source material: Paul Romer: The Trouble With Macroeconomics

I'm two gold threads late to the party, but after finally getting to read Paul Romer's latest diatribe I've decided I might as well R1 it, because honestly, you're more likely to find better rants against macro on a median-quality EJMR thread than in this paper.

I'll try to summarize Romer's main points and respond to them in turn. Since I wanted to cover several things, my comments may be bit rushed, so feel free to push back a bit.

1) Macroeconomists have been pushing theories where money is neutral, or close to it, for past 30 years.

Although the real business cycle research program, which indeed does ignore money and to which Romer alludes, has played a large role in modern macroeconomics, by no means can macroeconomics be reduced to it. Even back in the 80s, other people were building microfounded models, where money was not neutral, under the New-Keynesian label. Decade or two later, NK models have become popular tool used to study monetary policy not only in academia, but also in central banks. Surely central bankers would not use models which would imply their own jobs are irrelevant!

2) Macro models are full of imaginary shocks.

Yes, larger models usually include several types of shocks that cause the economy to fluctuate. So? Modelling the business cycle as stochastic process, where various economic mechanisms amplify and propagate exogenous shocks, has a long tradition preceding even Cowles Commission macroeconometrics (which Romer views favorably, at least in relative terms), and it's hard to see what the alternative would be - deterministic models where all the dynamics is endogenous, generate cycles which are too regular, or must be shoehorned to rely on fragile chaotic dynamics.

Once we allow for exogenous shocks, there's no reason why we should limit ourselves to only one (though maybe Prescott would disagree). And the fact that the shocks are specified in terms of microeconomic foundations is a feature, not a bug - after all, one of the role that models play is to tell a story in a formal and precise way, and any economic story must be eventually traced to actions of individuals on the microeconomic level.

3) Models explaining joint behavior of several simultaneously-determined variables require additional assumption for identification.

True, as everyone who took a couple econometrics courses would know. Yet this problem must be faced by any macroeconomic model, be it DSGE, 1960s Keynesianism or any other, so I fail to see the point.

4) Models with rational expectations make the identification problem worse.

This is a part where Romer is actually wrong. While it's true that introducing expectations into the model requires us to estimate number of additional parameters (e.g. how sensitive is today's investment to expected future return?), getting rid of RE would require even more parameters. See, under rational expectations, the function mapping current state of the economy to expectations themselves is an outcome of the model (this is what people sometimes have in mind when talking about "cross-equation" restrictions). Without it, we'd need to model and estimate the expectation-forming process itself as well (how sensitive is expected return to past returns?), and thus be even in a worse position. Romer is essentially confusing the concept of rational expectations with presence of any forward-looking behavior, and attacking the latter - which is just idiotic (not the least because his own research on growth models involves plenty of forward-looking agents).

5) Bayesian methods are used to mask identification issues in DSGE models.

This is true to a certain extent (see this post by /u/Integralds ). It's also an active research area, so it's not like the issues are ignored. And on the other hand, whether this is a problem depends on the context. If your goal is prediction, overparametrized model combined with Bayesian priors can often do a pretty good job even if it's unidentified in the classical sense.

6) DSGE models hide their identifying assumptions in nontransparent way.

This seems to be a key argument, yet it's not really supported by anything. Romer doesn't discuss any issues in actual DSGE models, he simply presents a contrived example in which identification is obtained by restricting the weight of leisure in the utility function, and stops there. The problem is that no DSGE model I know of imposes such restriction (since the weight of leisure is typically used for calibrating the average share of time spent working), so what exactly has Romer proved?

And again, the fact that restrictions imposed by DSGE models are cast in terms of microeconomic behavior means that we can meaningfully discuss their interpretation and limitations. Thus for example the empirical failures of permanent income hypothesis make us think about the presence of liquidity constraints or precautionary saving and allow a fruitful link with empirical research on individual consumption behavior, something which would be much less obvious in a model cast purely in aggregate terms.

7) Something about string theory.

I'll let /u/kohatsootsich deal with this one.

8) Something about how Lucas, Prescott and Sargent behave badly.

Yup, in the end, Romer's claim that the past 30 years of macroeconomics is full of unscientific nonsense is "justified" by whole two anecdotes involving whole three researchers. Many scientific, much data, such wow. Really, the whole thing feels like Romer's butthurt for some reasons and decided to go on some kind of personal crusade, declaring himself a warrior for scientific ethics and openly attacking others as frauds - and then acts suprised when he meets hostile reaction.