Oh dear, oh dear, Krugman gets it so wrong, so wrong

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Lars Pålsson Syll
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from Lars Syll

Economics is a science of thinking in terms of models joined to the art of choosing models which are relevant to the contemporary world. It is compelled to be this, because, unlike the typical natural science, the material to which it is applied is, in too many respects, not homogeneous through time. The object of a model is to segregate the semi-permanent or relatively constant factors from those which are transitory or fluctuating so as to develop a logical way of thinking about the latter, and of understanding the time sequences to which they give rise in particular cases … Good economists are scarce because the gift for using “vigilant observation” to choose good models, although it does not require a highly specialised intellectual technique, appears to be a very rare one.

J. M. Keynes in letter to Roy Harrod (1938)

I came to think of this passage when I read “sort of  New Keynesian” economist Paul Krugman’s blog in the ongoing discussion on the state of macro. Krugman argues that even though he and other “sort of New Keynesian” macroeconomists use the same “equipment” as RBC-New-Classical-freshwater macroeconomists, he resents the allegation that they are sharing the same endeavour. Krugman writes: 

The real test came when the financial crisis struck, and pretty much to a man freshwater economists not only argued against fiscal stimulus — which is a defensible position — but insisted that there was no possible way to justify stimulus, that such ideas had been refuted and that “nobody” believed in them anymore  … I’m not saying that the [“New Keynesian”] NK approach is necessarily right; but it’s a serious intellectual effort, undertaken by people who thought they were part of an open professional dialogue. Oh, and there’s a lot of evidence for the price stickiness that is central to NK models; again, maybe it doesn’t mean what the theorists think, but surely that evidence ought to be part of any discussion.

Here we get a view that all macroeconomists more or less share the same basic mainstream theory and “techniques”, so when we discuss and argue it is only about which special assumptions we choose to make (sticky wages or not). But people like Hyman Minsky, Michal Kalecki, Sidney Weintraub, Johan Åkerman, Gunnar Myrdal, Paul Davidson, Axel Leijonhufvud — and yours truly — do not share any theory or models with Real Business Cycle theorists and  “sort of New Keynesians” like Greg Mankiw or Paul Krugman.

It’s nice to see that Krugman explicitly acknowledges what I have argued for many years now — “New Keynesian” macroeconomic models are at heart based on the modelling strategy of RBC and DSGE, using representative agents, rational expectations, equilibrium and all that. And yes, they do have some minor idiosyncracies like “menu costs,” “price rigidities” and “sticky wages.” But the differences are not really that fundamental. The basic model assumptions are the same.

The macroeconomic modelling strategy of people like Greg Mankiw and Paul Krugman has a lot to do with Robert Lucas and Thomas Sargent – and very little, or next to nothing, to do with John Maynard Keynes. “New Keynesian” macroeconomic models build on Real Business Cycle foundations,  regularly assuming representative actors, rational expectations, market clearing and equilibrium. But if we know that real people and markets cannot be expected to obey these assumptions, the warrants for supposing that conclusions or hypothesis of causally relevant mechanisms or regularities can be bridged, are obviously non-justifiable. Macroeconomic theorists – regardless of being New Monetarist, New Classical or ”New Keynesian” – ought to do some ontological reflection. For those of us who have not forgotten the history of our discipline, and not bought the freshwater nursery tale of Lucas et consortesthat Keynes was not “serious thinking,” we can easily see that there exists a macroeconomic tradition inspired by Keynes — a tradition that has absolutely nothing to do with any New Synthesis or “New Keynesianism” to do. Its ultimate building-block is the perception of genuine uncertainty and that people often “simply do not know.” Real actors can’t know everything and their acts and decisions are not simply possible to sum or aggregate without the economist risking to succumb to “the fallacy of composition.”

Instead of basing macroeconomics on unreal and unwarranted generalizations of microeconomic behaviour and relations, it is far better to accept the ontological fact that the future to a large extent is uncertain, and rather conduct macroeconomics on this fact of reality.

Building models based on an “equipment” that assumes the equivalent of portraying people as being green and coming from Mars is not recommendable. There have to be better ways to optimize our time and scientific endeavours than spending hours and hours working through or constructing unreal and irrelevant “New Keynesian” RBC and DSGE macroeconomic models.