Ebook The Current Crisis and the Culpability of Macroeconomic Theory
One of Keynes’s most well known statements refers to the power of ideas. In his 1936 magnum opus, The General Theory, he wrote “practical men, who believe themselves to be quite exempt from any intellectual influences, are usually the slave of some defunct economist. Madmen in authority who hear voices in the air are distilling their frenzy from some academic scribbler of years back.”
A great deal has been written about the role of ‘practical men’ in the current financial crisis, whether bankers, regulators or politicians. I focus here on the role of ideas, and specifically of ideas in economic theory.
It is the ideas at the heart of modern macroeconomics which provided the intellectual justification of the economic policies of the past 10 to 15 years. It is these ideas which the current crisis has falsified. The dominant paradigm in macroeconomic theory over the past 30 years has been that of rational agents making optimal decisions under the assumption that they form their expectations about the future rationally - the rational agent using rational expectations, or RARE for short.
This is not the place to set out a detailed critique of the RARE view of the world. The specific focus is on the way in which mainstream economics deals with risk and uncertainty. It is this which is at the root of the problems, both for the discipline of economics and, much more importantly, for the economy itself and the financial crisis.
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