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Business cycle, and the dynamic stochastic general equilibrium (DSGE) theory, and has
become the mainstream in the United States.
In part, this development in macro is understandable. As the new work has
demonstrated, the macro theory that was prevalent in the 1960s claimed a much stronger
theoretical foundation than was warranted, and many of the conclusions it came to were
not supported by either empirical evidence or theory. However, while the new theoretical
models have done a good job in eliminating the old theory, it is less clear as to what the
new theoretical work has added to our understanding of the macro economy. At best, the
results of the new macro models can be roughly calibrated with the empirical evidence,
but often the calibration of these new models is no better than any other model, and the
only claim they have to being preferred is aesthetic—they have micro foundations.
However, it is a strange micro foundation—a micro foundation based on assumptions of
no heterogeneous agent interaction, when, for many people intuitively, it is precisely the
heterogeneous agent interaction that leads to central characteristics of the macro
economy. This is essentially Keynes’ fallacy of composition insight.
In our view, the interesting cutting-edge work in macro is not in the theoretical
developments organized around representative agent micro foundations work, but in the
work that is going beyond that and viewing the macro economy as a complex system. In
this work, one sees the macro economy as being endogenously organized. The issue is
not why there are fluctuations in the macro economy, but instead, why is there so little