Saturday, January 6, 2007

Akerlof’s Fatwa- incorporate norms into economics

Akerlof gave a speech at the World Bank last year on the topic of norms in macroeconomics;

Akerlof spoke on how inclusion of certain norms changes our view of macroeconomics, by negating the concept that decision makers are utility maximizers. He put forth a view of motivation that involves individual dignity and behavioral expectations, the use of which broadens the application of the utility function for each individual. The implication of these motivations is that it is not only outcomes that lead to certain behavior, but also expectations about what should occur. These missing motivations give us a better understanding of why people make economic decisions, and may recommend a more naturalistic and observational approach for understanding decision-making processes.


He talked about the same topic at the annual meeting of the American Economic Association this year;

“Mr. Akerlof’s style, in contrast, is more diffident and modest. But he has already contributed significantly to a revamping of the economic theory that Mr. Friedman championed. Now, at 66, he is hoping to spread that debate by taking on some of the profession’s most sacred cows...

“I am trying to effect a return to sensible economics,” Mr. Akerlof said in an interview. “And what is sensible economics? It is very pragmatic. You think about problems in the world and you ask: can government do something about that? At the same time, you maintain your skepticism that government is often inefficient.”

This challenge is not from some outsider in economics. Mr. Akerlof — educated at Yale and the Massachusetts Institute of Technology, and currently a professor at the University of California, Berkeley — is at the heart of the academic establishment. His wife, Janet Yellen, a top economist in the Clinton administration, is president of the Federal Reserve Bank of San Francisco. Their son, Robert, is a Ph.D. candidate in economics at Harvard…

What Mr. Akerlof is trying to do, with Ms. Kranton’s help, is to reflect the variety of motivations that come from the sense people have of “what they are and how they should behave,” as Ms. Kranton put it.

Among the examples they cite:
A teacher in good standing among the parents of her students puts the preservation of that reputation ahead of attempts to maximize her pay.

A change in income will permanently alter a worker’s spending, a view that challenges the more common belief that spending matches a worker’s lifetime income and savings, evening out over time.

Workers resist wage cuts even when unemployment is rising, despite standard theory that they will accept less pay to save their jobs.
The variations in norms and behavior are numerous and Mr. Akerlof, in his speech, calls on economists to incorporate this diversity into standard economic theory.

If there is a difference between real behavior and behavior derived from abstract preferences, New Classical economics has no way to pick up those preferences,” Mr. Akerlof asserts. “A macroeconomics that incorporates observations regarding how people think they should behave combines the best of the two approaches.”


Related:
George Akerlof: The Missing Motivation in Macroeconomics
In Condemnation of One-Equation Economics
AEA Meeting Papers
George Akerlof, Milton Friedman and Moroccan Lemons
The Year in Economics
‘Norms’ at Rasmusen’s blog
Getting it Wrong
Buy low, sell high / Silly signals

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