Wednesday, May 26, 2010

Models and reality

The dustup between Mark Thoma and David Andolfatto summarized by Rajiv Sethi is perhaps more symptomatic of the divide between - at extreme risk of too much simplification - "new" macroeconomists and "old" macroeconomists. The macroeconomists of my generation were taught DSGE models. Facts were "stylized" facts, i.e. first and second moments of "key" economic variables such as GNP, investment and consumption. During my entire 6 years at graduate school things like institutional details and historical events that may have affected the economy were laid aside or treated as not being "relevant" to the model. Economies were frictionless and markets always cleared. Sure, some frictions were eventually introduced but perhaps the biggest elephant in the room was that the curriculum cultivated us with a certain attitude that:
1) There are those who can build DSGE models and there are those who can't.
2) All partial equilibrium models can be dismissed off hand.
3) All structural equation models are completely irrelevant especially those not based on DSGE models. (IS-LM or Keynesian "cross" models are definitely in this category.)
4) Any paper that does not present a model can be dismissed - this included narratives as well as historical papers.

Perhaps the economists who fail to understand history will be doomed to repeat them?

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