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TOWARD A POLITICAL ECONOMY OF MACROECONOMIC THINKING Gilles St. Paul Working Paper 17431 http://www.nber.org/papers/w17431 NATIONAL BUREAU OF ECONOMIC RESEARCH 1050 Massachusetts Avenue Cambridge, MA 02138 September 2011

I am grateful to the European Commission for financial support under the "Sci-Fi Glow" project. The views expressed herein are those of the authorand do not necessarily reflect the views of the National Bureau of Economic Research. © 2011 by Gilles St. Paul. All rights reserved. Short sections of text, not to exceed two paragraphs, may be quoted without explicit permission provided that full credit, including © notice, is given to the source.

Toward a Political Economy of Macroeconomic Thinking Gilles St. Paul NBER Working Paper No.17431 September 2011 JEL No. A11,E6 ABSTRACT This paper investigates, in a simplified macro context, the joint determination of the (incorrect) perceived model and the equilibrium. I assume that the model is designed by a self-interested economist who knows the true structural model, but reports a distorted one so as to influence outcomes. This model influences both the people and the government;the latter tries to stabilize an unobserved demand shock and will make different inferences about that shock depending on the model it uses. The model's choice is constrained by a set of autocoherence conditions that state that, in equilibrium, if everybody uses the model then it must correctly predict the moments of the observables. I then study, in particular, how the models devised by theeconomists vary depending on whether they are "progressive" vs. "conservative". The predictions depend greatly on the specifics of the economy being considered. But in many cases, they are plausible. For example, conservative economists will tend to report a lower keynesian multiplier, and a greater long-term inflationary impact of output expansions. On the other hand, the economists' margin of manoeuveris constrained by the autocoherence conditions. Here, a "progressive" economist who promotes a Keynesian multiplier larger than it really is, must, to remain consistent, also claim that demand shocks are more volatile than they really are. Otherwise, people will be disappointed by the stabilization performance of fiscal policy and reject the hypothesized value of the multiplier. In some cases,autocoherence induces the experts to make, loosely speaking, ideological concessions on some parameter values. The analysis is illustrated by empirical evidence from the Survey of Professional Forecasters. Gilles St. Paul IDEI Universite de Toulouse 1 21, Allee de Brienne 31000 Toulouse France gilles.saint-paul@univ-tlse1.fr

Toward a Political Economy of Macroeconomic Thinking
Gilles Saint-PaulToulouse School of Economics and CEPR September 13, 2011

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Introduction

The formation of expectations plays a key role in our understanding of the macroeconomy. Historically, economists have moved from a naive, mechanical representation of expectations to a more sophisticated one, where rational agents optimally use their information to forecast the future. To be able to do so, agentsneed to use a model, which allows them to compute the expectations of the relevant variables that they need in order to make their decisions. Typically, in the rational expectations literature, it is assumed that one uses the correct model. In practice, though, the "correct model" is unknown, and, to the extent that it is inevitably an abstraction, the concept of "correct model" is probablymeaningless. Instead, we observed different models produced by different economists. Depending on the model one is using, one will act differently. This issue has been recognized by the recent literature, which studies what happens if , instead of being in rational expectations equilibrium (REE), the economy settles at a self-confirming equilibrium (SCE), where people use an incorrect model to formulate...