does macroeconomics need microfoundations

7/25/2019 Does Macroeconomics Need Microfoundations

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Does

Macroeconomics

Need

Microfoundations?Kevin D. Hoover


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Topics to be covered

From Political EconomytoMicroeconomics

Reductionism: Taking Science to Economics

Methodological Individualism

The Illusion of Aggregation

Representative Agent Models


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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


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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


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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


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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


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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


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!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


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!et"odo#ogica#$ndividua#ism Lucass Critique

People are not stupid!

Securing against Lucass Critique Birth of Methodological Individualism

Methodological or Ontological Individualism?


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!et"odo#ogica#$ndividua#ism Supervience of Macroeconomics to Microeconomics

Intentionality at micro Cournot Problem

Microeconomics necessarily uses Macroeconomics models as input


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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


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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


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These conditions do not hold Distributional Variations Aggregate functions are unrestricted

Altering fundamental categories after aggregation


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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


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+"om or ,"at doest"e representativeindividua# represenAlan P. Kirman


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+"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


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+"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


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)pprac" o( t"e artic#e

TO TEAR APART THE ARGUMENT OF THE OPPOSINGPARTY(REPRESENTATIVE INDIVIDUAL ARGUMENT) ONE DIMENTTIME


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.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


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+"/ 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)


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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


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o, about #oca##/ uniue

We could use locally unique and stable equilibriums.

This argument is weak because of Inconsistencies

Not actually used by macroeconomists.


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+"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


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+"/ ,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


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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


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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


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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


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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


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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.


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.o trade counter point,eaknessThe argument requires some adjustment mechanism e.g. tatonment

these adjustment process are found to hold


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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)


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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


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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.


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)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.


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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)


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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


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$.TR=


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?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.


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8onc#usion

We should take the right way out, not the easy way out.


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T).A @

does macroeconomics need microfoundations

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