John Handley asks via Twitter, "[W]here do models like [Eggertsson and Mehrotra] fit into your view of quantitative, qualitative, and toy models?"

I think my answer would have to be a qualitative model, but an unsatisfying one. The major problem is that it is much too complex. However, a lot of the complexity comes from the "microfoundations" aspects, the result of which is exactly as put by

*Mean Squared Errors*:Consider the macroeconomist. She constructs a rigorously micro-founded model, grounded purely in representative agents solving intertemporal dynamic optimization problems in a context of strict rational expectations. Then, in a dazzling display of mathematical sophistication, theoretical acuity, and showmanship (some things never change), she derives results and policy implications that are exactly what the IS-LM model has been telling us all along. Crowd -- such as it is -- goes wild.

Except in this case it's the AD-AS model. The IS-LM model is already a decent qualitative model of a macroeconomy when it is in a protracted slump, and what this paper does is essentially reproduce an AD-AS model version of Krugman's zero-bound/liquidity trap modification of the IS-LM model [pdf]. This simple crossing curves (e.g. shown above) are far simpler and tell basically the same story as the "microfounded" model.

The model does meet the requirement of being qualitatively consistent with the data. For example, it is consistent with a flattening Phillips curve:

This illustrates a positive relationship between inflation and output - a classic Phillips curve relationship. The intuition is straightforward: as inflation increases, real wages decrease (as wages are rigid) and hence the firms hire more labor. Note that the degree of rigidity is indexed by the parameter γ. As γ gets closer to 1, the Phillips curve gets flatter ...

This is observed. The model also consists of stochastic processes:

An equilibrium is now defined as set of stochastic processes ...

This is also qualitatively consistent with the data (in fact, pure stochastic processes do rather well at forecasting).

"I think my answer would have to be a qualitative model, but an unsatisfying one. The major problem is that it is much too complex."

ReplyDeleteI half expected your answer to be along the lines of "the results of a the model are qualitatively accurate, but there are so many parameters that it should be treated as a quantitative model" in which case its likely failure to be quantitatively accurate would discredit it.

Of course the premise that the model is supposed to explain "secular stagnation" seems a little bit strange to me, considering everyone (or at least the CBO) knew about the demographic transition a long time ago and projected that labor force participation rates would fall by pretty much the amount that they did (you can download the CBO's estimates of 'Potential GDP and Underlying Inputs' going back to 2002, and the 2007 projection for the size of the 'potential' labor force is not far off from reality) and that the lacklustre growth of the last few years is mostly the result of low productivity growth. A model of secular stagnation should tie low productivity growth to shortfalls in aggregate demand, yet for some reason all I see is people pretending we are in a prolonged employment slump and trying to explain that.

This leads me to an admittedly unrelated question (or set of questions):

To my knowledge, the only growth model(s) that you have dealt with in relation to the IT framework are Solow (and Ramsey, if you count that separately). Have you ever looked at, for example, Romer's model of endogenous growth (link to slides from Dietrich Vollrath: https://drive.google.com/open?id=0Bx67UBQmAKOESDlvMWJLNUZ1d28), or endogenous growth in general? Also, how does declining growth over time due to increased concentration of low-growth sectors in the economy match with longer term data going back to the 1870's and earlier on GDP per capita (data from Angus Maddison here: http://www.ggdc.net/maddison/maddison-project/data.htm) which shows, for instance, relatively constant growth in US per capita income since 1800?

I think there are only 6 parameters; there are only 4 in the IE version of the minimal NK model (the normal version has 5, I think). They add the collateral constraint D. This isn't too bad for a model of output, employment and inflation.

DeleteHowever, the only defense of the microfounded stuff is that the model fits the empirical data quantitatively. This one does not (do any?). That's my take on Friedman's take on "unrealistic assumptions" (that he didn't follow). If you're going to add stuff, it needs to result in a better explanation.

I completely agree though about explaining a problem that might not be a "new" problem (low growth being mostly demographics) or even a problem at all (there does not appear to be persistent unemployment).

I will look at the other models. And to answer your question about declining growth over time, that is when the economy reaches equilibrium. When economies are small, large fluctuations in individual industries (or individual firms) can (and generally do) drive nearly all of the growth. Additionally, from much earlier time there is the transition from a non-ideal monetary economy to an ideal one to think about:

http://informationtransfereconomics.blogspot.com/2015/10/can-we-extrapolate-growth-into-distant.html

And finally, the IE quantity theory of labor (and capital) does not have a changing IT index so that process of declining growth is due to demographics and not changes in the individual firm k-states (i.e. there's no increased occupation of low-growth states).

Also, here's a post about the Kaldor facts, one of which is constant growth per capita.

It is a bit of a cop out to have more than one model I know, but then I'm not claiming this is a subject where all the answers are known. Those are just some possibilities to understand the data using different factors of production.

If you think money is the primary factor of production (i.e. the monetary models), then the declining growth requires the "economic temperature" to fall. If you think labor is the primary factor of production, then declining growth is probably just a result of declining population growth/demographics.

I almost forgot -- there is also the possibility of monetary regime changes:

Deletehttp://informationtransfereconomics.blogspot.com/2014/09/the-us-economy-1798-to-present.html

Again, this is just to say there are many potentially interesting lines of research that can't necessarily all be covered by one weirdo with strange preferences for his spare time. Information equilibrium is a framework, not a single model that explains everything. Maybe eventually one of those will be built.