January 5, 2017

How to finally hammer down the nails in the coffin of Monty Python economics

Comment on Peter Radford on ‘Tectonics and Growth’

Blog-Reference

Peter Radford puts his enduring perplexity about economics on record: “The description of human behavior that underpins modern economics is so bizarre that my first thought was that it must be some form of Monty Pythonesque satire. Surely, I thought, this is a joke and in a few pages all will be revealed. But no. Economics really is built on a foundation that to outside eyes is not just odd, but what appears to be a deliberate spoof.”

All this, of, course, is obviously true. But then, how could it happen and, much more important, how can we ― after 140+ years ― stop wondering and finally get out of Monty Python economics?

The inevitable failure of economics started with this fundamental methodological blunder: “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)

The definition of the subject matter translates into the following hard core propositions, a.k.a. axioms: “HC1 economic agents have preferences over outcomes; HC2 agents individually optimize subject to constraints; HC3 agent choice is manifest in interrelated markets; HC4 agents have full relevant knowledge; HC5 observable outcomes are coordinated, and must be discussed with reference to equilibrium states.” (Weintraub, 1985)

From these premises follows what Leijonhufvud famously called the Totem of Micro/Macro, that is, SS-curve―DD-curve―equilibrium. This construct is the analytical workhorse of economics and the one-size-fits-all explanation of how markets work.

For every person with keen scientific instincts, this construct is immediately and forever unacceptable. Economists, to their disgrace, have no scientific instincts at all. They simply swallow any junk. Obviously, the Walrasian axiom set contains THREE NONENTITIES: (i) constrained optimization (HC2), (ii) rational expectations (HC4), (iii) equilibrium (HC5). Every theory/model that contains a nonentity is A PRIORI false. By consequence, economics from Jevons/Walras/Menger to DSGE/RBC is false.

The microfoundations speak about human behavior. Now, human behavior is the subject matter of psychology, sociology, anthropology etcetera and NOT of economics. What is worse, NO way leads from the understanding of human behavior to the understanding of how the monetary economy works.

So, the definition of the subject matter has to be changed from Arrow’s methodological individualism to: Economics is the science which studies how the monetary economy works. Or, as Victor Beker puts it: “Economics deals with the study of the economic system. Why not starting by studying the economy as a system?”#1

First of all, the behavioral axioms HC1/HC5 have to be replaced by objective systemic axioms. The most elementary configuration of the economy consists of the household and the business sector which in turn consists initially of one giant fully integrated firm and is given by these three axioms: (A1) Yw=WL wage income Yw is equal to wage rate W times working hours L. (A2) O=RL output O is equal to productivity R times working hours L. (A3) C=PX consumption expenditure C is equal to price P times quantity bought/sold X.#2

(A1) to (A3) defines the pure consumption economy. Note that the set of foundational equations is entirely FREE of green cheese behavioral assumptions, i.e., the axiom set is purely SYSTEMIC.#3

From macro one arrives at micro by successive DIFFERENTIATION. Differentiation is top-down, aggregation is bottom-up. The methodologically correct way is to start with macrofoundations and then to differentiate.

The TRUE systemic macrofoundations A1/A3 replace the false behavioral microfoundations HC1/HC5 and Keynes’s false systemic macrofoundations.#4 From the true macrofoundations the WHOLE superstructure of economics has to be rebuilt.#5

To paraphrase a summary of Blaug: ‘At long last, it can be said that the history of general theory from Walras to Arrow-Debreu and on to DSGE has been a journey down a blind alley, and it is the set A1/A3 to have finally hammered down the nails in the coffin.’

Egmont Kakarot-Handtke

#1 Source
#2 See also ‘From microfoundations to macrofoundations
#3 For details see the short paper ‘How the Intelligent Non-Economist Can Refute Every Economist Hands Down
#4 See ‘How Keynes got macro wrong and Allais got it right
#5 See cross-references Paradigm shift

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NOTE on Lars Syll on Macroeconomic Challenges, RWER-blog, Jan 5

For those who are dissatisfied with the time-wasting heterodox blubbering about the countless challenges of Orthodoxy, it will be most welcome to learn that the whole microfoundations issue has already been solved. See ‘How to finally hammer down the nails in the coffin of Monty Python economics