Justin Fox: What Macroeconomists Don't Know
JF:
The (Many) Things Macroeconomists Don't Know: Jean-Claude Trichet… did regret something about the last few years. He regrets that economists didn't give him better advice. What Trichet said was that state-of-the-art macroeconomic theory was almost entirely useless in dealing with the crisis that began in 2007. Yeah, he tried to be polite about it: "This doesn't mean we have to abandon DSGE," he said, referring to the dynamic-stochastic general equilibrium models — in which an economy of rational, far-seeing actors struggles with the occasional friction or shock, but generally gets along okay — that dominated the work of economists at central banks. Buuut "atomistic rational agents [the figures that populate DSGE models] don't capture behavior during a crisis."… Trichet finally reached for the last refuge of the frustrated economic policymaker: John Maynard Keynes. He quoted (at length) a famous story from Keynes' General Theory. It describes a beauty contest in a newspaper where the goal is to pick the face that the most readers will vote for.
It is not a case of choosing those which, to the best of one's judgment, are really the prettiest, nor even those which average opinion genuinely thinks the prettiest. We have reached the third degree where we devote our intelligences to anticipating what average opinion expects the average opinion to be. And there are some, I believe, who practise the fourth, fifth and higher degrees.
"It captures what's happening when a systemic crisis is unfolding," Trichet said. At the height of the 2008 crisis, he went on, "it was clear that an immensely large number of [market] participants were thinking that if there was not a game change, the system would collapse." Now, none of this is exactly news. Lots of people have said similar things over the past couple of years. But it was very interesting hearing them from someone who until recently was one of the most powerful economic policymakers on the planet — and one who has been criticized mainly (at least among English-speakers; the Germans have their own unique view) for being too conservative, and too unwilling to jettison faulty models of how the world works. Not that he has any regrets or anything…
