Micro wishes versus macro realities

There was some blogging done last week concerning the merits of micro foundations in macroeconomic modeling. See Thoma’s link to this Simon Wren-Lewis piece, followed by Krugman’s take, Robert Waldmann’s two-cents, the Noah Smith response, and another go-ahead by Krugman. I’m sure there are others. The long and short of it is this – economists have taken to primarily using macroeconomic models based off microeconomic functions, like maximum behavior and perfect utility, except that those micro-founded macro models often don’t perform any better (or in some cases, worse) than looser aggregate macro-models at prediction. The problem, according to Krugman, is that economists insist on only using micro-founded models even when they clearly don’t work. I’m not an economist so much of this back and forth on methodology looks like the academic equivalent of Inside Baseball. Other than simply being curious about the intra-field dialogue this wouldn’t warrant a post, BUT…

…over the weekend Harold Pollack chimed in and reminded me how these discussions relate to public policy (edited and emphasis added to form my point – do yourself and favor and read the whole post):

[…] In practical policy analysis, we rarely insist on using models that percolate up from some tight model of individual optimizing agents, […]

[…] We don’t have the data to do that. We don’t have the tight micro-theories to do that, either. We need tractable, somewhat fuzzily-modeled alternatives, what Krugman calls “intellectual scratch-pads.” Policy analysis is a more rough-and-ready enterprise. Moreover, there is one embarrassing little secret in many areas of applied economics and social science. Most of the time, good intellectual scratch pads provide more accurate forecasts and better policy guidance than do more elegant and tractable micro-grounded models.

[…] We can debate tax policy by considering what’s fair and reasonable in the deals people strike, a few at a time, acting in essential isolation from wider social concerns ranging from the intergenerational transmission of inequality to global warming. We’re likely to miss things that become apparent as we watch millions of apparently simple and fair exchanges play out among billions of people, operating through complicated human institutions over generations.  Sometimes micro-arguments need macro-foundations, too.

Economic models that are grounded in micro-assumptions that assume idealized human behavior are often going to poorly predict macro-aggregate behavior. This focus on individuals, to the detriment of actually “getting it right” on the macro level, has consequences for how we shape our economic public policy.

I understand why we base much of our national values on the idealized individual, his or her idealized actions, and the idealized consequences for those actions. But we don’t live in an idealized country. Grounding national policies in this same vein doesn’t necessarily produce the results we want or expect because public policy needs to predict how the world actually works, not as we might want it to work.

 

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