The calibration hoax

The calibration hoax

There are many kinds of useless economics held in high regard within the mainstream economics establishment today. Few — if any — are less deserved than the macroeconomic theory and method, mostly associated with Nobel laureates Finn Kydland, Robert Lucas, Edward Prescott and Thomas Sargent, known as calibration.

In physics, it may not be straining credulity too much to model processes as ergodic — where time and history do not really matter — but in the social and historical sciences it is plainly absurd. If societies and economies were ergodic worlds, why would econometricians fervently discuss things such as structural breaks and regime shifts? The fact that they do is an indication of the unrealistic nature of treating open systems as if they were analysable with ergodic concepts.

The future is not reducible to a known set of prospects. It is not like sitting at the roulette table and calculating what the future outcomes of spinning the wheel will be. Reading Sargent and other calibrationists, one is reminded of Robert Clower’s apt remark that

much economics is so far removed from anything that remotely resembles the real world that it’s often difficult for economists to take their own subject seriously.

Instead of just assuming calibration and rational expectations to be correct, one ought to confront the hypothesis with the available evidence. It is not enough to construct models. Anyone can do that. To be seriously interesting, models must have an aim. They must have an intended use. If the intention of calibration and rational expectations is to help us explain real economies, they must be evaluated from that perspective. A model or hypothesis without specific applicability is not really worthy of our interest.

To say, as Edward Prescott does, that

one can only test if some theory, whether it incorporates rational expectations or, for that matter, irrational expectations, is or is not consistent with observations,

is not enough. Without strong evidence, all kinds of absurd claims and nonsense may masquerade as science. We must demand more justification than this rather watered-down version of ‘anything goes’ when it comes to rationality postulates. If one proposes rational expectations, one must also justify its underlying assumptions. None is given, which makes it rather puzzling how rational expectations has become the standard modelling assumption in much of modern macroeconomics. Perhaps the reason is, as Paul Krugman has it, that economists often mistake

beauty, clad in impressive-looking mathematics, for truth.

But I think Prescott’s view also explains why calibration economists are not particularly interested in empirical examination of how real choices and decisions are made in real economies. In the hands of Lucas, Prescott and Sargent, rational expectations has been transformed from an — in principle — testable hypothesis into an irrefutable proposition. Irrefutable propositions may be comfortable — like religious convictions or ideological dogmas — but they are not science.