The financial crisis burst into our lives and, then, Macroeconomic Pandora’s box was opened. All the evils spread in the Macroeconomic world: the consensus between saltwater and freshwater economists that we had during the last 15 years was broken, doubts about the validity of the “orthodox” models were cast, the very foundations of the neoclassic economic reasoning were questioned… Krugman (here), Shiller (here) or even The Economist (here and here) describes the evils that Macroeconomics has to face. Let’s have a closer look to this criticism.
From a very general perspective, Economics is accused of having an excessive reliance in the rationality of their agents. This made that the most widely used models in Macroeconomics were totally blind to concepts like bubble and busts or the limitations on human rationality when taking decisions. The Economist points out that, for example “The Bank of England’s DSGE [Dynamic Stochastic General Equilibrium] model (…) does not even try to incorporate financial middlemen, such as banks. “The model is not, therefore, directly useful for issues where financial intermediation is of first-order importance,” its designers admit”. The assumption of complete markets or frictionless finance are other concepts frequently assumed that do not seem very realistic or pertinent when trying to study the real world.
Should we throw out the baby with the bath water? I do not think so. First of all, one has to remember that all the economist have not been so blind to the market failures: there exist a vast literature headed by economists like Stiglitz or Shleifer devoted to the analysis of such deviations of the “classical hypothesis” about the market. Furthermore, Shiller correctly asserts that the rationality can be applied to some fields as the price setting by a monopolist. On the other hand, Lucas -maybe the most prominent figure among freshwater economist- has defended the predictive power of current models and the general state of our social science (see here).
To sum up, we are used to the metaphore according to which our models are a map of reality in which only the essential aspects are represented. Probably, all we have to do is truly reflect such essential aspects (not so simple, I know!). Which are, then, the solutions that can be raised? Some economists -like David Colander- has a strong faith on new methods on computational economics to simulate and detect unforeseen patterns that can emerge. Other promising evolutions are given by fields like Behavioral Economics or Experimental Economics, which offer an interesting way to analyze the limits of the hyper-rationality in agent’s behavior or showing the influence of other social aspects in the economic behavior. It seems also that the future of Economics has to be more sensitive to the results in the other social sciences (such as Psychology, History, Sociology, Anthropology…). As George Akerlof pointed out in his magnificent Nobel Prize Lecture Behavioral Macroeconomics and Macroeconomic Behavior “behavioral macroeconomists, incorporating realistic assumptions grounded in psychological and sociological observation, have produced models that comfortably account for each of these macroeconomic phenomena. In the spirit of Keynes’ General Theory, behavioral macroeconomists are rebuilding the microfoundations that were sacked by the New Classical economics”. Maybe, after all, this time Hope did not lay at the bottom of the box…
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