The disarray of economics

Imagine if a world-renowned biologist fundamentally disagreed with the basic theories and models underlying the core Molecular Biology course at Duke. Though it would be very worrisome, any biology major will tell you that their discipline doesn’t face such a problem. Unfortunately, as an economics major, I cannot say the same thing.

The major’s core macroeconomics course that I am currently taking uses the micro-foundation approach of Robert Barro and other New Classical economists: models that base explanations of macroeconomic phenomena on the microeconomic understanding of individual behavior. While I have found many aspects of these “New Classical” models compelling, there are many influential economists—such as Paul Krugman, winner of the Noble prize in Economics, and Duke’s very own Kevin Hoover—who have serious qualms with these models.

Hoover has said that the micro-foundation approach faces the Cournot problem, which arises from the difficulty of tracing the decisions and constraints of all the individuals in an economy and aggregating them to get macroeconomic relationships. However, even if these difficulties could be surpassed, Hoover still holds that certain macro concepts are irreducible to micro concepts because there is a conceptual divide between micro and macro. Why is this the case? According to him, the aggregation of micro-level entities creates macro-level concepts that are “emergent properties” of the aggregation. These emergent properties only make sense in relation to the aggregation of the micro-level entities and to apply them to the micro-level entities themselves is a conceptual confusion.

Perhaps the following analogy will help clarify. In physics, certain properties of gas—which is an aggregation of individual molecules for all those who took “Rocks for Jocks” as their NS requirement—such as entropy and temperature are concepts that are unique to the macro-level aggregation and do not apply to the constituent molecules that make up the aggregation. Similarly, in economics, a concept such as the general price level—a measure of the overall prices in an economy that is normalized relative to some base year—is a uniquely macro concept, as are all the real variables that are derived from it.

Therefore, a group of serious economists have a fundamental disagreement with the approach being taught in one of the largest economics courses at Duke. Indeed, because of their belief in the existence of concepts that lie solely in the domain of macroeconomics, they argue that many of the cause-and-effect relationships of macroeconomics are not reducible to the aggregation of individual behavior. As a result, they believe that certain ad-hoc models, such as IS-LM, are a better way to understand the economy even if they are not consistent with the micro-foundation approach.

There are many more quarrels within the discipline that highlight its state of disarray. The same economists who advocate the micro-foundation approach have also rejected the Keynesian model as incapable of providing accurate explanation of economic phenomena, including the 1930s depression: the very event it was designed to explain! At Duke, the Keynesian model—once viewed as the pinnacle of economics—is not even covered in the core macroeconomics course in certain semesters. However, this model remains one that a few economists such as Krugman still view as one of the strongest in economics.

The reason for this state of affairs lies in the very nature of economics. Because the discipline deals with infinitely complex phenomena that are constantly changing and affected by many different kinds of causal factors (political, psychological, technological, etc.), economic theories are forced to include ceteris paribus clauses (Latin for “all else equal”). This allows them to create a simplified world, with many factors of the economic environment assumed away, in order to develop theories about (what they believe to be) the most important causes of various economic phenomena. Unfortunately, the explanatory power of economic models is limited by these ceteris paribus assumptions that they must make in order to derive their cause-and-effect conclusions. Indeed, when one of the factors that a model assumed away actually does interfere in the real world, the model will likely fail to explain or predict the real world phenomenon it was intended to.

Take Keynes’ model. In light of the Great Depression, Keynes concluded that, in the short run, demand shocks were far more likely to cause recessions than supply shocks. The main cause-and-effect relationship Keynes’ theory sought to illustrate was that the level of employment depends on the level of aggregate demand. In order to illustrate the relationship between inadequate demand and recessions, the Keynesian model assumes away (or at least does not include) the possibility of many other economic factors such as supply shocks. Consequently, Keynes’ model failed to explain the stagflation (high unemployment and high inflation) of the 1970s because, in the period leading up to it, many of the factors Keynes implicitly assumes away or ignores in his magnum opus, The General Theory of Employment, Interest, and Money, became important characteristics of the economic environment. Indeed, a series of negative supply shocks, mainly the dramatic increase of oil prices by OPEC in late 1973, invalidated Keynes’ implicit non-interference clause for supply shocks. The year of 1972 also marked a period of excessively expansionary monetary policy, while the Depression—the focus of Keynes’ theory—occurred after a period of severely contractionary monetary policy.