Krugman on methodology

24 Apr, 2012 at 20:05 | Posted in Economics, Theory of Science & Methodology | 2 Comments

“New Keynesian” macroeconomic models are at heart based on the modeling strategy of DSGE – representative agents, rational expectations, equilibrium and all that. They do have some minor idiosyncracies (like “menu costs” and “price rigidities” preferably in a monopolistic competition setting ), but the differencies are not really that fundamental. The basic model assumptions are the same.

If macoeconomic models – no matter of what ilk – assume representative actors, rational expectations, market clearing and equilibrium, and we know that real people and markets cannot be expected to obey these assumptions, the warrants for supposing that conclusions or hypothesis of causally relevant mechanisms or regularities can be bridged, are obviously non-justifiable. Macroeconomic theorists – regardless of being “New Monetarist”, “New Classical” or ”New Keynesian” – ought to do some ontological reflection and heed Keynes’ warnings on using thought-models in economics:

The object of our analysis is, not to provide a machine, or method of blind manipulation, which will furnish an infallible answer, but to provide ourselves with an organized and orderly method of thinking out particular problems; and, after we have reached a provisional conclusion by isolating the complicating factors one by one, we then have to go back on ourselves and allow, as well as we can, for the probable interactions of the factors amongst themselves. This is the nature of economic thinking. Any other way of applying our formal principles of thought (without which, however, we shall be lost in the wood) will lead us into error.

People calling themselves “New Keynesians” ought to be rather embarrassed by the fact that the kind of microfounded dynamic stochastic general equilibrium models they use, cannot incorporate such a basic fact of reality as involuntary unemployment!

Of course, working with representative agent models, this should come as no surprise. If one representative agent is employed, all representative agents are. The kind of unemployment that occurs is voluntary, since it is only adjustments of the hours of work that these optimizing agents make to maximize their utility.

From a methodological and theoretical point of view Paul Krugman’s comments in the debate on microfounded macromodels is really interesting because they shed light on a kind of inconsistency in his own art of argumentation.

During a couple of years Krugman has in more than one article criticized mainstream economics for using to much (bad) mathematics and axiomatics in their model-building endeavours. But when it comes to defending his own position on various issues he usually himself ultimately falls back on the same kind of models. This shows up also in the microfoundations debate, where he refers to the work he has done with Gauti Eggertsson – work that actually, when it comes to methodology and assumptions, has a lot in common with the kind of model-building he otherwise criticizes.

In 1996 Krugman was invited to speak to the European Association for Evolutionary Political Economy. I think reading the speech gives more than one clue on the limits of Krugman’s critique of modern mainstream economics (italics added): 

I like to think that I am more open-minded about alternative approaches to economics than most, but I am basically a maximization-and-equilibrium kind of guy. Indeed, I am quite fanatical about defending the relevance of standard economic models in many situations.
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I won’t say that I am entirely happy with the state of economics. But let us be honest: I have done very well within the world of conventional economics. I have pushed the envelope, but not broken it, and have received very widespread acceptance for my ideas. What this means is that I may have more sympathy for standard economics than most of you. My criticisms are those of someone who loves the field and has seen that affection repaid. I don’t know if that makes me morally better or worse than someone who criticizes from outside, but anyway it makes me different.
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To me, it seems that what we know as economics is the study of those phenomena that can be understood as emerging from the interactions among intelligent, self-interested individuals. Notice that there are really four parts to this definition. Let’s read from right to left.
1. Economics is about what individuals do: not classes, not “correlations of forces”, but individual actors. This is not to deny the relevance of higher levels of analysis, but they must be grounded in individual behavior. Methodological individualism is of the essence.
2. The individuals are self-interested. There is nothing in economics that inherently prevents us from allowing people to derive satisfaction from others’ consumption, but the predictive power of economic theory comes from the presumption that normally people care about themselves.
3. The individuals are intelligent: obvious opportunities for gain are not neglected. Hundred-dollar bills do not lie unattended in the street for very long.
4. We are concerned with the interaction of such individuals: Most interesting economic theory, from supply and demand on, is about “invisible hand” processes in which the collective outcome is not what individuals intended.
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Gould is the John Kenneth Galbraith of his subject. That is, he is a wonderful writer who is beloved by literary intellectuals and lionized by the media because he does not use algebra or difficult jargon. Unfortunately, it appears that he avoids these sins not because he has transcended his colleagues but because he does not seem to understand what they have to say; and his own descriptions of what the field is about – not just the answers, but even the questions – are consistently misleading. His impressive literary and historical erudition makes his work seem profound to most readers, but informed readers eventually conclude that there’s no there there.
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Personally, I consider myself a proud neoclassicist. By this I clearly don’t mean that I believe in perfect competition all the way. What I mean is that I prefer, when I can, to make sense of the world using models in which individuals maximize and the interaction of these individuals can be summarized by some concept of equilibrium. The reason I like that kind of model is not that I believe it to be literally true, but that I am intensely aware of the power of maximization-and-equilibrium to organize one’s thinking – and I have seen the propensity of those who try to do economics without those organizing devices to produce sheer nonsense when they imagine they are freeing themselves from some confining orthodoxy.

On many macroeconomic policy discussions I often find myself in agreement with Krugman. To me that just shows that Krugman is right in spite of and not thanks to those neoclassical models/methodology/theories he ultimately refers to. When he is discussing austerity measures, ricardian equivalence or problems with the euro, he is actually not using those neoclassical models/methodology/theories, but rather simpler and more adequate and relevant thought-constructions in the vein of Keynes.

As all students of economics know, time is limited. Given that, there has to be better ways to optimize its utilization than spending hours and hours working through, constructing or adding tweaks to irrelevant “New Keynesian” DSGE macroeconomic models. I would rather recommend my students allocating their time into constructing better, real and relevant macroeconomic models – models that really help us to explain and understand reality.