Friday, February 19, 2016

Working towward a notion of plausibility -- Krugman on models

I know I always promise I'm going to come back later and tie things together, but thiss time I really mean it.

Paul Krugman -- Making And Using Models
And that really gets at my point, which is not that 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.

Take, for example, the famous open letter to Ben Bernanke demanding that he call off quantitative easing. The signatories declared that “The planned asset purchases risk currency debasement and inflation, and we do not think they will achieve the Fed’s objective of promoting employment.” OK, how is that supposed to work? What model of the inflation process do you have in which an expansion of the Fed’s balance sheet translates into inflation without causing an overheating of the labor market first? I’m not saying that there is no possible story along those lines, but spell it out so we can see how plausible it is.

What I said in my Mundell-Fleming lecture was that 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.

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