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David and Goliath: The sunspot agenda meets the MIT machine

Summary:
Two interesting developments occurred on the DSGE front this week. CEPR, the London based research organization, published an ebook on the future of Dynamic Stochastic General Equilibrium Models and Aurélian Saïdi and Beatrice Cherrier released an updated version of their history of the Penn/CEPREMAP research agenda on indeterminacy and sunspots. There could have been, and should have been, considerable overlap in these two events. Sadly there was not.  For forty years, macroeconomics has been dominated by a battle between classical ideas emanating from the universities of Minnesota and Chicago, and New Keynesian ideas, emanating from MIT. In the past decade or so, MIT has been dominant and MIT trained economists have steamrolled an agenda that developed from Samuelson's interpretation of Keynes. According to this interpretation, the economy is Keynesian in the short run, when prices are sticky, and classical in the long-run, when all prices have had time to adjust. The MIT machine is the Goliath of my story.A parallel agenda developed in the 1980s at the University of Pennsylvania in the U.S. and at CEPREMAP in France.

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Two interesting developments occurred on the DSGE front this week. CEPR, the London based research organization, published an ebook on the future of Dynamic Stochastic General Equilibrium Models and Aurélian Saïdi and Beatrice Cherrier released an updated version of their history of the Penn/CEPREMAP research agenda on indeterminacy and sunspots. There could have been, and should have been, considerable overlap in these two events. Sadly there was not. 

For forty years, macroeconomics has been dominated by a battle between classical ideas emanating from the universities of Minnesota and Chicago, and New Keynesian ideas, emanating from MIT. In the past decade or so, MIT has been dominant and MIT trained economists have steamrolled an agenda that developed from Samuelson's interpretation of Keynes. According to this interpretation, the economy is Keynesian in the short run, when prices are sticky, and classical in the long-run, when all prices have had time to adjust. The MIT machine is the Goliath of my story.

A parallel agenda developed in the 1980s at the University of Pennsylvania in the U.S. and at CEPREMAP in France. This separate agenda accepted some but not all of the ideas of Minnesota and Chicago and married them with notions of  indeterminacy, sunspots and multiple equilibria as a way of understanding the macroeconomy. The sunspot/indeterminacy program is the David of my tale.

There is much to like and to agree with in the CEPR ebook, edited by Refet Gürkaynak and Cédric Tille. As with other projects in this series, it consists of a series of short articles from practitioners in the field, each giving a different perspective on the current state of the art in macroeconomic modeling. I particularly liked the piece by Del Negro and Giannoni explaining progress made at the Federal Reserve Bank of New York (FRBNY) on developing a suite of models for forecasting and policy evaluation. The FRBNY DSGE model has been around for a while and is now available as free open source code written in the programming language Julia. Julia, like MatLab, is a matrix based language compiled in real time. It is up to ten times faster than MatLab and free. Time (for me) to make the switch.

The CEPR ebook ends with speculation by Jordi Galí and Olivier Blanchard on the future of DSGE modeling. Here, I was disappointed by the inability of either Jordí or Olivier to acknowledge the body of knowledge developed over the past three decades by researchers in the sunspot/multiple equilibrium program. Neither Jordí nor Olivier are unaware of these ideas. Jordi has written sunspot papers and Olivier was the discussant on the Animal Spirits paper I wrote for the new Phelps volume where I showed how models with indeterminate steady state equilibria can explain hysteresis, a topic after Olivier’s heart.

Saïdi and Cherrier speculate that sunspot ideas did not capture the hearts of the profession because the researchers involved in the program failed to develop a common language and engaged in territorial disputes over property rights. There was no single leader to push the agenda. There is certainly an element of truth to that. Sunspots, self-fulling prophecies, animal spirits and confidence were all used interchangeably by different groups of authors to mean the same thing. Now there is yet another emergent power play by George-Marios Angeletos and Jennifer La’o to take the mantle. Rather than use sunspots, self-fulfilling prophecies or animal spirits, Angletos and La’o substitute yet another term ‘sentiments’ to mean the ability of non-fundamental shocks to influence economic activity.

There will always be turf battles over intellectual ideas. The stakes are high, particularly when these ideas are once more gaining prominence. It is a personal view, expanded on here, that the entire MIT inspired New Keynesian edifice is built on sand. It is hard to read the General Theory without recognizing the role of multiple equilibria. Not just multiple paths, as in the first generation sunspot models, but multiple indeterminate steady states, as in the second generation models based on search theory that I survey here.  By marginalizing that idea and building their models on ‘frictions’, the New Keynesians sold their collective soul.

In some circles, DSGE is a four-letter term of abuse. That is a pity and here, I am on the side of Gürkaynak and Tille. To quote from my 1993 book, The Macroeconomics of Self-Fulfilling Prophecies, [page 1]  “… the future of macroeconomics is as a branch of applied general equilibrium theory.”  For forty years or more, Post-Keynesian economists clung to the idea that, whatever Keynesian economics is about, it is not about sticky prices. I agree.   But unlike the Post-Keynesians, I am also a fan of DSGE modelling. As I argue here, by adopting the ideas of second generation models of indeterminacy and sunspots, it becomes possible to be a Post-Keynesian, as opposed to a New-Keynesian, and a DSGE fan, at the same time. 

I am optimistic, perhaps in vain, that David's sling-shot will one day, bring down Goliath.

 

 

Roger Farmer
ROGER E. A. FARMER is a Distinguished Professor of Economics at UCLA and served as Department Chair from July 2008 through December 2012. He was the Senior Houblon-Norman Fellow at the Bank of England, January-December 2013.

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