The Fallacy of Micro Foundation and Micro Fluctuations

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Date

1999-02

Authors

Chen, Ping

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IC² Institute

Abstract

Argues that there is no micro foundation for microeconomic fluctuations, or business cycles, based on the law of large numbers in probability theory and statistical mechanics. Discusses the Lucas model of rational expectations as inconsistent with the efficient market hypotheses because arbitrage activities in financial markets can eliminate the intertemporal substitution effect to the macro economy. Suggests the need for nonlinear macroeconomic dynamics and a non-equilibrium mechanism to understand large and persistent business cycles.

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