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Monetary Policy, the NK Model, and Humility

Summary:
In an NBER working paper John Cochrane concludes that … we have been guilty of playing with too-complex models when we don’t really understand basics, such as stability, determinacy, and the frictionless limit. … Given the state of actual agreed-on knowledge, central banks’ proclamations of detailed technocratic ability to manipulate delicate frictions is laughable. Figure 10 shows in chart form the Rube-Goldberg list of mechanisms the ECB thinks it understands and can manipulate. Central bankers who think they have any idea how all these boxes and arrows work, and how to manipulate them, should reread Bob’s unsung classic “on a report to the OECD” Lucas (1979) once a week. A little humility would do us all good.

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In an NBER working paper John Cochrane concludes that

… we have been guilty of playing with too-complex models when we don’t really understand basics, such as stability, determinacy, and the frictionless limit. …

Given the state of actual agreed-on knowledge, central banks’ proclamations of detailed technocratic ability to manipulate delicate frictions is laughable. Figure 10 shows in chart form the Rube-Goldberg list of mechanisms the ECB thinks it understands and can manipulate. Central bankers who think they have any idea how all these boxes and arrows work, and how to manipulate them, should reread Bob’s unsung classic “on a report to the OECD” Lucas (1979) once a week. A little humility would do us all good.

Dirk Niepelt
Dirk Niepelt is Director of the Study Center Gerzensee and Professor at the University of Bern. A research fellow at the Centre for Economic Policy Research (CEPR, London), CESifo (Munich) research network member and member of the macroeconomic committee of the Verein für Socialpolitik, he served on the board of the Swiss Society of Economics and Statistics and was an invited professor at the University of Lausanne as well as a visiting professor at the Institute for International Economic Studies (IIES) at Stockholm University.

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