08-14-2016, 01:41 AM
When are economic models useful? When they make interesting predictions that pan out, according to Krugman. On that score, the workhorses of macro economics (the DSGE models) do not fare very well, but old-fashioned ISLM model did make a few notable predictions that are highly counter-intuitive, and these have panned out.
The answer, I’d suggest, is that we look for surprising successful predictions. General relativity got its big boost when light did, in fact, bend as predicted. The theory of a natural rate of unemployment got a big boost when the Phillips curve turned into clockwise spirals, as predicted, during the stagflation of the 1970s. So has there been anything like that in recent years? Yes: economists who knew and still took seriously good old-fashioned Hicksian IS-LM type analysis made some strong predictions after the financial crisis that were very much at odds with what lay commentators, and quite a few economists, were saying. They – OK, we – declared that with interest rates near zero massive increases in the monetary base would not cause high inflation, that large budget deficits would not drive interest rates up or crowd out private investment, and that fiscal multipliers would be positive, in fact more than one, and would be considerably larger than estimates based on non-liquidity-trap episodes suggested. And all of that came to pass. Those of us who knew our Hicks, directly or indirectly, seem to have had a real advantage over those who didn’t. Can you say anything comparable about DSGE? Were there any interesting predictions from DSGE models that were validated by events? If there were, I’m not aware of it. Yet even while failing to offer any measurable gains in insight, DSGE had the effect of crowding out the stuff that actually did work.
The state of Macro is sad by Paul Krugman - The New York Times