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Representative agent models — macroeconomic foundations made of sand

from Lars Syll

Representative-agent models suffer from an inherent, and, in my view, fatal, flaw: they can’t explain any real macroeconomic phenomenon, because a macroeconomic phenomenon has to encompass something more than the decision of a single agent, even an omniscient central planner. At best, the representative agent is just a device for solving an otherwise intractable general-equilibrium model, which is how I think Lucas originally justified the assumption.

o-OSTRICH-IN-THE-SAND-facebookYet just because a general-equilibrium model can be formulated so that it can be solved as the solution of an optimizing agent does not explain the economic mechanism or process that generates the solution. The mathematical solution of a model does not necessarily provide any insight into the adjustment process or mechanism by which the solution actually is, or could be, achieved in the real world …

Here’s an example of what I am talking about. Consider a traffic-flow model explaining how congestion affects vehicle speed and the flow of traffic. It seems obvious that traffic congestion is caused by interactions between the different vehicles traversing a thoroughfare, just as it seems obvious that market exchange arises as the result of interactions between the different agents seeking to advance their own interests. OK, can you imagine building a useful traffic-flow model based on solving for the optimal plan of a representative vehicle?

I don’t think so. Once you frame the model in terms of a representative vehicle, you have abstracted from the phenomenon to be explained. The entire exercise would be pointless – unless, that is, you assumed that interactions between vehicles are so minimal that they can be ignored. But then why would you be interested in congestion effects? If you want to claim that your model has any relevance to the effect of congestion on traffic flow, you can’t base the claim on an assumption that there is no congestion.

David Glasner

Instead of just methodologically sleepwalking into their models, modern followers of the Lucasian microfoundational program ought to do some reflection and at least try to come up with a sound methodological justification for their position.  Just looking the other way won’t do. Writes Kevin Hoover:

garciaThe representative-­agent program elevates the claims of microeconomics in some version or other to the utmost importance, while at the same time not acknowledging that the very microeconomic theory it privileges undermines, in the guise of the Sonnenschein­Debreu­Mantel theorem, the likelihood that the utility function of the representative agent will be any direct analogue of a plausible utility function for an individual agent … The new classicals treat [the difficulties posed by aggregation] as a non-issue, showing no apprciation of the theoretical work on aggregation and apparently unaware that earlier uses of the representative-agent model had achieved consistency wiyh theory only at the price of empirical relevance.

Where ‘New Keynesian’ and New Classical economists think that they can rigorously deduce the aggregate effects of (representative) actors with their reductionist microfoundational methodology, they — as argued in chapter 4 of my  On the use and misuse of theories and models in economics — have to put a blind eye on the emergent properties that characterize all open social and economic systems. The interaction between animal spirits, trust, confidence, institutions, etc., cannot be deduced or reduced to a question answerable on the individual level. Macroeconomic structures and phenomena have to be analyzed also on their own terms.

And then, of course, there is Sonnenschein-Mantel-Debreu!

So what? Why should we care about Sonnenschein-Mantel-Debreu?

Because  Sonnenschein-Mantel-Debreu ultimately explains why “modern neoclassical economics” — New Classical, Real Business Cycles, Dynamic Stochastic General Equilibrium (DSGE) and “New Keynesian” — with its microfounded macromodels are such bad substitutes for real macroeconomic analysis!

These models 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.

  1. October 18, 2015 at 7:03 am

    an alternative to assuming ‘rational choice’ models or ‘representative agents’ which seems to be most parsimonous (a la occam’s razor) might be http://www.arxiv.org/abs/cond-mat/0309233

    j d farmer of SFI postualtes ‘zero intelligence agents’ might be the most rational choice. to me that seems reasonable (from a subjective perspective, since i definately have zero intellignece or at least anything measurable). i do think one needs to combine this later with 2 papers or concepts (and one more in a footnote–sort of like the famous footnote in Dirac’s book on quantum theory, where he introduced the ‘ladder operators’—bra-ket notation, which led to the feynman path integral formalism (though landau may have had ab earlyer version, and maybe there were more). http://www.arxiv.org/abs/0902.4274 R Sato’s ‘symmetry in econ’ of which there are more recent versions does the other side.

  2. October 18, 2015 at 8:33 am

    Has the writer considered using many agents in the modelling of the macroeconomics system? I’m sure he has yet he writes as if he has not. Curious!

  3. October 18, 2015 at 12:33 pm

    David Glasner’s congestion model is very interesting, for it leads to Russell’s Paradox. The solution to congestion which produced motorways was multiple lanes, where the primary issue is neither speed nor numbers of cars on motorways but need to overtake. Here not numerical but Russell’s logical quantification applies, i.e. none, one, some and all. A three-lane motorway with a hard shoulder thus normally suffices. Broken down cars don’t overtake, non-overtakers just go with the flow, occasional overtakers use the centre laine and those in a real hurry try to overtake everyone in the middle lane. The problems arise when a car becomes immobile and cannot reach the hard shoulder, or relatively immobile by hogging the overtaking lanes at speeds lower than other would-be overtakers; relative immobility can be caused simply by vehicles slowing down to take in details of e.g. an accident in traffic going the other way. Similar streaming of incomes occurs in capitalism: some die of starvation, the majority get sufficient, a few high-fliers enjoy social mobility and others take for granted their right to more than anyone else. Except for those who have run out of fuel, this more or less works for everyone until would-be high-fliers start seeing themselves as permanent overtakers, hog the centre lane and/or move into the middle lane, when paradoxically there is no fifth lane for overtaking.

    The fallacy of composition in micro-founded macro models doesn’t occur on single lane roads: perforce one cannot overtake. Consumers, producers and auctioneers can co-exist for ever so long as the auctioneer’s fees don’t soak up all the circulating money. The problems arise when the high-fliers see the way to make money is to be an auctioneer and too many are not satisfied with what they’ve got, and the highway authorities are not sensible enough to lock up auctioneers [including usurious bankers] who use monetary motorways not for going places – even to acquire luxuries – but to show off their power or enjoy its exhilarations. The apparent alternative of state run banking is no real solution because (a) those now controlling state policy through international banking simply continue to do so as political parties buying up the offices of state (b) one lane roads – whether run by privateers or the state – are not the solution to congestion but the cause of it.

    The real need is to induce a change of mind in those seeking power and status. To me the obvious answer is bottom-up international acceptance that money is debt. Those who have more owe more, and have power over others only by persuading them to believe lies.

  4. October 19, 2015 at 5:08 pm

    Economics in self-paralysis
    Comment on Lars Syll on ‘Representative agent models — macroeconomic foundations made of sand’

    You summarize: “… Hugo Sonnenschein , Rolf Mantel and Gerard Debreu unequivocally showed that there did not exist any condition by which assumptions on individuals would guarantee neither stability nor uniqueness of the equilibrium solution.” (See intro)

    Yes, indeed, since 1972 every smart economist can know this: GET is dead. So what? What exactly follows from this proof?

    It follows nothing less than this: Orthodoxy is dead. Why? Because it has been defined thus: “It is a touchstone of accepted economics that all explanations must run in terms of the actions and reactions of individuals. Our behavior in judging economic research, in peer review of papers and research, and in promotions, includes the criterion that in principle the behavior we explain and the policies we propose are explicable in terms of individuals, not of other social categories.” (Arrow, 1994, p. 1)

    There is not the slightest ambiguity, according to this self-definition of Orthodoxy the representative-agent approach is a priori out, inadmissible, a self-contradiction, a methodological absurdity.

    What follows from this? Because the microfoundation program is a shot in the foot it has no future. What, in turn, follows from this? “There is another alternative: to formulate a completely new research program and conceptual approach. As we have seen, this is often spoken of, but there is still no indication of what it might mean.” (Ingrao and Israel, 1990, p. 362)

    So, what could it possibly mean? Hmmm? Which part of ‘a completely new research program’ is unclear?

    It simply follows that it is a waste of time to either defend or to attack the microfoundation program because we now know for sure that it was already dead when Jevons/Walras/Menger started it.

    It is not worth the time to criticize again and again different aspects of Orthodoxy because the program is as meaty as Geo-centrism in physics. Yet, what is even worse than ‘finicky scholasticism — getting tied up in little assertions or minor criticism (Popper)’ — is to resort to the conclusion that Orthodoxy is scientific junk but that it is, given the complexity/uncertainty of the subject matter, the best that could be achieved. This, unfortunately, seems to be the resignative deadlock between Orthodoxy and Heterodoxy “Yet most economists neither seek alternative theories nor believe that they can be found.” (Hausman, 1992, p. 248)

    This self-paralysis explains why economics is still a proto-science. There is no way around this: after the SMD proof there remains only one worthwhile talking point and that is, what does the new economics paradigm look like?*

    Egmont Kakarot-Handtke

    Arrow, K. J. (1994). Methodological Individualism and Social Knowledge. American Economic Review, Papers and Proceedings, 84(2): 1–9. URL http:
    Hausman, D. M. (1992). The Inexact and Separate Science of Economics. Cambridge:
    Cambridge University Press.
    Ingrao, B., and Israel, G. (1990). The Invisible Hand. Economic Equilibrium in the History of Science. Cambridge, MA, London: MIT Press.

    * For a start see cross-references Paradigm shift

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