The microfoundationalist illusions of Yates & Wren-Lewis

17 December, 2013 at 20:42 | Posted in Economics | 7 Comments

In a blogpost the other day Tony Yates argues that microfoundations do have merits:

The merit in any economic thinking or knowledge must lie in it at some point producing an insight, a prediction, a prediction of the consequence of a policy action, that helps someone, or a government, or a society to make their lives better.

the_one_and_only_2008aMicrofounded models are models which tell an explicit story about what the people, firms, and large agents in a model do, and why.  What do they want to achieve, what constraints do they face in going about it?  My own position is that these are the ONLY models that have anything genuinely economic to say about anything.

And yesterday Simon Wren-Lewis — non-surprisingly — says he basically agrees:

scrrewmicrofoundations have done a great deal to advance macroeconomics. It is a progressive research program, and a natural way for macroeconomic theory to develop. That is why I work with DSGE models.

The one economist/econometrician/methodologist who has thought most on this issue — writing om microfoundations for now more than 25 years — is without any doubts Kevin Hoover. It’s actually quite interesting to compare his qualified and methodologically founded assessment on the representative-agent-rational-expectations microfoundationalist program with the more or less apologetic views of Yates and Wren-Lewis:

hoovGiven what we know about representative-agent models, there is not the slightest reason for us to think that the conditions under which they should work are fulfilled. The claim that representative-agent models provide microfundations succeeds only when we steadfastly avoid the fact that representative-agent models are just as aggregative as old-fashioned Keynesian macroeconometric models. They do not solve the problem of aggregation; rather they assume that it can be ignored. While they appear to use the mathematics of microeconomis, the subjects to which they apply that microeconomics are aggregates that do not belong to any agent. There is no agent who maximizes a utility function that represents the whole economy subject to a budget constraint that takes GDP as its limiting quantity. This is the simulacrum of microeconomics, not the genuine article …

[W]e should conclude that what happens to the microeconomy is relevant to the macroeconomy but that macroeconomics has its own modes of analysis … [I]t is almost certain that macroeconomics cannot be euthanized or eliminated. It shall remain necessary for the serious economist to switch back and forth between microeconomics and a relatively autonomous macroeconomics depending upon the problem in hand.

So next time these guys want to write atrocities like Wren-Lewis’s

Let’s take a very basic example. Suppose in the real world some consumers are credit constrained, while others are infinitely lived intertemporal optimisers. A microfoundation modeller assumes that all consumers are the latter

a visit to Dr Hoover is recommended!

Added November 18:  And as part of the ongoing debate, Noah Smith contributes with the following tirade on his blog:

I think microfoundations are a great idea! I think they’re the dog’s bollocks! I think that macro time-series data is so uninformative that microfoundations are our only hope for really figuring out the macroeconomy. I think Robert Lucas was 100% on the right track when he called for us to use microfounded models.

Hmm … To me this is like saying “OK, to get our economic model-machine going we have to assume that people are hyper-rational robot-imitations from Mars. But these guys aren’t green, as you say, but blue!” That doesn’t seem to be the right approach to tackle the problem.

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  1. Microfoundations is not the same thing as representative agent model, and there are plenty of papers that investigate models with some heterogeneity across agents. For example, the introduction of “hand-to-mouth” consumers into a New-Keynesian DSGE model, mentioned by Wren-Lewis, has been studied in Gali et al. (2007) [1] (a paper with about 750 citations in Google Scholar, by the way).

    You also seem to be misrepresenting Wren-Lewis – he explicitly says that while microfounded models are useful, there are also other alternatives and macroeconomics requires an eclectic approach that combines different classes of models. Which is rather different reading than the one implied by your clipped quote.


    • RARE are standard assumptions made in microfoundations of “modern” macro. No one has, as far as I know, said that RARE IS the same thing as microfoundationalist models. Gali (2007) and other elaborations doesn’t fundamentally change anything — when the methodological-ontological foundation is principally wrong, no matter how many successive approximations to a distant reality you make, you still don’t get any warranted export licenses!

    • Even a multi-agent model uses aggregation. I.e. it is assumed that there are GROUPS of agents x, y and z. In order to be truly microfounded a model of an economy with 50m individuals would have to have 50m different agents — or some approximation thereof. That would be like drawing a map on a scale of 1:1. Without doing this the model isn’t really microfounded at all.

      This is actually so obvious that only economists, with their disdain for self-reflection, could miss it.

  2. In many ways it is best when theories are true independent of their microfoundations. If we look at the advances in physics and chemistry during the 19th century, they were all made top-down. We actually didn’t get down to the microfoundations of physics (the quantum theory) until the beginning of the 20th century. And with hindsight we can say that there is no way we would have made progress so fast if we had had to work out quantum dynamics first and then develop the rest from it..

    Likewise with economic theory, it’s probably best to work out the high-level laws first and then use them to rule out microfoundations which don’t fit. That way we are far less likely to waste time building on a particular set of microfoundations which are wrong.

  3. Prof Syll, do you argue that there can be no sound economic theory based on microfoundations for some reasons and what are those reasons specifically? The only reason I have come across so far is observational evidence but nothing of intrinsic value. For example, based on observational evidence 3,000 years ago, any theory of gravity that claimed that acceleration of gravity is independed of mass of falling object was falsified because a feather fell more slowly to the ground than a rock. But it was the observational evidence that was in error because it was considering a special case of no vaccum. .

    In essence, do you argue that economies have properties that are above and beyond the ensemble properties of their participating agents? This is of course too interesting but also metaphysical in an ontological sense.

  4. “I think that macro time-series data is so uninformative…”

    So, THAT is why Smith’s prognostications on real-world issues usually comes across as sophomoric…

  5. […] Tony Yates, who shows off his professional ignorance by stating about the  micro-founded (not!) neoclassical macro economic […]

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