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Friday, June 10, 2011

Caballero: Pretense of Knowledge Syndrome

Ricardo Caballero on the state of macroeconomics:

...Region: At the end of last year, you published a rather biting critique of the way both academic and central bank researchers practice macroeconomics.18 You warned that what you called the “pretense-of-knowledge syndrome” is dangerous for both methodological and policy reasons.
Would you briefly review that critique and elaborate on what you consider a silver lining—that by seeking tools and policies that are robust to the “enormous uncertainty to which we are confined,” we can make some progress? ...
Caballero: ...I’m about to teach a course in which I will, in the introduction, talk briefly about this methodological issue. But I still need to teach the basic models. That won’t change.
In fact, I think it is very important to clarify that I am not antimodel. On the contrary, the economy is so complex that there is little hope of understanding much without models. I just don’t want these models to acquire a life that is independent from the purpose they are ultimately designed to serve, which is to understand the functioning of real economies.
The critique part of the paper you refer to argued that the current core of macroeconomics has become so mesmerized with its own internal logic that it begins to confuse the precision it has achieved about its own world with the precision it has about the real one.
There is absolutely nothing wrong with building stylized structures as just one more tool to understand a piece of the complex problem. My problems with this start when these structures take on a life on their own, and researchers choose to “take the model seriously”—a statement that signals the time to leave a seminar, for it is always followed by a sequence of naïve and surreal claims.
The quantitative implications of this core approach, which are built on supposedly “micro-founded” calibrations of key parameters, are definitely on the surreal side. Take, for example, the preferred “micro-foundation” of the supply of capital in the workhorse models of the core approach. A key parameter to calibrate in these models is the intertemporal substitution elasticity of a representative agent, which is to be estimated from micro-data. A whole literature develops around this estimation, which narrows the parameter to certain values, which are then to be used and honored by anyone wanting to say something about “modern” macroeconomics.
This parameter may be a reasonable estimate for an individual agent facing a specific micro decision, but what does it have to do with the aggregate? ...
My point is that by some strange herding process, the core of macroeconomics seems to transform things that may have been useful modeling short-cuts into a part of a new and artificial “reality.” And now suddenly everyone uses the same language, which in the next iteration gets confused with, and eventually replaces, reality. Along the way, this process of make-believe substitution raises our presumption of knowledge about the workings of a complex economy and increases the risks of a “pretense of knowledge” about which Hayek warned us in his Nobel Prize acceptance speech.
Region: We mistake the model for truth itself.
Caballero: Yes. It is much more convenient to talk about things we understand than about things we are struggling to understand. But at the end of the day, we’re supposed to explain the things that are hard to understand, so we are spinning the wheels to help us feel busy rather than making actual progress.
Region: What should be done to improve this state of affairs?
Caballero: I argue in the paper that there are lots of useful insights being produced in the periphery of macroeconomics, and that perhaps a key step is to embrace the complexity of the environment and what it does to economic agents and their decisions, as well as to our conclusions as researchers. I think the work on robust control by Hansen, Sargent and others is a step in the right direction, although it still assumes that policymakers know too much.
But a big part of my point is that no one really knows with any certainty what we need to do next, and hence we need to allow for much more freedom of exploration. We shouldn’t specialize so much in one particular class of models because we’re not sufficiently close to an absolute truth to do that. That’s the optimal thing to do when you’re very close to the global maximum, which we are not. We should be a lot more tolerant of alternative approaches and never forget our mission, which is to help understand an overwhelmingly complex reality, not to replace it with one that is more convenient to us as researchers.

On his point about being tolerant of alternative approaches, I agree:

...current macroeconomic models are unsatisfactory. The question is whether they can be fixed, or if it will be necessary to abandon them altogether. I am OK with seeing if they can be fixed before moving on. It's a step that's necessary in any case. People will resist moving on until they know this framework is a dead end, so the sooner we come to a conclusion about that, the better. ...

But there's no reason to wait until we know for sure if the current framework can be salvaged before starting the attempt to build a better model within an entirely different framework. Both can go on at the same time. What I hope will happen is that some macroeconomists will show more humility they've they've shown to date. That they will finally accept that the present model has large shortcomings that will need to be overcome before it will be as useful as we'd like. I hope that they will admit that it's not at all clear that we can fix the model's problems, and realize that some people have good reason to investigate alternatives to the standard model. The advancement of economics is best served when alternatives are developed and issued as challenges to the dominant theoretical framework, and there's no reason to deride those who choose to do this important work.

I do think the tools and techniques macroeconomists use have value, and that the standard macro model in use today represents progress. But I also think the standard macro model used for policy analysis, the New Keynesian model, is unsatisfactory in many ways and I'm not sure it can be fixed. In any case, in my opinion the people who have strong, knee-jerk reactions whenever someone challenges the standard model in use today are the ones standing in the way of progress. It's fine to respond academically, a contest between the old and the new is exactly what we need to have, but the debate needs to be over ideas rather than an attack on the people issuing the challenges.

    Posted by on Friday, June 10, 2011 at 12:33 AM in Economics, Macroeconomics, Methodology | Permalink  Comments (17)


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