Putting Economic Models in Their Place (and economists too?)

Prof. Brad Delong has a piece reflecting on the Paul Romer outlash.

Romer’s principle objection is to the assumption that the only interaction allowable in economic growth models is what is known as “price taking,” the buying or selling of goods and services at the price currently offered by the market. I would add to that my objection to the assumption that individual decision-making is always characterized by rational expectations.

Assumptions like these might be adequate as foundations on which to build models to help us understand the world, but only if market processes were structured exactly right, smoothing out at the aggregate level all the deviations from price-taking and rational expectations that are clearly evident at the individual level. Asking whether, which, and when market processes meet such criteria is an empirical question. Claiming that all market processes must be so structured is theoretical malfeasance.

And it is widespread. In the field of growth theory, Romer sees the current generation of neoclassical economists grind out paper after paper imposing the theoretical restrictions necessary for a price-taking equilibrium. As he correctly notes, such papers are useless for any purpose other than advancing their authors’ positions in academic status games.

Meanwhile, in my field, macroeconomics, I see economists, bankers, industrialists, technocrats, and politicians make the claim that the policies governments could implement to speed an economic recovery must be, if not counterproductive, at least too risky. After all, that is what a model with a very restricted class of rational expectations would predict.

At the same time, we should recognize that the problem Romer pinpoints is not a new one. Just the other day, I came across critiques of expansionary fiscal and monetary policy made by the Canadian economist Jacob Viner and the French economist Étienne Mantoux. They both argued in the 1930s (in the middle of the Great Depression!) that government efforts to boost employment would always result in undesirable and unwarranted inflation, and would probably reduce output in the long run.

What is most depressing about Romer’s argument is how unlikely it is to be heeded. Romer may be able to convince academic economists to be more cautious about making claims concerning the generality of theories of economic growth. But it is less than clear that bankers, industrialists, technocrats, and politicians – who are responsible for the policies that impact people’s lives – will do the same.

Well, if likes of Delong don’t see anything happening, then nothing really will happen. It is business as usual and we continue to make one outsized prediction after other only to be proven wrong..

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