Some Thoughts on the State of Macro

N. Kocherlakota (Minnesota)[links to pdf via brad delong] 

These researchers have been much more interested in the consequences of shocks than in their sources.

Why do we have business cycles? Why do asset prices move around so much? At this stage, macroeconomics has little to offer by way of answer to these questions. The difficulty in macroeconomics is that virtually every variable is endogenous – but the macro-economy has to be hit by some kind of exogenously specified shocks if the endogenous variables are to move.

The sources of disturbances in macroeconomic models are (to my taste) patently unrealistic. Perhaps most famously, most models in macroeconomics rely on some form of large quarterly movements in the technological frontier. Some have collective shocks to the marginal utility of leisure. Other models have large quarterly shocks to the depreciation rate in the capital stock (in order to generate high asset price volatilities). None of these disturbances seem compelling, to put it mildly. Macroeconomists use them only as convenient short-cuts to generate the requisite levels of volatility in endogenous variables.

This particular group of younger scholars has worked more on the consequences of these disturbances and less on uncovering their true sources. I suspect that this ranking of priorities can be attributed in part to the Great Moderation of 1982-2007. Recent events may well lead to a shift in research priorities.

The modeling of financial markets and banks in macroeconomic models is stark.

It is not true that all macroeconomic models assume complete financial markets – quite the contrary (see point 2 above). However, few macroeconomic models capture an intermediate messy reality in which markets are incomplete but there are nonetheless many assets and/or asset trade is conducted through intermediaries. As a consequence, we don’t understand the sources (or costs/benefits) of large-scale daily (or even quarterly) financial asset re-allocation.

In part, this omission reflects a belief among macroeconomists that this level of institutional detail was not essential for questions of interest. In part, it reflects the

extreme difficulty in handling mathematical formalizations of these features of reality (see point 9 below). Again, recent events may well lead to a re-ordering of priorities.

Macroeconomics is mostly math and little talk.

The work of the people on this list is pretty technical. Most are very gifted intuitive economists. But intuition necessarily plays a limited role in macroeconomics. There are just too many things going on in a macroeconomic model of any interest to rely on intuition alone. Intuitive explanations invariably end up focusing on one or two of the many equations in a macro model (let alone the many more that operate in the world). The other equations might well end up undoing an effect that seems perfectly reasonable from just looking at one equation in isolation.

I believe that it is our need to formalize ideas and intuitions in mathematics that leads to a key misperception about macroeconomics, even among other economists. Macroeconomic models leave out many possibly important features of the real world. Sometimes, we choose to do so. Far more often, we leave out these aspects of reality because we

must: given our computational and conceptual limitations, we simply cannot handle these things in our mathematical models.

The good news is that, thanks in part to the people on this list, we’ve made enormous progress in the kind of realistic complications that we can usefully model. Of course, there is always more left to be done – and recent events have certainly pointed out useful directions for future work.

 The macro-principles textbooks don’t represent our field well.

Little of the exciting work that’s been done by this group has made its way into undergrad textbooks. That’s probably inevitable. But it leads to a real misunderstanding about what macroeconomists do – both among lay-people and among economists in other fields. I hope that some of our gifted textbook writers rectify that situation soon!

 

Posted via email from Jim Nichols