The Lucas Critique, microfoundations and performativity

7 August, 2015 at 13:33 | Posted in Economics | 5 Comments

The Lucas Critique has justified the micro-foundations approach to macroeconomics for four decades. Put simply, unless you model the macro economy as a result of ‘deep parameters’ of the human psyche, you will never be sure whether your model will apply in a different regulatory or institutional environment. Overcoming the Lucas Critique is apparently achieved by offering a macroeconomic model that stems from a utility function of a representative agent.

gadget-tampon-wtf-05But why should we believe that the ‘deep parameters’ of micro-foundations, the utility functions themselves, are somehow independent of the institutional environment?

You can’t escape Lucas’ critique by plucking a utility function out of the air and giving it to a representative agent unless you believe that utility functions are independent of the social environment.

Which raises the question, how can it be possible for individuals preferences, their utility function, to arise in a social vacuum?

It can’t. The evidence is absolutely clear on this point. Preferences, and even perception, are socially constructed. There simply are no ‘deep parameters’.

The whole micro-foundations exercise has been a waste of time for all involved.

While economics has taken seriously this critique from Lucas, they have generally ignored its logical extension of the performativity of economic analysis. Basically performativity says that the use of an economic model in society to guide decisions itself changes behaviour, thus changing the environment in which the analysis applies. Or more simply, utility functions with change in response to the use of models built upon utility functions.

The easy way to see this in action is in sports. As soon as one coach creates a play that exploits a common behaviour in other teams, using that play changes the other team’s response, and thus the environment in which the coach’s original analysis was relevant.

You can’t escape any of this logic.

The lesson is that to understand economic phenomena requires a better understanding of institutional environments, and historical and social context. The micro-foundations approach has merely been an excuse to continue to conceptualise the economy as self-stabilising and in equilibrium in the face of the Lucas Critique, while any rational response would have been to acknowledge the inherent instability of social processes, of which the performativity of economic analysis itself a part of.

Cameron Murray

5 Comments »

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  1. Romer has got back on where and why things went wrong in macro-economics. I think it is flawed because it is fundamentally based on a flawed view of what science actually is. It needs, however, a serious reply, or series of replies. He is certainly a Samuelsonian (that is a ‘Walrasian’ – prefers General Equilibrium approaches rather than Marshallian – a preference for partial equilibrium approaches). His dismissal of Keynes as “talky” suggests again he is confusing mathematicisation with science. Interestingly both Friedman, a supreme empiricist, and Keynes were arguably Marshallians (at least Keynes was early in his career), and the former was surely against what Samuelson was doing even if he did not say so publically. The hijacking of the Chicago School by Lucas/Sargent et al (and its transformation into what is essentially an uber-Samuelsonian institute) needs more discussion.

    http://paulromer.net/what-went-wrong-in-macro-historical-details/

    • Has Romer ever explained what he means by science because I am not exactly sure what he is arguing for in his two recent blogs?

      He writes:

      “Only the ones that are right will having lasting influence.”

      The precepts of The Wealth of Nations have been around for 250 years, is this the “right” one?

      He goes on to write:

      ” Sticking to science means both paying attention to scholars who are exploring new paths and refusing to pay attention to breakaway groups. No matter what they say, when they stop engaging with outsiders who disagree, they stop doing science.”

      He seems to be contradicting himself. Why would “breakaway groups” necessarily not be doing science? Who would decide what is a breakaway group?

      I find some of the things Romer has said rather disturbing. For instance:

      “This means that when we engage in a discussion with colleagues, it will contribute to scientific progress only if a few key prerequisites are met:

      e) In our discussions, claims that are recognized by a clear plurality of members of the community by as being better supported by logic and evidence are the ones that are provisionally accepted as being true.
      f) In judging what constitutes a “clear plurality,” we put more weight on the views of people who have more status in the community and are recognized as having more expertise on the topic.”

      http://paulromer.net/protecting-the-norms-of-science-in-economics/

      There was a time when the consensus was that the Earth was flat. There was a time when the consensus was the celestial bodies all revolved around the Earth (well they might but the infinitely far out celestial bodies must be moving at infinite velocity, which they might be).

      I can’t see how this aspect of Romer’s approach is scientific.

      • Exactly Henry. When I said “I think it is flawed because it is fundamentally based on a flawed view of what science actually is” – ‘it’ refers to Romer’s (poorly defined and expressed – and I think wrong) – conception of science.

      • It seems to me that Romer’s calls for the appeal to consensus and authority are the road to scientific perdition. It seems he’s been reading too much Plato – philosopher kings of economics will make adjudications in accordance with their collective wisdom. Isn’t science, if it is anything, an iterative process? It’s like a fly in a jar – it will bang about a bit, wall to wall, until it finds the opening and escape.

  2. The basic approach of New Keynesianism is to keep at its core nonsensical RBC and New Classical assumptions and try and introduce some realism. Of course this is not-scientific. What they are doing by introducing frictions or behavioural factors through “search models” etc is keeping their assumption that the world is flat but arbitrarily introducing things which make it look more realistic. Of course this does not clear up analysis, but greatly confuses it.


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