Postwar Metrics

1. Postwar Metrics Session 15

2. 1970s Problems with the Phillips curve: • Trade-off between inflation and unemployment / real output • Used as a (Keynesian) policy instrument • Appeared not to be that stable as originally was supposed (not by Phillips!) • Stagflation: increase of both inflation and unemployment

3. Rational expectations Expectations and the Neutrality of Money (1972): • No usable trade-off, notwithstanding econometric evidence • Rational agents + inadequate price signals + equilibrium system Econometric policy evaluation: A critique (1976) • No invariance under policy interventions Robert Lucas

4. Lucas Critique (1976) invariant for policy variations Tastes and Technology

5. Debate in and about econometrics CC econometrics has failed • Hendry, David F. (1980). Econometrics – Alchemy or Science? Economica. • Sims, Christopher A. (1980). Macroeconomics and Reality. Econometrica. • Leamer, Edward E. (1983). Let’s take the con out of econometrics. American Economic Review.

6. 1985 • August 19 A Symposium on Econometric Methodology at the World Congress of the Econometric Society. David Hendry, Edward Leamer and Christopher Sims. • December 29 Joint Session with the HES at the Annual Meeting of the AEA: ‘First Forays Into the History of Econometrics’. Roy Epstein, Mary Morgan and Chris Gilbert. Edward Leamer was discussant. • Foundation of Econometric Theory by Peter C.B. Philips

7. Editorial policy of ET • To publish historical studies on the evolution of econometric thought and on the subject's early scholars. • To publish high-level professional interviews with leading econometricians.

8. David Hendry LSE inaugural lecture Econometrics: Alchemy or Science? LSE approach: General to Specific

9. Keynes according to Hendry Problems of the linear regression model: • using an incomplete set of determining factors (omitted variables bias) • building models with unobservable variables (such as expectations) • estimated from badly measured data based on index numbers • obtaining spurious correlations from the use of proxy variables and simultaneity • being unable to separate the distinct effects of multicollinear variables • assuming linear functional forms not knowing the appropriate dimensions of the regressors • mis-specifying the dynamic reactions and lag lengths • incorrectly pre-filtering the data • invalidly inferring causes from correlations • predicting inaccurately (non-constant parameters) • confusing statistical with economic significance of results • failing to relate economic theory to econometrics.

10. Additional problems: • stochastic mis-specification • incorrect exogeneity assumptions • inadequate sample sizes • aggregation • lack of structural identification • inability to refer back uniquely from observed empirical results to any given initial theory

11. Keynes’s critique still relevant: “It is difficult to provide a convincing case for the defence against Keynes’s accusation almost 40 years ago that econometrics is statistical alchemy since many of his criticisms remain apposite.” Don Patinkin (1974 Presidential Address to the Econometric Society): “I find it somewhat depressing to see how many of them are, in practice, still of relevance today.”

12. Hendry’s methodology “The three golden rules for econometrics are test, test and test; that all three rules are broken regularly in empirical applications is fortunately easily remedied. Rigorous tested models, which adequately described the available data, encompassed previous findings and were derived from well based theories would greatly enhance any claim to be scientific.”

13. Christopher Sims VAR approach (vector auto regressive) Response against Koopmans critique of Measurement without Theory: CC methodology implies too much a priori theory “I think the most reliable way to do empirical research in macroeconomics is to use assumptions drawn from ‘theory,’ which actually means intuition in most cases, as lightly as possible and still develop conclusions.”

14. Edward Leamer • Economic tricks, econo-mystics, icon-ometrics • Bayesian approach • Statistical approach too much based on statistics developed in agricultural experimentation (RCT, R.A. Fisher)

15. Non-econometric response • Kydland and Prescott carrying out the Lucas program to localize invariance not in the relations but in the parameters. • Stable facts = stylized facts = NBER facts • Calibration

16. NBER Workingplans Observable characteristics “The way we have chosen is to observe the business cycles of history as closely and systematically as we can before making a fresh attempt to explain them.”

17. Woodward: Data - Phenomena • Phenomenaare relatively stable and general features of the world and therefore suited as objects of explanation and prediction. • Data, that is, the observations playing the role of evidence for claims about phenomena, on the other hand involve observational mistakes, are idiosyncratic and reflect the operation of many different causal factors. • Theories are not about observations but about phenomena.

18. Stylized Facts “Since facts, as recorded by statisticians, are always subject to numerous snags and qualifications, and for that reason are incapable of being summarized, the theorists, in my view, should be free to start off with a ‘stylized’ view of the facts – i.e. concentrate on broad tendencies, ignoring individual detail” - Nicholas Kaldor (1961), 'Capital Accumulation and Economic Growth.’

19. Kaldor’s Facts • The continued growth in the aggregate volume of production and in the productivity of labour at a steady trend rate; • A continued increase in the amount of capital per worker; • A steady rate of profit on capital; • Steady capital-output ratios over long time periods • A high correlation between the share of profits in income and the share of investment in output; a steady share of profits (and of wages) in societies and/or in periods in which investment coefficient (the share of investment in output) is constant. • There are appreciable differences in the rate of growth of labour productivity and of total output in different societies, the range of variation (in the fast-growing economies) being of the order of 2-5 per cent.

20. Stylized Kaldor’s facts Solow: “There is no doubt that they are stylized, though it is possible to question whether they are facts.” • Output per worker grows at a roughly constant rate that does not diminish over time. • Capital per worker grows over time. • The capital/output ratio is roughly constant. • The rate of return to capital is constant. • The share of capital and labor in net income are nearly constant. • Real wage grows over time.

21. Lucas’s Program “A ‘theory’ is not a collection of assertions about the behavior of the actual economy but rather an explicit set of instructions for building a parallel or analogue system – a mechanical, imitation economy. A ‘good’ model, from this point of view, will not be exactly more ‘real’ than a poor one, but will provide better imitations. Of course, what one means by a ‘better imitation’ will depend on the particular questions to which one wishes answers.”

22. Computational Experiment • pose a question • use a well-tested theory • construct a model economy • calibrate the model economy • run the experiment

23. Question how much-questions instead of why-questions Measurement In our business cycle studies, we do not try to fit or explain anything. Rather, we derive the business cycle implications of growth theory. […] We emphasize that we deduce the quantitative implications of theory for business cycle fluctuations.

24. Well-tested Theory Theory: set of instructions for building a mechanical imitation system to answer a question Well-tested: to provide reliable answers to a class of questions

25. Calibration data are used to calibrate the model economy so that it mimics the world as closely as possible along a limited but clearly specified, number of dimensions Stylized Facts of Economic Growth

26. Stylized Facts • Real output grows at a more or less constant rate. • The stock of real capital grows at a more or less constant rate greater than the rate of growth of the labor input. • The growth rates of real output and the stock of capital tend to be about the same. • The rate of profit on capital has a horizontal trend.

27. Real Business Cycles Instructions: ct + xtyt (1+)kt+1 = (1-)kt+ xt

28. Calibration I: Shaping Stylized Facts of Economic Growth

29. Question What is the quantitative nature of fluctuations induced by technology shocks? Technology: zt+1 = zt+ t

30. Technology Tastes          0.40 0.012 0.95 0.007 0.0156 0.987 1 0.64 0.012 Calibration II: Parameter values