Understanding business cycles has been a central topic in modern macroeconomics for decades. Business cycles are complex phenomena, so it is difficult to disentangle the underlying causal structure. The phenomenon itself is the only clear thing: capitalist economies suffer from recurrent episodes of falls and rises in general macroeconomic performance. Different schools of the economic thought have attributed different causes to the same event. Neoclassical orthodoxy tries to address the problem in a choice-theoretic framework, whilst heterodox currents challenge this approach by emphasizing a multitude of possible social, institutional or even political causes. Due to these efforts, by now we have had several explanations each of which highlights some selected facets of the business cycles. As a result, our understanding of the business cycles is made up of partial truths, and such partial truths oftentimes seem to contradict one another. However, a synthesis is possible, thus partial truths as building blocks can form a coherent big picture. Such a synthesis requires us to understand how selective models connect to reality, that is, how models represent the selected parts of our socio-economic reality. Understanding the way models connect to reality requires a methodological analysis, thus the understanding of the different methodologies must be the first step to the understanding and the reconciliation of the different thoughts in economics.
Today multiple disciplines regard modern business-cycle theories as their centres of interest. First, history of economics reconstructs the theoretical content and evaluates the economic policy consequences. However, the analysis of the methodological background is only of marginal importance here. Studies regarding methodological analysis as a crucial constituent has appeared only very recently. These efforts ought to be regarded as pathbreaking initiations; for the most important item, see (De Vroey, 2016). Blaug (1992) is also one of the exceptions. Second, modern philosophy of economics has put the study of modern business-cycle theories under the general interest in economic methodology. The discourse here addresses the methodology of economics as such rather than the methodologies of individual currents. One of the few exceptions (Mäki, 2009) analysed the methodological recommendations of Friedman’s business-cycle theory. This is the book that opened the avenue for a methodological analysis of modern business-cycle theory. However, it is still a question whether its ideas can be extended to the post-Friedmanian achievements.
Today these two approaches (the history of economics and the methodology of economics) constitute two distinct directions. Considering methodological aspects in the history of economics is further hindered by the fact that initially the historiography of economics treated methodology as troublesome and void (Weintraub, 1989). One of the most worrying consequences of this situation is that new insights occurring in methodology cannot or can only slowly and superficially build into the historiographical narratives. A methodologically underpinned history of modern business-cycle theories can fill this lacuna.
The positive content of a theory is inseparable from its methodological background. What we conceive of the possibility of accumulating knowledge of the surrounding reality; of the roles our assumptions play; or of the relationship between our theory and the rival approaches: these considerations require solid methodological footing that may change how we interpret the very theoretical content. How we know something determines what we can know and whether we know something at all (Epstein, 2015). It is particularly true of modern business-cycle theories. When new classical macroeconomics (Lucas, 1972) assumed voluntary unemployment, it seemed as if Lucas and his followers had cancelled the study of involuntary unemployment from the agenda. By contrast, their purpose was to scrutinize whether the workers’ decision to reject job offers contributes to unemployment dynamics. In other words, whether there is a voluntary component in unemployment. Simply put, their focus was on only one component of unemployment dynamics. Unless we clearly recognize this selective strategy, it would seem as if modern business-cycle theory by assuming voluntary unemployment placed the blame on the workforce for remaining unemployed. However, modern business-cycle theory succeeded in revealing how the real structure of the economy without any inference from the institutional environment can lead to large-scale macroeconomic fluctuations. Methodology is crucial for us even to evaluate the economic policy consequences. If only particular mechanisms are selected from the complex causal structure, these particular approaches, if taken at face value, necessarily contradict one another. A thorough methodological analysis will lead to a consensus in which all the rival approaches can find their adequate scopes.
The way business-cycle models connect to reality is unclear. The fundamental question regards whether these models can give approximately true descriptions of the causal structure—or they are useful instruments only capable of generating predictions with considerable empirical performance. This is the conflict that underlies the debate between economic realism and instrumentalism. Realists make efforts to argue for the truth of models, while for instrumentalists, models are only constructs for predictive purposes. However, an instrumentalist model fails to teach us anything about the underlying causes: this leads to no knowledge in the strict sense. Although Mäki (2009) provided strong arguments for the realism of economics, according to the standard interpretation Friedman put economics on an instrumentalist track. Both Lucas and the succeeding RBC-theory are conceived as further steps along this line, so today modern business-cycle theory is regarded as useless in terms of creating true knowledge of the economy. This is a rather worrying interpretation that can deprive economics of the possibility of understanding the causes of business cycles. This interpretation may delimit even the scope of economic policy applications (Elson, 2017).
Admittedly, the full-blown realism of economics seems untenable for some apparent instrumentalist tendencies in modern times. However, Kevin Hoover (2009) made efforts to argue for Friedman’s realism along a more modest line of reasoning. For Hoover, Friedman set up instrumentalist agent-level assumptions to achieve causal realism at a macro-level. However, our knowledge of a causal realism built on agent-level instrumentalism in economics is rather limited.
The main purpose is to consider the plausibility of this mix and to suggest a framework for a methodological history of modern business-cycle theory. This framework is Epistemic Structural Realism (ESR) suggested by John Worrall (1989). In the general philosophy of science Anjan Chakravartty (2007) and Stathis Psillos (2006) clarified structuralist ideas. ESR describes the relations connecting entities (in economics: agents) so that the structure is described at the level of the structure, whilst ignoring the entity-level properties. As causal mechanisms work along the relations that connect entities, ESR is the general philosophical framework in which it can be analysed whether structural/causal realism underpinned by entity-level instrumentalism is a viable option both as an interpretation for the history of economics and as a research strategy for economics.
According to my hypothesis, the answer is negative. Knowledge of the way economic agents connect with their fellows requires knowledge of the properties of the agents. Individuals and their features are prior to the structure, so the structure is derived from the individuals. In economics, the microfoundations carry the macro-level. Providing a realistic description of a structure is impossible through assumptions that abandons the idea of realistic descriptions of individuals. Thus, the proposed project clarifies the relationship between the microfoundations and the macro-level, thus the microfoundations will turn out to be our instruments of connecting with reality. Based on the critically reconsidered ESR, we can judge which chapters of the theoretical evolution are properly anchored to socio-economic reality.
To sum up, the purpose is to analyse how modern theories of the business-cycle have changed in terms of their relation to reality. Through this methodological analysis, I can offer a narrative of the changes in the relevance of theories to understanding socio-economic reality. This narrative can be the first step to a deeper understanding of the relationship of the rival theoretical approaches of the business cycle.
Blaug, M. (1992). The methodology of economics. Cambridge: Cambridge University Press.
Chakravartty, A. (2007). A metaphysics for scientific realism. Knowing the unobservable. Cambridge: Cambridge University Press.
De Vroey, M. (2016). A history of macroeconomics from Keynes to Lucas and beyond. Cambridge: Cambridge University Press.
Elson, A. (2017). The global financial crisis in retrospect. New York: Palgrave Macmillan.
Epstein, B. (2015). The ant trap. Oxford: Oxford University Press.
Hoover, K. (2009). Milton Friedman’s stance. The methodology of causal realism. In U. Mäki (Ed.), The methodology of positive economics (pp. 303-320). Cambridge: Cambridge University Press.
Lucas, R. E. (1972). Expectations and the neutrality of money. Journal of Economic Theory, 4(2), 103-124.
Mäki, U. (Ed.). (2009). The methodology of positive economics. Cambridge: Cambridge University Press.
Mäki, U. (2009). Unrealistic assumptions and unnecessary confusions. Rereading and rewriting F53 as a realist statement. In U. Mäki (Ed.), The methodology of positive economics (pp. 90-116). Cambridge: Cambridge University Press.
Psillos, S. (2006). The structure, the whole structure, and nothing but the structure? Philosophy of Science, 73(5), 560-570.
Weintraub, E. (1989). Methodology doesn’t matter, but the history of thought might. The Scandinavian Journal of Economics, 91(2), 477-493.
Worrall, J. (1989). Structural realism. The best of both worlds? . Dialectica, 43(1-2), 99-124.