Archive for August 13th, 2009

Historical account of macroeconomic modelling

August 13, 2009

I came across this short paper by 4 economists  on macroeconomic modelling. The focus of the paper is on the need for simpler macroeconomic models and go beyond DSGE models.

This paper argues that macro models should be as simple as possible, but not more so. Existing models are “more so” by far. It is time for the science of macro to step beyond representative agent, DSGE models and focus more on alternative heterogeneous agent macro models that take agent interaction, complexity, coordination problems and endogenous learning seriously. It further argues that as analytic work on these scientific models continues, policy-relevant models should be more empirically based; policy researchers should not approach the data with theoretical blinders on; instead, they should follow an engineering approach to policy analysis and let the data guide their choice of the relevant theory to apply.

 I liked the paper more for its interesting account (brief though) of the history of macroeconomic modelling. It tells you how the thinking evolved and finally we had a DSGE model. Here is a sample: 

The reason researchers clung to the rational expectations representative agent models for so long is not that they did not recognize their problems, but because of the analytical difficulties involved in moving beyond these models. Dropping the standard assumptions about agent rationality would complicate the already complicated models and abandoning the ad hoc representative agent assumption would leave them face to face with the difficulties raised by Sonnenschein, Mantel and Debreu.

Building more realistic models along these lines involves enormous work with little immediate payoff; one must either move beyond the extremely restrictive class of economic models to far more complicated analytic macro models, or one must replace the analytic modeling approach with virtual modeling. Happily, both changes are occurring; researchers are beginning to move on to models that attempt to deal with heterogeneous interacting agents, potential emergent macro properties, and behaviorally more varied and more realistic opportunistic agents.

Thankfully we are seeing some changes with more realistic model setting. However, the rep agent model is still too powerful.

Anyways a nice short discussion on history of macro modelling.


US unemployment in recessions- Historical comparison

August 13, 2009

I had pointed about a very useful short research notefrom  FRBSF economists. It said high unemployment trends are going to continue as firms would recruit from already slack labor markets.

Here is another superb paperfrom Kansas Fed economists Edward S. Knotek II and Stephen Terry givings us more ideas on US unemployment in this crisis.

In this paper the authors:

  • Compare unemployment trends with all previous Post WWII crisis (current rate is still lower than 1981-82 crisis)
  • Last 2 recessions 1990-91 and 2001 were what is called as jobless recovery. It looks at reasons for the same. There are 3 reasons – 1) firms delayed restructuring, 2) mild recessions are followed by weak recoveries leading to lower rise in employment, 3) the firms have moved from temporary lay-offs in previous recessions to permanent lay-offs in 1990-91 and 2001 recessions. Temporary lay-offs can be reversed quickly but not in permanent lay-offs case.
  • Compares the US unemployment with unemployment in other major advanced economies banking crisis
  • Then it forecasts US unemployment taking international experience and forecasts US unemployment with just recession and recession+banking crisis.
  • As it is recession +banking crisis it does not look good at all as unemployment is at 6.5% in 2018. Moreover, the growth in labor markets is very slow.
  • However, there is a caution as US labor markets are very flexible and drawing from international experiences may not be right.

A very useful paper on a very hot issue.

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