A Project of The Annenberg Public Policy Center

When Economists Disagree, Part II

In a post last week, we explained some of the difficulties involved in trying to determine whether or not the stimulus package will work. As we said at the time:

Well, for one thing, economists have very little data with which to work. There are plenty of theoretical models out there, but those models are largely untested. … [O]ur long period of relative prosperity means that economists haven’t been able to plug a lot of real-world situations into their models to see how well those models hold up.

A working paper from macroeconomist Arnold Kling, an adjunct scholar at the Cato Institute, sheds additional light (or is that murk?) on the problem. According to Kling, our assessment might not go far enough: The real problem is that there isn’t any data at all. As Kling puts it:

There are no controlled experiments in macroeconomics. We would like to observe what would happen to employment and output in the United States in 2010 under different stimulus proposals. Ideally, we could construct alternative universes with the exact same initial conditions and try different policies. In practice, this is not possible.

The problem, Kling says, is that every attempt to model the effects of a given policy will end up comparing two different points in time. But that means introducing a whole host of new variables. Consider just a few factors that are relevant today:

  • Most of the labor force now graduates from high school and a large percentage also attends college.
  • Lots of Americans have relatively easy access to credit cards.
  • The Internet gives workers access to vast amounts of information nearly instantly.
  • Very few Americans are full-time farmers.

None of these things was true in the 1930s when the U.S. last faced a recession this large. So any economic model will have to attempt to control for all these differences. Kling, however, is skeptical that we can make all the necessary adjustments. He concludes:

We badly want macroeconometrics to work. If it did, we could resolve bitter theoretical disputes with evidence. We could achieve better forecasting and control of the economy. Unfortunately, the world is not set up to enable macroeconometrics to work. Instead, all macroeconometric models are basically simulation models that use data for calibration purposes. People judge these models based on their priors for how the economy works. Imposing priors related to rational expectations does not change the fact that macroeconometrics provides no empirical information to anyone except those who happen to share all of the priors of the model-builder.

In other words, macroeconomic models presuppose the biases of the model builders. The result: conservative economists with models that show that the stimulus won’t work and liberal economists with models that show it will. Which is a fancy way of saying that the evidence you get will depend on what you believe to start with.