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Friday, September 04, 2009

Beauty and the Macroeconomic Beast

Discover Magazine's blog Cosmic Variance responds to Paul Krugman's essay How Did Economists Get it So Wrong?:

...One part of the essay worth commenting on, or at least musing about, is the punchline. Krugman thinks that a major factor leading to the failures of economics to understand the mess we’re currently in was the temptation to think that beautiful models must be right. ...
Without knowing much of anything about the relevant issues, I nevertheless suspect that this moral might be a bit too pat. Sure, people can fall in love with beautiful theories, to the extent that they overestimate their relationship to reality. But it seems likely to me that the correct way of understanding all this, once it’s properly understood, will look pretty beautiful as well. General relativity is widely held up as an example of a beautiful theory — and it is, when understood in its own language. But if you put the prediction of GR in the Solar System into the language of pre-existing Newtonian physics (which you could certainly do), it would look ugly and ad hoc. Likewise, Newton’s theory itself is quite elegant, when phrased in the language of potentials on a fixed spacetime background; but if you express the theory in terms of differential geometry (which you could certainly do), it looks like a mess. Sometimes the beauty/ugly distinction between theoretical conceptions is more a matter of how well we understand them, and less about their intrinsic qualities.
So my counter-hypothesis would be that it wasn’t beauty that was the problem, it was complacency. If you have a model that is beautiful and works well enough, you’re tempted to take pride in it rather than pushing it to extremes and looking for problems. I suspect that there is a very beautiful theory of economics out there waiting to be developed, one that understands perfectly well that individuals aren’t rational and markets aren’t perfect. One that has even more impressive-looking equations than the current favored models! Beauty isn’t always a cop-out.

I'm not sure if complacency is the right word, there is great credit in the profession for finding anomalies within the existing framework. The problem is that it's almost always possible to tweak the existing model in some way that rationalizes any new regularity discovered in the data that is at odds with existing theory. And without the ability to take the models to the lab and subject them to experiments, there's no way to immediately test the augmented theoretical structures (and as I've noted before, of course the models will pass the test with existing data, they were built to rationalize all the important known regularities in the data). It's only when a lot of time has passed and we have enough data to sort things out, or when we have large shocks of the type we've recently had, that we get the kind of information that we need to subject models to rigorous tests.

In addition, we didn't have "a model," we had competing models all of which claimed to be able to explain the known regularities in the data, and while I think the evidence does point in one direction, the existing pre-crash evidence was not conclusive enough to seal the case for one model over another, or to point in a new direction altogether. As I said once before, "I think what has happened will have a much bigger impact on the profession and the models it uses to describe the world than most economists currently realize," and hopefully this shakeup will move macroeconomic theory in a positive direction. With any luck, "the correct way of understanding all this, once it’s properly understood, will look pretty beautiful."

    Posted by on Friday, September 4, 2009 at 12:51 PM in Economics, Methodology | Permalink  Comments (41)

          


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