Monday, December 21, 2009

Models and economics

Paul Krugman suggests that it was Keynes and Samuelson's effective use of economic models to understand and combat the great depression that helped gain the ascendancy over more complex and nuanced historical and institutional explanations. However, it appears that we reached a point where the institutional and historical context was lost. The model is just a model and the model used must be suited to the situation. The situation can probably only be assess with institutional and historical knowledge.

The current crisis does not appear to be that different from previous crises: there is a period of calm complacency and de-regulation; there is excess credit growth and increased risk-taking as the consequence of risk disappears into the background. What is new is the institutional and historical context: the international financial system is inter-connected; there is a huge increase in savings that is being intermediated between developing and developed countries; there is demand for safe assets.

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