Economics is in crisis: it is time for a profound revamp
"With so much disagreement it is no surprise that policymakers are unsure and vacillate. Some countries, such as the US and France, go all out for the Keynesian story; others, such as Germany, put more faith in the Ricardians. Personally I think the Keynesians are right, but my opinion is irrelevant. The point is that the cacophony of analysis helps to explain why policymakers react in different ways to the same crisis and why it is so difficult for them to come up with co-ordinated action.
How to resolve this crisis in macro-economics? The field must be revamped fundamentally. Some of its shortcomings are obvious. Before the financial crisis, most macroeconomists were blinded by the idea that efficient markets would take care of themselves. They did not bother to put financial markets and the banking sector into their models. This is a major flaw.
There is a deeper problem, though, that will be more difficult to resolve. This is the underlying paradigm of macroeconomic models. Mainstream models take the view that economic agents are superbly informed and understand the deep complexities of the world. In the jargon, they have “rational expectations”. Not only that. Since they all understand the same “truth”, they all act in the same way. Thus modelling the behaviour of just one agent (the “representative” consumer and the “representative” producer) is all one has to do to fully describe the intricacies of the world. Rarely has such a ludicrous idea been taken so seriously by so many academics. (Other fields of economics have not been deluded by this implausible idea and therefore do not face the same criticism.)We need a new science of macroeconomics.
The good news is that the framework for behavioural economics is well defined.
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