Tuesday, February 23, 2010

Saltwater = macroeconomics

I often say that one of the main problems with the US economy is the predominance of microeconomic thinking. For instance, renewables may be expensive, but that is the microeconomic view -- maybe they are cheaper than energy imports macroeconomically?

The New Yorker has published an interesting report about economist Paul Krugman's political turn, and it includes this explanation:

Freshwater economists—who live near lakes, particularly at the University of Chicago, but also in Rochester and Minneapolis—are more likely to insist that macroeconomics be based on microeconomic foundations, which is to say that one should study large phenomena like recessions and inflation as functions of the behavior of many perfectly rational individuals... It isn’t that freshwater types believe that actual people are perfectly rational—they just believe that making that assumption enables a more rigorous economics than is possible without it. After all, while there is only one way to be perfectly rational, there are an infinite number of ways to be irrational, and how do you choose? It all begins to look awfully arbitrary.

The explanation at the end is also quite interesting -- some economists tend to focus on the rational individual because they simply cannot model irrational masses. The article goes on to explain that Krugman himself is famous as an economist for his ability to mathematically model things that other economists have failed to model but non-economists consider obvious.

So the distinction I make is actually one commonly accepted in economics. I thought I had come up with it myself.

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