New Directions in Modern Economics series
Chapter 4: Heterogeneity and the Status of Macroeconomics
THE STATE OF MACROECONOMICS Since the approach followed in this book is mainly macro, it is important to understand how the methodology characterizing its construction affects its nature. As is well known, there is no unique methodology underlying the study of economic systems: classical theory, general equilibrium and macroeconomics are competing paradigms directed at explaining the working of the economic system. Furthermore, macroeconomics itself has changed dramatically since its inception. In particular, it has been developed, according to Keynes (1936), as a general framework that includes the neo-classical analysis as a particular case, the particularity being represented by the hypothesis of full employment. In modern language, complete markets and full information should be added. Over time, this relationship has been reversed and macroeconomics has become the operative branch of general equilibrium. Furthermore, in order to have scientific status, it is claimed that it must be microfounded (see Lucas and Sargent, 1981). This neo-classical school of thought states that microfoundation is a sine qua non for economic analysis to maintain a scientific status, and this opinion is shared by the different scientific paradigms, ranging from the Real Business Cycles school (see Long and Plosser, 1983) to the so-called new Keynesians (see Farmer, 1999, Woodford, 2003 and Blanchard, 2008). In order to respect the tenets of this methodology, markets must be complete, uncertainty replaced by risk and agents’ heterogeneity must be contained. 2. IRREDUCIBILITY AND ISOMORPHISM Every model is based upon a set of assumptions, and this cannot be an object of...
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