Macroeconomics made easy?

See also David Glasner’s review of the book
http://uneasymoney.com/2014/02/03/big-ideas-in-macroeconomics-a-review/

Brilliant essay John.

My 2 cents worth on why this stuff has the grip it has on academic economics is that it really is hard, as Athreya once said. The fact that it is so difficult gives anyone who can master it an incredible sense of achievement that overwhelms the question of whether it has any relevance to reality.

I read David Glasner’s review as well as Herbert Gintis’ review at Amazon. (Gintis writes a lot of reviews on Amazon — worth looking for them)

I kinda understand how one could pursue this sort of analytic inquiry as a intellectual challenge, but I never can grasp why anyone would think that these models are in any useful sense descriptive of or analogues to the actual economy. It is easier to grasp what they are doing — and this book sounds like it does a remarkable job in that regard — than why anyone thinks it worthwhile. It seems a determined defiance of all common sense.

Walras unravels with the first market, which doesn’t clear. The incompleteness of knowledge stands before the incompleteness of markets. Why are these not insurmountable obstacles to such scholasticism being seen even by its practitioners as central approaches?

The Raven: “no-one does mechanics without recognizing that some states are not equilibria”

Apparently, according to Athreya, many macroeconomics do, and call it a method.

@Bruce Wilder #5:

I suspect it is not so much the descriptive qualities as the normative ones that drive this kind of modelling. The policy implications tend to be attractive to certain preconceived mindsets and interests.

John: “Macroeconomics began with Keynes. Before Keynes wrote The General Theory of Employment, Interest, and Money, economic theory consisted almost entirely of what is now called microeconomics.”

I totally disagree with this.

What about (for example) David Hume? Hume has nominal rigidity, so while money might be neutral in the long run it is non-neutral in the short run. Hume is nothing like Walrasian GE theory (which doesn’t really have money or nominal rigidities). All(?) the pre-Keynesian (i.e. pre-GT) monetary theorists and Trade Cycle theorists had monetary non-neutrality. Wicksell, Fisher, Hawtrey, etc. They were nothing like New Classical Macro.

Before Keynes, there was “Monetary theory and trade cycle theory” (macro) and “price theory” (micro).

John Q,
one correction:
“it’s OK to assume full employment, and ignore inflation, but not to omit rigorous microfoundations for your model”

surely should be (to save Robert Waldmann from a heart attack)
“it’s OK to assume full employment, and ignore inflation, but not to omit rigorous but totally unrealistic microfoundations for your model”

“New Classical economists have generally preferred to reassert dogma without too much attention to facts.”

You’re not recognizing just how deep the problem is that causes people to talk past each other about economics. Economists on the other side of the divide have different axioms, axioms that originate in basic ideas about politics and justice, not money. The other side can’t recognize what you think of as real-world facts as refuting their theories’ power to explain the real world because they imagine that the influence of your theories has distorted the political world we live in.

The Cave is not at all a brilliantly original creation of Plato, and is not presented as such. It’s the mechanism by which Homo theoreticus has always rescued his pet theories from empirical refutation. “It’s not actual facts going against my theory, it’s not real things being observed, it’s shadows on the wall cast by artificial things paraded in front of a false light.”

People are going to agree with your economics if they share your political axioms, and disagree if they don’t. There’s no sense debating at the level of economics, because you really will inevitably talk right past even the most sensible and fair-minded among them. Do not expect an appeal to facts to settle your differences, because you can’t agree on what is fact and what is manufactured pseudo-reality.

“…liquidate labor, liquidate stocks, liquidate farmers, liquidate real estate… it will purge the rottenness out of the system. High costs of living and high living will come down. People will work harder, live a more moral life. Values will be adjusted, and enterprising people will pick up from less competent people.”

I had something like this I mind, that if you brought back Andrew Mellon from his eternal reward (or punishment, far be it from me to judge that issue), he would tell you that the apparent success of demand-side measures in the past 80 years has all been illusory. It just prolonged and deepened the rottenness that, 80 years later, still needs to be purged from the system. He would blame all of our present ills on that failure of nerve, that govt intervention to prevent the liquidation of everything back when the rottenness of the system had almost finished that job for us by collapsing all that artificial high living of the working class.

His thinking works, in its own terms. And wherever he is, leering down or up at us, it’s hard to say he isn’t having the last laugh. We seem to be having a go at secular contraction as our way out of the rottenness of high living that we’ve indulged far too many people with. If you’re going to appeal to empiricism to settle our differences of view with Mellon, does that mean we have to say that he had it right?

“His thinking works, in its own terms. And wherever he is, leering down or up at us, it’s hard to say he isn’t having the last laugh. We seem to be having a go at secular contraction as our way out of the rottenness of high living that we’ve indulged far too many people with. If you’re going to appeal to empiricism to settle our differences of view with Mellon, does that mean we have to say that he had it right?”

Only in opposite land Glen where people wear shoes on their heads and hamburgers eat people.

The link I mentioned is bellow:

http://economics.mit.edu/files/8135/

So my first background was an engineering field with heavy enough math and complex enough simulation models that I find the arrogance of people like Athreya amusing.

What’s less amusing is that in such engineering, as Zamfir implies, the first thing people do is ask “so how are you going to measure this up to reality” and the second thing that comes up is “given the divergences from reality, what correction factors could make this useful – and what applications mean we should bother, rather than heading for another model”?

All that appears to be absent for Athreya.

Really, from the perspective of people in fields required to get actual useful results, it’s hard to view Athreya’s methodological claims to primacy as much more than smoke and mirrors.

As an aside, I’ll mention my hobby horse – it’s not just that he lives in a world of static snapshots masquerading as dynamic analysis – it’s also that said statics repeatedly assume a single equilibrium exists – despite all real world evidence to the contrary.

” One can describe how a river flows without knowing what individual atoms are doing, and you can model it without referring to individual atoms. Macro-economics is about the macro-economy – BASTA.”

This is the kind of bullshit that those denying the need for microfoundations regularly endorse: “Since plenty of theories in physics don’t have microfoundations, or they acquired microfoundations only as a later development, macroeconomics does not need microfoundations.”

What the no-need-for-microfoundations people invariably fail to mention is that theories in physics that work without microfoundations have available huge amounts of data, often experimental data.

If you can find models at the macro scale which pass a large number of severe tests, tests using the large amount of available data, then yes, of course you don’t need microfoundations. Or you can view microfoundations as an intellectual luxury, to be added or not according to taste.

But that is not the situation in macroeconomics where you have a sparse amount of data coming from highly complex situations. Even with the relatively small amount of data available, you either have simple models that invariably fail in some circumstance or another, or you have models with lots of parameters which get conveniently “tuned” when confronted with data. “Beware the macroeconomist bearing free parameters” as they say.

So the situation in macroeconomics is not at all the same as the situation in physical contexts which have lots of experimental data, hence the need for microfoundations is not at all equivalent between those types of domains.

All that said, there is no guarantee that a macroeconomics with solid microfoundations will satisfy the hopes of some for finding a handful of variables and a handful of simple causal mechanisms which would allow them to “fine-tune” the economy using only those variables. (Which is why, when mentioning the need for microfoundations, Keynesian macroeconomists generally run for the tall grass, as fast as their legs will carry them. This doesn’t describe all Keynesians, but unfortunately it describes a lot of them.)

@Alex K.

1) There’s plenty of evidence that some elements of macro-economic behaviour are emergent – which is to say they are not correctly modelled by the micro foundation approach. (Micro-economists do the Nelson thing with their telescopes when looking for evidence of emergent behaviour – it’s virtually all published in non-econ journals as a result.)

2) Many “solid micro foundations” break down outside of the lab – but again, little of that is published in econ-journals.

None of which is to say that the search for good micro foundations should be ignored. It needs to continue and indeed, get more funding.

But, for the next 10-20 years at least we’re going to have to make our macroeconomics policy advice useful without a proper micro foundation, because the micro foundation is that far away from being “proper.”

reason, MPAVictoria

Well, Mellon would say that those people who lived the high life for 80 years, because the govt intervened to preserve demand, not only failed to live for themselves the moral life that contraction would have given them, but that they just deepened the eventual impact of the inevitable great liquidation. Maybe we are all dead in the long run, but we should care what sort of world we leave our children, and Mellon would say that the New Deal just set up our children for a harder fall by cushioning the blow 80 years ago.

We three all find this way of thinking monstrous, because I suspect that we would all subscribe to the axiomatic belief that the economy exists, and its rules should be set, to maximize the common good. I strongly advise you to at least entertain the idea that not everyone subscribes to any such axiom, and that the dominant economic thinking right now takes property rights as foundational, and not any sort of commonwealth. If Mellon’s ideas are farcical, and are like wearing shoes on your head, well, look around you. Look at what ideas dominate our response to the current economic crisis. The farceurs and shoe-hat crowd sure seem to be in charge at the moment.

One reason that they are winning, is that our side posits this idea that the economy exists to serve some set of values. Accept that idea as axiomatic, and yes, you are going to get to the theorem that the value the economy should serve is our common prosperity, because even the already wealthy do even better the more people have more to spend. But is seems intellectually simpler and more pure, to go with the other side’s vision of an economy that just exists, and doesn’t exist to serve any particular ends. We have property and we have value and we should just let those factors play out by their own dynamics, and not interfere with some soft-hearted aims imposed on the economy from outside. Even though this “hard-headed” theoretical structure will eventually impoverish even the rich, it has that appeal of simplicity, of generating itself, rather than appealing to “soft-hearted” impulses brought in from outside as arbitrary and axiomatic.

The momentum right now certainly seems to be in favor of the folks pushing secular contraction that will destroy the commonwealth, in service to an economy that is an end in itself. Appearances can be deceiving, of course, and even if that momentum really is with the forces trying to push us over a cliff, if you want to push the other way effectively, the first task is to acknowledge the seriousness of your opposition. They are not dim. They are not, any day now, about to be convinced by the evidence of the wreckage their ideas are making of the commonwealth, to come over to our way of thinking.

Wonderful post.

You are, as always, much too kind to DSGE. I think you are right about MacKenzie, but not about Arrow and Debreu. Yes Arrow and Debreu did some work with a static Walrasian model, but they extended that work to a general inter-temporal stochastic model. RBC macro consists of special cases of a general equilibrium model presented by Arrow and Debreu in the 50s. New Keynesian DSGE macro added Calvo alarm clocks which aren’t in the work of Arrow or Debreu (at least I hope they aren’t) but RBC added nothing new to theory. I think their introduction of numerical methods is genuinely new and made a big difference, but 1950s era GE was already D and S.

Metatone,

I’m more of a macro-skeptic — I don’t believe that macroeconomics has much of a chance of becoming a science, at least not in the sense of being able to make strong predictions.

Nevertheless, I think it’s important to think about microfounded models since microfoundations allow you to describe a plausible range of models which might describe some actual situation. Once you have that range of models, you can focus on the policy space that is robust to model specification errors — as long as the model is within that plausible range.

So from my perspective, I don’t see what the existence of emergent economic phenomena (I’m sure that there are many) or the fact that some microfounded models fail (of course they do!) has to do with the need for microfoundations or with the defense of some particular narrow macroeconomic model.

Alex K.

The irony is, I agree with you, it is important to think about micro founded models.

However – I’m a micro-skeptic. They don’t scale and they don’t provide many useful results. Most of the useful results involve as many fudge factors as the macro models.

Frankly, the state of the art in micro at the moment is mostly really bad science and your faith in it depresses me because it shows how much the propaganda from the micro-econ profession has tainted economic thought.

“Frankly, the state of the art in micro at the moment is mostly really bad science and your faith in it depresses me ”

Well, if it makes you any happier I don’t think that general equilibrium is actual science — it’s more like a thought experiment. There is also not enough emphasis on the difference between models that assume rational behavior but are actually quite robust to deviations from it and models that fail as soon as you have an as small as you like epsilon departure from rationality. Virtually no one is investigating disequilibrium dynamics even though that might be the most relevant aspect of microeconomics as far as macroeconomics goes. Etc.

But I still don’t see how you can have a scientific theory of a system that is both highly complex and produces relatively sparse aggregated data, without an investigation of the micro-mechanisms present.

This comment is not on the substance of the thread, but to Bruce Wilder (@5):
You don’t mean: “Walras unravels with the first market, which doesn’t clear.” You mean: “Walras unravels with the first market which doesn’t clear” [no comma].

The two sentences have different meanings, and since you presumably don’t intend to refer to a “first market” lost in the mists of time, the meaning you want is the second. (Yes, this is arguably a picky point, but it bugs me. Sorry.)

What the no-need-for-microfoundations people invariably fail to mention is that theories in physics that work without microfoundations have available huge amounts of data, often experimental data.

The less data you have, the less useful microfoundations are. Not the other way around. Economies are chaotic systems, and the closer to your microfoundations you get the more complex and thus the more chaotic they become, and the more — not less — sensitive to initial conditions. And “sensitive to initial conditions” is also “sensitive to bad data”.

Nick Rowe @ 11

I thought of writing a similar comment, though I didn’t think of Hume particularly.

Keynes really did invent macroeconomics as an analysis of statistical aggregates corresponding to the categories of the then novel national accounts. In the General Theory, in using his colleague, Prof Pigou, as a foil, to describe what had been more an immanence than a doctrine of specific theorists, he invented his own doctrine’s predecessor, as well — the predecessor cited by Professor Quiggin.

As you say, as a matter of historical fact, the mind-space taken by Keynesian economics had been previously occupied by students of the business cycle, like Wesley Clair Mitchell and Joseph Schumpeter, or by monetary theorists, like Wicksell, Irving Fisher or Keynes’ only lovely self of a few years previous. Keynes’ new apparatus proved to be immediately useful not to solving the problems of idle resources in the Great Depression (to which it was never applied), but to wartime economic planners, coping with the opposite problems of constrained resources and finance.

It was the trade cycle studies, with their attention to descriptive, circumstantial narrative, historical and institutional detail, which were displaced from the academy by the Keynesians, while the macroeconomic analysis of aggregate flows and stocks co-existed with monetary theory, and financial economics was re-invented on its own terms later on. Scholars of the trade cycle had been pre-occupied by the drudgery of creating statistics tracing the outlines of industrial output and employment, and, after the war, national bureaucracies took up the generation and publication of such statistics, and the Keynesians had an analytic apparatus that seemed to make use of those statistics.

Minsky thought the General Theory should be read as a continuation of Keynes’ Treatise on Money, and extended by a theory of finance, but that sensible view, oriented as it is, to descriptive, operational analysis, never seems to have had traction in the academy.

The Keynesian analysis of aggregates ran aground, I think, when computer-based simultaneous equations models proved to have little power. Simple rules-of-thumb, based on serial autocorrelation, worked well enough, but the introduction of more detailed data, say, on demand for autos or televisions or steel, just emphasized the unpredictable plasticity of the economy. It was that sense that aggregate analysis, in its “reduced forms” was “in the air” with no girding reaching a terra firma below, and that the structure of the economy could change and would change in “unintended” ways (or ways that the policymaker shouldn’t intend in the conservative view), which prepared the ground for the Lucas Critique and its demand for “microfoundations”.

In another thread, someone quipped something to the effect that Lucas missed the point of his own critique, that his putative candidates for microfoundations are just as likely to be shaped or altered by policy as other factors.

Equally curious, if we are to imagine the Keynesian aggregates gambit failing in the 1970s both as policy and as academic research program, and a reversion to pre-Keynesian approaches, why didn’t macroeconomics go back to being a theory of money and finance?

When I was a young dinosaur, people looked at Arrow-Debreu-McKenzie (ADM) with awe and admiration, nodding sagely that it provided, not a model of the world as it was or could be, but, rather, a sharp contrast to the world, which could be used to discover the nature of our imperfect institutions. ADM had shown that the market economy as a system needed a lot of insurance to be efficient, and everyone recognized, by contrast, the actual world did not have that much insurance. It seemed to many to be a fatal blow to laissez faire liberalism, and a vote in favor of social democracy, since the latter promised public provision of cheap and efficient social insurance, now a formally proven necessity for an efficient market economy.

The ideal of the market economy, coordinating and equilibrating itself, had been modified by the insight that lots of insurance was required to realize that ideal. The classic, siamese-twin handicaps on the competitive market provision of insurance — adverse selection and moral hazard — promised to be the keys to a new understanding of imperfect competition and hierarchy in the organization of the economy. The Phelps volume was greeted as the harbinger of a new era, a paradigm shift in the making.

The success of the Keynesian apparatus in war-time, centralized economic and public finance planning, tainted it in the eyes of the ideological enemies of economic planning. The model of Keynesian management-of-the-economy-as-a-whole as a problem of control theory narrowed with the end of war-time planning: fiscal policy was the accelerator and monetary policy was the brake, and automatic stabilizers smoothed shocks to the system, ran aground on the stagflation of the 1970s, and a resurgent conservatism.

Management-of-the-economy-as-a-whole got recast as a problem of control theory, narrowed to monetary policy managing a policy interest rate. That evolution, I guess, took a decade or more, ending with the advent of Alan Greenspan and the Great Moderation, when Greenspan put his first put, in the great crash that wasn’t in 1987.

The details of that decade, when the focus of macroeconomics narrowed decisively, are curious, in that conservative ideas seemed to crash and burn regularly. Friedman’s treasured idea of a fixed money supply rule didn’t survive. Lucas’s New Classical model didn’t do a good job of predicting the shape of the Reagan recessions and recoveries. Barro’s Ricardian Equivalence seemed to contradict Reagan’s innovations in deficit spending, which were driven by the nutty goldbugs on the Wall Street Journal’s editorial board and Arthur Laffer, not academics of any note. Kydland and Prescott 1977’s credibility thesis seemed to do OK, thanks largely to Paul Volcker’s intransigence, but Kydland and Prescott 1982 Real Business Cycle ideas took macroeconomics thru the Looking Glass into a highly abstracted “calibrated” dream world of no particular relevance.

The most important conservative policy innovations of the 1970s — those, which attacked trade unions, by de-regulating transportation sectors and by opening autos and steel to international competition, and the de-regulation of banking (!), which was set in motion by the disintermediation accompanying stagflation, and exacerbated by Volcker’s high interest rate policy, were outside of the narrowing scope of academic macroeconomics.

Lucas, Kydland and Prescott, and their successors kept aggregate analysis as the defining characteristic of macro, and not just kept it, but made it narrower and, for all the talk of “microfoundations”, more abstract and detached from any clear referents in the actual economy. A DSGE model “forecast” is almost absurdly stylized. Keeping analysis of aggregates at the center of macro means that the New Keynesians are relying on time-series regression analysis, to test their ideas, which does a remarkable job of squeezing an abundance of economic data down to almost no information at all. Even those not lost like Alice in Wonderland do not allow themselves to know much of anything about the economy.

LFC @ 38 Point taken. I should have written: Walras unravels with the first market that doesn’t clear.

Alex K: In this universe, economies exist, and are chaotic or not, quite independently of the economist’s model.

Not if the economists knew what they were about.

Economies do not operate independently of economists’ ideas about them. If economies are chaotic, it may be perfectly sensible to blame the economists.

A key aspect of the “talking past one another” noted in the OP is a difference of opinion concerning what constitutes valuable knowledge or expertise in economics. There’s a long tradition in economics, supportive of laissez faire, which likes to argue a kind of Socratic position of solipsistic skepticism, where knowing that you don’t know is a badge of honor.

If you are an economist and you don’t recognize a two trillion dollar housing bubble forming over several years, a naive observer might regard you as stupid and useless. But, the conservative economist is a superior creature, who knows that he cannot possibly distinguish a two trillion dollar housing bubble (because EMH or whatever), so it is really people who fall for the illusion that they see a two trillion dollar housing bubble, even in retrospect after said bubble has crashed and devastated the economy, who are stupid and useless.

If economies are chaotic, it may be perfectly sensible to blame the economists.

No, anything with feedback gets chaos, pretty much. People’s incomes are people’s outgoings: that closes the loop, makes chaos unavoidable absent radical redesigns of the economy.

“People’s incomes are people’s outgoings” isn’t a loop; it’s an accounting identity.

“anything with feedback gets chaos”
Anything with feedback can be controlled, I would think.

Our knowledge is always limited, and so control has its limits, beyond which chaos takes over, of course, and any scheme of control is technically inefficient to some (usually large) degree. The economy, though, consists of controlled processes. This is fundamental.

“People’s incomes are people’s outgoings” isn’t a loop; it’s an accounting identity.

Right. It’s the (current) income determines outgoing step that makes the loop. That step is also one of the key sites of theoretical dispute.

The problem with thinking you can use feedback to control the economy is that you have a many input many output system and don’t really know most of the gain terms. Most systems with known gain terms can be stabilized and you can even do a good job with a fair amount of uncertainty. But if you try to look at the aggregates and just control those… you’ll find that the gain terms don’t seem to be stable over time. Or that you’re constantly discovering new cross terms that are non-linear and only manifest themselves in particular circumstances. This is the sort of thing that could lead one to start searching for microfoundations.

I’m not saying that you can’t manage the economy to a tolerable degree. But it’s certainly not going to be easy and you certainly will get surprises. And even more that there will be legitimate debates about the sign of the action of certain policy levers with respect to aggregate outputs. But this is what macro is for. To try and figure all these things out and determine what are really the relationships between policy levers and outputs for all the circumstances we might experience. I don’t see any reason to believe that it’s been solved yet though. Even if we reject the DSGE approach, there’s still not a fool proof system out there.

Unless I’m missing something, Alex K.’s appeal for “micro-foundations”, involving the underlying structure of inter-sectoral balances and exchanges, sounds more like “meso-foundations” to me. And it’s not really anything new, but really belongs to basic concepts of economic thinking. The idea of a reproduction schema goes back to the Physiocrats, and it was basic to Marx’ notion of inter-sectorally balanced expanded reproduction. And Kalecki’s appeal to “degrees of monopoly” determining profit shares and thus levels of both consumption and investment demand. Add in underlying technical change which changes inter-sectoral ratios and creates whole new “markets”, and the genesis of macro-economic “fluctuations” via failures in realizations and coordinations of investment and cycles of investment demand seem readily comprehensible. Add in the role of money and finance, which both advance and retard productive investment and the recognition of losses, and you have a fairly realistic rough sketch account of industrial capitalist economies. (And alternative post-capitalist economies would face something of the same problems with realization and coordination failures). Not much new here, except growing levels of technical complexity and extensive inter-twinements of the division-of-labor with increased technical specialization.

“Macro-economics” emerged as an explicit, separate thematic concern in economic thinking with the discovery/invention of the Keynes/Kalecki principle of real effective aggregate demand, which determined the overall state of the economy, beyond or independently from micro-economic behaviors or “partial equilibria”. But what’s really strange is how that insight has undergone a complete reversal of meaning into a version of learned helplessness. Granted, much has changed since then. Technical change has meant that the industrial sector is a smaller share of both investment and employment and globalization means that it is no longer possible to conceive of economies as fairly closed national systems, subject to government regulation and policy. And finance has grown to an ever larger share and role in both the allocation and extractions of capital. But in this age of growing natural resources limits, environmental and ecological crises, (of which AGW is the intensification, not the root), and population pressures, settling for a highly mathematized form of Babylonian astrology, rather than anything like an authentic social science, is just the counsel of despair, a luxury we can not afford.

Also what john c. halasz said.

When I took economics courses as an undergrad half a century ago, the joke was that micro was true but irrelevant and macro was relevant but untrue. The effect of the microfoundations movement seems to have made freshwater macro both irrelevant and untrue. Reminiscent of the apocryphal dialogue between George Bernard Shaw and Isadora Duncan. Duncan says, “Imagine a child with your brains and my beauty,” and Shaw replies, “But imagine a child with my beauty and your brains.”

I suspect it is underrepresented because online discussion centers on policy relevant discussions about what can be done about unemployment, income distribution, inflation, etc. If your starting point is that there is nothing that can be done about these things then why bother saying anything?

I wonder if anyone can provide at least a sketch of an account of what proper microfoundations for economics might look like.

[or, economies have a stable mode of extreme income disparity and widespread grinding poverty and starvation and misery and shit. An economy that’s not actively managed will sooner-or-later hit this stable point and stay there.]

Cdbarry #30 says “macroeconomics is like doing fluid dynamics without viscosity”. That is wrong. The microfoundations of fluid dynamics are the intermolecular forces that produce viscosity. In fluid dynamics, it’s (for the most part) a waste of time to worry about the intermolecular forces; you simply insert a value of viscosity and see what the equations predict. That’s exactly analogous to inserting, say, sticky wages or some such seemingly arbitrary construct in a macroeconomic model. The justification for this seeming arbitrariness is that it’s what one observes in the real world. (Some would say that makes it far from arbitrary.) The value of viscosity is not determined by micro models of molecules but by direct observation, measuring the viscosity of your fluid.

There must also be a separate part of fluid dynamics that attempts to predict viscosity from molecular forces (I’m not aware of it so I’m not certain), but it is of interest more for theory than for practical application.

What is the conclusion? That if economics is like physics, it should pay more attention to what exists in reality than to the question of whether some model or theory has microfoundations. And if economics is not like physics (some would take that idea seriously), then the analogy is still suggestive. In either case, insisting that a working model have microfoundations is naive ideology.

if econblogers say simplistic things that’s because its not hard to point out the problems with extreme neoclassical models

@Jerry Vinokurov #68: Thank you for the correction about the usefulness of theoretical calculation of viscosity. My point stands, though, that if you want to calculate fluid flow, you can get the viscosity from measurement (if measurement is possible). Throwing out a flow analysis because the viscosity was measured rather than deduced from intermolecular forces — or if one goes the whole way as apparently they do in economics journals, from quantum mechanics — would be unacceptable. That is the analogical relevance.

I must say I found Bruce Wilders @43 little summary of the history of economic thought very enjoyable. I do think it underestimates the diversity of opinion, so maybe it be better to summarise it as a history of “a la mode” economic thought.

I will ask a little question though. Why are economists so reluctant to give up GE. I see GE as a mirage – some ideal in the distance that always fades away as we move to it. I think Bruce’s description of it is very good. Wouldn’t we be much better thinking of the economy, like the weather, as being moved by disequilibrium. In a world of full equilibrium, nothing happens, all the trading has already been done.

You have your mainstream Keynesians like Paul Krugman and Brad Delong, who are the most powerful in actual academia and policy levels

Is this true? The hegemonic tendency in economics seems to me to be a sort of “Keynesian in form but monetarist in content” consensus – although it’s accepted that monetarism, RBC, new classicism etc don’t actually work as methods to make testable predictions, and NK/DGSE is the standard methodology, the upshot is policy and sometimes even justification that is indistinguishable from monetarism or new classicism. Inflation is the great bugbear and adjustment must come from lower wages, and the primary means of achieving this is fiscal austerity and perhaps even monetary restriction if you’re in the eurozone.

By contrast, both Krugman and DeLong (although more so DeLong) are fairly often found being “monetarist in form but Keynesian in content”, arguing for monetary expansion and unconventional monetary policy as a means of expanding aggregate demand and reducing unemployment. Between the two of them, I think DeLong is intellectually convinced of this case while Krugman chooses it as a pragmatic concession, because action from the Fed is more politically practical than anything that has to pass through Congress or the European Commission.

I don’t think it is that simple, Straightwood. You left out those who have reasoned their way to some counter-intuitive conclusion, and who are so pleased with themselves and their tricksy intellectual gymnastics that they won’t yield to either altruism or selfishness.

@77

Economists do not call upon politicians to support their theories and models; the relationship is clearly one of subservience of economic theory to political power. If the policy implications of the micro-foundation freshwater economists supported strong labor unions and a guaranteed basic income, their political patrons would desert them overnight, and their presence in academia would diminish accordingly. Marx did get a few things right.

“That largely puts you into the realm of simulations of limited duration, a direction that conflicts with the “solve for the answer” mindset.”

Just an aside, but this calls to my mind one of Tyler Cowen’s characteristic blog tics – “solve for the equilibrium.” I’d never really thought about why this is sort of annoying and seemingly self-satisfied. Maybe it’s because it typically presumes a stupid question.

It is not just equilibrium, which they are holding onto — it is the exclusivity of allocational efficiency. The two go together, to form the “market” economy model, where the market allocates factor resources by price.

What that leaves assumed away in a black box, to be fished out only for hand-waving exercises and informal rhetoric, is technical efficiency.

Economic theory traditionally abstracts away from technical efficiency, leaving the problems of allocational efficiency as the defining topic of economics. In the actual world, the problems of technical efficiency coincide with the problems of allocational efficiency, and the two cannot be so neatly cleaved.

Technical efficiency dominates allocational efficiency as a practical matter in many circumstances, creating anomalies for allocational efficiency, such as increasing returns to scale. Technical efficiency is why the actual economy is dominated by administrative hierarchies, and why prices are administered (aka, prices are “sticky”). Technical efficiency achieved by technology-embedding capital investment limits the practical scope of factor substitution.

From the Herb Gintis review :

” The market economy is in fact a complex dynamic system whose behavior can be simulated, much as the weather is simulated by supercomputers, but cannot be captured in a few recursive equations, as the RA macro supporters claim. Instead of a large number of economic actors, RA macro assumes there is one “representative agent,” and instead of large numbers of firms and industries, RA macro assumes there is one “production function.” The only source of volatility in such a world is technology shocks and the vagaries of “expectations” (which of course cannot be measured, because they don’t really exist)….Of course, all of that is now changing. Economists around the world are revamping their theories and developing the empirical data on finance so that a more useful theory is likely to be forthcoming. IT IS A VERY EXCITING TIME FOR MACROECONOMICS. (emphasis added) Athreya’s defense of the current theory is quite brilliant and I urge the reader to learn from him….”

What are we talking about here, in terms of the shift in how people model the macro economy ?

86: The methodological individualism of mainstream economics and the ideal representative agent is not merely a technical impediment to clear analysis but their moral imperative, and obviously extends far from economics into politics and other social sciences.

Keynes, so they say, attempted to shift the basic unit to aggregates and institutions. Central Banks, nations. (Mercantilism and corporatism are probably closest to Keynes)

Marxians consciously start with analytical units that are collective, classes.

The theoretical unit of latter two also lead to almost inevitable moral and political consequences.

And thus, Western social democracy is based on the “unit” of the ideal rational informed unconstrained individual voter, and builds its political theories and systems from there to maximize her freedom while maintaining a minimal social stability and security.

Freshwater economists and libertarians get the connection between the politics and the economics at their core. “Liberals” are something of an incoherent mess, but tend toward group and institutional analysis and will always have to beware of sliding into corporatisms, nationalisms, and yes fascism.

Marxists start with:”No one is free until all are free.” and fight romantic individualism from page one.

I could be wrong but Gintis seems somewhat dismissive of classical Keynesianism (celebrating the Keynes-neoclassical synthesis of the postwar era?).

“The only virtue of rational expectations macro (RA macro), which Athreya explains so nicely in this book, is that it killed Keynesian macro.”

Is this Gintis paraphrasing or affirming Athreya?

The listing of topics that Athreya’s book does not cover (recessions, depressions, unemployment, etc.) that you expect him to cover, is reminiscent of the inventory Bacon gives us in the New Organon of phenomena he expects that the nascent science of physics will cover, will explain. Were Bacon to open a contemporary physics text 400 years later, he would, of course, find amazing developments along a few of the lines of inquiry he had envisioned, but he would find that physics had completely ignored most of his list. Where mathematical modeling proved useful in explaining phenomena, physics was all over it in the coming centuries, with rapid progress explaining things in areas like optics and planetary astronomy. But even where science eventually explained items on his list only centuries later and by long detours (e.g., why compost and dung heaps give off heat), progress was made by rigidly ignoring 99% of Bacon’s list at the outset in order to concentrate on the one or two items here and there that were amenable to modeling.

Presumably Athreya would look at your list of things you expect macroeconomics to cover, and dismiss all but the scattered topics amenable to formal and rigid modeling that he does deem worthy of discussion, out of something akin to the way people today are inclined to look at Bacon’s list. He would say that your list is a gemisch of epiphenomena that simply aren’t solid enough to stand up to rigid analysis. Even if it would be nice to one day be able to explain recessions, we can’t pay them serious attention now and expect economics to ever rise out the muck, any more than physics would ever have advanced, and eventually, via microbiology, been able to explain the warmth of dung heaps, had not physicists learned to ignore 99% of Bacon’s list, including dung heaps, to focus on the few phenomena that did lend themselves to a mathematical approach.

Unless we rid ourselves of Physics Envy, and stop seeing modern physics as the prototype of what a science ought to look like, I’m afraid it’s going to be hard to get past this point of view, and restore a respect for your list as the areas economics should be covering.

Look at it this way. Physics has developed in the peculiar direction it has taken because it has exercised the luxury of picking and choosing what it would pay attention to. It chose the easy problems, following paths that lent themselves to formal models and nice equations, and was thereby able to make amazing, if narrow, progress.

A science like medicine has not had that luxury. We have to have some answer to whatever problem is posed to us by whatever patient wanders into our offices. Sometimes we do have nice equations to help us out, as in the Henderson-Hasselbalch equation for acid-base disturbances, but mostly the answers we do have are based on much woolier modeling. Our nosology is a Baconian gemisch. Some of the diseases in our nosology are wrapped pretty tight, with rigid diagnostic criteria and an understanding of their pathophysiology built up from microfoundations — a few maybe even enough to satisfy Athreya. But I suspect that Athreya would accept an antibiotic for a life-threatening infection, even for particular infections where the diagnoses and treatments are based on theories much woolier than any dreamt of in your economics. In those cases he would accept the antibiotic because we have empirical evidence that the antibiotic does work, not because we have any microfoundational understanding of how and why it works.

Similar reasoning applies to govt interventions in recessions, no? Proven to work, even if the modeling is woolier than Athreya might like. His life has probably been saved by things much woolier than anything in Keynes.

We had medical schools for centuries before their graduates actually dirtied their hands treating patients. Considering the treatments available in the Middle Ages, perhaps a bias against intervention was salutary at that time. But for centuries you had Doctors of Physic who spent a great deal of effort learning all sorts of theory of medicine, all sorts of esoterica whose mastery was probably as hard as Athreya’s economics that is too hard for bloggers. But then Medicine dumbed down, Doctors of Physic started rubbing shoulders with common surgeons, and only then could we start the real work of understanding the actual problems that patients present with. However rough the models, only models that address the real problems presented by sick economies are at all worth anything.

“But I suspect that Athreya would accept an antibiotic for a life-threatening infection, even for particular infections where the diagnoses and treatments are based on theories much woolier than any dreamt of in your economics”

I think you are understating the problem. It may work empirically, but fresh-water economists will claim imperiously that it cannot work.

reason 94,

Well, at least the fresh-water economists aren’t as benighted as the neo-Classicists, who would call for liquidating the patient on the grounds that any intervention would only interfere in the workings of the infallible marketplace of microbes.

Whoops – that should be 9 BILLION human inhabitants. (I know it is now only 7 billion but by the time warming really has an impact it will be 9 billion.).

@Lee Arnold.

So here is my question: Do you think that the need of the New Classicals to adhere to the “efficient markets hypothesis”, and to “rational expectations”, is partly an unconscious preference to avoid the intractability that would result from introducing an additional compartment, a “finance” compartment, into the models?

Not a macro person, but I’ll give this a shot.

1. RE is not an unconscious preference to avoid the intractable. It’s a conscious attempt to make it tractable. We need some model of how people form expectations about the future, and RE is the baseline. RE is not what non-economists typically think it is. It really boils down to “Let’s assume that people are right, on average, in their expectations about the world.” It is a reasonable baseline, but obviously fraught with problems. Most economists I know would consider it a reasonable baseline. Few would think it true.
2. EMH isn’t so much an assumption, as a consequence of RE. When people are right on average about their expectations, then stock prices will adjust so that individual stocks are not clearly under- or over-priced. (It follows that splitting your money 1/n ways over the n firms listed on a stock exchange is a decent investment strategy, with surprising empirical support.)

In the sky,
isn’t the issue not what people are on average, but how wrong they might be. This sounds awfully like that famous and misunderstood statement of Keynes about “in the long run we are all dead”.

No, reason, it’s really quite the opposite. Rational Expectations is, to cite Deirdre McCloskey, an admission of intellectual modesty. We do not know more about farms in Wisconsin than Wisconsin farmers.

About Andrew Mellon and rottonness for 80 years. I think Mellon would have said that the Great Depression proved his point. The 1930s got rid of the rottonness in the system, and allowed the great post-war expansion. Now there’s new rottonness, but we’ve haven’t tried to get rid of it.

Also, I’m amused by JQ’s claim of the sweeping intellectual victory of Keynesianism. If it’s won, then why can’t it get published in at least one journal?

In the sky, you need to look into the models they build more carefully. Besides which your answer is decidedly stupid – rational expectations are always about macro-economic variables

Oh, please.

1. If you’re going to be dismissive, at least be correct. Dismissing the price of agricultural goods in the Midwest as “local knowledge” leads you to saying RE is only useful for expectations over GDP and the Fed funds rate. Nonsense.
2. If you dismiss Deirdre McCloskey’s arguments as “decidedly stupid”, then I’m simply going to assume you have no idea what you’re talking. Disagree with her? Sure. “Decidedly stupid”? Get a grip.

“intellectual modesty” in this case, being an example of what I referred to @45: taking refuge in not-knowing, not-expertise.

Economics — financial economics in particular — has produced a series of null results, of which the efficient market hypothesis stands as a prime example. The EMH stands for the proposition that no individual can know better than the (well-functioning) financial markets, what the best estimate of the value of a financial security traded on those markets, is. Such a view follows from a careful consideration of the effects of well-informed individuals betting against one another on those markets.

Rational expectations is, in effect, a highly abstract extension of this general idea. Rational expectations assumes not just that individuals make their best individual estimates, but that institutions exist which are so efficient that their individual estimates combine — as they would in a well-functioning financial market — into a superior institutional estimate, and everyone then jettisons their private, subjective estimate for decision-making purposes, and accepts in its place the synthetic fact of the institutional estimate. Everyone accepts the shared, institutional estimate as superior to their idiosyncratic and subjective assessment, and as a akin to a commonly known fact of nature, upon which one can rely in decision-making. (Behold the Representative Agent!)

Knowing that one can not-know is taken by conservative economists as a badge of honor and expertise, when it is nothing, but what it appears: stubborn ignorance and stupidity. But, upon this ignorance, they have erected this elaborate and towering scaffolding of rational expectations, within which they build their panglossian nonsense.

The difficulty, which must trouble actual experts, is managing the functioning of the institutions, which are to combine individual and local knowledge into these shared estimates upon which everyone is to rely.

Expertise — actual expertise, not rank and wilful ignorance misnamed, modesty — can and must judge whether the institutions are, in fact, well-functioning. The goal of public policy ought to be to make them function well, not to assume that they function perfectly.

So, one might, for example, recognize that a $2 trillion housing bubble has formed, as the integrity of mortgage underwriting, property appraisal, and securities rating, etc. has broken down. Just to pull an odd example out of the ether.

Physics is for idiot savants who pick and choose what they will examine based on what will produce the shiniest and cleanest theoretical structure.

Really, dude? I seriously hope you don’t actually mean that.

john c. halasz: Where do you get that $2 tn figure?

The mind grows fuzzy as to the exact details, but I followed closely the estimates developed by Calculated Risk from 2005 onward, I focused on forming in my own mind, conservative estimates of the bank asset values at risk of disappearing entirely.

It’s worth going back and reviewing an archive from the Calculated Risk blog from 2005, just to see how completely idiotic our elites were. Here’s July 2005:
http://www.calculatedriskblog.com/2005_07_01_archive.html
Dean Baker’s estimate as of that time was $5 trillion of inflated “wealth”. Ben Bernanke and Janet Yellen were sure there was no problem.

Indeed, John; I’ve told people several times that that’s the real problem with homothetic preferences. (That, and that preferences are not actually homothetic; but that’s just a trivial empirical matter.)

In truth, Full Employment Hawk, I think just about everyone would agree that preferences are not homothetic. The “question” is how important is variety in MPCs are to your object of interest. That’s more subtle.

Sarcasm doesn’t transmit well, Jerry :-)