Monday, November 26, 2012

SED Newsletter: Lucas Interview

The November 2012 SED Newsletter has some useful information on upcoming meetings. There is also an interview with Robert Lucas, which is a gem. Some excerpts:

On the Lucas Critique:
But the term "Lucas critique" has survived, long after that original context has disappeared. It has a life of its own and means different things to different people. Sometimes it is used like a cross you are supposed to use to hold off vampires: Just waving it it an opponent defeats him. Too much of this, no matter what side you are on, becomes just name calling.

Business cycles are all alike?
As I have written elsewhere, I now believe that the evidence on post-war recessions (up to but not including the one we are now in) overwhelmingly supports the dominant importance of real shocks. But I remain convinced of the importance of financial shocks in the 1930s and the years after 2008. Of course, this means I have to renounce the view that business cycles are all alike!

Microfoundations:
ED: If the economy is currently in an unusual state, do micro-foundations still have a role to play?
RL: "Micro-foundations"? We know we can write down internally consistent equilibrium models where people have risk aversion parameters of 200 or where a 20% decrease in the monetary base results in a 20% decline in all prices and has no other effects. The "foundations" of these models don't guarantee empirical success or policy usefulness.
What is important---and this is straight out of Kydland and Prescott---is that if a model is formulated so that its parameters are economically-interpretable they will have implications for many different data sets. An aggregate theory of consumption and income movements over time should be consistent with cross-section and panel evidence (Friedman and Modigliani). An estimate of risk aversion should fit the wide variety of situations involving uncertainty that we can observe (Mehra and Prescott). Estimates of labor supply should be consistent aggregate employment movements over time as well as cross-section, panel, and lifecycle evidence (Rogerson). This kind of cross-validation (or invalidation!) is only possible with models that have clear underlying economics: micro-foundations, if you like.

This is bread-and-butter stuff in the hard sciences. You try to estimate a given parameter in as many ways as you can, consistent with the same theory. If you can reduce a 3 orders of magnitude discrepancy to 1 order of magnitude you are making progress. Real science is hard work and you take what you can get.

"Unusual state"? Is that what we call it when our favorite models don't deliver what we had hoped? I would call that our usual state.

7 comments:

  1. The final comment is priceless - yet so true. I really enjoy reading what Lucas has to say. I don't always agree, but he is always interesting and serious about what he is talking about. It always makes me think. This interview is especially good because he is talking about broad strokes about the profession.

    I totally agree that the Lucas critique finds its way into discussion way to easily, but I disagree in the sense that it is still a useful check in a lot of different settings. Macro sometimes really needs to think harder about endogeneity and heterogeneity in the data - sometimes I get tired of attending a seminar which tells me a particular mechanism is consistent with some moments of the data without any serious robustness. As a structural labour guy, sometimes I just feel like how did you get away with that?

    Anyways, macro is a hard subject and there are plenty of really bright people on the case. I can't wait for the next 20 years to see what comes next!

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  2. Andrew, nicely said, I agree.

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    1. Some of Lucas's important contributions came in the form of sophisticated theory, but this gives you the flavor of the practical-minded empiricist at the heart of that.

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  3. Great find, always love reading Lucas.

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    1. You would learn more by reading Coase

      In an essay published on Nov. 20 in Harvard Business Review, Coase argues that in the early 20th century, economists began to focus on relationships among statistical measures, rather than problems that firms have with production or people have with decisions. Economists began writing for each other, instead of for other disciplines or for the business community. “It is suicidal for the field to slide into a hard science of choice,” Coase writes in HBR, “ignoring the influences of society, history, culture, and politics on the working of the economy.” (By “choice,” he means ever more complex versions of price and demand curves.) Most economists, he argues, work with measures like gross domestic product and the unemployment rate that are too removed from how businesses actually work.

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  4. this interview is yet another example of willingness of Lucas to change his mind on major issues and causes of recessions

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