Simon Wren-Lewis has a post on the state of macroeconomics that I mostly agree with — but part of which bothers me a lot....
Wren-Lewis argues against the many people insisting that the crisis means that we must rebuild macroeconomics from the ground up; he argues, on the contrary, that the crisis doesn’t require a fundamental rethink of macro. And I am very much in agreement there. Basic sensible macro — what we learned from Keynes and Hicks — has actually held up very well in the crisis. To the extent that we have a crisis in macroeconomics as practiced, it comes from the way many economists chose to reject sensible macro....
My liquidity trap work (pdf) has, I think, aged pretty well; and even back then I was very much worried about issues of debt overhangs and balance sheet effects....
Now, what’s true is that my old work on balance sheet stuff focused on corporate rather than household debt, and that I was entirely concerned with the balance sheet effects of a movement in the exchange rate as opposed to, say, a drop in housing prices. And I really, really should have connected the dots and seen how a burst housing bubble could produce similar effects — but I didn’t; I thought the end of the bubble would be nasty, but failed to realize how nasty. Mea culpa.
But this was a failure to look at the right variables, not a fundamental flaw in the theory — and once it became clear that we were in a balance-sheet crisis, it was quick work to slot that into our understanding.Read it at The New York Times
Gadgets Versus Fundamentals (Wonkish)
by Paul Krugman
Whaaat? Had the right model but didn't look at the right variables?
Doesn't he know that in hindsight one can get anything right by changing the assumptions?
Ah. That's why these people think that they missed the crisis. The the model worked fine, but they just didn't know how to use it correctly at the time. Next time will be different. Right-o.
The theory itself should tell you what to be looking for. The mainstream theories didn't so they got it wrong, wrong, wrong. Those using the theory based on Minsky's financial instability hypothesis and Godley's SFC macrro modeling based on sectoral balances, Wynne Godley and the MMT economists, for instance, got it right. Steve Keen got it right, too, using his model and Minsky. Others, too. See Dirk J. Bezemer, "No One Saw This Coming": Understanding Financial Crisis Through Accounting Models and James K. Galbraith, Who are these economists anyway?