does macroeconomics need microfoundations
TRANSCRIPT
-
7/25/2019 Does Macroeconomics Need Microfoundations
1/42
Does
Macroeconomics
Need
Microfoundations?Kevin D. Hoover
-
7/25/2019 Does Macroeconomics Need Microfoundations
2/42
Topics to be covered
From Political EconomytoMicroeconomics
Reductionism: Taking Science to Economics
Methodological Individualism
The Illusion of Aggregation
Representative Agent Models
-
7/25/2019 Does Macroeconomics Need Microfoundations
3/42
From Political EconomyMicroeconomics Lucass Longing Sound economics vs Bad Economics
Economics: Management of the household Political Economics: Management of the state
Early (17th& 18thcentury) Economics Hierarchy > Individual
Determining and enhancing military capabilities
-
7/25/2019 Does Macroeconomics Need Microfoundations
4/42
From Political EconomyMicroeconomics Seeds of Individualism Adam Smith
Classical Economists with a love for markets Limited Individualism
19thCentury marginalism Individual highlighted by the French
Individualism vs Super Individual categories Methodological Individualism
-
7/25/2019 Does Macroeconomics Need Microfoundations
5/42
From Political EconomyMicroeconomicsAlfred Marshall
Removed the Political in Political Economy
Representative Firm and agent
Mid 1930s, Keynes andGeneral Theory Distinguishedmacrofrommicro
Heterogeneity of individuals, but
No systematic aggregation technique
1936 Criticism ofGeneral Theoryand IS-LM Models
Birth of representative agent models
-
7/25/2019 Does Macroeconomics Need Microfoundations
6/42
Reductionism: TakingScience to Economics Scientific explanation: Parsimony
18thCentury gas laws: Boyles-Charles law
Reduced macro-physical gas into microphysical Newtonian mechani Restrictive assumptions
TemperatureMean energy
PressureMean momentum
-
7/25/2019 Does Macroeconomics Need Microfoundations
7/42
Reductionism: TakingScience to Economics the only way to reduce biology to chemistry is through death
The philosophical mind/body problem Mental state (macro) and brain-state (micro)
Supervenience: No one-to-one mapping between micro and macro phenomena
-
7/25/2019 Does Macroeconomics Need Microfoundations
8/42
!et"odo#ogica#$ndividua#ism Defining Economics
Plutology:Study of wealth Mill and Marshall Study of wealth + Study of man
Lionel Robbinson The science of choice
Cournot Problem
Heterogeneousindividuals with unique tastes and constraints
Reclaiming teleology in economics Contrast with biology
-
7/25/2019 Does Macroeconomics Need Microfoundations
9/42
!et"odo#ogica#$ndividua#ism Lucass Critique
People are not stupid!
Securing against Lucass Critique Birth of Methodological Individualism
Methodological or Ontological Individualism?
-
7/25/2019 Does Macroeconomics Need Microfoundations
10/42
-
7/25/2019 Does Macroeconomics Need Microfoundations
11/42
!et"odo#ogica#$ndividua#ism Supervience of Macroeconomics to Microeconomics
Intentionality at micro Cournot Problem
Microeconomics necessarily uses Macroeconomics models as input
-
7/25/2019 Does Macroeconomics Need Microfoundations
12/42
T"e $##usion o( )ggregatio
Microeconomics or Macroeconomics? Same language, technique and mathematics
Economists part ways with physicists
Economics is about heterogeneous things In search of a common denominator
Coal and Oil
H2O
-
7/25/2019 Does Macroeconomics Need Microfoundations
13/42
T"e $##usion o( )ggregatio
Composite Commodity Theorem Constant Relative prices
Assumptions Constant tastes and technology (Identical Utility Functions)
Utility function is homothetic Renders Income distribution unimportant
Same ratio of consumption and relative prices Composite Commodity theorem holds
-
7/25/2019 Does Macroeconomics Need Microfoundations
14/42
T"e $##usion o( )ggregatio
These conditions do not hold Distributional Variations Aggregate functions are unrestricted
Altering fundamental categories after aggregation
-
7/25/2019 Does Macroeconomics Need Microfoundations
15/42
Representative* )gent!ode#sAssuming the problem away is not actually a solution!
Aggregates that belong to no one!
Frank Ramseys optimal savings problem and the wise men at Camb
Two theorems of welfare economicsTop down rather than Bottom up
Ignores redistribution He who comes into equity shall come with clean hands
Avoid the category mistake
-
7/25/2019 Does Macroeconomics Need Microfoundations
16/42
+"om or ,"at doest"e representativeindividua# represenAlan P. Kirman
-
7/25/2019 Does Macroeconomics Need Microfoundations
17/42
+"om or ,"at does t"erepresentative individua# repres
Theoretical in nature
Published in Journal of Economic Perspectives
By Alan P. Kirman (professor at European Universtiy Institute, Flore
The year 1992
Volume no 6
Pg 117-136
-
7/25/2019 Does Macroeconomics Need Microfoundations
18/42
+"at is t"e artic#e about
HOW THE MODEL OF REPRESENTATIVE AGENT IS NOT NEEDED
CREATES PROBLEMS IN THE ANALYSIS
WHAT SHOULD BE FOLLOWED INSTEAD OF THE REPRESENTATI
AGENT MODELALLOW HETROGENIETY
-
7/25/2019 Does Macroeconomics Need Microfoundations
19/42
)pprac" o( t"e artic#e
TO TEAR APART THE ARGUMENT OF THE OPPOSINGPARTY(REPRESENTATIVE INDIVIDUAL ARGUMENT) ONE DIMENTTIME
-
7/25/2019 Does Macroeconomics Need Microfoundations
20/42
.eed (or Representativeindividua# Due to microfoundations
Why microfoundations are called for? Because they believe that an adequate model of agent behavior has been
Because they need unique and stable equilibrium Need to use comparative statics in order to analyze policy changes.
Need to create appropriate shape of the aggregate demand curve
-
7/25/2019 Does Macroeconomics Need Microfoundations
21/42
+"/ cant ,e 0nd conditio(or uniue and stab#e
eui#ibrium Need for representative individual might not arise If there conditions cfound which give a unique and stable equilibriumThere are none
Sonnenschein (1972)
Debreu (1974)
-
7/25/2019 Does Macroeconomics Need Microfoundations
22/42
Restrictuve conitions
Attempting to create unique and stable equilibrium via assumptionsapplying 3 assumptions continuity; that the value of total excess demand must equal zero at all pprices
the budget constraint for the economy as a whole be satisfied (Walras' law
Excess demand is homogeneous of degree zero (only relative prices count
Even this solution suffers from weak axiom of revealed preferences
-
7/25/2019 Does Macroeconomics Need Microfoundations
23/42
o, about #oca##/ uniue
We could use locally unique and stable equilibriums.
This argument is weak because of Inconsistencies
Not actually used by macroeconomists.
-
7/25/2019 Does Macroeconomics Need Microfoundations
24/42
-
7/25/2019 Does Macroeconomics Need Microfoundations
25/42
+"ere ,ou#d t"e representatindividua# be use(u#
Stoker(1986)individuals take their decisions only the basis of aggregate variables
all individuals have the same marginreaction
-
7/25/2019 Does Macroeconomics Need Microfoundations
26/42
+"/ ,e cant skiprepresentative individua# If we do either
Preferences vary
Income distribution would vary.
Prefernce vary Degrees of freedom would be too high
Multiple equilibria
Income distribution vary Multiple equilibria
-
7/25/2019 Does Macroeconomics Need Microfoundations
27/42
Representative individua
Representative individual is one "representative" standard utility mindividual whose choices coincide with the aggregate choices of theheterogeneous individuals
Will discuss the issues that come by one by one.
Where repetitive we would mention the concept again without givingdetails
-
7/25/2019 Does Macroeconomics Need Microfoundations
28/42
17 .o coordination
Identical agents dont need to coordinate as there is nothing to coorabout.
Such models are particularly ill-suited to studying macroeconomic plike unemployment, which should be viewed as coordination failures
Economists show this through models of no trade such as Rubenstein, 1975;
Hakansson et al., 1982;
Milgrom and Stokey, 1982
-
7/25/2019 Does Macroeconomics Need Microfoundations
29/42
8ounter pointsArgument for representative agent says that Such models are not inte
study those problems which involve, in an essential way, questions ofcoordination but are designed to examine some central macroeconomphenomena.
The failure of the above argument is due to four reasons
Aggregate behavior is not equal to individual behavioEconomy might be rational on the aggregate but it does not
the individual is rationalUsing such a model to analyze the consequences ofchanges may not be validBecause actions preferred by the representative individual mpreferred by the actual individuals
-
7/25/2019 Does Macroeconomics Need Microfoundations
30/42
The preferences of the representative individuallegitimately be used to decide whether one econosituation is "better" than another because
it may well be the case that in two situations of which representative prefers the first to the second, every indprefers the second to the first
Empirical testing of the representative agent migfalsified because
Individual possessing unnatural characteristics.if one rejects a particular behavioural hypothesis, it iswhether one is really rejecting the hypothesis in questrejecting the additional hypothesis that there is only oindividual
-
7/25/2019 Does Macroeconomics Need Microfoundations
31/42
27 .o trade counterargument Counter point is that economy is always in equilibrium.
i.e. the representative agent eats what he produces.
Hence the actions of the representative agents are movements arounequilibrium which show the evolution of the economy.
-
7/25/2019 Does Macroeconomics Need Microfoundations
32/42
.o trade counter point,eaknessThe argument requires some adjustment mechanism e.g. tatonment
these adjustment process are found to hold
-
7/25/2019 Does Macroeconomics Need Microfoundations
33/42
37 Representative agentbe(ore and a(ter t"e po#ic If the representative agent that represents the aggregate choice mighrepresent the aggregate change after the policy change. His equilibrium and not his choices coincide with the society.
Proven in the papers. Geweke (1985)
Kupiec and Sharpe (1991)
-
7/25/2019 Does Macroeconomics Need Microfoundations
34/42
47 9rob#em o( pre(erencet"e individua# It is possible that the representative individual prefers situation a tob, whilst all the individuals that are "represented" strictly prefer b toJerison (1984),
For technical details refer to the paper
-
7/25/2019 Does Macroeconomics Need Microfoundations
35/42
57 oint "/pot"esis prob#em: testing tc"ange or t"e compatibi#it/ o( t"e c",it" t"e representative individua#
Whenever we are testing a behavioral hypothesis we are testing two th the behavioral hypothesis itself
if the choices of the aggregate can indeed be described as the choices of a maximizing agent.
Summers (1991) says that in Hansen and Singleton (1982, 1983) the
the asset pricing and consumption relationship was more a rejecrelationship between consumption and asset pricing of the reindividual rather than the asset pricing of the aggregate.
-
7/25/2019 Does Macroeconomics Need Microfoundations
36/42
)not"er e;amp#e: e;cessconsumption smoot"ingThe very existence of the Deaton paradox might be due to the represagent i.e. Clarida (1991) constructed a model that allowed for heterobut does not contain excess smoothing.
-
7/25/2019 Does Macroeconomics Need Microfoundations
37/42
ST>$.?ETR?E.$ET@ )RE TE ).S+
Increasing dispersion of income and preferences would be a positivedevelopment because It would more stable outputs Hildenbrand (1983) and Grandmont (1987,
erratic individual demand behaviour may give very smooth aggregate dembehaviour(Cournot)
Individual jumps will occour at diferent prices and hence cause the Dembe more continuous. (Trockel, 1984).
if the income distribution is decreasing -that is if each successively higheclass contains a smaller proportion of agents-then the law of demand holHildenbrand (1983)
-
7/25/2019 Does Macroeconomics Need Microfoundations
38/42
ST>$.?ETR?E.$ET@ )RE TE ).S+
Increasing dispersion of income and preferences would be a positivedevelopment because if agents have very spread out preferences, then aggregate excess demandthe well known "gross substitutability" property and equilibria will be unstable. Grandmont (1991) Dont even require maximization as long as the budget constraints are satisfied
-
7/25/2019 Does Macroeconomics Need Microfoundations
39/42
$.TR=
-
7/25/2019 Does Macroeconomics Need Microfoundations
40/42
?ame t"eor/
Single agent models are being replaced by multiple agent models
Individuals operate in sub-pockets of economy. local but interacting activity emerges some sort of self organization whichregularity at the macroeconomic level. Lesourne (1991)
Models for interaction of agents and how the changes are propogated throthe economy are also investigated.
-
7/25/2019 Does Macroeconomics Need Microfoundations
41/42
8onc#usion
We should take the right way out, not the easy way out.
-
7/25/2019 Does Macroeconomics Need Microfoundations
42/42
T).A @