Saturday, September 3, 2011

Macro vs. Micro


A debate on the relation between micro and macroeconomics has been raging in the mailing list of the Societies for the History of Economics (SHOE; yep that's the acronym they went for!).  The main question being discussed is whether micro-foundations are necessary for coherent macroeconomic theory. I have argued in a previous post that, in fact, this is the other way round, macro-foundations for microeconomics are essential.

From a history of thought point of view, it is important to note that the distinction is a relatively modern one, starting in the 1930s.  The term macroeconomics was first used, most likely, by Ragnar Frisch in his lectures notes in 1933-34, and first used in print by Jan Tinbergen and Eric Lindahl in 1936 and 1939, respectively (for a full discussion see Vela Velupillai, 2009; subscription required).  Keynes did not use the term in his General Theory, even though the book is considered the foundational book of macroeconomics. To a great extent the work of John Hicks -- both his ISLM paper and his Value and Capital -- is central to understand the direction in which the profession developed.

Yet, Keynes book was central in the eventual split of macroeconomics and microeconomics.  In particular, because Keynes defied the conventional wisdom, associated with marginalism, that the rational maximizing behavior of firms and individuals would lead to the optimal (meaning full) utilization of resources, including obviously labor resources.  Full employment was not the normal equilibrium position of the economy.  In that sense, Gary Mongiovi provided the most enlightened note to the SHOE debate.  He tells us:
"the macro/micro distinction actually arose after Keynes's theory took root, and students had to be taught two distinct and apparently incompatible stories about how market economies work: (1) a neoclassical distribution theory in which the real wage adjusts to bring the S & D for labor into line with one another; and (2) a Keynesian story about how the economy could settle into an equilibrium in which the labor market doesn't clear."
That incompatibility and incoherence is still with us.  Students are taught that markets are efficient in their micro text, and some imperfectionist story is told in order to provide a foundation for the Keynesian macro story (at least in salt-water departments).  Of course an alternative would be to discard the marginalist approach altogether, since it does have insurmountable problems as admitted by Paul Samuelson during the capital debates in the 1960s.  But that's another story for a different post.

3 comments:

  1. this is a very important point. I've had this sense for a while. the distinction between macro and micro is pretty arbitrary and from other things I've read gotten the sense that the fracturing of economics caused by the general theory created the distinction. the dichotomy between macro and micro is illusory and not very useful. feedback loops (among other dynamic processes) lead to changes at the level of an individual firm or person to influence the working of an institution or national economy and vice versa.

    two side notes on this point. the feedback loops between different structural levels is what gives me an appreciation for wynne godley's "stock-flow consistent" approach since even though your modeling an entire national (or three country) economy you can break the accounting down to focus on decisions of individual firms or households without ignoring feedback effects (ala marshallian partial equilibrium). it also gives you the ability to look at the neo-schumpeterian mesoeconomics concept since the flow of funds can be disaggregated into sectors and industries.

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  2. Matías, i disagree with Mongiovi. The Micro/Macro splits reflectes deep problems with capital theory that actually arose even before Keynes magnus opus.
    As i see, Hicks is the responsable; until the "Theory of Wages" micro and macro were one single piece. Shove´s harsh review of it since it was not clear what Hicks means with the term "capital".
    Then in "Value and Capital" the concept of intertemporal equilibrium was developed and soon mainstreem economist started to think macro in terms of microeconomics.

    Gualra

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  3. Yep, the distinction is arbitrary, and Gary is right (if you go to the link his whole e-mail to the list is there) in suggesting that classical authors were interested in system level phenomena, which would include things that modern economists would classify as both micro and macro. On Keynes being responsible, I think that what Gary is saying is that the profession (Hicks being central for that for sure) created the inconsistency in order to accommodate Keynes message within a marginalist framework.

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