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Thursday, June 12, 2014

Rational Expectations: Protecting the Public From Economists or Methodlogical Arrogance?

     As I said in my previous post, I'm very impressed by Athreya's book. 

     http://diaryofarepublicanhater.blogspot.com/2014/06/kartik-athreya-on-adaptive-expectations.html

      I did question him a little on RE though-he kindly corresponded with me via email. In rereading a somewhat critical review of his book by David Glasner I had read initially before reading the book itself, I think of anything Glanser's criticism of his defense of RE is in even sharper relief. 

      Essentially, Athreya's defense of RE amounts to the idea that sure it's an exaggeration, it's not literally true-but 'all models are false and the point for economists is to find false models that are useful'-and that, in any case, there is nothing feasible to replace RE with. I asked him about the previous Adaptive Expectations-as suspected, he had no use for that. 

        "Your read of my view is correct--though recent advances having to do with the modeling of "rational inattention" and "sticky information" are promising alternatives to full-blown RE."

     "Re: adaptive expectations--they are riddled with the same arbitrariness problems that afflict almost all alternatives to RE."

     "The ends of major hyperinflations also seem inconsistent with any sort of slow-moving expectations. This was important in the early arguments against such slow-moving expectations formation."

     http://www.minneapolisfed.org/research/wp/wp158.pdf

     "Also, AE can lead to very unpalatable policy implication-a model with adaptive expectations might then imply that an "optimal" policy is one where the policy authority tries (and will succeed, under AE) to fool the citizenry--for their "own good." This seems a risky proposition, unless one really trusts the political system."

     http://diaryofarepublicanhater.blogspot.com/2014/06/kartik-athreya-on-adaptive-expectations.html

     This idea that RE saves the citizenry from the machinations of economists-that it's a kind of straitjacket for their treacherous ambitions to control the public, I find rather questionable to say the least. Glasner does a great job here of describing it. 

     "Athreya offers the following explanation and defense of rational expectations:
[Rational expectations] purports to explain the expectations people actually have about the relevant items in their own futures. It does so by asking that their expectations lead to economy-wide outcomes that do not contradict their views. By imposing the requirement that expectations not be systematically contradicted by outcomes, economists keep an unobservable object from becoming a source of “free parameters” through which we can cheaply claim to have “explained” some phenomenon. In other words, in rational-expectations models, expectations are part of what is solved for, and so they are not left to the discretion of the modeler to impose willy-nilly. In so doing, the assumption of rational expectations protects the public from economists.
     "This defense of rational expectations plainly belies betrays the methodological arrogance of modern macroeconomics. I am all in favor of solving a model for equilibrium expectations, but solving for equilibrium expectations is certainly not the same as insisting that the only interesting or relevant result of a model is the one generated by the assumption of full equilibrium under rational expectations. (Again see Thompson’s “Reformulation of Macroeconomic Theory” as well as the classic paper by Foley and Sidrauski, and this post by Rajiv Sethi on his blog.) It may be relevant and useful to look at a model and examine its properties in a state in which agents hold inconsistent expectations about future prices; the temporary equilibrium existing at a point in time does not correspond to a steady state. Why is such an equilibrium uninteresting and uninformative about what happens in a business cycle? But evidently modern macroeconomists such as Athreya consider it their duty to ban such models from polite discourse — certainly from the leading economics journals — lest the public be tainted by economists who might otherwise dare to abuse their models by making illicit assumptions about expectations formation and equilibrium concepts"
     http://uneasymoney.com/2014/02/03/big-ideas-in-macroeconomics-a-review/
      I don't get this concern by modern Macro where economists decide they're going to protect the public from themselves by imposing RE. Is it really the public they mean to protect? I think this question is one that will continue to be debated and rightly so.

      UPDATE: However, I should also second Glasner here. 

      "Anyway, despite my obvious and strong disagreements with much of what I read, I learned a lot from Athreya’s well-written and stimulating book, and I actually enjoyed reading it."
     
     

1 comment:

  1. Mike, one of the things I find refreshing about Jason Smith's model is that it doesn't rely on any models of expectations, rational agents or utility for that matter. He assumes he has no idea what human behavior is.

    Now his model might ultimately prove to be wrong, but the idea of being able to dump the "phlogiston" of expectations is super intriguing to me. He's certainly "thinking outside the box" on this. The comment I left for you yesterday with a link to a comment by Jason in response to talldave2 on Nunes' blog fits in here. And the following post and the thread between libertarian leaning Mike Freimuth and Jason is also interesting:

    http://informationtransfereconomics.blogspot.com/2014/05/utility-is-silly-and-other-observations.html

    I love the analogy: 19th century scientists were able to develop a useful theory of thermodynamics (that we still use today) without ever knowing what the heck an atom was, or what was going on inside it. Instead they focused exclusively on the statistical behavior of large ensembles of atoms and molecules. So if the analog holds, perhaps useful macro theories can be developed without rational agents, utility functions, and expectations today... (i.e. perhaps a useful theory can result, even if maximum ignorance is what's assumed for what's going on inside the humans participating in an economy).

    Historically, Max Planck came up with the fundamental idea behind quantum mechanics (that energy is quantized) in 1899 by trying to square the observed behavior of radiating black bodies with statistical mechanics (statistical mechanics is another 19th century science that can be used to help explain thermodynamics). So focusing on the statistics of ensemble behavior led to science's most successful theory to date (QM). And of course QM tells us a lot about how atoms behave. Ironic, no? So ultimately focusing on ensembles led to giant breakthroughs in other areas. Who would have guessed at that time?

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