Yellen Almost, but not Quite, Gets Whats wrong with Modern Macro

Janet Yellen have a good speech last Friday at a Boston Fed conference on Macro Research after the crisis.

She almost got it

Many macroeconomists work with models where groups of individual actors, such as households or firms, are treated as a single “representative” agent whose behavior stands in for that of the group as a whole. …

Prior to the financial crisis, these so-called representative-agent models were the dominant paradigm for analyzing many macroeconomic questions. However, a disaggregated approach seems needed to understand some key aspects of the Great Recession. To give one example, consider the effects of negative housing equity on consumption. Although households typically reduce their spending in response to wealth declines, the many households whose equity positions in their homes were actually driven negative by the reduction in house prices may have curtailed their spending even more sharply because of a markedly reduced ability to borrow. …

In light of the housing bubble and subsequent events, policymakers clearly need to better understand what kinds of developments contribute to financial crises. What is the relationship between the buildup of excessive leverage and the value of real estate and other types of collateral, and what factors impede or facilitate the deleveraging process that follows? Does the economic fallout from a financial crisis depend on the particulars of the crisis, such as whether it involves widespread damage to household balance sheets?

I underlined the last two words myself because all of the above matter because balance sheets matter.

In DGSE representative agent based models balance sheets dont matter because with a single agent inflows and outflow balance, there are no balance sheets, there is no distinction between stocks and flows mathematically.  Hence it is impossible for the model to behave in a non linear manner with feedback loops and complexity, the model can be linearised and is hence tractable within the limited simultaneous equation linear dynamics framework of DGSE.

So whilst Janet gets empirically what is wrong with modern macro research she misses the fundamental reasons this matters.

  1. Economics must be rebuilt around balance sheets and fundamental accounting identities
  2. Hence state – balance sheets- must be the basis of all models.  If the model is not a state machine it cannot describe the state of anything economic.
  3. Hence credit and debt, and money matters
  4. As debt issues are fundamentally non linear and complex models which require linearisation, such as DGSE, must be discarded, they are too broken to be fixed.

5 thoughts on “Yellen Almost, but not Quite, Gets Whats wrong with Modern Macro

  1. Yes! State machines are a great way to put it! (As long as economics stewed persons don’t think the state, like I did until I got to the second sentence.)

    State machines are covered in engineering and systems, and maybe calculus. Congratulations on using that great concept. Where and how did you come across it if I might ask?

    I was sitting in macro. class and thought look at all these variables, GDP, quantity Q, (in supply and demand), G, C, S, I, X, M, T, deficit/surplus, etc. etc. They are all flows and/or changes. In algebra it would be expressed the delta symbol (change in) variable name or in calculus derivative of the variable. And, wondered why hardly any state variable or equivalently Level variable to be found! Why is that? I asked. Then, I knew this whole thing was a muddled mess with the Important information of
    levels or states as you said not presented! With out the states or levels its incomplete B.S.

    Almost, only rates of changes or changes of rates of change are covered in class. In mechanics that would be only covering velocity and acceleration and ignoring position!

    Why? Ignorance, misdirection, or some thing else? If ignorance that is really inexcusable and most likely only possible if economists don’t talk to any one else or read any thing else. If it is misdirection, is it a huge costly waste, a cult?

    But, statistics of levels are measured and provide to the public, but hardly covered in the text book. Flow of funds report and national accounts have levels.

    How can any one swallow this stuff? Being too young?

    So, I quit going to class and went to the library every class day instead, to search for the levels and dynamics. Looking for dynamics because equilibrium goes against personal economic experiences and evidence. Almost nothing is standing still or not accelerating.

    Yeah, it maters how rich, poor, in debt, total stuff made, total pile of stuff imported, total pile of stuff exported, total money received for imports, etc. That has got to be obvious to every one before they step in an economics class or open a econ book. The state of the machine matters. The state of every ones economics matters. Why not in econ. class? I wondered. Are they misdirecting away from who is rich or poor, states of the system, or levels.

    The accumulations of the flows are the state or level! In math it is calculated in these ways: In algebra it is sum of the changes and in calculus integral of the flows or derivatives.

    So, I wondered. What knowledge makes this problem totally obvious? What knowledge would inoculate one from swallowing all of macro economics class? These are the few I know of:

    1. Accounting i.e. Balance Sheets. (you mentioned above)
    2. Knowledge of processes of accumulation.
    I. Filling a pot under the tap. River flowing into a reservoir. Filling a bath tub. A full bath beats 2 inches of water!
    II. Bank accounts, savings, keeping a check book balanced.
    III. Running a business.
    IV. Cooking. What happens when the proportional level of salt is to high?
    4. Math classes: summation, and integral calculus
    5. Science or engineering. Particularly mechanics.
    6. Math description of systems.
    7. Maybe mechanical knowledge.
    Are there other knowledge bases?

    i would have loved to watch an accounting student pepper the professor with questions! Now, I would love to see accountants interviewed on the economy, Any time now?

  2. I agree with you.

    What good, it would do, to require accounting for economics students.

    Or, all students by the way because it is so valuable and endemic in society and history.

  3. We don’t need to completely reject DSGE we need to integrate its particles of truth with the nascent awakening of disequilibrium and complexity theory to its essential alignment with the fully fleshed out PHILOSOPHICAL AND EXISTENTIAL concept of grace as a dynamic, flowing process.

    • You’ve included everything except what will actually resolve the systemic problem…..a continuing policy of dynamic monetary flow directly to individuals and businesses. All of you disequilibrium dunces are ultimately hung up in the irony of accounting equilibriums. It’s yours and Keen’s final cognition to discover that the full solution is “the higher disequilibrium” of a rate of flow of total individual incomes that is continuously greater than the rate of flow of total costs/prices combined with a retail discount that effects a continuous .state of price deflation. Oh well. Carry on.

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