I was not alone. Apparently Tim Harford of FT.com was also confused and disappointed while learning the modern macro models and theories. I however figured it was a bunch of nonsense. The assumptions made by modern macro models, particularly the Rational Expectations stuff of New Classical and New Keynesian theory are the problem. By making assumptions that enable them to use their elegant math, they assume away any possibility of the model being useful. The assumptions are not just “simplifying”, they are contra-reality. It is as if I were to create a theory of flying in physics by first assuming that gravity cannot exist. There’s a lot of work to be done in macro now to repair this failed research program.
I am struck by the soul-searching that has gripped the profession in the face of the economic crisis. The worry is not so much that macroeconomists did not forecast the problem – bad forecasts are more a sign of a complex world than intellectual bankruptcy – but that macroeconomics seems unable to provide answers. Sometimes it cannot even ask the right questions.
Willem Buiter, a former member of the UK’s Monetary Policy Committee who blogs for the FT, complains that macroeconomists have simply discarded the difficult stuff to make their models more elegant: “They took these non-linear stochastic dynamic general equilibrium models into the basement and beat them with a rubber hose until they behaved.”
Mark Thoma offers additional insight at Economist’s View.