September 19, 2017

The new macroeconomic paradigm

Comment on Brian Romanchuk on ‘DSGE Wars (Again)’

Blog-Reference and Blog-Reference adapted to context and Blog-Reference

(i) Every economist knows by now that DSGE is a failed approach. Strictly speaking, the microfoundations approach has already been dead in cradle 140+ years ago.

(ii) The microfoundations approach is defined by this axiom set: “HC1 economic agents have preferences over outcomes; HC2 agents individually optimize subject to constraints; HC3 agent choice is manifest in interrelated markets; HC4 agents have full relevant knowledge; HC5 observable outcomes are coordinated, and must be discussed with reference to equilibrium states. (Weintraub) Fact is that every model that contains just one of the axioms is false.

(iii) Because the microfoundations approach is axiomatically false a paradigm shift is imperative. Methodologically it holds: “When the premises are certain, true, and primary, and the conclusion formally follows from them, this is demonstration, and produces scientific knowledge of a thing.” (Aristotle) The paradigm shift consists of the replacement of false premises, i.e. microfoundations, by true premises, i.e. macrofoundations.#1

(iv) This is the correct core of macroeconomic premises:#2
(A0) The objectively given and most elementary systemic configuration of the (world-) economy consists of the household and the business sector which in turn consists initially of one giant fully integrated firm.
(A1) Yw=WL wage income Yw is equal to wage rate W times working hours L,
(A2) O=RL output O is equal to productivity R times working hours L,
(A3) C=PX consumption expenditure C is equal to price P times quantity bought/sold X.

These premises are certain, true, and primary, and therefore satisfy all methodological requirements. The set of premises is MINIMALISTIC, that is, it cannot be reduced further, only expanded. The graphical representation of the pure production-consumption economy is given on Wikimedia.#3, #4

(v) The condition of market clearing is X=O and of budget balancing C=Yw. From non-clearing and non-balancing follow the phenomena of inventory changes (O-X greater than 0 or less than 0) and of monetary saving/dissaving (Sm≡Yw-C greater than 0 or less than 0) and of monetary profit/loss (Qm≡C-Yw greater than 0 or less than 0). It always holds Qm+Sm=0 or Qm=-Sm, in other words, loss is the counterpart of saving and profit is the counterpart of dissaving. This is the most elementary form of the Profit Law.#5

(vi) Given the minimalist core propositions (A0) to (A3) one has to proceed top-down by successive DIFFERENTIATION until one arrives at the individual agent. Differentiation is the opposite of bottom-up or aggregation. The bottom-up = microfoundations approach has always been methodologically indefensible because it runs with necessity into the Fallacy of Composition.

(vii) Note that the macro axioms are composed of measurable variables. This is the precondition for testing the derived complex relationships = economic laws.

(viii) The correct systemic macrofoundations FULLY replace the false Walrasian microfoundations and the false Keynesian macrofoundations. There can be NO pluralism of axiom sets. For ALL economic research, the macroeconomic premises (A0) to (A3) are ABSOLUTELY necessary. It holds: If it isn’t macro-axiomatized, it isn’t economics.

Egmont Kakarot-Handtke

#1 Keynes’s macrofoundations are false, see ‘How Keynes got macro wrong and Allais got it right
#2 For the complete set of macro axioms® see Wikimedia

#3 Wikimedia: The pure production-consumption economy
#4 True macrofoundations: the reset of economics
#5 From the macro axiom set follow the Five Basic Economic Laws®