Is ‘modern’ macroeconomics for real?

12 January, 2019 at 10:59 | Posted in Economics | 1 Comment

861cf344575acd50ed67b35d88615f2318610d8148e8c471ad10ca0132cda91eEmpirically, far from isolating a microeconomic core, real-business-cycle models, as with other representative-agent models, use macroeconomic aggregates for their testing and estimation. Thus, to the degree that such models are successful in explaining empirical phenomena, they point to the ontological centrality of macroeconomic and not to microeconomic entities … At the empirical level, even the new classical representative-agent models are fundamentally macroeconomic in content …

The nature of microeconomics and macroeconomics — as they are currently practised​ — undermines the prospects for a reduction of macroeconomics to microeconomics. Both microeconomics and macroeconomics must refer to irreducible macroeconomic entities.

Kevin Hoover

Kevin Hoover has been writing on microfoundations for more than 25 years, and is beyond any doubts the one economist/econometrician/methodologist who has thought most on the issue. It’s always interesting to compare his qualified and methodologically founded assessment on the representative-agent-rational-expectations microfoundationalist program with the more or less apologetic views of freshwater economists like Robert Lucas:

hoovGiven what we know about representative-agent models, there is not the slightest reason for us to think that the conditions under which they should work are fulfilled. The claim that representative-agent models provide microfoundation​s succeeds only when we steadfastly avoid the fact that representative-agent models are just as aggregative as old-fashioned Keynesian macroeconometric models. They do not solve the problem of aggregation; rather they assume that it can be ignored. While they appear to use the mathematics of macroeconomics​, the subjects to which they apply that microeconomics are aggregates that do not belong to any agent. There is no agent who maximizes a utility function that represents the whole economy subject to a budget constraint that takes GDP as its limiting quantity. This is the simulacrum of microeconomics, not the genuine article …

[W]e should conclude that what happens to the microeconomy is relevant to the macroeconomy but that macroeconomics has its own modes of analysis … [I]t is almost certain that macroeconomics cannot be euthanized or eliminated. It shall remain necessary for the serious economist to switch back and forth between microeconomics and a relatively autonomous macroeconomics depending upon the problem in hand.

Instead of just methodologically sleepwalking into their models, modern followers of the Lucasian microfoundational program ought to do some reflection and at least try to come up with a sound methodological justification for their position. Just looking the other way won’t do. Writes Hoover:

garciaThe representative-­agent program elevates the claims of microeconomics in some version or other to the utmost importance, while at the same time not acknowledging that the very microeconomic theory it privileges undermines, in the guise of the Sonnenschein-­Debreu­-Mantel theorem, the likelihood that the utility function of the representative agent will be any direct analogue of a plausible utility function for an individual agent … The new classicals treat [the difficulties posed by aggregation] as a non-issue, showing no appreciation​ of the theoretical work on aggregation and apparently unaware that earlier uses of the representative-agent model had achieved consistencywith​h theory only at the price of empirical relevance.

Where ‘New Keynesian’ and New Classical economists think that they can rigorously deduce the aggregate effects of (representative) actors with their reductionist microfoundational methodology, they — as argued in my On the use and misuse of theories and models in economics — have to put a blind eye on the emergent properties that characterize all open social and economic systems. The interaction between animal spirits, trust, confidence, institutions, etc., cannot be deduced or reduced to a question answerable on the individual level. Macroeconomic structures and phenomena have to be analyzed also on their own terms.

1 Comment

  1. Macroeconomic structures and phenomena have to be analyzed also on their own terms.

    The New Classical economics and RBC were united in being fundamentally anti-institutional in their approach to macroeconomics with knock-on effects on general policy economics.
    Samuelson’s reliance on analytic theory with only handwaving where a knowledge of
    institutional facts is required prepared the ground in microeconomics and Keynes’s own enthusiasm for an analysis of statistical aggregates and accounting artifacts played a large part, mediated by the profession’s ill-fated attempts to fashion computer-based linear models of such aggregates.
    Many — maybe all! — of the practical problems of policy and macro economics are problems of institutional mechanism design and management: designing and managing a fiat currency, supervising a banking system, regulating financial markets to limit fraud and predation, not to mention the institutional infrastructure of social insurance, the fiscal apparatus for financing public goods production from taxing away economic rents, sectoral industrial policy and countervailing private monopoly power with antitrust and regulation. The institutions we use to cope with the reality of pervasive and radical uncertainty are where all the action is.
    The representative agents of high theory basically assume all “the frictions” of institutional functioning away. Rational expectations, as Axel Leijonhufvud has pointed out, amount to an assumption that institutions like financial markets are operating with such ideal efficiency that every actor treats market price as an objective and unquestionable fact, discarding any idiosyncratic knowledge or assessment as inferior to the informational aggregate of financial market prices. No actor believes his own eyes over the market consensus, so every actor is effectively identical.
    Such a blinkered view is clearly absurd on its face as a descriptive model of the actual economy, but the New Keynesian economists take too easy a path when they introduce abstract and generic ad hoc “frictions” (e.g. sticky prices) to demonstrate how such “frictions” improve the alleged description, without investigating the institutional mechanics.
    The lack of familiarity with institutional problematics and detail means that economists are terrible technicians: no political economy suffering Keynes’ “magneto trouble” should call on these clownish mechanics. The debacle that is the Euro is a prime example, with economists smugly certain their impenetrable analysis of optimal currency areas is sufficient explanation. The “unexpected” GFC of 2007-8 and the policy aftermath rescuing a predatory banking and financial system at the expense of the former working and merely middle classes furnish additional abundant examples. The bad advice given to the Japanese and the former Soviet bloc nations in the 1990’s revealed how little leading economists understood the institutional infrastructure of a so-called market economy.

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