by Severin Reissl
With in-course exams coming up, I have started dipping into the recommended reading for my Macroeconomic Analysis module, specifically for the “short run” part of the course. Most of this comes from “Macroeconomics – Imperfections, Institutions & Policies” by Carlin & Soskice. This book claims to be presenting the state of the art of “modern” macroeconomics, and, sadly enough, that is probably true. Most of what I have read of it appears very similar to New Consensus Macroeconomics as described and critiqued, for example, by Arestis and Tcherneva. It covers a remarkably great amount of material, ranging from very basic stuff like IS-LM to a more advanced microfounded New Keynesian model. Most of the short run discussion centres on a “Three-Equation-Model” consisting of an IS curve, a Phillips Curve and a central bank monetary rule. Of course, being an 800 page tome, there will be no course in the world teaching the whole of this book. It will be taught selectively anywhere, just as it is on my course. I’ll admit I’ve not read the whole of it and I doubt I’d be able to. I’d probably soon throw the book or myself out the window.
Coming straight to the point, I think this book is full of crap and I am finding it exhausting and painful to read. While it is reasonably clear and concise, it is full of sweeping generalisations, frequent allusions to “empirical evidence” that are not elaborated upon and, most importantly, what I would consider to be pedagogically harmful methods of exposition. Focusing in particular on the “three equation model” it would have the student believe not only that there is such a thing as a well defined, stable IS curve, as well as a strictly upward sloping Phillips curve, but also that the central bank knows exactly just what these look like, and is consequently able to “choose” a point on the relevant PC according to its “indifference curves”, to pick a combination of output and inflation exactly to its liking. This is reached without any difficulty. No distinction is made between the fantasy-world of this model and reality. Transition between them is completely unproblematic. If it really was that simple, why not elect a bunch of monkeys to the monetary policy committee, if all this body does is to pick a point on a curve? Interest rate targeting by the central bank is presented as a deliberate choice, being merely preferable to money supply targeting. Possible problems with targeting the money supply are grossly understated and confined to one short paragraph in a different chapter (which, incidentally, is not being covered on the course). The exposition is typical of economics textbooks. Heavy on (admittedly quite basic) maths and pretty curves, very very light on reality and practice, methodology, and self-reflection. I’m not sure what this is supposed to prepare me for. But it is certainly trying to get me to think uncritically in terms of some half-baked models by wrongfully presenting them as analogous to reality and representative of some universal “consensus”. As a student, I feel strangely patronised by this. The authors ascribe to me the ability to comprehend the mathematical exposition of their model, yet obviously they think I am, or should be, incapable of critically evaluating what they present to me. Is this what higher education is supposed to achieve?
For instance, the book is utterly uncritical of the rational expectations hypothesis, presenting it as a genius insight, while the exposition itself is inconsistent and self-contradictory. The central bank is presented as being able to distinguish perfectly between temporary and permanent shocks to aggregate demand, but firms are unable to distinguish a rise in overall inflation from a change in relative prices. The most basic problem with rational expectations is ignored, namely that it turns macroeconomics as such into a tautology. Rational expectations imply that any policy to affect output will be ineffective because people have rational expectations, and hence they cannot be “fooled” by policy. Because they are rational, they have in their head the correct model of the economy, hence being able to perfectly predict outcomes. The correct model, of course, is the one that assumes rational expectations (as well as a bunch of other stuff). Therefore, the model is correct because it is correct. Wow. To put it another way, the model is correct because we assume that people think it is correct (which is why they use it). Why do they think it is correct? Because they are rational. Why are they rational? Because the model assumes it. The circularity here should be obvious.
The book claims that
“It is now accepted that macro models should be anchored in microfoundations with optimizing agents who have rational expectations and hence that such models should be immune to the Lucas critique (p. 545)”
It is quite remarkable how seriously the Lucas critique is taken, yet how uncritically other assumptions are accepted. The cutoff point, so to speak, is completely arbitrary. It is not ok to have a model without microfoundations, because a change in policy will change the parameters of the model, essentially the optimising decisions of individuals, which have to be modelled on a micro level. But it is ok to model these microfoundations using unchanging parameters such as the preferences of these individuals (for an elaboration on this see this post by Phil Pilkington on Robinson’s critque of marginal utility). So while the model may be “immune” to the Lucas critique in a narrow sense, it is still “vulnerable” to similar critiques pertaining to different aspects of the model. It is simply a matter of how far one chooses to take the critique.
Phil sums this up rather nicely in another post:
“The Lucas critique itself is similar in many ways to a small child asking the question “why?” over and over again until told to shut up by the adult. If properly and coherently formulated the critique would be bottomless. First the critic would ask why the analyst has not taken into account the “behaviour” of “individuals”. Then he would ask why the analyst has not taken into account the “psychology” of these “individuals”. Then perhaps he would ask why the analyst has not taken account of the “biological” and “genetic” features behind this “psychology”, and so on and so on ad infinitum. (The sharp reader will note that the words placed in quotation marks in the last three sentences all imply some sort of aggregation, whether of something called an “individual” or of some sort of “average” of behaviours of this “individual” and so on). This process of looking deeper and deeper into the micro or the molecular is, as we have seen in our discussion of schizophrenia and human cognition, by its very nature interminable. In order to stop at some point and stop the nattering questioning the analyst must come to a halt at some given level of abstraction. And this is precisely what Lucas and his followers – who pretty much constitute the entire of the mainstream economics profession – did.”
The chosen “cutoff” point is the rational, maximising, representative individual. Why this is so is not discussed or justified. This choice means we ignore any emergent properties at higher levels of aggregation as well as any “deeper” properties of the individual. Keep in mind that the predictions of “microfounded” models arise precisely from these arbitrary decisions and are in no way as inevitable as the textbooks would have you believe!
I realise this is a rather incoherent post, but this is an 800 page book and there is so much wrong with it that one could probably write at least another 800 page book just about that. The basic message should be this: Learn this stuff, by all means, because having done an economics degree you’ll be expected to know it. But don’t accept it uncritically. Just because it’s precise and mathematical doesn’t mean it is right! Don’t buy into any of it without reflecting upon it.