Paul Romer is worried about Macroeconomics… and what others think about his worries…

Paul Romer’s latest paper “The Trouble with Macroeconomics” is definitely one of the hottest topic in the economics blogosphere. The central message is that Romer thinks the state of Macroeconomics has been going backward ever since the Real Business Cycle Theory and DSGE model took the center stage of macroeconomics.

Accroeding to Romer, One of the major issues in modern macroeconomics model is the problem in identifying the so-called “exogenous shocks” in the model:

…[M]acroeconomists got comfortable with the idea that fluctuations in macroeconomic aggregates are caused by imaginary shocks, instead of actions that people take, after Kydland and Prescott (1982) launched the real business cycle (RBC) model…

…[P]roponents of the RBC model cite its microeconomic foundation as one of its main advantages. This posed a problem because there is no microeconomic evidence for the negative phlogiston shocks that the model invokes nor any sensible theoretical interpretation of what a negative phlogiston shock would mean…

…[I]n response to the observation that the shocks are imaginary, a standard defense invokes Milton Friedman’s (1953) methodological assertion from unnamed authority that “the more significant the theory, the more unrealistic the assumptions (p.14).” More recently, “all models are false” seems to have become the universal hand-wave
for dismissing any fact that does not conform to the model that is the current favorite….

As Romer demonstrated in the paper,  when the number of variables in the model increases, the problem of identification would get worse, as econometrician would have more flexibility to feed non-factual based values into the model, so they can generate the desired prediction. 

…. [I]  will refer to things that get fed in as facts with unknown truth value (FWUTV) to emphasize that although the estimation process treats the FWUTV’s as if they were facts known to be true, the process of estimating the model reveals nothing about the actual truth value. The current practice in DSGE econometrics is feed in some FWUTVs by “calibrating” the values of some parameters and to feed in others tight Bayesian priors. As Olivier Blanchard (2016) observes with his typical understatement, “in many cases, the justification for the tight prior is weak at best,and what is estimated reflects more the prior of the researcher than the likelihood function.”

In his blog “Thoughts on ‘The Trouble with Macroeconomics’” , Narayana Kocherlakota agrees with Romer’s observations on the methodological problems in macroeconomics.

…[M]any of the most essential features of macroeconomic models have little grounding in evidence. For example, most of the models presume that:

– agents have rational expectations.

– product markets are purely competitive or are monopolistically competitive

– labor markets are purely competitive, entirely union-based, or based on fairly structured one-on-one bargaining.

All of these modeling assumptions matter for key macroeconomic questions, like the effect of monetary policy on inflation and unemployment. But they are based largely on theoretical introspection (done thirty or forty years ago!), not data…

Except for methodological problem, Romer went even further and claimed that the above-discussed issues are partly the result as macroeconomists didn’t rise up and challenge the “great masters” in modern macroeconomics, namely Robert Lucas, Ed Prescott and Tom Sargent, even when the masters are wrong.

…[B]ob Lucas, Ed Prescott, and Tom Sargent led the development of post-real macroeconomics. Prior to 1980, they made important scientific contributions to macroeconomic theory… . As a result, they developed a bond of loyalty that would be admirable and productive in many social contexts…

…[S]ome of the economists who agree about the state of macro in private conversations will not say so in public. This is consistent with the explanation based on different prices. Yet some of them also discourage me from disagreeing openly, which calls for some other explanation.

They may feel that they will pay a price too if they have to witness the unpleasant reaction that criticism of a revered leader provokes. There is no question that the emotions are intense. After I criticized a paper by Lucas, I had a chance encounter with someone who was so angry that at first he could not speak. Eventually, he told me, “You are killing Bob.”

But my sense is that the problem goes even deeper that avoidance. Several economists I know seem to have assimilated a norm that the post-real macroeconomists actively promote – that it is an extremely serious violation of some honor code for
anyone to criticize openly a revered authority figure – and that neither facts that are false, nor predictions that are wrong, nor models that make no sense matter enough to worry about….

On this front, Kocherlakota doesn’t seem to agree with Romer, as he wrote:

. I find this personalization of the problem to be extremely misleading. I say this for a couple of reasons. First, I can think of more than a few research agendas that have flourished in macroeconomics in the past thirty years without strong support – and at times active opposition – from these particular economists. Second, over the past thirty years, all of them have pushed their own research at various times in interesting directions that have (as of yet) not been adopted by the mainstream…

There are economists responded rigorously to Romer’s claims, though. one of the best example is Tony Yates. In a detailed tweetstorm, Yates tried to rebut many of Romer’s claims, implying that Romer doesn’t really understand the developments in macroeconomics in last few decades. For example, Yates explains that Tom Sargent often questions the validity of classic RBC model, opposite to Romer’s claim.

Here is the tweetstorm:

This discussion on the troubles with macroeconomics is likely to develop further, so stay tuned for more updates on this great academic debate.

Read the whole things:

– The Trouble with Macroeconomics
– Thoughts on “The Trouble with Macroeconomics

Further Readings:
– Economics, DSGE and Reality: a personal story
– The new heavyweight macro critics