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Noah Smith

An Economics Lab Where Theories Go to Die

All the bright ideas look kind of dim when you try to explain Japan.
A head scratcher, for sure.

A head scratcher, for sure.

Photographer: Kiyoshi Ota

The main thing you have to understand about macroeconomic theory -- both of the type used by academics and the type employed by private-sector forecasters -- is that it doesn’t really work. Events are constantly taking macro people by surprise, counterexamples to pet theories are a dime a dozen, and the rare theory that can be tested against available data is usually rejected outright. In macroeconomics, your choice of model is usually between “awful” and “very slightly less awful.”

Most macroeconomic theories can be easily tested: all we have to do is take a look at Japan. Japan has a number of unusual traits that make it a very good proving ground for macro models, including a shrinking population, inefficient labor markets, an economy out of sync with the rest of the world and a government willing to engage in dramatic economic experiments. Once we start examining theories used to explain the U.S. economy, and apply them to Japan, we find that these theories usually fail.