The Failure of Macroeconomics

by Mario Rizzo  

The current issue of The Economist has a very interesting article on the turmoil among macroeconomists (“The Other-Wordly Philosophers”). Essentially, the article argues that although the dominant macro model, dynamic stochastic general equilibrium theory [DSGE], appears to be in a state of near-total breakdown, there is no agreement among economists as to what should replace it.

“Would economists be better off starting from somewhere else? Some think so. They draw inspiration from neglected prophets, like Minsky, who recognised that the “real” economy was inseparable from the financial. Such prophets were neglected not for what they said, but for the way they said it. Today’s economists tend to be open-minded about content, but doctrinaire about form. They are more wedded to their techniques than to their theories. They will believe something when they can model it.”  

Therefore, it is not simply a matter of finding the right explanation of the recent financial meltdown and recession. The search by most macroeconomists is constrained by a certain set of unquestioned methodological precepts. These precepts go to the heart of the conception of Economics as a Science. They are the standards of what constitute acceptable forms of expression of economic ideas.  

First, here are some anecdotes.  

My friend Peter Boettke tells a story of a conversation he had years ago with a prominent economist. (I may have some details wrong but the main point is accurate.) The young Peter Boettke said of this person’s theory: All that is in Adam Smith. The response, dripping with arrogance, was: Maybe — but until my theory it was not Science.  

This is the great problem with economics today: methodological exclusivism (or in my more intemperate moments I call it “methodological fascism”). 

A young person goes to graduate school. He or she is filled with the excitement of ideas. Today, in particular, some may come with a great desire to understand what has happened in the real world of the bailouts, recessions, stimulus, and so forth.  And then academic reality hits.  

Formal modeling, axiomatic foundations, tractability, technical power, and topological studies. Shall I get an MA in mathematics? Do I need to take a third semester of macro-econometrics?  

As a member of NYU’s Ph.D. admissions committee for the past fifteen years, I have even seen applicants who apologize for taking “too many” philosophy courses in college. I have seen others remind us that although they have been interested in history and literature, they are fully cognizant of the need to express their ideas in precise mathematical terms.  

What of a clearly brilliant student who wants to question (or at least think about) these methodological issues? I had a colleague tell me, informally, that he would probably be a disruptive influence in the first-year classes. I guess it depends on one’s definition of “disruptive.”  

This wouldn’t be so bad if Economics as a Science were as successful as, say, modern medicine, or if the criterion of predictive success gave the dominant macro theories high marks.  

It seems pretty clear that what we have is a collective insecurity. If we open the floodgates to methodological inquiry, or even worse, to methodological pluralism, we shall become like political science, or God forefend, like sociology. So let’s keep those with disruptive instincts out of the profession. If this is not possible, then let’s at least keep them out of the good schools.  

Second, what is the root of the difficulty in which macroeconomics finds itself?  

I think it is the inability to reconcile a reasonable treatment of radical uncertainty with the strictures of out-of-control formalism. We have come a long way from Alfred Marshall’s idea that one does the mathematics and then burns it. In a 1906 letter to A.L. Bowley (of the Edgeworth-Bowley box fame) Marshall says:  

“But I know I had a growing feeling in the later years of my work at the subject that a good mathematical theorem dealing with economic hypotheses was very unlikely to be good economics: and I went more and more on the rules – (1) Use mathematics as a shorthand language, rather than an engine of inquiry. (2) Keep to them till you have done. (3) Translate into English. (4) Then illustrate by examples that are important in real life. (5) Burn the mathematics. (6) If you can’t succeed in (4), burn (3). This last I did often.”  

Clearly, the adherents of DSGE did not follow points (4) through (6).  

Furthermore, in The Economist article Perry Mehrling of Barnard College is quoted as saying:  

 “Philosophically speaking,” economists are “materialists” for whom “bags of wheat are more important than stacks of bonds.” Finance is a veil, obscuring what really matters. As a poet once said, “promises of payment/Are neither food nor raiment”.  

The objective facts are far easier to handle in the models than the shifting, subjective expectations of people trying to deal with radically uncertain futures. This is what may get reflected in financial markets. Attempting to understand all of this requires conceding that some knowledge will be imprecise and will lie outside of the box (model). The model is simply a toy that can be thrown out when it no longer suits. This means that it is indeed possible to have valuable knowledge outside of hyper-models (although, of course, all thinking proceeds in terms of assumptions and simplifications).  

But this will give the “scientists” among us headaches. As John Maynard Keynes famously said about the econometrician Jan Tinbergen, “[H]e is much more interested in getting on with the job than in spending time in deciding whether the job is worth getting on with.”  

As long as this is the dominant attitude, macroeconomics will remain “other-wordly.”  Instead, the way to greater realism is through more attention to the methodology of science and to whether “the job is worth getting on with.” Paradoxically, greater philosophical sophistication would put economists is closer touch with the real world. (Or so I hope.)   

Of course, the doctrinaire among us will no doubt reject all of this. They will tell us: Just a little more tweaking of the models is what we need.

Good luck.

26 thoughts on “The Failure of Macroeconomics

  1. There is another possible response from the theorist. Deepak Lal recounted running into a distinguished colleague, and asking him what he thought should be done about the current crisis. “I do not consider that an intellectually respectable question.” Indeed.

  2. Ah, indeed! This brought back some sour memories of my graduate school days at NYU:

    * In 1st year macro, every week we were shown a mathematical model, went through the math, and were shown the conclusions, with no thought to whether any of this made sense or had anything to do with the economy. After a while, I could hold back no longer, and said what I thought. The prof had little interest in debating the issue, and a fellow student who was sympathetic to my views pointed out that almost all the students regarded my outburst as a negative externality, interfering with their attempts to understand the math.

    * When it came time to recruit a dissertation committee, I discussed my topic with one prospective committee member, with the blunt message that I didn’t intend to do any formal modeling in the dissertation. He, equally bluntly, told me that without either formal modeling or some econometrics, he wouldn’t sign off on a Ph.D. Amazing criteria: they completely rule out dissertation topics in huge areas of economics. Needless to say, I kept him off my committee.

    But the methodological fascists won – I fled economics as soon as I finished the Ph.D. In what I regard as a repudiation of those who assume that any reputable economist would choose not to use math only because he can’t do math, I am happily ensconced in a career as an actuary, where I use math when it makes sense, and avoid it when it doesn’t.

  3. Awesome post. We have been feeling this at the University of Florida in our Economics Society for a few years. More interestingly, several of our members have gone on to PhD programs with exactly the type of experience you recount.

    Part of the problem is institutional, no? Macroeconomics may be full of cheap, street corner preaching, but it sounds intelligent and relevant, and assumptions underlying much of its current study also gird the idea that policy-making is (always!) the way to make people’s lives better.

    I smell revolution in the air.

  4. I wonder how much these mathematical advocates use models in managing their own personal funds.

    During my research analyst days, a high profile econometrician, who had a best selling college text on the subject, would call me regularly and ask for my decidedly non-econometric views on, of all things, gold–which he was clearly day trading.

  5. Great post. I had some economics as a kind of minor subject in college. I am so fascinated that I really like to study it in full. But the math just puts me off. It is not that I do not like it…I can not see the use of it. It often seems detached from reality. What really interests me is the connections between economics and philosophy.

  6. I think the trouble with macroeconomics is that human behavior is too unpredictable. Economists hope that rationality will create order that can be modeled. The behavior of large groups of people seems to be irrational enough to make modeling difficult.

    I’m not sure what the answer is. However, more complex mathematics isn’t going to solve macroeconomic problems.

  7. Incidentally, this was basically why I switched from economics to philosophy. Great post, Dr. Rizzo!

  8. As someone familiar with Austrian economics, you should be very much aware that Wieser would say that the statement wages equal the marginal product of labor is mathematical nonsense. Wages are measured in money, and the marginal product of labor is measured in real output. The two simply can’t be equated. Thus the Austrians avoided the use of mathematics in economics. Mainstream economists are totally unaware of both Wieser and the mathematical impossibility of what they are saying.

    The key problem is the attemmpt to base everything on real analysis. The statement about wages can be made correct by simply multiplying the marginal product by the price of output. But this introduces money as an integral part of the analysis, and this is what mainstream economists stubbornly refuse to do.

    Some years ago, I attended some lectures by Robert Barro at the University of Chicago. He had recently made quite a name for himself by translating Keynes into the calculus of variations. I pointed out that all his equations violated the second order conditions for a maximum in the calculus of variations. Many of out best economists are quite incomepetent in their use of advanced mathematics.

  9. Excellent post, Mario.

    I’d comment that the fundamental problem is not mathematics per se, as some seem to think. The problem is faulty concepts and assumptions, as well as a phony empiricism that is detached from the real world.

    I heard Mark Gertler (Rizzo’s colleague at NYU, & my monetary theory prof) explaining on NPR how the brilliant model he and Bernanke developed in the 90s was guiding our monetary policy through the crisis. What he neglected to say was that he and Bernanke were blindsided by this mess…as were the rest of the mainstream macro people. What a scam.

    BTW, Menzie Chinn of Econbrowser has just posted a rebuttal of sorts, defending macro:

    I’d like to see you post a response.

  10. One has to be careful not to confuse two things. (1) mathematics as a tool (2) the kind of models to which mathematics is applied

    I just finished refereeing a paper that was outside the mainstream, though I consider myself very much a mainstream economist. I guess a lot of the ‘macroeconomics went wrong’ crowd will now expect me to say that I found the main thesis of the paper to be crap — but I did not. However, I saw many mistakes in specifying the interaction of economic agent, because the author did not carefully do his math. And it mattered, because it (potentially) invalidates results (the results that are at first sight intuitive, but then when you work through the math, are just as intuitively wrong).

    Of course people misapply tools, but one should not equate tools with ends.

    Moreover, teaching people the same tools in graduate school is a bit of a necessary evil; if everybody has his own type of screwdriver and produces his own type of screws, it would be impossible to fix somebody else’s radio/car/etc.

    It’s a valid point that macroeconomics in general did not give banking and financial frictions the proper attention. It’s something different entirely that therefore all methods applied before to perhaps less important other problems are should be disregarded. Let’s also see how for stochastic general equilibrium models supplemented with appropriate trading frictions bring us in explaining what’s happening now.

    It’s really easy to just complain about somebody else’s work …

  11. I am not simply complaining. I am saying that economists tend to resist reflection on their methods. It is one thing to say that mathematics is a tool, but the reality is that mathematics is not simply logic (as many people conveniently pretend it is). Certain methods, for better or for worse, constrain what you can say. Let’s see whether it is for better or for worse. My point is that the constraints do not necessarily produce benefits that offset their costs. I may be wrong. But most “conventional” economists I know don’t want to think about the issue seriously. I want to “force” them to do so.

  12. I definitely agree with Rizzo. Economics concentration on mathematical models is highly overrated. Econometrics can be used as a tool to attempt to explain real world movements, but the problem that arises is that many of the assumptions are not viable in the real world.

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