Thursday, October 7, 2010

Macroeconomics after the Crisis: Time to Deal with the Pretense-of-Knowledge Syndrome - By Ricardo J. Caballero

Found via the Mises Institute.

The root cause of the poor state of affairs in the field of macroeconomics lies in a fundamental tension in academic macroeconomics between the enormous complexity of its subject and the micro-theory-like precision to which we aspire.

This tension is not new. The old institutional school concluded that the task was impossible and hence not worth formalizing in mathematical terms (for example, Samuels, 1987, and references therein). Narrative was the chosen tool, as no mathematical model could capture the richness of the world that is to be explained. However, this approach did not solve the conundrum; it merely postponed it. The modern core of macroeconomics swung the pendulum to the other extreme, and has specialized in quantitative mathematical formalizations of a precise but largely irrelevant world. This approach has not solved the conundrum either. I wish the solution was to be found somewhere in between these polar opposites, but it is not clear what “in between” means for a range that has a framework based on verbal discussions of the real world on one end and one based on quantitative analysis of an “alternative” world, on the other.

The periphery of macroeconomics has much to offer in terms of specific insights and mechanisms, but to fulfill the ambition of the core we need to change the paradigm to go from these insights on the parts to the behavior of the whole. It is not about embedding these into some version of the canonical real business cycle model. It is, among other things, about capturing complex interactions and the confusion that they can generate.

The challenges are big, but macroeconomists can no longer continue playing internal games. The alternative of leaving all the important stuff to the “policy”-types and informal commentators cannot be the right approach. I do not have the answer. But I suspect that whatever the solution ultimately is, we will accelerate our convergence to it, and reduce the damage we do along the transition, if we focus on reducing the extent of our pretense-of-knowledge syndrome.


Related previous post: F.A. Hayek's 1974 Nobel Speech: The Pretence of Knowledge