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A Response to Mankiw’s “The Macroeconomist as Scientist and Engineer”

Thursday, April 10th, 2008

Mankiw begins his endeavor by relating the field of economics to that of a science, whether it’s a social science or a hard science is up for debate. Nevertheless, he feels that it should be termed a science so that the undergraduates starting out in this discipline don’t mistake it for a lot of haphazard guessing of what is the world and how the world should be based on policy decisions. It’s a science for one simple reason: “economists formulate theories with mathematical precision, collect huge data sets on individual and aggregate behavior, and exploit the most sophisticated statistical techniques to reach empirical judgments that are free of bias and ideology.” Economics is also considered a type of engineering because economics was developed to also solve practical problems. Mankiw sets up his paper to trace the history of macroeconomics and evaluate what we have learned. His goal throughout this paper is to show that macroeconomics was created out of two mindsets–those who view macroeconomics as a science (understanding how the world works) and those who feel it is a type of engineering (an application/tool to solve problems). He concludes the introduction by claiming that macroeconomics started out as an engineering discipline where people attempted to solve problems and only in the last several decades did it become a science where theories and tools were developed, with little or no practical application (though others would beg to differ I’m sure).

Macroeconomics first appears in literature during the 1940s due to the Keynesian Revolution. Many nobel laureates (i.e. Solow, Klein, Modigliani, Samuelson, and Tobin are specifically named in the paper) point to Keynes’ General Theory as their starting point in the field of macroeconomics. This influential book probably would not have been published had it not been for the Great Depression because “there is nothing like a crisis to focus the mind.” Keynes’ General Theory left a lot of questions unanswered, especially the question as to what model tied together all of his thoughts. This spurred others to continue in this field of economics, with early attempts left up to Hicks and Modigliani to develop a more clear model of the macroeconomy using the IS-LM curve. Though critics say it’s too simplified for the macroeconomy, the whole concept of the IS-LM model was to simplify a “line of argument that was otherwise hard to follow.” In that respect, the IS-LM model did its job. It’s just not the entire story. By the 1960s, there were many complex simultaneous equation models that were developed in order to forecast and evaluate the effectiveness of policy, with the framework still being used by the Federal Reserve’s U.S. model to this day. As Mankiw points out, the science of economics became engineering of economics starting in the 1940s when the theorists behind macroeconomics wanted to put their ideas to use and worked as advisors to the presidents to formulate policy.

Classical undertones stemmed from Keynesian economics with the onset of monetarism and new classical economics. Monetarists attacked the Keynesian consumption function because Milton Friedman theorized that the marginal propensity to consume would produce much smaller multiplier effects throughout the economy than Keynes’ model predicts. Mankiw does make it a point that though Friedman’s idea regarding the transparent and easy-to-understand rules by the Federal Reserve doesn’t have a strong following, it was a precursor to other countries’ central banks as they have established bands around which inflation rates can move. During the late 1960s, the development of the Phillips curve was able to better complete the Keynesian model that lacked a lot of theory. Though Keynes knew there was a relationship between unemployment and inflation, not much was able to be said about this topic. Friedman, however, recognized that there remains a difference between short-run and long-run tradeoffs. In the short run, the Phillips curve relationship holds water because inflation may be unexpected or unanticipated and therefore, unemployment will be able to decrease. However, in the long run, this relationship isn’t a strong one because of expectations, which was a huge step forward in the field of macroeconomic theory. Rational expectations, especially the Lucas Critique, was able to be strengthened from Friedman’s introduction of expectations. The Lucas Critique says that “Keynesian models were useless for policy analysis because they failed to take expectations seriously.” Lucas continues his argument in which he claims that the economy has rational economic agents who have imperfect information. Markets will clear, but monetary policy may get in their way because all monetary policy does is confuse people about the difference between absolute prices (nominal) and relative prices (real). Real business cycle theorists were the third wave of new classical economists to branch off of the Keynesian Revolution. Like the rational expectation theorists, RBC economists assumed markets clear instantly, but where they differed is that they looked at monetary policy as ineffective, and thus, it wasn’t in their business cycle model. Rather, business cycles were traced out due to random shocks of technology and the resultant intertemporal choice between work and leisure–the determinant of unemployment.

New Keynesians came onto the scene and looked to the issue of microfoundations because all microeconomics courses taught their students that firms and households look to maximize and promote efficiency in market clearing. However, these new Keynesians realized that there is a time element involved in market clearing. Not to say that markets won’t clear, but it won’t be instantly as assumed by earlier new classical economists. Rather, markets won’t clear in time period t because of sticky wages and sticky prices, especially seen in the labor market where wages adjust sluggishly over time as a result of labor contracts. New Keynesians were “divided” into two early waves, those that looked to understand allocation of resources when markets don’t clear in one time period and those that looked at rational expectations and market clearing. These first two waves failed to come up with conclusions as to why sticky prices and wages hinder markets from clearing instantly. Thus, a third wave of new Keynesians came onto the scene and answered these earlier questions by saying firms face menu costs when changing their prices, pay their workers efficiency wages above the market level to increase productivity, and that decision making deviates from rational thinking. Mankiw evaluates macroeconomic theory up to this point and argues that as a science, macroeconomics was successful. So, how was it as a engineering discipline in evaluating policy? He suggests that the answer is much less positive.

Long-run growth, rather than short-run fluctuations, became a hot topic in the 1980s and early 1990s because of three things: there was an ever-increasing gap between rich and poor countries, cross-country data became more readily available, and the U.S. economy in the 1990s was experiencing insurmountable growth. The clash and sort-of-schism between new classicals and new Keynesians was getting larger, but as these older economists were retiring, newer and more civil economists were stepping on the scene, which looked to “improve” the image of macroeconomics. One way in evaluating the degree to which economics is an engineering discipline is to look at Laurence Meyer’s A Term at the Fed. As a professor, Meyer served one term as the governor of the Federal Reserve. The book was a way for people to see the approaches taken in analyzing the economy. The bottom line is that work by new classicals, new Keynesians, and others have had “close to zero impact on practical policymaking.” Who is to thank for this? For one thing, there seems to be a confusion in the field of macroeconomics. While the Federal Reserve is independent, it doesn’t create policy rules, as was proposed by Friedman so people have the expectation of a the rate of money supply. Mankiw views inflation targeting, which is a policy rule implemented by the European Central Bank (ECB), as a way to “communicate with the public” rather than a rule that was introduced out of macroeconomic theory. What about low rates of inflation? Countries that have imposed inflation bands by their central banks and those who have not (i.e. United States) have both experienced low levels of inflation for a long range of time. The answer for this could be one of two things. Either supply shocks aren’t prevalent like they were during the oil crisis of the 1970s or because central banks have realized that high levels of inflation, as experienced in the 1970s, should be avoided at all costs because it is detrimental to the economy.

The other side of the coin is looking at the effectiveness that macroeconomic theory has had on the practical applications of fiscal policy. Bush’s tax cuts aimed at consumption rather than income is consistent with literature in public finance, especially with Atkinson and Stiglitz of the 1970s. The short-run analysis of tax policy is consistent with Keynesian economics because less taxes means more disposable personal income, which will lead to higher demand of goods and services. In conclusion, Mankiw views economics as more of a science than as an engineering tool. The reason is not because the Federal Reserve and government ignore the new ideas and theories developing in the field of macroeconomics. Rather, “modern macroeconomics research is not widely used in practical policymaking [because there is] little use for this purpose.” Undergraduates, though, are more like the engineer than the scientist. Except for the few who want to pursue economics in the academia (i.e. science), the majority of undergraduate students want to see how macroeconomic tools can be applied to the real world for effective policymaking (i.e. engineer).

Source: Mankiw, N. Gregory. 2006. The macroeconomist as scientist and engineer. Harvard University (May): 1-26, http://www.economics.harvard.edu/faculty/mankiw/files/Macroeconomist_as_Scientist.pdf (accessed April 10, 2008).