Microfoundations — Keynes buried the idea already in 1926

9 December, 2013 at 20:55 | Posted in Economics | 3 Comments

keynes essays in biographyThe atomic hypothesis which has worked so splendidly in Physics breaks down in Psychics. We are faced at every turn with the problems of Organic Unity, of Discreteness, of Discontinuity – the whole is not equal to the sum of the parts, comparisons of quantity fails us, small changes produce large effects, the assumptions of a uniform and homogeneous continuum are not satisfied. Thus the results of Mathematical Psychics turn out to be derivative, not fundamental, indexes, not measurements, first approximations at the best; and fallible indexes, dubious approximations at that, with much doubt added as to what, if anything, they are indexes or approximations of.


Where “New Keynesian” and New Classical economists think that they can rigorously deduce the aggregate effects of (representative) actors with their reductionist microfoundational methodology, they have to put a blind eye on the emergent properties that characterize all open social and economic systems. The interaction between animal spirits, trust, confidence, institutions etc., cannot be deduced or reduced to a question answerable on the individual level. Macroeconomic structures and phenomena have to be analyzed on their own terms.

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  1. Microfoundations, however, do not even make sense on their own terms – i.e. even if the RARE framework was realistic and was not just another aggregate. This is because large groups of people have more influence on the individual than individuals have on large groups of people. Consider, for example, a football stadium filled with one hundred spectators lined up ten-by-ten. They are all sitting down. We know that every individual can stand up to get a better view except those in the front row (whose view is not obstructed). Let us also assume that if the individual in front of another individual stands up, the individual having their view blocked will also stand up to compensate.

    Now, what does this mean? Well, it means that any given individual can stand up to get a better view but by doing so they will cause other individuals to stand up. If the most influential individual in the front row stands he will cause nine other people to stand, while if the least influential individual in the back row stands he will have no influence on anyone else at all. So, the maximum power an individual has to block the ability of other individuals to stand up to get a better view is the power to block nine other individuals. However, if the group all stands up at the same time then no one is able to get a better view.

    This is simply a numbers game with no metaphysical overtones and it applies to many problems in economics and other sciences. For example, the so-called paradox of thrift states that if the whole community try to save at one time, no one will increase their savings (because they rely on the spending of others for income out of which they can save). The group thus has an enormous constraining influence on the individual. However, if a single individual tries to save he will lower the group’s income to some very small extent (to put it in economic terms: the multiplier will fall by a small amount) but it will not have any very significant effect on the group.

    Read more at http://www.nakedcapitalism.com/2013/02/philip-pilkington-of-madness-and-microfoundationsm-rational-agents-schizophrenia-and-a-noble-attempt-by-one-noah-smith-to-break-through-the-mirror.html#gomCXoTQLecmJXqM.99

  2. The same phenomenon (the near impossibility of deducing the macro from the micro) seems to occur in astronomy. E.g., every time a space probe gets a close look at a planet, we see things that astronomers would never have deduced from their existing knowledge about astronomy, physics, etc.

  3. Even if you take all the assumptions for granted, the mathematics is still sloppy. I have a background in control systems (applied math), and I have been looking at DSGE models on my blog, and there seem to be obvious math problems.

    For microfoundations in particular, they use some logic based on the representative household to derive what they call the transversality condition – that the NPV of government debt at infinity is zero. However, flow of funds analysis shows that the micro logic will not work, and the transversality condition does not have to hold. This throws their whole math framework into question.

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