Are those who sweat the big stuff in meltdown?
A confession: I was never very good at macroeconomics as an undergraduate, and my postgraduate studies were even more of a challenge. My lecturers described the economy as the solution to an inter-temporal optimisation problem in which a single representative household decided how much to consume and how much to save. I struggled with the sums (they were hard ones) and almost as much with the entire concept, which seemed to ignore what was interesting about macroeconomics. I did what I could, passed my exams and concentrated on microeconomics instead. (Those confused should recall P.J. O’Rourke’s explanation of the difference between the two: microeconomics concerns things that economists are specifically wrong about, while macroeconomics concerns things that they are wrong about generally.)
I do not regard my own confusion as an indictment of modern macroeconomics, but 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.”
He is not alone in his frustration. Paul Krugman, a left-leaning New York Times columnist and the most recent winner of the Nobel memorial prize in economics, thinks macroeconomics is in a dark age, in the sense that rather than discovering new insights, we are actually going backwards and forgetting what we used to know. Mark Thoma of the University of Oregon, another influential economics blogger, opines: “I think that the current crisis has dealt a bigger blow to macroeconomic theory and modelling than many of us realise.”
We shall see. While many commentators have reached for Keynes – or some caricature of Keynes – as a solution to this crisis, this is not because he is the fount of all knowledge, but because he was asking good questions about problems that now seem relevant again.
Economists now understand much more than Keynes ever could about networks and complex interactions (thanks to agent-based modelling), psychology (thanks to behavioural economics) and the real world (thanks to econometrics). In principle, these advances should inform our understanding of the crisis. An early attempt is Animal Spirits, a book by George Akerlof, a Nobel laureate, and Robert Shiller, who identified the housing bubble early. But macroeconomics has a lot of momentum and it will take time to turn the oil tanker around.
Justin Wolfers, a new editor of Brookings Papers on Economic Activity and an unabashed microeconomist, says that, “formally elegant but empirically irrelevant macroeconomists had a much harder time getting hired this year,” while Buiter reckons that the central banks have already jettisoned conventional macroeconomics in favour of a pragmatic combination of hunches and judgment calls. If so, the market for macroeconomic ideas seems to be self-correcting – much like the market for financial weapons of mass destruction. It is just a shame, in both cases, that the correction did not come more smoothly and much, much earlier.
Also published at ft.com.