Even as right wing nobel memorialettes are proclaiming the victory of rational expectations, there is a growing movement within economics which disputes that aggregate measures are always correct. Our own Hale Stewart, and former Bopster Barry Ritholtz have done it, so has energy economist Jerome Guillet.
Oldman and I have argued that there is such a thing as "mesoeconomics" and that it is a consistent paradigm with a developing formalism. So who are the mesoeconomists? And what is mesoeconomics?
The answer to the first question is you are one of them, and the answer to the second question is that mesoeconomics is the study of non-linear strategy in economics.
What is Mesoeconomics
Mesoeconomics comes from when you think about, not just the transaction, nor the big picture only, but in specifics of how you expect things to play out. Mesoeconomics comes from the fact that you aren't just an eating machine, that decides to eat or not eat, consuming generic phlogiston, but specific things.
Let me take an example of mesoeconomic thinking. Suppose you have a choice between two software packages. One is better than the other at a better price. The other is by Microsoft. You worry that MS will kill off the small company that makes the first one, and therefore buy the MS product because of the stability of the company. Congratulations, you've just shown mesoeconomics at work, because you didn't buy what you liked, you bought into a strategy.
Origins of Mesoeconomic Thinking
As with many things in economics, the first clear statement which can be identified as expressly mesoeconomic comes from Adam Smith, this is not to say that the ideas that he used were new with him, but the idea that they could produce measurable effects was new from him. Thus Adam Smith takes pride of place not for discovering that strategy is important in economic behavior - Plato, Aristotle, Machiavelli, Hobbes, Locke and Hume had all pointed this out - but that the expectations of the relationships in an economy, and the expectations of the value of different strategies having a meaning that would be reflected in price and output was.
Specifically when Adam Smith is outlining the requirements for a market - such as an expected rate of profit - he is talking about actors having some conception of choices having meaning beyond the immediate incentives. He argues that people generally make bad strategic decisions, and that therefore the best road to economic growth is to compress all of the information into price. That is, people shouldn't have to distinguish between all other alternatives, if price measures everything that is important, it reduces a choice to a simple mechanism - is the money/time worth more than the commodity/opportunity it will buy. Is present happiness or opportunity more important than future happiness and opportunity.
And this is where matters stood. Like Newton's kinematic theory which threw down a challenge to find all of the ways energy will flow through systems, Smith's idea set of a nearly 150 year search to prove that all information could be compressed into price, and that actors could be made to think only in terms of immament price and future concerns trade offs. Eventually this would lead to the downfall of purely micro-economic reasoning, as Keynes showed that whole economies could decay, and that this caused people to act on something other than price, namely the fear of an economic collapse. Thus, according to Keynes, the way to restore Smithian market dynamics was to have a layer of government mediation which would keep the market within equilibrium. Or as Prof Brad DeLong puts it "to make Say's law apply in practice, even if it does not apply in theory."
Keynes and The Macro-Economists
Keynes, like Smith, did not reveal all of truth, but put forward a challenge - he argued that the dynamics that did not appear in micro-economics could be found in the study of the whole economy - or macroeconomics. That is, when actors aren't behaving as microeconomics says they should, it is because there is some macroeconomic effect that is influencing their behavior. Remove the effect, and they will go back to being microeconomic actors.
The first step was creating a paradigm of macroeconomic analysis. I mean this in the strict sense of a series of equations and concepts which could be manipulated to produce predictions based on measurements - and in the broader sense that people could think in macroeconomic terms.
This lead to the work of John Hicks, Kenneth Arrow, Robert Mundell and a host of others to show that macroeconomic effects were measurable, predictive, and differentiable form purely microeconomic reasoning, even if macroeconomic beahavior could be seen as microeconomic behavior on a large scale. This would lead to what is called the "neoclassical synthesis" - the ability to join micro and macro worlds.
Like the Standard Model in Physics, it has one large problem, it rests on a metaphysical entity that no one can detect in nature.
RashEx and the Conservative Macroeconomists against Mesoeconomics
But before economics would accept this idea, there had to be a grand attempt at refutation of it.
Enter rational expectations, which argued that actors could decide about events "to infinity" and that they would make decisions about the future based on infinite time horizons in the right environment. Since infinite time horizons could be expressed as "present future value" - that is as a number which represented the expected return on an action over the life time of the action - the competitive rational equilibrium would work in practice and not just in the textbook. Key to this attempt to assert that the rational economic actor at infinity would produce a Saysian equilibrium is Robert J. Barro.
This line of reasoning would, strangely, produce a series of papers and a large literature about the expectations of actors about the actions of, for instance, central banks. One example is the following argument: central banks can either restrict credit to fight inflation, or allow a little bit of extra inflation for extra growth. Since there is no obvious penalty to them for doing this - they will be expected to cheat. This means other actors will bet on higher inflation than is the case, and this will reduce growth by a like amount. From this people such as Bernanke argue for inflation targetting.
These theories of credibility are built into the European Central Bank, and are being proposed for the Federal Reserve. The problem is, they don't seem to work.
The Rise of the idea of Meso-economics
Before there was mesoeconomics, there was John Kenneth Galbraith, who almost alone, argued that there was a level of economic reasoning that was noe encapsulated in the increasingly complex linear models of his day and age. This level of thinking - about industrial systems, systematic incentives, the effect of affluence and political behavior - remained outside of mainstream formalisms. However, as is the case with Smith and other seminal thinkers, the mathematics began to grow up like patches of wild flowers along the path that he sowed.
But if his work was of sowing, the seeds belonged to mathematical reasoning provided by Game Theory - John Nash who pioneered equilibrium in games, von Neumann who created formalisms for studying the theory of games. These were not entirely new, in the 19th century, Cournot's Researches into the Mathematical Pricniples of the Theory of Wealth showed how gambling strategies could be applied to the study of what was then called "political economy". Two other key figures are John Harsanyi and Reinhard Selten, the first who again extended the ideas of equilibrium to include Bayesian games, and the second who wrote a General Theory of Equilibrum selection in Games.
In 1980 Yew-Kwang Ng published a paper on the effects of imperfect competition within a non-neoclassical framework. It was one of a series of papers that examined how information concentration could benefit some actors over others. Later Stiglitz would publish his famous paper "The Market for Lemons", on how hiding information could benefit some actors, rather than neoclassical theory that asserts that money is exchanged for information - that is that profit comes from reducing the amount of uncertainty in the economic marketplace. By showing that increasing uncertainty could bring a profit, this line of reasoning argued first, that spreading information was a public good, and second that money and information were not connected directly, but through some other intermediary quantity. This contradicted both monetarism, which asserted that the money supply was the bandwidth, and classical Keynesianism which asserted that money was transperant to the exchange process.
In 1987 Stuart Holland published a land mark work on the move of markets from a micro to a meso economic paradigm. He argued, based on the differentiation of capital, a measurable effect, that different parts of the economy would remain separate. That is, capital is not infinitely fungible, and therefore the study of markets has to take into account the speed at which relocation of resources takes place.
These studies began drawing on evolutionary theory, particularly in the work of Kurt Dopfer, where strategies can be pursued by agents that don't have any idea of what the future brings or what the pay off is. Instead, they take past experience, formulate rules and follow them until there is a Bayesian break with experience - an event which cannot be explained as a variation on a rule.
The point of contention: price equilibrium or volatility equilibrium
Not ironically, but inevitably rashex began using game theory equilibriums to argue for restrictions on government action and the failure of government planning. Game theory was used by Thomas Schelling to attack the very idea of trying to control global warming.
The central issue is one that has shown up again and again in economics since Smith, that of equilibrium conditions.
Conservative economic thinking - in any era - argues that equilibrium can be maintained by controlling the inputs, and that the results of a controlled input economy will be the best, not just measurably, but in some quasi-moralizing way that is more appropriate to the Spanish Inquisition. At any given time, those who challenge the present equilibrium are attacked by conservative economic thinkers, not merely as wrong, but as inhuman monsters in league with (the devil, the liberals, the jews, the stalinists, the terrorists). This tendency to use morally normative language is a constant.
Progressive economic thinking argues that there are hidden disequilibriums in the controlled input system. At any given time, it argues that the means to create equilibrium are in sufficient, that there are possible, and indeed statistically or xaotically inevitable outcomes which disturbe equilibrium enough so that actors will begin to act in overly risk averse ways, stop cooperation, and spiral the economy down into the subsitence level.
Each series of challenges to the establish order has gone roughly in the order of derision and attack, then attempts at cooption - proving that there is no disequilibrium that is "a ghost in the machine", and finally, acceptance - producing a series of conservative means of maintaining equilibrium against the new threats. It is a measure of how far Keynesianism has come when conservative economists are declaring that macro-economics is triumphant. What they are saying is that with a sufficiently carefully controlled macro-economic system, meso-economics is not necessary.
The meso-economic reply points to how far back the theory of games actually goes in economic and political economic reasoning. Plato advances a game theory argument about the evolution of a polis in The Republic as the subsistence city follows to the feverish city, to the oligarchical city, to th philosopher-king, and then to dissolution. Smith relied on strategy arguments and the need to create equilibrium, not assume it. Game theory has been introduced in the form of gambling strategies since the 19th century. In the 1930's FDR argued for government regulation based on what we would now call "the free rider" argument - that is, that the pareto optimal system has a dominant strategy for some group of betrayers who can make the total worse off, but themselves better off.
The mesoeconomic answer also points to much harder data - namely that current macroeconomic policy is working, so long as the Chinese loan us money to keep marines in Iraq - but that it is not producing the expected wide distribution of income gains. That is, that it is attacking the classical idea that markets will efficiently distribute gains, in the same way that economic policies of the post-World War I period undermined the equilibrium of globally clearing markets.
In essence, meso-economics has already won, even though it is not mentioned by name very often - everyone is using the basic idea of actors in imperfect communication of information and Bayesian rule estimation, even if many of them are only doing so to try and make the question go away.
For the mesoeconomic challenge, the central point is that actors don't simply respond to, or seek, equilibriums of price, but equilibriums of volatility. That is they seek situations where there is a level of risk within which their hoped for outcome exists. This causes them to behave in ways which may have a lower total economic expectation, but which have the probability, however small, of the higher economic expectation they want. That is, that games are not measured merely in price payoffs, but in volatity payoffs as well.
But to explain this is going to take another long post, one that is going to talk about controversial models of economic action, and is likely to make some people upset (again).
This debate is ultimately important for reasons that are explained by Amartya Sen, one of the unacknowledged godfathers of mesoëconomics - namely, that within optimal economies, there are many distributions of wealth that are clearly unequal, and unnecessary. Mesoeconomics argues, first that such distributions of wealth can happen by restriction of information and profiting from artificial scarcity of information, and second, that they can be relieved without lowering the total welfare of all. The example of this is the three slice of cake example. Imagine a cake sliced three ways with three people. Now for any unequal distribution of the cake there will be two votes to one for it - even though the one gets nothing. Each person getting one will only be voted for, if no unequal voting block takes hold. Since there is what is called "diminishing marginal utility", one actor can secure the 2-1 simply by accepting slightly less than half of the third slice. He gets more than he would, and gives up only on the lowest margin.
The Bottom Line
The bottom line here is that when economists like Paul Krugman, or even Alan Greenspan, are arguing that macro-economic gains in GDP aren't improving real wages and well being, they are arguing that there is "something else" in economics. One way to handle this is by creating "effects" like "price stickiness" or "the wealth effect" or hoping that computers "improve productivity" - and then estimate these by, I'm not joking, seeing how wrong your models are.
The other way, which is getting increasing force, is to argue that human beings aren't "home oeconomicus", but, instead, "homo sapiens" who apply a different way of working with the world than money. That we evolved to live in societies, but that money, being a recent thing, doesn't always work the way we do.