Robert's Stochastic thoughts

Saturday, April 14, 2012

Pulled back from comments. I typed the first two lines in

Robert said...[skip]

I don't know when the quest for micro foundations could have been a serious enterprise. I perceived it to be completely absurd nonsense 30 years ago.

6:38 AM

Anonymous said...
No Robert, that is not a serious position. The "microfoundations" research programme in the 1970s and early 1980s was focused on answering the fundamental questions of macroeconomics, originally posed in the General Theory by Keynes. How could a capitalist market economy settle on extremely inefficient outcomes, or states, such as equilibria (or disequilibria) with high unemployment and low output? How do market economies coordinate (or fail to coordinate) in the absence of the Walrasian auctioneer? Why might a market system fail to coordinate the actions of heterogeneous individuals? Etc.

Robert Lucas, perhaps surprisingly, put it very well in a 2008 lecture in Italy (http://faculty.chicagobooth.edu/brian.barry/igm/ditella.pdf ). Referring to 34% decline in real output in the USA from 1929 to 1933 he asks: "Why did we, collectively, choose to reduce production by 1/3, with no change in available resources?" He describes these events as "frightening precisely because they are so mysterious."

Since the early 1980s economists have made literally no progress in understanding these fundamental questions of macroeconomis. But to dismiss the attempt as "absurd nonsense" is, well, absurd nonsense. Perhaps macroeconomics is just too complex and difficult, forcing us to rely on more or less ad hoc aggregate models which seem to have some predictive power (although we are not sure why). But should economists really give up on any attempt to reach a deeper understanding of the questions posed in the General Theory?

PS Lars P Syll is clearly right that a big part of this is dealing with risk versus uncertainty, and moving away from the inappropriate use of Baysian reasoning in "large world" contexts, a subject recently taken up at length in Ken Binmore´s book Rational Decisions.

The comment by "anonymous" enraged me. I will try to respond semi rationally here.

First some things which might be of interest to people other than me.

The normal usage of "micro foundations" does not refer only to efforts to find micro foundations for Keynesian models, as anonymous asserts without any evidence or any qualification. Some participants in the effort aimed to develop realistic consistent models with aggregate implications inconsistent with Keynes's views. It was partly because economists didn't agree about what would happen that the argument that they needed better theory was so convincing.

The idea of abandoning the assumption that agents are Baysian (sic) is not, to my mind, a new approach to micro foundations. A large part of what has been meant by "micro foundations" at least since 1985 (when I became an economist) is that one must assume that agents are Bayesian. For many years it was further required to assume that we have rational expectations.

The huge advance of considering the possibility that we are not Bayesian, if widely accepted, would bring the profession part of the way back to Keynes who wrote a treatis on probability.

Now I don't think that no possible quest for micro foundations can ever be serious. I would tend to guess that psychologists will have something useful to teach economists (in fact I think they already do). But my expression of ignorance about a serious period in the past referred to the past and, in particular (following an unquoted comment above mine) to a period which has ended during which, it was alleged, the quest for micro foundations was seroius. That means a period during which finding micro foundations meant reconciling the macro evidence with assumptions about psychology which everyone agreed were false. That doesn't seem to me to be a serious endevor.

This doesn't mean that I consider all micro founded macro equally worthless. It is clear that some people believe that the core (false) assumptions including rational expectations have policy relevant implications. Finding examples in which agents are rational and the policy implications are the opposite of what these people imagine can prevent the quest for micro foundations from doing damage -- prevent it from leading us astray by preventing it from leading us. If this is the way things are, then the combined impact of the better and worse micro founded research is exactly nothing.

Note it begins with an attack on me. Anonymous notes that my view as of 30 years ago was not a serious contribution to economic thought. Wow. 30 years ago, I was trying to be a biologist. I had no responsibility to make serious contributions to economics. Today, I am accurately reporting what I thought then. I don't think that an accurate report of a fact can be "not a serious position."

I assume that "anonymous" does not claim to have more expertise on the thought of Robert Waldmann in 1982 than Robert Waldmann. Evidently "anonymous" must consider it to be "not ... serious" to report a fact.

The other part of the claim which anonymous denounces as "not a serious position" begins "I don't know ..." Does anonymous assert that I do know and know not that I know ? I assure anonymous that I am more expert on my lack of knowledge than he or she is.

The claim that micro foundations were added to achieve publishability is a paraphrase of something which Paul Krugman wrote (no link yet I'm working on it). He described conversations with people he knew at MIT. He has won the Nobel memorial prize for extremely micro founded international and has made highly influential contributions to extremely micro founded macroeconomics. He knows what he wrote about. He didn't name the friends at MIT, but I would guess that they are rather in the thick of things too.

Since anonymous is anonymous, I have no idea if he or she has reason to claim to understand the motivations of leading economists better than Paul Krugman. But frankly, I don't think that anyone in any position to contest Krugman's views of what motivates those who move the economics profession would comment on my blog. I did not provide a link in a comment on my blog, but the assumption that I based my claim on nothing was uncharitable to put it mildly.

2 comments:

Justin Dylan said...: Robert,
It certainly wasn't my intention to upset you, let alone enrage you, so I apologize for that. I merely meant to point out that dismissing the microfoundations literature, as I thought you were doing, seems an unreasonable position to me. I'm beginning to see that people understand "microfoundations" in different ways, and it appears that the New Classical economists may have given the idea a bad name. But I agree strongly with Stiglitz (http://onlinelibrary.wiley.com/doi/10.1111/j.1542-4774.2011.01030.x/pdf) that it is "important that macroeconomics be based on the right microeconomic assumptions, those consistent with actual behavior, taking into account information asymmetries and market imperfections". The use of representative agent models with perfect competition, complete markets, perfect information, instantaneous market clearing etc etc, as has become standard, makes it more or less impossible to address any worthwhile macroeconomic questions. But it is that particular, and somewhat perverse, choice of microfoundations which is at fault and not the idea of microfoundations in general. I also agree with Stiglitz that the rational expectations hypothesis (REH) is not necessarily always the problem. Once you move away from the New Classical (or most DSGE) models, REH no longer has the same strong implications that it has in these contexts.

Macroeconomics has probably lost 20 or 30 years, but interesting work is now being done, by Roger Guesnerie, Roman Frydman and others, both in reevaluating REH and assessing its implications (see for instance, http://www.econ.nyu.edu/user/frydmanr/RFandESPIntroductoryEssay_WhichWayForward_Revised3_16_2012final.pdf ). Hopefully much more will follow.

Finally, I would quibble with you on what is probably a semantic point: I don't think the issue is to consider "the possibility that we are not Bayesian" as you put it, but rather to recognize that Bayesian arithmetic only in applies in Savage's "small worlds" in which we can know what all possible states of the world are (or every conceivable possible course of future events), and assign probabilities to them. In a "small world" new knowledge never leads us to reconsider the basic model we use in determining our beliefs, or feel the need to alter our model of the world after being surprised by a chain of events whose implications had not previously been considered (all of this paraphrases Binmore). The New Classical model describes just such a "small world" in which we all agree on the relevant model of the economy and in which true "surprises" can never occur. But neither can most of the macroeconomic phenomena we are interested in, which I guess is why Robert Lucas finds it all so surprising.

Thanks very much for a stimulating discussion.

Respectfully,
Justin Dylan; 9:29 AM
Lars P Syll said...: Robert, this was a nice post, again, but I have two comments I would like to make.
Pro primo:
New-classical, real business cycles, dynamic stochastic general equilibrium and new-Keynesian micro-founded macromodels are bad substitutes for real macroeconomic analysis.
Not only do they trivialize uncertainty into risk. These models also try to describe and analyze complex and heterogeneous real economies with a single rational-expectations-robot-imitation-representative-agent. That is, with something that has absolutely nothing to do with reality. And - worse still - something that is not even amenable to the kind of general equilibrium analysis that they are thought to give a foundation for, since Hugo Sonnenschein (1972) , Rolf Mantel (1976) and Gerard Debreu (1974) unequivocally showed that there did not exist any condition by which assumptions on individuals would guarantee neither stability nor uniqueness of the equlibrium solution.
Opting for cloned representative agents that are all identical is of course not a real solution to the fallacy of composition that the Sonnenschein-Mantel-Debreu theorem points to. Representative agent models are rather an evasion whereby issues of distribution, coordination, heterogeneity - everything that really defines macroeconomics – are swept under the rug.
Conclusion – don’t believe a single thing of what these microfounders tell you until they have told you how they have coped with – not evaded – Sonnenschein-Mantel-Debreu!
Of course, most macroeconomists know that to use a representative agent is a flagrantly illegitimate method of ignoring real aggregation issues. They keep on with their business, nevertheless, just because it significantly simplifies what they are doing. It reminds – not so little – of the drunkard who has lost his keys in some dark place and deliberately chooses to look for them under a neighbouring street light just because it is easier to see there!
Pro secondo:
Although I certainly agree with Krugman’s harsh judgements on microfoundations of macroeconomics – and it goes for both the “new-Keynesian” and new-classical variety – Krugman’s explications on this issue is really interesting also because they shed light on a kind of inconsistency in his own art of argumentation. During a couple of years Krugman has in more than one article criticized mainstream economics for using too much (bad) mathematics and axiomatics in their model-building endeavours. But when it comes to defending his own position on various issues he usually himself ultimately falls back on the same kind of models. This shows up when he repeatedly refers to the work he has done with Gauti Eggertsson – work that actually, when it comes to methodology and assumptions, has a lot in common with the kind of model-building he otherwise criticizes.
On most macroeconomic policy discussions I find myself in agreement with Krugman. To me that just shows that Krugman is right in spite of and not thanks to those models he ultimately refers to. When he is discussing austerity measures, ricardian equivalence or problems with the euro, he is actually not using those models, but rather simpler and more adequate and relevant thought-constructions in the vein of Keynes.; 9:38 AM