Ptolemaic Woes: Ohanian, Prescott, McGrattan

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This is the second in a series of posts focusing on the Ptolemaic modeling that is characteristic of modern macroeconomics. Recall that Ptolemaic models result from research that is principally directed at supporting mainstream theory. Consistency with important evidence and relevance to effective policymaking are secondary objectives, always trumped by defense of established thinking.

In macroeconomics, the indiscriminate wreckage of the anti-Keynesian revolution is a predictable outcome of the modern revival of Ptolemaic research. It is a crucial subject, most apparent in mainstream inability to plausibly explain or figure out how to tame macro instability. The huge welfare cost of the Great Recession makes a powerful case that the leaders of the profession have got to stop goofing around. The design of effective stabilization policy is not a parlor game. Reasonable objectives cannot emphasize go way the preservation of human capital and reputations of the academy’s gatekeepers who govern dissemination of macro research.

Most obviously, we must stop  ignoring important information generated during extreme 2008-09 instability. Among the most significant facts, the sizeable lost output turns out to be wholly attributable to reduced labor input, with no contribution from lower productivity. From peak to trough, employee hours dropped 8.7% while total product fell 7.2%. Jobs declined 6.7%. In the average postwar recession, jobs contract 3.8%, output 4.4%, and hours 3.2%. It crucially matters that the job separation, as in all recessions, was overwhelmingly involuntary. Fitting the Great Recession into a general-market-equilibrium research program ultimately turns on the capacity of coherent modeling to accommodate the size and nature of the labor cutback. The GEM Project demonstrates the facts to imply that, in order to be simultaneously coherent and stabilization-relevant, macro models must be capable of rationally suppressing wage recontracting and, as a result, require the rational existence of meaningful wage rigidity. (Chapter 1)

The restriction of rational exchange to the marketplace causes mainstream theory to instead suppress labor-price rigidity, forcing its analysis of the Great Recession to get off on the wrong foot. Once on that path, theorists get the key question posed by the 2007-09 empirical configuration wrong. Consider the following from Ohanian (2010, pp. 51-52): “… hours worked during the 2007-2009 recession are much too low relative to the marginal product of labor. Thus, the key to understanding this recession is finding a factor that works like a large increase in the tax on labor income that depresses the incentive to work relative to the observed marginal product of labor.” What do we know about the mainstream presumption that the reduced labor input resulted from some wedge that motivated a huge counter-cyclical movement in voluntary job separation? Answer: It is utterly rejected by the evidence. For starters, empirical work cannot find any counter-cyclicality in voluntary quits – good news for those of us who believe in rational behavior. More crucially, everybody knows that cyclical unemployment results from forced job loss.

Ohanian, without apology or explanation, simply begins his analysis of the Great Recession with the presumption of market clearing. Evidence to the contrary be damned. That common practice is the most egregious Ptolemaic convention in mainstream macroeconomics. Why is it tolerated? Here’s what I think. The beautiful general-market-equilibrium model constructed by the estimable late-19th century marginalists is a box that has become way too comfortable; breaking out of it, way too costly. A huge pile of human capital has been invested in its maintenance and development. Nobody wants to come to grips with the generation of graduate students have been horribly misled. The result is unselfconscious collusion on the indefensible practice of using Walrasian conclusions as foundations upon which to construct modern macro analysis.

Responding to the huge public-policy challenge of the Great Recession is something macroeconomists are expected to do, providing opportunity to observe Ptolemaic thinking in action. An interesting example is how modern research often gets stuck in blind alleys. McGrattan and Prescott (2012, 2014) have written a series of papers seeking to explain one aspect, the increase in labor productivity, of the 2007-09 empirical configuration. Such behavior is interesting in its inconsistency with the idea that recessions are caused by technological disturbances, which are manifest in procyclical productivity. There is no attempt to confront other evidence or to consider other explanations, exercises made moot by the Ptolemaic convention of market clearing. Instead, McGrattan and Prescott focus on the construction of the offending productivity data.  In particular, they argue that total labor productivity can be made procyclical in the Great Recession by including intangible investment in the measurement of output. They have expended significant effort struggling with the measurement of R&D, software, artistic originals, brand equity, and organizational capital. It is a familiar class of Ptolemaic response to difficult evidence. Rework the offending evidence until it gives the desired answer; or, failing that, conveniently define some unmeasurable component that does the job conceptually.

Ptolemaic modelers unsurprisingly lose sight of what really matters. Wouldn’t it be logical in considering labor-productivity correlation with the business cycle to first identify, at least to a first approximation, which of the several potential causes produced the result in question? That line of inquiry would encompass the more useful question: Was the Great Recession actually caused by technical regress? Is the favorite argument wrong? Did the massive job separation result from something else, something that forced layoffs? What about practitioner reports of collapsing demand inducing massive market failure and involuntary unemployment, opening up different lines of research from figuring out how to recalculate labor productivity to reverse its sign? Would it be worthwhile to consider the coherent generalized-exchange model class, developed in the GEM Project, that microfounds the meaningful wage rigidity needed to suppresses wage recontracting?

Such questions, especially the Keynesian ones, are ruled out by Ptolemaic thinking that allows the presumption, without justification, of market clearing. That mainstream macroeconomists so easily turned their backs on stabilization relevancy is unfathomable.

Blog Type: New Keynesians Paris, France



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