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Does Economics Really Need a “New Paradigm”?

Joe Stiglitz says economics needs a new paradigm:

“Bad models lead to bad policy: central banks, for instance, focused on the small economic inefficiencies arising from inflation, to the exclusion of the far, far greater inefficiencies arising from dysfunctional financial markets and asset price bubbles. After all, their models said that financial markets were always efficient. Remarkably, standard macroeconomic models did not even incorporate adequate analyses of banks. No wonder former Federal Reserve chairman Alan Greenspan, in his famous mea culpa, could express his surprise that banks did not do a better job at risk management. The real surprise was his surprise: even a cursory look at the perverse incentives confronting banks and their managers would have predicted short-sighted behaviour with excessive risk-taking.

The standard models should be graded on their predictive ability – and especially their ability to predict in circumstances that matter. Increasing the accuracy of forecast in normal times (knowing whether the economy will grow at 2.4 per cent or 2.5 per cent) is far less important than knowing the risk of a major recession. In this the models failed miserably, and the predictions of policymakers based on them have, by now, totally undermined their credibility. Policymakers did not see the crisis coming, said its effects were contained after the bubble burst, and thought the consequences would be far more short-lived and less severe than they have been.

But a new paradigm, I believe, is within our grasp: the intellectual building blocks are there and the Institute for New Economic Thinking is providing a framework for bringing the diverse group of scholars striving to create this new paradigm together. What is at stake, of course, is more than just the credibility of the economics profession or that of the policymakers who rely on their ideas: it is the stability and prosperity of our economies.”

I’ve echoed many of these criticisms.  I don’t think the economy operates much like the theoretical world that mainstream econ promotes, I think it’s a colossal mistake to remove banks from macro models and current macro thinking tends to obsess over the exogenous powers of the Fed far too much.  But do we really need to scrap the old paradigm and pretend to “rediscover” how the world works?  I don’t think so.  I just think modern macro needs some tweaking.  More economists could benefit from understanding banking, financial instability, double entry bookkeeping, flow of funds, sectoral balances, etc.

I know some groups are oceans apart on a lot of this stuff, but I also think we’re probably closer to agreeing than we think.  The “Macro Wars” don’t really need to turn into a war.  They should become a meeting of the minds where mainstream economists try to explore why Post-Keynesian thinking got so much right about the crisis.  That doesn’t require a whole new paradigm.  It just requires some open-minds and perhaps some tweaking.

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