This page intentionally left blank Post Walrasian Macroeconomics Macroeconomics is evolving in an almost dialectic fashion. The latest evolution is the development of a new synthesis that combines insights of new classical, new Keynesian and real business cycle traditions into a dynamic, stochastic general equilibrium (DSGE) model that serves as a foundation for thinking about macropolicy. That new synthesis has opened up the door to a new antithesis, which is being driven by advances in computing power and analytic techniques. This new synthesis is coalescing around developments in com- plexity theory, automated general to specific econometric modeling, agent- based models, and nonlinear and statistical dynamical models. This book thus provides the reader with an introduction to what might be called a Post Walrasian research program that is developing as the antithesis of the Walrasian DSGE synthesis. While both the Walrasian and Post Walrasian approaches assume rational agents, they differ in the environment in which they model the interaction of those agents. To make their models tractable the DSGE approach, which is the culmination of the Walrasian modeling tradition, assumes either that agents operate in an information-rich environment, or that there is an outside controller who processes all information. The Post Walrasian model, which this collection explores, assumes that agents operate in information-poor environments, without any outside controller. David Colander has been the Christian A. Johnson Distinguished Professor of Economics at Middlebury College, Middlebury, Vermont since 1982. He previously taught at Columbia University, Vassar College, and the University of Miami. Professor Colander has authored, co-authored, or edited more than 35 books and 100 articles on a wide range of topics. His books have been, or are being, translated into a number of different languages, including Chinese, Bulgarian, Polish, Italian, and Spanish. He is a former President of both the Eastern Economic Association and History of Economics Society and is, or has been, on the editorial boards of the Journal of the History of Economic Thought, Journal of Economic Methodology, Eastern Economic Journal, Journal of Economic Education, The Journal of Socioeconomics, and Journal of Economic Perspectives. He has also been a consultant to Time-Life Films, the U.S. Congress, a Brookings Policy Fellow, and a Visiting Scholar at Nuffield College, Oxford. In 2001À02 he was the Kelly Professor of Distinguished Teaching at Princeton University. Post Walrasian Macroeconomics Beyond the Dynamic Stochastic General Equilibrium Model Edited by DAVID COLANDER Middlebury College Cambridge, New York, Melbourne, Madrid, Cape Town, Singapore, São Paulo Cambridge University Press The Edinburgh Building, Cambridge ,UK Published in the United States of America by Cambridge University Press, New York www.cambridge.org Information on this title: www.cambridg e.org /9780521865487 © Cambridge University Press 2006 This publication is in copyright. Subject to statutory exception and to the provision of relevant collective licensing agreements, no reproduction of any part may take place without the written permission of Cambridge University Press. First published in print format 2006 - ---- eBook (EBL) - --- eBook (EBL) - ---- hardback - --- hardback - ---- paperback - --- paperback Cambridge University Press has no responsibility for the persistence or accuracy of s for external or third-party internet websites referred to in this publication, and does not guarantee that any content on such websites is, or will remain, accurate or appropriate. Contents List of Contributors page vii Foreword by Alan Kirman xiii Introduction1 PART I WHERE WE ARE IN MACRO AND HOW WE GOT THERE 1 Episodes in a Century of Macroeconomics 27 Axel Leijonhufvud 2 Post Walrasian Macroeconomics: some Historic Links 46 David Colander 3 The Problem of Time in the DSGE Model and the Post Walrasian Alternative 70 Perry Mehrling 4 Who Is Post Walrasian Man? 80 Peter Hans Matthews PART II EDGING AWAY FROM THE DSGE MODEL 5 Social Interactions and Macroeconomics 97 William A. Brock and Steven N. Durlauf 6 Macroeconomics and Model Uncertainty 116 William A. Brock and Steven N. Durlauf 7 Restricted Perceptions Equilibria and Learning in Macroeconomics 135 William A. Branch 8 Not More So: some Concepts Outside the DSGE Framework 161 Masanao Aoki v vi Contents PART III LEAPING AWAY FROM THE DSGE MODEL 9 Agent-Based Computational Modeling and Macroeconomics 175 Leigh Tesfatsion 10 Multi-agent Systems Macro: A Prospectus 203 Robert L. Axtell 11 Agent-Based Financial Markets: matching Stylized Facts with Style 221 Blake LeBaron PART IV LETTING THE DATA GUIDE THEORY 12 The Past as the Future: the Marshallian Approach to Post Walrasian Econometrics 239 Kevin D. Hoover 13 Old World Econometrics and New World Theory 258 Roger E. A. Farmer 14 Four Entrenched Notions Post Walrasians Should Avoid 277 Robert L. Basmann 15 Confronting the Economic Model with the Data 287 Søren Johansen 16 Extracting Information from the Data: a European View on Empirical Macro 301 Katarina Juselius and Søren Johansen PART V POLICY IMPLICATIONS 17 Economic Policy in the Presence of Coordination Problems 335 Russell W. Cooper 18 Monetary Policy and the Limitations of Economic Knowledge 347 Peter Howitt Bibliography 369 List of Contributors Masanao Aoki has taught at UCLA, UC Berkeley, University of Illinois, Osaka University, Tokyo Institute of Technology, and the University of Cambridge. He is a past President of the Society for Economic Dynamics and Control, Fellow of the Econometric Society (inactive), and a Fellow of the IEEE Control Systems Society (inactive). He has served as editor and associate editor of a number of journals, such as the International Economic Review and the Journal of Economic Dynamics and Control. He is the author or editor of a dozen books, including Modeling Aggregate Behavior and Fluctuations in Economics for which he received the 2003 Nihon Keizai Shinbun Center for Japanese Economic Research Prize. Rob Axtell is a Senior Fellow in Economic Studies at the Brookings Institution. He is co-founder of the Center on Social and Economic Dynamics there, a research center dedicated to promulgating agent-based computational modeling techniques across the social sciences. He is also an External Faculty Member of the Santa Fe Institute. He is the co-author of Growing Artificial Societies: Social Science from the Bottom Up with J. M. Epstein. His research has been published in leading general science journals (e.g. Science, Proceedings of the National Academy of Sciences) and disciplinary journals. His new book, Artificial Economies of Adaptive Agents, will appear soon. Robert L. Basmann studied agricultural economics and econometric statistics at Iowa State University. The focus of his graduate research was on (1) filling some gaps in the neoclassical demand theory by incorporating budget constraint prices, income, random disturbances, and other factors as preference-changers of indifference maps and (2) finite-sample proper- ties of distributions of new estimators and test statistics for simultaneous equations models. He is well known for his work in developing the vii viii List of Contributors two-stage least squares technique. He has published many articles and books on statistical problems, often inspired by former students’ interests in special applications. William A. Branch is an Assistant Professor at the University of California, Irvine. He is the author of many articles on heterogeneous expectations and adaptive learning in macroeconomics. Recent publications document evolving distributions of heterogeneity in survey data on inflation expec- tations. Contributions to the literature on Post Walrasian Macroeconomics include deriving heterogeneous expectations as an equilibrium outcome, stochastic volatility in macroeconomic models with misspecified beliefs, and bounded rationality explanations for the Great Moderation. His current research interests are the implications of heterogeneous expecta- tions for monetary policy in fully specified business cycle models. William A. ‘‘Buz’’ Brock is Vilas Research Professor, Department of Economics, University of Wisconsin, Madison. He is a Guggenheim Fellow (1987), as well as a Fellow of the Econometric Society, American Academy of Arts and Science (since 1992), National Academy of Sciences (USA) (since 1998), and Distinguished Fellow, American Economics Association (2004). He is known for his work on dynamical systems, time series analy- sis, political economy, macroeconomics, finance, and ecological economics. David Colander is the Christian A. Johnson Distinguished Professor of Economics at Middlebury College. In 2001À02, he was the Kelly Professor of Distinguished Teaching at Princeton University. He has authored, co- authored, or edited over 35 books and 100 articles on a wide range of topics. He has been the President of both the Eastern Economic Association and the History of Economic Thought Society and is, or has been, on the editorial boards of numerous journals, including Journal of Economic Perspectives and the Journal of Economic Education, and Journal of the History of Economic Thought. Russell Cooper is currently the Fred Hofheinz Regents Professor of Economics at the University of Texas, a position he has held since 2003. He previously taught at Yale, the University of Iowa and Boston University. He is an NBER Faculty Research Associate and a Fellow