Monday, May 19, 2014

Animal Spirits: an Empirical Test

Christian Zimmerman draws attention to a new paper by Paolo Gelain and Marco Guerrazi, "A demand-driven search model with self-fulfilling expectations: The new ‘Farmerian’ framework under scrutiny" 

Here is the abstract from the paper
In this paper, we implement Bayesian econometric techniques to analyze a theoretical framework built along the lines of Farmer’s micro-foundation of the General Theory. Specifically, we test the ability of a demand-driven search model with self-fulfilling expectations to match the behaviour of the US economy over the last thirty years. The main findings of our empirical investigation are the following. First, all over the period, our model fits data very well. Second, demand shocks are the most relevant in explaining the variability of concerned variables. In addition, our estimates reveal that a large negative demand shock caused the Great Recession via a sudden drop of confidence. Overall, those results are consistent with the main features of the New ‘Farmerian’ Economics as well as to latest demand-side explanations of the finance-induced recession.
In Christian's words...
Roger Farmer’s recent work has been causing quite a stir, especially as it seems to validate some the things that happened during the recent crisis. This paper provides an empirical test of Farmer’s theory and shows that he is indeed onto something.
Christian's website was set up to promote discussion of research on DSGE models and he invites visitors to leave comments on the papers he highlights. Thanks Christian, for drawing attention to this very interesting piece.

Sunday, May 4, 2014

New Keynesian Flimflam

Simon Wren-Lewis, seeks a serious debate with our heterodox colleagues, and judging by the excellent comment thread that appears on his post, there are plenty of heterodox economists who are ready and willing to take up the challenge. This is a welcome debate.

Simon defends his view of orthodoxy, by which he means New Keynesian economics. In its simplest form, New Keynesian economics is a three-equation model that explains the behavior of the nominal interest rate, the "output gap" and the inflation rate.

I agree firmly with Simon, that from a policy perspective, we should not care one iota if NK economics has anything to do with what Keynes might or might not have thought. But from the perspective of the history of thought, we should not mislead our students with false labels. The New Keynesian model is neither new nor Keynesian. It is a beautiful formalization of David Hume's verbal argument in his 1742 essay "Of Money"; an early piece on the Quantity Theory of Money  that every macroeconomics student should read at least once.