Ray Fair: The Future of Macro

Ray Fair:

The Future of Macro: There is an interesting set of recent blogs--- Paul Romer 1, Paul Romer 2, Brad DeLong, Paul Krugman, Simon Wren-Lewis, and Robert Waldmann---on the history of macro beginning with the 1978 Boston Fed conference, with Lucas and Sargent versus Solow. As Romer notes, I was at this conference and presented a 97-equation model. This model was in the Cowles Commission (CC) tradition, which, as the blogs note, quickly went out of fashion after 1978. (In the blogs, models in the CC tradition are generally called simulation models or structural econometric models or old fashioned models. Below I will call them CC models.)

I will not weigh in on who was responsible for what. Instead, I want to focus on what future direction macro research might take. There is unhappiness in the blogs, to varying degrees, with all three types of models: DSGE, VAR, CC. Also, Wren-Lewis points out that while other areas of economics have become more empirical over time, macroeconomics has become less. The aim is for internal theoretical consistency rather than the ability to track the data.

I am one of the few academics who has continued to work with CC models. They were rejected for basically three reasons: they do not assume rational expectations (RE), they are not identified, and the theory behind them is ad hoc. This sounds serious, but I think it is in fact not. ...

He goes on to explain why. He concludes with:

... What does this imply about the best course for future research? I don't get a sense from the blog discussions that either the DSGE methodology or the VAR methodology is the way to go. Of course, no one seems to like the CC methodology either, but, as I argue above, I think it has been dismissed too easily. I have three recent methodological papers arguing for its use: Has Macro Progressed?, Reflections on Macroeconometric Modeling, and Information Limits of Aggregate Data. I also show in Household Wealth and Macroeconomic Activity: 2008--2013 that CC models can be used to examine a number of important questions about the 2008--2009 recession, questions that are hard to answer using DSGE or VAR models.

So my suggestion for future macro research is not more bells and whistles on DSGE models, but work specifying and estimating stochastic equations in the CC tradition. Alternative theories can be tested and hopefully progress can be made on building models that explain the data well. We have much more data now and better techniques than we did in 1978, and we should be able to make progress and bring macroeconomics back to it empirical roots.

For those who want more detail, I have gathered all of my research in macro in one place: Macroeconometric Modeling, November 11, 2013.