Navigare necesse est: markets, crises, and our models

Abstract

The events of the past decade and a half have posed unprecedented challenges to macroeconomic policymaking. Modern policymaking has long been relying on a spectrum of models both at national and supranational levels. However, none of the standard models have predicted any of the major crises of the past decade and a half, nor could they capture the dynamics of the ensuing readjustment processes well. In general, standard workhorse models make several assumptions that may not hold in the economies they are applied to. Moreover, they perform particularly poorly during crisis episodes. This short article reviews the issues surrounding these models and proposes a simple modelling strategy to be applied in the face of such large model uncertainty.