There’s been a couple criticism floating about regarding how macroeconomics do their thing. Here’s Matt Yglesias wondering about Levitt wondering about microfoundations. And here’s Ezra Klein turning , unwittingly I think, Cowen’s newest paper into an ideological flamewar about… rational expectations… of all things.

These criticisms are kinda funny. They’re a bit like going after the President for the order he inserts his legs into his pants in the morning. As in… who cares how macro folks get they’re job done, as long as they get their job done. Yeah, I get it. Macro failed to predict the crisis and there was too much hubris and blah blah blah, but I don’t see how dredging through the minutiae of day to day macro research is going to fix those problems. If you think we should be seers, say so. Let us decide the shape and color of our crystal balls.

But I’ll defend rational expectations and microfoundations anyway. These — like Occam’s razor does in the rest of science — bring discipline to macroeconomics. They’re a common language and they make progress in research more transparent.

Rational expectations is just an assumption about the psychology of agents in the model. By insisting on rational expectations, we get a common set of psychological assumptions across models. This is good for two reasons. First, economists know about economics and we don’t know much about psychology (or social psychology or whatever the appropriate level of abstraction). Given this, we choose to fight on the margin we know about.

Second, if every macro researcher had his own psychological assumptions, we wouldn’t know if when two models conflicted in their implications it was because of those different assumptions or because of the other features of the models. By limiting the set of possible assumptions, we limit the set of theories to more manageable size. This makes the game much easier for us cognitively constrained macroeconomists to play. Just imagine what chess would be like to play (or watch) if each player was allowed to make his own rules about how the various pieces could move.

But psychological assumptions only make sense in the context of microfounded modelling. Models without microfoundations aren’t required to have agents and so psychology doesn’t even have to play a role. Again, this discipline limits the size of the allowable macro theories to a set for which its even possible to have a unified vocabulary for talking about those theories. It takes years for a PhD student to get her head around this vocabulary and many students never master it (I’m certainly not even close). So all of you calling to expand the set of possible theories, please think of the children!

(Notice I haven’t even mentioned the Lucas Critique. It was an important impetus for the introduction of microfoundations in the 60’s and 70’s, but they’ve taken a life of their own since then. And the demonstration of the unstable nature of the Phillips curve is an important milestone in the history of macroeconomic thought, but microfoundations live on because they continue to provide value as a discipling mechanism.)

The second function of these disciplining devices is they provide a way to mark progress in the field. If you can build a microfounded, rational expectations model that rationalizes seemingly irrational behavior or displays market failure, then, well, you’ve really done something. Presumably, by building such a model, you’ve supplanted an ad-hoc theory built on some sort of irrationality. Explainations based on irrationality are, inevitably, just-so stories.

“Why did we have a crisis? Well, subprime lenders/borrowers were stupid.” Doesn’t tell you much, does it.

Stories that depend on irrationality are also a sort of god-of-the-gaps. Progress in macro research, as it rationalizes more and more, makes such ad-hoc theories obsolete in the same way that progress in science makes the explanation “God willed it so” obsolete. Ad-hoc theories aren’t wrong, but because they’re less universal, they’re less satisfying.

Maybe you don’t have the same aversion to ad-hoc macro stories based on irrationality as you do to stories about the natural world that depend on the will of God. I do and, more importantly, so do most macroeconomists.

9 thoughts on “Discipline”

  1. >> “Rational expectations is just an assumption about the psychology of agents in the model.”

    OMG, that again. I think you’re the only one who claims that, AFAIK.

    R.E. is about common knowledge of the structure of the economy. That is all. — If you are optimizing and you know the structure of the economy then you are going to take your expectations in that structure.

    Economics and Psychology are different department and I wish we could keep it that way :-)

  2. Both words, rational and expectations, have to do with things in peoples heads. And consider the alternatives to RE; learning or adaptive expectations. These sound awfully pschological-y to me.

    I’m certainly not even close to being the first person to make this connection.

  3. Well, then would you say that all social sciences (including Economics) are mere fields of Psychology?

    I would push the difference because in Economics we don’t touch the cognitive process, we characterize Nash equilibria in detailed games: i.e., we look at the consequences of the structure of interaction.

    Maybe that’s ignorant of Psychology, most likely it is, but I really see a disconnect.

  4. P.S. Let me try again:

    Economics: if agents (humans, robots, aliens, groups) behave like this (WARP, RE, whatever) then this is what happens when they are placed in such and such setup;

    Psychology: this is why agents behave in this and that way when in such and such setup.

    We condition on behavior, they condition on setup? Maybe? — Let me stop here before I embarrass myself. What do you think?

  5. Well, I think my point in the post is that macro folks condition on particular psychological assumptions; we don’t do psychology (i.e. we don’t explore which assumptions would be psychologically more realistic) and there’s good reason not to.

  6. Maybe you don’t have the same aversion to ad-hoc macro stories based on irrationality as you do to stories about the natural world that depend on the will of God. I do and, more importantly, so do most macroeconomists.

    I think it’s very important for researchers to have a strong aversion to ad-hoc stories.

    That doesn’t mean that the stories produced by anti-ad-hoc researchers are necessarily any good, of course.

    For example, Gary Becker was rather critical of ad-hoc explanations for fertility patterns. So he proposed an economic model, built up from first principles, that predicted that richer families would have more children. And he had a data set that showed that all other things being equal, richer families did have more children. Unfortunately most of the time all other things were not equal and poorer families generally had more children. Knowledge of contraception was probably a pretty important factor.

    I would say that Becker made a contribution to the scientific study of family formation. But I think economists tend to judge his contribution by the fact that he relied on a narrow set of powerful assumptions, while non-economists tend to judge his contribution by how much of the variation in the data his theory was able to explain. These two criteria give different judgments; I don’t think the former is necessarily more scientific. Maybe a lot of human behavior just can’t be explained by first principles.

    Macro researchers need to have a particular ethos. They need to be concerned with progress and communication. But a lot of non-researchers are also interested in economics, probably because of its broader political and philosophical implications. I don’t think these people should necessarily have the same ethos.

  7. Thanks for the very nice comment Jesse. You make a good point: just because these things add discipline, they may not do so optimally. This suggests there may be other disciplines macro folks could follow that would yield progress in “better” directions.

    BTW, Jason Lindo wrote a paper suggesting kids are, in fact, normal goods.

  8. A group will always have sanctioned practices… before R.E. and whatnot, the ppl who were doing large, simultaneous equations models were applying “disciplining” practices of their own.

    Actually, adherence to particular rules and practices is what defines a group. Contrary to popular opinion, economists are not those ppl who study the economy but rather people who use a particular set of tools and assumptions.

  9. I think everyone needs to take a step back and consider what rational expectations really is — especially those outside the discipline that like to throw stones at those of us inside.

    Rational expectations (and by this I mean the idea that everyone knows the structure of the economy and thus agreeing with Gabriel) emerged as the alternative to ad hoc expectation formation that was routinely used at the time.

    Unfortunately, rational expectations has been perverted into the view that everyone knows everything and the problem has been solved before it is asked, etc.

    Of course, there are other working within the framework such as Jess Benhabib, Roger Farmer, and others who argue that even in a rational expectations model, beliefs that are not related to fundamentals can have an influence on economic fluctuations. Regardless of whether you agree with their conclusions or the particulars of their work, they do demonstrate that these characterizations of rational expectations are ill-informed (most especially by those outside the discipline).

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