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A new perspective on microfoundations

from Lars Syll

Defenders of microfoundations and its rational expectations equipped representative agent’s intertemporal optimization often argue as if sticking with simple representative agent macroeconomic models doesn’t impart a bias to the analysis. I unequivocally reject that unsubstantiated view, and have given the reasons why here.

These defenders often also maintain that there are no methodologically coherent alternatives to microfoundations modeling. That allegation is of course difficult to evaluate, substantially hinging on how coherence is defined. But one thing I do know, is that the kind of microfoundationalist macroeconomics that New Classical economists and “New Keynesian” economists are pursuing, are not methodologically coherent according to the standard coherence definition (see e. g. here). And that ought to be rather embarrassing for those ilks of macroeconomists to whom axiomatics and deductivity is the hallmark of science tout court.

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The fact that Lucas introduced rational expectations as a consistency axiom is not really an argument to why we should accept it as an acceptable assumption in a theory or model purporting to explain real macroeconomic processes (see e. g. here). And although virtually any macroeconomic empirical claim is contestable, so is any claim in micro (see e. g. here).

On this issue I think Paul Krugman comes closer to truth than his “New Keynesian” buddies with his remark that 

what we call “microfoundations” are not like physical laws. Heck, they’re not even true.

Using formal mathematical modeling, mainstream economists sure can guarantee that the conclusions hold given the assumptions. However, the validity we get in abstract model worlds does not warrantly transfer to real world economies. Validity may be good, but it isn’t enough. From a realist perspective both relevance and soundness are sine qua non.

broken-linkIn their search for validity, rigour and precision, mainstream macro modellers of various ilks construct microfounded DSGE models that standardly assume rational expectations, Walrasian market clearing, unique equilibria, time invariance, linear separability and homogeneity of both inputs/outputs and technology, infinitely lived intertemporally optimizing representative household/ consumer/producer agents with homothetic and identical preferences, etc., etc. At the same time the models standardly ignore complexity, diversity, uncertainty, coordination problems, non-market clearing prices, real aggregation problems, emergence, expectations formation, etc., etc.

Oscar Reutersvärd’s impossible ‘Penrose triangle’ certainly looks possible when you look at one corner at a time. The problem — paradox — appears first when you view the triangle as a whole …

  1. July 17, 2017 at 4:56 am

    Like all other essays, Lars Syll is sharp in his critique of mainstream economics, but he does not present his own perspective on how to re-build or re-construct economics.

    In this post, Syll attacks mainstream notion of microfoundations and show how it s misplaced. But, isn’t it now a time to think about how to construct our theory. In that perspective, microfoundations are one of necessary parts of economics. Why does he always talk in negative form and scarcely in positive form? I know criticism is necessary but criticism alone can never change economics.

    He argues that it is necessary to incorporate “complexity, diversity, uncertainty, coordination problems, non-market clearing prices, real aggregation problems, emergence, expectations formation, etc.” in real world economics. But he does not show how to approach in that direction. If we want to do so, pursuit of microfoudantions is necessary. It is necessary in order to reconsider the very foundations of new economics, or real world economics, if he like.

    He may say that, even if it is necessary, if it is not possible to do so, we cannot do so. But microfoudantions are possible. If it is successful or not, please see my draft below: Microfoundantions of Evolutionary Economics. This is the first chapter of a book with the same title with two of my colleagues. I am now writing the second chapter. In this second chapter, I will argue questions more close to the ordinary notion of economics, like prices, choice of production techniques, firms’ behavior, coordination between firms, and others.

    Microfoundations of Evolutionary Economics
    https://www.researchgate.net/publication/301766363_Microfoundations_of_Evolutionary_Economics

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