Cross-posted from Life, the Universe, and Everything
Paul Krugman has an article in this week's New York Times magazine about the disarray in macroeconomic theory. In simplest terms, neither the New Classical nor New Keynesian economic theories are able to explain how the American economy got into its current parlous condition. Krugman identifies, correctly, the root of these problems in the economics profession's insistence on grounding economic models in perfectly rational behavior.
As he points out, a brave band of the economics tribe has insisted for years that such approaches to behavioral modeling are deeply flawed. The basis for this assertion is (wait for it) observation of consumer and investor behavior that is (gasp) irrational. However, as a professor in my own economics doctoral program observed, "You can't bash a theory with facts, you bash a theory with another theory." The purpose of this post is to point out that the hyper-rationality in behavior which is the foundation of modern macroeconomic (and other economic) theories is based upon a profoundly uneconomic assumption.
Read More