Macroeconomics and Bull Hockey

Why does academic macro contradict practitioners' macro? And why I reject both

Note: I will discuss this in more depth at the Sunday afternoon, October 30 event for paid subscribers.

Back when there were words that you could not say on television, one could use “Horse Hockey” to substitute for one of the forbidden epithets. Comedian Pat Paulsen tweaked censors by coming up with the amalgam “Bull Hockey.”

Recently, I invited John Cochrane to join me to discuss Alan Blinder’s book that provides a retrospective look at macroeconomics since the 1960s. One point that came up is that Blinder, a distinguished professor at Princeton University, uses 1970s macroeconomics as his analytical framework.

Cochrane reacted to Blinder’s book with rage. Cochrane endorses what I call 1990s macroeconomics, and he terms 1970s macroeconomics Bull Hockey (except that he used the more explicit epithet).

What I call 1990s macro is the macroeconomic modeling approach that took hold in the 1990s and still prevails today in the most prestigious academic realms. Meanwhile, as Cochrane repeatedly complained, Blinder’s treatment of 1990s macroeconomics is snarky and dismissive.

In fact, the only environment in which 1990s macroeconomics is popular is the world of graduate programs and academic journals. Cochrane is correct that you could not use anything other than 1990s macroeconomics to publish a paper in a leading journal or obtain a Ph.D in the subject.

But 1970s macroeconomics still prevails everywhere else. Practitioners, including forecasters and policy makers, use 1970s macro. Textbooks aimed at undergraduates and MBA students use 1970s macro. And yet Cochrane and other academics think that 1970s macro is Bull Hockey.

In no other field that I know of do the graduate courses tell you that what you learned as an undergraduate is utter nonsense. I can imagine someone with an advanced degree in physics or chemistry saying that the freshman course is certainly incomplete. Some of it may be oversimplified and a little misleading from a more advanced perspective. But you would not call the freshman course Bull Hockey.

In fields like engineering or biology, practitioners and academic theorists may approach problems a bit differently from one another. But as far as I know, the practitioners and the theorists do not completely disregard one another, as is the case in macroeconomics.

In a 2006 essay that tries to take the most upbeat view of the division I am describing, Greg Mankiw wrote,

While the early macroeconomists were engineers trying to solve practical problems, the macroeconomists of the past several decades have been more interested in developing analytic tools and establishing theoretical principles. These tools and principles, however, have been slow to find their way into applications. As the field of macroeconomics has evolved, one recurrent theme is the interaction—sometimes productive and sometimes not—between the scientists and the engineers. The substantial disconnect between the science and engineering of macroeconomics should be a humbling fact for all of us working in the field.

Later in the essay, he says

Recent developments in business cycle theory, promulgated by both new classicals and new Keynesians, have had close to zero impact on practical policymaking.

…The fact that modern macroeconomic research is not widely used in practical policymaking is prima facie evidence that it is of little use for this purpose. The research may have been successful as a matter of science, but it has not contributed significantly to macroeconomic engineering.

Mankiw, the author of a best-selling undergraduate economics textbook, echoes my view that undergraduate courses are still stuck in 1970s macroeconomics.

the basic framework that modern [undergraduate] students learn to make sense of the business cycle is one that would be familiar to an early generation of Keynesians.

Why is 1990s macro so completely isolated within the ivory tower? Cochrane’s answer is that it is hard. The standards of rigor that 1990s macro demands require the use of stochastic calculus that is barely understandable to Ph.D students, much less to practitioners or undergraduates.

I am skeptical of that explanation. I look at the field of derivatives pricing in finance, which requires equally difficult math. But because Black-Scholes and other derivative pricing tools have proven useful, theory and practice enjoy the symbiotic relationship that one sees in other STEM fields.

If 1990s macro were of any use, somebody would have figured out how to make it intelligible to practitioners. Or else, as in finance, practitioners would be hiring “quants” to help solve real-world problems.

In fact, I share Blinder’s harsh assessment of 1990s macro. It was a dead end. Academic macroeconomists have turned out to be like the scholastics who labored over the question of how many angels can dance on the head of a pin.

But I also share Cochrane’s assessment of 1970s macro. Every time there is a new shock to the economy, practitioners are caught with their pants down. They never predict the event, and only months or even years afterward do they settle on an explanation.

My favorite book on macro is Macroeconomic Patterns and Stories, written by Edward Leamer, who relies on neither 1970s nor 1990s methods. In the introduction, Leamer writes,

You may want to substitute the more familiar scientific words "theory and evidence" for "patterns and stories." Do not do that. With the phrase "theory and evidence" come hidden stow-away after-the-fact myths about how we learn and how much we can learn. The words "theory and evidence" suggest an incessant march toward a level of scientific certitude that cannot be attained in the study of the complex self-organizing human system that we call the economy. The words "patterns and stories" much more accurately convey our level of knowledge, now, and in the future as well. It is literature, not science.

In August of 2009, I wrote a post on Leamer’s book, in which I remarked,

If housing is at the center of nearly every postwar economic recession, then this recession ought to be a doozy. We went from nearly 2 million housing starts a year to 0.5 million starts in about two years. I suspect that it did not matter one way or the other how we handled the banks. We were destined to get a whopper recession, because we had to adjust housing construction down by so much to restore balance to supply and demand.

It turned out that we did have a long, deep recession, at least in terms of unemployment.

I have proposed a “third way” of approaching macro, using neither 1970s methods nor 1990s methods. Some of you may already know that I call this Patterns of Sustainable Specialization and Trade, or PSST. I discuss this approach more in this paper, this paper, and in my book Specialization and Trade.