From the Dark Ages to Renaissance

Arnold reflects on the recent history of macroeconomics:

The problem is that macro time series are nonstationary and have low statistical power. Go back to the table on labor force composition I gave earlier in this post. There is no way to estimate a model in a way that is robust to such dramatic structural changes.

Because the data are not powerful enough to reject any hypothesis against an interesting alternative, the macroeconomic "scientists" divorced themselves from the "engineers," who continued to use macroeconometric models. In my view, neither the scientists nor the engineers accomplished anything. The scientists did mathematical masturbation, with some occasional, isolated empirical work that satisfied journal referees based on whatever fads were taking place at the moment but had no lasting persuasive impact. The engineers provided forecasts and policy simulations that were precise in form and totally unreliable in substance. In any case, the engineers were kept out of economics departments.

This generation of academic macro wankers managed to achieve consensus, primarily by avoiding discussing the fundamental issues of macro--how labor markets fail to clear and how financial markets affect real activity. So we get Olivier Blanchard's smug pronouncement

a largely shared vision both of fluctuations and of methodology has emerged. Not everything is fine. Like all revolutions, this one has come with the destruction of some knowledge, and suffers from extremism, herding, and fashion. But none of this is deadly. The state of macro is good.

Now that we are in a financial crisis, this "shared vision" is turning out to be nothing of the sort. Christina Romer and Larry Summers have gone back to trusting macroeconometricians, treating model multipliers as if they were fact rather than fiction. On the other side, Fama and others seem to have gone back to some pre-Keynesian view that simply ignores the possibility that there can be such a thing as unemployment.

Unfortunately, just because mainstream macroeconomists wasted their efforts the past thirty years does not mean that the answer is to rediscover macroeconomics as it stood in 1970. The pre-Dark-Age macro is not some mystical treasure map. It has a lot of theoretical and empirical gaps that make it unsatisfying.

I find myself incorporating strands as disparate as Hayek's information theory and Minsky's risk preference cycles into my thinking. I wish I had more professional company. I agree that macroeconomics has been through a Dark Age. But I think it has a way to go in order to experience a Renaissance.