The glass is half full eh one fourth full. Would you believe slightly damp ?
To be fair, applying maximizing thinking has achieved some major successes even in macroeconomics. The permanent income/life cycle style of consumption theory does a much better job of accounting for the stylized facts about spending than the old, mechanical consumption function. The natural rate hypothesis, with its crucial implication that high inflation would get built into expectations and not reduce unemployment, was the result of (loose) maximizing reasoning.
I have two discouraging thoughts. First both of the examples of a useful application of the assumption of maximizing behavior are due to Milton Friedman (and others). This shows that Milton Friedman can say useful things while appealing to maximization. I think we can conclude that either the concept of maximization is useful or Milton Friedman was so smart that he could say smart things when standing one foot, rubbing his belly, patting his head, and talking about maximizing agents. I’m afraid the question of which conclusion is more plausible answers itself. Outside of macro we have Arrow and Samuelson and well a bunch of smart people who can say smart things and solve equations at the same time.
Second I now wonder if the PIH glass is half full. Consider a model of totally myopic backward looking agents with habit formation, so consumption moves sluggishly towards current income. This can give consumption depending on lagged income — say a geometric lag. Which of the stylized facts expalained by the PIH are also explained by this not at all optimizing model ? I think basically all of them. The model is due to Stever Marglin who was a bit too heterodox to get attention. But I think it works as well as the PIH.
Taking an equation for x and re-interpreting it as giving x* and making an error correction model of (x-x*) is exactly what macroeconomists used to do before the Rational expectations revolution. It is exactly what Sargent denounces as not taking a model seriously. And, I think, it fits consumption just as well as the PIH.
Oh and as for the shifting Phillips curve, one can go back to a golden oldy “The General Theory of Employment Interest and Money” to find a very clear warning that one better not treat a Phillips curve as a structural equation (only slighly hampered by the lack of the terms “Phillips” and “structural”).
No one every said how expectations were formed. Backward looking seems as good as any.
No one every said how expectations were formed. Backward looking seems as good as any.
I’m not talking about expectations. I am talking about habits. In the model I described, agents do not forecast, do not consider their intertemporal budget constraint and do not maximize any well defined objective function.
Yes, the moving average with exponentially defining weights on past observations would give good forecasts. Thus a model with optimizing agents and a model with completey myopic agents imply almost exactly the same consumption. This is not a good thing for those who consider the optimizing model glass at least half full.
I think by “No one” you mean “neither Friedman nor Krugman.” That is true. However there is a huge literature on testing the PIH with rational expectations. This literature does not stick to one model — auxiliary hypothesis are changed and changed in a desperate effort to reconcile the model with the data (amazingly the data are so clear that they reject models with dozens of free parameters).
Thus this research program is unlike Ptolemaic astronomy, which stuck with the same model for over a milenium. In contrast to Ptolemaic astronomy which was an excellent model (which was surpassed by much much better models) modern economics is a degenerative research program. Lakatos did not know the facts about Ptolemaic astronomy, but he did know the facts about economic research. He challenged Friedman to a debate and promised to give Friedman the last word. Friedman, who was as noted in my post, very smart, declined.
Robert,
a) Could you give the title or link to Marglin’s paper?
b) Your Ptolemy vs Copernicus vs Kepler post really needs to be here on AB too.
If economist really think the way they write, no wonder we are in trouble. “Maximizing thinking”???? “Stylized facts”??? This quotation gives new meaning to the term “jargon.”
Dear Herman
a) no. I just remember the model being mentioned in a graduate macro lecture (by Summers) and explained verbally by Brad DeLong. Sorry to drop names, but I have never seen the paper. I can google scholar
This seems relevant
http://rrp.sagepub.com/content/16/2-3/95.short
but I can’t find Marglin’s paper. I’m not sure it was published.
b) but this is supposed to be an economics blog and the posts are two and each is very long and are you sure ? I guess I could try a brief version (but that would be like uh work yech).
Stormy. Yes that is part of why we are in trouble. Usually we don’t use jargon to be deliberately obscure. We can’t help it. I honestly wouldn’t consider “stylized facts” and “maximizing thinking” to be jargon. They sound like plain English to me.
Too bad about Marglin.
On the Pt v C v K, the false claim is so often made my macro guys that it is certainly relevant on an econ blog.
“taking models seriously” : the best recent response to this piece of absurdity comes from Caballero:
‘… “take the model seriously” (a statement that signals the time to leave a seminar, for it is always followed by a sequence of naive and surreal claims).’
on the Marglin reference it could be the book “Growth, Distribution and Prices”