Economic Modelling: Status Quo Ante

While there have been alternatives proposed (see for instance this post), large scale structural and stochastic models are still the bread and butter of macropolicy. Yet the inability of virtually every statistical model to provide substantive guidance on policy issues remains a problem.

This article on VoxEU provides an insight as to why (excerpt; emphasis added):

Dynamic stochastic general equilibrium models and their forecasts
Rochelle M Edge & Refet S. Gürkaynak

Dynamic stochastic general equilibrium (DSGE) models represent a major strand of the modern macroeconomics literature and are an important tool for policy analysis at central banks...

...The success of the DSGE model-based forecasts relative to other methods was viewed as evidence in favour of DSGE models’ reliably capturing the dynamics in the data…

...To see the absolute forecasting ability of the DSGE model, we run a series of standard forecast efficiency tests, where the realised inflation is regressed on forecasts made at different times in the past. A good forecast should have a zero intercept and unit slope as well as a high R-squared. Table 1 shows the efficiency tests for DSGE model forecasts of inflation at different maturities and demonstrates clearly that the forecasts are very poor. R-squareds at all horizons are essentially zero, implying no forecasting ability. All Figure 1 is therefore telling us is that all other forecasting methods perform just as poorly....

Lovely, Lovely Post On The State Of Macro-modelling

I stumbled on this post this morning, via The Economist magazine’s Free Exchange blog:

The Emperor has no Clothes: MA on the state of "modern" macro

Much has been made of the failure of modern macroeconomics to predict or understand the Great Recession of 2007–2009. In this MACRO FOCUS, our resident time-series econometrician, James Morley, explains what is currently meant by “modern” macroeconomics, what is behind its failure, and what can be done to rehabilitate its reputation.

This should be required reading for undergraduate and graduate economics students interested in applied work. It’s highly wonkish for everybody else (lots of jargon and math), but if you’re interested in the mechanics of macro-modelling, it’s well worth a read.

Links of the Day

Esther Duflo says we can't trust bankers:

"There is another argument, implicit or explicit, for the nationalisation of banks; we can not trust bankers not to leave with the cash, let alone spend any assistance whatsoever in the general interest. Two recent studies that analyse the experience of recent years show that they will not hesitate to enrich themselves at the expense of the public good if they have the opportunity."

Willem Buiter offers a stinging critique of modern macroeconomics:

"In both the New Classical and New Keynesian approaches to monetary theory (and to aggregative macroeconomics in general), the strongest version of the efficient markets hypothesis (EMH) was maintained. This is the hypothesis that asset prices aggregate and fully reflect all relevant fundamental information, and thus provide the proper signals for resource allocation. Even during the seventies, eighties, nineties and noughties before 2007, the manifest failure of the EMH in many key asset markets was obvious to virtually all those whose cognitive abilities had not been warped by a modern Anglo-American Ph.D. education."