by From Gerald Holtham (originally a comment) Radford’s points are true but the microfoundations movement in macroeconomics is guilty of greater intellectual crimes than merely attempted reductionism. It is not as if the foundations are built on extensive empirical study of the decision-making elements in an economy. We have a representative consumer who behaves according to the axioms of rational choice under conditions of certainty equivalence. Similarly there is a representative firm modelled in the same way. So we start with illegitimate aggregates, illegitimate because the behavioural reaction functions are not strictly linear so the aggregate would behave like an individual only if all individuals were identical. Spoiler alert: Elon Musk is not absolutely identical with the homeless
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from Gerald Holtham (originally a comment)
Radford’s points are true but the microfoundations movement in macroeconomics is guilty of greater intellectual crimes than merely attempted reductionism. It is not as if the foundations are built on extensive empirical study of the decision-making elements in an economy. We have a representative consumer who behaves according to the axioms of rational choice under conditions of certainty equivalence. Similarly there is a representative firm modelled in the same way. So we start with illegitimate aggregates, illegitimate because the behavioural reaction functions are not strictly linear so the aggregate would behave like an individual only if all individuals were identical. Spoiler alert: Elon Musk is not absolutely identical with the homeless guy in the doorway. Amazon is not identical with your corner shop. Moreover, there is no empirical basis for the supposed individual behaviour anyway, since empirical work from the Allais paradox on has often found the axioms of choice are violated in the case of the consumer.. And companies do not generally have a set of well defined strategies before them and know the consequences of each at least probabilistically. People do not operate under conditions of certainty equivalence and how they actually deal with uncertainty is not considered or explored. These are not microfoundations. They are not really micro and are themselves without any empirical foundation. Yet every macroeconomist who produces a theory or proposition is encouraged to jump through the pointless hoops of showing it is consistent with optimisation by non-existent representative agents. I wonder if there has ever been a greater distortion of a serious discipline. On top of that, Radford is right. Even if we had real microfoundations we should have to deal with emergent properties as the elements interacted to yield group behaviour. .
But we cannot keep beating the dead horse. We have to do better. Agent-based models with diverse participants and reasonable behaviour based on empirical observation are one way forward. They can either be very detailed to apply to a particular question or highly stylized to try and get more general insights. They will not be solvable mathematically but their consquences and patterns have to be explored by computer simulation. Experiments can explore the effect of changing different factors. Empirical verification is extremely difficult since there will be many formulations that can be calibrated to resemble the available data. We must not let an inability to achieve perfection, though, stop us from doing the best we can..