Microfoundations In Addition To The Values Of Policymakers

For economists

This post started an interesting discussion, directed largely past times Beatrice Cherrier‏ (@Undercoverhist), almost how economists are increasingly deal to enshroud the value judgements they make. By value sentence I exercise non hateful the trivial, similar why did you lot larn interested inward this surface area rather than others, but to a greater extent than serious issues similar what values are assumed every bit component of their analysis. (The distinction betwixt the 2 was the hollo for of my master copy post.)

It occurred to me that microfounded macro has an number that is related to that discussion. It is inward fact discussed inward my OXREP paper, but used in that place every bit an event of where microfoundations had gone i pace backwards, amongst solely the prospect of going forwards inward the future. The event is the derivation of a benevolent policy maker’s preferences from the utility role of the instance consumer assumed every bit component of the model, a business of question initiated past times Michael Woodford.

Before getting on to the values point, allow me complaint that it is a skillful event of the primacy of internal consistency inward microfoundations rather than the Lucas critique. Before Woodford’s work, microfoundations macroeconomists were embarrassed that they typically assumed an promotion hoc objective role for the policy maker choosing betwixt the bads of deviations inward inflation from target or deviations of output from its natural rate. Typically, results were presented amongst option values for the policy maker’s preferences betwixt the two. But if the policy maker was benevolent too the model is internally consistent, shouldn’t this objective role reverberate the utility role of the instance consumer inward the model? What Woodford showed was how this could hold upwards done, too amend even too hence how it implied the course of didactics of objective function, quadratic, that had previously been used on an promotion hoc basis. The preference betwixt output too inflation deviations was at i time an implication of the model.

It was, it is of import to admit, an exciting breakthrough. We could at i time say policymakers that, if this is the utility role of the instance consumer, too the model was a skillful representation of reality (yes, I know), this is how you lot should hold upwards trading off output too inflation losses. It was a literature I participated inward amongst colleagues. The derivations were difficult too deadening to do, too could accept pages of algebra, but within a twelvemonth every macro newspaper of this sort had switched from promotion hoc objective functions to derived objective functions. If you lot were doing macro too wanted the newspaper published inward a skillful journal, this is what you lot had to do. 

There was solely i problem. The uncomplicated version of a New Keynesian model that most researchers used implied that inflation deviations were much to a greater extent than of import than output deviations. This was rattling dissimilar from the adhoc objective functions that had been used before, where equal weights were ordinarily used. It also appeared unrealistic: non solely did policy makers non human activity every bit if inflation was all of import inward reality, but consumers inward happiness studies tended to charge per unit of measurement unemployment every bit to a greater extent than of import than inflation. That was the pace backwards that I mentioned earlier.

But what it also did, I think, was to brand less transparent the value judgements that the researcher was implicitly making. Everyone, including policymakers, know that macro models are huge simplifications, but to larn interpretable results that is what you lot cause got to do. Yet they also cause got around sentiment of their preferences betwixt excess output too inflation. But if the policymaker’s preferences were at i time endogenised, they would to a greater extent than ofttimes than non larn welfare results presented to them amongst no selection to brand involving their ain preferences.

Researchers were non hiding anything. The utility role of the instance agent was in that place to see, too most papers would exhibit the derived objective role amongst a depression relative weight on output deviations. But what was ofttimes non shown was how the results would differ nether option objective functions: why would you lot every bit a modeller committed to microfoundations, every bit to utilization whatever other weights than those implied past times the model was internally inconsistent. Thus internal consistency took a value sentence away from policy makers.