Working Paper: NBER ID: w16429
Authors: Ricardo J. Caballero
Abstract: In this paper I argue that the current core of macroeconomics--by which I mainly mean the so-called dynamic stochastic general equilibrium approach--has become so mesmerized with its own internal logic that it has begun to confuse the precision it has achieved about its own world with the precision that it has about the real one. This is dangerous for both methodological and policy reasons. On the methodology front, macroeconomic research has been in "fine-tuning" mode within the local-maximum of the dynamic stochastic general equilibrium world, when we should be in "broad-exploration" mode. We are too far from absolute truth to be so specialized and to make the kind of confident quantitative claims that often emerge from the core. On the policy front, this confused precision creates the illusion that a minor adjustment in the standard policy framework will prevent future crises, and by doing so it leaves us overly exposed to the new and unexpected.
Keywords: Macroeconomics; Financial Crises; Dynamic Stochastic General Equilibrium; Policy Implications; Knowledge Limitations
JEL Codes: A1; B4; E01; G01
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Reliance on DSGE models (E13) | Overconfidence in policy recommendations (D80) |
| Overconfidence in policy recommendations (D80) | Significant policy missteps during financial crises (G01) |
| Reliance on DSGE models (E13) | False sense of security regarding ability to predict and mitigate crises (H12) |
| Reliance on DSGE models (E13) | Failure to capture complexities and uncertainties in economic interactions (D89) |
| Shift towards incorporating insights from the periphery of macroeconomic research (B22) | More robust frameworks for addressing real economic problems (E13) |