Home > Uncategorized > Rational expectations — the triumph of ideology over science

Rational expectations — the triumph of ideology over science

from Lars Syll

Research shows not only that individuals sometimes act differently than standard economic theories predict, but that they do so regularly, systematically, and in ways that can be understood and interpreted through alternative hypotheses, competing with those utilised by orthodox economists.

Senate Banking Subcommittee On Financial Institutions Hearing With StiglitzTo most market participants — and, indeed, ordinary observers — this does not seem like big news … In fact, this irrationality is no news to the economics profession either. John Maynard Keynes long ago described the stock market as based not on rational individuals struggling to uncover market fundamentals, but as a beauty contest in which the winner is the one who guesses best what the judges will say …

Adam Smith’s invisible hand — the idea that free markets lead to efficiency as if guided by unseen forces — is invisible, at least in part, because it is not there …

For more than 20 years, economists were enthralled by so-called “rational expectations” models which assumed that all participants have the same (if not perfect) information and act perfectly rationally, that markets are perfectly efficient, that unemployment never exists (except when caused by greedy unions or government minimum wages), and where there is never any credit rationing.

That such models prevailed, especially in America’s graduate schools, despite evidence to the contrary, bears testimony to a triumph of ideology over science. Unfortunately, students of these graduate programmes now act as policymakers in many countries, and are trying to implement programmes based on the ideas that have come to be called market fundamentalism … Good science recognises its limitations, but the prophets of rational expectations have usually shown no such modesty.

Joseph Stiglitz

Those who want to build macroeconomics on microfoundations usually maintain that the only robust policies and institutions are those based on rational expectations and representative actors. As yours truly has tried to show in On the use and misuse of theories and models in economics there is really no support for this conviction at all. On the contrary. If we want to have anything of interest to say on real economies, financial crisis and the decisions and choices real people make, it is high time to place macroeconomic models building on representative actors and rational expectations microfoundations in the dustbin of pseudo-science.

For if this microfounded macroeconomics has nothing to say about the real world and the economic problems out there, why should we care about it? The final court of appeal for macroeconomic models is the real world, and as long as no convincing justification is put forward for how the inferential bridging de facto is made, macroeconomic modelbuilding is little more than hand-waving that give us a rather little warrant for making inductive inferences from models to real world target systems. If substantive questions about the real world are being posed, it is the formalistic-mathematical representations utilized to analyze them that have to match reality, not the other way around.

The real macroeconomic challenge is to accept uncertainty and still try to explain why economic transactions take place — instead of simply conjuring the problem away by assuming rational expectations and treating uncertainty as if it was possible to reduce it to stochastic risk. That is scientific cheating. And it has been going on for too long now.

  1. Alan
    October 5, 2017 at 2:33 pm

    Adam Smith’s invisible hand — the idea that free markets lead to efficiency as if guided by unseen forces — is invisible, at least in part, because it is not there …

    It’s not Adam Smith’s invisible hand. It’s an idea invented by neo-classical economists and then projected back on Smith. They get away with this nonsense because they can’t be bothered reading Smith and they know their readers can’t be bothered either.

  2. robert locke
    October 5, 2017 at 4:27 pm

    What about the “visible hand,” which has relied on a managment class to assure efficiency in a world dominated by international corporations?

  3. October 5, 2017 at 8:06 pm

    Rainer Mausfeld, Patrick Schreiner, and Thomas Gehlen explain that neoliberalism is an ideology that becomes a natural law. Neoliberalism is an indoctrination and a totalitarianism dominating all life. The financial markets stylized as a shy deer must be placated and the real economy becomes dependent or extorted by the financial sector.

    Mohssen Massarrat’s latest book in German is titled “Does the World Need a Financial Sector?” Debts soared from neoliberalism from the 1980s to today, not from the Keynesian era from the 195s to the 1970s. Here’s a link to his article “State Indebtedness as a Power Strategy”: https://www.indybay.org/newsitems/2017/10/04/18803447.php

  4. October 9, 2017 at 9:03 am

    Rainer Mausfeld, Patrick Schreiner, and Thomas Gehlen, among many others are correct. Neoliberalism is an ideology, a cultural artefact. Using Harari’s words, it is “made-believe.” And it’s not the only made-up dogma that has shaped the way we live our lives today. Most obviously there is science, and then of course democracy, and last but not by any means least religion. And literally dozens of others. So, neoliberalism isn’t a problem because it is “an ideology that becomes a natural law.” It’s a problem because most humans are unable to perceive it as the result of historical cultural processes that can be examined and understood (if not completely). And this failure is itself one of the guiding cultural ideologies of our day. Today humans insist they must only live in the real world. Yuval Noah Harari, points out the problem. “But what about truth? What about reality? Do we really want to live in a world in which billions of people are immersed in fantasies, pursuing make-believe goals, and obeying imaginary laws? Well, like it or not, that’s the world we have been living in for thousands of years already.” That’s the human world. Till that is accepted, dealing with destructive ideologies such as neoliberalism is impossible.

  5. October 11, 2017 at 12:10 pm

    Nothing i read except historical surveys from the 60’s , with the one exception of Robert Lucas (who won one of those prizes) , used ‘rational expectations’ or RBC. I think that is an ok idea—just the way the ‘ideal gas’ of Boltzmann is an ok idea (assume a spherical cow, which is a point particle–has measure zero, and undergoes elastic cllisions (‘stossehnaultz’ (sic) or ‘molecular chaos’—people saw this had a problem — they could prove ‘the arrow of time’ or 2nd law of thermodynamics starting with an implcit assumption that the world was already at equilibrium, and hence timeless. I first got this point from Georegescu_Roegescu (i forget where i found that old book—he got that right, but i felt some of his math was wrong. In statistical physics, you have to be very careful . )

    Most current models in econophysics i see take the opposite view —-there is no rational expectations or perfect information. In fact there is no information at all. You get pretty good results –eg can fit 85% of data assuming an economy where people are dumb as rocks. If you change the assumptions, and assume some rocks have some limited memory, then you can fit like 95% of data.
    Of course these use an equilibrium asssumption. But if you dont like that you just transform it to a nonequilibrium solution.

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