Fischer Black and Escher Economies

Yesterday, Tyler Cowen of Marginal Revolution wrote an interesting piece about Fischer Black as a macroeconomist. Fischer Black is famous for his Black-Scholes asset-pricing model and is considered a giant in financial economics. He would have won the Nobel prize with Myron Scholes in 1997 had he not died in 1995. But his macroeconomic views were highly unorthodox. Here is Tyler’s description of Black’s view that the Federal Reserve would have no effect on interest rates:

Black's economic thought is centered around the view that all profit opportunities will be exploited. So what happens if the central bank decides to add zeros to the accounts held at the Fed?

Here is the standard account. In Black's view banks were already holding all the dollars they wished to. One reaction is for banks to borrow less money at the discount window, or perhaps borrow less from each other. Money will leave the system as quickly as it entered. Another reaction is simply for banks to sit on the new money. Prices will not go up. Alternatively, it could be argued that an indifference relation holds, and whatever people expect to happen will happen. Multiple equilibria obtain. Prices might go up, fall, or stay constant. Monetarism is then true only if people expect it to be true.

Tyler says that if this theory and some of his other theories were correct, “Black would be the greatest macroeconomist of the century.”

To say that Black’s ideas “if true” would make his the greatest macroeconomists of the 20th century is about like saying that if M.C. Escher’s perpetual motion machine (Waterfall 1961) “were true” then he would be the greatest engineer of the twentieth century. Both of these statements are vacuous because in both cases it is impossible to make a working model of their “ideas.” Black’s idea is an Escher Economy because he has created an idea that cannot be made into a working computer model. This is an important point: in order for an idea to be more than just an idea, one has to be able to turn it into a working model.

The reason why the field of macroeconomics is underdeveloped is because it is still dominated by people who do not believe in the utility of computer modeling. Computer macroeconomic models are really big and require an enormous up-front programming investment. It is easy to look at that investment as perhaps unjustifiable compared with the benefits, when a smaller investment in econometrics will produce a guaranteed benefit. In any case, it isn’t the first instinct of most economists to say “can you model that theory” and it should be.