Krugman, Summers and deLong emphasizing the need for economic models

Economists Paul Krugman (NY Times), Lawrence Summers (Harvard University) and Bradford deLong (UC Berkeley) lashed out against the Federal Reserve’s decision to increase rates and the overall lack of clarity in their actions, emphasizing the need for economic models dictating ideas, and not the other way around.

Krugman writes:

…existing models are always the right guide for policy, but that policy preferences should be disciplined by models. If you don’t believe the implications of the standard model in any area, OK; but then give me a model, or at least a sketch of a model, to justify your instincts.

What, after all, are economic models for? They are definitely not Truth. They are, however, a way to make sure that the stories you tell hang together, that they involve some plausible combination of individual behavior and interaction of those plausibly behaving individuals.

…simple models don’t seem to have room for the confidence crises policymakers fear — and that I couldn’t find any plausible alternative models to justify those fears. It wasn’t “The model says you’re wrong”; it was “Show me a model”.

The reason I’ve been going on about such things is that since 2008 we’ve repeatedly seen policymakers overrule or ignore the message of basic macro models in favor of instincts that, to the extent they reflect experience at all, reflect experience that comes from very different economic environments. And these instincts have, again and again, proved wrong — while the basic models have done well. The models aren’t sacred, but the discipline of thinking things through in terms of models is really important.

deLong elaborates on it further:

…it depends on what you think the proper function of economic modeling is. Are models properly idea-generating machines, in which you start from what you think is the case and use the model-building process to generate new insights? Or are models merely filing systems–ways of organizing your beliefs, and whenever you find that your model is leading you to a surprising conclusion that you find distasteful the proper response is to ignore the model, or to tweak it to make the distasteful conclusion go away?

Both can be effectively critiqued. Models-as-discovery-mechanisms suffer from the Polya-Robertson problem: It involves replacing what he calls “plausible reasoning”, where models are there to assist thinking, with what he calls “demonstrative reasoning”. in which the model itself becomes the object of analysis.

In the real world, it is, of course, the case that models are both: both filing systems and discovery mechanisms.

Moreover, the Fed does not engage in reflective equilibrium. It rejects the conclusions of what I regard as the standard Patinkin-style existing model of Krugman (1999). But it does not propose an alternative model. There seems to me to be no theoretical ground, no model even considered as a filing system, underpinning the “orthodox” modes of thought that the Fed believes. And it does not seem to feel this absence aaa a problem. I find that somewhat disturbing.

Finally, Summers concludes by saying that the Fed is enthralled by an orthodoxy of ideas:

…the Fed seems to be in the thrall of notions that might be right but do not, to my knowledge, have analytic support.

Why is the Fed making these mistakes if indeed they are mistakes? It is not because its leaders are not thoughtful or open minded or concerned with growth and employment. Rather I suspect it is because of an excessive commitment to existing models and modes of thought. Usually it takes disaster to shatter orthodoxy. We can all hope that either my worries prove misplaced or the Fed shows itself to be less in the thrall of orthodoxy than it has been of late.