Critiquing Micro-Foundations, a Response to Mark Thoma

There has been a lot of talk on the blogosphere about so-called "micro-foundations" for years. It has especially picked up since David Levine's post on Keynesian economics.

So it should not surprise me to wake up and read two posts on the topic: one from Paul Krugman and another from Mark Thoma. After thinking about it more by myself and on Twitter, I am still left confused about what the critique is of micro-foundations. Thoma's article is more substantive and interesting, so I'll focus on his.

Macro, by definition, deals with aggregates, such as unemployment, GDP, and inflation. While individual actions determine GDP, economists study them as aggregates statistics. So first off, all macro is aggregation.

According to Thoma, there are two main ways to do macro. The newer version uses micro-foundations. These models start with standard micro-style consumers and producers. The other approach, older in origin, assumes some steady macro relationship, such as a constant relationship between aggregate consumption and aggregate output. This is the style of Keynes and Fisher.

Since the 1970's, macroeconomists have tended to use the micro-founded approach. But it's still an aggregate. Both are aggregates. Even Thoma recognizes this when he describes the modern approach which must ultimately "aggregate across household and firms to determine macroeconomic relationships." The most common way to do this is using a "representative agent." When Thoma draws a distinction between micro and aggregate models, I'm left confused. I might not be reading it right.

Leaving that aside, Thoma levels a reasonable critique of the representative household models:

Unfortunately, the representative agent approach is unsuited for studying behavior in financial markets. The problem is that there is no way for a single representative household to trade stocks and bonds with itself based upon different forecasts of future economic conditions (e.g. a person who thinks the price of a stock will fall in the future sells the stock to someone who believes the price will rise).

I agree. The representative agent model is not suited for financial markets. But the old Keynesian model of aggregates is suited for financial markets? How does the aggregate Y and aggregate C or IS/LM or whatever aspect of the Keynesian model explain financial markets? I don't see it. To explain financial markets, there must be two people who value a financial asset, e.g. a stock, differently.  I just don't see how the representative agent or the old Keynesian model can explain. Any critique of the micro-founded DSGE model in this respect also is a critique of the old models. So the score is 0-0.

There is one difference that I see. DSGE models have developed beyond the representative agent models and are working to model financial markets. Are the models perfect? No. Should the models have been more common before the Great Recession? Probably.

The only critique I understand of Thoma's,which he makes in a linked-to article, is that DSGE doesn't give clear policy advice the old Keynesian model does. Sure, but the model wasn't designed to manipulate the economy like an engineer. That's not the purpose of the DSGE model, at least not the purpose that I learned in class. It may have been the purpose of the Keynesian model. But as Thoma says in the linked-to article "when a model is applied to situations it was not designed to address, it is not the model that failed. The model has been misused."

I am left wondering what are the "simple, fast, and accurate answers to our questions" that the old Keynesian model provides. I would love to hear in the comments.

Thoma ends with

Thus, the approach to take depends critically on the question the researcher is asking. For some questions, the aggregate approach (sic) is best despite the criticism it has received in recent years from those using modern models, and we shouldn’t think of it as going backwards if we adopt this approach when it provides simple, fast, and accurate answers to our questions. The “correct” model to use is not an either/or decision, and macroeconomists should be open to both approaches as we try to improve our ability to understand the macro-economy, and provide policy advice when the economy experiences problems.

Here I am absolutely in agreement. As micro teaches us, there are trade-offs everywhere. Just as consumers don't buy only one type of good, economists should probably not use only one type of model. But Thoma has left me unconvinced that the old aggregate approach is the way to focus efforts on the margin.

I can't believe I wrote a post defending DSGE models. But if the critique is not compelling, it's not compelling. This is true regardless of what it is critiquing.

Models, Who Needs Them?

There are many books that I've read that continue to influence my thinking. An important book for me is "Philosophy: Who Needs It?" by Ayn Rand. This book was important, not because I became a Randian. I didn't after that book nor "Atlas Shrugged". Instead, it was the first book I read that urge me to think about philosophy.

Before Rand, I was like most people, scoffing at philosophy, dismissing argument as "just philosophical." I, in all my infinite wisdom, didn't need to think of the mumbo-jumbo philosophy.

Rand's main argument in the title essay is that the question isn't whether to have a philosophy or not. Every person must have a philosophy of how to live their lives. It's unavoidable.

The options are to follow the philosophy that we absorb through life or consciously choose our philosophy. If we do the first, our philosophy might come indirectly from parents, friends, teachers, or celebrities. It might be whatever we pick up through our day-to-day.

Or, as Rand argues we should know what our philosophy is and why it is our philosophy. We can think deeply about the way we want to live our lives and work to pursue that. Instead of passively floating down the river, we can direct our philosophical boat in the direction we want.

The answer to Rand's question "who needs it?" We all do.

Economic Models

The same is true for models of the world, although I have economic models in mind for this post. For this post, I'm using the word "model" to mean a systematic way of analyzing economic questions. We can debate elsewhere the difference between models, theories, frameworks, etc.

If you don't want to talk or think about economics, you don't need a model. That's fine. Economics is not as fundamental as philosophy.

But I haven't met anyone yet who doesn't talk about economic issues. Every time you blame those greedy oil companies for high gas prices, you're using a theory of economics that you probably picked up without knowing. As Rothbard reminds us,

[i]t is no crime to be ignorant of economics, which is, after all, a specialized discipline and one that most people consider to be a ‘dismal science.’ But it is totally irresponsible to have a loud and vociferous opinion on economic subjects while remaining in this state of ignorance.

After reading Rand, I realized I can passively pick up my economic analysis from newspaper or our humanities professors. Or I can pick the models I use and then do are best to understand how to apply them. Models push me to clarify my thinking. That's why economists love models and are insistent on being explicit about them.

Using models might seem odd to non-economists who aren't used to talking about or thinking about models explicitly. I know it was weird for me when I first studied economics.

Our love of models comes up in discussions with critical students, who usually invoke some heterodox economics. Complaints are levied against the common models, say standard consumer theory. "Individuals aren't rational" is one classic complaint. Sometimes Samuelsonian economists get annoyed at these complaints and ask "what's your model?" That is not because economists are evil jerks who want to crush any outside opinion. Every economist I've met is nice and willing to discuss models. We love that.

Instead, we are looking for what model the complainer has in mind. Only then can we judge whether it is a helpful way of looking at the world. If the model you use is "corporations are evil and cause all the bad in the world", fine. You should at least know that so you can decide for yourself whether that is a good model.

Models are just tools, nothing more, nothing less. The economist who insists on a model does so because he finds it easier to discuss a topic when it is clearer where people are coming from. Once a model is put forward, then we can talk about what are the costs and benefits of using it.

People cannot debate economics, nor any social science, without at least using implicit models. It's not only ill-advised, but impossible. One person asserts QE will cause inflation. He is using a model, probably not a good one. If a person says capitalism impoverishes Africa. He is probably invoking a poor model.

Since it's impossible to not use models, I want to know what model I am using. I hope the people I discuss economics with have the same goal. This is an idea I've been going on about all week on Twitter.

To be clear, the models don't need to be equations. A supply and demand graph is a model, and a damn good one. Sometimes equations help clarify a model. Sometimes they don't. Either way, I want to choose my models carefully to aid my understanding of the world.

Practical men, who believe themselves to be quite exempt from any intellectual influences, are usually slaves of some defunct economist.

My advice to other: Don't be the "practical men" who Keynes is talking about. Figure out which models you use and only use the ones you want.

There are many references that explore the nature and role of models, specifically how economists use them. Some that people recommended by Erik Angner and Beatrice Cherrier are here, here, and Mary Morgan's book The World in the Model: How Economists Work and Think. Morgan's book is by far the most thorough examination of models that I've seen.

Why Aren't There More Microeconomics Blogs?

That was the question I posed last night on Twitter. Maybe I better question would have been, why aren't micro blogs more popular?

Now I don't have any data on whether there are less microeconomics blogs or whether they get less traffic, but that is my impression. Most people agreed with me too. Of course there are counterexamples (Freakonomics, Marginal Revolution, Chris Blattman), depending on how one defines "microeconomics blog". There are blogs on every topic imaginable and every blog touches on micro topics. But the blogs that I see talked about on Twitter and from other blogs are almost always macro focused.

For the sake of argument, let's say it is true that micro has fewer/less popular blogs. Then the next question is, why?

Here were some of the suggestions

All these make sense to me. Yet, I'm not completely satisfied with any of the answers.

First, micro can be political too. Yes, pure micro theory is not political; nor is applied work concerned with identification political. But neither is macro. Solving an OLG or Neoclassical Growth model is not inherently political either. Yet, when macro gets applied, especially to monetary policy, people make it political. That adds a huge readership and drives macro blogging. It's fun to see Krugman and Cochrane go back and forth.

Micro can be the same way. It's political when it gets applied to policy. I'm not just thinking about minimum wage, but also topics like regulation and patent protection. Microeconomists analyze all  these and they are inherently political. Walter Williams and Thomas Sowell have made a living for a long time by writing popular pieces from a microeconomics point of view. There is no reason microeconomists couldn't debate taxation online. Yes, many macro bloggers have taken this up too.

Secondly, I don't see how micro is more specialized than macro. Research in both fields is highly specialized. Yet, most blogs are not about leading research. Instead, they are brought down to a more basic level that non-specialists can understand. I see no reason a microeconomist working on development couldn't blog about identification problems in IO. Trade economists blog about monetary policy.

I think the most compelling point was Claudia's. Macro has a natural readership of people involved in business and finance. Again, I see no reason these same people wouldn't read industry or policy analysis from a microeconomist. Explaining the state of some industry or the effects of some policy seem extremely beneficial to businesses. Businesses hire microeconomists to do this. (Maybe that is why people don't blog for free...) Of course, monetary policy affects all businesses, while micro policies are more, well, micro.

But I refuse to give up hope.

People suggested two options which I would love to see.

  1. A group on microeconomists that blog on different topics. One blogger writes about healthcare policy. One writes about regulation. This would avoid the specialization problem about microeconomics.
  2. A whole blog could be about industrial organization.

Until then, I hope to encourage a group of microeconomists to pick up blogging. That is my new crusade (after prelims, of course). I hope all my readers will join me in this fight.

Year 1 PhD Update: Spring Break Edition

At the beginning of the year, I hoped to have a running blog of what first year is like. I thought it would be a good resource for people who are considering a PhD in economics. I have failed in that attempt.

Still, I want to get down my thoughts when I can. Spring break, aka now, turns out to be a great time for that. That's the only thing spring break-y about this. Sorry, no fun stories to tell about the beaches in Cancun... I'm a PhD student. Zero fun sir.

Well, it's a little fun. I get to spend every day learning about a subject that I love. How awesome is that? (Yes, I am bragging about spending all day, every day studying for an exam.) It might not be the exact models that I would pick, but it is still intellectually rewarding. Just because you don't get to pick every song at the club doesn't mean you can't dance anyways. (That is the only analogy on the internet between econ grad school and dance clubs. Correct me if I'm wrong.)

Since I last checked in about school, I have finished one more quarter. That makes three. This past quarter involved two courses, game theory with Aldo Rustichini and macro with V.V. Chari. (I also audited microeconometrics and a computer science course. Yet, since I'm not getting tested on them this spring they weren't my main focus.) Continue reading

What Football Taught Me About PhD Economics


(Disclaimer: Most of what I say below, Pete Boettke already said better. A lot of the ideas come from things he has written or said. Of course, any mistakes or dumb ideas are all mine.)

One of the great honors of my life was being able to play college football. It left me with a bad back ("and probably some brain damage," yells the crowd), but I wouldn't trade those years for anything. I continue to use the life lessons I learned on the field every day of my life.

On my first day of college football, my defensive line coach, who is as good of a coach and man as I've ever met, said "forget everything you knew about playing D-Line. That was good in high school. Congrats. It got you here. I will teach you how to play college football."

And he went on to teach me more than I could have imagined. I'd like to think he turned me into an okay college football player. Without his advice and training, I would have been crap. He knew what he was saying.

The game is completely different at the college vs. the high school level. If you come into the college level thinking it is still high school, you will get crushed. It's not only a higher level, but a different game. What works in high school does not work in college, so players are better off forgetting what they learned. (Of course, if you are a true FREAK, which I was not, you can do whatever you want.)

That doesn't mean that I truly forgot everything. That's impossible. But as much as possible, I needed to clear my head of what I thought a D-Lineman should do. I had to go back to stage one and learn how to take a single step. Over, and over, and over again. Step. Step. Step.

We spent hours just working on our first step. An outsider watching might say, "why would you have players doing the same drill 1000 times? Doesn't everyone know how to step after being a baby? That's not how football is played. You should play real football."

People who say that don't know the sport.

My first year in a PhD has brought me back to Day 1 of football camp, August 2008. I've had to relearn it all. I never can (nor want to) forget my understanding of economics that I discovered through reading people like Thomas Sowell, Walter Williams, or Murray Rothbard. But I'm now playing a different game now. I signed up to play a new sport, not blog or pop economics, but professional academic economics.

To play that sport, I needed to go back to stage one and learn my first step. Day one micro involved basic producer theory, but with advanced notation. Day one macro involved defining equilibrium "concepts." That might seem basic.  It is. But it's a new game.

The way academics talk about producer theory or equilibrium is not the way undergrad courses or blogs talk about these concepts. Demand isn't a curve, but a vector. It doesn't slope downwards, but the matrix of partial derivatives with respect to price is negative semi-definite. Equilibrium isn't where two lines cross. It's a whole page of definitions.

Getting down those basics takes a long time. That's what first year (and more) is about. We spend the year learning basic academic economics. It's long. It's tedious. It's probably a waste of time. But ultimately, I believe there is a light at the end of the tunnel and first year is definitely worth it. In the words of the scripture, this too shall pass.

Before my Austrian friends think I've completely crossed over to the dark side (I've already annoyed them too much), let me add two things.

First, I don't mean that players or students have to think what they are learning is the best way. What are the odds that all of your teachers are right on everything? Students and players should have questions about why they learn what they learn. But it takes a lot of arrogance (which I certainly have been guilty of) to come in and think you know how the game should be played on day one.

My advice to myself and others: be patient. Learn the game. After you have developed an understanding of the new game, make your ultimate decision on how it should be played. If you're right, you'll win games in football and publish articles in economics.

A second point I want to emphasize is that students ultimately must find their comparative advantage. When I started college football, I had to learn to play how everyone else played. That's just the nature of being 1 person learning in a group.

While the basic skills you learn help everyone, each player eventually needs to figure out how he best plays. For me in football, that was different from most people. I was 2 inches too short, 40 pounds too light, and 0.3 seconds too slow. I had to learn my unique style. My style wasn't right for everyone. It was right for me.

For me in economics, I don't know what my style is. Hopefully I will find it someday.

Most people will play traditional economics. That's fine. If you're interested in something non-traditional like Austrian economics, you have to adjust your play to that. You'll get crushed if you try to play like a pure theorists or econometricians. That's not your comparative advantage.

Take Pete Leeson. He is one of the most interesting young economists in the world. My guess: he would be a nobody if he tried to imitate what comes out of MIT. Instead, he works on what he loves and does it well. He is more successful and the profession is more interesting, because he doesn't imitate.

Grad school is about finding the area that I can contribute to. If I don't want to be a traditional football player, there is a huge difference between finding a niche (pass rushing, for example) and sitting on the bench all year. If I insist that my "economics" is right and no one else agrees, I'll have to enjoy sitting on the bench.

I came here to play. So I'll keep working on my steps. Hopefully, I'll get a few good hits in along the way, like the top picture :)

Nothing New Under The Sun

Studying history, including economic history, is quite odd. Maybe I'm crazy, but I see parallels almost everywhere I look.

As I've written before, one of my research projects is on the Panic of 1907. In many ways, it resembles our recent economic crisis. For me, the most startling resemblance is the absolute fear that the monetary authority had about any contraction in the credit market1.

Before 1907, since there was no Federal Reserve, the Treasury decided to act like a modern central bank. Facing a slowdown in economic activity, Treasury Secretary Shaw made some policy changes. Quoting from an academic article at the time1:

Until within the last decade [1898-1908], also, the treasury had never ventured to intervene in the money market, except in moments of really great distress, such as the outburst of an unreasoning panic.

Nor had any secretary ever attempted, or probably ever thought of attempting, to render the currency responsive to the changing needs of trade by deliberate manipulation of the public funds.

For the first time the treasury's policy appears to be influenced by the rate of interest prevailing in the financial centers, and by the condition of the stock market.

With him it became the avowed endeavor of the department to check every incipient stringency, and to prevent any contraction of credit, no matter what might have been its cause.

By the end of 1902, Mr. Shaw had increased the amount of deposits at banks to $150 million. This is at a time where total money in the United States was around $2.5 billion.  Again, this is not during the height of the Panic, where the Treasury was acting as a lender of last resort. No. This was during a normal downturn in the economic.

On August 27, 1903, Mr. Shaw announced that, according to his ruling, money could be transferred en bloc from the treasury vaults to the banks, and that he had on hand about thirty-eight millions available for that purpose. In other words, he announced to the banks before any panic had occurred, that he intended to assist them if they were in need, and that he was ready to assist them upon a scale never before conceived possible.'

In 1906, trying to hold off the inevitable correction, Mr. Shaw announced that the Treasury would deposit government money with any bank that imported gold. This amounted to $49 million deposited in New York banks, $31 million in National City Bank alone. In September, another $44 million were poured in. Again, think of the total amount of money in the economy at the time.

The Treasury literally just gave government money to the banks to hold. That makes quantitative easing look like a joke.

Nearly a billion dollars had been added to our supply of gold and about three hundred millions to our bank circulation, which meant an average annual increase for ten years of about one hundred and thirty millions. A considerable part of this increase had passed into bank reserves and had naturally formed a basis for enlarged credit.

Secretary Shaw just could not understand the role of credit in coordinating production. That might be excusable. Mises and Hayek hadn't formulated their theories of the boom/bust. 1902-1907 might be excusable. 2002-2007? You decide.

But remember, since there were recessions and banking panics before the Fed, a "free-market" in credit cannot work...

1. Andrew, A. Piatt. 1908. “The United States Treasury and the Money Market. The Partial Responsibility of Secretaries Gage and Shaw for the Crisis of 1907.” American Economic Association Quarterly 9, no. 1 (April): 210–231.

Reply on Austrians and Math

(I apologize to any commentators for the slow response. I just got back from my honeymoon and as much as I love discussing economics with you, it wasn't my first priority.)

We should not write so that we can, but that we must, be understood. - Marcus Quintilian

One might think that after 4 years at a good liberal arts college I might be able to write. You'd think I'd be able to make a small point. A las, that is not so. I will keep working. Thank you to all who put up with my poor writing.

My goal in my last post was simple. I wanted to encourage people, like myself, who are interested in Austrian economics to do one thing:

Give math a shot.

That is all I wanted to do. It wasn't a bold claim and I don't think anyone disagreed with that point. Most people probably dismissed it as trivial.

Yet, I didn't believe there is a single post/article by someone friendly to Austrians urging people to study math. I still haven't heard of one. If you know of one, please let me know and I will post it.

I didn't want to get into discussions of the usefulness of continuity or the benefits of advanced mathematical economics. But people latched on to the continuity or mathematical economics. Those are interesting conversations, but they've been had other places.

I just wanted to say to someone like me during my undergrad, someone who had read more than academic Austrian journals, "Hey, Austrian economics is really cool. Keep studying it. But also don't be turned off to math. It can be helpful to understand the world if used right." Continue reading

Study Math, My Austrian Friends


(Update: I've posted a reply to some concerns here.)

Austrian economists hate math. That’s a broad brushstroke, but I stand by it.

And it's a shame. I understand the Austrian concerns about math and agree with most. But the concerns call for hesitation when applying math to economic problems. Yet, justified hesitation wrongly became abstention. I want to fight that tide.

This is not a post to bash Austrian economists and their lack of math. If you came here for a smackdown of Austrian economics, you will get no such pleasure from me. I'm not sure advanced math has been a net gain for economists.

Instead, this is an apology, in the religious sense, for math- pleading to young scholars interested in Austrian economics: Put away your concerns for a moment. Learn math. Math can be your friend. You will be a better (Austrian) economist for it.

Let me echo something I've heard Bryan Caplan say: Austrian economists are among the most interesting in the profession. My criticisms come from a love for the tradition and a wish to keep improving it. People who understand Mises/Hayek/Rothbard/Kirzner will push our understanding of the world in the coming decades. I'm sure of it. You, my Austrian friend, will help in that.

From one friend to another

First, let me set up my street-cred within Austrian economics. I am no Trojan horse; I am truly a strong supporter of advancing Austrian economics. Whether other people will label me as an Austrian is up to them.

First, I am an Adam Smith Fellow at the Mercatus Center, which is THE heart of academic Austrian economics in the world. My job literally involves discussing Hayek and Mises with some of the best in the business. I believe they would vouch for me as a friend of Austrian economics.

Second, my research is clearly Austrian-inspired. One paper I'm working on examines the boom/bust Panic of 1907. The second looks at Hayek's theory of spontaneous order, specifically when that spontaneous order breaks down. I see my research as following in the footsteps of the greats.

Third, look at this blog. It's called, a reference to Israel Kirzner's first book. The site's banner has Rothbard, Mises, and Kirzner- my way to show respect to those who I think are superb economists.

While none of what I've written makes me an expert on Austrian economics, I hope Austrians will be more willing to accept my point, coming from a friendly stance. I won't belittle those who choose to do a more literary form of economics. Do your thing. But along the way, pick up a math book. Continue reading

A Better Understanding of Equilibrium

For economists

I've thought a lot about equilibrium recently. At the same time that I'm reading some excellent game theory books (including a nice little book by David Kreps that is accessible to non-economists), I am also studying agent-based modeling.

Game theory uses equilibrium heavily and distinguishes a billion different types of equilibria. Agent-based modeling rejects equilibrium as central to economic analysis.

Oh yeah, and I just got done with a full course on general equilibrium theory. Throw that on top of my skepticism of equilibrium as an important concept and you have one confused grad student.

This jumble has me thinking heavily about the meaning of equilibrium. Is it useful? When? How do we need to adjust our understanding? What is the role of disequilibrium?

Then I re-watched a speech by Mario Rizzo title "A Better Concept of Coordination." In it, Rizzo is trying to clarify our understanding of coordination and equilibrium. He is trying to understand the relationship between aspects of the economy that lead to equilibration, or better coordination, and disequilibration, or when people's plans don't align.

For Rizzo, equilibration and disequilibration are like yin and yang. They cannot be separated.

I just love the quote he starts out with from Oskar Morgenstern.

I'm not sure I have any more insight to add to Rizzo's speech. It is clear to me that a focus on equilibrium has killed much of the interested parts of economics. What is a better option to replace it? I don't know. I just enjoyed the speech and thought you might too.