The Biggest Problem with Modern Macro…

There’s been a lot of ink spilled in recent weeks over the problems (or lack thereof) in modern macroeconomics (see here and here).  I’ve expressed my opinion that the state of modern macro is moving in the right direction because there’s serious debate about the problems with the mainstream approaches which has resulted in the rise of competing ideas.  But any progress that’s been made shouldn’t completely overshadow the major problem at the heart of macroeconomics – political ideology.

If you study modern macro you inevitably end up studying some sort of policy.  Most economists don’t build their models around an understanding of the monetary system.  They build their understanding of the system to fit an ideology in a classic case of confirmation bias.  For instance, most Keynesians will fit their model of the way the system works to confirm some form of countercyclical government policy.  Market Monetarists fit their understanding of the monetary system to confirm NGDP Targeting.  Austrian economists fit their description of the monetary system to confirm a small government view.  Almost all of the major mainstream economic schools are attached to some specific policy agenda which is then confirmed by some politicized explanation of the monetary system.

The flaw in this approach is that it doesn’t actually result in any agreed upon understanding of the actual inner workings of the monetary system (like this).  So you have a bunch of economists who all essentially disagree on policy AND their understanding of the way the monetary system works.  Can you imagine if all of the surgeons in the world didn’t work from similar understandings of the way the human body functions and instead just experimented on the body with various hammers, scalpels and other fun toys?  Modern macro is not that far from that world where a bunch of PhDs just sit around hammering the body with their policy tool of choice screaming at one another about how their tool is better than another tool.  Obviously, that’s a silly approach.

I often talk about a Da Vinci approach to modern macro.  Leonardo Da Vinci was famous for his work in anatomy.  But Da Vinci didn’t take bodies apart so he could fix them.  He took them apart so he could understand them.  Da Vinci knew that you couldn’t even begin to fix a system until you understood it.  Curiously, modern macroeconomists still haven’t undergone this process of discovering an agreed upon understanding of the system.  There has been no Da Vinci approach in modern macro.  There are plenty of surgeons pretending to have the best tools.  But what we need is a Da Vinci (or group of Da Vincis).  Until then, the state of modern macro will remain fairly dismal.

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Cullen Roche

Mr. Roche is the Founder of Orcam Financial Group, LLC. Orcam is a financial services firm offering research, private advisory, institutional consulting and educational services.

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  • LVG

    Politics rules everything. Hate to say it, but MR will remain obscure until you guys venture into politics.

  • SS

    The biggest issue in economics is that the field is dominated by people with no real world experience.

  • Aussieminer

    Yes but surely someone or group of people must have had an understanding of the system when it was originally set up and legislated right? What happened to their understanding and why was it never documented? We shouldn’t after all need a group of Da Vinci’s to try figure it all out from scratch!

  • J Dukate

    Cullen here’s an idea that might cause your head to spin a little. Perhaps I’m wrong. But don’t all modern economic theories still rely on human/labor/productivity within their equations?

    What would happen if machine/productivity outpaced and replaced human productivity? Wouldn’t that render alot of our modern economic models useless.

    And the results might create high and stagnant unemployment despite fully recovered corporate profits:

    http://www.businessinsider.com/corporate-profits-hit-new-record-high-2012-11

  • Matthijs

    You make an excellent point Cullen. What you say about political ideology forming the base of someone’s economic thoughts could explain why people, including “top” economics, have so widely diverse views of how economics works (or should work in their minds).

    However, what I fail to understand is that almost nobody realizes what it means to have a democratic government, supposedly by the people for the people. Ruling over a country. Meaning also ruling over monetary and fiscal policy. And money creation. Almost everybody, including politicians and economists, takes a complete “dependent” viewpoint. As if “money” comes from some foreign entity (china, aliens, dug up from the ground?) and everybody, including the government, has to do eveything it can to “obtain” a portion of that money. The viewpoint that everybody is just completely dependent on “the markets”.

    Here in Europe, it’s the only mantra I hear and read day in day out. Don’t scare the markets. Please consolidate the budget, take harsh austerity measures, everything to please the markets, to make sure they keep having “confidence” and make sure Moodys et al doesn’t lower our credit rating. Bail out the banks if needed and lower government spending. Etc

    The bottom line: all the power is placed with some mysterious outside force, the “market” (the banks, financial institutions and big corps). Like the governments have no power at all themselves.

    (the other extreme point of view would be saying that the government is (or should be) the ONLY entity in power of money creation. I agree that that’s not true as well and that such a situation isn’t a good idea either.)

  • http://www.nowandfutures.com bart

    True, and they also fail via making the field *way* too complicated.

  • Frederick

    I think most economists are working from similar understandings. They just happen to be the wrong understandings. You start with banking so your view is totally different from that of most economists who don’t even include banking in their model. But that doesn’t mean they aren’t working with one model. It just means they’re not using a complete model.

  • http://australianpropertyforum.com/forum/3210735 Delusional Economics

    The problem with any asset or investment class these days is the amount of debt and leverage involved in all markets. Even if you’re not highly leveraged yourself, you can bet most of the other market participants will be, and that makes for an unstable investment (through no fault of your own) when the global economy has another dip and all asset classes get the jitters.

    My biggest fear as an investor right now would be China. A drop in Chinese asset values would not only shake confidence in China’s economic vitality, but it would also open debate about whether or not the global economy is over-leveraged and over-reliant on the success of China (it is).

    Excessive leverage is partly what made the property bubble aftermath so devastating for Japan, America and Ireland. There’s a great discussion here ( http://australianpropertyforum.com/topic/8768882 ) about the Chinese economic bubble and it’s potential impact on the global economy. Several months ago, so-called Chinese ‘expert’ Nick Lardy dismissed worries about what he called the “so-called property bubble” – this was during a conference held at Peterson Institute in DC. However, he now concedes that says a real estate downturn may cause a significant in China, and this is an opinion shared by many other mainstream economic analysts.

    So what changed his opinion? I would suggest a dawning realisation that most of the massive Chinese stimulus, lending and spending during 2009/10 just ended up in property purchases, which drove real estate prices in an alarming and totally unsustainable manner. Also, a realisation that China’s economic system frequently produces bubbles, and that’s not very likely to change in the near future!!

    To understand why excessive debt and leverage is going to have a hugely negative impact on all asset classes going forward, read up on some of the work by Professor Steve Keen ( http://australianpropertyforum.com/blog/main/3567572 ). He’s the Australian guy who predicted the GFC, and he has also shown that unsustainable debt to GDP ratios in a country (which you definitely have in the UK, and we have in Australia too) will always result in deflation or depression.

  • Kaleberg

    My problem with modern macro is that it doesn’t make very much sense in terms of accounting. I only have a limited knowledge of accounting, enough to read an annual report or write a simple double entry bookkeeping system. Every business and private entity is subject to the laws of accounting, and that means any aggregate macro system has to give each of them reasonable results. Unfortunately, whenever I try to imagine the component balance sheets that must underlay any macro theory, I wind up with things that can’t be reconciled. I’m not talking about the mysteries of creating money, fractional reserve banking or economic growth, just very simple stuff like the relationship between savings and investment. What gives? Is this a class thing? Is accounting too blue color to be acknowledged by the aristocrats of economics? Maybe we do need some economists who aren’t afraid to get their hands dirty cutting up a few bodies, metaphorically in this case.