Knowing and Making

[ Apologies to X-Factor fans: this article is about "one direction" towards a new model of macroeconomics, not about the band. But do feel free to stick around and join in the discussion. ] If you read nothing but Rajiv Sethi 's and Interfluidity 's blogs, and developed all the consequences of what they said, you'd get a spectacular career in economic research out of it. Fortunately, Mark Thoma reads them - as well as hundreds of others - and has a good commentary on a recent post of Rajiv's . I won't quote the whole thing, but here is the key message. Without the assumption of a representative agent - the idea that everyone in the economy behaves identically - current macroeconomic models can't work. But this assumption misses some of the key dynamics in the economy - the fact that some people borrow and others save; the fact that different people have different beliefs and preferences - which are fundamental to both why and how economic activity...

Karl at Modeled Behavior responds to Richard Posner (I am surprised to hear Posner emphasising psychology - I thought he was talking about Richard Thaler at first): I am not sure exactly what Posner means by psychology. I have never been optimistic about feelings as an economics model. Perhaps people spend more when they feel better but how do we get a consistent measure of feelings and even more to the point how does policy consistently effect them. What I do think makes a difference is expectations . Expectations do fit nicely into macroeconomic models because they bear a simple relationship to real events. Macro models mostly deal with visible events such as monetary transactions. And an expectation is just an event, translated in time and perhaps given a probability weighting. But we do model things in economics that are not that simple. The most obvious example: preferences . Preferences are very complex - just think of all the factors that impacted on your choice of what dinne...