The Influence and Significance of Human Action after 75 Years

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Human Action, the Way Forward

JEFFREY M. HERBENER

As Joseph Schumpeter (1954, 181–94) remarked, Adam Smith and the British Classical School shunted economics onto the wrong track. By grounding their analysis on the activity of the businessman, the British Classical School economists derailed the realistic value theory that had been under development from the scholastics to A. R. J. Turgot (Rothbard 1995, 383–413). The Marginalist Revolution raised the hope that the economic train was back on track by emphasizing the subjective valuation of consumers in price theory. The work of the marginalist authors, however, turned out to be only a crossroads for economics. The Mengerian path of causal-realist method has indeed proven to be the way forward for economics. The formal-modeling method of mainstream economics has served to derail economics once again.

Before the end of the 1920s, Ludwig von Mises had anticipated the fateful turn mainstream economics was to take. He devoted his Epistemological Problems of Economics to the fundamental issue that had derailed economics in the nineteenth century: faulty value theory employed by British Classical economists; and the fundamental issue that would derail economics in the twentieth century: faulty method employed by mainstream economists.

As Guido Hülsmann (2003, x–xi) pointed out in his introduction to the third edition of Epistemological Problems of Economics:

First, Mises argues that the Austrian theory of value, which had been developed by Carl Menger and his followers, is the core element of a general theory of human behavior that transcends the traditional confines of economic science. Value theory applies to human action at all times and places, whereas economic theory only applies to a special subset of human action, namely, to human action guided by economic calculation. In Epistemological Problems of Economics, Mises not only explains these fundamental distinctions and stresses that economics is just one part of a general theory of human action. He also ventures into the elaboration of this general theory, in particular, through the analysis of its central component—value theory. Mises contributes a thorough critique of the value theories of Carl Menger and Eugen von Böhm-Bawerk, and in several chapters of the book carefully refines and restates value theory.

Second, Mises argues that the general social science of which economics is the best-developed part has a rather unique logical and epistemological nature. In distinct contrast to the natural sciences it is not based on observation or any other information gathered through the human senses. It relies on insights about certain structural features of human action, such as the fact that human beings make choices or that they use self-chosen means to attain self-chosen ends. The validity of economic theory does therefore not stand and fall with empirical investigations. Rather, economic laws are a priori laws that cannot be confirmed or refuted by the methods predominant in the natural sciences. They exist independent of the particular conditions of time and place, and the social scientist comes to know them through pure deductive reasoning.

It was their adherence to a causal-realist method that protected Misesian economists from being sidetracked by the issues that have beset mainstream economists since they came to rely on the method of abstract modeling.

Misesian Praxeology versus Mainstream Modeling

Regardless of their different approaches in doing so, economists of goodwill aim to understand the facts of reality brought about by human action. Both the Misesian approach and the mainstream approach strive to establish a connection between theory—that is, the conceptual structure of cause and effect—and the facts of reality brought about by their underlying causes.

The Misesian approach starts with the universal, realistic facts of human persons from which the logic of human action can be deduced. For example, in striving to attain an end by acting with a combination of means, a human person makes choices based on his judgment as to the value of the end and the value of means that will be realized over the duration of his action. As finite, temporal beings, human persons face genuine uncertainty concerning the future realization of the anticipated valuations they make when choosing to begin a course of action. From these facts and others, discovered by reflection, praxeology deduces the most general principles of human action, which constitute the foundation for analyzing all human action. The logic of the personal economy, then, provides realistic, conceptual understanding of all human action. This conclusion implies that not only consumers but also producers and entrepreneurs act within the conditions facing all human persons, including using human judgments in making choices concerning their actions.

In moving from the logic of personal action to the logic of social interaction, praxeology inserts into economic theory the realistic empirical fact of the heterogeneity among (1) human persons; (2) natural resources, including land sites; and (3) capital goods. The logic of social economy follows deductively from the integration of personal economies.

In understanding the contingent, concrete facts of reality brought about by human action, the Misesian approach is thymology (Mises 1957, 264–84). Thymology is a harmonization of praxeological understanding (i.e., the universal logic of action) and thymological understanding (i.e., the specific conditions, preferences, and choices of persons). The former provides the list of causal factors operating to bring about the empirical result. The latter provides the relevance of each causal factor. Assessing the relevance of each causal factor requires the economist to exercise human judgment. Such assessments can appeal neither to the logic of action nor to statistical estimation to establish the quantitative magnitude each causal factor contributes to the empirical effect. There are no fixed quantitative relationships between the empirical magnitude of a cause and the empirical magnitude of its contribution to the effect because the effect is the product of human action, which in turn is the product of human choice, which is in turn the product of the human judgments made by the persons who acted. There is no quantitatively constant relationship fixed in the mind of a human person between changes in the empirical magnitude of a cause external to his mind and its contribution to changes in the empirical magnitude of the effect that follows from his action.

In contrast, mainstream economists employ a modeling approach. In the name of science, reliance on human judgment is to be expunged from economic analysis. At the conceptual level of understanding, this means formulating theory mathematically (i.e., constructing a model) to avoid the ambiguities of verbal language that arise from the necessity of human interpretation of the meaning of language. It also entails stipulating economic agents instead of human persons as the fountainhead of behavior that generates the results of the model. At the empirical level of prediction, this means tailoring the model to best fit the data. For this goal to be accomplished, statistical techniques supplant the human judgments of economists in assessing the relevance of causal factors in generating the facts, and mathematical tractability limits the range of causal factors that can be included in a model.

In both the Misesian and mainstream approaches, progress in discovering truth incorporates feedback between theory and facts. In the Misesian approach, the stronger line runs from praxeology to thymology, while in the mainstream approach, the stronger line generally runs from facts to theory—in other words, the theory is more malleable than in the Misesian approach.

The Misesian approach builds facts into the analysis at the most fundamental level. Reflectively discovered facts about the human person (e.g., his finitude and temporality) form the foundation of the logic of personal action. Empirically discovered facts (e.g., the heterogeneity of persons with respect to their preferences and labor services) are inserted to build the logic of social interaction. Acceptance of these facts is what makes Misesian theory less malleable than that of the mainstream. Specific facts of contingent, concrete actions enter the analysis at the level of thymology. While such facts are understood within the praxeological framework, they can influence the development of theory (Salerno 2012).

The mainstream approach inserts facts into the analysis at the point the economist thinks most useful in generating harmony between the theory and the facts. Early Keynesian macroeconomic models, for example, sought to increase such harmony by adding more and more equations to their models in search of a better econometric fit with the facts. Early new classical models, in contrast, sought to increase such harmony by adopting the conceptual stipulations of Walrasian general equilibrium, which entailed redefining what it meant for a model to better fit the facts.

Progress or Regress: Macroeconomic Modeling

The rise of the method of constructing abstract models and assessing their correspondence with reality by the accuracy of empirically testable predictions drawn from them was invigorated by the Keynesian Revolution. J. R. Hicks (1937) gave his first formulation of what would become his IS-LM model of the economy as early as 1937. Two years later, Jan Tinbergen (1939) published Statistical Testing of Business Cycle Theories. As the testing of Keynesian macroeconomic models proceeded apace, mainstream economists began to grapple with their disconnect from microeconomic models (Klein 1948).

The Rise and Fall of Neoclassical Synthesis Models

Between the publication of Mises’s Epistemological Problems of Economics in 1933 and Human Action in 1949, mainstream economics was well on its way to engineering the so-called neoclassical synthesis. Announced by Paul Samuelson (1955), the synthesis dealt with several issues that had arisen within the modeling approach (De Vroey and Duarte 2013; Romer 1993): how to reconcile (1) short-run equilibrium with long-run equilibrium, (2) partial equilibrium with general equilibrium, (3) assumptions grounded in the behavior of individual economic agents with assumptions asserted for aggregations, and (4) changes in nominal data with changes in real data, and what stipulations to impose on disaggregated market adjustment processes, elasticities of demand for and supply of the output of representative firms, and information asymmetries that generate aggregate macroeconomic fluctuations.

These vexing issues facing mainstream economists were, however, self-imposed by their adherence to a modeling approach as the only suitable method for a science of economics. To generate models that render empirically testable predictions, one must expunge several fundamental characteristics of real human persons acting in the real world. Yet these characteristics are the very principles that adequately address the issues that continue to bedevil mainstream economists.

Consider Samuelson’s (1947) treatment of economic science in his seminal work, Foundations of Economic Analysis, which ushered in the rise of mathematical models and statistical inference in economics. In summarizing Samuelson’s book, Roger Backhouse (2015, 347) wrote:

Central to Samuelson’s book was the idea that there were common mathematical structures underlying different problems, both within economics and across disciplines. Operational theorems could be obtained by analyzing the properties of the appropriate equilibrium systems. For problems involving aggregates where optimization was not involved, comparative statics results could be derived by assuming that the equilibrium was stable. . . . What mattered to Samuelson was not the analogies with thermodynamics per se, but the mathematical structures on which certain physical, chemical, and biological theorems were based.

Foundations reflected the view that there was much more to economics than optimizing behavior. Macroeconomics required different foundations, for aggregate behavior could not be explained as the outcome of optimizations: hence the need for the correspondence principle.

In Human Action, Mises rebutted the two fundamental claims of the mathematical economists’ project to supplant literary economics. On the use of statistical analysis to derive economic theory, Mises (1998, 348) wrote: “Experience of economic history is always experience of complex phenomena. It can never convey knowledge of the kind the experimenter abstracts from a laboratory experiment. Statistics is a method for the presentation of historical facts concerning prices and other relevant data of human action. It is not economics and cannot produce economic theorems and theories.”

On the use of equations to formulate theory, Mises (350) wrote: “It cannot be denied that all investigations concerning the relation of prices and costs presuppose both the use of money and the market process. But the mathematical economists shut their eyes to this obvious fact. They formulate equations and draw curves which are supposed to describe reality. In fact they describe only a hypothetical and unrealizable state of affairs, in no way similar to the catallactic problems in question.”

On the appeal to an analogy of economics to mechanics to justify using mathematics, Mises (351) wrote: “As there exist constant relations between various mechanical elements and as these relations can be ascertained by experiments, it becomes possible to use equations for the solution of definite technological problems. Our modern industrial civilization is mainly an accomplishment of this utilization of the differential equations of physics. No such constant relations exist, however, between economic elements.”

On the unbridgeable gulf between the mathematical approach and the real market process, Mises (353) wrote: “The problems of process analysis, i.e., the only economic problems that matter, defy any mathematical approach. The introduction of time parameters into the equations is no solution. It does not even indicate the essential shortcomings of the mathematical method. . . . The main deficiency of mathematical economics is not the fact that it ignores the temporal sequence, but that it ignores the operation of the market process.”

Mainstream economists had no interest in addressing these fundamental issues. Because they considered their modeling approach the only scientific manner of conducting economic analysis, they diverted their energies instead to issues that arose within their modeling framework.

The conceptual disconnect between macroeconomic models and microeconomic models fostered attempts to (1) construct microfoundations for macroeconomic models, (2) bridge the gap between short-run disequilibrium Keynesian models and long-run equilibrium classical models, and (3) integrate dynamic analysis with its static equilibrium constructs. Success proved elusive. The models constructed were not even able to generate an explanation of involuntary unemployment except by assuming wage rigidity, the very cause that Keynes explicitly rejected. The neoclassical synthesis appears in retrospect to be merely an uneasy compromise between Keynesian and classical approaches.

In contrast, the Mengerian line of economics had solved these problems. The capital structure developed by Eugen von Böhm-Bawerk (1959) bridged the gap between microeconomics and macroeconomics. The capital structure demonstrates the way the market economy in its entirety is constituted by entrepreneurially organized, individual production processes sequentially from the extraction of natural resources, which are used to produce higher-stage capital goods, which are used to produce middle-stage capital goods, which are used to produce lower-stage capital goods, which are used to produce consumer goods. This conception also renders a microeconomic foundation for aggregating production processes useful for macroeconomic analysis. Another development crucial to grounding macroeconomics upon microeconomics was Mises’s (1953) integration of money into marginal utility theory in The Theory of Money and Credit, originally published in German in 1912. From the fact that in a market economy preferences persons have for goods are expressed for and against money, Mises developed his theory of economic calculation, which, in turn, was the basis for his theory of the dynamics of the market economy. In this theory, Mises demonstrated the relationship between the emergence of money prices, which clear markets at each moment, and decisions about production, trade, and consumption based upon anticipations persons form about the future configuration of prices as they relate to the attainment of their ends from their chosen actions. This ongoing process of persons striving to economize their actions drives the process of the market through time. The dynamic of the market, Mises argued, would culminate in a long-run equilibrium condition, what Mises called the “final state of rest,” if not for the fact that conditions of human action during the process continually change the configuration of the final state of rest. This general theory of the market economy, in turn, became the foundation upon which Mises (1998) built both his business cycle theory and theory of economic growth.

Efforts to address these problems by mainstream economists working both in theory and in application continued to develop the neoclassical synthesis project. Two notable examples are Money, Interest, and Prices by Don Patinkin (1956) and Economic Fluctuations in the United States, 1921–1941 by Lawrence Klein (1950). Patinkin put together a model employing Keynesian disequilibrium for explaining short-run movements in the economy and long-run, Walrasian equilibrium as the pivot point for short-run fluctuations. Klein constructed a model integrating Walrasian microeconomic theory with Keynesian aggregates to organize data.

Despite ongoing efforts to develop neoclassical synthesis models, criticisms of this approach began to appear as early as the 1960s. Notably, Milton Friedman (1968) argued, contrary to Keynesians who asserted a stable Phillips curve, that there was no long-run trade-off between inflation and unemployment. Friedman came to this conclusion by introducing asymmetric expectations about the impact of inflation: entrepreneurs were assumed to have accurate and rapidly adapting inflationary expectations, and workers inaccurate and slowly adapting inflationary expectations. Consequently, monetary policy changes have effects on real production and employment in the short run. As worker expectations catch up, however, the stimulus to real production and employment wanes. Government fiscal and monetary policy aiming to manage output and employment is, therefore, doomed to fail. Attempts to do so in the short run will merely exacerbate economic volatility.

In the ensuing debate over the best way to model expectations, Thomas Sargent and Neil Wallace (1975) argued that the Phillips curve is vertical in both the short run and the long run as long as agents have rational expectations about the impact of monetary policy on prices. Being grounded on rational expectations, new classical models (discussed below) tended to model money as neutral to production in the economy.

In contrast, Mises’s praxeology accepts the realistic position that each person must use his judgment to formulate expectations about the future because the future is genuinely uncertain to human persons. In addition to the fact that persons vary in their acumen in anticipating the future, changes in the money relation are necessarily nonneutral to real production regardless of the time frame considered. Moreover, money’s nonneutrality is integrated into individual buying and selling of goods for and against money because the subjective value of money and goods in a person’s preference rank are based on his expectations about the aid acquiring or disposing of them will provide in the attainment of his ends. In other words, the money relation is integrated into the microeconomics of the market economy. Money is neither a separate consideration graphed onto the barter-price general equilibrium of the real economy nor an arbitrary identification of a good to be a numeraire for the real economy.

Another challenge to the neoclassical synthesis came from Axel Leijonhufvud (1968) in his book On Keynesian Economics and the Economics of Keynes. He argued that the divide between Keynes’s economics and that of Léon Walras could not be bridged: Keynes held that the market economy is irredeemably inefficient because information and signaling problems render complete coordination among people impossible. There can be no Walrasian general equilibrium state even in the abstract.

Perhaps more important in the decline of neoclassical synthesis modeling than these theoretical challenges was its failure to predict the inflationary recessions of the 1970s. Coupled with both its inability to ground models adequately in agent behavior and the unwieldy system of equations which had seen models growing to contain hundreds of equations, its catastrophic predictive failure sealed its fate.

The Rise and Fall of Rational Expectations Models

The neoclassical synthesis dissolved in the wake of acceptance by mainstream economists of the rational expectations model of economic agents advanced by Robert Lucas and Thomas Sargent (1979). They argued for the superiority of a new classical model which incorporated rational expectations as a microeconomic foundation. Its key features were that (1) agents are rational, including adapting to policy changes; (2) markets clear; and (3) unanticipated shocks are the main cause of business cycles. The new classical approach demonstrated that a Walrasian general equilibrium model can encompass the fluctuations modeled by the Keynesian short-run wing of the neoclassical synthesis approach. Since nothing was lost by cutting off the Keynesian wing, the neoclassical synthesis was abandoned.

Mainstream economists accepted the rational expectations stipulations of economic agents as the microeconomic foundation of macroeconomic models (De Grauwe 2010). Doing so put them on the road to an internally consistent framework instead of the tenuous compromise of the neoclassical synthesis. New classical theory reconciled Keynesian disturbances and economic growth by denying the former altogether and reducing all variations in real production to changes in the underlying rate of growth. Dynamic stochastic general equilibrium (DSGE) models were the result. They are dynamic in that agents are forward looking, stochastic in incorporating shocks, general in including the entire economy, and equilibrium in stipulating constraints and objectives of agents. Samuelson recognized the eclipse of Keynesian insights in the new classical models. He wrote that “the new classical economics of rational expectations is a return with a vengeance to the pre-Keynesian verities” (Samuelson 1983, 212).

In addition to fulfilling the desire of macroeconomists to ground their framework in microeconomics, Lucas offered a devastating critique of econometrics, which was the major method of linking theory with facts in the neoclassical synthesis models. Lucas demonstrated that estimates generated by models are useless for policy purposes, since the optimizing agents of the model adapt to policy changes (De Vroey 2016). Because the parameters of the model change during the time over which the data emerges, the model cannot be used to make predictions in the face of policy initiatives.

As noted above, Mises went further in arguing that not just policy impositions but changes in any external condition induce real persons to adapt, and therefore the parameters of the model change even if there are no policy initiatives introduced. Since external conditions continually change, Mises concluded that there are no constants in the data of human action, only variables. Being inside the bubble of the modeling method, mainstream economists could ignore Mises’s critique. They had no such luxury with the Lucas critique, as he lived with them inside their bubble.

In addition to the two strictures that agents are rational and markets clear, Lucas insisted on a Walrasian notion of general equilibrium. This condition entailed interactions among all markets that were fully adjusted to all gains available to the agents of the model. Moreover, the agents not only acted according to microeconomic choice-theoretic stipulations but were forward looking in the face of probabilities concerning future states, including shocks to the economy. Combining these two elements, equilibrium in the model means individually optimal intertemporal consumption allocation coordinated in advance by the assumption of an auctioneer who ensures that all markets clear before any trades are made.

Finally, Lucas claimed that theory—that is, the conceptual structure related to cause and effect—pertains only to fictitious models and not to reality. This claim meant that theory cannot be the locus of realistic features of the economic framework, because theory is strongly insulated from the facts of the world to be explained. Even so, Lucas maintained that the goal of economic analysis is to establish a correspondence between theory and facts. He thought this goal could be accomplished by constructing a fully described artificial economy which mimics the time series of actual economies. Such a procedure reduces economic analysis to prediction. Understanding the cause-effect structure, which generates economic data, recedes into the background.

Mises had dealt with these issues in his realistic framework. Markets always clear at each moment given the future realization of the ends that persons anticipate attaining from their actions. Because they face genuine uncertainty of the future, persons act using their personal judgments regarding the likelihood of the outcomes they imagine can occur from various courses of action they contemplate taking. Success in attaining ends increases the wealth and expands the scope of action of a person with superior entrepreneurial acumen. Failure does the opposite. Given real human persons, a market economy brings about a fully adjusted, integrated general system of economizing resource use as determined by the preferences of persons acting in the economy. The correspondence between praxeological theory and historical facts in thymology provides both an explanation of the cause-effect structure that brought about the facts of the past and prediction suitable for decision-making into the future.

Despite Samuelson’s lament that new classical models had returned economics to its pre-Keynesian formulations, objections quickly arose to the new classical project. “Old” Keynesians such as James Tobin, Robert Solow, and Arthur Okun continued to assert the “realism” of disequilibrium—that is, the lack of coordination among market participants, the failure of labor markets to clear, and the existence of involuntary unemployment. Much of their debate with new classical economists, however, proved to be merely talking past each other.

The early “New” Keynesians, however, made progress in coming to terms with new classical insights while retaining Keynesian views. While accepting the rationality of agents, they otherwise retained the neoclassical synthesis positions of Keynesian short-run disequilibrium and monetary and fiscal policy efficacy. They argued for an IS-LM model augmented by imperfectly competitive markets and price or wage rigidities and, therefore, the nonneutrality of money. Their models imposed “realistic” stipulations, such as implicit contracting, efficiency wages, staggered wage setting, and menu costs.

Lucas, for his part, admitted the existence of both voluntary and involuntary unemployment in the real world, while denying the latter in theory. He insisted that the only foundation for progress in economic science was models built on equilibrium in the sense that he understood it. Moreover, Lucas admitted that such models could not account for episodes like the Great Depression, because they are limited to accurately mimicking time series during periods of moderate variation. This inability proved to be their undoing. Like the neoclassical synthesis models during the 1970s that failed to predict during stagflation, Lucas-inspired—that is, real business cycle (RBC)—models failed to mimic time series of real data during the Great Recession.

During the 1980s, Finn Kydland and Edward Prescott developed RBC models which came to dominate macroeconomics by the end of the decade (De Vroey 2016, 260–81). On the new classical foundation, they imposed a policymaker who acted to maximize a social welfare function by choosing policy alternatives sequentially across time. The agents of the model, then, reacted to each policy initiative based on their assessment of its credibility in being carried out. Credibility was crucial, since the policymaker may reoptimize with a different policy initiative at a later date after agents have adapted to the earlier policy.

One reason for the popularity of the RBC approach was its reintroduction of policy into models. The fact that this approach has led mainstream economists to come to think of policy analysis as an art and not a science does not seem to have impaired its widespread adoption. Another factor in the rise of RBC modeling was Prescott’s work providing a “quantitative” dynamic general equilibrium, which Lucas’s work had not done.

Two key innovations were introduced by RBC modeling. First, Kydland and Prescott grounded fluctuations of economic activity within a model of economic growth. Prescott employed a Solow growth model by adding new classical microfoundations to it. He expunged monetary shocks from Lucas’s reliance on both monetary and technological shocks. Prescott then subdivided the trend impact of technological change from its stochastic impact. This innovation was made possible by Solow’s own work, which identified total factor productivity as encapsulating technological change which shifts the aggregate production function in distinction from movement along a given aggregate production function. In the real world, however, technological shocks cannot be separated by direct observation from the effects of other causes of changes in production, such as movements in demand. Solow argued that technological improvement could be indirectly estimated by subtracting the weighted rates of capital and labor inputs, as estimated by their marginal productivity, from the rate of growth of output. Prescott then decomposed this Solow residual into the trend of output growth, estimated by the weighted average of past, current, and future observations and the stochastic element as deviations from the trend. The latter was the model’s conception of economic fluctuations.

Second, RBC models employ computer computations based on calibration instead of econometric estimation to test the efficacy of a model. Calibration has the goal of coming up with a model that generates a time series that tracks the time series of real data. In contrast to Keynesian modeling, RBC modeling substitutes a general equilibrium configuration for a system of equations; computer simulations for econometric testing; and calibration for fit with the data as a method of adjusting the model. What matters for RBC models is the simulation results of the model, not its empirical correlation with real data.

A calibration method only makes sense if the theory is well established. RBC authors chose the neoclassical growth model as “established theory.” In their view, this theory was so well settled that they could focus on the next step of deriving implications from it to formulate their models. Because he considered the theory settled, Prescott held that any mismatch between theory and the facts requires better measurement of economic variables, not a change in theory.

The similarity of the dominance of theory over facts in RBC models to the dominance of theory over facts in Mises’s thymology is superficial. Praxeology is founded on realistic characteristics of human action. The constraints that the logic of action places on facts, therefore, are consistent with the veracity of realistic characteristics of human action. As a consequence, thymology can render genuine understanding of reality. The theory of RBC models is founded on unrealistic assertions about economic agents and the adaptation process they engage in when responding to unfolding circumstances. Manipulating facts into consistency with a model based on known-to-be-unrealistic assertions risks leading economic analysis further away from understanding reality.

A final reason for the popularity of RBC models is that they rely on Lucas’s analogy principle in the method of economics (De Vroey 2016). RBC models rest on the assumption that the Crusoe economy of the model, in which Crusoe optimally organizes his economic activity, is analogous to that of a competitive market economy. The model of a market economy is a set of Crusoes, each isolated on his own island. The Crusoes are identical and make rational choices through time. They would all come to the same actions except for “weather” shocks which generate a stochastic response as well as a trend response. Since each island economy is structurally the same as the others, the model only needs to incorporate one of them. In short, a modern, real-world market economy is modeled as a one-person, self-sufficient island economy.

Mises’s praxeology demonstrates that a market economy economizes resource use in a social economy just as Crusoe does so in his personal economy. However, Mises (1998, 328–32) famously rejected the claim that the former can be shown by analogy to the latter. A market economy integrates the personal economies of each of its members in a manner that economizes for each person and for society at large. By demonstrating their preferences for consumer goods by purchasing them with money, consumers generate monetary revenue for entrepreneurs who have organized their production to earn such revenue. In turn, entrepreneurs demonstrate their preference for producer goods by purchasing the services producer goods render with money. The existence of money prices for outputs and inputs directs entrepreneurs to produce goods that are valuable enough to generate revenue above costs and to avoid producing goods that suffer monetary losses. Such economic calculation is necessary for coordinating the use of producer goods across the division of labor and throughout the capital structure of the economy in a manner that economizes for society at large.

The Rise of New Keynesian and the Fall of DSGE Models

By adding theoretical stipulations to new classical models, RBC models provoked opposing reactions. One was to jettison theory altogether and merely use statistical presentations of the data itself to predict. The result has been vector autoregressive (VAR) models. But the lure of explaining as well as predicting has been strong enough that even such models have given into stipulations, in so-called structural VAR models, to broaden their scope sufficiently to include a conceptual structure of cause and effect. The other reaction was to drive Keynesian stipulations into RBC models behind the wedge inserted by Kydland and Prescott. The result has been New Keynesian DSGE models (De Vroey 2016, 307–35).

These models attempt to overcome perceived deficiencies of their RBC predecessors (Galí 2018). Limitations of RBC models include the following: (1) their use of equilibrium rules precludes explaining dramatic episodes of business cycles; (2) they explain neither the underlying causes of business cycles nor the specific features of each cycle; (3) their reliance on Solow growth theory because it is “established” is shortsighted, since such theories have been abandoned before; (4) they omit money; and (5) they conflate economic growth and business cycles.

New Keynesian DSGE modeling advances two innovations: (1) replacing perfect competition and flexible prices with monopolistic competition and rigid prices and (2) returning the monetary side of the economy. Sticky prices come from the laundry list of labor market imperfections asserted by Keynesians, such as Calvo pricing and menu costs (mentioned above). The nonneutrality of money comes from asserting an unpredictable effect of changes in the money relation on real production.

New Keynesian DSGE models incorporate these innovations by (1) stipulating optimizing conditions for a representative agent, firms, and the monetary authority and (2) inserting these conditions into the aggregate demand equation, a new Phillips curve equation, and a modified Taylor rule equation. The resulting model, therefore, has a system of equations that is branded as a dynamic version of IS-LM. The model then generates both a trend in economic growth and deviations from trend.

Adoption of New Keynesian DSGE models opened the channel of influence from facts to theory that had been closed under RBC modeling. The Taylor rule, for example, was developed from an empirical regularity into a theory and then into the policy trade-off between the variability of output and the variability of inflation. These connections then led to a shift toward interest rate targeting in monetary policy and the view that monetary policy is more important than fiscal policy because erratic monetary policy accentuates cycles.

New Keynesian DSGE modeling seems to have brought together the method approach of RBC proponents with causal elements favored by Keynesian advocates. Its deficiencies were exposed when it failed to accurately predict during the Great Recession. It has been criticized for being a closed economy, lacking heterogeneity, and having room for neither unemployment nor financial volatility.

The Rise of Agent-Based Models

In the wake of predictive failures of New Keynesian DSGE modeling, mainstream economists have been considering agent-based models as a superior alternative (Richiardi 2017). In the wake of Leijonhufvud’s endorsement of such models, they have developed the following distinguishing features: (1) stipulating more expansive characteristics and behavioral rules for agents, (2) supplanting the representative agent with heterogeneous agents, and (3) accepting agents that end up in disequilibrium. Agent-based models replace rational expectations and a representative agent with agents heterogeneous in their knowledge and computational skill. They are stipulated to learn over time with varying success. In agent-based models, there is no institutional condition, such as the auctioneer, to ensure equilibrium at each moment in time. Agents interact with each other and adapt to the facts brought about by their interactions. Agents make decisions about their activity on the basis of simple heuristics drawn from psychological studies of human persons. Heuristics themselves are subject to learning and adaptation as circumstances change. In an agent-based model, equilibrium becomes an aggregate condition only achieved in statistical terms. Regardless of the activity of individual agents, the system is otherwise out of equilibrium.

Agent-based models relate to the historical facts of human action using the technique of computer simulations. Models with varying states, parameters, actions, and decision rules for agents can be tested for their convergence to equilibrium state using computer simulations. Models that converge can then be tested for their fit to empirical data.

As discussed above, Misesian praxeology and thymology address each of the issues identified by agent-based models on a realistic foundation and therefore render superior understanding and prediction of historical facts.

Agent-based modeling in macroeconomics shatters the generality of a model enforced under the logic of rational expectations. The result threatens to mimic that of the introduction of psychological assumptions into microeconomics by behavioral economists. Tailoring models to fit various datasets without giving them a uniform, realistic anchor threatens to reduce economics to a sophisticated version of data analysis. Mises’s approach answers this challenge. Praxeology anchors all economic analysis in economic theory—that is, the realistic logic of action. Thymology incorporates the concrete facts of each historical episode of human actions to tailor the economic historical explanation within the framework of the logic of action.

Conclusion

The Misesian approach in economics has given us a genuine science of human action. Praxeology (i.e., the logic of action) is founded on realistic characteristics of human persons which are discovered by reflection on the meaning of human action. Even though human action entails judgments made by persons for which there is no scientific analysis, Misesian economists have developed praxeology to build a universal, conceptual structure of cause and effect for any personal economy and any social economy. They continue to expand the logic of action to incorporate the creative development of human action as it has unfolded in human history. By blending praxeological understanding with their human judgments concerning the relevance of various causes bringing about historical facts, Misesian economists have explained historical facts and predicted the configuration of facts yet to emerge. They have worked to continually improve their thymological understanding of past events and prediction of future events.

Moreover, the Misesian approach has answered every problem that has bedeviled mainstream economists working within their modeling approach. Despite its achievements, mainstream economists have resisted the Misesian approach in the vain attempt to impose their view of science on economics. For them, science must expunge, as far as possible, all human judgment. In their models they strive to accomplish this goal by supplanting (1) human persons with economic agents, (2) verbal logic with mathematical logic, and (3) human judgments of relevance with statistical analysis. Released from building on a realistic foundation, mainstream modeling relies on prediction to distinguish superior from inferior models. As a result, every advance in macroeconomic modeling has been followed by a predictive failure which has ignited further debate followed by a reconfiguration of the model, ad infinitum. While this groping process may result in a tendency to move toward the truth in the natural sciences, regrettably, it cannot do so in economics. As Mises (1998, 39) wrote:

The real thing which is the subject matter of praxeology, human action, stems from the same source as human reasoning. Action and reason are congeneric and homogeneous; they may even be called two different aspects of the same thing. That reason has the power to make clear through pure ratiocination the essential features of action is a consequence of the fact that action is an offshoot of reason. The theorems attained by correct praxeological reasoning are not only perfectly certain and incontestable, like the correct mathematical theorems. They refer, moreover, with the full rigidity of their apodictic certainty and incontestability to the reality of action as it appears in life and history. Praxeology conveys exact and precise knowledge of real things.

Because of the aimless meandering of the trajectory of the conclusions generated by modeling techniques, mainstream economics always has been ripe for being reduced to the handmaiden of politics (Bernstein 2001). This impulse has worsened as the modeling method of mainstream economics has fractured into specialized models tailored for one case after another. (Rubenstein 2006).

Only the firm foundation of praxeology can serve as the solid rock upon which economics can be built into a structure of permanent truth and thereby fulfill the aspiration for it held by Mises. As Mises (1998, 881) wrote at the close of Human Action:

The body of economic knowledge is an essential element in the structure of human civilization; it is the foundation upon which modern industrialism and all the moral, intellectual, technological, and therapeutical achievements of the last centuries have been built. It rests with men whether they will make the proper use of the rich treasure with which this knowledge provides them or whether they will leave it unused. But if they fail to take the best advantage of it and disregard its teachings and warnings, they will not annul economics; they will stamp out society and the human race.

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