The microfoundations crusade

14 June, 2018 at 08:36 | Posted in Economics | 3 Comments

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 …

UnknownI 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.

Simon Wren-Lewis

On this argumentation I would like to add the following comments:

(1) The fact that Lucas introduced rational expectations 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 are the hallmark of science tout court.

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  1. Crucial questions and well summarised. But it is difficult to have a serious conversation with the economics profession about why a rational choice model must underpin the way they look at an economy or why they think econometrics should be used even it it totally inappropriate. Whether it applies to Wren Lewis or not I don’t know, but I know that for many the the short answer is there is far too much at personally stake, or far too much associated with their identity as economists, to seriously throw it all away and start asking serious questions about the philosophy that underpins the methodology they use.

  2. “Can the microfoundations approach embrace all kinds of heterogeneity, or will such models lose their attractiveness in their complexity?”
    .
    When the microfoundation that is me tries to post on Wren-Lewis’s blog, he apparently finds my heterogeneity so unattractive he bans me. I’m curious as to how I fit into his economic model, since I don’t want to sell my labor but would gladly volunteer it to clean up campsites in the forests I love to spend most of my time in, if only public policy would help by letting me access public equipment without charge. Why can’t I check out a public truck, like checking out a laptop at a public library, to haul garbage from forest dump sites?
    .
    I think this microfoundation is so heterogeneous that Wren-Lewis prefers to ignore me, ban me, sweep me under the carpet, hope that I go away quietly. I contradict his assumptions about human nature, therefore I must be coerced into his normative model, or left out of it altogether. I don’t fit with Wren-Lewis’s view of the world. I am irrational. He does not care what I think, his economic model is happy to exterminate me.
    .
    I wish he would at least come out in favor of liberalized suicide markets. He doesn’t want to hear my voice, his normative system has no place for me unless I submit to his view of rationality, at least give us non-neoliberals (or non-ordoliberals, if that is his pedantic name for himself these days) an exit from his distasteful system.

    • “a failure to understand what was going on before the financial crash?”
      .
      Another thing: I don’t believe Wren-Lewis has much of a clue what was going on before, or after, the financial crash, because he ignores the huge dollar volumes of derivatives created by finance which were devalued by panicky traders influenced (irrationally) by chatroom rumors of a looming default crisis that never happened on the scale predicted. The top tranches of Mortgage-Backed Securities were devalued by traders but their defaults were actually minimal. I don’t think Wren-Lewis has the financial awareness to understand the role of MBS and insurance on MBS in the lead-up to the crisis.


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