Chapter 2: Monetary and Social Relationships
Charles A.E. Goodhart Introduction The social sciences are much more complex than the physical sciences. Not only are experiments generally easier to undertake in the physical sciences, but also the subject matter of any such studies in the social sciences, we individuals, respond and change our own behaviour in the light of those same economic experiments. Moreover, human behaviour is both variable and reactive, especially in response to major regime changes. So, any attempt to depict the economic macro system has to involve models which are gross simplifications of underlying reality. How best then to simplify our macro models? It is such macro models which will be the main subject of my discussion. When we macroeconomists started building solvable models at the outset of the computer age, some 40 or so years ago, we generally aimed at getting a detailed and comprehensive structure of the economy, on a sector-by-sector, equation-by-equation basis, using national income statistical categories, and this led to large computable macro models, often with 50 or more equations. Amongst the resulting problems, however, were that the optimizing, so-called ‘micro foundations’ were weak, if not nonexistent. Expectations, when considered at all, were often inconsistent with the model’s own workings; and some of the implications of such large models were difficult to discern and, when worked out, often totally implausible. All this led to the Lucasian revolution, whereby macro models had to have ‘rigorous’, optimizing, micro foundations, often based on so-called ‘rational’ expectations. This, in turn, led to a degree...
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