit elsewhere, they said "econometric," non economic. They meant it.
Everyone was perfectly aware of the lack of "microfoundations" of Keynesian models, in addition to the 50 twelvemonth fruitless search for such foundations. But so long every bit the models worked, that had no existent comport upon on their occupation for the "scientific" in addition to technical policy advice Lucas in addition to Sargent so admired.
And rightly so. Chemistry, until the final few decades, lacked "microfoundations" inwards quantum mechanics, outset because nobody knew quantum mechanics, in addition to afterward because working out how chemicals react from outset principles was besides hard. That did non halt chemical scientific discipline from existence a perfectly feasible science. Biology, until the final few decades, lacked "microfoundations" inwards chemistry.
But chemical scientific discipline in addition to biological scientific discipline worked pretty well. Lucas in addition to Sargent pointed to, in addition to needed to indicate to, a grand empirical failure.
And that failure had to live on accompanied non merely past times "well, these are reasonable rules, but they're non microfounded." The failure had to live on accompanied past times showing how the Keyensian model was logically flawed. That failure had to live on accompanied past times a amend theory, which showed why the Keynesian equations were inconsistent amongst basic economics. That amend theory had already predicted Keynesian model's failure -- Friedman 1968, Phelps, in addition to Lucas' prediction that the Phillips flexure would shift if exploited. That is a lot to a greater extent than than "methodological purity."
3. So what happened?
As I survey the landscape now, it is interesting how much of the macroeconomics Lucas in addition to Sargent praised has vanished. Quantitative, scientific discipline? Explicit statistical descriptions of economical behavior? Reliance of authorities officials on technical economical expertise? The occupation of mathematical command theory to create out an economy? All that has vanished.
The sub-basements of fundamental banks possess got large DSGE models, or combined models where you lot tin plow Lucas in addition to Sargent on in addition to off. But I think it's fair to say nobody takes the results real seriously. Policy -- our stimulus, for trial -- is based on dorsum of the envelope multipliers in addition to the authorisation in addition to expertise, if you're charitable, or the unvarnished, verbal, opinions if you're not, of direction officials.
There are merely about large-scale empirical DSGE models left inwards academia too. But the vast mass of policy analysis does non occupation them, every bit they did, say, the models of 1972. At conferences in addition to inwards papers, academic travel uses small-scale scale toy models in addition to a lot of words. Models practise non seem to live on cumulative. Each newspaper adds a niggling twist ignoring all the previous niggling twists.
Influenza A virus subtype H5N1 consummate carve upward occurred. "Equilibrium" models, inwards which I include new-Keynesian DSGE models, took over academia. The policy footing stuck amongst uncomplicated ISLM logic -- non "models" inwards the quantitative scientific tradition Lucas in addition to Sargent praised -- despite Lucas in addition to Sargent's devastating criticism. And, every bit I remarked inwards the before weblog posts, the "purely verbal" or literary trend of analysis is becoming to a greater extent than in addition to to a greater extent than mutual forthwith inwards academia every bit good every bit policy.
I'm non complaining nigh goodness vs. bad here. I write simpler in addition to simpler models every bit I grow older, in addition to pass to a greater extent than fourth dimension thinking in addition to writing nigh what those equations mean. It merely is a fact nigh how nosotros practise things today in addition to the "scientific," quantitative condition of macroeconomics.
Lucas in addition to Sargent's final sentence:
Unless the forthwith evident limits of these models are also frankly acknowledged in addition to radically dissimilar novel directions taken, the existent accomplishments of the Keynesian Revolution volition live on lost every bit for sure every bit those nosotros know to live on illusory.Academic economic science took the outset one-half to hart. Policy economic science froze inwards place. But Lucas in addition to Sargent's "real accomplishments" were lost, or at to the lowest degree consciously abandoned, anyway.
PS: Lucas in addition to Sargent possess got a delicious quote nigh Keynesian's loss of religious belief inwards their ain model, every bit applicable forthwith every bit then:
The electrical flow moving ridge of protectionist sentiment directed at "saving jobs" would possess got been answered 10 years agone amongst the Keynesian counterargument that financial policy tin attain the same terminate but to a greater extent than efficiently. Today, of course, no 1 would accept this response seriously, so it is non offered. Indeed, economists who 10 years agone championed Keynesian financial policy every bit an option to inefficient straight controls increasingly favor such controls every bit supplements to Keynesian policy.
