General equilibrium theory — still dead after all these years

1 September, 2016 at 21:19 | Posted in Economics | 13 Comments

Raphaële Chappe has written a very interesting article about the value of general equilibrium theory, concluding in the following words:

For a student of real world markets, general equilibrium theory appears strangely distant. It is not surprising that a highly abstract framework consisting of hyper-rational agents might be ill equipped to provide a sufficiently credible account of markets in modern capitalism. 24958274What is more surprising is that despite these obvious limitations (some even claim that general equilibrium has been “dead” since the Sonnenschein-Mantel-Debreu results in the 1970s) the framework is still central to the Ph.D. curriculum, and continues to play a preeminent role in the high theory of economics. To the extent it shows the limits of the way of thinking, this is fair enough, but that is not how the subject is approached, by Mas-Colell/ Whinston/Green or any other major text. Is this an example of the greater importance given in our ‘science’ to the rites of justification than to the task of explanation? When a way of thinking limits our thinking then it’s time, with due appreciation for those who built it, to ‘throw away the ladder’.

The economist considering general equilibrium since the SMD results dead, is Frank Ackerman, and this is what he has to say on general equilibrium:

Frank-Ackerman_0General equilibrium is fundamental to economics on a more normative level as well. A story about Adam Smith, the invisible hand, and the merits of markets pervades introductory textbooks, classroom teaching, and contemporary political discourse. The intellectual foundation of this story rests on general equilibrium, not on the latest mathematical excursions. If the foundation of everyone’s favourite economics story is now known to be unsound — and according to some, uninteresting as well — then the profession owes the world a bit of an explanation.

Frank Ackerman

Almost a century and a half after Léon Walras founded general equilibrium theory, economists still have not been able to show that markets lead economies to equilibria. We do know that — under very restrictive assumptions — equilibria do exist, are unique and are Pareto-efficient. But after reading Ackerman’s and Chappe’s articles one has to ask oneself — what good does that do?

As long as we cannot show that there are convincing reasons to suppose there are forces which lead economies to equilibria — the value of general equilibrium theory is nil. As long as we cannot really demonstrate that there are forces operating — under reasonable, relevant and at least mildly realistic conditions — at moving markets to equilibria, there cannot really be any sustainable reason for anyone to pay any interest or attention to this theory.

A stability that can only be proved by assuming Santa Claus conditions is of no avail. Most people do not believe in Santa Claus anymore. And for good reasons — Santa Claus is for kids.

Continuing to model a world full of agents behaving as economists — ‘often wrong, but never uncertain’ — and still not being able to show that the system under reasonable assumptions converges to equilibrium (or simply assume the problem away), is a gross misallocation of intellectual resources and time. As Ackerman writes:

The guaranteed optimality of market outcomes and laissez-faire policies died with general equilibrium. If economic stability rests on exogenous social and political forces, then it is surely appropriate to debate the desirable extent of intervention in the market — in part, in order to rescue the market from its own instability.

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  1. I really don’t see why the general equilibrium theory has not been proved. When euilibrium has been broken (which is nearly all the time), the increment of money-flow will spread and re-distribute itself around the whole of the economic system. (We should think of this economy as a social system containing a number of entities with connections of money-flows and returning goods, services, etc. passing between them. The structure of this system is general, regardless of its assumed details. An example is shown in my model, see DiagFuncMacroSyst.pdf in Wikimedia).

    As the disturbance flows around the system and is dissipated, it weakens in strength, because it is often having to divide between two or more flow paths. By the time some of it returns to the point where the disturbance began, it is smaller and consequently the system is closer to its equilibrium condition than before. This process is continuous, with all of the disturbances acting together. Due to each entity having to balance (or substitute for) its input and output money-flow quantities, there is a trend toward stability and balance within each entity, which is also a form of expression of the equilibrium being self-sought.

    • That explanation is only coherent if debt is excluded from the model.

      Debt is a speculative commitment today of unrealized future cash flows. Debtors are historically unsympathetic to having disturbances from economic equilibrium redistributed and dissipated (in the form of e.g. defaults or haircuts) through these committed cash flow channels, and this asymmetry between the ease of committing future cash flows today and difficulty of reducing the commitment tomorrow is at the root of nearly every serious economic dislocation.

      • [edit: “creditors are historically unsympathetic”]

  2. Prof. Steve Keen is another who thinks GET is dead. I read about Sonnenschein-Mantel-Debreu and the implications of what they found in his book Debunking Economics.

  3. Well! my above explanation about how equilibrium is treated in macroeconomics should surely resurrect it again! If you REALLY examine the situation of money circulation (as in my book) you will notice that the system does not get started with a debt being there. Indeed, there is no need for any explanation about how it gets started, since it already exists and runs. Then we can manage to follow it without any debt needing to be introduced.

    I do not deny the existence of debts, but I fail to see why any emphasis on them is needed for explaining how our social system works. The money already there circulates without help, and the rate of macro-economic activity depends on the speed of this circulation, which is naturally sensitive to both the bank-rate of interest and the average yield from shares. Promissory “money” like post-dated cheques is not debt and due to its time-limit cannot honestly be regarded as being the same thing as the uniquely printed folding stuff obtainable from banks.

    • Excuse my ignorance, but does your seemingly “debt-free” theory demonstrate how the banking crisis or great depression work? Or were these just extremely high disturbances which naturally dissipated?

      And I am not sure I understand how a theory of equilibrium exists if equilibrium is broken “nearly all the time.” Surely “nearly all the time” means equilibrium does not exist?

      • Huw Williams: Its not me that has any “debt free” money theory. Without debts there would have to be promises of a different kind, which would be a lot harder to arrange (and keep).

        The aim of making a theory about anything is to create an ideal model, which is almost the same as the actual the situation, but not quite. So an equilibrium theory can continuously but not exactly correspond to our actual non-balanced social system, and still be of relevance. This gets very interesting when we begin to examine where the dis-equilibrium lays and what the situation (or possibly the government) can decide to do about it, to try to restore equilibrium again–not that it ever will be fully successful!

        And you are right, “equilibrium does not exist”, but its significance is most necessary for our understanding–its about how we think.

    • At the risk of pointing out what ought to be obvious, though money as tokens might arguably “circulate”, money in the form of credit doesn’t “circulate” at all — it can just sit there, unmoving though adjusted at intervals, absorbing the minor fluctuations and anomalies in economic outcomes and activity. This has always been the bane of quantity theories of money that attempt to trace economic activity to the hydraulic force of money flows: money is also insurance. The pace of economic activity is related simultaneously to both the transactions demand for money (where the velocity of money so-called might seem to matter) and to what Keynes called the precautionary motive and the speculative motive, where money “flows” into or from an imaginary future, but in the present, simply sits still on some latent contingency.
      .
      The economic usefulness of money as a token for transactions is de minimus, but as language for writing fiction imagining the future, it is extremely valuable and indeed without substitute. This is money as debt.

  4. Bruce–when money is used for buying something it passes to the seller who can either save it (by lending it to the banks, or possibly to a “capitalist” for shares in his/her company), or use it to buy something else. Very few of the people having got money, stuff their mattresses with it and leave it it there. So generally it circulates and does not remain static, even though the certificate for the savings or the debt for the loan or the credit for borrowing or the shares certificate are documents and understandings which remain static, some for a specified time period and some indefinitely. The money itself continues to fulfill a useful role and certainly does not remain fixed in somebody’s pocket as you apparently claim.

    J.M.Keynes thought that when money is saved it stops being spent, and his theory reflects this idea. So his policy was to encourage supply and purchase and not thrift. But when you look at the big picture you will find that this apparent waste is not true. Keynes was wrong, but because many people were unable to think properly (if at all) about the subject, his claims were thought to be right at the time when austerity was a problem in the UK. Keynes misled millions of others too!

    • I do not think I would characterize Keynes’s beliefs as including the alleged notion, “when money is saved it stops being spent”. In general, recognizing that money has an insurance function, he tried to draw attention to the ways in which the smooth functioning of a money economy depended on routine independence of expectations. Common panic or common euphoria or just the common expectation that interest rates must rise because the zero lower bound has been reached — these are all circumstances in which the insurance function may be compromised in ways that can affect the circulation so-called of money as effective demand.
      .
      A more difficult issue, which Keynes did not handle as well imho, was the usefulness of wages and prices as equilibrating mechanisms for the system as a whole. All wages and goods prices are contingent and the control of production and investment is conditioned on (inframarginal) economic rent, not marginal costs. This and its implications he failed to grasp — this failure has come down to us as “sticky prices”, a stubborn (and un-Keynesian) insistence that the money economy can return to equilibrium on its own by microeconomic supply and demand driven changes in wages and goods prices, but is a bit slow to do so.
      .
      As I said, money is a fiction, but not an illusion.

  5. “J.M.Keynes thought that when money is saved it stops being spent, and his theory reflects this idea.”
    .
    .
    David,
    .
    Not exactly correct – far from it.

    Saving was the term Keynes used to describe that part of income directed to spending on goods which were not consumer goods but goods which were produced and put into inventory and/or goods produced of a capital nature.
    .
    (Hoarding was the term Keynes used for money stuffed under the mattress.)

    • Keynes theory of the money multiplier relies on the fact that saved money does not continue to circulate. His theory is nonsensical, yet for many years and even today, people not only accept it but use it to feel content about how our macro-economy must grow. Keynes was completely wrong and in fact there is no multiplier of his kind, although I have shown that one (of a somewhat different kind) does exist for certain parts of our system. (Its in my book.)

      Neo Keynesians tried to explain that what you state was actually what Keynes wrote, and they got a bit closer to the facts but they are still tangled up. Unless we go to the beginning of the way for representing and modelling and the resulting understanding about how our social system works, we will never be able to agree–current thinking about money is too confused and many of its experts admit that this theory is imperfect and incomplete. The so called MMT is actually Neo Keynesian again, with a slight clean-up but nothing new.

  6. “Keynes theory of the money multiplier relies on the fact that saved money does not continue to circulate. ”

    David,

    Where does he actually say this?

    As far as I can see you are confusing money and income.

    The multiplier you speak of was an income multiplier, not a money multiplier.


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