Paul De Grauwe, professor of economics at the University of Leuven and the Centre for European Policy Studies made some interesting points about the different economic schools of thought, which in his opinion needs some re-think. The article appeared on FT.com:
We need a new science of macroeconomics. A science that starts from the assumption that individuals have severe cognitive limitations; that they do not understand much about the complexities of the world in which they live. This lack of understanding creates biased beliefs and collective movements of euphoria when agents underestimate risk, followed by collective depression in which perceptions of risk are dramatically increased. These collective movements turn uncorrelated risks into highly correlated ones. What Keynes called “animal spirits” are fundamental forces driving macroeconomic fluctuations.
The basic error of modern macro-economics is the belief that the economy is simply the sum of microeconomic decisions of rational agents. But the economy is more than that. The interactions of these decisions create collective movements that are not visible at the micro level.
It will remain difficult to model these collective movements. There is much resistance. Too many macro-economists are attached to their models because they want to live in the comfort of what they understand – the behaviour of rational and superbly informed individuals.
To paraphrase Isaac Newton, macroeconomists can calculate the motions of a lonely rational agent but not the madness of the crowds. Yet if macroeconomics wants to become relevant again, its practitioners will have to start calculating this madness. It is going to be difficult, but that is no excuse not to try.
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