Thursday, August 28, 2008

Olivier Blanchard on the state of Macro

In a new NBER working paper, after 25 pages of making nice, Olivier gets down to business:

"A macroeconomic article today often follows strict, haiku-like, rules: It
starts from a general equilibrium structure, in which individuals maximize the
expected present value of utility, firms maximize their value, and markets clear.
Then, it introduces a twist, be it an imperfection or the closing of a particular set
of markets, and works out the general equilibrium implications. It then performs
a numerical simulation, based on calibration, showing that the model performs
well. It ends with a welfare assessment."

He suggests three ways to improve:

1. Go back to partial equilibrium models.

2. Have independent validation for any new twist being inserted in the DSGE model

3. I have to quote here because it's pretty weird: "the re-legalization of shortcuts and of simple models. "

I am fully on board with #2 as but #1 and #3 are strange at best.

I would replace his #1 and #3 with "estimate, don't calibrate" and "lay off the welfare stuff because in the real world agent are heterogeneous and welfare evaluations are intractable".