13 November 2009

Whats wrong with modern macroeconomics?

Mark Thoma points to the conference on the theme 'Whats wrong with modern macroeconomics' at Munich last week.
Some excerpts from the comments on that
THOMA: One thing I learned from it is that I need to read the old papers by Sonnenschein (1972), Mantel (1974), and Debreu (1974) since these papers appear to undermine representative agent models. According to this work, you cannot learn anything about the uniqueness of an equilibrium, whether an equilibrium is stable, or how agents arrive at equilibrium by looking at individual behavior (more precisely, there is no simple relationship between individual behavior and the properties of aggregated variables - someone added the the axiom of revealed preference doesn't even survive aggregating two heterogeneous agents).

Roberto Cruccolini said... I think, this phenomenon of forgetting and/or neglecting former knowledge, e.g. the whole discussion and aspects of aggregation, which is really central to the methodology of modern macro, as the notion of microfoudations via optimizing agents was one of the core-arguments of New Classical Makro Revolution, is deeply unsettling. You could also add the oblivion of coordination & interaction problems, of discontinuities & emergence as probably central aspects of makroeconomics, which seem to be the reasons, why macro was once thought to be necessarily a different approach than micro.
There seem to be two ways to deal with this finding. One is to complain about the way modern macro has developed, and to suggest other/better solutions; this is, what we see most of the time right now.
That is of course worthwhile and understandable, but there remains a strange aspect: nearly all of nowadays criticisms were already mentioned 20 or 30 years before (recall Solow 1978 at the same conference as Lucas & Sargent, or Summers 1986 in response to Prescott, or Blinder 1987, or, which is sort of funny, Kirman 1989 & 1992 and - again - 2009,...)
And this leads to the interesting question, why modern macro/new classical methodology & thinking was so successful in conquering the field:
why did economists think, that Lucas 1976 said something new, given the reflections of Marshall how to theorize given ever changing structures, given Haavelmos ideas on the autonomy of economic relations, given the debates between Keynes and Tinbergen of econometrics and structural instability, and so on?
And why did they follow him in applying a Walrasian program using the representative-agent methodology given all these challenging aggregation results (see for the makro-production-function Fisher 1969 or Fisher&Felipe 2003 & 2006 and the bunch of literature to the Cambridge Capital Controversies and of course the literature interpreting the Sonnenschein-Mantel-Debreu results, f.e. Rizvi 1994 or 2006)
And in what sense does it make sense to describe modern macro models as "microfounded", if at the same time, you need some Friedman-1953-as-if argumentation to justify & make plausible your way of modeling, which is often referred to, that the inner functioning of your model is a black box and unknown, only built to generate predictions, not less. but certainly not more, in the sense that we think the way of modeling is reasonably realistic and corresponding to some mechanisms in the real world. Why should we, or why is this commonly called "microfoundations"??

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