April 12, 2017
Macro in a state of denial
The debate about the future of macroeconomics remind us a little about the debate about the German current account surplus. Various people or institutions criticise the surpluses. But Germany thinks of itself not as the defendant but as the judge. Not guilty, says Berlin, let’s move on and talk about Greece. Donald Trump has been the first person willing and able to mount a challenge to that position.
Similarly, economists have reacted to criticism of their profession by simply dismissing it. A good example is the long paper by Ricardo Reis, which is very defensive in tone and only concedes that there is a problem with a lack of good graduate level textbooks. He bases his defence of the profession on the assertion that young economists produce a lot of novel and exciting research - which is true - and that even macro is now gradually introducing notions of finance into its models (which misses the point of the criticism - it is not that there is no finance in them, but that there is no relevant finance in them). We cannot do justice to all points in this short review, but it strikes us that he, too, is playing both accused and judge.
One of the sections that struck us was his defence of economic forecasts. He acknowledges that their performance has not been great, but then asks in relation to what? We can answer that question. The forecasts that showed persistent upswings in the post-crisis years were not only wrong in absolute terms, but they underperformed against a random number generator, or a monkey with a dartboard. The criticism is not that the forecasts are wrong, but that they were biased. His response gives a good flavour for the defensiveness of the macro profession:
“Moreover, the supposedly most embarrassing forecast errors come with regards to large crises. Yet, these crises are rare events that happen once every many decades. Since typical economic time series only extend over a little more than one hundred years, statistically forecasting the eruption of a crisis will always come with large imprecision.”
That's a very strange defence, given that economic analysis is needed the most during those crisis. If economists say that their toolkit does not work, then they should not be surprised by the reactions they are getting. Nor should they be surprised that the public and the media are ignoring economists' views in political debates, as happened during Brexit.
We prefer Olivier Blanchard’s more constructive approach, which at least recognise the problems though it still strikes us that he tries to combine truth-telling with an attempt to cause the least amount of offence possible. This is what he had to say about the overuse of the DSGE models:
“We need different models for different tasks. The attempts of some of these models to do more than what they were designed for seem to be overambitious. I am not optimistic that DSGEs will be good policy models unless they become much looser about constraints from theory. I am willing to see them used for forecasting, but I am again skeptical that they will win that game.”