79 Comments

There is a fundamental question: Do our models represent the "real world" sufficiently so that any policy experiment on a model would actually work out there?

Having studied in Minnesota, taking classes with Sargent, Prescott, Wallace, Sims and Hurwicz, I came out convinced that DSGE models that *assume* linearity right at the outset (with quadratic utility function for all participants if not outright identical ones) is far far away from reality. Leo Hurwicz taught us (taking a cue from Koopmans) that utility function additive in time require absurd assumptions about the preferences of the participants.

All of this is shoved under the carpet in a Lucas island model.

For the economics profession, what it has done is to completely take over the macro research. IMHO, in the long run, it has done more damage than help.

Executive summary: In the even longer run, we know what will happen to us as Keynes noted.

Expand full comment
May 16, 2023Liked by Noah Smith

While I'm sure this is meant to be complimentary, this ultimately sounds like he posed some interesting research work that ended up being counterproductive and probably hurt the economy. In the end we ended up with the old Keynesian insights. The market monetarists and monetarists can pretend they have something altogether new but it all builds on Keynesianism in the end.

Expand full comment

I'll point out that we did indeed know how to deal with the 2008 Great Recession, we just didn't do it. We did rescue the banks and bank-like institutions.

But we left fiscal policy mostly unused, and left homeowners saddled with the debt from underwater mortgages, rescuing only the banks.

Banks essentially refused to participate in any of the programs design to refinance homes with a more reasonable balance and instead foreclosed on houses, a failure of government oversight.

Annoyingly, bank stockholders were left whole, while every startup I've participated would have faced real share dilution had they f**ked up to the degree that the big banks did with their CDS-based synthetic bonds.

Expand full comment
May 16, 2023Liked by Noah Smith

Even the Great Depression didn't matter much in the long run. But, as Keynes said, in the long run we are all dead.

If you look at the remarkable divergence between Australia and New Zealand since 1980s, the most plausible explanation is that NZ has had more and deeper recessions and has never recovered the lost ground.

Expand full comment

I’ve always had a problem with ‘rational expectations’ stuff as if ppl are walking around all day thinking if price inflation & grown rates when making decisions considering 80% of ppl couldn’t tell you the right number for either in a spot quiz and spend way more of their time thinking about their kids soccer game or the TV show they watched last night

Expand full comment

I do admire your ability to take a fair and measured perspective, even if your subject, in this case Lucas, didn’t always.

Expand full comment
May 16, 2023Liked by Noah Smith

"That said, I think that macroeconomics is a very very hard subject, given the complexity of the phenomena involved and the paucity of good empirical data. "

Exactly why you can't just create some neat little model and assume you've got it all figured out.

Expand full comment
May 16, 2023Liked by Noah Smith

It seems a shame Lucas never could update his views to recognize where he was wrong.

https://archive.nytimes.com/krugman.blogs.nytimes.com/2011/09/26/lucas-in-context-wonkish/

I can't find it at the moment, but I know there's a wonkish post from Krugman where he lays out that _even if you accept Lucas' model_ of how consumers rationally update behavior in response to stimulus, that doesn't mean stimulus won't work, because if consumers expect higher taxes _over the long term_, that means they will lower their consumption _in out-years_, whereas the stimulus is concentrated in the present. So while the multiplier will be lower than you might expect, you still can boost GDP and escape the liquidity trap via fiscal policy. If anything, the Lucas-ian theory here improves the argument for stimulus because it implies you'll get a counter-cyclical pullback in consumption spending in future good years, exactly when you want it!

Ah, here we go:

https://archive.nytimes.com/krugman.blogs.nytimes.com/2011/12/26/a-note-on-the-ricardian-equivalence-argument-against-stimulus-slightly-wonkish/

Expand full comment

Excellent history lesson combined with a valuable insight: our ignorance of causes always stretches farther than we can see

Expand full comment
May 16, 2023Liked by Noah Smith

Really, really nice summary for me. Thank you.

Expand full comment

I think you are mistaken when you say Lucas used simple math and simple logic.His business cycle models used sophisticated signal extraction mathematics and he published in the Journal of Economic Theory. In fact, the high powered math helped to obscure the simple logic that his results about policy irrelevance depended on perfect competition. Perhaps you had to be there…

Expand full comment

Thanks Noah!

Of course, I didn't get it all, but Noahpinion has the best chance of 'splaining it to me.

Best economics course since my sophomore year in college.

Expand full comment
May 16, 2023Liked by Noah Smith

Good overview, thanks.

Expand full comment

Very interested in the idea that Lucas' simple logical intelligence was inherently destructive. I'd be interested in hearing more about the roles of different types of intelligence in economics if you have anything on that

Expand full comment
May 16, 2023Liked by Noah Smith

Thank you in particular not just for your insight, but for your concluding sentence!

Expand full comment

Nice one

Expand full comment