Granted that the final result will be capable of being expressed in the form of a system of simultaneous equations applying to the economy as a whole, it does not follow that the best way to get to that final result is by seeking to set such a system down now. As I am sure those who have tried to do so will agree we now know so little about the dynamic mechanisms at work that there is enormous arbitrariness in any system set down. Limitations of resources – mental, computational, and statistical – enforce a model that, although complicated enough for our capacities, is yet enormously simple relative to the present state of understanding of the world we seek to explain.
Until we can develop a simpler picture of the world, by an understanding of interrelations within sections of the economy, the construction of a model for the economy as a whole is bound to be almost a complete groping in the dark. The probability that such a process will yield a meaningful result seems to me almost negligible.
Milton Friedman (1951)
One view, prevalent among mathematical theorists of general equilibrium, is that traditional macroeconomic theory suffers from its lack of firm microeconomic foundations. The behavioral relations of macro models, it is said, are not rigorously derived from optimization by individual agents and from the clearing of markets in which optimizing agents participate. In short, macro models do not look like general equilibrium models.
Of course, it is hard to make them look like general equilibrium models without emptying macro models of the aggregative simplicity, institutional content, and definiteness of conclusion which are their raison d’étre. It is possible to give macro relations the veneer of rigorous derivation from utility or profit maximization by assuming the aggregate of firms to behave if they were one firm. Since the procedure involves a dubious assumption of aggregation, it is not clear it is as much an improvement of the rigor and robustness as a gratification of the trained consciences of the theorists.
James Tobin (1978)
In this paper I argue that the current core of macroeconomics – by which I mainly mean the so-called dynamic stochastic general equilibrium approach – has become so mesmerized with its own internal logic that it has begun to confuse the precision it has achieved about its own world with the precision that it has about the real one. This is dangerous for both methodological and policy reasons. On the methodology front, macroeconomic research has been in “fine-tuning” mode within the local-maximum of the dynamic stochastic general equilibrium world, when we should be in “broad-exploration” mode. We are too far from absolute truth to be so specialized and to make the kind of confident quantitative claims that often emerge from the core. On the policy front, this confused precision creates the illusion that a minor adjustment in the standard policy framework will prevent future crises, and by doing so it leaves us overly exposed to the new and unexpected.
Ricardo Caballero (2010)