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Policymakers and macroeconomic models: a warning from Sweden

How useful is mathematics in economics? The discussion is open, even in central banks. Last month, the Sweriges Riksbank’s First Deputy Governor Svante Öberg warned his colleagues about an excessive reliance in the Swedish macroeconomic model adopted by the central bank. “The model calculations are made with the aid of the Ramses model, which is, like all other models, a simplification of reality”, he said, according the recently published minutes of the last monetary policy meeting. He was not speaking about Ramses the Pharaoh: it was an acronym for Riskbank Aggregate Macromodel for Studies of the Economy of Sweden.

In the model, Öberg added, “the effects are linear, that is, they are as great with a cut [of interest rates] close to zero or even below zero as with a more normal interest rate level, […] there is no developed financial sector in the model, […] the model does not take into account the Riksbank's extensive lending to the banks, […] there is no unemployment in the model and […] employment varies in proportion to production, which goes against empirical experience”. “It is good – Öberg concluded to have models as aids, but one must not believe in them slavishly”.

It is good to remember what Alfred Marshall said about mathematics in economics: it is “a marvellously terse and exact language for expressing clearly some general relations and some short processes of economic reasoning” that “gives a grasp, that cannot be obtained equally well in any other way, of the mutual interaction of economic changes”. So the problem is not mathematics, it is the methodology of “unrealistic assumptions”, defended by Milton Friedman in an influential essay. An unrealistic assumption maybe is simply false.