On Microfoundations of Macroeconomics Prabhath Jayasinghe [University of Colombo, Sri Lanka]
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The Lucas Critique – Is It Really Relevant?
Working Paper Series Department of Business & Management Macroeconomic Methodology, Theory and Economic Policy (MaMTEP) No. 7, 2016 The Lucas Critique – is it really relevant? By Finn Olesen 1 Abstract: As one of the founding fathers of what became the modern macroeconomic mainstream, Robert E. Lucas has made several important contributions. In the present paper, the focus is especially on his famous ‘Lucas critique’, which had tremendous influence on how to build macroeconomic models and how to evaluate economic policies within the modern macroeconomic mainstream tradition. However, much of this critique should not come as a total surprise to Post Keynesians as Keynes himself actually discussed many of the elements present in Lucas’s 1976 article. JEL classification: B22, B31 & E20 Key words: Lucas, microfoundations for macroeconomics, realism & Post Keynesianism I have benefitted from useful comments from Robert Ayreton Bailey Smith and Peter Skott. 2 Introduction In 1976, Robert Lucas published a contribution that since has had an enormous impact on modern macroeconomics. Based on the Lucas critique, the search for an explicit microfoundation for macroeconomic theory began in earnest. Later on, consensus regarding methodological matters between the New Classical and the New Keynesian macroeconomists emerged. That is, it was accepted that macroeconomics could only be done within an equilibrium framework with intertemporal optimising households and firms using rational expectations. As such, the representative agent was born. Accepting such a framework has of course not only theoretical consequences but also methodological ones as for instance pointed out by McCombie & Pike (2013). Not only should macroeconomics rest upon explicit and antiquated, although accepted, microeconomic axioms; macroeconomic theory also had to be formulated exclusively by use of mathematical modelling1. -
How the Rational Expectations Revolution Has Enriched
How the Rational Expectations Revolution Has Changed Macroeconomic Policy Research by John B. Taylor STANFORD UNIVERSITY Revised Draft: February 29, 2000 Written versions of lecture presented at the 12th World Congress of the International Economic Association, Buenos Aires, Argentina, August 24, 1999. I am grateful to Jacques Dreze for helpful comments on an earlier draft. The rational expectations hypothesis is by far the most common expectations assumption used in macroeconomic research today. This hypothesis, which simply states that people's expectations are the same as the forecasts of the model being used to describe those people, was first put forth and used in models of competitive product markets by John Muth in the 1960s. But it was not until the early 1970s that Robert Lucas (1972, 1976) incorporated the rational expectations assumption into macroeconomics and showed how to make it operational mathematically. The “rational expectations revolution” is now as old as the Keynesian revolution was when Robert Lucas first brought rational expectations to macroeconomics. This rational expectations revolution has led to many different schools of macroeconomic research. The new classical economics school, the real business cycle school, the new Keynesian economics school, the new political macroeconomics school, and more recently the new neoclassical synthesis (Goodfriend and King (1997)) can all be traced to the introduction of rational expectations into macroeconomics in the early 1970s (see the discussion by Snowden and Vane (1999), pp. 30-50). In this lecture, which is part of the theme on "The Current State of Macroeconomics" at the 12th World Congress of the International Economic Association, I address a question that I am frequently asked by students and by "non-macroeconomist" colleagues, and that I suspect may be on many people's minds. -
Tipping Points in Macroeconomic Agent-Based Models
Tipping points in macroeconomic Agent-Based models Stanislao Gualdi,1 Marco Tarzia,2 Francesco Zamponi,3 and Jean-Philippe Bouchaud4 1 Universit´ePierre et Marie Curie - Paris 6, Laboratoire de Physique Th´eoriquede la Mati`ere Condens´ee, 4, Place Jussieu, Tour 12, 75252 Paris Cedex 05, France and IRAMIS, CEA-Saclay, 91191 Gif sur Yvette Cedex, France ∗ 2 Universit´ePierre et Marie Curie - Paris 6, Laboratoire de Physique Th´eoriquede la Mati`ere Condens´ee, 4, Place Jussieu, Tour 12, 75252 Paris Cedex 05, France 3Laboratoire de Physique Th´eorique, Ecole´ Normale Sup´erieure, UMR 8549 CNRS, 24 Rue Lhomond, 75231 Paris Cedex 05, France 4CFM, 23 rue de l'Universit´e,75007 Paris, France, and Ecole Polytechnique, 91120 Palaiseau, France. The aim of this work is to explore the possible types of phenomena that simple macroeconomic Agent-Based models (ABM) can reproduce. Our motivation is to understand the large macro- economic fluctuations observed in the \Mark I" ABM devised by D. Delli Gatti and collaborators. Our major finding is the existence of a first order (discontinuous) phase transition between a \good economy" where unemployment is low, and a \bad economy" where unemployment is high. We show that this transition is robust against many modifications of the model, and is induced by an asymmetry between the rate of hiring and the rate of firing of the firms. This asymmetry is induced, in Mark I, by the interest rate. As the interest rate increases, the firms become more and more reluctant to take further loans. The unemployment level remains small until a tipping point beyond which the economy suddenly collapses. -
5. the Lucas Critique and Monetary Policy
5. The Lucas Critique and Monetary Policy John B. Taylor, May 6, 2013 Econometric Policy Evaluation: A Critique • Highly influential (Nobel Prize) • Adds to the case for policy rules • Shows difficulties of econometric policy evaluation when forward-looking expectations are introduced • But it left an impression of a “mission impossible” for monetary economists – Tended to draw researchers away from monetary policy research to real business cycle models • Nevertheless it was constructive – An alternative approach suggested through three examples: • One focussed on monetary policy – inflation-unemployment tradeoff • The other two focused on fiscal policy – consumption and investment • Worth studying in the original First Derive the Inflation-Output Tradeoff Derive "aggregate supply" function : Supply yit in market i at time t is given by P c yit yit yit where P yit is "permanent" or "normal" supply c yit is "cyclical" supply Supply curve in market i c e yit ( pit pit ) pit is the log of the actual price in market i at time t e pit is the perceived (in market i) general price level in the economy at time t Find conditional expectation of general price level pit pt zit 2 pt is distributed normally with mean ptand variance 2 zit is distributed normally with mean 0 and variance Thus 2 2 pt p is distributed N t p 2 2 2 it pt e 2 2 2 pit E( pt pit , I t1 ) pt [ /( )]( pit pt ) (1 ) pit pt where 2 /( 2 2 ) Covariance divided by the variance Now, substitute the conditional expectation e pit (1 ) pit -
The Econometrics of the Lucas Critique: Estimation and Testing of Euler Equation Models with Time-Varying Reduced-Form Coefficients
The Econometrics of the Lucas Critique: Estimation and Testing of Euler Equation Models with Time-varying Reduced-form Coefficients Hong Li ∗y Princeton University Abstract The Lucas (1976) critique argued that the parameters of the traditional unrestricted macroeconometric models were unlikely to remain invariant in a changing economic envi- ronment. Since then, rational expectations models have become a fixture in macroeconomics Euler equations in particular. An important, though little acknowledged, implication of − the Lucas critique is that testing stability across regimes should be a natural diagnostic for the reliability of Euler equations. This paper formalizes this assertion econometrically in the framework of the classical two-step minimum distance method: The time-varying reduced- form in the first step reflects private agents' adaptation of their forecasts and behavior to the changing environment; The presumed ability of Euler conditions to deliver stable parame- ters that index tastes and technology is interpreted as a time-invariant second-step model. Within this framework, I am able to show, complementary to and independent of one an- other, both standard specification tests and stability tests are required for the evaluation of Euler equations. Moreover, this conclusion is shown to extend to other major estimation methods. Following this result, three standard investment Euler equations are submitted to examination. The empirical results tend to suggest that the standard models have not, thus far, been a success, at least for aggregate investment. JEL Classification: C13; C52; E22. Keywords: Parameter instability; Model validation testing; Classical minimum dis- tance estimation; The Lucas critique; Euler equations; Aggregate investment. ∗Department of Economics, Princeton University, NJ 08544. -
Das Maynard Keynes Problem: Rethinking Rationality
Das Maynard Keynes Problem: Rethinking Rationality Ailian Gan Abstract As with Adam Smith in Das Adam Smith Problem, critics have observed that, across the large body of work produced in John Maynard Keynes’s lifetime, Keynes displays a shifting or even inconsistent view of rationality. In the Treatise on Probability, Keynes argues that economic actors use all available information to make rational decisions. In The General Theory, however, Keynes argues that people are irrational and are highly susceptible to psychological forces. This paper seeks to reconcile both views by arguing that, if one allows economic actors to display a range of rationality, Keynes’s work is wholly consistent. I. Introduction For any great intellectual who produces an enormous body of work, tracing his philosophical foundations and precise intentions is a valuable but daunting task. For Adam Smith, critics were intrigued by the transformations and inconsistencies in arguments of his two most prominent works. In The Theory of Moral Sentiments, Smith was an advocate of sympathy for our fellow human being. In The Wealth of Nations, however, he became a strong advocate of self-interest, arguing that it was the primary motive behind economic behavior and the driving force of the economy. This selfless/selfish mismatch has led many economists following in Smith’s footsteps to question which stance he truly intended and whether the two can be reconciled. Either reading of his intentions can lead to vastly different interpretations of his theories and his legacy. Such was the nature of das Adam Smith problem. For John Maynard Keynes, interpreters of his work face a similar problem. -
The Microeconomic Foundations of Aggregate Production Functions
NBER WORKING PAPER SERIES THE MICROECONOMIC FOUNDATIONS OF AGGREGATE PRODUCTION FUNCTIONS David Baqaee Emmanuel Farhi Working Paper 25293 http://www.nber.org/papers/w25293 NATIONAL BUREAU OF ECONOMIC RESEARCH 1050 Massachusetts Avenue Cambridge, MA 02138 November 2018, Revised November 2019 We thank Maria Voronina for excellent research assistance. We thank Natalie Bau and Elhanan Helpman for useful conversations. This paper was written for the 2018 BBVA lecture of the European Economic Association. The views expressed herein are those of the authors and do not necessarily reflect the views of the National Bureau of Economic Research. NBER working papers are circulated for discussion and comment purposes. They have not been peer-reviewed or been subject to the review by the NBER Board of Directors that accompanies official NBER publications. © 2018 by David Baqaee and Emmanuel Farhi. All rights reserved. Short sections of text, not to exceed two paragraphs, may be quoted without explicit permission provided that full credit, including © notice, is given to the source. The Microeconomic Foundations of Aggregate Production Functions David Baqaee and Emmanuel Farhi NBER Working Paper No. 25293 November 2018, Revised November 2019 JEL No. E0,E1,E25 ABSTRACT Aggregate production functions are reduced-form relationships that emerge endogenously from input-output interactions between heterogeneous producers and factors in general equilibrium. We provide a general methodology for analyzing such aggregate production functions by deriving their first- and second-order properties. Our aggregation formulas provide non- parameteric characterizations of the macro elasticities of substitution between factors and of the macro bias of technical change in terms of micro sufficient statistics. -
Reconstructing the Great Recession
Reconstructing the Great Recession Michele Boldrin, Carlos Garriga, Adrian Peralta-Alva, and Juan M. Sánchez This article uses dynamic equilibrium input-output models to evaluate the contribution of the con- struction sector to the Great Recession and the expansion preceding it. Through production inter- linkages and demand complementarities, shifts in housing demand can propagate to other economic sectors and generate a large and sustained aggregate cycle. According to our model, the housing boom (2002-07) fueled more than 60 percent and 25 percent of employment and GDP growth, respectively. The decline in the construction sector (2007-10) generates a drop in total employment and output about half of that observed in the data. In sharp contrast, ignoring interlinkages or demand comple- mentarities eliminates the contribution of the construction sector. (JEL E22, E32, O41) Federal Reserve Bank of St. Louis Review, Third Quarter 2020, 102(3), pp. 271-311. https://doi.org/10.20955/r.102.271-311 1 INTRODUCTION With the onset of the Great Recession, U.S. employment and gross domestic product (GDP) fell dramatically and then took a long time to return to their historical trends. There is still no consensus about what exactly made the recession so deep and the subsequent recovery so slow. In this article we evaluate the role played by the construction sector in driving the boom and bust of the U.S. economy during 2001-13. The construction sector represents around 5 percent of total employment, and its share of GDP is about 4.5 percent. Mechanically, the macroeconomic impact of a shock to the con- struction sector should be limited by these figures; we claim it is not. -
The Alleged Necessity of Microfoundations*
CORE Metadata, citation and similar papers at core.ac.uk Provided by Erasmus University Digital Repository MAARTEN C. W. JANSSEN Erasmus University Rotterdam Rotterdam, The Netherlands The Alleged Necessity of Microfoundations* It is often said that models in the microfoundations literature derive macroeconomic results from the theory of individual behavior only. This paper examines two of the assumptions that are usually made in these models: market clearing and rational expectations. In the context of simple models it is shown that only in some special cases these assumptions can be derived from the fundamental notion that individ- uals behave rationally. Thus, the usual rationale for the microfoundations literature is challenged. The paper concludes with a more modest rationale for the "necessity" of microfoundations. 1. Introduction Macroeconomics is in need of a microeconomic foundation. Nowadays, this is a widely accepted doctrine in the economics profession. Most economists take the necessity for a microeconomic foundation for granted. If arguments in favor of the necessity for microfoundations are cited, they often are of the following reduc- tionist form. Society consists of individuals who are the only sub- jects that make economic decisions. So, in order to explain what is going on in the economy as a whole--for example, unemployment, inflation, business cycles--we have to understand the individual de- cisions from which a particular situation originates. I think that this "'reductionist credo" itself is largely correct. However, if it is used as an argument in favor of the necessity for microeconomic foun- dations it is presupposed either that microeconomics is only con- cerned with individual behavior or that all microeconomic propo- sitions can be derived from statements concerning individual decision *This paper was written while I was visiting Duke University. -
The Lucas Critique and the Stability of Empirical Models∗
Working Paper Series This paper can be downloaded without charge from: http://www.richmondfed.org/publications/ The Lucas Critique and the Stability of Empirical Models∗ Thomas A. Lubik Paolo Surico Federal Reserve Bank of Richmond Bank of England and University of Bari July 2006 Working Paper No. 06-05 Abstract This paper re-considers the empirical relevance of the Lucas critique using a DSGE sticky price model in which a weak central bank response to inflation generates equilib- rium indeterminacy. The model is calibrated on the magnitude of the historical shift in the Federal Reserve’s policy rule and is capable of generating the decline in the volatility of inflation and real activity observed in U.S. data. Using Monte Carlo simulations and a backward-looking model of aggregate supply and demand, we show that shifts in the policy rule induce breaks in both the reduced-form coefficients and the reduced-form error variances. The statistics of popular parameter stability tests are shown to have low power if such heteroskedasticity is neglected. In contrast, when the instability of the reduced-form error variances is accounted for, the Lucas critique is found to be empirically relevant for both artificial and actual data. JEL Classification: C52, E38, E52. Key Words: Lucas critique, heteroskedasticity, parameter stability tests, rational expectations, indeterminacy. ∗WearegratefultoLucaBenati,AndrewBlake,Jon Faust, Jan Groen, Haroon Mumtaz, Serena Ng, Christoph Schleicher, Frank Schorfheide, Shaun Vahey and seminar participants at the Reserve Bank of New Zealand, the Bank of England, the 2006 meeting of the Society of Computational Economics, the con- ference on “Macroeconometrics and Model Uncertainty” held on 27-28 June 2006 at the Reserve Bank of New Zealand, and our discussant Timothy Kam for valuable comments and suggestions. -
The Role of Values of Economists and Economic Agents in Economics: a Necessary Distinction Nestor Nieto
The Role of Values of Economists and Economic Agents in Economics: A Necessary Distinction Nestor Nieto To cite this version: Nestor Nieto. The Role of Values of Economists and Economic Agents in Economics: A Necessary Distinction. 2021. hal-02735869v2 HAL Id: hal-02735869 https://hal.archives-ouvertes.fr/hal-02735869v2 Preprint submitted on 28 May 2021 HAL is a multi-disciplinary open access L’archive ouverte pluridisciplinaire HAL, est archive for the deposit and dissemination of sci- destinée au dépôt et à la diffusion de documents entific research documents, whether they are pub- scientifiques de niveau recherche, publiés ou non, lished or not. The documents may come from émanant des établissements d’enseignement et de teaching and research institutions in France or recherche français ou étrangers, des laboratoires abroad, or from public or private research centers. publics ou privés. Copyright The Role of Values of Economists and Economic Agents in Economics: A Necessary Distinction Nestor Lovera Nieto1 Abstract The distinction between the value judgments of economists and those of economic agents is not clear in the literature of welfare economics. In this article, I show that this distinction is important because economists have to step back and consider not only their own value judgments but also those of economic agents when they study economic phenomena. I use the subject of Interpersonal Comparisons of Utility to discuss this distinction, more specifically the analysis of Harsanyi’s impartial observer theorem, which provides a framework to justify that value judgments of economists and those of economic agents have to be properly identified. I suggest that it is essential to have a theoretical framework to make this distinction. -
Agent-Based Macroeconomics
Faculty of Business Administration and Economics Working Papers in Economics and Management No. 02-2018 January 2018 Agent-Based Macroeconomics H. Dawid D. Delli Gatti Bielefeld University P.O. Box 10 01 31 33501 Bielefeld − Germany ISSN 2196−2723 www.wiwi.uni−bielefeld.de Agent-Based Macroeconomics Herbert Dawid∗ Domenico Delli Gatti yz January 2018 This paper has been prepared as a chapter in the Handbook of Computational Economics, Volume IV, edited by Cars Hommes and Blake LeBaron. Abstract This chapter surveys work dedicated to macroeconomic analysis using an agent- based modeling approach. After a short review of the origins and general characteristics of this approach a systemic comparison of the structure and modeling assumptions of a set of important (families of) agent-based macroeconomic models is provided. The comparison highlights substantial similarities between the different models, thereby identifying what could be considered an emerging common core of macroeconomic agent-based modeling. In the second part of the chapter agent-based macroeconomic research in different domains of economic policy is reviewed. Keywords: Agent-based Macroeconomics, Aggregation, Heterogeneity, Behavioral Rules, Business Fluctuations, Economic Policy JEL Classification: C63, E17, E32, E70, 1 Introduction Starting from the early years of the availability of digital computers, the analysis of macroe- conomic phenomena through the simulation of appropriate micro-founded models of the economy has been seen as a promising approach for Economic research. In an article in the American Economic Review in 1959 Herbert Simon argued that "The very complexity that has made a theory of the decision-making process essential has made its construction exceedingly difficult.