Uncertainty and “trailing clouds of vagueness”

5 Jan, 2022 at 16:24 | Posted in Economics | 1 Comment

We live in a world permeated by unmeasurable uncertainty — not quantifiable stochastic risk — which often forces us to make decisions based on anything but ‘rational expectations.’ Our expectations are most often based on the confidence or ‘weight’ we put on different events and alternatives, and the ‘degrees of belief’ on which we weigh probabilities often have preciously little to do with the kind of stochastic probabilistic calculations made by the rational agents as modelled by ‘modern’ social sciences. Often we simply do not know.

So why do economists, companies and governments continue with the expensive, but obviously ratherworthless, activity of trying to forecast/predict the future?

A couple of years ago yours truly was interviewed by a public radio journalist working on a series on Great Economic Thinkers. We were discussing the monumental failures of the predictions-and-forecasts-business. But — the journalist asked — if these overconfident economists with their ‘rigorous’ and ‘precise’ mathematical-statistical-econometric models are so wrong again and again — why do they persist wasting time on it?

In a very personal discussion of uncertainty and the hopelessness of accurately modeling what happens in the real world, Nobel laureate Kenneth Arrow  comes up with what is probably one of the most plausible reasons:

It is my view that most individuals underestimate the uncertainty of the world. This is almost as true of economists and other specialists as it is of the lay public. To me our knowledge of the way things work, in society or in nature, comes trailing clouds of vagueness … Experience during World War II as a weather forecaster added the news that the natural world as also unpredictable. cloudsAn incident illustrates both uncertainty and the unwilling-ness to entertain it. Some of my colleagues had the responsi-bility of preparing long-range weather forecasts, i.e., for the following month. The statisticians among us subjected these forecasts to verification and found they differed in no way from chance. The forecasters themselves were convinced and requested that the forecasts be discontinued. The reply read approximately like this: ‘The Commanding General is well aware that the forecasts are no good. However, he needs them for planning purposes.’

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  1. We should accept that economists are not different from Commanding Generals or lay people in general. Consequently, economists should admit – like Commanding Generals – that they make and assume useless forecasts. Alas, they hardly ever do.

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