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.