The Emperor Has No Clothes

Posted by: Michael Mandel on June 24

In a recent column, Washington Post columnist Robert Samuelson says that:

Our ideas for explaining trends in output, employment and living standards — what we call “macroeconomics” — are in a state of disarray.

Mark Thoma, an economist at the University of Oregon, responds by making fun of Samuelson, saying that

Yes, change in macroeconomics certainly has outpaced his comprehension…If he reflects the best and brightest in our press corps, we should be very worried.

I don’t agree with Samuelson on a lot of things. But on this question he is right on. Anyone with a bit of sense in them knows that macroeconomics has some real problems. The proof is in the pudding.

1) Year ahead forecasts of short-run growth, by and large, are terrible, because macroeconomists have developed no good way of forecasting structural productivity growth.

2) Year ahead forecasts of long-term interest rates, by and large, are terrible. On average, forecasts peg the interest rate next year as being equal to the interest rate today.

3) There’s little agreement about the magnitude of the link between wealth and consumption, and whether it matters which kind of wealth it is. Forecasts about the effect of the stock market decline on consumption were way off.

4) The estimated “natural rate of unemployment” seems to move around unpredictably, as Samuelson says.

5) Even though macro models have formally included an international component for years, economists have continued to make policy suggestions as if the U.S. was still a relatively closed economy.

Macroeconomics fails the empirical test—it missed the biggest economic events of the past ten years, including the acceleration of growth in the mid-1990s, the tech investment slump of 2000-2002, the continued strength of consumption over the past 5 years, and even the housing boom.

Not really anything to be proud of.

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Reader Comments

James

June 24, 2005 03:26 PM

I would have to agree with Samuelson. The fact is we are pretty clueless on most issues. The old joke about the need for a one handed economist is now even more applicable. The major problem is not that we don't have theories and concepts to explain the phenomena, but that the modern economy is becoming so complex and rapidly changing, that we cannot assimilate all the data. It is like one of those weather pattern simulations, where scientists have a supercomputer crank out calculations for months to predict a weather pattern that is already over by the time they are finished. Just like the famous butterfly flapping its wings, there is no way to account for all the inputs.

Michael Mandel

June 24, 2005 04:58 PM

James

It's actually worse than that. In some cases, like the effect of wealth on consumption, parameter values seem to be shifting over time unpredictably. In the case of predicting structural productivity gains, there simply isn't any theory at all worth anything.

pgl

June 24, 2005 06:37 PM

I just emailed Mark Thoma your defense of Robert Samuelson's oped. Included was a point by point commentary on your defenses - each of which left me shaking my head in disbelief anyone would write such things. Your defense of Samuelson's very bizarre oped was even more bizarre. If you are interested in the details, tell Mark that he can forward to you my email to him.

Michael Mandel

June 24, 2005 08:27 PM

It's okay to call me bizarre--I've been called names before.

We're entering another period where it appears that some of the underlying parameters of the economy are shifting. It's only wisdom to admit that.

Jack Krupansky

June 26, 2005 10:48 PM

My suggestion is that economists need to take a fresh look at what is actually happening in the *real* economy, in terms of business formation, business restructuring, so-called mobility, the psychological processes that consumers and businesses use for making economic decisions, etc.

The very concept of "productivity" probably needs to be disaggregated and reconstituted in such a way that the relevant inputs that really matter can be tracked in a more effective manner.

The human elements of psychology, human nature, and social interaction need to be modeled more effectively, such as with dynamic software agents that learn, rather than with mere mechanistic formulas.

In other words: No more coasting on past research results and no more mild extrapolation of the recent past or even past episodes or apparent economic cycles from history.

Try to imagine a time in the future when economics is no longer called "The Dismal Science."

If the outlook appears gloomy, it's only because you lack suficient respect for the nature of the very concept of "the future" itself.

-- Jack Krupansky

John Cronin

June 29, 2005 08:52 AM

I am not an economist and don't understand all of the details, but it is clear that throughout history we have had to reevaluate our understanding of macroeconomics and improve or change the metrics we use to measure and predict. One of the most profound instances of this was the "paradox of the thrift" during the great depression. In believe we must take a hard look at how we measure and predict macroeconomic trends in today's global, real-time, hyper-efficient world.

"The problems that exist in the world today cannot be solved by the level of thinking that created them." - Albert Einstein

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Michael Mandel, BW's award-winning chief economist, provides his unique perspective on the hot economic issues of the day. From globalization to the future of work to the ups and downs of the financial markets, Mandel-named 2006 economic journalist of the year by the World Leadership Forum-offers cutting edge analysis and commentary.

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