David Colander’s take on what’s wrong with modern macro

There’s been a lot written about what’s wrong with modern macro. But this quite quiet methodological discussion by Colander is well worth the read – including I think for non-economists. It’s quite rich in descriptive detail about what policy economics was like – and still is like in Australia. And how the ‘new-macro’ is coming to colonise policy making – which is a disaster for reasons he eloquently explains.

Now, I am sure some will argue that the DSGE model is not only a useful model for advancing the science of macroeconomics (and I agree; the DSGE model is a much better scientific model than is the IS/LM model); it is also the more useful model for policy guidance. I find that suggestion hard to swallow for two reasons. The first reason the DSGE model is such a poor guide for policy is the same reason that it is a better foundation for a serious scientific model than is the IS/LM model. It is such a highly abstract model that is so far removed from reality that the thought that it could shed much direct light on reality is almost beyond comprehension. Somehow a model of a representative agent, who is infinitely rational and who faces no model uncertainty, is supposed to shed light of something as complex as the macro economy is on the face of it absurd. It is that absurdity that underlies Solow’s “rhetorical swindle” comment at the beginning of this paper. The absurdity is, however, not the model—the model is reasonable; the absurdity is its direct use for guiding policy, rather than just a background information for guiding policy. The DSGE model does pass even a low level common sense hurdle as a guide for policy. Yet, with the development of computer software, such as DYNARE, the DSGE model’s influence is spreading.

Anyway, like I said, well worth reading. One thing I would say is that it’s a bit of a pity that Keynes’ name is used so liberally. It’s true that he pioneered macro, and had particularly perspicacious views about method in the context of complexity, but the point of the essay is really that Keynes was practising economics in the way that the classicals did. He disagreed with ‘classical macro’ and came up with some new theory, but his method was self-consciously in the spirit of people like his teacher Marshall, and saw itself as in the spirit of the discipline that grew up through the classical economists of the nineteenth century. Anyway, the essay is not particularly ‘Keynesian’ in the sense that that’s sometimes understood as arguing for expansionary fiscal policy.

PS: This article by Colander was also of interest I thought but a bit less for the general reader -unless they’re interested in the dynamics of academia. Can European Economics Compete with U.S. Economics? And Should It? .

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Paul Frijters
Paul Frijters
13 years ago

fascinating articles by Colander.
Our central bank also runs a DSGE model and it is also in the game of trying to attract top academics into its doors. What, then, would make Australia immune to the dynamics talked about?