April 15, 2015 New York Times by Paul Krugman — There’s been another blogospheric debate on methodology, this time involving a currently fashionable critique of mainstream macroeconomics — namely, that it’s too reliant on linear models and fails to make allowance for multiple equilibria. Frances Coppola and Wolfgang Munchau are leading the charge, with Roger Farmer (I think) in support; Brad DeLong and Tony Yates beg to differ. So do I.
There’s plenty wrong with macroeconomics as practiced, and plenty more wrong with macroeconomists as practitioners — and I haven’t been shy about pointing these failings out. But this is the wrong line of attack, for two reasons.
First, claims that mainstream economists never think about, and/or lack the tools to consider, nonlinear stuff and multiple equilibria and all that are just wrong. Tony Yates notes Munchau declaring that the zero lower bound is a minefield that economists have avoided; what? As Yates says,
The implication is ‘ooh, look at this really obvious real world thingy that economists just can’t deal with’. But actually, they can and do, and it’s embraced by 100s of papers now, since Krugman wrote the first modern one in 1998.
What about multiple equilibria? Well, most of my academic macroeconomic work is in international macro, especially on currency crises, and in that sub-field multiple equilibria — oh, and the effects of leverage and balance sheet effects — is a long-standing part of the approach. Here’s my 1999 paper on a multiple-equilibrium approach to the Asian financial crisis. For that matter, Diamond-Dybvig — the standard model for thinking about bank runs — is all about multiple equilibria and self-fulfilling prophecies.
So if your assertion is that economists don’t have the tools to think about such things, and/or are too boring and conventional to go there, well, that’s just uninformed. Been there, done that.
But maybe the complaint is simply that economists don’t do enough nonlinear analysis. And I can say personally that while I am, I think, pretty well aware of the possibilities of multiple equilibria and all that, they aren’t the staple of my analysis. There is, however, a reason for that: that kind of stuff is too easy and too much fun.
When you first start playing around with multiple-equilibrium models — in my generation that generally happened in grad school — there’s a period of enthusiasm. Crazy things can happen! Anything can happen! I can write down a model in which X leads to Z instead of Y!
Also, you can call spirits from the vasty deep. But will they come when you do call?
The point is that it’s quite easy, if you’re moderately good at pushing symbols around, to write down models where nonlinearity leads to funny stuff. But showing that this bears any relationship to things that happen in the real world is a lot harder, so nonlinear modeling all too easily turns into a game with no rules — tennis without a net. And in my case, at least, I ended up with the guiding principle that models with funny stuff should be invoked only when clearly necessary; you should always try for a more humdrum explanation.
So, was the crisis something that requires novel multiple-equilibrium models to understand? That’s far from obvious. The run-up to crisis looks to me more like Shiller-type irrational exuberance. The events of 2008 do have a multiple-equilibrium feel to them, but not in a novel way: once you realized that shadow banking had recreated the hazards of unregulated traditional banking, all you had to do was pull Diamond-Dybvig off the shelf.
And since the crisis struck, as I’ve argued many times, simple Hicksian macro — little equilibrium models with some real-world adjustments — has been stunningly successful. Notice, by the way, that in the linked post I do include the zero lower bound — no minefield here — which in turn makes the model nonlinear, with a qualitative change in behavior when the economy is sufficiently depressed that the zero bound is binding. But all that comes straight out of a quite simple framework, with no huffing and puffing and diatribes against conventional economics.
As I said, there are plenty of problems with economics. But I’d argue that ranting about the need for new models is not helpful; in policy terms, our problem has been refusal to use the pretty successful models we already have.