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Some [mainly hostile] links about Real Business Cycles

November 10, 2010

Erkal, if you’re reading this, then you should read this. (And the rest of you, too, of course)

This one provides a good, intuitive, and hostile summary of what’s going on in an RBC model (note: he refers to them as DSGE models, but the two terms mean roughly the same thing)

And here’s a paper in which the chair of MIT’s economics department takes gives RBC a kicking.

Finally, I reproduce [yet another hostile] post on RBC, this time by Paul Krugman

Macroeconomic Madness

“Via Yglesias, an interview with Laurence Meyer, in which he says

So I think we have two kinds of modeling traditions. First there is the classic tradition. I was educated at MIT. I was a research assistant to Franco Modigliani, Nobel laureate, and the director of the project on the large-scale model that was used at the time at the Federal Reserve Board. This is the beginning of modern macro-econometric model building. That’s the kind of models that I would use, the kind of models that folks at the Board use.

There’s also another tradition that began to build up in the late seventies to early eighties—the real business cycle or neoclassical models. It’s what’s taught in graduate schools. It’s the only kind of paper that can be published in journals. It is called “modern macroeconomics.”

The question is, what’s it good for? Well, it’s good for getting articles published in journals. It’s a good way to apply very sophisticated computational skills. But the question is, do those models have anything to do with reality? Models are always a caricature—but is this a caricature that’s so silly that you wouldn’t want to get close to it if you were a policymaker?

My views would be considered outrageous in the academic community, but I feel very strongly about them. Those models are a diversion. They haven’t been helpful at all at understanding anything that would be relevant to a monetary policymaker or fiscal policymaker. So we’d better come back to, and begin with as our base, these classic macro-econometric models. We don’t need a revolution. We know the basic stories of optimizing behavior and consumers and businesses that are embedded in these models. We need to go back to the founding fathers, appreciate how smart they were, and build on that.

“My first reaction, on reading this, was to say that Meyer overstates the case — and he does, a bit. It has been possible to publish New Keynesian models in the journals, and these models do, I think, provide some useful guidance — if only as a consistency check on more ad hoc approaches.

“But fundamentally Meyer is right. And it has been going on a longtime. By the early 1980s it was already common knowledge among people I hung out with that the only way to get non-crazy macroeconomics published was to wrap sensible assumptions about output and employment in something else, something that involved rational expectations and intertemporal stuff and made the paper respectable. And yes, that was conscious knowledge, which shaped the kinds of papers we wrote. So you could do exchange rate models that actually had realistic assumptions about prices and employment,but put the focus on rational expectations in the currency market, so that people really didn’t notice. Or you could model optimal investment choices, with the underlying framework fairly Keynesian, but hidden in the background. And so on.

“In my own case, the part of my work that intersected macroeconomics was always on the international side — and international macro kept in closer tough with Meyer’s “founding fathers” than the rest of the field. For example, we never stopped modeling and teaching fiscal policy, and hence never fell completely into the Dark Ages. But the reason, I think, was that focusing on the technical razzle-dazzle needed to model exchange rate and balance of payments issues allowed people like Maury Obstfeld and Ken Rogoff to sneak their Keynesian foundations in without attracting too much attention.

“So yes: something has gone terribly wrong in macro. And I’m sorry to say that the crisis has only made people dig deeper into their positions.”

10 Comments leave one →
  1. Erkal permalink
    November 10, 2010 1:37 am

    Sean, thanks for the post. I read the first link and enjoyed it. Although his points are all true, it would be fair to point out that there have been efforts to correct those problems. For example, there are heterogeneous agent models with evolving composition of consumers–to avoid the representative agent problem–that use Markov chains/processes.
    And also, it’s not necessarily true that the representative agent knows all the future shocks and prepare himself for them. If we’re dealing with stochastic shocks, he only knows the distribution of the productivity shocks. Obviously, that doesn’t tell him when he’ll be hit by a shock and whether it will be positive or negative.

    I’ll read the rest when I get a chance. I should probably sleep now, if I want to be on time for Micro tutorial tomorrow!

  2. Erkal permalink
    November 10, 2010 1:41 am

    On another note, this guy got his PhD in physics and is a statistician at CMU. It’s kind of strange that he’s so hostile towards RBC models, because some of the important supporters of RBC models are from there.

    • David permalink*
      November 11, 2010 10:13 am

      If you are interested I would advise you to checkout Cosma Shalizi’s blog called the Three-Toed Sloth…there is a link to it on the SGPE blog and here:

      I am an avid reader of his blog, and for me it is not strange at all that Cosma is so hostile to RBC models…

  3. November 10, 2010 6:11 pm

    Can somebody (or Rob) send a link to the orig. Nelson and Plosser paper? Google spits out many pages of reviews or later papers, but not the original one. Or maybe I am to dumb to find.
    In either case I would appreciate a link.

  4. Rob permalink
    November 10, 2010 7:12 pm

    I don’t think I can post a direct link, but if you log into the library page then you can access every journal article ever published for free – just search JME and find the 1982 edition and its all there! Pretty good right – I think I need to devote a day to downloading every article that might be of interest while I can! Also its quite fun going into the basement of the library to find the journals because they have those crazy moving bookshelves.

    Also for what its worth irt the above posts, the BoE, the Fed and the ECB all have enormously complicated DSGE models that run alongside their usual “macroeconometric” models (read enormous VAR models) and their forecasts are never as accurate as the vars. So central banks still use a modelling framework that modern academic macroeconomics from the last 30 years has yet to dent.

  5. Marcus permalink
    November 10, 2010 11:45 pm

    Cheers!!! It is a great paper, but in my eyes it is not rocket sciences. They were simply the first to apply the Fuller-stuff to economic time series. But thats what makes smart people to well reputed smart people: Be the first to do it and put it in a readable way.
    And the paper has this great old and used style. Even economics is a bit like studying history or archeology (I had the same feelings with the Moore problem sets).

  6. Jonas permalink
    November 14, 2010 10:10 pm

    I enjoyed Buiters blog post – could someone (Sean or Rob) give me hints about a good book on Economic History?


    • Sean permalink
      November 14, 2010 10:52 pm

      I have responded (sort of) here:

  7. Rob Jump permalink
    November 15, 2010 11:18 pm

    Read the Affluent Society (Galbraith)!! Its not really proper economic history, but it shows the blurred line all the best stuff follows (imo). And its really short and easy to read so won’t take up too much time (and provides lots of stuff to disagree vigorously with!). Also The Great Crash 1929 is a classic (also Galbraith). Which period are you thinking of?

    If I can find my copy I’ll lend you it, but it seems to have disappeared which sucks. .

    PS in the intro to the History of Economic Analysis Schumpeter states that if he could only study one area he’d study economic history over theory. And everyone loves schumpeter 🙂


  1. Economic History « Scottish Graduate Programme in Economics

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