Microfoundations – neither laws, nor true8 June, 2013 at 17:27 | Posted in Economics | 2 Comments
Oxford professor Simon Wren-Lewis doesn’t agree with Paul Krugman’s statement that
the whole microfoundations crusade is based on one predictive success some 35 years ago; there have been no significant payoffs since.
Why does Wren-Lewis disagree? He writes:
I think the two most important microfoundation led innovations in macro have been intertemporal consumption and rational expectations. I have already talked about the former in an earlier post … [s]o let me focus on rational expectations … [T]he adoption of rational expectations was not the result of some previous empirical failure. Instead it represented, as Lucas said, a consistency axiom …
I think macroeconomics today is much better than it was 40 years ago as a result of the microfoundations approach. I also argued in my previous post that a microfoundations purist position – that this is the only valid way to do macro – is a mistake. The interesting questions are in between. Can the microfoundations approach embrace all kinds of heterogeneity, or will such models lose their attractiveness in their complexity? Does sticking with simple, representative agent macro impart some kind of bias? Does a microfoundations approach discourage investigation of the more ‘difficult’ but more important issues? Might both these questions suggest a link between too simple a micro based view and a failure to understand what was going on before the financial crash? Are alternatives to microfoundations modelling methodologically coherent? Is empirical evidence ever going to be strong and clear enough to trump internal consistency? These are difficult and often quite subtle questions that any simplistic for and against microfoundations debate will just obscure.
On this argumentation I would like to add the following comments:
(1) The fact that Lucas introduced rational expectatuions as a consistency axiom is not really an argument to why we should accept it as an acceptable assumption in a theory or model purporting to explain real macroeconomic processes (see e. g. Robert Lucas, rational expectations, and the understanding of business cycles).
(2) “Now virtually any empirical claim in macro is contestable” Wren-Lewis writes. Yes, but so is virtually also any claim in micro (see e. g. When the model is the message – modern neoclassical economics).
(3) To the two questions “Can the microfoundations approach embrace all kinds of heterogeneity, or will such models lose their attractiveness in their complexity?” and “Does sticking with simple, representative agent macro impart some kind of bias?” I would unequivocally answer yes (I have given the reasons why e. g. in David Levine is totally wrong on the rational expectations hypothesis , so I will not repeat the argumentation here).
(4) “Are alternatives to microfoundations modelling methodologically coherent?” Well, I don’t know. But one thing I do know, is that the kind of miocrofoundationalist macroeconomics that New Classical economists in the vein of Lucas and Sargent and the so called New Keynesian economists in the vein of Mankiw et consortes are pursuing, are not methodologically coherent (as I have argued e. g. in What is (wrong with) economic theory?) And that ought to be rather embarrassing for those ilks of macroeconomists to whom axiomatics and deductivity is the hallmark of science tout court.
So in the Wren-Lewis – Krugman discussion on microfoundations I think Krugman is closer to truth with his remark that
what we call “microfoundations” are not like physical laws. Heck, they’re not even true.