The Economic and Social Research Council’s (ESRC) has invested in a brand-new network to understand the macroeconomy. This is an extraordinary opportunity; we know of no comparable research funding anywhere in the world. Through our network, Rebuilding Macroeconomics, over the next four years we will support creative and rigorous research that addresses ‘real world’ macroeconomic challenges. All applications are welcome and funding will go to whoever proposes the best ideas. Full details of our priorities, the funding opportunities and our progress can be found on our website rebuildingmacroeconomics.ac.uk.
Rebuilding Macroeconomics is a network of scholars from mainstream and ‘heterodox’ economics and anthropology, biology, complexity, history, physics, sociology, psychology and more, together with policy makers and representatives from civil society groups. Our aim is to transform macroeconomics back into a policy-relevant social science. This requires new ideas that address the considerable ’real world’ macroeconomics challenges we face today. We are looking to support creative and rigorous research, perhaps on a ‘proof of concept basis’, which can reveal new insights for the future direction of macroeconomics.
But why rebuild macroeconomics at all? To some, this is obvious; to others, it is a deeper issue. It really depends on what one believes is the whole point of macroeconomics. At the core of modern mainstream macroeconomics is an elegant set of self-contained models where the actions of ‘rational’ forward looking households and firms are simultaneously coordinated through markets. To the extent that our agents face unexpected economic shocks, they respond in an optimal way that returns the economy back to its stable equilibrium growth path. The structure of the markets can be altered to add more realism, but agents understand the stable long run properties of the economy.
To justify some strong assumptions, the self-declared litmus test for these models is not whether they are realistic or not but whether they can be used to predict. In this context, prediction is defined as explaining the co-movement between economic variables, perhaps in response to a proposed policy change, but abstracting from changes in the underlying structural trends in the economy. In other words, they are to explain the quarter to quarter business cycle variations in the data on the assumption that there is no change in the underlying structure of the economy.
This was perfectly explained by Robert Lucas, a ‘high priest’ of mainstream macroeconomics. In 2009, he described the simulations of modern macroeconomic models as forecasts of what could be expected to happen – conditional on a crisis not occurring. This is very different to predicting whether a crisis could or even might occur. The real answer to the Queen’s question about why mainstream economists did we not see the crisis coming is that this is not what they were looking for. It should be pointed out that there were in fact a number of economists who had warned of the mounting instabilities; but they usually outside the world of mainstream models.
The task of modern macroeconomics has deviated a long way from its origins. Macroeconomics as a branch of economics emerged in the Great Depression. Keynes’s revolutionary insight that unemployment could persist, even if agents are acting in their own best interest, justified policies to stabilise the system. After the war and the Depression had been forgotten economics moved on. The joint rise of inflation and unemployment in the 1970s brought an end to the post-war consensus and began another shift to the new dominant mainstream macroeconomic approach.
But with the Global Financial Crisis the macroeconomic tectonic plates have shifted once again. The charge is not that mainstream models failed to predict the crisis, it is more that it was not even possible and therefore they had little to add in terms of policy direction. Former Fed Chairman Ben Bernanke, a scholar of the great depression, introduced quantitative easing in response to the global financial crisis. Yet even he remarked that the problem with quantitative easing is that it “works in practice, but it doesn’t in theory”. As Lucas pointed out, mainstream macroeconomics has had little to say about the crisis because this is not what it was seeking to explain.
The costs of economic and financial crises are far greater than business cycles. Ten years after Northern Rock and the economy is yet to self-correct or normalise. Macroeconomics ought to respond to ‘real world’ evidence and incorporate methods that can make constructive predictions. We don’t know where the answers will come from. Mainstream macroeconomics has made significant advances since the crisis. But history suggests that no one model can explain an economy for all time. At Rebuilding Macroeconomics, we encourage scholars to be creative and apply for funding.
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27 September 2017