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Sep 10, 2015

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Nobel Lec

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Nobel Lec

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effects

Christopher A. Sims

Princeton University

sims@princeton.edu

December 8, 2011

Outline

Tinbergens Project

Haavelmos critique: the renewed project

The large models run aground, as probability models

The monetarist vs. Keynesian debates: failure to model policy

behavior

Bayesian inference

Rational Expectations

Causality tests, VARs, SVARs

Dynamic stochastic general equilibrium models (DSGEs)

What still requires work

The project

on parameter estimates.

aggregate level.

Outline

Tinbergens Project

Haavelmos critique: the renewed project

The large models run aground, as probability models

The monetarist vs. Keynesian debates: failure to model policy

behavior

Bayesian inference

Rational Expectations

Causality tests, VARs, SVARs

Dynamic stochastic general equilibrium models (DSGEs)

What still requires work

them one at a time.

probability model of all the time series.

error terms, it could explain any observed data and

therefore could not be used to test theories of the business

cycle, contrary to Tinbergens claims.

instead that economic models, in order to be testable, must

contain explicit error terms, since they would not make precise

predictions.

formulated as probability models that make assertions about

the likely size and correlation patterns of their error terms.

Haavelmos proposal

distribution for a complete set of data, containing many

variables and many time periods.

be formulated, estimated and tested this way.

Outline

Tinbergens Project

Haavelmos critique: the renewed project

The large models run aground, as probability models

The monetarist vs. Keynesian debates: failure to model policy

behavior

Bayesian inference

Rational Expectations

Causality tests, VARs, SVARs

Dynamic stochastic general equilibrium models (DSGEs)

What still requires work

Large models

I

had many sources and that many policy instruments were

relevant to stabilization policy.

month-to-month policy decisions, a model would have to be

on a much larger scale than Haavelmos example.

the Cowles Foundation methdology for codifying and

expanding Haavelmos ideas about inference.

that models with hundreds of equations could be estimated

and solved.

econometricians led to the formation and estimation of

models with hundreds of equations.

Problems of scale

I

has, in principle, tens of thousands of unknown coefficients

describing the relations of variables to one another.

One cant ask the data to tell you the values of all of them

there are not tens of thousands of observations.

some potential channels of influence are negligible, or of a

priori known form.

The large scale modelers did exactly this, but in the process

assumed away many sources of uncertainty. They simplified

the models as if they were certain that the restrictions they

were imposing were correct, even though they were only

approximate.

Tinbergens Project

Haavelmos critique: the renewed project

The large models run aground, as probability models

The monetarist vs. Keynesian debates: failure to model policy

behavior

Bayesian inference

Rational Expectations

Causality tests, VARs, SVARs

Dynamic stochastic general equilibrium models (DSGEs)

What still requires work

others formulated a view of the business cycle and

stabilization policy that suggested that the large Keynesian

models were overcomplicated and had missed some simple

statistical relationships that were central to good policy.

income, they argued, and patterns of timing suggested that

this tight relationship was causal fluctuations in money

growth causing fluctuations in income.

current and past money growth implied that most of the

business cycle could be eliminated by simply making money

supply growth constant.

(contrary to the Keynesian consensus of the early 1950s)

monetary policy was a powerful tool.

But their models did not imply that constant money growth

would eliminate the business cycle, or even be a good policy.

income relation that monetarists displayed could arise in a

model that had no causal influence of money on income.

make his point. Those models were not credible, and had a

flaw that made them unusable for his purposes.

I

extent systematic, but is also a source of uncertainty to the

private sector.

of systematic policy responses, and also of their random

component.

confronted this issue. Each group treated its favorite policy

variables as non-random, exogenous, autonomous, or

determined outside the model.

left the Keynesian vs. monetarist debate of the 1960s in a

confused state.

Tinbergens Project

Haavelmos critique: the renewed project

The large models run aground, as probability models

The monetarist vs. Keynesian debates: failure to model policy

behavior

Bayesian inference

Rational Expectations

Causality tests, VARs, SVARs

Dynamic stochastic general equilibrium models (DSGEs)

What still requires work

unknown, parameters from random quantities that

repeatedly vary, or could conceivably repeatedly vary.

random, until it is observed, after which it becomes

non-random.

I

that we know to be biased, so that it has an unknown

probability p of turning up heads.

zero and one equally likely.

turn up heads.

random. The outcome of the next flip is also random, with

part of the randomness coming from our uncertainty about p.

the next would be heads would be .75. Not the apparently

natural estimate of p, which is .8, because we cant rule out

the possibility that the 8 of 10 result was a random outcome

with p below .8.

I

probability on the next flip being heads, using the information

in the first 10 flips.

but its distribution depends on p, which is fixed, not random.

across many possible samples of an estimator (like the

apparently natural estimate here, p = .8), but this cannot be

transformed into a probability distribution for the next flip.

decision makers want distributions for forecasts, there are

frequentist tricks to produce something like a probability

distribution for a forecast, but they are all forms of mental

gymnastics.

I

notion that policy-makers see their own actions as

non-random, while from the point of view of the private sector

or an econometrician those same actions have probability

distributions.

probability models of policy-maker behavior, and at the same

time can be useful to policy-makers in planning their own

actions.

computationally, and it is only in recent years, with the

importation into economics of Markov Chain Monte Carlo

methods, that implementing it for large models has become

practical.

prior information.

the values of unknown parameters, without pretending that

these restrictions are without uncertainty.

model parameters, then allowing the data to update or

sharpen those distributions.

probability distributions for model predictions.

Tinbergens Project

Haavelmos critique: the renewed project

The large models run aground, as probability models

The monetarist vs. Keynesian debates: failure to model policy

behavior

Bayesian inference

Rational Expectations

Causality tests, VARs, SVARs

Dynamic stochastic general equilibrium models (DSGEs)

What still requires work

unpredictable components, is an essential part of the

environment for all economic decision-makers.

models policy behavior and to recognize that this component

influences the behavior of the private sector.

Keynesian models and the monetarist regressions.

I

actions as realizations of random variables, took the view that

rational expectations modeling required that policy changes

could be modeled only as non-random, exogenous changes

in the policy rule itself.

choose values for variables that they control, was trivial, was

not an activity for which economists could provide advice, or

both.

with the sometimes tedious complexity of policy models

eagerly took up the excuse to ignore the still widely used large

policy models.

wandered still further away from Haavelmos project.

Tinbergens Project

Haavelmos critique: the renewed project

The large models run aground, as probability models

The monetarist vs. Keynesian debates: failure to model policy

behavior

Bayesian inference

Rational Expectations

Causality tests, VARs, SVARs

Dynamic stochastic general equilibrium models (DSGEs)

What still requires work

correlations of money growth with income primarily reflected a

causal influence of monetary policy errors on income, future

money growth should not contribute to explaining current

income, once the influence of current and past money growth

on income had been accounted for.

monetarist regressions passed the test. Future money growth

did not help predict current income.

predictive power can be misleading.

why this is true: prices of frequently traded assets will react

promptly to all new information, and hence themselves be

unpredictable.

thus tend to show that current and past asset prices help in

prediction, but that future asset prices do not.

smooths the time path of interest rates may make money

behave like an asset price in causality test regressions, even

when monetary policy errors actually have little influence on

income.

me. I showed it was true in a detailed model in a 1989

American Journal of Agricultural Economics paper.

I

money-explains-income monetarist equations, others were

estimating demand for money, explaining money stock as a

function of income and interest rates.

seemed unlikely that current and past income could properly

be treated as helping to determine money stock in the money

demand equations.

demand equations passed the same kind of test I had used on

the monetarist income-money regressions.

using more than one equation.

capturing empirical regularities while using only prior

distributions without economic content expressing belief

that coefficients on longer lags were less likely to be important

and that variables were likely to evolve smoothly over time

were called vector autoregressions, or VARs.

that the estimated systems had potential causal

interpretations, the system was called a structural VAR, or

SVAR.

Larry Christiano, Olivier Blanchard, and Mark Watson among

the earliest, were able to show using SVARs that influences of

monetary policy were detectable in the data.

both money stock and interest rates represented systematic

reactions of monetary authorities to the state of the economy.

attributed to erratic monetary policy.

Tinbergens Project

Haavelmos critique: the renewed project

The large models run aground, as probability models

The monetarist vs. Keynesian debates: failure to model policy

behavior

Bayesian inference

Rational Expectations

Causality tests, VARs, SVARs

Dynamic stochastic general equilibrium models (DSGEs)

What still requires work

In the last 10 years economists, starting with Christiano,

Eichenbaum, Frank Smets and Raf Wouters developed models that

aimed at mimicking the SVARs estimated patterns of influence of

monetary policy and that were:

I

economic interpretations;

original example

measurs of fit, as are VARs.

at than their predecessors.

advance, they represent the result of a history of scrambling

up an unstable slope.

and probably will be again.

And we can see today that these models are still vulnerable to

important criticisms.

Tinbergens Project

Haavelmos critique: the renewed project

The large models run aground, as probability models

The monetarist vs. Keynesian debates: failure to model policy

behavior

Bayesian inference

Rational Expectations

Causality tests, VARs, SVARs

Dynamic stochastic general equilibrium models (DSGEs)

What still requires work

Outliers

The crash of 2008 and its aftermath have taught us that very

large errors, or shocks in our models do occasionally occur

and have strong effects.

at historically fitted error terms would make it clear that it

was not only in the 1930s and in 2008-10 that such large

shocks have occurred.

Outlier examples

period 1979-1982, the Volcker disinflation appears as very

large shocks to the usual predictable behavior of monetary

policy.

federal government primary deficit (expenditures, other than

interest payments, less revenues) relative to outstanding debt

showed a huge jump in the second quarter of 1975.

these rare events, but we should be recognizing that they

occur, using theory and what data we have to bring them in

to policy discussions.

Unbelievable stories

shocks, some of these interpretations are dubious.

monetary non-neutrality, which are essential to welfare

evaluation of monetary policy.

Phillips curve, in other words, in the context of these models.

Fiscal policy

impacts on inflation, using the insights of rational

expectations.

the monetarist/Keynesian controversies of the 60s and 70s.

gap.

shifted away from serious probability-based policy modeling

after the rational expectations revolution.

remain with us.

there remains substantial resistance to giving them academic

respect.

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