To anybody other than an experienced and expensively-trained macroeconomist, it is pretty obvious that conventional modern macroeconomics has been torpedoed by the financial crisis and its aftermath. If we needed any reminder about the limitations of the dynamic stochastic general equilibrium model of the economy built by aggregating the behaviour of individually rational individuals, this rapidly-going-viral public resignation letter by former Goldman Sachs executive Greg Smith underlines the role of institutions, culture, morals, and all those intrinsically human characteristics.
However, one of the challenges in dethroning standard macro – because events are never enough, ideas have to follow suit – is the absence of any obvious alternative. Although it might take a while to develop the workhorse models and teaching tools, one candidate will definitely be complexity theory and network economics. I’ve just readby Alan Kirman, which is a moderately technical but clear explanation of how complexity/network models can be applied to economics.
Given as a series of lectures, the chapters cover specifics such as network structures, segregation models, bubbles and herding behaviour, co-ordination problems in public goods, and – my favourite – the way co-ordinated behaviour emerges in the aggregate from all sorts of individual behaviours in the fish market in Marseille. Any applied economist who has looked at actual markets (as I did for 8 years on the Competition Commission) will know that the ‘free market’ model of textbooks is a non-existent abstraction. Markets are institutions which take a variety of forms and include a mix of personal and impersonal relationships. Economists (not just) like fish because they are traded in markets where there is a catch sold every day – no need to worry about inventory decisions, and lots of movement of prices and quantities.
Prof Kirman shows that prices paid for specific types of fish by different people on different days can follow all kinds of patterns, not remotely corresponding to the assumptions on preferences made in an economists’s model which aggregates from individual consumer choice to a market demand curve. Yet even so taking all the data in the aggregate reveals the standard downward-sloping relationship between quantity demanded and price. The chapter concludes that there is no simple link between individual and aggregate behaviour, although simulations that give ‘agents’ simple rules of thumb to follow in their choices do conform to the downward sloping demand curve and the real life pattern of fish market prices.
This is intriguing but it called to mind a number of studies suggesting that other creatures such as pigeons and capuchin monkeys act like rational, self-interested homo economicus in some circumstances. It would be odd to claim that real humans do not act in accordance with rational choice theory but pigeons do. Prof Kirman argues that the experiments teach the pigeons rational choice by their set up. However, I was very struck by listening to cognitive scientists at a conference in Toulouse (pdf) last autumn explain that neurons in the brain act like homo economicus in a constrained optimisation model, competing for energy as they process perceptual inputs and turn them into the things ‘we’ (our conscious mind) notice.
I don’t know how all this will add up to a new microfoundations for macroeconomics, if it ever will. Complex Economics gives us proof-of-concept for the role this type of model can play in several areas of economics, and think we can’t be too far away from having tractable models and programmes for applied economists and students. There’s still quite a gap between market models of this kind and a way of thinking about the economy as a whole. Meanwhile, it seems obvious to me that macroeconomists need to be eclectic and combine the complexity approach of this book, the time series macroeconometric approach ofand others, a dash of Keynesian sauce in the short run (with a laser-like focus on jobs), and plenty of history.
[amazon_image id=”0415594243″ link=”true” target=”_blank” size=”medium” ]Complex Economics: Individual and Collective Rationality (The Graz Schumpeter Lectures)[/amazon_image]