Beating a dead horse

17 March, 2017 at 16:27 | Posted in Economics | 2 Comments

Dead-HorseIf 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.

Robert Solow

‘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) & 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!



  1. […] via Beating a dead horse — LARS P. SYLL […]

  2. “…hypothesis of rational expectations has proved to be a powerful tool for making precise statements about complicated dynamic economic systems”

    The fundamental problem in macroeconomic theories is that parametric approximation equations are used to model laws of supply and demand. Technically, rational expectation(or whatever euphoric name) is just used to estimate the parameter values with optimized errors(irrational expectation) in approximation equations.

    These approximation equations are valid only over one specific set of time periods that errors are calculated for identifying these parameter values. They are not valid beyond that one specific set of time periods. Economists should know time-specific approximation equations cannot be used for valid temporal assertions about actual economy in future time periods or even one different set of past time periods.

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