The importance of going beyond academic models

In this article, I will try to convince you that what is being taught on the academic level is not sufficient to understand current issues in economics (modeling).

The last financial crisis painfully showed us how wrong many people were. Many professions simply failed to see what was happening. Of course one can blame wild Wall-Street bankers, but it is also important to consider the fact that the vast majority of economists didn’t predict anything of it. This came – at least to me – as a surprise. After all, aren’t the economists the ones that are supposed to be the best equipped to foresee such events?

It would however be unfair to simply condemn the field of economics as a whole and such a thing is by far not the message of the blog. My goal is simply to shed some light on what went wrong. There are numerous things we could talk about but I decided to focus on the mismatch and the lack of applicability of academics models. I am no one to criticize the macroeconomics models that are taught in academia. They have all been established by brilliant and extremely clever economists. The thing is however that these models might suffer to some extent from obsolescence.

To illustrate this point, let’s talk about the failures of the standard models. Over the last 30 years, one can honestly say that economics has been dominated by what one calls the “academic orthodoxy”. Elegant models have been preferred to ugly but more realistic ones. One striking example is the absence of given to banks within these models. Often, this feature comes as an assumption that is intended to make results clearer. Today, one can say that it was an extreme and wrong simplification. The problem isn’t so much that mistakes were made, I mean, it happens. What is however more surprising is the little economic rethinking that took place, at least on the academic cursus plan. What is being taught at the University level didn’t change much. Our models still don’t include banks, that’s nonsense! It is true that more and more economists try to come up with alternatives, but isn’t it totally insane to not change what is being taught to the next generation of economists? Hence the necessity to inform economics students about alternatives and the state of macro.

While deregulation was increasing and financial institutions were creating risky products that stimulated risk-taking behaviors, academics and central bankers might have come to rely solely on their beautiful models without taking into account what was happening in the real world and without including historical parameters. While it is true that the housing bubble has been spotted by many economists, it is also true that its implications were largely underestimated.

All this to say that we need have a wider knowledge of what is being done in the field of macroeconomics.

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