Friday, July 2, 2010

The poor state of macroeconomics

Many have written about the poor state of macroeconomics and how it was not able to predict the crisis. I don't think this was as large a problems as stated. Looking at the Taylor rule during the late Greenspan era showed that monetary policy was loose. The result was a bubble in housing because rate weer low. You needed to have innovations like ARM's to capitalize on the low short rates, but the result should not have been surprising.

We have also had bank crises in the past and we know what the impact will be on an economy. If you have one of the largest insurance companies and one of the largest broker-dealers in the world go bankrupt in the same week and you have the largest mortgage market in the world implode with the two GSE's in receivership you should expect a systemic failure.

A more nuanced view on the problem with macroeconomics was stated by Richard Posner. He remarked that the problem is macroeconomics and politics being too tightly interwoven. If you state a set of macroeconomic policies, you can make a good guess on the politics of the economist. The same is true if you start with their politics. The austerity and tax cut camp represents Republicans. The government spending an tax increase camp represents the Democrats. Unfortunately, this simple characterization works.

If you have a strong well-defined science, the models and prescriptions for the economy should be independent of politics. They are not. Of course, it could be stated that there are preference on what is more important, but the basic facts and linkages within the economy should be well understood. Unfortunately, they cannot be divorced from the politics. This is th real problem with macroeconomics. There cannot be agreement on the facts.

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