Thinking about thinking

7 Feb, 2021 at 15:42 | Posted in Economics | 6 Comments

Unfortunately, the greater part of economic controversies arise from confronting dogmas. The style of argument is that of theology, not of science … In economics, new ideas are treated, in theological style, as heresies and as far as possible kept out of the schools by drilling students in the habit of repeating the old dogmas, so as to prevent established orthodoxy from being undermined …

Image result for joan robinson further contributionsOn the plane of academic theory, the importance of the Keynesian revolution was to show that all the familiar dogmas are set in a world without time and cannot survive the simple observation that decisions, in economic life, are necessarily taken in the light of uncertain expectations about their future consequences.

Orthodox theory reacted to this challenge, in true theological style, by inventing fanciful worlds in which the difference between the past and the future does not a rise and devising intricate mathematical theorems about how an economy would operate if everyone in it had correct foresight about how everybody else was going to behave.

Mainstream — ‘orthodox’ — economists extensively exploit ‘rational choice’ assumptions in their explanations. That is probably also the reason why the theory has not been able to accommodate well-known anomalies in its theoretical framework. That should hardly come as a surprise to anyone. Mainstream theory with its axiomatic view on individuals’ tastes, beliefs, and preferences, cannot accommodate very much of real-life behaviour. It is hard to find really compelling arguments in favour of us continuing down its barren paths since individuals obviously do not comply with, or are guided by, ‘orthodox’ theory.

Looking, e.g., at the special branch of mainstream theory called game theory, it is — apart from a few notable exceptions — difficult to find really successful applications of the theory. Why? To a large extent simply because the boundary conditions of game theoretical models are false and baseless from a real-world perspective. And, perhaps even more importantly, since they are not even close to being good approximations of real-life, game theory is lacking predictive power. This should come as no surprise. As long as mainstream economic theory sticks to its ‘rational choice’ foundations, there is not much to be hoped for.

Game theorists can, of course, marginally modify their tool-box and fiddle with the auxiliary assumptions to get whatever outcome they want. But as long as the ‘rational choice’ core assumptions are left intact, it seems a pointless effort of hampering with an already excessive deductive-axiomatic formalism. If you do believe in a real-world relevance of game theoretical ‘science fiction’ assumptions such as expected utility, ‘common knowledge,’ ‘backward induction,’ correct and consistent beliefs etc., etc., then adding things like ‘framing,’ ‘cognitive bias,’ and different kinds of heuristics, do not ‘solve’ any problem. If we want to construct a theory that can provide us with explanations of individual cognition, decisions, and social interaction, we have to look for something else than — as Robinson eloquently puts it — “invented fanciful worlds.”

Building theories and models on unjustified patently ridiculous assumptions we know people never conform to, does not deliver real science. Real and reasonable people have no reason to believe in ‘as-if’ models of ‘rational’ robot-imitations acting and deciding in a Walt Disney-world characterised by ‘common knowledge,’ ‘full information,’ ‘rational expectations,’ zero  transaction costs, given stochastic probability distributions, risk-reduced genuine uncertainty, and other laughable nonsense assumptions of the same ilk. Science fiction, with its “invented fanciful worlds,” is not science.

Much work done in mainstream theoretical economics is devoid of any explanatory interest. And not only that. Seen from a strictly scientific point of view, it has no value at all. It is a waste of time. And as so many have been experiencing in modern times of austerity policies and market fundamentalism — a very harmful waste of time.

The world’s worst writing

7 Feb, 2021 at 11:22 | Posted in Economics | 1 Comment

Image result for scientific mumbo jumboEach year Philosophy and Literature, an academic journal, runs a bad-writing contest to celebrate “the most stylistically lamentable passages found in scholarly books and articles” … Here are the 1998 results. The journal found it hard to suppress its delight that “two of the most popular and influential literary scholars in the US are among those who wrote winning entries.”

“The move from a structuralist account in which capital is understood to structure social relations in relatively homologous ways to a view of hegemony in which power relations are subject to repetition, convergence, and rearticulation brought the question of temporality into the thinking of structure, and marked a shift from a form of Althusserian theory that takes structural totalities as theoretical objects to one in which the insights into the contingent possibility of structure inaugurate a renewed conception of hegemony as bound up with the contingent sites and strategies of the rearticulation of power.”

Judith Butler, professor at UC Berkeley

Interview with Tony Lawson

6 Feb, 2021 at 15:32 | Posted in Economics | 3 Comments

Jamie Morgan: Let’s return to your work on economics and place this in the context of how you came to work in the field. As suggested in the biographical introduction, you have been closely associated with the critique of the ‘formalisation’ of theory and the dominance of mathematical modelling, including the use of statistical techniques, not least econometrics. Were you always critical of these?

Image result for journal of critical realism Tony Lawson: I was. Or at least I was from the moment I moved across to economics. I first completed a degree in mathematics. Pure maths. I loved the subject. I was set to do a PhD in either Group Theory or Ring Theory at Queen Mary College in Cambridge. But I was aware I would be feeling more and more isolated if I took that road, with few people in the world to discuss my research with. Additionally, I was aware that I was fairly ignorant about how the social world, capitalism, money, etc., worked. Indeed, I knew almost nothing of economics, and yet I was getting quite heavily involved in student politics. So, I decided to go for a change. I took up an MSc in Economics at the LSE instead.

However, I was equally ignorant of the situation in academic economics. I had not the slightest notion that it would be all about mathematical modelling. So, in my very first lecture I asked the lecturer why he kept trying to express everything in terms of mathematical models, focussing only on comparing different ones. I was keen to learn about social reality, and the models seemed to me to be an obvious distraction. The question did not go down well. I felt in my gut that these methods were inappropriate, given the nature of social reality. However, I was not in a position to articulate that view very well. I needed to be able to express my intuitions in a manner that I could easily communicate to others. That is where my excursions into social ontology effectively started; and that is also when I started criticizing the emphasis on methods of mathematical modelling as tools for social analysis. There was never a moment that I thought that seeking mathematically to model human behaviour was, in most situations anyway, other than absurd.

But I was very naïve about the state of academic economics. I was always surprised that criticizing this modelling emphasis was received so badly. There was never much of a reasoned defence of it provided by anyone. Mostly the reaction has been annoyance. Of course, the very reason I was so readily accepted into economics was the same reason that a critique of modelling has had so little impact. Economists, in my experience, were and are in awe of mathematicians. In addition, they seem to think not only that economics must be a science, but that mathematics is essential to science, and ‘so’ they have to do it. It’s a form of methodological ideology, and it is very difficult to shift.

Journal of Critical Realism

To have ‘consistent’ models and ‘valid’ evidence is, as Lawson again and again has reminded us, not enough. Models may help us think through problems. But we should never forget that the formalism we use in our models is not self-evidently transportable to a largely unknown and uncertain reality. The tragedy with mainstream economic theory is that it thinks that the logic and mathematics used are sufficient for dealing with our real-world problems. They are not. Model deductions based on questionable assumptions can never be anything but exercises in hypothetical reasoning.

The world in which we live is inherently uncertain and quantifiable probabilities are the exception rather than the rule. To every statement about it is attached a ‘weight of argument’ that makes it impossible to reduce our beliefs and expectations to a one-dimensional stochastic probability distribution. If “God does not play dice” as Einstein maintained, I would add “nor do people.” The world as we know it has limited scope for certainty and perfect knowledge. Its intrinsic and almost unlimited complexity and the interrelatedness of its organic parts prevent the possibility of treating it as constituted by ‘legal atoms’ with discretely distinct, separable and stable causal relations. Our knowledge accordingly has to be of a rather fallible kind.

If the real world is fuzzy, vague and indeterminate, then why should our models build upon a desire to describe it as precise and predictable? Even if there always has to be a trade-off between theory-internal validity and external validity, we have to ask ourselves if our models are relevant.

‘Human logic’ has to supplant the classical — formal — logic of deductivism if we want to have anything of interest to say of the real world we inhabit. Logic is a marvellous tool in mathematics and axiomatic-deductivist systems, but a poor guide for action in real-world systems, in which concepts and entities are without clear boundaries and continually interact and overlap. In this world, I would say we are better served with a methodology that takes into account that the more we know, the more we know we do not know.

Mathematics and logic cannot establish the truth value of facts. Never has. Never will.

[Added: For those who read Swedish, my article on Tony Lawson’s thoughts on economics and ontology published in Fronesis 54-55 may be of interest.]

La Sagrada Famiglia (personal)

4 Feb, 2021 at 18:45 | Posted in Economics | 2 Comments

Tora (27), Amanda (30), David (30), Sebastian (27), Linnea (21) and Hedda (6).

It was great to be able to have all our sons and daughters home over Christmas holidays in spite of the ongoing pandemic. To me that was the greatest pandemic depression antidote of all.

The future of macroeconomics

4 Feb, 2021 at 08:37 | Posted in Economics | 6 Comments

But why are DSGE models still in the mix at all, and in a key position? Given all the criticisms, what can such models tell us, even as a ‘first pass at important questions’? Multiple equilibria do allow for discussion of a wider range of scenarios, but any discussion of a particular scenario is still constrained by the requirements of general equilibrium theory. These requirements are at the root of the more fundamental critiques of DSGE. While Vines and Wills set out an impressive research agenda to flesh out this multiple-equilibrium approach, we need to reflect on the constraints imposed by general equilibrium theorising itself.

Image result for macroeconomics lars syllWe therefore need to revisit the fundamental problems with general equilibrium theory and the restrictions it imposes on what is admissible. Individual behaviour needs to be determinate such that indeterminacy can only enter due to an ad hoc restriction or else as a shock. Institutional structures need to be fixed, or else evolve in a deterministic way. Further, the very focus on equilibrium as an outcome of market forces severely constrains the subject matter. This is epitomised by the treatment of uncertainty as risk, or concealed risk. Without being able to absorb the significance of fundamental uncertainty for individual behaviour, for social structures and institutions, and for economics itself, the subject matter and the theoretical structures designed to capture it are inevitably constrained.

The force of these restrictions is embodied in the requirement for microfoundations, whereby all propositions need to be derivable from axioms with respect to individual behaviour. The issue of microfoundations (their role and content) lies at the heart, not only of critiques of general equilibrium theory but also of debate within mainstream macroeconomics itself.

Sheila Dow

Thanks to latter-day Lucasian new-classical-new-Keynesian-rational-expectations-representative-agents-microfoundations-economists, we are supposed not to – as our primitive ancestors – use that archaic term ‘macroeconomics’ anymore (with the possible exception of warning future economists not to give in to ‘discomfort.’)  Being intellectually heavily indebted to the man who invented macroeconomics – Keynes – yours truly firmly declines to concur.

Microfoundations – and a fortiori rational expectations and  representative agents – serve a particular theoretical purpose. And as the history of macroeconomics during the last thirty years has shown, this Lakatosian microfoundation programme for macroeconomics is only methodologically consistent within the framework of a (deterministic or stochastic) general equilibrium analysis. In no other context has it been possible to incorporate these kind of microfoundations, with its “forward-looking optimizing individuals,” into macroeconomic models.

This is of course not by accident. General equilibrium theory — built on heaps of known to be fictitious assumptions — is basically nothing else than an endeavour to consistently generalize the microeconomics of individuals and firms on to the macroeconomic level of aggregates.

But it obviously doesn’t work. The analogy between microeconomic behaviour and macroeconomic behaviour is misplaced. Empirically, science-theoretically and methodologically, mainstream microfoundations for macroeconomics are defective.  Tenable foundations for macroeconomics really have to be sought for elsewhere.

Defenders of microfoundations standardly say there is no alternativ. But of course there are alternative to mainstream general equilibrium microfoundations! Behavioural economics and Goldberg & Frydman’s “imperfect knowledge” economics being two noteworthy examples that easily come to mind.

And for those of us who have not forgotten the history of our discipline, and not bought the sweet-water nursery tale of Lucas et consortes that Keynes was not “serious thinking,” we can easily see that there exists a macroeconomic tradition inspired by Keynes (that has absolutely nothing to do with any “new synthesis” or “new-Keynesianism” to do).

Its ultimate building-block is the perception of genuine uncertainty and that people often “simply do not know.” Real actors can’t know everything and their acts and decisions are not simply possible to sum or aggregate without the economist risking to succumb to “the fallacy of composition”.

Instead of basing macroeconomics on ontological blindness and unreal and unwarranted generalizations of microeconomic behaviour and relations, it is far better to accept the ontological fact that the future to a large extent is uncertain, and rather conduct macroeconomics on this fact of reality.

The real macroeconomic challenge is to accept uncertainty and still try to explain why economic transactions take place – instead of simply conjuring the problem away by assuming uncertainty to be reducible to stochastic risk. That is scientific cheating. And it has been going on for too long now.

The Keynes-inspired building-blocks are there. But it is admittedly a long way to go before the whole construction is in place. But the sooner we get rid of the ontological blindness of mainstream macroeconomics and are intellectually honest and ready to admit that the microfoundationalist programme has come to way’s end – the sooner we can redirect are aspirations and knowledge in more fruitful endeavours. To accomplish this, the starting point needs to be — as Dow so eloquently puts it — “explicit statements about the nature of the real world.”

Teaching heterodox microeconomics

3 Feb, 2021 at 16:13 | Posted in Economics | 1 Comment

In memoriam: Frederic S. Lee (1949-2014), el adiós a un “economista  blasfemo”[*] | LumpenproletariatClearly, neoclassical economists believe that neoclassical microeconomic theory is theoretically coherent and provides the best explanation of economic activity; therefore there is no good reason to not teach it, if not exclusively. Many heterodox economists also broadly agree with this position, although not with all the particulars. However, sufficient evidence exists showing that as a whole neoclassical microeconomic theory is theoretically incoherent and without empirical support (see Lee and Keen, 2004; and Keen, 2001). Moreover, the methodological underpinning of neoclassical microeconomics is open to criticisms. The methodological approach of neoclassical economics is based on a pre-vision of supply and demand and/or a Walrasian general equilibrium all combined with scarcity and constrained maximization. Accepting this vision as a matter of faith, neoclassical economists construct axiomatic-based arguments via a deductivist methodology (with or without the use of mathematics) to articulate this pre-vision. There is no attempt to establish that the pre-vision has any connection to or is grounded in the actual capitalist economy it purports to explain. Hence the method of constructing theory is not tied to or informed by the real world, which means that the axioms qua assumptions used are not chosen because of their realism or some other way grounded in reality but solely because they contribute to articulating the pre-vision. Therefore with a methodology unconcerned with the real world, the theories derived therefrom​ are theoretically vacuous and hence not really explanations. They are in fact non-knowledge. Consequently,​ the methodology of neoclassical economics is not just wrong, it is also misleading in that it cannot inherently provide any understanding of how the real works or even predict outcomes in the real world.

Fred Lee

Fred was together with Nai Pew Ong, Bob Pollin and Axel Leijonhufvud one of those who made a visit to University of California such a great experience for a young economics scholarship holder back at​ the beginning of the 1980s. I especially remember our long and intense discussions on Sraffa and Neo-Ricardianism. It is now more than five years since Fred passed away. I truly miss this open-minded and good-hearted heterodox economist.

What is wrong with modern economics?

2 Feb, 2021 at 18:01 | Posted in Economics | Leave a comment

It is simply that modern economists persist in insisting that a set of tools be everywhere adopted that are mostly inadequate to social analysis, given the nature of social phenomena …

wrong toolTo put the matter bluntly (the pun may be useful), it is like attempting to cut the grass with a hammer or a piece of paper. The latter objects have their uses, but mowing the lawn is not one of them. Methods of applied mathematics of the sort economists wield have their uses, but illuminating social reality is not one of them, or at best, is so only in exceptional circumstances. I hope that it is clear that this explanation, whether correct or not, reflects a stance that is not anti-mathematics but anti a mismatch of tool and object — and so, given the circumstances, anti the abuse of mathematics …

There is a good deal wrong with modern economics. There is much to be done to remedy matters at all levels of analysis. But little can improve at any level until we discard the widely-worn methodological blinkers which encourage the view that mathematical modelling is everywhere automatically relevant, even essential, so that paying explicit attention to matters of ontology is unnecessary.

Tony Lawson

Modern economics has become increasingly irrelevant to the understanding of the real world. In his seminal book Economics and Reality (1997), Tony Lawson traced this irrelevance to the failure of economists to match their deductive-axiomatic methods with their subject

largepreview It is — sad to say — as relevant today as it was twenty five years ago.

It is still a fact that within mainstream economics internal validity is everything and external validity nothing. Why anyone should be interested in that kind of theories and models is beyond imagination. 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, but autism!

Studying mathematics and logic is interesting and fun. It sharpens the mind. In pure mathematics and logic, we do not have to worry about external validity. But economics is not pure mathematics or logic. It’s about society. The real world.

Economics and Reality was a great inspiration to yours truly twenty five years ago. It still is.

Best advice to an aspiring economist — don’t be an economist

1 Feb, 2021 at 17:12 | Posted in Economics | Comments Off on Best advice to an aspiring economist — don’t be an economist

And still, amidst all this tumult, many economists are disinclined to rethink the foundations of their field. It reminds me of the closing joke in Woody Allen’s film Annie Hall. A guy has a crazy brother who thinks he is a chicken.  The doctor asks, ‘Why don’t you turn him in?’ The guy replies, ‘I would, but I need the eggs.’ ” 

wrong-focusWhy is the free-market discourse so perdurable despite so many social, ecological, and political realities that call its logic and categories of thought into question?  Because the whole field, despite its flaws, is functional enough and entrenched. It needs the eggs — the certitude of quantitative analysis aping the hard sciences, the credentialed expertise always in demand by powerful institutions, the prestige that comes with proximity to power. 

But behind these factors, there is a new world a-bornin’ that economics needs to engage with and understand. There are brilliant economic thinkers like Kate Raworth, inventor of “doughnut economics” framework; the writings of degrowth economist Jason Hickel and the late anthropologist David Graeber; the thinkers associated with the web journal Real World Economics; and a number of student associations clamoring for new economic paradigms and pedagogy. Beyond reading the right things, I find that it helps a lot to hang out with the right crowd, listen to serious new voices, and bring one’s full humanity to the questions of the moment. 

Economists of all ages – but especially younger ones who have the suppleness and imagination to grow – need to pay attention to these outsider voices. There is a new world that is fast-overtaking us, and it needs to be seen and explained on its own terms.

David Bollier / Evonomics

A science that doesn’t self-reflect on its own history and asks important methodological and science-theoretical questions about the own activity, is a science in dire straits.

Already back in 1991, a commission chaired by Anne Krueger and including people like Kenneth Arrow, Edward Leamer, and Joseph Stiglitz, reported from own experience “that it is an underemphasis on the ‘linkages’ between tools, both theory and econometrics, and ‘real world problems’ that is the weakness of graduate education in economics,” and that both students and faculty sensed “the absence of facts, institutional information, data, real-world issues, applications, and policy problems.” And in conclusion, they wrote that “graduate programs may be turning out a generation with too many idiot savants skilled in technique but innocent of real economic issues.”

Not much is different today. Economics — and economics education — is still in dire need of a remake.

More and more young economics students want to see a real change in economics and the way it’s taught. They want something other than the same old mainstream catechism. They don’t want to be force-fed with useless and harmfully irrelevant mainstream theories and models.

It’s time to tax the Wall Street casino!

30 Jan, 2021 at 16:11 | Posted in Economics | 10 Comments

Speculators may do no harm as bubbles on a steady stream of enterprise. But the position is serious when enterprise becomes the bubble on a whirlpool of speculation. When the capital development of a country becomes a by-product of the activities of a casino, the job is likely to be ill-done.8489342The measure of success attained by Wall Street, regarded as an institution of which the proper social purpose is to direct new investment into the most profitable channels in terms of future yield, cannot be claimed as one of the outstanding triumphs of laissez-faire capitalism — which is not surprising, if I am right in thinking that the best brains of Wall Street have been in fact directed towards a different object.

These tendencies are a scarcely avoidable outcome of our having successfully organised “liquid” investment markets. It is usually agreed that casinos should, in the public interest, be inaccessible and expensive. And perhaps the same is true of Stock Exchanges … The introduction of a substantial Government transfer tax on all transactions might prove the most serviceable reform available, with a view to mitigating the predominance of speculation over enterprise in the United States.

Occupy GameStop

30 Jan, 2021 at 10:15 | Posted in Economics | 1 Comment

Steht der Fall GameStop tatsächlich für eine Krise des Aktienmarkts, gar des Kapitalismus? Und sorgen die Anleger mit ihren Absprachen in den sozialen Netzwerken für eine Demokratisierung des Handels? Offen ist auch, ob es überhaupt legal ist, sich online abzusprechen und dann gemeinsam einen bestimmten Wert einfach aufzukaufen. “Darauf gibt es keine einfache Antwort”, sagt Michael Grote, Professor für Kapitalmärkte an der Frankfurt School of Finance & Management. “Es ist erst mal etwas vollkommen Neues, dass sich lauter Kleinanleger zusammenschließen und zunächst schlicht Tipps austauschen. Das ist auch legal.”

GameStop is just a pawn in the new battle between Wall St and Main St - ABC  NewsOb das bereits eine Absprache im rechtlichen Sinne darstelle, müsse ein Gericht klären, weil es solche Fälle bisher nicht gegeben habe. “Verboten ist es, wenn sich große institutionelle Anleger absprechen.” Doch wo liegt da der Unterschied? …

Die Kritik des demokratischen US-Senators Brown richtet sich vor allem gegen die Entscheidung des Onlinebrokers Robinhood, Käufe der seit Tagen hochfliegenden GameStop-Aktie zu sperren …

Michael Grote von der Frankfurt School of Finance sieht diese Entscheidung kritisch. Es sei zwar verständlich, wenn eine solche Aktie an der Börse zeitweise vom Handel ausgesetzt werde. “Das kommt immer wieder vor, wenn etwas Außerordentliches passiert”, sagt Grote. Man gebe den Marktteilnehmern dann Zeit, das zu verarbeiten. Aber in diesem Fall würden Kunden einer privaten Plattform systematisch ausgeschlossen. “Das halte ich für extrem problematisch, weil es nicht Aufgabe eines privaten Unternehmens ist, das zu entscheiden, sondern der behördlichen Aufsicht”, sagt Grote.

J. C. Iser & Z. Zacharakis / Die Zeit

For another angle on this cause celèbre, here’s Yves Smith’s (Naked Capitalism) point of view.

Tobin tax — could it work? | LARS P. SYLL

Affaire Gamestop — les fonds spéculatifs pris à leur propre jeu

29 Jan, 2021 at 18:00 | Posted in Economics | Comments Off on Affaire Gamestop — les fonds spéculatifs pris à leur propre jeu

Cette semaine, le groupe new-yorkais Melvin Capital a perdu sa chemise sur les marchés – sur l’action de la société Gamestop, pour être précis –, le contraignant à mendier 2,75 milliards de dollars (2,27 milliards d’euros) auprès de ses concurrents pour éviter une faillite.

Congress plans hearings after GameStop stock frenzy and Robinhood trading  freeze - CBS NewsSes vainqueurs : une foule de boursicoteurs, saisis par l’ennui pendant la pandémie et qui se sont mis à jouer à Wall Street depuis qu’a éclaté le Covid-19. Ils se sont passé le mot sur le forum Reddit, mais aussi sur Twitter ou Facebook, faisant monter, monter, monter l’action de Gamestop pour mieux ruiner Melvin Capital …

Les boursicoteurs réussissent là où avaient échoué les militants d’Occupy Wall Street après la crise de 2009 : enrayer le système. L’affaire suscite un vif émoi aux Etats-Unis. La société de courtage TD Ameritrade a cessé de passer des ordres sur Gamestop et AMC. Le Wall Street Journal a ouvert un « live » pour couvrir l’affaire …

La sénatrice du Massachusetts Elizabeth Warren s’est moquée des arroseurs arrosés. « Pendant des années, ces mêmes fonds spéculatifs et investisseurs fortunés consternés aujourd’hui par les transactions sur Gamestop ont traité le marché boursier comme leur propre casino alors que tout le monde en paie le prix », a tweeté Mme Warren, estimant qu’« il est grand temps pour la SEC et les autres régulateurs financiers de se réveiller et de faire leur travail. Et avec une nouvelle administration et des démocrates qui dirigent le Congrès, j’ai l’intention de m’assurer qu’ils le feront ».

Arnaud Leparmentier / Le Monde

Mainstream economics — nonsense masquerading as science

27 Jan, 2021 at 17:39 | Posted in Economics | 8 Comments

Assumptions in scientific theories/models are often based on (mathematical) tractability (and so necessarily simplifying) and used for more or less self-evidently necessary theoretical consistency reasons. But one should also remember that assumptions are selected for a specific purpose, and so the arguments (in economics shamelessly often totally non-existent) put forward for having selected a specific set of assumptions, have to be judged against that background to check if they are warranted.

This, however, only shrinks the assumptions set minimally – it is still necessary to decide on which assumptions are innocuous and which are harmful, and what constitutes interesting/important assumptions from an ontological & epistemological point of view (explanation, understanding, prediction). Especially so if you intend to refer your theories/models to a specific target system — preferably the real world. To do this one should start by applying a Real World Filter in the form of a Smell Test: Is the theory/model reasonable given what we know about the real world? If not, why should we care about it? If not – we shouldn’t apply it (remember time is limited and economics is a science on scarcity & optimization …)

I came to think of the importance of applying the Smell Test when re-reading Mark Thoma’s article — in The Fiscal Times — on “Do people have rational expectations?”:

Rational expectations attempts to avoid [the mistakes made by earlier expectational theories] by assuming people optimally incorporate all available information into their expectations …

The assumption of rational expectations is still present in most models today. But is it proper to assume that … people fully understand the policy rules that monetary and fiscal policymakers are using to stimulate or slow down the economy?

I think it’s a stretch to assume that people have this knowledge, but there are two responses to the objection that the economy is too complex for individuals to understand in the sense that rational expectations requires. The first is an “as if” argument … The other argument is that although individuals may not get things exactly correct, markets aggregate information efficiently, e.g. individual errors average out at the market level …

Rational expectations are important for two reasons. First, they serve as a “perfect case” benchmark … Assuming rational expectations is like assuming a perfect vacuum in physics – it provides a baseline that can be augmented with real-world features. Second, there are cases – simple games and financial markets for example – where the assumption of rational expectations may be approximately satisfied. But it’s a mistake, I think, to assume that rational expectations apply in all other settings or to the economy as a whole.

Although there is quite a lot of healthy skepticism on the rational expectations hypothesis (REH) here that yours truly agrees with, I still think that Thoma’s picture of the extent to which the assumption of rational expectations is useful and valid, is inadequate and unwarranted.

Let me elaborate a little on why I think so.

The concept of rational expectations was first developed by John Muth in  an Econometrica article in 1961 — Rational expectations and the theory of price movements  — and later — from the 1970s and onward — applied to macroeconomics. Muth framed his rational expectations hypothesis in terms of probability distributions:

Expectations of firms (or, more generally, the subjective probability distribution of outcomes) tend to be distributed, for the same information set, about the prediction of the theory (or the “objective” probability distributions of outcomes).

But Muth was also very open with the non-descriptive character of his concept:

The hypothesis of rational expectations does not assert that the scratch work of entrepreneurs resembles the system of equations in any way; nor does it state that predictions of entrepreneurs are perfect or that their expectations are all the same.

To Muth its main usefulness was its generality and ability to be applicable to all sorts of situations irrespective of the concrete and contingent circumstances at hand.

Muth’s concept was later picked up by New Classical Macroeconomics, where it soon became the dominant model-assumption and has continued to be a standard assumption made in many neoclassical (macro)economic models – most notably in the fields of (real) business cycles and finance (being a cornerstone of the “efficient market hypothesis”).

REH basically says that people on the average hold expectations that will be fulfilled. This makes the economist’s analysis enormously simplistic, since it means that the model used by the economist is the same as the one people use to make decisions and forecasts of the future.

pasteBut, strictly seen, REH only applies to ergodic – stable and stationary stochastic – processes. If the world was ruled by ergodic processes, people could perhaps have rational expectations, but no convincing arguments have ever been put forward, however, for this assumption being realistic – and this goes for Thoma too.

Of course you can make assumptions based on tractability, but then you do also have to take into account the necessary trade-off in terms of the ability to make relevant and valid statements on the intended target system. Mathematical tractability cannot be the ultimate arbiter in science when it comes to modeling real world target systems. Of course, one could perhaps accept REH if it had produced lots of verified predictions and good explanations. But it has done nothing of the kind. Therefore the burden of proof is on those who still want to use models built on utterly unreal assumptions.

In models building on REH it is presupposed – basically for reasons of consistency – that agents have complete knowledge of all of the relevant probability distribution functions. And when trying to incorporate learning in these models – trying to take the heat of some of the criticism launched against it up to date – it is always a very restricted kind of learning that is considered. A learning where truly unanticipated, surprising, new things never take place, but only rather mechanical updatings – increasing the precision of already existing information sets – of existing probability functions.

Nothing really new happens in these ergodic models, where the statistical representation of learning and information is nothing more than a caricature of what takes place in the real world target system. This follows from taking for granted that people’s decisions can be portrayed as based on an existing probability distribution, which by definition implies the knowledge of every possible event (otherwise it is in a strict mathematical-statistically sense not really a probability distribution) that can be thought of taking place.

But in the real world it is – as shown again and again by behavioural and experimental economics – common to mistake a conditional distribution for a probability distribution. Mistakes that are impossible to make in the kinds of economic analysis that build on REH. On average REH agents are always correct. But truly new information will not only reduce the estimation error but actually change the entire estimation and hence possibly the decisions made. To be truly new, information has to be unexpected. If not, it would simply be inferred from the already existing information set.

In the world of REH, learning is like being better and better at reciting the complete works of Shakespeare by heart – or at hitting bull’s eye when playing dart. It presupposes that we have a complete list of the possible states of the world and that by definition mistakes are non-systematic (which, strictly seen, follows from the assumption of “subjective” probability distributions being equal to the “objective” probability distribution). This is a rather uninteresting and trivial kind of learning. It is a closed world learning, synonymous to improving one’s adaptation to a world which is fundamentally unchanging. But in real, open world situations, learning is more often about adapting and trying to cope with genuinely new phenomena.

In the real world, it is not possible to just assume that probability distributions are the right way to characterize, understand or explain acts and decisions made under uncertainty. When we simply do not know, when we have not got a clue, when genuine uncertainty prevail, REH simply is not — to use Thoma’s own word — “reasonable.” In those circumstances it is not a useful assumption, since under those circumstances the future is not like the past, and henceforth, we cannot use the same probability distribution – if it at all exists – to describe both the past and future.

Now Thoma says that assuming rational expectations

is like assuming a perfect vacuum in physics – it provides a baseline that can be augmented with real-world features.

But although in physics it may possibly not be straining credulity too much to model processes as taking place in “vacuum worlds” – where friction, time and history do not really matter – in social and historical sciences it is obviously ridiculous. If societies and economies were frictionless ergodic worlds, why do econometricians fervently discuss things such as structural breaks and regime shifts? That they do is an indication of the unrealisticness of treating open systems as analyzable with frictionless ergodic “vacuum concepts.”

If the intention of REH is to help us explain real economies, it has to be evaluated from that perspective. A model or hypothesis without a specific applicability is not really deserving our interest. Without strong evidence all kinds of absurd claims and nonsense may pretend to be science. We have to demand more of a justification than rather watered-down versions of “anything goes” when comes to rationality postulates. If one proposes REH one also has to support its underlying assumptions. None is given. REH economists are not particularly interested in empirical examinations of how real choices and decisions are made in real economies. REH has been transformed from an – in principle – testable hypothesis to an irrefutable proposition.

The perhaps most problematic part of Thoma’s argument is that he maintains — with the help of his “tickling game” — tha young children in it (emphasis added)

have rational expectations in the sense that economists use the term.

But as shown already by Paul Davidson in the 1980s, REH implies that relevant distributions have to be time independent (which follows from the ergodicity implied by REH). This amounts to assuming that an economy is like a closed system with known stochastic probability distributions for all different events. In reality it is straining one’s beliefs to try to represent economies as outcomes of stochastic processes. An existing economy is a single realization tout court, and hardly conceivable as one realization out of an ensemble of economy-worlds, since an economy can hardly be conceived as being completely replicated over time. It’s really straining one’s imagination trying to see any similarity between these modelling assumptions and children’s expectations in the “tickling game.” In REH we are never disappointed in any other way than as when we lose at the roulette wheels, since, as Muth puts it, “averages of expectations are accurate.” But real life is not an urn or a roulette wheel, so REH is a vastly misleading analogy of real-world situations. It may be a useful assumption – but only for non-crucial and non-important decisions that are possible to replicate perfectly (a throw of dices, a spin of the roulette wheel etc).

Most models building on ratinal hypothesis are time-invariant and so give no room for any changes in expectations and their revisions. The only imperfection of knowledge they admit of is included in the error terms, error terms that are assumed to be additive and to have a give and known frequency distribution, so that the models can still fully pre-specify the future even when incorporating these stochastic variables into the models.

Thoma maintains that

Rational expectations are important for two reasons. First, they serve as a “perfect case” benchmark … Second, there are cases – simple games and financial markets for example – where the assumption of rational expectations may be approximately satisfied.

As I have tried to argue here, there is no support for this conviction at all. On the contrary. If we want to have anything of interest to say on real economies, financial crisis and the decisions and choices real people make, it is high time to replace the rational expectations hypothesis with more relevant and realistic assumptions concerning economic agents and their expectations.

Any model assumption — such as ‘rational expectations’ — that doesn’t pass the real world Smell Test is just silly nonsense on stilts.

4703325Suppose someone sits down where you are sitting right now and announces to me that he is Napoleon Bonaparte. The last thing I want to do with him is to get involved in a technical discussion of cavalry tactics at the battle of Austerlitz. If I do that, I’m getting tacitly drawn into the game that he is Napoleon. Now, Bob Lucas and Tom Sargent like nothing better than to get drawn into technical discussions, because then you have tacitly gone along with their fundamental assumptions; your attention is attracted away from the basic weakness of the whole story. Since I find that fundamental framework ludicrous, I respond by treating it as ludicrous – that is, by laughing at it – so as not to fall into the trap of taking it seriously and passing on to matters of technique.

Robert Solow

Häften för Kritiska Studier

27 Jan, 2021 at 11:31 | Posted in Economics | 1 Comment

polomarkÅr 1968 utkom det första numret av Häften för kritiska studier. Under de mer än femtio år som gått sedan dess har mer än 200 nummer utkommit. För att fira detta tog några av tidskriftens redaktions-medlemmar ett initiativ till en jubileumsskrift som kom ut i början av år 2020.

Yours truly har ett bidrag med i skriften och tänkte därför ta tillfället i akt att säga något lite mer personligt om denna fantastiska tidskrift som alltid legat mig varmt om hjärtat.

Som en tämligen intellektuellt brådmogen 13-åring började jag läsa — och snart prenumerera på — HfKS. Jag vågar väl inte påstå att jag alltid fullt ut förstod de tankedigra och många gånger ‘djupa’ artiklar tidskriften var fylld med, men tillräckligt för att jag skulle lockas att läsa mer och förkovra mig. Mitt intresse stod tidigt till ekonomin, och jag minst speciellt ett par artiklar som handlade om handelsteori (som en av jubileumsskriftens bidragsgivare, Jan Otto Andersson, författat.)

Tidskriften gav god ammunition när jag några år senare på gymnasiet också dristade att ifrågasätta en samhällskunskapslärare (nybakad nationalekonom från Lund) som försökte få oss alla att tänka inom den traditionella neoklassiska teoriramen.hfDet var ju inget som gjorde en populär i lärarens ögon, men svaren uteblev ofta och förstärkte min övertygelse att de heterodoxa teorier HfKS introducerade hade fog för sig i kritiken av den förhärskande teoriuppfattningen.

På 90-talet kom jag själv att publicera ett flertal artiklar i tidskriften. För dem av oss som ville utveckla och publicera något annat än den vanliga färdigtuggade ekonomigröten vi matades med på de nationalekonomiska institutionerna gav HfKS oss möjlighet att göra våra röster hörda.

Nu så här när HfKS fyllt 50 år kan man inte heller annat än bli imponerad av det oförtröttliga arbete och kulturgärning den ständige redaktörn för tidskriften — Göran Fredriksson Humlesjö — bestått oss med. Få tidskrifter kan stoltsera med att ha en redaktör som varit med på ‘resan’ under ett halvt sekel!

Truth and rationality

27 Jan, 2021 at 11:16 | Posted in Economics | 4 Comments

Explaining Social Behavior: More Nuts and Bolts for the Social Sciences:  Elster, Jon: 9780521777445: Books - Amazon.caLet me conclude the discussion of rational-choice theory by emphasizing again its radically subjective nature

The rationality of beliefs is a completely different matter from that of their truth. Whereas truth is a feature of the relation between the belief and the world, rationality is a feature of the relation between the belief and the evidence possessed by the agent. Although rationality may require the agent to invest in new information, the investment is always constrained by its expected (that is, believed) costs and benefits.

Mainstream economics — a waste of time on a staggering scale

25 Jan, 2021 at 09:49 | Posted in Economics | 1 Comment

Though an enthusiast of reason, I believe that rational choice theory has failed abysmally, and it saddens me that this failure has brought discredit upon the very enterprise of serious theorizing in the field of social study …

bunbgeRational choice theory is far too ambitious. In fact, it claims to explain everything social in terms of just three assumptions that would hold for all individuals in all social groups and in every historical period. But a Theory of Everything does not explain anything in particular … And being unable to account for differences among individuals and for the variety of social interactions, systems, processes, and institutions, the theory is bound to be unrealistic, i. e., false …

The reader may feel that my criticism is excessive: that I am throwing the baby out along with the bath water. My reaction is that there is no baby … It died long ago from mathematical anemia, from deficiency in the enzymes required to digest the simplest social facts, and from lack of exposure to the sound and light and fury of the social weather.

Most mainstream economists want to explain social phenomena, structures and patterns, based on the assumption that the agents are acting in an optimizing — rational — way to satisfy given, stable and well-defined goals.

The procedure is analytical. The whole is broken down into its constituent parts so as to be able to explain (reduce) the aggregate (macro) as the result of the interaction of its parts (micro). Building their economic models, modern mainstream economists ground their models on a set of core assumptions describing the agents as ‘rational’ actors and a set of auxiliary assumptions. Together these assumptions make up the base model of all mainstream economic models. Based on these two sets of assumptions, they try to explain and predict both individual and social phenomena.

The core assumptions typically consist of completeness, transitivity, non-satiation, expected utility maximization, and consistent efficiency equilibria.

When describing the actors as rational in these models, the concept of rationality used is instrumental rationality – choosing consistently the preferred alternative, which is judged to have the best consequences for the actor given his in the model exogenously given interests and goals. How these preferences, interests, and goals are formed is not considered to be within the realm of rationality, and a fortiori not constituting part of economics proper.

The picture given by this set of core assumptions – ‘rational choice’ – is a rational agent with strong cognitive capacity that knows what alternatives she is facing, evaluates them carefully, calculates the consequences and chooses the one – given her preferences – that she believes has the best consequences according to her. Weighing the different alternatives against each other, the actor makes a consistent optimizing choice and acts accordingly.

Besides the core assumptions the model also typically has a set of auxiliary assumptions that spatio-temporally specify the kind of social interaction between ‘rational’ actors that take place in the model. These assumptions can be seen as giving answers to questions such as: who are the actors and where and when do they act; which specific goals do they have; what are their interests; what kind of expectations do they have; what are their feasible actions; what kind of agreements (contracts) can they enter into; how much and what kind of information do they possess; and how do the actions of the different individuals interact with each other.

So, the base model basically consists of a general specification of what (axiomatically) constitutes optimizing rational agents and a more specific description of the kind of situations in which these rational actors act (making the auxiliary assumptions serve as a kind of restriction of the intended domain of application for the core assumptions and the deductively derived theorems). The list of assumptions can never be complete since there will always be unspecified background assumptions and some (often) silent omissions (usually based on some negligibility and applicability considerations). The hope, however, is that the ‘thin’ list of assumptions shall be sufficient to explain and predict ‘thick’ phenomena in the real, complex, world.

These models are not primarily constructed for being able to analyze individuals and their aspirations, motivations, interests, etc., but typically for analyzing social phenomena as a kind of equilibrium that emerges through the interaction between individuals.

Now, of course, no one takes the base model (and the models that build on it) as a good (or, even less, true) representation of reality (which would demand a high degree of appropriate conformity with the essential characteristics of the real phenomena, that, even when weighing in pragmatic aspects such as ‘purpose’ and ‘adequacy,’ it is hard to see that this ‘thin’ model could deliver). The model is typically seen as a kind of thought experimental ‘as if’ bench-mark device for enabling a rigorous mathematically tractable illustration of social interaction in an ideal-type model world, and to be able to compare that ‘ideal’ with reality. The ‘interpreted’ model is supposed to supply analytical and explanatory power, enabling us to detect and understand mechanisms and tendencies in what happens around us in real economies.

Based on the model – and on interpreting it as something more than a deductive-axiomatic system – predictions and explanations can be made and confronted with empirical data and what we think we know. The base model and its more or less tightly knit axiomatic core assumptions are used to set up further ‘as if’ models from which consistent and precise inferences are made. If the axiomatic premises are true, the conclusions necessarily follow. But if the models are to be relevant, we also have to argue that their precision and rigour still holds when they are applied to real-world situations. They often do not. When addressing real economies, the idealizations and abstractions necessary for the deductivist machinery to work simply do not hold.

If the real world is fuzzy, vague and indeterminate, then why should our models build upon a desire to describe it as precise and predictable? The logic of idealization, that permeates the base model, is a marvellous tool in mathematics and axiomatic-deductivist systems, but a poor guide for action in real-world systems, where concepts and entities are without clear boundaries and continually interact and overlap.

Being told that the model is rigorous and amenable to ‘successive approximations’ to reality is of little avail, especially when the law-like (nomological) core assumptions are highly questionable and extremely difficult to test. Being able to construct ‘thought-experiments’ depicting logical possibilities does not take us very far. An obvious problem with the mainstream base model is that it is formulated in such a way that it realiter is extremely difficult to empirically test and decisively ‘corroborate’ or ‘falsify.’

e201ada1b6To achieve explanatory success, a theory should, minimally, satisfy two criteria: it should have determinate implications for behavior, and the implied behavior should be what we actually observe. These are necessary conditions, not sufficient ones. Rational-choice theory often fails on both counts. The theory may be indeterminate, and people may be irrational …

I believe that much work in economics and political science that is inspired by rational-choice theory is devoid of any explanatory, aesthetic or mathematical interest, which means that it has no value at all. I cannot make a quantitative assessment of the proportion of work in leading journals that fall in this category, but I am confident that it represents waste on a staggering scale.

Jon Elster

Such models have — from an explanatory point of view — indeed no value at all. The ‘thinness’ is bought at too high a price unless you decide to leave the intended area of application unspecified or immunize your model by interpreting it as nothing more than two sets of assumptions making up a content-less theoretical system with no connection whatsoever to reality.

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