Wednesday, October 13, 2010

Is Macroeconomics just looking under the streetlamp?

A fascinating new paper by Ricardo Caballero basically says yes:

"In this paper I argue that the current core of macroeconomics—by which I mainly mean the so-called dynamic stochastic general equilibrium approach—has become so mesmerized with its own internal logic that it has begun to confuse the precision it has achieved about its own world with the precision that it has about the real one. This is dangerous for both methodological and policy reasons. On the methodology front, macroeconomic research has been in “fine-tuning” mode within the local-maximum of the dynamic stochastic general equilibrium world, when we should be in “broad-exploration” mode. We are too far from absolute truth to be so specialized and to make the kind of confident quantitative claims that often emerge from the core. On the policy front, this confused precision creates the illusion that a minor adjustment in the standard policy framework will prevent future crises, and by doing so it leaves us overly exposed to the new and unexpected."

The piece is well worth reading both for its own arguments and the list of interesting "periphery" papers mentioned and cited.


Anonymous said...

Just out of curiosity what is your take on where modern macro should go with respect to research method, etc.?

(I love the "macro is hard" category here at Kids Prefer Cheese, thanks for the great links!)

Angus said...

Thanks for the positive feedback. Macro is awesome.

I very much like the trend toward estimation and away from calibration.

I think models need to to a better job of modeling (A) heterogeneity among agents (B) the political process (C) how the probability of rare events affect everyday choices