The global crisis has innumerable adverse outcomes. One among these is that the settled economic theory was shaken harshly. Economists now even more frequently discuss how the science of economy can survive from this 'bad' situation. I wrote two commentaries on this issue at the end of August and at the beginning of November. And it is most likely that I will write more on this issue.

Models frequently used particularly at doctorate studies fail to contain satisfactorily the financial markets. In some cases, financial markets even do not take place in the models. And thus those models become delinked from the real world. How can you foresee the economic crisis that has shaken the whole world with a model that does not contain financial markets? It would be almost impossible. How can you understand the problems resulting from the crisis and then provide solutions for those problems?

Exclusion of financial markets is not the only problem of the mentioned models.  Another thing is that they do not include consumers or firms with different goals. They in general assume a single type of firms. And when they loosen this clearly unrealistic assumption and let them seek different goals, the models become even more tangled. If you skip this part, you have to admit that these models are quite 'cool'. For instance, some commonly used types of macroeconomic models can be categorized under the title 'dynamic stochastic general equilibrium.' See: it is both 'dynamic', 'stochastic' (based on possibilities; not certain) and 'general' as well including an 'equilibrium'.

Models are 'cool' not only because of their names. Once constructed, you have to make dynamic optimization to solve the model. Thus, you will get complex results (nonlinear relations) which you will linearize to reach a mathematical solution. This linearization will be made on the basis of the long term 'equilibrium' values for the variables you use. Then you will 'calibrate' those linear relations in order to reflect the relations you observe in real life. After that, you will introduce shocks that will 'shake deeply' the model you constructed and observe the results.

I am sorry if some lines in the last paragraph sounds like Chinese to you. I intentionally tried to write complicated sentences to give you an idea about how 'cool' the mentioned models are. When you read the last paragraph above, you can say "So what? You can analyze the impacts of deep shocks, cannot you?" However, the shocks these models can analyze are not the shocks in the sense we know. For example, you can analyze the results of a shock that changes the level of technology; whereas you cannot analyze the possible impacts of the bankruptcy of a giant financial institution.

Charles Goodhart, a well-known economist speaks like this for the mentioned models: "Dynamic stochastic general equilibrium models exclude everything I am interested in as an economist." As an interesting study on this issue, I recommend you to read William Buiter's 6 March dated article: "The unfortunate uselessness of most 'state of art' academic monetary economics".

This commentary was published in Radikal daily on 21.12.2009