I invite you, dear reader, to journey with me back in time to January 1993, to join me at the meeting of the American Economic Association held in Anaheim, California. You and I are seated in a great ballroom of the conference hotel, together with some 6oo economists and economic commentators, to listen to the wisdom of some of America’s leading macroeconomists: Laurence Summers (Harvard) in the chair, Olivier Blanchard (MIT), Robert Hall (Hoover and Stanford), and Edward Prescott (Federal Reserve Bank of Minneapolis and University of Minnesota). The topic: what caused the last recession? The topic was important, not because of the magnitude or duration of the recession of 1990-1991, but because a second dip in that recession had done in the second term prospects of President George Herbert Walker Bush.

As is usual when ‘important’ scholars are speaking, little time is left for contributions from the floor. Few individuals, other than similar demi-gods are ever recognized by the chair, ever secure an opportunity to speak. Well, on this occasion, yours truly was fortunate indeed. By waving my arms as if engaged in semaphore, I attracted the eagle eyes of chairman Summers, right at the end of the conference. He indicated that I would be allowed a brief moment to ask my question.

I rose to my feet, with 600 pairs of eyes focused on me, and addressed the panel as follows:

“Colleagues”, I advanced, with evident presumption, “I have listened very carefully to each of your three presentations. Since each of you utilizes the rational expectations approach to macroeconomics, an unanticipated shock is necessary to throw the economy off course . Each of you in turn has strived valiantly, but without effect, to find a relevant shock in this instance.

Professor Blanchard, you locate a dip in consumption, which is not surprising since the growth rate of the economy performed below trend rates; but you cannot locate the cause of that dip, the shock, if you will that triggered the dip, despite a considerable amount of empirical research.

Professor Hall, you explored empirically several possible shocks, but concluded that none of the shocks explored triggered the 1990-1991 recession. You conclude that ‘established models are unhelpful in understanding this recession, and probably most of its predecessors’.

Professor Prescott, you utilize a real business cycle model to explore the possibility of a technology shock. Unfortunately, you cannot locate such a shock, and you end your paper by talking casually about a range of other possible shocks not picked up by your model.

Well, gentlemen, I should like to ask whether you have ever contemplated the possibility that the central postulate of each of your models – rational expectations – is the problem. Should not models whose predictions are consistently falsified by the evidence be discarded in favor of alternative models? Is that not the logic of scientific discovery?”

Well, dear reader, you should have absorbed the discomfort that my simple words generated in that oxygen- depleted ballroom! The papers that were rustled, the eyes that were cast down to the ground, the covert glances projected at me by the more adventurous members of the gathering. The panel briefly consulted, clearly agitated for the first time during the session. Eventually, Robert Hall was designated to respond to my question. He rose to his feet, his body extended to its full stature, his face crimson, his eyes flashing with disapproval. ‘Sir’, he politely spluttered, (probably meaning, ‘you moron’) “you have just challenged the revealed truth of the profession”.

The meeting ended without another word, the audience dispersed in an unworldly silence, and I left the room knowing exactly what it must have been like to contract leprosy before a cure became available. But, of course, I was right…

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Tags: economy-wide shocks, failure of macroeconomics, falsification of theories, rational expectations, recessions