February 4, 2018

From false microfoundations to true macrofoundations (II)

Comment on Simon Wren-Lewis on ‘Large models, small models and Brexit’


Anyone can climb on a soapbox and tell the world how they would save the country or humanity ― except an economist. An economist needs the true theory: “In order to tell the politicians and practitioners something about causes and best means, the economist needs the true theory or else he has not much more to offer than educated common sense or his personal opinion.” (Stigum)

This, then, is the methodological challenge: “The highest ambition an economist can entertain who believes in the scientific character of economics would be fulfilled as soon as he succeeded in constructing a simple model displaying all the essential features of the economic process by means of a reasonably small number of equations connecting a reasonably small number of variables. (Schumpeter)

Economists do not have the true theory/model. The failure of economics had been programmed by the founding fathers with the definition of the subject matter as social science and later on with this very specific guideline: “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)#1

Arrow’s definition covers General Equilibrium Theory, Marshallian partial analysis, Behavioral Economics, DSGE, Agent-Based Models, and verbalized/common sense/ad hoc/special purpose models.

The common denominator of these approaches is that they take individual/social behavior as a starting point and then try to explain the behavior of the economy as a whole. The methodological defect of the microfoundations approach is that NO way leads from the explanation of Human Nature/motives/behavior/action to the explanation of how the economic system works. This is known as the Fallacy of Composition. Economics does not conform to Aristotle’s general definition of science: “When the premises are certain, true, and primary, and the conclusion formally follows from them, this is demonstration, and produces scientific knowledge of a thing.”

Because the premises/microfoundations are NOT certain/true/primary a Paradigm Shift is necessary. Economics has to move from microfoundations to macrofoundations. For a graphical summary of the methodological basics see Wikimedia.#2

Methodologically it holds, (i) all microfoundations approaches are axiomatically dead, (ii) all Keynesian approaches are defective with regard to the definition of macroeconomic profit/income,#3 (iii) if it isn’t macro-axiomatized it isn’t economics,#4 (iv) lacking the true theory, economists have not more to offer than educated/computer-aided common sense.

Egmont Kakarot-Handtke

#1 This translates into the neo-Walrasian hardcore propositions a.k.a. as 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)
#2 Wikimedia AXEC126 From microfoundations to macrofoundations

Source of the inserted chart: Simon Wren-Lewis, mainly macro blog

#3 Is Nick Rowe stupid or corrupt or both?
#4 The core of macroeconomic premises a.k.a. axioms reads: (A0) The objectively given and most elementary systemic configuration of the economy consists of the household and the business sector which, in turn, consists initially of one giant fully integrated firm. (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.

Related 'Where economics went wrong (I)' and 'Where economics went wrong (II)' and 'Where modern macroeconomics went wrong' and 'How Arrow pushed economics over the cliff' and 'From false microfoundations to true macrofoundations (I)' and 'From false micro to true macro: the new economic paradigm' and 'Dilettantes at the end of the coal-pit' and 'Macro for dummies (II)' and 'The new macroeconomic Paradigm' and 'MMT and the canonical macroeconomic model'. For details of the big picture see cross-references Paradigm Shift.


Wikimedia AXEC121i