Consistency and rationality

4 Dec, 2019 at 00:00 | Posted in Economics | 7 Comments

consistentAxioms of ‘internal consistency’ of choice, such as the weak and the strong axioms of revealed preference … are often used in decision theory, micro-economics, game theory, social choice theory, and in related disciplines …

Can a set of choices really be seen as consistent or inconsistent on purely internal grounds, without bringing in something external to choice, such as the underlying objectives or values that are pursued or acknowledged by choice? …

The presumption of inconsistency may be easily disputed, depending on the context, if we know a bit more about what the person is trying to do. Suppose the person faces a choice at a dinner table between having the last remaining apple in the fruit basket (y) and having nothing instead (x), forgoing the nice-looking apple. She decides to behave decently and picks nothing (x), rather than the one apple (y). If, instead, the basket had contained two apples, and she had encountered the choice between having nothing (x), having one nice apple (y) and having another nice one (z), she could reasonably enough choose one (y), without violating any rule of good behavior. The presence of another apple (z) makes one of the two apples decently choosable, but this combination of choices would violate the standard consistency conditions, including Property a, even though there is nothing particularly “inconsistent” in this pair of choices (given her values and scruples) … We cannot determine whether the person is failing in any way without knowing what he is trying to do, that is, without knowing something external to the choice itself.

Amartya Sen

Being able to model a credible world, a world that somehow could be considered somehow ‘similar’ to the real world is not the same as investigating the real world. The minimalist demand on models in terms of ‘credibility’ and ‘consistency’ has to give away to stronger epistemic demands. Claims in a ‘consistent’ model do not per se give a warrant for exporting the claims to real-world target systems.

Questions of external validity are important more specifically also when it comes to microfounded macro models. It can never be enough that these models somehow are regarded as internally consistent. One always also has to pose questions of consistency with the data. Internal consistency without external validity is worth nothing.

Yours truly has for many years been urging economists to pay attention to the ontological foundations of their assumptions and models. Sad to say, economists have not paid much attention — and so modern economics has become increasingly irrelevant to the understanding of the real world.

As long as mainstream economists do not come up with any export-licenses for their theories and models to the real world in which we live, they really should not be surprised if people say that this is not science.

To have ‘consistent’ models and ‘valid’ evidence is not enough. What economics needs are real-world relevant models and sound evidence. Aiming only for ‘consistency’ and ‘validity’ is setting the economics aspirations level too low for developing a realist and relevant science.

Economics is not mathematics or logic. It’s about society. The real world.

7 Comments

  1. Paper can be found at:

    Click to access Sen_(Econometrica_93).pdf

  2. Without consistency and transitivity of preference relations, don’t prices become arbitrary, or at least have very wide error margins? Black said prices were efficient to within a factor of two, so oil could be $120/barrel or $30/barrel due to noise alone, so 300% inflation could be just noise?

    • Prices of goods (not financial securities that Black concerned himself with) are a strategic variable in an administrative scheme to control costs driven by error and waste on one hand and to manipulate a bargain on the other. They are a gambit and a transitory one. Held fixed administratively they are arbitrary in a sense, but they are also importantly contingent and have implicit warranties attached. Inflation can be very disruptive, for good or ill, to such schemes, without there ever being any implication that a price is “accurate” as a representation of cost as an economist would understand it.

      • Finance has innovated ways of neutralizing inflation using inflation swaps. If you fear inflation you can lock in a 2% rate and if inflation rises above that, someone who benefits from inflation pays you the difference. The inflation taker benefits from rising prices and locks in a minimum rate; if inflation falls, you pay him a premium as insurance against higher inflation.
        .
        Indexation, also known as Cost of Living Adjustments, also used in Treasury Inflation Protected Securities, are other ways of neutralizing nominal inflation’s unwanted effects.
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        Inflation need not be anyone’s concern, if they know their income is guaranteed to increase in lockstep with prices. Israel used this linkage technique for decades and only suspended it in the 1980s because they lacked the technology at the time to fully automate the linkage adjustments …
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        If prices are pretty arbitrary and administered anyway, why not manipulate the money supply to maintain everyone’s real purchasing power no matter what nominal inflation does?

        • In my view, money is properly thought of as a score-keeping device and thinking about money as a commodity that has to be supply-constrained in “quantity” is serious misunderstanding or misdirection. For score-keeping purposes, how players in the games of business or finance use and respond to scoring behaviorally (including how they try to cheat in the game or alter the rules and conventions of game-play [“innovate”]) is what should matter for public policy in managing the monetary system.
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          The integrity of score-keeping is related to the integrity with which the games of business and finance are played.
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          The deep corruption of mainstream economics manifests in a culture of indifference to fraud and predation in the conduct of finance and business. Managing a fiat money requires effective regulation in the public interest of banking, financial markets, bankruptcy and financial accounting as well as a strong fiscal capacity to heavily tax economic rents.
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          I tend to think a low but definitely positive rate of inflation in the unit-of-account is in many circumstances likely to be in the public interest, but most of the reasons I can think of for why positive inflation would be, on balance, a good thing, depend on people NOT being able to defend themselves against it or being able to defend their interests only by altering their strategic economic behavior in ways that contribute to the general welfare or the overall efficiency of the financial and economic system.
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          A derivative that allowed them to pay a bankster to intermediate “inflation risk” instead of altering their behavior in economic cooperation could well subvert the power of monetary authorities to pursue the public interest effectively.
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          The rhetoric of quantity theories of money — though conventional — are seriously misleading about the nature of money and the proper scope and institutional objectives of public monetary and financial policy. Inflation is likely to be seriously misconceived by someone relying even without conviction on a quantity theory for rhetoric.

          • My story is that regulation misfires and causes more harm than doing nothing. Capital surcharge and liquidity coverage ratio regulations are currently blamed for a liquidity shortage in repo markets, which has led to the Fed stepping in to replace liquidity lost due to their own poorly-thought-out regulations. The urge to regulate should be resisted. There are better ways to insure individuals against financial panics.
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            “depend on people NOT being able to defend themselves against it”
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            But that ship has sailed. The Treasury sells TIPS so any saver can inflation-protect. Social Security is inflation-protected by COLA.
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            “altering their strategic economic behavior”
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            If prices are more or less arbitrary, this phrase reminds me of a David Bowie tune “Fashion! Turn to the left! Fashion! Turn to the right!” Price changes due to inflation are also arbitrary and say more about social control than economics …
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            “subvert the power of monetary authorities to pursue the public interest effectively.”
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            Again, that ship has sailed. Monetary authorities are hopeless. The best they can do is insure individuals against financial panics by implementing an explicitly inflation-protected basic income. Central banks could also sell panic insurance so banks could pre-hedge against irrational panics. CBs should also sell inflation swaps if private markets aren’t liquid enough.

  3. Can a set of choices really be seen as consistent or inconsistent on purely internal grounds, without bringing in something external to choice, such as the underlying objectives or values that are pursued or acknowledged by choice?
    .
    Analysis done correctly asks this question and must answer, no. That actually is real logic at work. That mainstream economists hide from such obvious questions impeaches their silly claims of rigor.


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