Chris Dillow — The macroeconomic challenge

These facts are a challenge to both RBC and New Keynesian models. But they have something in common. They stress the heterogeneity of agents: some unemployed respond to benefit changes but most don't; some prices are sticky but others aren't; some firms are big enough to have macro effects, others aren't. This, I fear, means that the problem with conventional macro isn't so much its microfoundations per se as the assumption that these microfoundations must consist in representative agents.

Now, you'll object that any model that tries to embed these five facts will very quickly become very complex. But that's my point - the economy is a very complex system and any theory that doesn't see this is very dubious. It could be that the best way to understand it - if at all - lies in agent-based models rather than conventional DSGE ones.

Stumbling and Mumbling
The macroeconomic challenge
Chris Dillow | Investors Chronicle