Quote 22: Stumbling and Mumbling on Macroeconomics

From here:

Macroeconomics failed in this crisis because it has for ages under-rated the importance of the stuff we (might) learn in industrial organization classes

Industrial economics is effectively applied microeconomics in the field of the economy (as compared to some of the more social fields that some microeconomists have moved into). I have always believed that current macroeconomics is simply an application of applied micro from 20 years earlier. Given the amount of progress made in industrial economics over the past 20-30 years I agree with this quote, and can see why an ignorance of these lessons has lead us to some observable errors.

Furthermore, I agree with this quote as it paints the future of macro in “methodological individualistic” terms – specifically we want to understand the behaviour of the individuals in a system in order to understand, and then predict, how the system will work.

I fear that macro will move back to the Friedmanesque interpretation of economic models – where all that matters is current predictive power, not the underlying “truth” of the assumptions driving the model. Why do I fear this? Well, when something goes wrong and the model stops forecasting well (which it will), if we don’t understand the assumptions we don’t know where to look for the failure.

However, I have to admit that trying to apply these lessons to an aggregate framework (which we need for macro) is a lot harder than it sounds. A factor that may make my dreams more of a pie in the sky fantasy than an actual realistic prescription for the direction of the discipline.

Update: Anti-Dismal has a related post on criticisms of macroeconomics and DSGE models. I agree with him on this point “much of the criticism aimed at DSGE models seems to result from a failure to understand the use of the DSGE model”. However, when looking at macro we have to ask – did macroeconomists maybe exaggerate the scope of their own models to get attention? If so I think maybe we deserve a little criticism to put us back in line. However, don’t throw the baby (DSGE modeling) out with the bathwater.

I also discussed criticisms of macro here in March.