12/4/2015

Macroeconomists need new tools to challenge consensus - FT.com

April12,20155:37pm

Macroeconomists need new tools to challenge

consensus
WolfgangMnchau

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For the moment, the traditionalists still rule

M
Bloomberg

LawrenceSummers,above,andBenBernankehave
clashedonthesubjectofsecularstagnation

acroeconomists are once again caught up in a

discussion about the future of their profession. An
example has been the recent debate between Lawrence
Summers and Ben Bernanke about the deep causes of the
economic slowdown. The former US Treasury secretary has
defended the case of a secular stagnation while the former
chairman of the Federal Reserve sees an excess of savings
over investment.

It is an enlightened debate, but it also masks a much deeper

problem within macroeconomics. Secular stagnation a sharp fall in growth rates lasting a very
long time is not something that you can easily square with the current generation of
macroeconomic theories and models.

MartinSandbu's
FreeLunchisour
newemailbriefingon
themaineconomics
issuesoftheday,
exclusivelyfor
Premiumsubscribers.

Part of this debate reminds me of a discourse among mathematicians

at the end of the 19th century. At the time, mathematicians and
physicists too thought they had solved most problems, just as
economists did until 2008.

It is instructive to go back to one episode, concerning the German

mathematician Richard Dedekind. He was one of the rebels of his
time, and used a new technique to prove an important result. His
method would be considered standard stuff today, but was
Signupnow
revolutionary then. The response from the traditionalists was harsh.
Leopold Kronecker, another German mathematician, decried
Dedekinds proof as useless on the grounds that it had no practical
applications. Dedekind retorted, not helpfully, that he wanted to put thoughts in the place of
calculations.
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12/4/2015

Macroeconomists need new tools to challenge consensus - FT.com

The advent of chronic instability is the equivalent challenge for macroeconomics today. The present
tools used by mainstream macroeconomists cannot deal with this adequately. New ones are needed.
They exist in other disciplines, but to macroeconomists they look as weird today as the abstract stuff
looked to mathematicians of the 19th century.
For the moment, the traditionalists still rule. They managed to go beyond the ideological turf wars of
the 20th century, by taking a leap towards a new generation of economic models that were
technically complex in the sense of 19th century mathematics. The models integrated what
economists had learned about various markets with knowledge about the economy as a whole. The
so-called dynamic stochastic general equilibrium (DSGE) models were even designed to cope with
some unforeseeable disturbances like a technology shock. They were just not able to deal with the
shocks we eventually got a financial crisis, default and deflation.
From a mathematical perspective, the modern models have at least three questionable features. The
first is the assumption of a single macroeconomic equilibrium the notion that the economy
reverts to its previous position or path after a shock. Macroeconomists currently have no coherent
technical framework to deal with a secular stagnation or savings glut.
The second is linearity the idea of a straight-line relationship between events. Standard
macroeconomic models are complex, and their system of equations is linear. But if you want to
understand why the economy did well before 2007, why there was a break in 2008 and why the path
of economic output never returned to its previous trajectory, one would require models that
incorporate the notion of non-linearity, and even chaos.
The third is logically not a category of its own but a combination of the two above: the assumption of
a limitless space, that, wherever you stand, you can go further. We know, for example, that interest
rates cannot fall much below zero because people can always hoard cash and thus avoid a negative
rate. No-go zones like a zero lower bound are technical minefields in a model. Strange things
happen when you approach the outer limit of your space.
Few of these criticisms left a lasting impression on the profession. The mainstream invested a lifes
work in developing their DSGE models. They will not let go easily, but continue to tinker with their
models, and hope that no policy maker will ever use them. Unfortunately, many institutions already
have. An example is the European Central Banks use of a DSGE model that has produced
persistently too optimistic forecasts.
And what about the rebels? An early detractor was Hyman Minsky, who developed a framework of
how to comprehend a modern crisis in the 1980s and 1990s. Minsky was shunned by the
establishment. Todays consensus challengers, like Minsky before them, remain in the anterooms of
that debate, on Twitter and blogs, outside established journals and top universities.
Will they succeed? Just as none of these models has a hope of predicting our future, I cannot predict
the future of macroeconomics itself. Having followed the debate for a long time, my hunch is that,
unlike in mathematics, the successful challenge will come from outside the discipline, and that it
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Macroeconomists need new tools to challenge consensus - FT.com

will be brutal.
munchau@eurointelligence.com

Wrtsilbumpygrowthnewnormal

Teachingrealworldeconomicsto
undergraduates

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