Saturday, June 10, 2017

Summing up my thoughts on macroeconomics

I'd like to close the chapter of my life that involves complaining about macroeconomics. I've been out of that world long enough that it's becoming a distant memory. And much more qualified critics are on the job. Furthermore, macroeconomists I talk to - especially young macroeconomists - mostly seem to have heard and internalized all of the critiques. That doesn't mean I want to stop following developments in the macro field, but that my days as a certified "macro-basher" have come to an end.

So when the Norwegian Finance Ministry, Norges Bank and Statistics Norway asked me to give a talk about "What Has Happened in Macroeconomics (and what still needs to be done)", I viewed it as an opportunity to sum up. Here are the slides from that talk.



  1. These are great slides.

    Are you sure now is a good time to set aside macro? Liberalism and the enlightenment values themselves are in jeopardy, wilting because of gridlocks caused by mismanagement in the monetary systems of the western world. This is causing the more scholarly economies and governments of the world to slip and regress, their people to polarize into various clueless unscientific doctrines.

    Interest rates have been stuck to the floor because central banks prefer to strangulate their own countries than to let wages and prices catch up a bit. Investment has been sucked out of all sectors of European economies, human capital wasted, people in places like Greece simply perished for no other reason than lack of will from the ECB. They could have been saved at no cost, at a profit in fact. Just because the US is having some respite doesn't mean its problems have been solved. The US is still dangerously close to zero lower bound type problems.

    The weak aggregate demand of the west has been spilling over to all its trading partners. This may well be keeping large parts of Africa in first world conditions. No need to move factories and technologies to Africa and leapfrog them to the first world like Asia when lots of educated Europeans are unemployed or underemployed. Disadvantaged rural regions all over the world are being cut off from the financing needed to tool their projects, to build efficient production capacity, to fund institutions, to allow people to work and to grow functional communities.

    Competent ideas clearly haven't made sufficient inroads into central bank policy. We need more people advocating for improvement not fewer. It's a weird time to lay down arms on the macro fight is what I am saying.

    1. Oh, well I'll still write about macro policy, sure.

    2. If the state of knowledge in macro is unsatisfactory, the urgency of knowledge will not make it satisfactory. This was true in the 1930s and is true now.

  2. Great post.

    What level of mathematics is needed to read and understand these papers? What textbook teaches you this sort of economics. Also, how much time of reading does it take someone like you to read through and understand these papers? In other words, What study program would you recommend to someone who wants to understand all of this. I've gone through all of the intermediate macro textbooks and I am curious of what is the additional value of this higher level literature.



    1. To understand the papers that Noah cites, I would start with David Romer's Macro textbook. After that, I would work through Ljungqvist & Sargent's book "Recursive Macroeconomic Theory". Also, search the Internet for summaries, introductions (Harald Uhlig has one somewhere, I think).
      To read all this stuff, you need to understand differential equations and the discrete version of it.
      What is the additional value? You get to follow the literature in the academic journals, and you get to do your own simulations with Matlab (by the way, you need to learn Matlab or some other program, like Mathematica).
      That's it.

    2. Thanks for using blogspot. Google blocks your powerpoint because my IP is not from the US and i have to read your blog in

    3. Luca Pacioli7:02 PM

      Learn the basics of accounting. If you doubt me ask an experienced accountant if that is a good way to learn economics. Wile you at it ask her or him what they think of academic economics? Maybe ask an accounting professor.

    4. Luca Pacioli7:07 PM

      The text books need revision because American economics needs revision.

  3. Bill Ellis8:25 PM

    Noah gives up his fight against Macro the day BATMAN dies...

    Dick: "Gosh, Economics is sure a dull subject."
    Bruce: "Oh, you must be jesting, Dick. Economics dull? The glamour, the romance of commerce... Hmm. It's the very lifeblood of our country's society."

    1. It's more than commerce. It's the big themes. The rise and fall of civilizations. Freedom versus authority, the one and the many, the center and the periphery. Politics, broadly understood; therefore ethics, at least normatively described. Epistemology, too.

  4. "Why didn't macroeconomists predict the crisis? Or at least see the risks? Or at least point out the possibility?"

    In defense of macro I'll try to give a few reasons.

    1) The vast majority of economists aren't tying to identify potential bubbles, forecast the next recession, or "predict" the next crisis. While economists seem like the most likely and capable groups of doing so, the vast majority are not bussing themselves with it.

    2a) Some economists like Robert Schiller, Dean Baker, and Nouriel Roubini argued there was a housing bubble and that if it burst it would lead to a recession of some significance. Between 2001-2006 there were economists who did believe that the financial system and the housing market presented serious risks to the economy.

    2b) Many heterodox economists also identified the bubble, but they're always screaming about how the sky is falling. This is more an instance of throwing so much you-know-what against the wall until some of it sticks. Many believed things like hyperinflation, deflation, other recessions, or the US dollar collapsing would happen by now. So far they have not.

    3a) Economists can't really anticipate recessions. If you say troubled times are ahead, eventually you'll be right. See 2b

    3b) If economists, especially in private business, could predict when the next crash will occur firms would begin to lay off workers, stave off new investment, and cancel orders. Households would tighten their belts and decrease consumption while focusing one paying down debts. In essence they would become self fulfilling prophecies.

    3c) You don't know if you're in a bubble until its bursts. This is a statement I have mixed feelings about, however, it basically rings true. If investors could identify bubbles, they would never get caught up in them because they would know when they were most likely to start deflating.

    I personally believe that that statement is too rigid, there are instances where you can use the "fundamentals" of economies to try and argue if assets are being overvalued. The housing bubble is an example where more economists would and should have been savvy about the possibility of one.

    Geologists really can't predict earthquakes, that doest mean their profession has nothing to offer society. Similarly, macroeconomists really can't anticipate recessions, that does't mean they have nothing to offer either.

    1. The question is not why macroeconomists didn't identify the bubble--like so many psychics--but why macroeconomics did not, like a machine left to itself.

      If macroeconomics cannot predictively describe (and, in the hands of central bankers and fiscal authorities, moderate) the business cycle, it isn't doing what it was designed to do. If (as likely) a bubble cannot be identified as a bubble before it bursts, then macroeconomics has from its inception over-promised.

      Those slides' argument (with which I agree) is for more modest at-least-interim goals using reliable components from microeconomics; which is (forgive my implied invidious comparison) actual science.

    2. Anonymous5:11 AM

      1) Does it matter what the vast majority does? No one expects a frog specialist to know about gut bacteria. Why didn't the economists (and CBs/IMF/etc) who specialise in macro predict it? Not even predict it, but recognise risks as NS said.

      And this is a massive cop-out. Any scientist (who isn't a total drop-kick) would want to make accurate predictions.

      2) "Some economists predicted it, but the 'heterodox' ones were doomsayers, so who cares what they think. The real normal proper economists weren't doomsayers though, for some reason."

      3) "Economists can't anticipate recessions, but I just listed some economists who anticipated recessions."

    3. Luca Pacioli12:46 AM

      "I personally believe that that statement is too rigid, there are instances where you can use the "fundamentals" of economies to try and argue if assets are being overvalued. The housing bubble is an example where more economists would and should have been savvy about the possibility of one. "

      Correct. I think people and economists that understand accounting have an advantage in that respect.

      "Geologists really can't predict earthquakes, that doest mean their profession has nothing to offer society. Similarly, macroeconomists really can't anticipate recessions, that does't mean they have nothing to offer either. "

      So, if living in properly engineered structures or boats are the solution to unpredictable earthquakes what is the solution for for people with unpredicted recessions busts and busts of various assets?

  5. Nice one Noah. I hope you don't have some issues and this is your goodbye from blogging.

    A suggested addition: slide 7: Criticisms of Academic Macro, Critics named "Paul" please add: Paul Ormerod, an economist who wrote books on the nonlinear nature of economics (agent based rather than representative man based), such as "Butterfly Economics" (1998)

    1. Thanks, Ray! No, definitely not a goodbye from blogging, just closing one chapter.

      And thanks for the recommendation! I should have covered "sunspot" models more fully, because there really is the possibility that macro is all for naught and it's totally impossible to predict or even understand a macroeconomy except in some very limited, short-term ways.

    2. Anonymous7:54 PM

      Can you clarify the "sunspot" thing? I think I understand the point you are trying to make but not what the reference is.

  6. Richard Bookstaber's End of Theory does a good job critiquing macroeconomics. The main issues he lays out are:

    - The computational irreducibility of outcomes that emerge from complex dynamics and interactions. In other words, emergent behavior simply cannot be captured by elegant math short cuts.
    - Non-ergodicity of economics in the sense that history and sequence matters. In other words, actors may react differently to the same stimuli based on context. This ain't physics.
    - Radical uncertainty: we can't rely on probability distributions of outcomes based on past data because we can't even define all of the possible events for the probability space (there are "unknown unknowns" that can't be modeled as draws from a probability distribution)
    - People in the real world act based on heuristics rather than mathematical optimizations

    Then he shows how he has applied agent based modeling to model the financial crisis by focusing on interactions, heuristics in the market. I think that's the most promising approach to macro. It has it's own set of challenges, but I think it moves research in the right direction, because the models are at least capable of producing emergent behavior. And of course, Schelling pioneered some of these basic ideas in modeling for economics.

    1. Ooooh, that's next on my list of books to read...sitting right there on my shelf!

    2. Cool! I hope you'll blog about it.

    3. As for "radical uncertainty", the issue is not new. Frank Knight addressed it with his work on risk and uncertainty. In more modern work, Larry Epstein spent a lifetime trying to model Knight's ideas, and (to the best of my knowledge) Thomas Sargent as well. It ain't easy, and the more complications you introduce, the more mathematical you make it - and then, there are criticisms that it becomes too mathematical. You cannot have it both ways.

    4. He doesn't claim that it's an original idea, and gives credit Knight. He draws upon ideas from many to build his case against standard macro methods.

  7. This all great stuff and those slides are awesome. One nitpick. If somebody badgers you about "macroeconomics" you can remind them that traditionally it includes growth theory and inflation. Macroeconomists have quite a lot of useful stuff to say about those things with a good track record of predicting when politicians are going to screw things up. Think Venezuela hyperinflation... or Singapore and China (who invited Milton Friedman to give them advice)... Romer/positive externalities of human capital/Silicon Valley.... Adam Smith...

  8. Great summary. But for those of us on the front lines teaching intro macro to high school seniors and college freshmen: what do you think we should focus on? I pretty much teach what you'd find in any reputable, mainstream intro text. But I repeatedly stress to students that models/theories can only do so much: they have their strengths and weaknesses, and we must be prepared to deal with uncertainty in terms of predictions and outcomes. Now, I know most of my students will never take a second look at the field after the semester is over, so I also explain that at a minimum, I hope what they learn in the course will help them better understand what's going on in the world when they see/hear something in the news or in legislative debates. But beyond that...what do we say to the handful of intro students who are curious to learn more? What ideas and questions should they have in my mind as they advance to higher levels of study?

    1. Luca Pacioli1:31 AM

      Ahh, that is a conundrum. A great question. I think, focusing on the valid and valuable. What are those things? Is that acceptable to teach? If not acceptable that is a big problem. If the correct and valuable are not well known by the teacher that is solvable in time, by learning.

      Now, here is a conundrum from the students' side. Why learn a subject matter that includes false doctrines? How is that for morale for 3 to 4 years? Are there better, more valid, more valuable, and more interesting to learn? There are other things available to study? If not in economics there is else ware.

      My first micro and macro economics classes decreased my understanding of the world and had a large opportunity cost in investing. Decades later, learning a little accounting was enormously enlightening and is profitable to boot. And, it was much more interesting because the use and applications were obvious. It also made economics more clear and helps with culling the chaff out of economics.

      I think putting the theories to test using economic data. The data is available. One helpful skill needed making sure the units are specified and correct. This is a scientific approach accept it is not actually gathering the data, one is depending on the validity of the data. Oh, and it takes a little work.

      So, my suggestion is students should learn accounting and economic history.

      On that note, Jane Gleeson-white, wrote a book on the history of accounting and Luca Pacioli. Pacioli published a math and accounting book that brought both the Indian base 10 number system, math, and most likely Indian accounting to Venice and Europe, that was published right after the movable type printing press was invented. The Venicians were using roman numerals and were in contact with India.


      In nearest library:

      A place to buy:

    2. Anonymous1:21 PM

      ^ amazing new unclassifiable econotroll.

  9. Anonymous3:48 AM

    Hmmm ...

    I'm in industry and just built a pretty basic macro model. Why don't I use DGSE? Because it doesn't answer the questions I want to answer.

    I'm not trying to formulate policy. I don't want to regulate the money supply. I want a (perhaps rough) idea of what will happen to the value of a portfolio if unemployment gets a shock, or consumer confidence, or whatever.

  10. I learned a lot from this. Thanks.

    Just one overall comment, I think macro fetishizes and obsesses about cyclical stuff. I at least am far more interested in long-term secular: what's gonna make us more prosperous and wealthy over the next x decades?

    Related: need to fully incorporate wealth accumulation (assets/net worth) and its primary source — holding gains — into agents/sectors/classes' economic reaction functions. Not just the wildly incomplete income/saving cycle that is the basis of almost all models.

    The Piketty/Saez/Zucman focus is obviously a good example of, and move towards, all that.

  11. The behavior of real estate prices since the crash, and the magnitude of the crash versus the pre-crash expected ROR indicate there was no real estate bubble, unless it was a small one.

    1. Luca Pacioli12:34 AM

      Good point. Especially if you divide the prices by M2 money supply!

      What about a mortgage or leverage bubble?

  12. Fantastic seem to have reached new heights, so hardly time to hang up your spurs.

    Being a bit older, what you describe at the end recalls the 1960's microfoundations program. I can actually remember a class I took in which Lucas likened it to a pot luck supper. There were reasons people gave up on it, one of which was the finding that models with many equations had as many sources of inaccuracy. But perhaps if we approach it with more humble ambitions...

  13. Sums up a lot of the reasons I didn't pursue macro at the graduate level in the early 1990s and went into business law instead. Probably my biggest gripe is that economists don't even understand the nuts and bolts of how transactions work that is common knowledge among everyone who does them. This makes them vulnerable to huge, absurd mistakes, rather than merely subtle mistakes and personal biases. Economics needs to dramatically expand the descriptive side of the discipline and give the predictive side a break for a while.

    1. Luca Pacioli7:14 PM


      If all economists learned accounting or a little accounting do you think they would understand how transactions worked and expand their descriptive abilities?

      I have found accounting vocabulary and concepts to be more descriptive than the use of economic vocabulary.

  14. Macro collides against the challenges of group psychology. Explaining a sudden drop in aggregate demand really isn't all that different from explaining why Grumpy Cat went viral, why skinny jeans became a thing, and the mystery of avocado toast. Those aren't easy questions, but they can at least be tackled empirically -- tracing them back and looking for patterns in similar events. Econ will be a lot better when it realizes it's a mathematicized branch of psychology applied to group decision-making.

  15. A depressingly orthodox critique of orthodox thinking in economics. (It's Olivier Blanchard's recent statesman-like approach to repairing macroeconomics amped up a few degrees.)
    Slide #31 says it all. It shows intellectual capture of the so-called critic better than anything I have seen recently!

  16. Anonymous10:52 PM

    Did the word "bubble" appear in the slides once? Nope.

  17. Noah, first off I want to say you are by far my favorite macro-basher. I admire you ability to speak in layperson's terms about some of the most advanced topics. My favorite post of yours was 'The most damning critique of DSGE'. This post really opened my eyes to the world of academic macro. I liked how you said the most damning critique of DSGE is that nobody in the private sector uses these models.

    It seems that you now think DSGE models combined with credible microfoundations are the best way forward for macroeconomics. I agree that credible microfoundations are key for DSGE to work, but how can a DSGE model ever incorporate real world phenomena like new technologies and predict fraudulent financial securities? This seems implausible to me.

    I doubt that academic macro will ever get away from this path and that's okay. But, I think the best macroeconomists in the world will always be from the private sector (people like Michael Burry). Michael Burry style analysis is the key to predicting the next financial crisis (not DSGE).

  18. Very nice slides. I've been recently writing a couple of macroeconomic critiques myself. Roger Farmer wants to keep DSGE models, but is extremely critical of the natural rate of unemployment hypothesis. Instead, he thinks that models with multiple equilibria are the future. Note that the multiple equilibria story is more prominent in international macroeconomics (currency crises a la Obstfeld and Krugman).

    A second big omission of modern macro seems to me is that those models do not take credit creation against real estate into account. Housing is many advanced economies a substantial part of wealth and the biggest part of private sector debt is mortgages.

  19. Nice slides! I've been engaging recently in a little bit of macro criticizing myself. Roger Farmer wants to keep DSGE models but discard the natural rate of unemployment hypothesis for models with multiple equilibira. Note that the story of multiple equilibria is not uncommon in international macro (currency crises a la Obstfeld or Krugman).

    A second big omission to me seems to be that modern macro models do not take sufficiently the housing sector and credit creation into account. A large part of national wealth in advanced economies is held in the form of housing/land. The biggest part of private sector credit creation is mortgages.