Why Microfoundations?

This is about a million years late in blog time, but last week there were a range of interesting blog posts about the quest to provide “microfoundations” for macroeconomic theory. As someone who took more philosophy of science classes than economics courses as an undergrad, I have to say that I’ve always found this particular tick to be a bit puzzling.

In philosophy there’s an idea called “reduction.” We might start with a bunch of observed psychological regularities about human behavior (“when people go a while without drinking they get thirsty”) and then ask if we can reduce this psychological insight into some kind of neurological phenomenon. And perhaps someday we’ll be able to go down from neurology to chemistry and particle physics and understand the quantum mechanical underpinnings of thirst. But while reduction is something scientists inquire into, it’s never been the case that reduction is the sine qua non of useful scientific inquiry. To the best of my understanding, Newton’s account of gravity didn’t have any microfoundations at all. It was a mathematical formalization of observations about how the world functions. And while modern physicists aspire to come up with a “theory of everything” that will explain relativistic gravity in quantum mechanical terms they haven’t yet succeeded. But this hardly means that the whole history of human inquiry into how gravity works is some kind of silly parlor game that lacks rigor.

And crucially the key test a purported effort to provide microfoundations for gravity must pass is that it has to explain gravity well. The trend in economics since the Lucas Critique seems to be the reverse. If a theory lacks adequate microfoundations, it’s rejected out of hand while you get a lot of wriggle room in terms of accounting for the data properly.

People who seem very bothered by the fact that the observed reality of nominal wage stickiness is not well-microfounded don’t appear to have the same difficulty relying on the observed reality of gravity. This is particularly strange since microeconomics itself is not particularly microfounded in psychology or neurology. Non-economists often level this as a somewhat misguided purportedly devastating critique of microeconomics, noting that abstractions about welfare-maximizing agents are not justified by scientific understanding of actual decision-making procedures. The right answer is that productive inquiry can happen at many different levels of understanding and the appropriate test of a theory is whether it gives some kind of useful account of the thing it’s supposed to explain. But if microeconomics doesn’t require a psychological or neurological foundation to offer insight, then there’s no reason to think macroeconomics requires a microeconomic foundation. A theory of everything would be nice, but general relativity is a very impressive achievement.