Wednesday, November 16, 2011

Mark Thoma On Economists and The Future Of Economic Models

He’s responding to a Roger Martin essay (which you can read here) (excerpt):

Should economists be “imagineers” of our future?
By Mark Thoma

...I agree that macroeconomists need to fix their models. But I don’t think that predicting the future based upon “a straight-line projection of the past” is the problem...

...This year’s Nobel prize award to Thomas Sargent and the previous award to Robert Lucas were partly in recognition of their development of the tools and techniques that economists need to go beyond simply trying to extrapolate the future from the past, a procedure that can lead forecasters astray…

…people change their behavior in response to changes in the conditions they face. And this is one of the things that separate what researchers in the hard sciences do from the work of economists…

…This means that backward looking extrapolative estimates — the straight line projections objected to above — can give wrong answers about changes in economic policy…

…I am in agreement with the argument that our models need to be improved. But the problem is not mindless extrapolation from the past. As the discussion of the recent Nobel prize awards above shows, we are well aware of the limitations of that approach. Nor is the problem the failure to abandon models and move on to new ones when they cannot adequately explain the data. In my career, the attempt to find models that can explain past data and predict future data with more accuracy has caused Old Keynesian models and New Classical Models to be replaced by Real Business Cycle and New Keynesian models.

And it’s time for that to happen again. One of the big problems with the existing class of macroeconomic models is the failure to adequately incorporate the possibility and consequences of a meltdown in financial intermediation. There are technical reasons for this, and also the fact that many macroeconomists did not think a Great Depression style financial meltdown was possible and hence it wasn’t important to invest time asking questions related to such an event. That was a mistake, when financial intermediation began to malfunction we did not have the models we needed, and this was far from the only mistake we have made.

Presently, there is no shortage of work trying to fix the problems with our models. I don’t know if we will succeed — the next model will work until it doesn’t — but we are certainly trying. And there is also no shortage within economics of “imagining things other than as they are,” a phrase the author uses repeatedly…

Reviewing the present output of academic literature, I agree with Prof Thoma – there’s been a concerted effort to explicitly incorporate the financial sector into present modelling frameworks, with varying degrees of success (if you think the glass is half full) or failure (if its half empty).

I don’t think there’s really a big consensus as yet, and we still have some strange holdovers who insist that markets are efficient and unemployment is a voluntary change in the leisure/work balance (!!). The only big idea that has come out of the Great Recession so far has been market monetarism, which is more related to stabilisation policy.

But every crisis, every policy that goes wrong, adds to the sum of human knowledge and wisdom about our own collective interactions and behaviour. I’m not minimising here the pain and suffering of millions of people who’ve lost jobs and businesses, but getting it wrong (very wrong), would be a greater tragedy only if we don’t learn from our mistakes.

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