Home > New vs. Old Paradigm, The Economics Profession > Dumb and dumber in modern macroeconomics – the ‘New Keynesian’ version

Dumb and dumber in modern macroeconomics – the ‘New Keynesian’ version

from Lars Syll

The chicken that is fed by the farmer each morning may well have a theory that it will always be fed each morning – it becomes a ‘law’. And it works every day, until the day the chicken is instead slaughtered …

Now you might say that no chicken is an economist, but suppose that chickens were as intelligent as the farmer who keeps them, so they could be an economist … So if (the)  chicken had been an economist, they would not simply have observed that every morning the farmer brought them food, and therefore concluded that this must happen forever. Instead they would have asked a crucial additional question: why is the farmer doing this? … And of course trying to answer that question might have led them to the unfortunate truth …

Simon-Wren-Lewis_316pxYou can see why the habit of introspection would make economists predisposed to assume rationality generally, and rational expectations in particular … It only works to use your own thought processes as a guide to how people in general might behave, if you think other people are essentially like yourself. So if your own thoughts lead you to postulate some theory about how the economy behaves, then others similar to yourself might be able to do something like the same thing …

Economists may also be fooled into thinking their introspection is representative, because they are surrounded by other economists. So this conjecture about introspection does little to show that assuming agents have rational expectations is right (or wrong), but it may be one reason why most economists find the concept of rational expectations so attractive.

‘New Keynesian’ macroeconomist Simon Wren-Lewis

I like to think that I am more open-minded about alternative approaches to economics than most, but I am basically a maximization-and-equilibrium kind of guy. Indeed, I am quite fanatical about defending the relevance of standard economic models in many situations …

Paul Krugman may have more sympathy for standard economics than most of you. My criticisms are those of someone who loves the field and has seen that affection repaid. I don’t know if that makes me morally better or worse than someone who criticizes from outside, but anyway it makes me different …

To me, it seems that what we know as economics is the study of those phenomena that can be understood as emerging from the interactions among intelligent, self-interested individuals … Personally, I consider myself a proud neoclassicist. By this I clearly don’t mean that I believe in perfect competition all the way. What I mean is that I prefer, when I can, to make sense of the world using models in which individuals maximize and the interaction of these individuals can be summarized by some concept of equilibrium. The reason I like that kind of model is not that I believe it to be literally true, but that I am intensely aware of the power of maximization-and-equilibrium to organize one’s thinking …

‘New Keynesian’ macroeconomist Paul Krugman


The purported strength of New Classical and “New Keynesian” macroeconomics is that they have firm anchorage in preference-based microeconomics, and especially the decisions taken by inter-temporal utility maximizing forward-loooking individuals.

To some of us, however, this has come at too high a price. The almost quasi-religious insistence that macroeconomics has to have microfoundations – without ever presenting neither ontological nor epistemological justifications for this claim – has put a blind eye to the weakness of the whole enterprise of trying to depict a complex economy based on an all-embracing representative actor equipped with superhuman knowledge, forecasting abilities and forward-looking rational expectations. It is as if – after having swallowed the sour grapes of the Sonnenschein-Mantel-Debreu-theorem – these economists want to resurrect the omniscient walrasian auctioneer in the form of all-knowing representative actors equipped with rational expectations and assumed to somehow know the true structure of our model of the world (how that could even be conceivable is beyond imagination, given that the ongoing debate on mdoleing in economics, if anything, shows that not even we, the economists, can come to agreement on a common model).

solowFollowing the greatest economic depression since the 1930s, the grand old man of modern economic growth theory, Nobel laureate Robert Solow, on July 20, 2010, gave a prepared statement on “Building a Science of Economics for the Real World” for a hearing in the U. S. Congress. According to Solow modern macroeconomics has not only failed at solving present economic and financial problems, but is “bound” to fail. Building dynamically stochastic general equilibrium models (DSGE) on “assuming the economy populated by a representative agent” – consisting of “one single combination worker-owner-consumer-everything-else who plans ahead carefully and lives forever” – do not pass “the smell test: does this really make sense?” One cannot but concur in Solow’s surmise that a thoughtful person “faced with the thought that economic policy was being pursued on this basis, might reasonably wonder what planet he or she is on.”

  1. May 7, 2014 at 5:22 pm

    Rational expectation says rational agents believe in the best economic model, which is the DSGE model you happen to be building, so that everyone believes in the general equilibrium you are assuming and model convergence to equilibrium can occur. (It is possible to prove that rational expectation is a logical fallacy.) This is the actual garbage of rational expectation in practice, not some philosophical doctrine on introspection.

    This explains the anxiety about “forward guidance” to form public expectations in the hope of self-fulfilling prophecy. Unfortunately, central bankers and particularly the US Fed, have such poor reputation that even with the help of equally discredited mainstream media, few thinking people accept for one moment the self-delusional propaganda. Even with massive market manipulation to create the illusion, pigs will not fly, even if government economists have convinced everyone they will. Perception is not reality.

    It is more fruitful to focus on how rational expectation is used rather than waste a lot of time on general philosophical waffle. Put simply, rational expectation fails because it doesn’t work in practice. Forecasts of economic trajectories have failed time and time again. (By the way, rational expectation is Abenomics’ third arrow to achieve structural reform.)

  2. May 7, 2014 at 7:01 pm

    Reblogged this on Wissenswertes and commented:
    Makro-Ökonomen und ihre Micky-Maus Modelle.
    Aufgrund dieser “fundierten” Basis wird unsere Wirtschaft gesteuert…

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