This paper is based on a long-term research program with Rachel Kranton on the implications of identity

8

Different trial conditions yield different fractions of subjects who go the full way.

10

and refuses to give any more answers at 300 volts, more than 60 percent of subjects went all the

way.

8

Subjects’ motivation to do what they think should be done in the Milgram experiment is

not just a curious example from the laboratory.  Milgram’s motivation for the experiment was to

examine the psychology of those responsible for the Holocaust.  The experiment and the reality

correspond.   Ordinary Men (Browning, 1992) shows the detailed history of the anti-Jewish

rampage of one police SS unit in Poland.  Like Milgram’s subjects the members of this unit were

just ordinary people, recruited from the most ordinary walks of life.  They conceived that their

duty as recruits was to obey.  Surprisingly, they needed almost no persuasion to pursue their

orders, even for the grizzliest tasks.  In their first village round-up and massacre, they were even

given the opportunity to opt out with no questions asked.  None did.  

The Milgram experiment, and its counterpart in the Holocaust reality, are examples in

extremis of the motivation that is missing from the five neutralities.  The utility functions used in

derivation of those neutralities fail to take into account people’s wide range of views regarding

how they think that they, and others, should or should not behave. 

Framing and Norms

While the presence of norms in this form has been notably absent from economics, there

is one prominent line of thinking that can be naturally interpreted in this fashion.  Daniel

Kahneman and Amos Tversky (1979) have interpreted experimental results of people’s

unwillingness to take favorable odds in small bets as due to loss aversion.  They represent loss

---

9

Calibrations by Rabin (2000) suggest that such loss aversion is needed to explain experimental subjects’

risk aversion with relatively small stakes.  With life-time incomes in the millions of dollars for the typical subject it

is hard to explain such risk aversion with a globally concave utility function.  

10

Our interpretation of the Kahneman-Tversky results is consistent with experimental results obtained by

John List (2003) regarding the trading of sports cards.  List found that amateurs exhibit loss aversion, but dealers do

not.  Of course such a difference is exactly what would be expected with our interpretation of loss aversion as due to

norms, if dealers think they “should” trade if they can make a profit, but amateurs view the cards they own as part of

a “collection,” which “should not” be traded.  

11

Some years ago, at a conference in Spoleto, Italy, Edmund Phelps gave a still unpublished lecture

wondering why the economics of the 20

th

 Century had failed to discover what was central to most of the arts, which

was the role of subjectivity.  This paper is about the direct relevance of such subjectivity for macroeconomics.  I

have very much benefitted from enjoyable conversations with Professor Phelps.  He has summarized for me the

content of that talk in an email.

11

aversion mathematically with utility functions that are convex (rather than concave) for losses.  

Kahneman and Tversky say that people have a mental frame, which makes them reluctant to take

losses.  But there is another way to interpret both the aversion to these gambles and Kahneman

and Tversky’s utility-representation of it.  In this interpretation people have a norm which says

that they should not take losses.

9

  Accordingly, they lose utility if they make them.

10

  In this

interpretation, the findings of Kahneman and Tversky are very real, but they are revealing of a

phenomenon much more general than loss aversion.  In this interpretation people have a view of

how they should behave.  Insofar as they fail to behave that way they will lose utility.  

Prospect theory, and also the Milgram experiment with the interpretation we gave of it,

serve another useful purpose.  They illustrate that there is no necessary conflict between 

sociological norm-based approach to preferences and much recent work in behavioral

economics, which, for the most part, has interpreted departures from standard utility-

maximization in terms of mental frames (and cognitions) rather than in terms of preferences. 

The two types of interpretations can be interchangeable: for example when the cognitive biases

conform to subjects’ views of how the world should or should not be.

We now turn to applying the role of norms to each of the five neutralities.

11

  In each case

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12

It is useful to make an explicit disclaimer, although it should be obvious.  For each of the five neutralities

we see that the inclusion of broader preferences, inclusive of norms, will bring Keynesian behaviors back to life.

But, of course, that does not mean that the competitive forces and the maximizing behaviors responsible for the five

neutralities are not important, as well. 

13

That appreciation is of course due to Barro (1974).

14

This model is quite close to Ricardo’s original discussion. It is a considerable simplification of Barro’s

model. His model had a sequence of overlapping generations, each of which lived for two periods.  Barro’s

contribution was not only to show Ricardian equivalence in the two-generation model, but also its extension to a

sequence of generations when parents’ utility only depended on their own utility and the utility of their own children. 

Ricardo’s discussion, which is close to the two-generation model here, was then subsequently rediscovered.  There is

no uncertainty and all taxes are lump-sum.  This proposition may be generalized, for example, following Barro to a

model with m overlapping generations each of which have different consumption when young and old.  Each parent

derives utility from his own consumption and the utility of his child.  

12

we shall ask whether people’s views as to how they should behave might not change the utility

function.  In each case we shall see that such views will nullify the respective neutrality result. 

Indeed, we shall see that in each and every case there will be a natural norm consistent with the

early Keynesians’ views of economic behavior.

12

 

 

IV.  Ricardian Equivalence

We shall begin our detailed discussion with Ricardian equivalence.  Since it is the

simplest of the five, it is also the best place to begin—although it was chronologically the last of

the neutralities to be appreciated by modern economists.

13

  If there is missing motivation in the

utility function, it should be easiest to see here.

A very simple model demonstrates the essence of Ricardian equivalence.

14

  There are just

two periods, periods 1 and 2.  There are just two people, a parent and her child.  The utility of the

parent depends directly upon her own consumption, in period 1; it also depends upon the utility

of her child.  That utility depends upon his consumption, in period 2.  

The parent’s utility function can be expressed simply as U

1

(c

1

, U

2

 (c

2

)), where c

1

 is the

consumption of the parent, c

2

 is the consumption of the child, U

1

 is the utility of the parent, and 

---