Sunday, April 16, 2006

Missing motivation in macroeconomics

George Akerlof gave a fascinating talk on this topic to a World Bank forum last month. His earlier Nobel Prize lecture on behavioral macroeconomics is here. The World Bank talk is a gas - I would like to hear a stern neoclassical macroeconomist's views on Akerlof's demolition of Ricardian equivalence, the permanent income hypothesis, the Modigliani-Miller theorem, the natural rate hypothesis and rational expectations - and his enthusiastic support for Keynesian underpinnings for macroeconomics.

Akerlof's main line is that norms regarding what people should do - not only real outcomes - should enter the utility function we regard agents as maximising. He argues that the wrong models we have endorsed stem from a false endorsement of parsimonious 'positive economics' and flawed econometric methodology. Economists should study the 'microscopic' not just the average. Keynes' got it right and neo-classicals who supported the big 5 neutralities in economics got it wrong.

By the way, the discussion at the end of the Akerlof talk identifies major issues. Key issue: Where do the norms come from? Role of evolutionary economics? Neuroeconomics? Should macroeconomics be culture specific? Can you change behaviour by changing norms? Can you foster development by changing norms?

The World Bank talk is a stunning lecture - watch it circulate across the web! My speciality is microeconomics not macroeconomics so I'd be very interested in views of others.

6 comments:

Jan said...

A great lecture, an hour well spend. I agree with most of what he is saying about norms and the need to incorporate them in Macro models. However, I do not share his criticism of current Macro; when modelling you should start with simple cases and his suggestions constitute extensions. Modern macro seems to be more and more trying to derive models from micro-foundations and this my be another avenue. I would therefore modify his message from 'Macro has gone in the wrong direction' to 'Macro has got a long way to go and should be open to findings from other disciplines'.

One specific question re: 'Where the norms come from?' 'Are the norms endogenous to Macroeconomic outcomes?' Some surely are which would constitute another obstacle in analysing them in Macro models.

hc said...

Jan, The point you make is right I think and has been made generally in relation to behavioural economics intrusions - you can only intrude as we have already surveyed the landscape.

My main observation is that unless you can rationalise the norms clearly that you end up with something that seems arbitrary.

But Akerlof's assumptions sound more realistic than those underlying the 5 neutralities. Ricardian equivalence, for example, never sounded plausible.

But I am glad you enjoyed it - I did too.

Jan said...

I agree with the implausibility of Ricardian equivalence but I am still happy it is around - it certainly taught me an important insight. And this is something you cannot often say about some more realistic theories.

Anonymous said...

have a look at Rasmussen comment on this post on Akerlof lecture
http://truckandbarter.com/mt/archives/2006/04/where_do_norms.html
-Paul

hc said...

Paul, The quote from Rausmussen I saw says:

It's a bit odd coming from him, since information economics helps explain these things. The big thing is that borrowing is harder than saving, because of the bankruptcy constraint and asymmetric information. Thus, college students can't smooth consumption by borrowing against future income, and corporations have to pay more for outside funding (bonds, bank loans) than internal funding (retained earnings). No norms needed to explain that.

So he is suggesting there is a more parsimonious explanation in terms of asymmetric informmation and budgeting. Fair enough. I suppose I'd have to think about the links between this explanation and that of the behaviorists.

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