The Global Economy in Turbulent Times

CHAPTER 24 Reality Check on Economic Models¹

Since the 1970s, mainstream research on major macroeconomic issues (growth and inflation, boom and bust, etc.) has been grounded in individual behavior. Their best and brightest became Nobel Laureates (e.g., Robert Lucas of University of Chicago in 1995 and George Akerlof of University of California at Berkeley in 2001). The results were rigorous; indeed, the macroeconomic models are certainly that. Their roots date back to Professor Irving Fisher (Keynes’s contemporary), who determined behavior of the market in rational, mathematical terms. But policy makers and the public want them to be illuminating and useful, that is, being realistic. What we got was anything but that. To begin with, the idea of finding a single theory encompassing all of human behavior was not realistic. What emerged was based on the “efficient market” hypothesis—that everyone acts rationally and has perfect information so that the market accurately prices the real value of “goods” transacted.² Concepts like equity, ethics, and values are regarded as sloppy sociological constructs. In the real world, however, much of what brings about business opportunities and causes instability in the global economy results from the failure of assumptions such as these. Indeed, herd behavior, panic, asset mispricing, imperfect information, and irrational exuberance have resulted in the mess we now witness.

Failure of Models

The arrogance of it all is that these models claim ...