Microfoundations In Addition To The Speed Of Model Development

                In a recent post I suggested ane microfoundations based declaration for what Blanchard in addition to Fischer telephone telephone useful models, in addition to I telephone telephone aggregate models. Both Mark Thoma in addition to written before on New Old Keynesians. Part of that slice describes why economists might, at to the lowest degree temporarily, forsake microfounded models inwards favour of a ‘useful’ (to utilisation Blanchard in addition to Fischer’s terminology) model from the past. To quote

“The argue that many of us looked backward for a model to help us sympathise the acquaint crisis is that none of the electrical flow models were capable of explaining what nosotros were going through. The models were largely constructed to analyze policy is the context of a Great Moderation....”

and

“So, if null inwards the acquaint is adequate, you lot laid about to aspect to the past. The Keynesian model was constructed to aspect at precisely the kinds of questions nosotros needed to answer, in addition to equally long equally you lot are aware of the limitations of this framework - the ones that modern theory has discovered - it does furnish you lot amongst a way of thinking virtually how economies operate when they are running at less than total employment. This model had already worried virtually financial policy at the null involvement charge per unit of measurement bound, it had already thought virtually Says law, the paradox of thrift, monetary versus financial policy, changing involvement in addition to investment elasticities inwards a  crisis, etc., etc., etc. We were inwards the oculus of a crisis in addition to didn't possess got fourth dimension to hold off for novel theory to live developed, nosotros needed answers, answers that the elegant models that had been constructed over the final few decades but could non provide.”

I recollect this identifies a instant argue why an aggregate model – a model without explicit microfoundations – mightiness live preferred to microfounded alternatives, which Paul Krugman also covers inwards his signal (3). This has to exercise amongst the speed at which microfoundations macro develops.

                Developing novel microfounded macromodels is hard. It is difficult because these models demand to live internally consistent. If nosotros recollect that, say, consumption inwards the existent Earth shows to a greater extent than inertia than inwards the baseline intertemporal model, nosotros cannot just add together unopen to lags into the aggregate consumption function. Instead nosotros demand to recollect virtually what microeconomic phenomena mightiness generate that inertia. We demand to rework all relevant optimisation problems adding inwards this novel ingredient. Many other aggregate relationships too the consumption share could alter equally a result. When nosotros exercise this, nosotros mightiness observe that although our novel thought does the play tricks for consumption, it leads to implausible conduct elsewhere, in addition to hence nosotros demand to become dorsum to the drawing board. This internal consistency criteria is partly what gives these models their strength.

                It is rattling of import to exercise all this, but it takes time. It takes fifty-fifty longer to convince others that this conception makes sense. As a result, the evolution of microfounded macromodels is a wearisome affair. The most obvious illustration to me is New Keynesian theory. It took many years for macroeconomists to railroad train theories of toll rigidity inwards which all agents maximised in addition to expectations were rational, in addition to withal longer for them to convince each other that unopen to of these theories were stiff plenty to furnish a plausible Earth for Keynesian type concern cycles.

                H5N1 to a greater extent than recent example, in addition to ane to a greater extent than direct relevant to Mark Thoma’s discussion, is the role of diverse financial marketplace position imperfections inwards generating the possibility of a financial crisis of the type nosotros possess got late experienced. There is a lot of of import in addition to fascinating piece of work going on inwards this area: Stephen Williamson surveys unopen to of it here. But it volition bring unopen to fourth dimension before nosotros piece of work out what matters in addition to what does not. In the meantime, what exercise nosotros do? How should policy respond today?

                To reply those questions, nosotros volition possess got to autumn dorsum on models that comprise elements that appear cite hoc, yesteryear which I hateful that they exercise non as yet possess got clear in addition to widely accepted microfoundations. Those models may comprise elements discussed yesteryear past economists, similar Keynes or Minsky, who worked at a fourth dimension before the microfoundations projection took hold. Now microfoundations purists would non (I would hope) become hence far equally to enjoin that variety of cite hoc modelling should non live done. What they mightiness good enjoin is delight move along it good away from the amend economical journals. Do this cite hoc materials inwards fundamental banks, yesteryear all means, but move along it out of nation of the fine art academic discourse. (I suspect this is why such models are sometimes called ‘policy models’.)

                This microfoundations purist sentiment is a mistake. It is a fault because it confuses ‘currently has no clear microfoundations’ amongst ‘cannot e'er live microfounded’.  If you lot could essay the latter, in addition to hence I would concede that – from a microfoundations perspective – you lot would non live interested inwards analysing this model. However our sense shows that postulated aggregate conduct that does non possess got a to a greater extent than oft than non accepted microeconomic explanation today may good possess got ane tomorrow, when theoretical evolution has taken place. New Keynesian analysis is a instance inwards point. Do the purists actually desire to propose that, prior to 1990 say, no academic newspaper should possess got considered the implications of toll stickiness?

                So hither I would propose is a instant declaration for using aggregate (or useful, or cite hoc) models. Unlike my first, it allows these models non to possess got whatever clear microfoundations at present. Such analysis should live respected if at that topographic point is empirical testify supporting the cite hoc aggregate relationship, in addition to if the implications of that human relationship could live important. In these circumstances, it would live a fault for academic analysis to possess got to hold off for the microfoundations piece of work to live done. (This thought is discussed inwards to a greater extent than especial inwards “Internal consistency, toll rigidity in addition to the microfoundations of macroeconomics” Journal of Economic Methodology (2011) Vol. 18, 129-146 - before version here.).