Hicks on the inapplicability of probability calculus24 February, 2014 at 18:48 | Posted in Economics, Statistics & Econometrics | 11 Comments
To understand real world “non-routine” decisions and unforeseeable changes in behaviour, ergodic probability distributions are of no avail. In a world full of genuine uncertainty — where real historical time rules the roost — the probabilities that ruled the past are not necessarily those that will rule the future.
When we cannot accept that the observations, along the time-series available to us, are independent … we have, in strict logic, no more than one observation, all of the separate items having to be taken together. For the analysis of that the probability calculus is useless; it does not apply … I am bold enough to conclude, from these considerations that the usefulness of ‘statistical’ or ‘stochastic’ methods in economics is a good deal less than is now conventionally supposed … We should always ask ourselves, before we apply them, whether they are appropriate to the problem in hand. Very often they are not … The probability calculus is no excuse for forgetfulness.
John Hicks, Causality in Economics, 1979:121
To simply assume that economic processes are ergodic — and a fortiori in any relevant sense timeless — is not a sensible way for dealing with the kind of genuine uncertainty that permeates open systems such as economies.
Added 25 February: Commenting on this article, Paul Davidson writes:
After reading my article on the fallacy of rational expectations, Hicks wrote to me in a letter dated 12 February 1983 in which he said “I have just been reading your RE [rational expectations] paper … I do like it very much … You have now rationalized my suspicions and shown me that I missed a chance of labeling my own point of view as nonergodic. One needs a name like that to ram a point home.”