Modern macroeconomics: a review of the post 2008/2009 crisis debate

Abstract

This paper reviews the current debate on the state of modern macroeconomics from methodological standpoint. While some senior figures in economics have argued that modern macroeconomics has gone wayward and thus become irrelevant for policy, others argue otherwise. Methodologically, the fundamental sources of dispute have centered on realism of assumptions, mathematical formalism and empiricism and falsification of economic models. Our conclusion from this review is that the observable world upon which macroeconomist rely on to make their assumptions, theories and predictions represent a very tiny fraction of physical reality. Thus any policy derived from such partial and short sighted analysis can only produce a sub-optimal outcome. Moreover, the fundamental analysis employed in macroeconomic analysis overlook peculiarities which should be the rule rather than the exception for addressing important economic conundrums. In short, although we do not support the position of most critics on the view that macroeconomics of the last 30 years is completely useless, we are of the view that there is need for serious rethinking about the future of macroeconomics. This is the only way forward, if the subject has anything to say about policy.

Keywords: Financial Crisis, Modern Macroeconomics, Rational Expectations, Illusion, Perception and Reality