Wednesday, 12 October 2011

Toward a political economy of macroeconomic thinking

A new paper by Gilles Saint-Paul on Toward a Political Economy of Macroeconomic Thinking. The abstract reads:
This paper investigates, in a simplified macro context, the joint determination of the (incorrect) perceived model and the equilibrium. I assume that the model is designed by a self-interested economist who knows the true structural model, but reports a distorted one so as to influence outcomes. This model influences both the people and the government; the latter tries to stabilize an unobserved demand shock and will make different inferences about that shock depending on the model it uses. The model's choice is constrained by a set of autocoherence conditions that state that, in equilibrium, if everybody uses the model then it must correctly predict the moments of the observables. I then study, in particular, how the models devised by the economists vary depending on whether they are "progressive" vs. "conservative". The predictions depend greatly on the specifics of the economy being considered. But in many cases, they are plausible. For example, conservative economists will tend to report a lower keynesian multiplier, and a greater long-term inflationary impact of output expansions. On the other hand, the economists' margin of manoeuver is constrained by the autocoherence conditions. Here, a "progressive" economist who promotes a Keynesian multiplier larger than it really is, must, to remain consistent, also claim that demand shocks are more volatile than they really are. Otherwise, people will be disappointed by the stabilization performance of fiscal policy and reject the hypothesized value of the multiplier. In some cases, autocoherence induces the experts to make, loosely speaking, ideological concessions on some parameter values. The analysis is illustrated by empirical evidence from the Survey of Professional Forecasters.
When he considers the evidence from the Survey of Professional Forecasters, Saint-Paul finds that forecasters who believe that expansions are more inflationary also believe that public expenses are less expansionary.

The Economic Logician writes,
His [Saint-Paul] claim is that we live in a self-confirming equilibrium. We devise theories to understand our surrounding and take decisions, and those decisions then shape the economic environment. Theories can thus survive even if they deviate from the true structure as long as the decisions make it conform. This is a statement about a lack of uniqueness of the path to the rational expectations equilibrium. In a sense, this is not too disturbing, as long as decisions are still optimal and outcomes do not differ too much from the rational expectations first best. And if this true, we will never know what the rational expectations first best is. Of broader implications would be if the political agenda of an economist would lead an economy on an different path, on a different self-confirming equilibrium. Is this why Europe and the United States are different? Were Keynes and von Hayek that influential?
Is macroeconomics really all in the mind .... or the model of the economist?

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