From Mainly Macro:
It is a great irony that the microfoundations project, which was meant to make macro just another application of microeconomics, has left macroeconomics with very few friends among other economists. The latest broadside comes from Paul Romer. Yes it is unfair, and yes it is wide of the mark in places, but it will not be ignored by those outside mainstream macro. This is partly because he discusses issues on which modern macro is extremely vulnerable.
The first is its treatment of data. Paul’s discussion of identification illustrates how macroeconomics needs to use all the hard information it can get to parameterise its models. Yet microfounded models, the only models deemed acceptable in top journals for both theoretical and empirical analysis, are normally rather selective about the data they focus on. Both micro and macro evidence is either ignored because it is inconvenient, or put on a to do list for further research. This is an inevitable result of making internal consistency an admissibility criteria for publishable work.
The second vulnerability is a conservatism which also arises from this methodology. The microfoundations criteria taken in its strict form makes it intractable to model some processes: for example modelling sticky prices where actual menu costs are a deep parameter. Instead DSGE modelling uses tricks, like Calvo contracts. But who decides whether these tricks amount to acceptable microfoundations or are instead ad hoc or implausible? The answer depends a lot on conventions among macroeconomists, and like all conventions these move slowly. Again this is a problem generated by the microfoundations methodology.
Paul’s discussion of real effects from monetary policy, and the insistence on productivity shocks as business cycle drivers, is pretty dated. (And, as a result, it completely misleads Paul Mason here.) Yet it took a long time for RBC models to be replaced by New Keynesian models, and you will still see RBC models around. Elements of the New Classical counter revolution of the 1980s still persist in some places. It was only a few years ago that I listened to a seminar paper where the financial crisis was modelled as a large negative productivity shock.
Only in a discipline which has deemed microfoundations as the only acceptable way of modelling can practitioners still feel embarrassed about including sticky prices because their microfoundations (the tricks mentioned above) are problematic . Only in that discipline can respected macroeconomists arguethat because of these problematic microfoundations it is best to ignore something like sticky prices when doing policy work: and argument that would be laughed out of court in any other science. In no other discipline could you have a debate about whether it was better to model what you can microfound rather than model what you can see. Other economists understand this, but many macroeconomists still think this is all quite normal.