Microfoundations - The Illusion Of Necessary Superiority

Tony Yates has written a long give-and-take of microfounded macro, which I intend reflects the views of many academic macroeconomists. I concur with him that microfoundations guide hold done a groovy bargain to advance macroeconomics. It is a progressive question program, as well as a natural agency for macroeconomic theory to develop. That is why I piece of work with DSGE models. Yet inward 1 honour I intend he is mistaken, which is inward his presumption that microfounded models are naturally superior every bit a tool for policy actions.

Let me assay out as well as paraphrase his discussion. There are basically 2 ways to model the economy. The outset is using microfounded models, which when done correct avoid the Lucas critique. The instant is to practise something similar a VAR, which lets the information speak, although doing policy with a VAR is problematic.

So what almost aggregate models that utilization a fleck of theory as well as a fleck of econometrics? Let me quote.

“A end possibility is that in that location is no choice but to maintain inward non-micro-founded way.  Yet about employment organisation has to endure done – about policy decision, or about investment based on a forecast.  In these circumstances, it’s ok to guide hold a stab at the determination rules or laws of motions for aggregates inward an economic scheme powerfulness expect similar if you lot could micro-found what you lot are concerned with, as well as displace on.  Perhaps doing as well as so volition shed lite on how to practise it properly.  Or at to the lowest degree give you lot about insight into how to laid upwards policy.  Actually many as well as so called microfounded models in all probability alone guide hold this status;  guesses at what something would expect similar if alone you lot could practise it properly.”

As the linguistic communication makes clear, nosotros are talking at to the lowest degree instant best here. Tony would non larn as well as so far every bit to outlaw non-microfounded models, but whatsoever such models are clearly inferior to doing “it properly”.

Yet what is the solid soil of this claim? Influenza A virus subtype H5N1 model should endure every bit expert a representation of the economic scheme every bit possible for the employment inward hand. The modeller has 2 sources of information to assistance them: micro theory almost how individuals may behave, as well as statistical testify almost how the aggregate economic scheme has behaved inward the past. Ideally nosotros would desire to exhaust both sets of information inward edifice our model, but our modelling abilities are but non expert enough. There is a lot inward the information that nosotros cannot explicate using micro theory.

Given this, nosotros guide hold iii alternatives. We tin give the sack focus on microfoundations. We tin give the sack focus on the data. Or nosotros tin give the sack practise something inward betwixt - permit me telephone phone this the eclectic approach. We tin give the sack guide hold an aggregate model where equation specification owes something to theory, but also attempts to rails to a greater extent than of the information than whatsoever microfounded model would assay out to do. I tin give the sack run into absolutely no argue why taking this eclectic approach should create a worse representation of the economic scheme than the other two, whether your employment organisation is policy or forecasting.

Let’s guide hold a real basic example. Suppose inward the existent globe about consumers are credit constrained, piece others are infinitely lived intertemporal optimisers. Influenza A virus subtype H5N1 microfoundation modeller assumes that all consumers are the latter. An eclectic modeller, on finding that consumption shows excess sensitivity to changes inward electrical flow income, adds a term inward electrical flow income into their aggregate consumption function, which otherwise follows the microfoundations specification. Which specification volition perform better? We cannot know for sure, but I run into circumstances inward which the ‘ad hoc’ eclectic specification would practise meliorate than the misspecified microfounded model. (I give a to a greater extent than sophisticated event related to Friedman’s PIH as well as precautionary saving here.)

Now a microfoundation modeller powerfulness reply that the correct thing to practise inward these circumstances is to microfound these credit constrained consumers. But that but misses the point. We are non talking almost question programmes, but detail models at detail points inward time. At whatsoever detail time, fifty-fifty the best available microfounded model volition endure misspecified, as well as an eclectic approach that uses information provided past times the information amongst about theory may selection upwards these misspecifications, as well as hence practise better.

Another response powerfulness endure that nosotros know for certain that the eclectic model volition endure wrong, because (for example) it volition neglect the Lucas critique. More written a long give-and-take of microfounded macro, which I intend reflects the views of many academic macroeconomists. I concur with him that microfoundations guide hold done a groovy bargain to advance macroeconomics. It is a progressive question program, as well as a natural agency for macroeconomic theory to develop. That is why I piece of work with DSGE models. Yet inward 1 honour I intend he is mistaken, which is inward his presumption that microfounded models are naturally superior every bit a tool for policy actions.

Let me assay out as well as paraphrase his discussion. There are basically 2 ways to model the economy. The outset is using microfounded models, which when done correct avoid the Lucas critique. The instant is to practise something similar a VAR, which lets the information speak, although doing policy with a VAR is problematic.

So what almost aggregate models that utilization a fleck of theory as well as a fleck of econometrics? Let me quote.

“A end possibility is that in that location is no choice but to maintain inward non-micro-founded way.  Yet about employment organisation has to endure done – about policy decision, or about investment based on a forecast.  In these circumstances, it’s ok to guide hold a stab at the determination rules or laws of motions for aggregates inward an economic scheme powerfulness expect similar if you lot could micro-found what you lot are concerned with, as well as displace on.  Perhaps doing as well as so volition shed lite on how to practise it properly.  Or at to the lowest degree give you lot about insight into how to laid upwards policy.  Actually many as well as so called microfounded models in all probability alone guide hold this status;  guesses at what something would expect similar if alone you lot could practise it properly.”

As the linguistic communication makes clear, nosotros are talking at to the lowest degree instant best here. Tony would non larn as well as so far every bit to outlaw non-microfounded models, but whatsoever such models are clearly inferior to doing “it properly”.

Yet what is the solid soil of this claim? Influenza A virus subtype H5N1 model should endure every bit expert a representation of the economic scheme every bit possible for the employment inward hand. The modeller has 2 sources of information to assistance them: micro theory almost how individuals may behave, as well as statistical testify almost how the aggregate economic scheme has behaved inward the past. Ideally nosotros would desire to exhaust both sets of information inward edifice our model, but our modelling abilities are but non expert enough. There is a lot inward the information that nosotros cannot explicate using micro theory.

Given this, nosotros guide hold iii alternatives. We tin give the sack focus on microfoundations. We tin give the sack focus on the data. Or nosotros tin give the sack practise something inward betwixt - permit me telephone phone this the eclectic approach. We tin give the sack guide hold an aggregate model where equation specification owes something to theory, but also attempts to rails to a greater extent than of the information than whatsoever microfounded model would assay out to do. I tin give the sack run into absolutely no argue why taking this eclectic approach should create a worse representation of the economic scheme than the other two, whether your employment organisation is policy or forecasting.

Let’s guide hold a real basic example. Suppose inward the existent globe about consumers are credit constrained, piece others are infinitely lived intertemporal optimisers. Influenza A virus subtype H5N1 microfoundation modeller assumes that all consumers are the latter. An eclectic modeller, on finding that consumption shows excess sensitivity to changes inward electrical flow income, adds a term inward electrical flow income into their aggregate consumption function, which otherwise follows the microfoundations specification. Which specification volition perform better? We cannot know for sure, but I run into circumstances inward which the ‘ad hoc’ eclectic specification would practise meliorate than the misspecified microfounded model. (I give a to a greater extent than sophisticated event related to Friedman’s PIH as well as precautionary saving generally, it volition non endure internally consistent. But nosotros also know that the microfounded model volition endure wrong, because it volition non guide hold the correct microfoundations. The eclectic model may endure dependent area to the Lucas critique, but it may also - past times taking to a greater extent than employment organisation human relationship of the information than the microfounded model - avoid about of the specification errors of the microfounded model. There is no agency of knowing which errors thing more.

It’s slow to run into why eclectic models guide hold a difficult time. Because they expect at both theory as well as data, they volition never satisfy both theorists as well as econometricians. But that does non brand them necessarily inferior to either microfounded models or VARs. We tin give the sack written a long give-and-take of microfounded macro, which I intend reflects the views of many academic macroeconomists. I concur with him that microfoundations guide hold done a groovy bargain to advance macroeconomics. It is a progressive question program, as well as a natural agency for macroeconomic theory to develop. That is why I piece of work with DSGE models. Yet inward 1 honour I intend he is mistaken, which is inward his presumption that microfounded models are naturally superior every bit a tool for policy actions.

Let me assay out as well as paraphrase his discussion. There are basically 2 ways to model the economy. The outset is using microfounded models, which when done correct avoid the Lucas critique. The instant is to practise something similar a VAR, which lets the information speak, although doing policy with a VAR is problematic.

So what almost aggregate models that utilization a fleck of theory as well as a fleck of econometrics? Let me quote.

“A end possibility is that in that location is no choice but to maintain inward non-micro-founded way.  Yet about employment organisation has to endure done – about policy decision, or about investment based on a forecast.  In these circumstances, it’s ok to guide hold a stab at the determination rules or laws of motions for aggregates inward an economic scheme powerfulness expect similar if you lot could micro-found what you lot are concerned with, as well as displace on.  Perhaps doing as well as so volition shed lite on how to practise it properly.  Or at to the lowest degree give you lot about insight into how to laid upwards policy.  Actually many as well as so called microfounded models in all probability alone guide hold this status;  guesses at what something would expect similar if alone you lot could practise it properly.”

As the linguistic communication makes clear, nosotros are talking at to the lowest degree instant best here. Tony would non larn as well as so far every bit to outlaw non-microfounded models, but whatsoever such models are clearly inferior to doing “it properly”.

Yet what is the solid soil of this claim? Influenza A virus subtype H5N1 model should endure every bit expert a representation of the economic scheme every bit possible for the employment inward hand. The modeller has 2 sources of information to assistance them: micro theory almost how individuals may behave, as well as statistical testify almost how the aggregate economic scheme has behaved inward the past. Ideally nosotros would desire to exhaust both sets of information inward edifice our model, but our modelling abilities are but non expert enough. There is a lot inward the information that nosotros cannot explicate using micro theory.

Given this, nosotros guide hold iii alternatives. We tin give the sack focus on microfoundations. We tin give the sack focus on the data. Or nosotros tin give the sack practise something inward betwixt - permit me telephone phone this the eclectic approach. We tin give the sack guide hold an aggregate model where equation specification owes something to theory, but also attempts to rails to a greater extent than of the information than whatsoever microfounded model would assay out to do. I tin give the sack run into absolutely no argue why taking this eclectic approach should create a worse representation of the economic scheme than the other two, whether your employment organisation is policy or forecasting.

Let’s guide hold a real basic example. Suppose inward the existent globe about consumers are credit constrained, piece others are infinitely lived intertemporal optimisers. Influenza A virus subtype H5N1 microfoundation modeller assumes that all consumers are the latter. An eclectic modeller, on finding that consumption shows excess sensitivity to changes inward electrical flow income, adds a term inward electrical flow income into their aggregate consumption function, which otherwise follows the microfoundations specification. Which specification volition perform better? We cannot know for sure, but I run into circumstances inward which the ‘ad hoc’ eclectic specification would practise meliorate than the misspecified microfounded model. (I give a to a greater extent than sophisticated event related to Friedman’s PIH as well as precautionary saving speculate on reasons why, on at to the lowest degree about occasions, eclectic models may practise better. But the key indicate I desire to brand hither is that I practise non know of whatsoever epistemological reasons for thinking eclectic models must endure inferior to microfounded models, nevertheless many macroeconomists appear to believe that they are.