The macro/micro validity tradeoff

Many economists insist that the realism of their assumptions is not important - the only important thing is that at the end of the day, the model fits the data of whatever phenomenon it's supposed to be modeling. This is called an "as if" model. For example, maybe individuals don't have rational expectations, but if the economy behaves as if they do, then it's OK to use a rational expectations model.

So I realized that there's a fundamental tradeoff here. The more you insist on fitting the micro data (plausibility), the less you will be able to fit the macro data ("as if" validity). I tried to write about this earlier, but I think this is a cleaner way of putting it: There is a tradeoff between macro validity and micro validity.

How severe is the tradeoff? It depends. For example, in physical chemistry, there's barely any tradeoff at all. If you use more precise quantum mechanics to model a molecule (micro validity), it will only improve your modeling of chemical reactions involving that molecule (macro validity). That's because, as a positivist might say, quantum mechanics really is the thing that is making the chemical reactions happen.

In econ, the tradeoff is often far more severe. For example, Smets-Wouters type macro models fit some aggregate time-series really well, but they rely on a bunch of pretty dodgy assumptions to do it. Another example is the micro/macro conflict over the Frisch elasticity of labor supply.