The Sorry State of Macroeconomics

Rodrik Two pieces. First, Dani Rodrik:

The failures of contemporary macro theory remind me of the time we were interviewing a highly touted graduate student on the academic job market (I believe he was from the University of Minnesota, but I am not totally sure). We asked him how he would teach macro to public policy students at the Kennedy School. He thought for a while, and said: “I guess I would do it all using the overlapping-generations model, and since this is an introductory course, I wouldn't bring money in at all.” Enough said.

Willem_Buiter And Willem Buiter:

The most influential New Classical and New Keynesian theorists all worked in what economists call a ‘complete markets paradigm’. In a world where there are markets for contingent claims trading that span all possible states of nature (all possible contingencies and outcomes), and in which intertemporal budget constraints are always satisfied by assumption, default, bankruptcy and insolvency are impossible. As a result, illiquidity – both funding illiquidity and market illiquidity – are also impossible, unless the guilt-ridden economic theorist imposes some unnatural (given the structure of the models he is working with), arbitrary friction(s), that made something called ‘money’ more liquid than everything else, but for no good reason. The irony of modelling liquidity by imposing money as a constraint on trade was lost on the profession.

Both the New Classical and New Keynesian complete markets macroeconomic theories not only did not allow questions about insolvency and illiquidity to be answered. They did not allow such questions to be asked.

It is clear that, when searching for an appropriate simplification to address the intractable mess of modern market economies, the starting point of ‘no markets’, that is, autarky or no trade, is a much better one than that of ‘complete markets’.

[H/t: Mark Blyth]