Solow on the need to filter nonsense economics

9 June, 2015 at 18:07 | Posted in Economics | Leave a comment

smellFollowing the greatest economic depression since the 1930s, Robert Solow in 2010 gave a prepared statement on “Building a Science of Economics for the Real World” for a hearing in the U. S. Congress. According to Solow modern macroeconomics has not only failed at solving present economic and financial problems, but is “bound” to fail. Building microfounded macromodels on “assuming the economy populated by a representative agent” — consisting of “one single combination worker-owner-consumer-everything-else who plans ahead carefully and lives forever” — do not pass the smell test: does this really make sense? Solow surmised that a thoughtful person “faced with the thought that economic policy was being pursued on this basis, might reasonably wonder what planet he or she is on.”

Conclusion: an economic theory or model that doesn’t pass the real world smell-test is just silly nonsense that doesn’t deserve our attention and therefore belongs in the dustbin.

Rational expectations immediately comes to mind.

Those who want to build macroeconomics on microfoundations usually maintain that the only robust policies and institutions are those based on rational expectations and representative actors. As I tried to show in my Real-World Economics Review paper Rational expectations — a fallacious foundation for macroeconomics in a non-ergodic world — there is really no support for this conviction at all. On the contrary. If we want to have anything of interest to say on real economies, financial crisis and the decisions and choices real people make, it is high time to place macroeconomic models building on representative actors and rational expectations-microfoundations where they belong — in the dustbin.

If substantive questions about the real world are being posed, it is the formalistic-mathematical representations utilized to analyze them that have to match reality, not the other way around.

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