Macroeconomics

after the Crisis

by Ricardo J. Caballero

Luis, Chiara, Evangelia, Christoph

Introduction
• Ricardo Caballero (2010), MIT
• Core failed to predict the crisis, whereas Peripheral macro just
predicted part of it
• Goal should be to provide formal frameworks to address real
economic problems rather than purely literature-driven ones
“Of course compared with the precise predictions
that we have learnt to expect in the physical
sciences, this sort of pattern predictions is a second
best […]. To act in the belief that we posses
knowledge and the power which enable us to shape
the process of society to our knowledge, is likely to
make us do much harm.”

von Hayek, 1974

Periphery Macroeconomics - Introduction
• Focus on sub-problems, more sensible
• Provides mostly qualitative designs
o Understanding of phenomena that played central role in bringing the world
economy to the brink of a severe depression (bubbles etc.)
• Provides policy framework to contain the crisis
Periphery Macroeconomics – Critiques
• Not looking for a general equilibrium, incomplete answers
• Uses abstraction
• Narrow goals, designed to isolate insights and comprehensive
and/or quantitative answers to the overall effect in
macroeconomics.
Core Macroeconomics - Introduction
• Current core trying to model and apply micro-based models to
obtain quantitative answers

• The Dynamic Stochastic General Equilibrium (DSGE)

1. New Keynesians
2. Real business cycle: built on the neoclassical growth model : Y=F(K,AL)
from here core adds more and more constraints
Core Macroeconomics – Critiques
• Transmits from the individual to the aggregate directly
o i.e. intertemporal substitution elasticity → they take some parameters as given,
reasonable for an individual but not for the macro level
• Sometimes it cannot be “taken seriously” – even if it is built on
microeconomics foundations
• Assumptions too specific and do not represent the real world
→ “Fantasyland”
Integrationist movement
• There has been some progress (central banks) but we are
overpassing limits
• It is not only about the core acquiring the insights of the periphery
o i.e. rational expectations→ Lucas critique

• Spend more time modelling agents linkages

These linkages can cause substantial instability

Some of the literature includes:

1. Dominoes and avalanches
2. Panics
Economic Complexity – Dominoes,
Avalanches and Panic
• Complex environment has bigger chance to generate confusing
surprises
• Linkages can cause substantial instability with respect to shocks
• Interconnectedness of agents
o Local non-linear interactions can cause shocks and generate large aggregate
fluctuations
• Knightian uncertainty role
• Risky linkages are not known pre-crisis
Some Policies Implications
• Some policies and institutions might be useful but...
• Instead of preventing a crisis, it is needed to consider in advance
how the policies would respond.
o i.e. demand for insurance

• Also:
o Caballero & Kurlat (2009) → Tradable insurance credit
o Geanakopolos (2003, 2009) → Leverage cycles
Conclusion
• It is not about being more narrative, modelling is good but with
boundaries on it
• Academics can’t only focus on theory only but also take care of the
real world problems
• We are not looking for abstraction. Some of it is good but keeping
sensible assumptions.
• Optimism → there are some steps in the right directions
Thank you for your attention.