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23 Jul 2009

Economics in crisis: It is time for a profound revamp

Paul De Grauwe

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The basic error of modern macroeconomics is the belief that the economy is simply the sum of microeconomic decisions of rational agents. But the economy is more than that. The interactions of these decisions create collective movements that are not visible at the micro level. It will remain difficult to model these collective movements, but if the discipline of macroeconomics wants to become relevant again, its practitioners will have to start calculating the ‘madness of crowds’, that is, the collective movements of euphoria when agents underestimate risk, followed by collective depression in which perceptions of risk are dramatically increased.