Home > Uncategorized > Microfoundations — neither law nor true

Microfoundations — neither law nor true

from Lars Syll


Simon Wren-Lewis is one of many mainstream economists that staunchly defends the idea that having microfoundations for macroeconomics moves macroeconomics forward. A couple of years ago he wrote this:

I think the two most important microfoundation led innovations in macro have been intertemporal consumption and rational expectations …  [T]he adoption of rational expectations was not the result of some previous empirical failure. Instead it represented, as Lucas said, a consistency axiom …

I think macroeconomics today is much better than it was 40 years ago as a result of the microfoundations approach.

On this kind of argumentation I would like to add the following comments:

(1) The fact that Lucas introduced rational expectations as a consistency axiom is not really an argument as to why we should accept it as an acceptable assumption in a theory purporting to explain real macroeconomic processes (see e. g. Robert Lucas, rational expectations, and the understanding of business cycles).

(2) “Now virtually any empirical claim in macro is contestable,” Wren-Lewis writes. Yes, but so is virtually also any claim in micro (see e. g. When the model is the message – modern neoclassical economics).

(3) To the two questions “Can the microfoundations approach embrace all kinds of heterogeneity, or will such models lose their attractiveness in their complexity?” and “Does sticking with simple, representative agent macro impart some kind of bias?” I would unequivocally answer yes (I have given the reasons why e. g. in David Levine is totally wrong on the rational expectations hypothesis).

(4) “Are alternatives to microfoundations modelling methodologically coherent?” Well, I don’t know. But one thing I do know, is that the kind of miocrofoundationalist macroeconomics that New Classical economists in the vein of Lucas and Sargent and the ‘New Keynesian’ economists in the vein of Mankiw et consortes are pursuing are not methodologically coherent (as I have argued e. g. in What is (wrong with) economic theory?). And that ought to be rather embarrassing for those ilks of macroeconomists to whom axiomatics is the hallmark of science tout court.

As Paul Krugman once remarked — “what we call ‘microfoundations’ are not like physical laws. Heck, they’re not even true.”

  1. ghholtham
    June 1, 2020 at 3:05 pm

    Wren Lewis is a good man and I am slightly surprised at the quote since his work has been generally data driven. Other eminent UK macroeconomists, like John Mellbauer and David Hendry have criticised the current fashion for DSGE models sharply and proposed different, more empirically based methods. It’s obvious to me that the whole microfoundations movement was a massive detour that led nowhere. We are little wiser than we were forty years ago and have wasted a lot of time. Increasingly the academic fashion is to admit that representative agent theorising is a crock and to give up on macroeconomics altogether as an academic subject, leaving it to the lowly practitioners in government or the markets.

    • Meta Capitalism
      June 2, 2020 at 2:43 pm

      It’s obvious to me that the whole microfoundations movement was a massive detour that led nowhere. We are little wiser than we were forty years ago and have wasted a lot of time…. Increasingly the academic fashion is to admit that representative agent theorising is a crock and to give up on macroeconomics altogether as an academic subject, leaving it to the lowly practitioners in government or the markets. ~ Gerald Holtham.

      So this is your view now Gerald? There are many versions of “whole microfoundations” other than just the DSGE models or the “crock” of “representative agent theorizing”. Are you saying they are all a crock or waste of time? Or just one narrow school of theorizing?

  2. Craig
    June 2, 2020 at 6:25 am

    As Steve Keen is slowly coming to realize macro-economics has suffered from a sad lack of knowledge regarding the economic significance of accounting/double entry bookkeeping. As a result it has veered off into mere mathematics and flimsy theoretics if not complete irrelevance. When one stacks the real world power of mathematics up against self interest, the abstract “truths” of mathematics basically disappear.

    Attending to the conventions and groundings that accounting has on the money system and hence the economy enlightens truth and points the way toward real world economic solutions that are able to nullify the seeming power of both economic orthodoxies and vested self interests.

  3. ghholtham
    June 3, 2020 at 11:08 am

    Meta, to be more precise I meant the direction that the search for microfoundations took was one that led nowhere. I do think representative agent theorising has led to no useful empirical insights and focusing on DSGE models based on it has been a waste of time. Finding useful microfoundations would mean tackling intractable problems of aggregation in economics. The econo-physicists applying techniques of statistical mechanics is somewhat more promising but has yet to deal with the self-referential aspects of the economic system, at least so far as I know. ABM models are currently the most promising route. They are a “brute force” method rather than an attempt at parsimonious theorising but may be the best we can do.

    • Meta Capitalism
      June 4, 2020 at 3:10 am


    • Meta Capitalism
      June 4, 2020 at 3:12 am

      Appreciate the clarity my friend.

  4. Ken Zimmerman
    June 21, 2020 at 12:12 pm

    Would we be wrong to assume that in economics, the term microfoundations refers to the microeconomic analysis of the behavior of individual agents such as households or firms that underpins a macroeconomic theory? If our assumption is correct, then I must wonder why such an up/do, over/under classification is necessary in economic theory. First, such clear divisions do not exist in either the economic or noneconomic actions of actors as we observe those actions. In fact, in actual situations actions tend to overlap one another in terms of their purposes, breath, and expected outcomes. An observer may theorize connections but until such connections are observed by third parties they cannot be said to exist in any genuine sense. To put it another way, till such observations are accumulated and verified the relationships between actions should be put under the fiction rather than nonfiction category. Second, by assuming without such accumulated observations that micro economic actions and macro economic actions exist and the former is subsumed under the latter, researchers and theorists sabotage their work by neglecting and ultimately denying the work of actual actors in making their own ways of life, economic and otherwise. There is no greater sin in social science than this.

    The interests of those who study economic ways of life vary, of course. Medieval Scholastic economics focused on small-scale transactions between individuals and was dominated by monks who had taken a vow of poverty. So, this work could legitimately be called small scale or micro. And its focus could be correctly labeled “economic ethics.” By the time of the Renaissance (14th to 17th centuries), attention of researchers (now mostly not monks who had taken a vow of poverty) was shifting economic ways of life among institutions such as the church, monarchial states, and even international trade. This focus can legitimately be labeled large scale or macro. With most of its focus on accumulating money rather than ethics. But the relationships between these two foci of economics study is neither simple nor straight forward. There is no way to a priori assume that one is more important or superior to the other. In fact, the harder economists argue this structure the more obvious it becomes their arguments are not the kinds of fictions on which humans depend. French anthropologist Régis Debray shows us that: “It is the symbolic that creates the social bond, not the other way around.” Humans, he writes, “are institutional beings, dependent on mediations.” Israeli historian Yuval Noah Harari makes the same point. The power of our species says Harari “depends on creating and believing fictions. Ever since the Stone Age, self-reinforcing myths have served to unite human collectives.” But economists fail to create believable fictions to bind communities together. Reviewing their pathways makes this clear. The standard narrative maintains that we live in the age of microfoundations. The recent worldwide financial crisis may have emboldened critics of this microfoundational orthodoxy, but it remains the dominant view that macroeconomic models must go beyond supply and demand functions to “the level of objective functions, constraint sets, and market-clearing conditions” (Sargent 1982, 383). Only by doing this, the argument goes, can we truly understand “the way in which optimizing agents make their decision rules,” which in turn “depend on the dynamic environment in general, and the government policy rules in particular” (Sargent 1982, 383). The goal of the microfoundations project, as articulated in the 1980s, was to reincorporate “aggregative problems such as inflation and the business cycle within the general framework of ‘microeconomic’ theory” (Lucas 1987, 107). Microeconomics from this view is prior to macroeconomics, because “only when macroeconomic aggregates are explicable as consequences of well-formulated optimization problems for individuals … will macroeconomic reasoning be secure” (Hoover 1988, 87; see also Backhouse 1995, ch. 8). The aim is the “euthanasia of macroeconomics” (Hoover 1988, 87; 2010, 331). As Robert Lucas puts it, if the microfoundations project succeeds, “the term ‘macroeconomic’ will simply disappear from use and the modifier ‘micro’ will become superfluous. We will simply speak … of economic theory …” (Lucas 1987, 107-108). I challenge you to find any narrative less inspiring of social cohesion that this.

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