Macroeconomics made easy?

by John Quiggin on February 10, 2014

In my book, Zombie Economics, I started the account of macroeconomics with the observation

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. The difference between the two is commonly put by saying that microeconomics is concerned with individual markets and macroeconomics with the economy as a whole, but that formulation implicitly assumes a view of the world that is at least partly Keynesian.

Long before Keynes, neoclassical economists had both a theory of how prices are determined in individual markets so as to match supply and demand (“partial equilibrium theory”) and a theory of how all the prices in the economy are jointly determined to produce a “general equilibrium” in which there are no unsold goods or unemployed workers.

I went on to observe how the pre-Keynesian approach had been revived by the “New Classical” school, and how the apparent convergence with “New Keynesian” economics had been shown to be illusory after the failure of Dynamic Stochastic General Equilibrium models to deal with the 2008 financial crisis and the subsquent, still continuing, depression.

With all of this, though, I still never thought of academic macro, in either saltwater or freshwater form, as being a simple reversion to the pre-Keynesian notion of general equilibrium, with no concern about aggregate demand or unemployment, even in the short run. It turns out that, at least for a large segment of the profession, this is quite wrong. I’ve just received a book entitled Big ideas in Macroeconomics: A nontechnical view by Kartik Athreya, an economist at the Richmond Federal Reserve who made a splash a few years back with a piece entitled Economics is Hard. Don’t Let Bloggers Tell You Otherwise, which, unsurprisingly, did not endear him to bloggers. As a critic of mainstream macro, I’m briefly mentioned, and I just got a review copy.

The new book is an attempt to simplify things, and indeed it has proved enlightening to me and also to Herb Gintis who contributes a blurb on the back, commending it as an accessible and accurate description of the dominant way of thinking about macroeconomics.

The easiest way to see why the book is so striking is to list some topics that do not appear in the index (and are not discussed, or only mentioned in passing, in the text). These include: unemployment, inflation, recession, depression, business cycle, Phillips curve, NAIRU, Taylor Rule, money, monetary policy and fiscal policy.

By contrast, the book includes a lengthy treatment of such topics as Bayes-Nash equilibrium in game theory, intertemporal optimization of consumption and the theory of mechanism design.

If you think that this sounds like Hamlet not merely without the Prince, but without anyone in Elsinore, from King Hamlet’s Ghost to Fortinbras, that’s because you are expecting the wrong play.

In Athreya’s world, and that of a large part of the academic macroeconomics profession, macroeconomics does indeed begin with Walras, and the first modern development in the field was the formalization of Walras’ model by the economic theorists Arrow, Debreu and MacKenzie in the 1950s. The big subsequent development is the integration of growth theory into the static ADM framework to generate the modern dynamic stochastic general equilibrium (DSGE) models. Keynes’ 1936 ‘essay’ is treated as a curiosity, too vague and wordy to permit any real analysis.

This has the odd effect that many of the leading Keynesians of the postwar era (including Samuelson, Solow and the unjustly neglected Australian economist Trevor Swan) are given respectful cites for their work on growth theory, even as (what they would have regarded as) their macroeconomic work is dismissed as being too silly even to be refuted. Even Milton Friedman is treated similarly, with his intertemporal consumption model being praised, while his adaptive expectations model of inflation is ignored. Real macro (that is, Walrasian GE applied to issues like the business cycle) begins, in this analysis, with Robert Lucas in the late 1970s.

All this gives me a bit more insight into the apparent convergence in macroeconomics in the early years of this century, and its breakdown in 2008. The New Keynesians understood themselves as having met their New Classical colleagues halfway, with DSGE models which were Keynesian in character, at least in the short run, while meeting the demands for rigorous microeconomic foundations. Meanwhile, the New Classical school were quietly snickering whenever Keynes’ name was mentioned, but were prepared to concede the possible existence of largely unspecified market “imperfections”, whose only role in practice was to justify a policy of inflation targeting.

The crisis that erupted in 2008 destroyed this spurious consensus. On any kind of Keynesian view, New or Old, the combination of high unemployment and zero interest rates implied that the economy had been driven into a Keynesian liquidity trap, with a need for fiscal stimulus on a massive scale. By contrast, for the New Classicals, a disaster of this kind could only be the result of government failure (or, in places where they still mattered, the pernicious actions of trade unions). Since this was implausible, New Classical economists have generally preferred to reassert dogma without too much attention to facts.

Broadly speaking, as far as academic macroeconomics is concerned, DSGE has won the day, not so much by force of argument as by maintaining control of the criteria for publication of journal articles in the field: it’s OK to assume full employment, and ignore inflation, but not to omit rigorous microfoundations for your model. On the other hand, with the collapse of the intellectual case for austerity (though not its political dominance), the terms of public debate are set almost entirely by New Old Keynesians like Krugman and DeLong (that’s true, even if you don’t believe, as I do, that the outcome of that debate has been a knockout win for the Keynesian side).

The result is that there is almost zero intersection between Big Ideas in Macroeconomics and what I would think of as macroeconomics. It’s not so much that I think Athreya is wrong is that we are talking past each other. As Charles Goodhart said of DSGE, Athreya’s version of macro excludes everything in which I am interested.

{ 122 comments }

1

Donald A. Coffin 02.10.14 at 4:46 am

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

2

John Quiggin 02.10.14 at 5:28 am

I should clarify my final remark. I am interested in general equilibrium theory and think that, viewed with an appropriate scepticism, it yields some useful insights. I’ve even had a go at it myself, for example:

Quiggin, J. and Chambers, R.G. (2006), ‘Capital market equilibrium with moral hazard and flexible technology’, Journal of Mathematical Economics, 42, 358–63.

But the idea of using Walrasian GE to understand either the Great or Lesser Depression seems to me to be self-evidently silly.

3

Steve Keen 02.10.14 at 5:33 am

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.

4

bad Jim 02.10.14 at 6:41 am

Economics, and perhaps anything with policy implications, like climate change, is inherently political, which makes historical perspectives like Brad DeLong’s pertinent. I find the economic analyses I’m periodically sent by the investment arm of the Bank of America broadly compatible with what Krugman and the rest of the saltwater economists say, or for that matter what I learned from the courses I took at Berkeley in the early ’70’s.

5

Bruce Wilder 02.10.14 at 8:03 am

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?

6

The Raven 02.10.14 at 8:39 am

Bruce, the same was said of non-Euclidean geometry. But it turned out to have applications. But…but…no-one does mechanics without recognizing that some states are not equilibria. You have statics and dynamics. Statics is an important special case, but it is a special case.

So do Keynesians start their own journals now?

(And, damn, Keynes anticipated this, in his famous “In the long run…” remark.)

7

Bruce Wilder 02.10.14 at 9:12 am

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.

8

Zamfir 02.10.14 at 10:37 am

Then again, lots of mechanics and other physical processes are modelled as equilibria, or quasi equilibria, even when people know that it is not correct. That’s typically the opposite of purity-obsessed scholastism, it’s more an engineering fix to get bad results that are still better than no results. You multiply the results by an out-of-the-blue correction factor for ‘dynamical effects’, and hope for the best.

9

stostosto 02.10.14 at 11:34 am

@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.

10

Robert 02.10.14 at 11:38 am

It is a very boring book. It does not have math, in the sense that it does not have equations.

How you can get policy recommendations out of this stuff is puzzling. Athreya seems to think policy would ideally be directed toward achieving Pareto optimality, perhaps with some lump sum taxes to address legitimate equity concerns. Too bad some caveats apply. There’s a passage suggesting that if you do not agree with this perspective, you are a conspiracy theorist.

Economists like Myrdal, Sen, or Schumpeter do not exist for Athreya. Although Athreya’s description of dynamics is quite incompetent, the text suggests that anybody that says so just doesn’t understand what economists mean by equilibrium. (I did learn something about the existence of the belief that some results in Game Theory do not make neo-Walrasian general equilibrium seem absurd.)

11

Nick Rowe 02.10.14 at 1:54 pm

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).

12

reason 02.10.14 at 2:08 pm

Bruce Wilder @5

The reply from the author to Gintis’s review is also interesting:

“Thanks very much for the kind words about the book-I deeply appreciate it, especially since that you are not at all enthusiastic about the way modern macro, as my book describes it, is proceeding. With respect to the points you raise re: the prominence of representative agents, I’ll note a couple of things. First, Chapter 5 “Benchmark Macroeconomic Models and Policy Advice” especially, tries to show readers the substantial departure from representative agent models aimed at understanding questions of wide scope (what I’d define as macro). It is no longer the case that macro models abstract from rich heterogeneity. Much work now features rich differences between model participants along the lines of demographics, wealth, education, even gender. None of my own work has a rep. agent for instance. A hope of mine is to show the reader just how active and interesting this area is–questions of inequality, unemployment, income taxation, health insurance, higher education, macroeconomic consumer finance, entrepreneurship, etc., are all approached with these non-representative agent models. Second, you’re absolutely correct to wish for a better macro that deals with the financial sector in a more successful manner, especially over the business cycle. Most whom I know hope for the same, and some are working very hard at it–but there is a ton of work to be done. Chapter 6 “Macroeconomic theory and the Recent Events” describes some of the challenges here that I see. Also, the tradeoffs and constraints I talk about in chapter 4 on “Macroeconomic Shortcuts”, and especially in Chapter 6 with respect to the specific area business cycles and the recent crisis, intrude on us to separate reality from our wishlists. “

A couple of sentences here really stand out
1. His claim to have models with rich hetereogenity (with tellingly “even” different gender – no less) – but no representative agent. Count me skeptical, but I don’t think it is possible to do DSGE without representative agents (plural). With full hetereogenity (as Gintis hinted) you need to use simulation techniques.
2. The very odd last sentence where unfortunate reality ” intrude on us to separate reality from our wishlists” – suggesting that reality is not the original target in any sense.

13

reason 02.10.14 at 2:43 pm

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”

14

reason 02.10.14 at 2:50 pm

From the abstract to his infamous paper:
Economics is Hard. Don’t Let Bloggers Tell You Otherwise

“Macroeconomics is most narrowly concerned with the tracing of individual actions into aggregate outcomes, and most fatally attractive to bloggers: vice versa. What makes macroeconomics very complicated is that economic actors… act. Firms think about how to make profits, households think about how to budget their resources”

I find this odd – he is defining macro-economics as micro-founded – not in the specific sense of what journals define it as, but generally. 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. And this bit about actors acting – well animals act, but there is still biology and there is still ecology. The whole point is that, at least to some extent, their actions are predictable. If they weren’t we may as well just forget about the whole subject.

He has an odd way of expressing himself.

15

Glen Tomkins 02.10.14 at 3:57 pm

“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.

16

reason 02.10.14 at 4:08 pm

Glen,
I dispute this. There are enough examples of conservatives arguing facts when they support their argument, that they know perfectly well the facts are not on their side in this case. And there are examples of conservatives who have been convinced by the facts, to at least at the moment be tactical allies. If you want to argue the way you are and be believed, you have to be more specific.

17

Glen Tomkins 02.10.14 at 4:23 pm

“…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?

18

reason 02.10.14 at 4:33 pm

Glen Tomkins @17
” It just prolonged and deepened the rottenness that, 80 years later”

People have lived their entire lives in the interim – which rather reminds me of something that Keynes once said…

But truly such an attitude is beyond farcical. All conservatives are not so dim.

19

MPAVictoria 02.10.14 at 4:33 pm

“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.

20

Alex K. 02.10.14 at 4:34 pm

” On any kind of Keynesian view, New or Old, the combination of high unemployment and zero interest rates implied that the economy had been driven into a Keynesian liquidity trap, with a need for fiscal stimulus on a massive scale. By contrast, for the New Classicals, a disaster of this kind could only be the result of government failure (or, in places where they still mattered, the pernicious actions of trade unions). Since this was implausible, New Classical economists have generally preferred to reassert dogma without too much attention to facts.”

I don’t like the modelling approach taken by DSGE theories either (simply because they do not actually have microfoundations) but the implication that trade cycles can not be explained by appeal to microeconomics, only by appeal to Keynesian principles, is not warranted.

You can get aggregate fluctuations in output (and presumably in unemployment too) by considering the structure of the linkages between various industries. If the degrees of the graph describing those linkages follow a certain structure (a structure shown in the paper bellow to be roughly compatible with the structure found in the US economy) then you get aggregated fluctuations from sectoral fluctuations.

This is the perspective taken by Acemolgu et al. in “The Network Origins of Aggregate Fluctuations,” which is online here .

That paper is hardly a complete theory of macroeconomic fluctuations (it doesn’t have money and it’s simplified in a number of ways) but it does show that fluctuations can arise from sectoral imbalances, which is a perspective which the usual macroeconomic focus on aggregates only tends to miss.

21

Alex K. 02.10.14 at 4:36 pm

The link I mentioned is bellow:

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

22

reason 02.10.14 at 4:37 pm

23

Metatone 02.10.14 at 4:42 pm

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.

24

reason 02.10.14 at 4:45 pm

Alex K.
I briefly scanned that paper – and it doesn’t look like a DSGE model to me.

25

Alex K. 02.10.14 at 4:47 pm

” 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.)

26

Alex K. 02.10.14 at 4:49 pm

“I briefly scanned that paper – and it doesn’t look like a DSGE model to me.”

Who cares? I care about having microfounded models, not about DSGE models in particular — which do not actually have microfoundations.

27

Metatone 02.10.14 at 5:08 pm

@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.”

28

Barry 02.10.14 at 5:12 pm

“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.”

That sounds like calibration, which, IIRC is sorta associated with the macro school which also insists on microfoundations.

“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.”

That’s true. What’s the current state of model failure in the current situation?

29

Glen Tomkins 02.10.14 at 5:15 pm

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.

30

Cdbarry 02.10.14 at 5:41 pm

Microfoundations is like doing fluid mechanics while ignoring viscosity. We actually do that in some cases, and it gives some useful results, but it doesn’ t work in the general case.

The fundamental assumptions of micro are mostly over simplifications that are wrong and ultimately lead to contradictions as seriorus as inviscid lift or the ultraviolet catastrophy.

Inequality is one of the most important issues, because if microfoundations are true, then income distribution has to be log normal, not Pareto.

Sorry micro, you fail.

31

Robert Waldmann 02.10.14 at 5:59 pm

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.

32

Robert Waldmann 02.10.14 at 6:06 pm

dear reason

Thanks for trying to save me from a heart attack. In fact, I’m flattered you mentioned me. I did feel a twinge when I read “rigorous micro foundations.” But you see Quiggin fell into that other Waldmann trap by claiming that Arrow and Debreu did not consider dynamic stochastic models (what could “complete contingent claims markets” mean in a non stochastic model ?).

He did avoid mentioning the absence of Mises and Von Hayek or (equally incorrectly) Hayek and Von Mises

33

Alex K. 02.10.14 at 6:08 pm

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.

34

RW (the other) 02.10.14 at 6:19 pm

It appears that academic macro was (mostly) here: “Delight at having understood a very abstract and obscure system leads most people to believe in the truth of what it demonstrates.” -G. C. Lichtenberg

But now appears to (mostly) be here: “To insure the adoration of a theorem for any length of time, faith is not enough, a police force is needed as well.” -Albert Camus

A new journal may be a necessary.

35

Metatone 02.10.14 at 6:44 pm

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.

36

John Quiggin 02.10.14 at 7:02 pm

Nick Rowe @11 I presented that as an aphorism, in the same way as people say “Economics began with Adam Smith”. I go on to qualify it with a mention of earlier business cycle research, the Austrian model etc. But, I don’t think any of these precursors really amount to a full-scale macro theory in the way in which I (though clearly not Athreya) understand the term.

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Alex K. 02.10.14 at 7:03 pm

“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.

38

JohnS 02.10.14 at 7:05 pm

I’m a mathematician with some economics training and a lot of modeling experience. I find it ludicrous to try to produce a single macro model, or family of models, that’s generally applicable. Recently someone referenced Keynes’ characterization of economics as a diverse collection of models, each abstracting away all but a few elements of reality, and a good economist as one who excels in picking the one most applicable to the problem at hand. With the possible exception ofKarl Marx I can’t think of any economists further away from this job description than the macreconomists discussed in this book.

39

LFC 02.10.14 at 7:09 pm

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.)

40

Steven Kyle 02.10.14 at 7:44 pm

There is, I think, a missing part of the explanation of how intelligent people can convince themselves (and base an entire career on) of the usefulness of models which seem to be ridiculous on their face. One commenter above called it “defying common sense”

I am myself a card carrying economist who went to grad school at a reputable school where both Lionel McKenzie and Tom Sargent spent sabbatical semesters and taught courses while I was there. I well remember talking to my friends and making fun of the silly things they could convince themselves to believe were true.

But then again, economists have ALWAYS prized conclusions that fly in the face of “common sense”. It is part of the DNA of the profession to love clever proofs of things which seem counterintuitive at first glance. Once you are in the mode of valuing such things it is but a small leap to swallow ever larger bites of silliness. And to think that everyone is rational in the sense that economists use that word is hardly the most absurd thing I have ever seen them do.

(Side note – I used to be a government bond trader before I quit and went to academia. I know full well that markets arent perfect even in that most perfect of areas. But most academic economists truly have little idea how “real” people think or manage their affairs or what constraints they work under)

You may ask how such things can be believed in the face of data and evidence to the contrary. There are two main answers to that

1. Modern economists are amazingly ignorant of economic history – it has fallen out of fashion to require students to take such courses because there are only so many hours in the day and there are other things that are seen as more valuable.

2. We don’t really have that much data to begin with since national income accounting only was invented 75 or so years ago, and there are no true experiments to point to – we can only take advantage of chance “natural experiments” that present themselves from time to time. So nothing is ever truly “proven”.

I suspect it will be a long time before the econ profession changes its notion of what is “rigorous” analysis. Too many people have invested too much time in learning that stuff for it to be jettisoned easily.

41

Collin Street 02.10.14 at 8:18 pm

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”.

42

Alex K. 02.10.14 at 8:56 pm

“Economies are chaotic systems, and the closer to your microfoundations you get the more complex and thus the more chaotic they become,”

This might be true in a parallel universe where economists actually create real economies when they model them. In this universe, economies exist, and are chaotic or not, quite independently of the economist’s model.

“The less data you have, the less useful microfoundations are. “

There’s not a lot of data if you focus on the kind of aggregates that macroeconomists focus. There is plenty of microeconomic data. Whether that micro-data, in conjunction with microfoundations, can be leveraged to say something useful about the plausible range of the state of the economy in any give situation, I’m not sure — but it’s possible.

What I _am_ sure of is that you’re not making a lot of sense.

43

Bruce Wilder 02.10.14 at 9:26 pm

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.

44

adam.smith 02.10.14 at 9:38 pm

Whether that micro-data, in conjunction with microfoundations, can be leveraged to say something useful about the plausible range of the state of the economy in any give situation, I’m not sure — but it’s possible.

well sure it’s possible. But given what gets published as macro in top econ journals, you have to make the case that it’s obviously and unambiguously better than any other approach. The discipline of (macro-)economics behaves as if it were deep into “normal-science” territory. And if we stipulate your assessment of what microfoundation-macro does and doesn’t do, it very much shouldn’t be. We should see a much broader range of research programs, akin to what you see in more openly “pre-paradigmatic” (for lack of a better term) social sciences like polisci or sociology.

45

Bruce Wilder 02.10.14 at 10:00 pm

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.

46

Bruce Wilder 02.10.14 at 10:03 pm

LFC @ 38 I see I did too many commas again in the comment @ 42. It’s a disease! I’m an addict!

47

Collin Street 02.10.14 at 10:20 pm

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.

48

Bruce Wilder 02.10.14 at 10:23 pm

Cdbarry @ 30: Microfoundations is like doing fluid mechanics while ignoring viscosity.

Fluid mechanics has three conservation laws — mass, momentum and energy — from which to derive an analysis, before even getting to viscosity. Economics has never settled on a single conservation law. Its “equilibrium” was posited as homeostasis to bootstrap an analysis without one. Keynes proposed that full-employment of resources constituted a kind of conservation principle: an economic system, which did not achieve and maintain full employment of resources was clearly inefficient, in that it was wasting the unemployed resources. Political conservatives have been choking on that one ever since. The whole point of RBC is to make plausible arguments that any observed unemployment is just transitional, the self-regulating economy magically and efficiently adjusting to shocks.

Microfoundations is pretending that you have conservation principles, where none exist.

49

Bruce Wilder 02.10.14 at 10:30 pm

“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.

50

Kartik 02.10.14 at 10:31 pm

Hi John,

Thanks for the review of the book. I finally had time to thank David Glasner for his review. I’ve not much to say that a whole book hasn’t done already, so I’ll only add a couple of points.

First, I wanted to steer clear of making the book a compendium of what I personally, or what macroeconomists generally, think about policy issue x,y, or z. People disagree, as we know. Instead, the goal was to illustrate the M.O. of modern macro. There is, if not convergence of opinion, convergence of method by which to provide an account of things. And this is what I wanted to, and by your account and that of others did, successfully convey.

I also wanted, especially, to stress the work on models with lots of market malfunction. This is the point of a big chunk of chapter 5 (and 4 really). Models constructed to tackle many of the things you’ve noted (unemployment, especially) use precisely the models I describe.

This is why I am dismayed by statement, that this: “…version of macro excludes everything in which I am interested. ” Really, it just doesn’t.

And perhaps I should’ve said even more than I did about models of unemployment and imperfect trading arrangements. But the book covers a lot already.

Thanks again for taking a look

Kartik

51

JW Mason 02.10.14 at 10:34 pm

“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.

52

William Timberman 02.10.14 at 11:06 pm

The economy may consist of controlled, or at least controllable processes, but given how many such processes there are, and how complex their interactions, who can make sense of the aggregate, at least well enough to predict what’s coming next? From the point of view of a non-economist, it doesn’t seem that anyone’s managed this very well to date, except during those years when there’s a sort of stability, if not technically a state of equilibrium in the economy as a whole.

Obviously economists have learned a lot, and know enough to have some hope of managing a global economy successfully some day if the politics smile on what they’ve learned, but I wonder…. Do those of you who are economists think that one day all this uncertainty will amount to no more than a quaint historical footnote? (I suppose I could ask the same question with equal fairness of theoretical physicists/cosmologists, or climatologists, but they aren’t here, and some pretty accomplished economists are.)

53

mpowell 02.10.14 at 11:19 pm

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.

54

A H 02.10.14 at 11:42 pm

It’s interesting that the major trends in the econ blogging reflect the currents of academic econ circa 1970 – 1975. You have your mainstream Keynesians like Paul Krugman and Brad Delong, who are the most powerful in actual academia and policy levels. Larry Summers could be included in this group. They correspond to the mainstream Keynesians, who were dominant in 1970 like Samuelson and Tobin. Then you have your insurgent monetarists, represented now by Scott Sumner and in 1970 by Milton Friedman. Off to the side, but not completely ignored you have your post-Keynesians and other heterodox groups. Though in 1970 they were represented by academic heavy weights like Sraffa and Robinson, where presently they are rather shunned by the mainstream academics, and are represented by splitist groups like MMT.

These three groups interact through blogs quite a bit. Steve Randy Waldman at interfluidity comes to mind as someone who often takes ideas from all three sides. However, main stream publishable macro has basically no presence in the online debate. This may just be my own reading habits, but I think it reflected in what sites like FT Alphaville link to. I am actually having a hard time coming up with a topic that is so under represented online as modern DSGE macro.

55

john c. halasz 02.10.14 at 11:56 pm

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.

56

Collin Street 02.10.14 at 11:56 pm

Anything with feedback can be controlled, I would think.

Sure, but the control function has to be chaotic and the system as a whole remains chaotic, even if the bits-we-care-about aren’t.

[and a chaotic control function is one that has to be run by hand rather than rule: economies need to be actively managed and the libertarian/liberal dream just that]

57

Collin Street 02.10.14 at 11:58 pm

Also what john c. halasz said.

58

William Timberman 02.11.14 at 12:28 am

I appreciate jch’s yes, we can, or rather yes, we must — also Bruce Wilder’s observation on this and many other threads that competence, not the lack of theoretical tools, is the limiting factor which constrains our ability to manage the willful as well as the accidental aspects of our present dysfunction.

When all is said and done, it does seem to come down to politics in the end. I wonder how long we’ll have to wait before that idea penetrates the fog our experts have so expertly wrapped us in. (Present company excepted, of course.)

59

Daniel Pope 02.11.14 at 12:42 am

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.”

60

notsneaky 02.11.14 at 1:09 am

I am actually having a hard time coming up with a topic that is so under represented online as modern DSGE macro.

Essentially Simon Wren-Lewis, though even he is “old Keynesian leaning”

61

Steve Kyle 02.11.14 at 1:54 am

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?

62

Bruce Wilder 02.11.14 at 2:46 am

Collin Street: economies need to be actively managed

The economy is decentralized and in long-run disequilibrium — long-run disequilibrium is inherent in the nature of control in the presence of technological advance, and especially control of social processes, where strategic behavior to change the institutional rules-of-the-game is a given.

There’s an institutional life-cycle, and across that cycle there are times for a new architecture, times when building up is appropriate and times when tearing down, or running down, is appropriate. There’s no one right answer for all time, no end of history. The emergent political economy will continue to emerge.

So, even if the economy might be on auto-pilot for a generation, sooner or later, yes, the crisis will come, and the hand had better find the tiller, or be able to fashion a tiller, as the case demands.

Also, of course, what john c. halasz said.

63

Jerry Vinokurov 02.11.14 at 2:52 am

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

64

Collin Street 02.11.14 at 3:23 am

The economy is decentralized and in long-run disequilibrium

This isn’t entirely true: there is a stable income/asset distribution.

It’s where one bastard has all the income and all the assets.

65

Collin Street 02.11.14 at 3:25 am

[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.]

66

JP Koning 02.11.14 at 3:58 am

“Keynes really did invent macroeconomics as an analysis of statistical aggregates corresponding to the categories of the then novel national accounts.”

FWIW, Antoin Murphy credits Sir William Petty as the originator of national income accounting, first published in 1691 in Verbum Sapienti.

67

Thomas Zaslavsky 02.11.14 at 4:08 am

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.

68

Jerry Vinokurov 02.11.14 at 4:45 am

Um, intermolecular forces are of great interest in fluid dynamics. Viscosity is not some kind of arbitrary parameter that you just stick into your equations; it’s a direct consequence of the molecular structure of the fluid. It’s just that there are times when you can abstract away from that molecular structure to the collective dynamics, but if you want to completely understand how fluids work, you can’t just throw the molecular interactions away. Calculating bulk parameters like viscosity from molecular forces isn’t just some theoretical exercise, it’s of high practical significance.

69

Kyle 02.11.14 at 4:45 am

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

70

Jerry Vinokurov 02.11.14 at 4:46 am

Not that this really says much about economics one way or the other.

71

Thomas Zaslavsky 02.11.14 at 5:08 am

@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.

72

reason 02.11.14 at 8:32 am

Alex K @25
You misunderstand me. I’m not saying that (good) micro-foundations might not be part of the solution in macro-economics, but that it should not be part of the definition of the subject, which is something quite different. You don’t define particle physics as part of astronomy, even if eventually you need some particle physics to fully understand astronomy.

As for your point about disequilibrium dynamics, fully agree. I’m personally of the opinion that we need to emphasize the DS part and totally forget the mirage of GE.

73

reason 02.11.14 at 9:01 am

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.

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Paul 02.11.14 at 9:15 am

This is a fantastic article/discussion. It surprises me, though, that no-one has mentioned foundational mathematics – Russell et al. – as the obvious point of comparison. The work was important, it stimulated the creation of many new areas of mathematical research, (it ultimately failed!), but no-one tries to use mathematics in the real world without assuming 1 + 1 = 2.

75

Alex 02.11.14 at 12:36 pm

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.

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Straightwood 02.11.14 at 3:25 pm

I believe that the problem of why the economics discipline cannot supply coherent policy guidance can be greatly simplified by viewing economics as an intellectual area in which two major poles of human character, altruism and selfishness, are locked in perpetual combat. Those who believe in the necessity of suffering and deprivation will never give ground to contrary theories, and those who believe in generosity and the public good will never accept contradictory evidence.

77

Niall McAuley 02.11.14 at 3:45 pm

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.

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Michael Cain 02.11.14 at 4:15 pm

reason @72 and 73
I’m an outsider (who does modeling) with only a couple of semesters of graduate economics courses, so my observations of the economics community is probably inaccurate, but still… Holding onto GE seems to me to be a result of the type of mathematics that economists adopted: optimization, with one answer (and sometimes, it appeared, considerable contortion to produce a situation where a single answer was guaranteed). To a simple-minded observer like myself, the real economy consists of a bunch of agents acting like relatively simple optimization algorithms, but the constraints (and possibly the objective function) change long before convergence has occurred. That largely puts you into the realm of simulations of limited duration, a direction that conflicts with the “solve for the answer” mindset.

79

Straightwood 02.11.14 at 4:25 pm

@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.

80

reason 02.11.14 at 5:12 pm

Michael Cain @78
Yes – I believe that too, the economy adjusts slowly towards a moving target.

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GiT 02.11.14 at 5:12 pm

“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.

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Zamfir 02.11.14 at 5:36 pm

Michael Cain, that sounds so correct. Though I am less sure that individuals (or organizations) are fairly simple optimization algorithms. As far as I can tell, people don’t really have those objective functions that economists presuppose. They develop their goals and wants as they go, and that’s hard work. So the goals only develop in response to the circumstances, which is a tricky dynamic in itself.

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Bruce Wilder 02.11.14 at 6:25 pm

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.

84

Lee A. Arnold 02.11.14 at 6:37 pm

John Quiggin wrote, “for the New Classicals, a disaster of this kind could only be the result of government failure”

I have a question for the genuine mathematical macroeconomists in attendance.

I will try to set this up: I never studied macro mathematically because I formed the suspicion at the beginning of my studies about 40 years ago that mathematics would never be able to precisely predict complex systems in any subject area, including economics and ecology. So I studied math up to intro calculus, and then jumped over to Gödel’s late ruminations on foundations, because I already suspected that our real-world problems will turn into policy crises that are going to need some other standard of agreement besides mathematical certitude. And my suspicion seems to have been borne out about prediction of complex systems, aside from use of accounting identities, or morphologies described by power laws like Zipf’s law. I think it comes out of a very simple problem, a foundational type of problem: Newton’s N-body computation problem repeats itself, or has an analogy, with the number of compartments in your model.

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?

And, to ask a related question of New Old Keynesians, do you think that IS-LM adequately covers the reality of the financial system, for macro policy purposes?

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Ronan(rf) 02.11.14 at 6:41 pm

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

Rob Parenteau 02.11.14 at 7:00 pm

One point you don’t quite nail down, but which some of your readers seem to get, and may be worth highlighting in any future revisions/extensions of your note above: modern macroeconomics, at least within the economic profession, if we can be so bold as to call it that (more like a theology, so maybe it is a “calling”), is little more than aggregated microeconomics. This, of course, leaves modern macroeconomics completely open to all the old fallacies of composition that macroeconomists like Keynes (and yes, he was not the first one, there were trade cycle and credit cycle and aggregate growth theorists well before him) underlined, highlighted, and subsequently attempted to skillfully remove from macroeconomic analysis, both theoretical and applied. And so we must recognize, as most people familiar with the history of economic thought will tell you, that the economic profession can go retrograde…and apparently so for decades. Any physicist worth his salt will tell you that interacting particles often have emergent properties that cannot be assigned to any one of the particles per se. Same with chemists – catalytic reactions and all that. The stunting of economic thought by the victory of the “micro foundations first, macro second” wing is simply beyond belief, and has been a source of largely unnecessary real pain and suffering in many societies. Lose your delusions.

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bob mcmanus 02.11.14 at 9:05 pm

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.

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Collin Street 02.11.14 at 9:19 pm

It is not just equilibrium, which they are holding onto — it is the exclusivity of allocational efficiency.

And even the allocations are “efficient” only if you take people’s worth as directly proportional to the money they have to spend.

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bob mcmanus 02.11.14 at 9:27 pm

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.

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Roger Lindsley 02.11.14 at 11:00 pm

Anti-Keynesians have a patronage in the Financial sector that Keynesians do not enjoy. It is almost as if the vastly outnumbered financial sector participants have dominated fiscal policy by the virtue of the American campaign financing system alone. It is by sheer accident that Bernanke/Yellen took the helm of the Fed. In an alternative timeline a Republican Whitehouse would have emplaced a DSGE Fed Chair while engaging in fiscal stimulus on a broad scale (the former for idealism and retention of passive income for as long as possible, and the latter to pragmatically excise the economy without regard to debt limits, for in the end we are all Keynesians…), but instead we have the Anti-Obama thwarting of Fiscal stimulus with wide open monetary stimulus policies. Both timelines are thwarted by the perversions of liaise faire forces not at all concerned with managing economies. Deregulation of the financial sector and dismantling of the ability of government to reallocate wealth are the primary concerns and the effective outcomes of these policies. In their own measure, they have been highly successful. Class warfare is a disingenuous term for the disregard of civility in the world of finance, it isn’t warfare, it is simply a rejection of any and all social responsibility of the financial sector to any other competing use of capital and resources. This type of economic-sector-narcissism might not be unique, but in the financial sector it is unusually effective as the levers of American power have been grasped by the visible hands of lobbyists. The consequences of this disregard for all exigent forces is generating a very unquantifiable societal risk. The Public sector absorbed the risk of the financial sector in the crisis, the financial sector may be yet be held accountable for this transubstantiation…

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otpup 02.12.14 at 1:03 am

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?

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Full Employment Hawk 02.12.14 at 3:56 am

One major problem with New Classical Economics’ use of microfoundations is that it uses the wrong microfoundations; the theory of perfect competition. This theory is a spectial theory of economics which lacks sufficient generality to serve as a microfoundation for macroeconomics. New Keynesian economics made a major improvement in this area by replacing perfect competition with monopolistic competition as the microfoundations.

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Glen Tomkins 02.12.14 at 6:34 am

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.

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reason 02.12.14 at 10:17 am

Glen Tomkins @92

Let me get this straight – you think economics is in it’s infancy (after 300 years or so)?

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reason 02.12.14 at 10:22 am

“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.

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Glen Tomkins 02.12.14 at 2:40 pm

reason,

Well Medicine still is in its infancy 4500 years later, if by that you mean it isn’t like physics, that it’s still mostly descriptive, with a knowledge of microfoundations only here and there, and even in those areas, not really very deep. For all that, I would advise you to follow its advice if you ever find yourself in a personal, micro-health recession.

My point is that we should roughly invert our estimation of the “maturity” and other notions of value, when we look at Physics vs Economics and Medicine. Physics is for idiot savants who pick and choose what they will examine based on what will produce the shiniest and cleanest theoretical structure. Medicine and Economics are for adults, who come up with our best approximation of the full spectrum of phenomena, with special attention only to the phenomena we most need to understand and control. We go wherever people and econ0mies are the sickest, not where they are easiest to model.

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Glen Tomkins 02.12.14 at 3:05 pm

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.

98

reason 02.12.14 at 3:15 pm

Glen,
this relates back to what Bruce Wilder said about treating allocative efficiency (based on a pre-existing distribution of wealth no less) as the only sort of efficiency that counts. It reminds me of couple of things:
1. the frequent claim that “things are good for the economy” as though that is a meaningful statement. The economy is a tool, do you do things because they are good for “the hammer”?
2. those who claim that global warming can’t be a problem because “the earth” survived much more dramatic warming episodes in the past. (Not with 9 million human inhabitants it didn’t.)

99

reason 02.12.14 at 3:16 pm

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.).

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Patrick S 02.12.14 at 10:15 pm

I will just contribute a quote from John Maynard himself that seems relevant:

“It seems to me that economics is a branch of logic, a way of thinking; and that you do not repel sufficiently firmly attempts à la Schultz to turn it into a pseudo-natural-science.” …
“Good economists are scarce because the gift for using “vigilant observation” to choose good models, although it does not require a highly specialised intellectual technique, appears to be a very rare one.”
John Maynard Keynes, in a letter to Roy Harrod, 4 July 1938 (http://economia.unipv.it/harrod/edition/editionstuff/rfh.346.htm)

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In the sky 02.12.14 at 11:02 pm

@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.)

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In the sky 02.12.14 at 11:07 pm

(PS RE assumes people are right on average about their expectations. This will obviously lend itself quasi-libertarian conclusions: no need for gov’t interference, etc.

Of course, the alternative is that people are incorrect on average, and further that We Know Better Than You. This will lend itself to alternative quasi-political, and ones that I am sure are desirable. If like Henry Farrell you think “Nudge” is potentially nefarious, wait until you see what happens when you straight off assume that people are wrong on average. Let’s just throw that one out there!)

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reason 02.13.14 at 5:21 pm

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”.

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reason 02.13.14 at 5:23 pm

I also think that RE is worse than you paint it, in that it used for assuming that on average people expect not what will happen, but what OUR model thinks will happen. This is much worse!

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In the sky 02.13.14 at 5:58 pm

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.

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reason 02.14.14 at 8:19 am

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 – about which local knowledge is useless. It is true that if you average the information everybody has about local conditions, you can make (perhaps even an unbiased) estimate about global conditions, but if you ask everybody what they think global conditions are, then local knowledge helps not at all.

107

dax 02.14.14 at 11:22 am

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?

108

reason 02.14.14 at 1:22 pm

dax @107
I wonder what rottonness is?

I also wonder if perhaps WW II got rid of more rottenness than the Great Depression did?

109

In the sky 02.14.14 at 1:32 pm

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.

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reason 02.14.14 at 4:46 pm

In the sky
We are talking explicitly about macro-economic modelling here. So you are arguing that you are off-topic?

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Bruce Wilder 02.14.14 at 5:33 pm

“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.

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john c. halasz 02.14.14 at 5:56 pm

B.W.:

Where to you get that $2 tn figure? Dean Baker, who has “priority” rights in this domain, put the total excess in the U.S. housing bubble at $8 tn, (presumably in constant dollars and absent Fed manipulation/support of the housing.mortgage market). Are you citing just subprime?

113

Jerry Vinokurov 02.14.14 at 6:43 pm

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.

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In the sky 02.14.14 at 11:41 pm

Bruce Wilder,

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!)

I’m not sure if you were just jesting here, but for the record the existence/applicability of representative agents has nothing to do with rational expectations.

You can have RE and agents that cannot be represented as a unitary actor, and you can have representative agents without RE. The representative agent assumption is basically just a short-hand for “preferences are homothetic”. It’s far less robotic and dehumanising than people think.

115

Bruce Wilder 02.15.14 at 1:37 am

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.

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Bruce Wilder 02.15.14 at 2:49 am

In the sky @ 114

Yes, I was jesting. Sorry if it was distracting.

I’m not sure that I agree that rational expectations have nothing to do with the Representative Agent though. The combination of homothetic preferences and shared assessments of the future serves to erase the very conflicts of interest, which mark out the political economy of the actual business cycle.

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John Quiggin 02.15.14 at 7:25 am

Maybe worth observing that homothetic preferences rule out, by assumption, a standard Old Keynesian argument, namely that redistributing income towards the poor increases aggregate demand.

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Full Employment Hawk 02.15.14 at 3:38 pm

Conclusion: Old Keynesianism argues that people’s preferences are not homothetic.

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In the sky 02.15.14 at 5:51 pm

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.

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Jerry Vinokurov 02.15.14 at 6:10 pm

There’s no such thing as a “trivial empirical matter.” All empirical matters are definitionally non-trivial, at least if you’re doing any sort of science that, you know, is intended to reflect empirical reality.

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In the sky 02.15.14 at 8:45 pm

Sarcasm doesn’t transmit well, Jerry :-)

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Jerry Vinokurov 02.15.14 at 9:57 pm

My bad. Sometimes it’s hard to pick up these things over the internet.

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