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DSGE model and the State of Macroeconomics | Q&A with Olivier Blanchard |

“Where is the General Theory of the 21st Century?” is an interview series which ask top economists a very important question: “Why haven’t economists come up with a new General Theory that can explain the Great Recession?” This is an inquiry into how the macroeconomics academia changed since the Great Recession, and why the responses from macroeconomists since 2008 are different from their counterpart in the 1930s.

In this installment, we talked to Olivier Blanchard, the C. Fred Bergsten Senior Fellow of Peterson Institute for International Economics and formerly the economic counselor and director of the Research Department at the International Monetary Fund. He was also the chair of the economics department at MIT from 1998 to 2003 and remains as Robert M. Solow Professor of Economics Emeritus.


Keynesian Revolution of the 21st Century?

Q: EconReporter B: Olivier Blanchard

Q: Do you think there is another “Keynesian Revolution” happening in the macroeconomics academia since the Great Recession?

B: I think so. If you think of Keynesian Economics as the theory insisting that the demand side is the most important determinant of activities in the short run, then the answer is yes.

To understand what has happened to the world economy since 2008, one needs to look at what has happened to the demand . I think this is probably a generally accepted notion now.

Q: Yet, most of the “new ideas” emerged after the Great Recession are actually the resurgence of old ideas.

In this sense, do you think macroeconomics is, in fact, moving forward in recent years?

B: I think we now have a much better understanding of the short-run and the long-run effect of the financial shocks.

For example, what some people called financial cycle, or I should just call it financial shocks as I am not sure if in fact there is a financial cycle, clearly has some major macroeconomic effect. This is one example of what we understand much better than in 2007.

Q: Do you think that progress like these are “game changers” to the development of macroeconomics?

B: Two parts for the answer. Is it a game changer? No.

But it has added something that was missing to the basic model, that is the financial sector. Once we have done this, we have a different type of model and a different view of how the economy works.

So, is it a game changer? I am not sure. But it is an important development.

Another thing is that as the crisis has been so complex in so many ways, I think economists are much more willing to explore new mechanisms, new distortions, and new facts now. Much more so than they were in 2007. I think the facts that we did poorly in predicting the crisis and explaining what was going on have led to more open-minded research in macroeconomics.