Whenever I get taunted about not having a “model,” I assume the commenter is probably younger than me, highly intelligent, but not particularly wise. I often disagree with Paul Krugman, but he’s right that simple, off-the-shelf models are all we need to evaluate aggregate demand problems. Supply-side issues are another story—they are much more complicated.
There are basically two types of demand-side models, both of which are nearly useless:
1. Some general equilibrium models are used to find which stabilization policy regime is optimal from a welfare perspective. Most of these models assume some sort of wage/price stickiness. And 100% of the models taken seriously in the real world assume wage/price stickiness. The problem is that there are many types of wage and price stickiness, and many ways of modeling the problem. You can get pretty much whatever policy implication you want with the right set of assumptions. Unfortunately, macroeconomists aren’t able to prove which model is best. I think that’s because lots of models are partly true, and the extent to which specific assumptions are true depends on which country you are looking at, as well as which time period. And then there’s the Lucas Critique.
2. A second type of model tries to show how to best implement a specific type of policy regime, like inflation targeting. Thus the Taylor Rule is one way of implementing a flexible inflation target. Unfortunately, these “implementation models” conflict with the EMH—it’s not clear why the central bank wouldn’t just peg the price of a futures contract linked to the goal variable. This is embarrassing given that they are mostly based on New Keynesian models, which incorporate rational expectations.
To summarize, despite all the advances in modern macro, there is no model that anyone can point to that “proves” any particular policy target is superior to NGDPLT. There might be a superior target (indeed I suspect a nominal wage target would be superior.) But it can’t be shown with a model. All we can do is construct a model that has that superiority built in by design.
And once we have decided on a nominal aggregate target, there is no model that can outperform a policy of having the central bank peg the price of futures contract linked to the policy goal. And once you do all that, fiscal policy becomes a fifth wheel.
Models are toys to show our students. When we face serious real world dilemmas it’s time to put away the toys and get real . . . er, I’m mean get nominal.
PS. Wise readers will notice that I do have a model, indeed lots of them. They’re just not mathematical models.
PPS. One reason that very few models find NGDP targeting to be optimal is that very few models include a variable called “NGDP.”