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Macroeconomics After the Crisis: Time to Deal with the Pretense-Of-Knowledge Syndrome

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Macroeconomics After the Crisis: Time to Deal with the Pretense-Of-Knowledge Syndrome Journal of Economic Perspectives—Volume 24, Number 4—Fall 2010—Pages 85–102 Macroeconomics after the Crisis: Time to Deal with the Pretense-of-Knowledge Syndrome Ricardo J. Caballero hhee rrecentecent fi nnancialancial ccrisisrisis hhasas ddamagedamaged tthehe rreputationeputation ooff mmacroeconomics,acroeconomics, llargelyargely fforor iitsts iinabilitynability ttoo ppredictredict tthehe impendingimpending fi nancialnancial andand economiceconomic T ccrisis.risis. TToo bbee hhonest,onest, tthishis inabilityinability ttoo predictpredict doesdoes notnot concernconcern meme much.much. ItIt iiss aalmostlmost ttautologicalautological tthathat ssevereevere ccrisesrises aarere eessentiallyssentially uunpredictable,npredictable, forfor otherwiseotherwise ttheyhey wouldwould nnotot ccauseause ssuchuch a hhighigh ddegreeegree ooff ddistress.istress. OOff ccourse,ourse, iitt iiss wwell-knownell-known tthathat ccertainertain eelementslements ccanan iincreasencrease tthehe ffragilityragility ooff a fi nancialnancial system,system, suchsuch asas highhigh levelslevels ofof lleverageeverage oorr mmismatchesismatches bbetweenetween sshort-termhort-term lliabilitiesiabilities aandnd llong-termong-term aassets,ssets, aandnd tthathat tthesehese iissuesssues mmayay jjustifyustify ppolicyolicy iintervention.ntervention. ButBut kknowingnowing tthesehese mechanismsmechanisms isis qquiteuite ddifferentifferent ffromrom aarguingrguing tthathat a ssevereevere ccrisisrisis ccanan bbee ppredicted.redicted. MModernodern CCassandrasassandras wwillill aalwayslways cclaimlaim ttoo hhaveave sseeneen tthehe ccrisisrisis ccoming.oming. WWhathat ttheyhey wwillill nnotot ssayay iiss hhowow mmanyany ttimesimes ttheyhey ssawaw tthingshings ccomingoming tthathat nneverever mmaterialized,aterialized, oorr howhow tthehe sspecifipecifi c mechanismsmechanisms bbehindehind tthehe ccrisisrisis aarere ddifferentifferent ffromrom tthosehose oonn wwhichhich ttheirheir ppredictionsredictions wwereere bbased.ased. IInn mmyy vview,iew, tthehe cconvictiononviction tthathat oonene ccanan fforetelloretell a ssevereevere ccrisisrisis iinn aadvancedvance iiss mmostlyostly a mmanifestationanifestation ooff ppareidolia—theareidolia—the ppsychologicalsychological pphenomenonhenomenon tthathat mmakesakes ppeopleeople sseeee ffacesaces aandnd aanimalsnimals iinn ccloudslouds aandnd tthehe llike.ike. WWhathat ddoesoes cconcernoncern mmee aaboutbout mmyy ddiscipline,iscipline, however,however, isis thatthat itsits currentcurrent corecore ——byby wwhichhich I mmainlyainly mmeanean tthehe sso-calledo-called dynamicdynamic stochasticstochastic generalgeneral equilibriumequilibrium aapproach—haspproach—has bbecomeecome ssoo mmesmerizedesmerized wwithith itsits oownwn iinternalnternal llogicogic tthathat iitt hhasas bbegunegun ttoo cconfuseonfuse tthehe pprecisionrecision iitt hhasas aachievedchieved aaboutbout itsits oownwn worldworld withwith thethe precisionprecision tthathat iitt hhasas aaboutbout tthehe rrealeal one.one. ThisThis iiss ddangerousangerous forfor bothboth methodologicalmethodological andand ppolicyolicy rreasons.easons. OOnn tthehe methodologymethodology front,front, mmacroeconomicacroeconomic rresearchesearch hashas beenbeen inin ““fifi nne-tuning”e-tuning” mmodeode withinwithin tthehe llocal-maximumocal-maximum ooff thethe dynamicdynamic sstochastictochastic ggeneraleneral eequilibriumquilibrium wworld,orld, wwhenhen wwee sshouldhould bbee iinn ““broad-exploration”broad-exploration” mmode.ode. WWee aarere ttoooo ffarar ■ RRicardoicardo JJ.. CCaballeroaballero iiss tthehe FFordord IInternationalnternational ProfessorProfessor ofof Economics,Economics, MassachusettsMassachusetts Insti-Insti- ttuteute ooff TTechnology,echnology, aandnd alsoalso a RResearchesearch Associate,Associate, NationalNational BureauBureau ofof EconomicEconomic Research,Research, bbothoth iinn CCambridge,ambridge, MMassachusetts.assachusetts. HHisis ee-mail-mail aaddressddress iiss 〈[email protected]@mit.edu〉. doi=10.1257/jep.24.4.85 86 Journal of Economic Perspectives ffromrom aabsolutebsolute ttruthruth ttoo bbee ssoo sspecializedpecialized aandnd toto makemake tthehe kkindind ooff conficonfi dentdent quan-quan- ttitativeitative cclaimslaims tthathat ooftenften emergeemerge ffromrom tthehe ccore.ore. OOnn thethe ppolicyolicy ffront,ront, thisthis confusedconfused pprecisionrecision ccreatesreates tthehe iillusionllusion tthathat a mminorinor aadjustmentdjustment iinn tthehe sstandardtandard ppolicyolicy fframe-rame- wworkork wwillill ppreventrevent ffutureuture crises,crises, andand bbyy ddoingoing ssoo iitt lleaveseaves uuss overlyoverly exposedexposed toto thethe nnewew aandnd uunexpected.nexpected. TToo bbee ffairair ttoo ourour fi eeld,ld, anan enormousenormous aamountmount ofof workwork atat thethe intersectionintersection ofof mmacroeconomicsacroeconomics aandnd ccorporateorporate fi nancenance hashas beenbeen chasingchasing manymany ofof thethe issuesissues thatthat pplayedlayed a ccentralentral rolerole duringduring thethe currentcurrent crisis,crisis, includingincluding liquidityliquidity evaporation,evaporation, ccollateralollateral sshortages,hortages, bbubbles,ubbles, ccrises,rises, panics,panics, fi rere sales,sales, risk-shifting,risk-shifting, contagion,contagion, andand tthehe llike.ike.1 HHowever,owever, mmuchuch ooff tthishis lliteratureiterature belongsbelongs ttoo tthehe periphery ooff mmacroeco-acroeco- nnomicsomics rratherather tthanhan ttoo iitsts ccore.ore. IIss tthehe ssolutionolution tthenhen ttoo rreplaceeplace tthehe currentcurrent corecore fforor tthehe pperiphery?eriphery? I aamm ttempted—butempted—but I tthinkhink tthishis wwouldould aaddressddress oonlynly ssomeome ooff oourur pprob-rob- llems.ems. TThehe ddynamicynamic sstochastictochastic ggeneraleneral equilibriumequilibrium sstrategytrategy iiss ssoo aattractive,ttractive, andand eveneven pplainlain aaddictive,ddictive, bbecauseecause iitt aallowsllows oonene ttoo ggenerateenerate iimpulsempulse rresponsesesponses tthathat ccanan bbee ffullyully ddescribedescribed iinn ttermserms ooff sseeminglyeemingly scientifiscientifi c statements.statements. TheThe modelmodel isis anan irresistibleirresistible ssnake-charmer.nake-charmer. IInn ccontrast,ontrast, tthehe pperipheryeriphery iiss nnotot nnearlyearly asas aambitious,mbitious, andand iitt providesprovides mmostlyostly qqualitativeualitative iinsights.nsights. SSoo wwee aarere llefteft wwithith tthehe ttensionension bbetweenetween a ttypeype ooff aanswernswer ttoo wwhichhich wwee aaspirespire bbutut tthathat hhasas llimitedimited cconnectiononnection wwithith rrealityeality ((thethe ccore)ore) aandnd mmoreore ssensibleensible bbutut iincompletencomplete aanswersnswers ((thethe pperiphery).eriphery). TThishis ddistinctionistinction bbetweenetween corecore aandnd pperipheryeriphery iiss nnotot a mmatteratter ooff ffreshwaterreshwater vversusersus ssaltwateraltwater eeconomics.conomics. BBothoth tthehe rrealeal bbusinessusiness ccycleycle aapproachpproach aandnd iitsts NNewew KKeynesianeynesian ccounterpartounterpart bbelongelong ttoo thethe core.core. Moreover,Moreover, therethere waswas a timetime whenwhen KeynesianKeynesian eco-eco- nnomicsomics wwasas mmoreore llikeike tthehe ccurrenturrent ccore,ore, iinn tthehe ssenseense ooff ttryingrying ttoo buildbuild quantitativequantitative aaggregativeggregative mmodelsodels sstartingtarting ffromrom mmicro-foundedicro-founded cconsumptiononsumption ffunctionsunctions aandnd tthehe llike.ike. AAtt tthathat ttime,ime, iitt wwasas tthehe ““rational-expectations”rational-expectations” rrepresentativesepresentatives tthathat wwereere iinn tthehe iinsight-buildingnsight-building mmode,ode, iidentifyingdentifying kkeyey cconceptsoncepts fforor mmacroeconomicacroeconomic ppolicyolicy ssuchuch aass ttime-inconsistencyime-inconsistency aandnd eendogenousndogenous eexpectations,xpectations, withoutwithout anyany pretensepretense ofof beingbeing rrealisticealistic iinn aallll ddimensionsimensions ooff mmodelingodeling iinn oorderrder ttoo oobtainbtain qquantitativeuantitative aanswers.nswers. MMoreover,oreover, tthishis ttensionension iiss nnotot nnewew ttoo mmacroeconomicsacroeconomics oorr eevenven ttoo eeconomicsconomics mmoreore bbroadly.roadly. IInn hhisis NNobel-prizeobel-prize aacceptancecceptance llecture,ecture, HHayekayek ((1974)1974) wwrites:rites: ““OfOf ccourse,ourse, ccomparedompared wwithith tthehe ppreciserecise ppredictionsredictions wwee hhaveave llearntearnt ttoo eexpectxpect iinn tthehe pphysicalhysical ssciences,ciences, tthishis ssortort ooff mmereere ppatternattern ppredictionsredictions iiss a ssecondecond bbestest wwithith wwhichhich oonene ddoesoes nnotot llikeike ttoo hhaveave ttoo bbee ccontent.ontent. YYetet tthehe ddangeranger ooff wwhichhich I wwantant ttoo wwarnarn iiss ppreciselyrecisely tthehe bbeliefelief tthathat iinn oorderrder ttoo hhaveave a cclaimlaim bbee aacceptedccepted aass sscientificientifi c iitt iiss nnecessaryecessary ttoo aachievechieve mmore.ore. TThishis wwayay lliesies ccharlatanismharlatanism aandnd wworse.orse. TToo aactct oonn tthehe bbeliefelief tthathat wwee ppossessossess tthehe kknowledgenowledge aandnd tthehe ppowerower wwhichhich eenablenable uuss ttoo sshapehape tthehe pprocessrocess ooff ssocietyociety eentirelyntirely ttoo oourur lliking,iking, kknowledgenowledge wwhichhich iinn ffactact wwee ddoo nnotot ppossess,ossess, iiss llikelyikely ttoo mmakeake uuss ddoo mmuchuch hharm”arm” ((1974).1974). OOnene rreadingeading ooff HHayek’sayek’s ccommentomment isis asas
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