David Backus writes:
This is from my area of work, macroeconomics. The suggestion here is that the economy is growing slowly because consumers aren’t spending money. But how do we know it’s not the reverse: that consumers are spending less because the economy isn’t doing well. As a teacher, I can tell you that it’s almost impossible to get students to understand that the first statement isn’t obviously true. What I’d call the demand-side story (more spending leads to more output) is everywhere, including this piece, from the usually reliable David Leonhardt.
This whole situation reminds me of the story of the village whose inhabitants support themselves by taking in each others’ laundry. I guess we’re rich enough in the U.S. that we can stay afloat for a few decades just buying things from each other?
Regarding the causal question, I’d like to move away from the idea of “Does A causes B or does B cause A” and toward a more intervention-based framework (Rubin’s model for causal inference) in which we consider effects of potential actions. See here for a general discussion. Considering the example above, a focus on interventions clarifies some of the causal questions. For example, if you want to talk about the effect of consumers spending less, you have to consider what interventions you have in mind that would cause consumers to spend more. One such intervention is the famous helicopter drop but there are others, I assume. Conversely, if you want to talk about the poor economy affecting spending, you have to consider what interventions you have in mind to make the economy go better.
In that sense, instrumental variables are a fundamental way to think of just about all causal questions of this sort. You start with variables A and B (for example, consumer spending and economic growth). Instead of picturing A causing B or B causing A, you consider various treatments that can affect both A and B.
All my discussion is conceptual here. As I never tire of saying, my knowledge of macroeconomics hasn’t developed since I took econ class in 11th grade.