Where modern macroeconomics went wrong

• Published in: Oxford review of economic policy Vol. 34; no. 1/2; pp. 70 - 106
• Main Author: Stiglitz, Joseph E.
• Format: Journal Article
• Language: English
• Published: UK Oxford University Press 2018
• Subjects: deep downturns; representative agent; economic fluctuations; DSGE
• ISSN: 0266-903X; 1460-2121
• DOI: 10.1093/oxrep/grx057

This paper provides a critique of the DSGE models that have come to dominate macroeconomics during the past quarter-century. It argues that at the heart of the failure were the wrong micro-foundations, which failed to incorporate key aspects of economic behaviour, e.g. incorporating insights from information economics and behavioural economics. Inadequate modelling of the financial sector meant they were ill-suited for predicting or responding to a financial crisis; and a reliance on representative agent models meant they were ill-suited for analysing either the role of distribution in fluctuations and crises or the consequences of fluctuations on inequality. The paper proposes alternative benchmark models that may be more useful both in understanding deep downturns and responding to them.