The Problem with Macroecon

The state of macroeconomics seems to be a major topic of discussion these days - mostly focusing on how macroeconomics had been unable to predict the economic meltdown and has been unable to adequately respond to it. The Freakonomics blog has had a number of posts about it. Their overall take on the situation is that there are too few economists focusing on macro issues (and too many working in finance) which has left the field under-explored as of late.

Paul Krugman has a long article in the Times Sunday Magazine on this issue. He attributes problems in macroeconomics to a shift to the right - that too many economists have forgotten about the lessons of the Great Depression because of the lack of a truly serious recession since then. For at least the last few decades, liberal and conservative economists mostly supported the rational actor underpinning to economics and believed that the lack of a serious recession supported this. Krugman also feels that macro-economists have not correctly understood the recessions that did happen and were overconfident in our ability to control them.

The article is great - it isn't nearly as wonkish as his blog posts on this issue. Be aware though that it comes from a very liberal place. That being said, I do agree with most of it. Here is the key quote:

First, many real-world investors bear little resemblance to the cool calculators of efficient-market theory: they’re all too subject to herd behavior, to bouts of irrational exuberance and unwarranted panic. Second, even those who try to base their decisions on cool calculation often find that they can’t, that problems of trust, credibility and limited collateral force them to run with the herd.

There is a lot more to the article, like discussions about unemployment and the influence of capital on the recession, so I highly advise anyone to read all of it. Overall though, I hope that Krugam is right, that economists will spend more time understanding where economic actors actually deviate from the rational actor that we study in theory. Too much of our political debate is a back and forth about whether markets work or do not work. It would be much better if we talked about when they work and when they do not.