Ergodicity, rational expectations, and the true meaning of history

15 May, 2011 at 14:48 | Posted in Statistics & Econometrics | Comments Off on Ergodicity, rational expectations, and the true meaning of history

 

Ergodicity is a difficult concept that many students of econom(etr)ics have problems with understanding. Trying to explain it, you often find yourself getting  lost in mathematical-statistical subtleties difficult for most students to grasp.

In What is ergodicity? Vlad Tarko has made an admirably simplified and pedagogical exposition of  what it means for probability structures of stationary processses and ensembles to be ergodic.

After reading that you can go to –  tougher reading, but still fully accessible – Paul Davidson’s superb articles  Rational expectations: a fallacious foundation for studying crucial decision-making processes and Can future systemic financial risks be quantified? Ergodic vs nonergodic stochastic processes .

Then ask yourself: how can anyone take the rational expectations hypothesis seriously?

Is it not as Sir John Hicks had it already in Economic Perspectives (1977, vii): “One must assume that people in one’s models do not know what is going to happen, and know that they do not know what is going to happen. As in history”? And yet neoclassical economists still abstract from historical time and uncertainty, willfully ignoring that agents have different ways of approaching and coping with problems of non-routine decision-making and change in the absence of perfect knowledge, and that their heterogeneous expectations lead them to make different choices than the ergodic-rational-expectations  models suggest.

The conclusion has to be – as in Roman Frydman’s and Michael Goldberg’s The Imperfect Knowledge Imperative in Modern Macroeconomics and Finance Theory –  the rational expectations narrative “has no foundations.”  If macroeconomics has to have microeconomic foundations, they have to be found elsewhere!