The macro foundations of micro (crossposted at Crooked Timber)

Twitter alerted me to an amusing exchange between Chris Auld, posting a list of “18 signs you’re reading bad criticism of economics and Unlearning Economics, responding with 18 Signs Economists Haven’t the Foggiest. UL suggests that Stephen Williamson manages an impressive 9 out of 18 in his review of Zombie Economics (my response here with more from Noah Smith.

Scoring myself against Chris Auld’s list, I’d say I’m in the clear. But quite a few commenters on Zombie Economics have made complaints along the lines of his point 1, that I focus too much on macroeconomics (and finance). The implication is that, even if macro is totally wrong, only a minority of economists do it, and microeconomists are in the clear.

This defense doesn’t work, at least not in general.

The basic problem is that standard neoclassical microeconomics is itself a macroeconomic theory in the sense that it’s derived from a general equilibrium model as a whole. The standard GE model takes full employment (in an appropriate technical sense) as given, and derives a whole series of fundamental results from this. Conversely, if the economy can exhibit sustained high unemployment, there must be something badly wrong with standard neoclassical microeconomics.

Most notably, in a competitive GE with full information, no externalities and so on, prices of goods reflect the social opportunity cost of producing them. This means, that, other than redistributing the initial endowments of property rights, governments can’t do anything to improve on the competitive market allocation of resources.

Once you have involuntary unemployment, all of this fails. Keynes’ famous thought experiment of burying pound notes in coal mines made the point that an intervention that would be totally absurd in terms of standard microeconomic reasoning might nonetheless help to alleviate a recession and therefore make society better off.

The point can be made in more detail with respect to labour economics, finance theory, public economics and industrial organization. None of the standard conclusions of these fields of microeconomics can be assumed to be valid under conditions of sustained high unemployment.

Keynes specifically presented his macroeconomic ideas as making the world safe for neoclassical micro. If governments could stabilise the aggregate economy with fiscal policy, there was no need for comprehensive economic planning of the kind being practised, with apparent success, in the Soviet Union, or for ad hoc interventions like the price-fixing elements of the New Deal.

In summary, the failure of macroeconomists and finance economists to provide either a warning of the Global Financial Crisis or any consistent advice on how to deal with the ensuing Great Recession it isn’t just a problem for them. It undermines the whole economics profession. The sooner we realise that the entire discipline is in a state of scientific crisis the sooner we might start to do something about it.

57 thoughts on “The macro foundations of micro (crossposted at Crooked Timber)

  1. @Jim Rose
    I’m not sure I understand your question, nor why you think it’s relevant, but if you’re asking ‘Who goes on about the methodology of sociology?’, then I’m confident the answer is ‘Sociologists’.

  2. J-D,


    “as I have pointed out, BilB began by saying ‘I know this must be true, so does anybody have the evidence to prove I’m right?’.”

    is you quoting you, not me. That is your interpretation put in your words. Not Mine.

    And I am certain that I wused the term sector “ratio” not size.

    Anyway, you don’t agree. That is fine. Thanks for you opinion, J-D, that is what I asked for.

  3. @J-D

    Well put, sir.

    Also, sociologists don’t have the ear of government no matter how they may argue amongst themselves.

    Economists are like King Lear’s Fool whispering into the ear of the current king. This gives them a false sense of relevance and importance for their profession. Also, socialists are obviously socialists (why they didn’t call themselves “communologists” and give Jim Rose something serious to winge about, I don’t know)

    Surely, the most important economic question today is: what is the ideal (nay ANY) economic model that would allow the inhabitants of a country or, preferably, the world to live without undue stress and discomfort when the population is DECREASING (or at least staying the same) rather than increasing as it has been since the metaphorical adam walked the planet?

    Any idiot can make money on a rising share or property market but a smartie can survive, even prosper, on a falling market.

    Is there any equivalent economic theory that can be applied to a world depopulation that stabilises the decreases?

    No? Then we are doomed and a pox on all your economic theories; your profession will be as relevant as wheelwrights in a future world.

  4. Geof
    There is MMT that opens up possibilities on depopulation secure increase of living standard.
    To understand it how, you can not apply conventional thinking about money.

  5. @Geoff Andrews

    If, as you say, economists wisper in the ears of policy makers, then, it seems to me, the predominantly legally trained ears transform the message into the conceptual space of commerce.

    A decreasing in population reduces the demand on natural resources. It also reduces the demand for net debt generators’ services, both public and private. I say net debt generators because borrowing and lending would not have to stop; it merely would look more like that described in introductory economic textbooks.

  6. Sorry, I introduced an error when editing a sentence. A decreasing population reduces … is what I meant to write.

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