Home > Uncategorized > Chicago economics — only for people unlucky when trying to think

Chicago economics — only for people unlucky when trying to think

from Lars Syll

I ask myself what I could legitimately assume a person to have rational expectations about, the technical answer would be, I think, about the realization of a stationary stochastic process, such as the outcome of the toss of a coin or anything that can be modeled as the outcome of a random process that is stationary. If I don’t think that the economic implications of the outbreak of World war II were regarded by most people as the realization of a stationary stochastic process. In that case, the concept of rational expectations does not make any sense. Similarly, the major innovations cannot be thought of as the outcome of a random process. In that case the probability calculus does not apply.

Robert Solow

‘Modern’ macroeconomic theories from Chicago are as a rule founded on the assumption of rational expectations — where the world evolves in accordance with fully predetermined models where uncertainty has been reduced to stochastic risk describable by some probabilistic distribution.

The tiny little problem that there is no hard empirical evidence that verifies these models — cf. Michael Lovell (1986) & Nikolay Gertchev (2007) — usually doesn’t bother its protagonists too much. Chicago economics überpriest Thomas Sargent has the following to say on the epistemological status of the rational expectations hypothesis (emphasis added):  

Partly because it focuses on outcomes and does not pretend to have behavioral content, the hypothesis of rational epectations has proved to be a powerful tool for making precise statements about complicated dynamic economic systems.

Precise, yes, in the celestial world of models. But relevant and realistic? I’ll be dipped!

When asked if he thinks ‘that differences among people’s models are important aspects of macroeconomic policy debates’, Sargent replies (emphasis added):

The fact is you simply cannot talk about their differences within the typical rational expectations model. There is a communism of models. All agents within the model, the econometricians, and God share the same model.

Building models on rational expectations either means we are Gods or Idiots. Most of us know we are neither. Gods and idiots may share Sargent’s and Lucas’s models. But they certainly aren’t my models!

  1. June 8, 2016 at 4:21 pm

    Strange how most people will implicitly assume the average deviation of a series of coin tosses will remain close to zero rather than growing as root n then.

    • jlegge
      June 9, 2016 at 6:57 am

      The normalised standard deviation of the mean does decline with n increasing. The absolute value of the standard deviation may rise but not as fast as n.

  2. Paul Davidson
    June 8, 2016 at 10:21 pm

    In a rejoinder to critics of my argument that Keynes’s uncertainty required rejection of the ergodic axiom for stochastic models [or the ordering axiom for deterministic models I wrote:

    “The methodology of theory building permits the theorist to postulate anything he/she wants about restrictions, or lack thereof, on decision maker’s expectations and behavior in his/her model. For example, Thomas Sargent [1993, p. 21] states that in a rational expectations model, “The people inside the model have much more knowledge about the system they are operating in than is available to the economist or econometrician who is using the model to try to understand their behavior. In particular, an econometrician faces the problem of estimating probability distributions and laws of motion that the agents in the model are assumed to know. Further the formal estimation and inference procedures of rational expectations econometricians assumes that the agents in the model already know many of the objects the econometrician is estimating.”

    “Consequently, in new classical rational expectations theory, the theorist not only presumes an ergodic system but also the people in the model are able to estimate the relevant probability distribution and the effect that this has on the behavior of decision makers. Sargent is correct in stating that in such a restrictive presumption theory, it is not necessary for the theorist to know whether the actual economy in which we live is actually ergodic or not. The theory merely describes how people will behave given the presumptions (axioms) imposed by theory builder. In other words in building a macroeconomic theory, the model builder specifies the information set available, and behavior of people who exist in such a theoretical world. It is then up to the user of such models to determine whether or not the results from such a theoretical world reflect the characteristics of the world we live in and therefore provides an understanding of our economy and a possible guide to policy decisions.

    ” Neither I, nor Keynes, have to impose a nonergodic axiom as a require presumption of his general theory. Rejection of the ergodic axiom merely permits the theorist to analyze economic behavior if human decisions today can create the real economic future. This resulting general theory can then provide what the analyst may claim is a realistic explanation of the readily observable persistent of involuntary unemployment in labor markets and the use of money and money contracts, in the world of experience. Removal of the three classical axioms that I have identified that Keynes rejected, the resulting general theory analysis can recognize a system where the decision maker “cannot conceive of a complete list of all consequences that will occur in the future … [and] where liquidity is freedom to delay from taking action when possible consequences are uncertain” [Davidson, 1991, p.178] ”

    Believe it or not the current editors of the JPKE have so far refused to publish mylatest rejoinder to my critics

  3. June 9, 2016 at 4:24 am

    My approach is a bit more direct than Paul’s. In Physics I was taught to make theories straight forward and easily testable. For example, at a high level “assume a universe in which all the vectors are linear.” Simple, direct, and easily testable. From what I can see economic theories are none of these – not simple, not direct, and not easily testable.

  4. June 9, 2016 at 7:04 pm

    Forget Chicago, and also Cambridge
    Comment on Paul Davidson and Ken Zimmerman on ‘Chicago economics — only for people unlucky when trying to think’

    Every heterodox economist knows that the Walrasian approach is based on methodologically unacceptable axiomatic foundations (Arnsperger et al., 2006). The ergodic axiom is only one among others. Constrained optimization and equilibrium are even worse if something like a hierarchy of falseness exists.

    The crucial question is forward looking: What takes the place of the obsolete axioms of standard economics? The correct answer is that the unacceptable microfoundations have to be replaced by macrofoundations. This is achieved as follows.
    (A0) The objectively given and most elementary configuration of the (world-) economy consists of the household and the business sector which in turn consists initially of one giant fully integrated firm.
    (A1) Yw=WL wage income Yw is equal to wage rate W times working hours. L,
    (A2) O=RL output O is equal to productivity R times working hours L,
    (A3) C=PX consumption expenditure C is equal to price P times quantity bought/sold X.

    This OBJECTIVE structural axiom set is, in Zimmerman’s words, simple, direct, and easily testable, or in Aristotle’s words, certain, true, and primary (2014).

    These, indeed, are the criteria that axioms must satisfy. This is NOT the case with the familiar Walrasian and Keynesian axioms, yet this is obviously the case with the ABSOLUTE MINIMUM SET A1 to A3.

    Egmont Kakarot-Handtke

    References
    Arnsperger, C., and Varoufakis, Y. (2006). What Is Neoclassical Economics? The Three Axioms Responsible for its Theoretical Oeuvre, Practical Irrelevance and, thus, Discursive Power. Paneconomicus, 1: 5–18.
    Kakarot-Handtke, E. (2014). Objective Principles of Economics. SSRN Working Paper Series, 2418851: 1–19. URL
    http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2418851

    • June 10, 2016 at 12:18 pm

      Simple, direct, and easily testable, are not the same as certain, true, and primary. There is no assertion in developing a simple, direct, and easily testable theory that the theory will actually achieve any of these objectives. And no assertion that the result of either the theory or its testing will be primary, true, or certain in any sense of these terms. The best we can hope for is to expand our understanding, either by adding new bits to it or by getting rid of bits that aren’t working. Truth is not a consideration, and certainty is always (not being facetious) uncertain. And about primary vs. non-primary, at what point in time and space is primary achieved?

    • June 10, 2016 at 7:40 pm

      “The crucial question is forward looking: What takes the place of the obsolete axioms of standard economics? The correct answer is that the unacceptable …—–foundations have to be replaced by…(acceptable) —–foundations. ” Paraphrase of Egmont Kakarot-Handtke
      comment.
      For starters:
      A. Money can not create new wealth.
      B. Money is a measurement of a transfer of wealth.
      C. Fiat Money is a physical receipt of a transfer of wealth which
      can be redeem for any other wealth..
      D. Any Sovereignty that issues its own fiat money is a Monetary Sovereignty.

      ****One simple question..?
      True or False ?

      IMHO, SODDYISM.

      • June 11, 2016 at 8:42 am

        Carmen Basilovecchi

        You propose four monetary axioms and ask: “One simple question? True or False?”

        The answer is False because with purely monetary axioms you cover only a part of the subject matter of economics. This mistake is complementary to those who argue with ‘real’ (= money is a veil) constructs (e.g. Ricardo, Sraffa, RBC etc).

        Keynes had a great methodological insight: “In 1933, Keynes wrote a short contribution to a Festschrift for the German economist Arthur Spiethoff. He there attacked classical economists for not providing an adequate monetary theory. He then embarked upon the development of what he termed a monetary theory of production, a theory in which the interdependence of money and uncertainty, and their effects on economic behavior, could be properly investigated.” (Fontana, 2000, p. 40)

        Keynes’s insight has been that the proper subject matter of economics is the ‘monetary theory of production’. Obviously, your four axioms say nothing at all about production.

        The real-world economy manifests itself in the INTERACTION of real and nominal variables. From this interaction money emerges as a means of transaction and a store of value (2011). Because of this, all ‘real’ and ‘monetary’ approaches are one-sided=incomplete=false.

        Egmont Kakarot-Handtke

        References
        Fontana, G. (2000). Post Keynesians and Circuitists on Money and Uncertainty: An Attempt at Generality. Journal of Post Keynesian Economics, 23(1): 27–48. URL
        http://www.jstor.org/stable/4538713.
        Kakarot-Handtke, E. (2011). Reconstructing the Quantity Theory (I). SSRN Working Paper Series, 1895268: 1–28. URL http://ssrn.com/abstract=1895268.

  5. June 14, 2016 at 10:25 pm

    “The answer is False because with purely monetary axioms you cover only a part of the subject matter of economics. .”
    That it covers “only a part of the subject matter of economics. .” does not make the statement either true or false.
    Question, Can ‘money’ create wealth ?
    Economics, physics any platform ?
    There must be some form of wealth; before you can have ‘money’.
    Regardless of the fact that modern economics defines ‘money’ as something created “out of thin air” , modern economics uses the exact same term (‘money’) for a future redeemable receipt of a transfer of wealth.
    When this “Fictitious” ‘money’ is deposited it becomes indistinguishable from “Genuine” ‘money’.
    Let me ask again:

    A. Money can not create new wealth.
    B. Money is a measurement of a transfer of wealth.
    C. Fiat Money is a physical receipt of a transfer of wealth which
    can be redeem for any other wealth..

    One must exchange SOMETHING before you can get ANYTHING.
    You can not have an inch, if there is no distance. Nor a pound; if no weight.
    (IMHO a paraphrase of Soddy’s work. READ MORE: http://bit.ly/MlQWNs)

    “So elaborately has the real nature of
    this ridiculous proceeding been surrounded with
    confusion by some of the cleverest and most
    skillful advocates the world has ever known, that
    it still is something of a mystery to ordinary
    people, who hold their heads and confess they
    are ” unable to understand finance “. It is not
    intended that they should.” Frederick Soddy (The Role Of Money)

    “… Indeed, just as now not one in a
    thousand understands why the existing money
    system has such power to hurt him, so, if it were
    corrected as here outlined, not one in a thousand
    would need to know or, indeed, would know,
    except by the consequences, either that it had
    been rectified or how it had been rectified.” Frederick Soddy (The Role Of Money…
    https://archive.org/stream/roleofmoney032861mbp/roleofmoney032861mbp_djvu.txt ).

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