Now that everyone is rushing to bone up on the late Hyman Minsky
and at least some of us are concluding that New Keynesian macro needs to be dumped in favour of something more like behavioural economics Left for Dead psp , I thought I’d trawl through the hard disk and see what I had to say on the subject in the past. It turns out I had something of an each-way bet. Here’s something from my 2006 paper with Stephen Bell, advocating controls on financial innovation as the best approach to preventing asset price bubbles.
One obstacle to acceptance of Minsky’s work has been the lack of microeconomic foundations, that is, of a rigorous formal account of individual behavior and the markets in which individuals interact. The idea that such an account is a necessary prerequisite for a coherent macroeconomic theory became popular in the 1970s and reached its high point with new classical macroeconomics in the early 1980s. Since then, however, emphasis on microeconomic foundations has declined for several reasons. First, users of new classical models have found it necessary to make ad hoc adjustments to microeconomic assumptions in order to improve the capacity of their models to match the “stylized facts” about the macroeconomy that they seek to capture. Second, it has been shown that, in important instances, modest deviations from standard neoclassical microeconomic assumptions (rational optimization in competitive markets) can produce large changes in macroeconomic outcomes. Third, evidence arising from fields such as generalized expected utility theory and behavioral finance has cast doubt on the empirical validity of the standard assumptions of neoclassical microeconomics.
As improved models of individual behavior are developed, it seems likely that microeconomic foundations for models similar to Minsky’s will emerge. Such foundations will take account of the fundamental role of uncertainty, emphasized by writers as diverse as Keynes, [Frank] Knight, and Minsky. For the moment, it is sufficient to observe that none of the competing models of asset markets combine rigorous microeconomic foundations with empirically realistic predictions about market behavior.
So back in 2006, I hoped that New Keynesianism ( modest deviations from standard neoclassical microeconomic assumptions producing large changes in macroeconomic outcomes) would help in the process of shifting macro away from neoclassical microfoundations, along with the generalized expected utility/behavioral economics approach. I’ve now shifted to the view that NK macro is part of the problem, and that the generalized expected utility/behavioral economics understanding is the right way to go.
This reflects the fact that the second approach has helped me to understand the crisis and the first has not.