A Response to Hoover’s “Is Macroeconomics for Real?”

Kevin Hoover’s basis for writing this piece “Is Macroeconomics for Real” comes from comments that have been written anonymously on his class evaluations.  Many of the students side with the commonplace among economists that macroeconomics isn’t “real” because it cannot stand alone.  Rather, it is based off of microfoundations, something that has been seen time and time again through many readings.  Oftentimes, older macro theories are revoked because they don’t incorporate microfoundations, such as utility maximization functions and other maximizing behaviors.  Hoover, however, argues that macroeconomics is a “stand alone” discipline that cannot be reduced to a microeconomics form.  Hoover starts with basic definitions for macroeconomics and microeconomics, defining micro to be the “economics of individual economic actions” and macro to be “the economics of broad aggregates.”  Hoover continues, though, by saying that Keynes didn’t define these two terms as was just mentioned above.  Though he didn’t use the terms macro and micro when making the distinction, to him [Keynes], microeconomics was the “theory of the individual industry or firm” and macroeconomics was the “theory of output and employment as a whole.”  Macroeconomics has expanded beyond Keynes’ definition, but the aggregates that he referenced still refer to GDP, unemployment, interest rates, the flow of financial resources, etc.

I will attempt to answer Hoover’s question by summing up his claims, even with his philosophical undertones.  He references Uskali Maki (1994) to define and answer the “real” in the title of his article.  Maki looks at ontological and semantic realism and says the difference lies with the fact that ontological realism is “what there is” and semantic realism looks at the connection between “language and what there is.”  Remember, Hoover’s claim is to see if macroeconomics can remain independent from microfoundations.  Through his investigation and questioning, he determines that macroenomic aggregates “exist externally”–that is, they don’t rely on microfoundations, which is a huge shakeup from mainstream economic thinking since the 1940s.  Lionel Robbins (1935) makes a blanket statement that “economics is the science which studies human behaviour as a relationship between ends and scarce means which have alternative uses.”  From this statement alone, economics is about the individual, a microeconomic slant.  Keynes, however, developed the modern theory of macroeconomics with three main equations: the consumption function, which looked at aggregate consumption patterns in relationship to national income; investment on the basis of interest rates; and the liquidity preference.  Thus, going solely off of Robbins’ definition, Keynes’ contributions would be invalid because it doesn’t base its models off of the behaviors of the individual.

Hoover continues by looking at Mark Blaug’s (1992) individualism, which makes the claim that explanations of “social, political, or economic phenomena” cannot be explained without the understanding of the decisions of the individual.  Even Augustine Cournot of the 19th century says that “there are too many individuals and too many goods to be handled by direct modeling.”  Blaug, nevertheless, goes on to observe that “few explanations of macroeconomic phenomena have been successfully reduced to their microfoundations.”  Robert Lucas (1987) is a strong supporter of the individualism principle and the idea of microfoundations.  His colleagues and he have worked extensively on new classical economics that assumes that representative economic agents (the individual) make decisions to reach their optimal choices.  Essentially, macro theory must use these fundamental microeconomic elements (i.e. utility maximization, consumption maximization, etc.) in order to have any validity.  A. P. Kirman (1992) criticizes the idea of a “representative agent” because it fails to represent actual individuals.  Individuals inherently seek to maximize their utility and consumption, but without rationally modelling and plotting out their optimal points along a budget constraint.  David Levy (1985) has the same logic because information isn’t perfect.  As previous blogs have alluded to and directly mentioned, assumptions for some of these macro theories, though built upon microfoundations, doesn’t hold water because their assumptions are too “naive” and simplistic.  Though it helps with the model, what good is a model that doesn’t accurately capture actual observed behavior?

Hoover’s next set of arguments is based around the “validity” of the macroeconomic aggregates.  Nobody doubts that GDP, unemployment, and interest rates are interconnected.  People do disagree, however, that these aggregates are the “fundamental units” that constructs this economic reality.  Hayek (1979) says it best that these entitites are secondary because these entities cannot be explained and fully understood without having an understanding of the individual components.  This statement reverberates through all the macro theory that presented criticisms towards other theories for failing to be based upon microfoundations.  Nevertheless, even Hayek doesn’t believe in the pure definition of individualism, citing the Cournot problem.  (CAN SOMEBODY PLEASE TELL ME WHAT IS THE COURNOT PROBLEM?  I think it has to do with being unable to model an entire economy because it’s too complex, but I’m not sure.)

Referring back to the aggregates that consumes macroeconomics, Hoover states that there are two aggregates: natural and synthetic.  Natural aggregates are those that are simple sums or averages, such as total employment or an average interest rate on commercial paper/Treasury security for a certain period of time.  Hoover says that he terms them natural because they are calculated in the same units in which the individual units are also calculated.  The other aggregate is synthetic.  Synthetic aggregates are those that are “fabricated out of components” and therefore have a different structure.  The main example here is the aggregate/general price level.  An average of all prices will not work because apples and oranges cannot be added together.  The ultimate goal is to find out the price of money to see what something is worth in real terms.  Again, this is difficult to accomplish because the overall economy is complex and there would have to be thousands of equations to capture all of the movements in the economy, which is next to impossible and very, very time consuming.  The story goes on to discuss the indexes that have to be constructed.  Indexes give insight into general price levels because once again, percent changes of certain goods and services will weigh more heavily on the overall economy and “price of money” than other goods and services.  For instance, Hoover says a change in the price of gasoline will have a larger impact than the change in the price of caviar.  Thus, indexes reflect weights that have to be applied to certain industries and sectors of the economy.  (As a side note, PPIs and CPIs are calculated with and without food and energy because these two areas of the economy are the most volatile and will have a large impact on what is the perceived rate of inflation.)  This same thought process holds true for the need to calculate real GDP.  Price changes are bound to occur.  Therefore, nominal GDP will always increase, even if quantity does not change.  Therefore, real GDP is needed to see whether prices changed and the level of output did not change, or whether the economy experienced an increase in output due to more efficient methods.  If the latter is true, then real GDP will go up.  If the former is true, then it can be expected that only nominal GDP will increase due to the rise in prices.

The following section discusses supervenience, which I don’t understand.  I will quote the passage, but cannot provide insight only because it does not make sense to me.  On page 12, Hoover says “Macroeconomic aggregates I believe supervene upon microeconomic reality.  What this means is that even though macroeconomics cannot be reduced to microeconomics, if two parallel worlds possessed exactly the same configuration of microeconomic or individual economic elements, they would also possess exactly the same configuration of macroeconomic elements.”  The reverse doesn’t necessarily hold true.  On a different note, Hoover discusses irreducible aggregates and their ability to be manipulated.  Some macroeconomic aggregates cannot only be controlled, but “can be used to manipulate other macroeconomic aggregates (i.e. real interest rates and price levels and their effect on yield curves).  He ends the paper by stating that this paper only attempted to show the current behavior and interplay between macroeconomics and microeconomics.  Hoover does go on to mention that there are macroeconomic aggregates that are irreducible, and consequently, cannot be built upon microfoundations.  Therefore, these entities are indeed “real.” 

Source: Hoover, Kevin D.  1999.  Is macroeconomics for real?  University of California-Davis (June): 1-22, http://users.umw.edu/~sgreenla/e488/Macreal.htm (accessed April 8, 2008).

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