The current crisis certainly requires the economics research community to reflect on the appropriate allocation of research effort in terms of topics and methods. Willem Buiter gives his views here.
The current crisis certainly requires the economics research community to reflect on the appropriate allocation of research effort in terms of topics and methods. Willem Buiter gives his views here.
10 replies on “Buiter on Research in Macroeconomics”
No doubt there has been sub-optimal allocation of resources, but personally I think much of this breast-beating about the Economics Profession as a whole is misplaced. People who like studying anti-inflation policy study inflation: there are a lot of these and it is not a particularly difficult topic. There is currently essentially no inflation in advanced economies.
People who study systemic collapses do their thing. They have not been much in demand for the past 70 years, except in developing countries. For inherent reasons, systemic crises are difficult to predict — though easy to detect a zone of vulnerability as many economists did in this case for several years past. Moving the economy out of the zone of vulnerability is the job of regulators. As I have argued elsewhere, they failed because they were seduced by a flawed understanding of how accurate risk-management models are. These flaws were known and were railed against for years by close observers of the Basel process including myself.
Formal modeling of systemic crises problem is analytically very intractible, so it hasn’t engaged as many top theorists (who are naturally attracted to doable problems). Buiter has mentioned some of the top applied economists who have worked in the field. They were not ignored by students of the field.
Methinks Willem Buiter is settling some undisclosed scores. We are not in this mess because stochastic general equilibrium theorists got it wrong. We are here because of excessive aggregate credit growth, excessive leverage, dodgy lending, and opaque derivatives. Not one of these problems is new and all were spotted and publicised. There has been a failure of regulation and supervision, magnified by the globalisation of financial markets. The 100% mortgage, based on falsified income figures, was not invented by macro-theorists.
Question: If you could teach either macroeconomics or history to trainee regulators, which would you choose?
Seems like Willem Buiter is having a Minsky Moment, on quite a few levels.
If it is breast beating, then so be it. But I do sense that there is much frustration amongst macroeconomists that their warnings were not listened to. Cassandra complexes abound.
Perhaps markets are, like Schrödinger’s cat, beyond analysis that does not corrupt the subject. By measuring them are economists not effecting an outcome? I’m probably committing heresy here, so maybe I should not look to far down this road.
@Colm trainee regulators should learn sociology, law, history, game theory, maths and yes, macroeconomics. But then they’d be well qualified to become investment bankers too… Can morality be taught?
A couple of comments. First, I found the piece the most entertaining debunking of macroeconomics since Larry Summers’ priceless article “The Scientific Illusion in Empirical Macroeconomics”. We have to be able to laugh at ourselves every so often.
Second, I think most macroeconomists — even the people Buiter is explicitly criticizing — would recognize many of these criticisms as fair and would accept the current vintage of modern macro as not having been very useful during the current crisis.
Finally, yes it’s true that it’s a tricky to incorporate financial frictions (and in particular, system risk) into these models. But’s it’s not impossible and the DSGE guys haven’t tried very hard. For instance, Woodford’s new paper that attempts to get at this issue (Credit Frictions and Optimal Monetary Policy) has a model with two types of consumers with
differing preferences for consumption today. One group lends to the other
but must do so via a banking technology, the efficiency of which changes
over time. This is about as minimalist description of credit frictions as you could come up with and it still takes him 80 pages to do it! I get the impression that the Christiano, Motto, Rostagno stuff is a bit more advanced but haven’t read them closely.
Colm: your question about history versus macroeconomics is a false opposition in my view. The top graduate economics PhD programmes in the US traditionally had an economic history requirement (they all did, bar Princeton I think, when I was in grad school), and for good reason given that our subject is ultimately the real world. (This requirement has been eroded in recent years, sadly.) Regulators, and economists generally, need theory, but theory tempered with a knowledge of how the world actually works.
(I know, this is special interest pleading, and I feel suitably guilty about it!)
I think the insight to be gained from Buiter’s post is not whether regulators should learn macroeconomics or history but rather what kind of macroeconomics should they learn. The last 20 years has seen a dramatic shift towards the use of dynamic general equilibrium models as the only way to teach (and practice) macreconomics. Yes I know there are exceptions but I think that the general trend has been quite clear. In market clearing models with rational expectations it is very difficult to say anything interesting about what actually happens in an economy when there are large falls in aggregate demand. At the very least we should learn to be more skeptical of such models given their inability to explain the kind of macroeconomic fluctuations that we are currently witnessing around the world.
Colm may be right in saying that problems such as dodgy lending, opaque derivatives etc. were spotted and publicised but I think it is wrong to think that these problems were given much attention before the sub prime crisis begain in 2007. Robert Shiller has noted that he felt reserved talking about bubbles and financial instabilty in 2004 and 2005 because the general reaction from economists was so negative and dismissive.
Behind (well behind in most cases) every dodgy derivative lies a very smart finance expert or economist of some kind who has recommended to his sales people that they should market a particular product. David Colander and others have raised the issue of whether there should be a code of conduct for economists to ensure that adequate warnings are given about the risk of such products.
I think we have a ong way to go before we conclude that too much breast beating has happened.
Lorcan. I believe it is Heisenbergs uncertainty principle which describes the phenomenon you allude to. However halfway through Buitner and rapidly losing the will to live amongst that hail of verbiage, I would certainly have taken my chances with Schrodingers cat!
It is certainly over the top to claim “the manifest failure of the EMH in many key asset markets was obvious to virtually all…”. Just try beating those markets with the superior analysis toolbox that a “modern Anglo-American Ph.D. education” gives you. Either the education was not worth a dime, or those markets are not all that inefficient after all. Everything in my 20 years+ experience suggests the latter. Even today. Even with superior information. Mind you, good intelligence does help. And any market practitioner without it is a sham. But it takes 2 (hopefully many more) to make a market. And not everyone has the same information set.
I for one have found the insights of all the insights to conventional macro theory helpful… maybe not convincing, but at least a peg to organise ideas. Buiter indeed does a good a good job of reminding us of the limits to what we know. Not that we are surprised. No on disagrees that the maths is often “too hard” to solve, nor the value of approximations.
A far more constructive article, from an economist that has a wide following at the ECB, and among practitioners, can be found here . Guess who ? His analysis reads very true to me. I hope to get my hands on his book shortly.
colm mccarthy: “The 100% mortgage, based on falsified income figures, was not invented by macro-theorists. ”
No, but the models refused to countenance that the masses, egged on by the politicians and the marketers, would believe that asset prices could outrun inflation forever. Even worse than creating these daft mortgages, the models couldn’t even acknowledge their existence. This blindness ensured they wouldn’t be regulated and ensured their domination over us all.
I loved this piece.
Disclaimer: I have zero economic qualifications, but I couldn’t help but chipping in.
From the WSJ article linked to by Ciarán: “The greater the degree of monetary excess in a country, the larger was the housing boom.”
Cause and effect? Which is which? Could it be that a housing bubble meant, somehow, that less money was spent on consumption and therefore that inflation was artificially low. This then meant the central banks had to increase money supply?
On second thoughts, I’m not too happy with my own theory. But I don’t buy the simple theory in the WSJ article. I don’t like these witchhunts looking for a single cause. I think it’s more like a series of vicious circles.
Why not blame it on the collapse of communism? With the old enemy defeated, the US and its cronies didn’t have to worry about keeping a real economy functioning for the long haul, supplying happy workers and military resources. They could ignore the risks, and abandon the prudence and regulation that saved capitalism in the first half of the twentieth century.
In reality there are a lot of people that should go to jail, and otherwise be removed from power. Don’t let them off because they point and say “But, that other guy started it.”