Chicago economics — only for Gods and Idiots
from Lars Syll
If 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. 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.
‘Modern’ macroeconomic theories 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) and Nikolay Gertchev (2007) — usually doesn’t bother its protagonists too much. Rational expectations überpriest Thomas Sargent has the following to say on the epistemological status of the rational expectations hypothesis:
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!
And a few years later, when asked if he thought “that differences among people’s models are important aspects of macroeconomic policy debates”, Sargent replied:
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. So, Gods and Idiots may share Sargent’s and Lucas’s models, but they certainly aren’t my models.
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Real-World Economics Review Blog 
I suppose I should give Solow credit for seeing the light, much as I give Robert McNamara similar qualified credit (Fog of War). But what a tortured use of English is that Solow quote. Certainly it is true about World War II and “most people”. But is it any wonder that some of us wonder about the cluelessness of economists? “Most economists”? Hmmm?
Historians see the events as specific to time and place. and do not find patterns of the fulfillment of rational expections in them. Nothing I have seen on this blog gainsays the judgments of historians.
Rational expectations is an example of a theory devised with ideological intentions – to demonstrate policy interventions were pointless and ineffectual. Its popularity derived from the fact that it was tricky to implement in models and required slightly fancier maths than earlier models, so appealing to young economists trying to make their way in the academic profession. It is an exaggeration to say that modern theory is founded on it. True, it remains much more used than its empirical value would justify but there are alternatives. Behavioural finance etc relies on the insights of Kahneman et al, some macro models use Bayesian learning to generate expectations.
Rational expectations theorising reflects orthodox economists’ fixation with “equilibrium” and the wish to build dynamic models that can be solved analytically to show a unique equilibrium path.. A desire to avoid complexity and avoid the necessity of computer simulation of unsolvable models prevents the economist trade from growing up.
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No doubt there is a grain of truth in this statement; how big that grain is I don’t know. For some I suspect it was to follow the herd, to assure a tenured career, and to facilitate mathematical tractability more than sinister intentions. But your point is well taken.
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Complexity theory comes with its own problems of over-reach and underdetermination. Context counts; any theory taken to far stretch credulity. The art is in spotting the spoof.
If you cite Alan Kirman, it would be interesting if you read Chapter 4 Financial Markets: Bubbles, Herds and Crashes of his book:
Complex Economics: Individual and Collective Rationality.
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I read Kirman (2010) in its entirity. In following the citation trail I found what may be a citation error.
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When I attempt to find the original the only reference is to “Morishima, M. (1984) ‘The good and bad uses of mathematics’, in P. J. D. Wiles and G.Routh (eds), Economics in disarray, Oxford: Basil Blackwell.” (Alan Kirman. Complex Economics: Individual and Collective Rationality (Kindle Locations 5635-5637). Kindle Edition.)
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Did Kirman mistakenly cite the date for this quote of Morishima’s work as “1964” when he actually meant “1984”?
These are the only references I am seeing in Kirman (2010):
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Mirowski, P. (1964) Equilibrium, stability, and growth: A multi-sectoral analysis, Oxford: Clarendon.
——(1989) More heat than light: Economics as social physics, physics as nature’s economics, Cambridge: Cambridge University Press.
Mobius, M. (2000) ‘The formation of ghettos as a local interaction phenomenon’, mimeo, Harvard University Dept. of Economics.
Mobius, M. and T. Rosenblatt (2002) ‘The process of ghetto formation: evidence from Chicago’, mimeo, Harvard University Dept. of Economics.
Mookherjee, D. and B. Sopher (1997) ‘Learning and decision costs in experimental constant-sum games’, Games and Economic Behavior, 19: 97–132.
Morishima, M. (1984) ‘The good and bad uses of mathematics’, in P. J. D. Wiles and G.Routh (eds), Economics in disarray, Oxford: Basil Blackwell.
(Alan Kirman. Complex Economics: Individual and Collective Rationality (Kindle Locations 5626-5637). Kindle Edition.)
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I want to know the original source so I can view the quote in fuller context.
The right citation must be
Morishima, M. (1984) The good and bad uses of mathematics. In Wiles and Routh (eds.) Economics in Disarray, Basil Blackwell, Oxford, pp.51-73.
Kirman repeatedly cites the same place correctly in page 127, Kirman (1989), page 121, Kirman (1992) and page 255, Kirman (2006).
I think I have a copy of the book (not sure). Even if I have, it is more than 200 kilometer far from my place. But as you have now the correct reference, you can ask the copy of the chapter at a library. The book is still availble at a low price if you want to pay the shipping cost that may be higher than the book itself.
References:
Kirman, A. (1989) The Intrinsic Limits of Modern Economic Theory: The Emperor has no Clothes. Economic Journal 99 (Conference 1989): 126-139.
Kirman, A. (1992) Whom or what does the representative individual represent? Journal of Economic Perspectives 6(2): 117-36.
Kirman, A. (2006) Demand Theory and General Equilibrium: From Explanation to Inspection, a Journey down the Wrong Road. History of Political Economy 38 (annual suppl.): 246-280.
Thanks. Said same in Japanese but it was deleted.
Use Google translate before you delete.
What a dumb fucking blog. Deletes thank you in Japanese.