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Economic Depression: A commentary on Paul Romer’s The Trouble With Macroeconomics

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By David Orrell

In a previous article for this newsletter, I wrote about the rather long and withdrawn grief process that the economics profession is working through, as it comes to terms with its role in what has become known as the Great Financial Crisis. Initial denial was followed by anger towards critics, which in turn was followed by a bargaining stage. The latter (I used Dani Rodrik’s book Economics Rules as an example) involved claims that there is nothing seriously wrong with economic models, it was just that the wrong ones were used. According to this view, critics are just attacking a simplified straw man. (We will stop attacking the straw man when it stops threatening to blow up the world financial system.)

Signs that we may be proceeding to the next stage of the grief process, depression, are evident in the recent working paper (available online) by Paul Romer, The Trouble With Macroeconomics. The first sentence of the abstract announces that “For more than three decades, macroeconomics has gone backwards.” It goes on to describe the author’s “pessimistic assessment of regression into pseudoscience.” It mentions the “serious failure” of economists such as Robert Lucas, who announced in 2003, a little prematurely, that the “central problem of depression prevention has been solved.” Decidedly non-upbeat section titles include “Post-Real Models”, “Loyalty Can Corrode The Norms of Science”, “Back to Square One”, and “The Trouble Ahead For All of Economics”.

The paper is based on a lecture given in January 2016, and is forthcoming in The American Economist. Just to be clear, this is not a magazine bent on overthrowing the status quo; indeed its web site has an entire section devoted to “Articles from Nobel Laureate Authors”. Typical paper titles are more like “My Life Philosophy” (Paul Samuelson) and “How I Work” (Paul Krugman) and “Some Gleanings From My Mind” (I made that up). So this appears to represent a significant stylistic departure. And as Paul Mason observed in The Guardian, Romer’s paper is important exactly because he is not an outsider or a rebel, but “a doyen of the profession, and from the heart of the US academic mainstream.”

The paper’s title is modelled on that of Lee Smolin’s 2006 book The Trouble With Physics. In the same way that elegant but unfalsifiable string theory has taken over high-energy physics, so mainstream economics has increasingly emphasised elegant but unfalsifiable mathematical models over experimental reality. Romer for example notes that many economic models suffer from the problem that they have more parameters than can be determined from the data. Economists therefore resort to making up imaginary inputs which give the desired answers. In string theory these are called supersymmetric particles, and have names like selectrons, squarks, and winos; Romer gives the equivalent economics versions names such as phlogiston, trolls, gremlins, aether, and caloric.

However the problems are as much sociological as they are mathematical. Just as string theory is characterised by what Smolin described as “groupthink” about the correct way to approach problems, so some economists see it as “an extremely serious violation of some honor code for anyone to criticize openly a revered authority figure … neither facts that are false, nor predictions that are wrong, nor models that make no sense matter enough to worry about.”

(It is interesting to compare that with the self-image that many economists enjoy of being open to criticism. As one wrote, while commenting on one of my books: “Economists welcome criticism. In the academy, we are well-known, if not infamous, for being direct, abrupt, and rude in criticizing each other (and others). There is a very healthy discussion about methodology. Bring it on.”)

Striving for acceptance

The paper is written with commendable honesty, along with a good dose of sarcasm, and an obvious concern for the state of economics. As Romer writes: “science and the spirit of the enlightenment are the most important human accomplishments. They matter more than the feelings of any of us.” And it makes a nice change from the usual, rather self-congratulatory commentary that “celebrates steady progress” as Romer describes.

However, while readers of The American Economist may be shocked by the paper’s content, it will be less surprising to those people who never bought into the orthodoxy in the first place, or have found themselves on the other side of groupthink. The comparison with string theory (to which I would add a shared fascination with a certain type of aesthetics) is apt, but it would have been nice to supplement quotes from dissident physicists with something from the dissident economists who have been saying the same things for decades. Instead, the focus is on spats between various Nobel-winners and other leading insiders.

For example, one of Romer’s main criticisms of mainstream theory is that it ignores or downplays the role of money. Models typically say (or assume) that the money supply plays only an incremental role in the economy. But as Romer points out, citing some Volcker-era data: “If the Fed can cause a 500 basis point change in interest rates, it is absurd to wonder if monetary policy is important.”

It is certainly refreshing to read this, since the discussion of money as anything other than a passive medium of exchange seems to be almost taboo in proper economics circles (see my review of Rodrik’s book). But again, there is no acknowledgement that these issues have long been debated outside of the mainstream.

The reason this is important is not just to give credit where credit is due (we’re well past that point); it is because this deafness to other voices is at the root of the “trouble with economics.”

Of course, depression is a state of mind that involves turning inwards. But for an area as insular as mainstream economics, the final stage of the grief process – acceptance – will only come when it finally opens up to new ideas – or even the old ideas that have been there all along.

From: p.p.10-11 of World Economics Association Newsletter 6(5), October 2016

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