Winner of the New Statesman SPERI Prize in Political Economy 2016

Wednesday, 27 November 2013

Bertrand Russell’s chicken (and why it was not an economist)

When that pioneering economist David Hume wrote about the problem of induction, he talked about the possibility that the sun would not rise one morning. There is no way we can know ‘for sure’ that it will rise. (In contrast, we know for sure that 1+1=2.) Just because the theories we have suggest it will rise each morning, and those theories have been right so far, does nothing to ensure they will continue to be right.

The problem with this example is that it is very difficult to imagine the sun not rising every morning. Bertrand Russell had perhaps a better example. The chicken that is fed by the farmer each morning may well have a theory that it will always be fed each morning - it becomes a ‘law’. And it works every day, until the day the chicken is instead slaughtered.

When I used to lecture about economic methodology, I liked to say that this chicken was not an economist. Now you might say that no chicken is an economist, but suppose that chickens were as intelligent as the farmer who keeps them, so they could be an economist. Economics is at a disadvantage compared to the physical sciences because we cannot do so many types of experiments (although we are doing more and more), but we have another source of evidence: introspection. So if Bertrand Russell’s chicken had been an economist, they would not simply have observed that every morning the farmer brought them food, and therefore concluded that this must happen forever. Instead they would have asked a crucial additional question: why is the farmer doing this? What is in it for him? If I was the farmer, why would I do this? And of course trying to answer that question might have led them to the unfortunate truth.

I thought of this when reading through the fascinating comments on my post on rational expectations, and posts others had written in response. You can see why the habit of introspection would make economists predisposed to assume rationality generally, and rational expectations in particular. (I think it also helps explain economists’ aversion to paternalism.) It only works to use your own thought processes as a guide to how people in general might behave, if you think other people are essentially like yourself. So if your own thoughts lead you to postulate some theory about how the economy behaves, then others similar to yourself might be able to do something like the same thing.
 
But of course this line of reasoning could also be misleading. An economist who introspects does so with the help of the economic theory they already have, so their introspection is not representative. A psychologist or behavioural economist might come to very different conclusions from introspection - what biases do I bring to this problem, they may ask. Economists may also be fooled into thinking their introspection is representative, because they are surrounded by other economists. So this conjecture about introspection does little to show that assuming agents have rational expectations is right (or wrong), but it may be one reason why most economists find the concept of rational expectations so attractive.


28 comments:

  1. SW-L:
    "You can see why the habit of introspection would make economists predisposed to assume rationality generally, and rational expectations in particular."

    Yes, but not necessarily.

    Joe Stiglitz:
    "The belief in rationality is deeply ingrained in economics. Introspection—and even more so, a look at my peers—convinced me that it was nonsense. I soon realized that my colleagues were irrationally committed to the assumption of rationality, and shaking their faith in it would not be easy."

    SW-L"
    "An economist who introspects does so with the help of the economic theory they already have, so their introspection is not representative."

    Which is a very good reason for broadening economics education.

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  2. Rational thinking is of little use when people are misinformed. An excellent example is the widespread conviction that governments are limited in their spending by the requirement to borrow money. This has even lead econmists to make serious errors.

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    1. “This has even lead economists to make serious errors.” Slight understatement there. The way I’d put it is: “Half the economics profession thinks that governments are limited in their spending by the requirement to borrow money.”

      Certainly the IMF and OECD labour under that illusion, as do all the staff at the Harvard department of economics (Rogoff, Reinhart, etc).

      As MMTers keep pointing out, there is only one constraint on spending for a government that issues its own money: inflation.

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  3. On page 36 of Shiller's 'The Subprime Solution' (2008) there is a graph of real San Francisco metro area home-prices indices by price tier, Jan 1987 to March 2008. Shiller has three lines on the graph, one for 'low' price homes, another for 'middle' priced homes, and one for 'high' price homes.

    The size of the bubble was largest for low price homes, in the middle for middle priced homes, and lowest for high price homes.

    Shiller's questionnaires suggest that people think differently about home prices, and I wonder how much people's level of qualifications explains these differences?

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    1. Probably not a great deal.

      The bubble in housing prices was primarily a result of lenders bringing new buyers into the market by lowering income requirements. This would have far more effect with lower priced homes as buyers who never imagined they could get a loan found themselves with mortgage payments.

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    2. I agree. During a bubble, there is a definite tendency for low-priced (and less desirable) houses to show disproportionate price increases. My analysis of this is that prices at the bottom of the housing market are set by the marginal buyer's ability to get a mortgage. Increasing the availability of mortgages increases demand for entry-level houses. Luxury houses and homes in very desirable areas are purchased by the rich, for whom mortgage availability is not an issue.

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  4. Sebastian Benneker28 November 2013 at 01:52

    I think the assumption of rational expectations is best thought of as a baseline scenario.

    Since theorizing is a rational process, incorporating the possibility of irrationality is difficult, if not contradictory, as the term itself is negatively defined as anything 'non-rational'.

    Even quantifying or isolating irrationality does not provide our theories with empirical data, since there are many explanations for irrationality, whereas rational expectations are by definition self-explanatory in a 'rational' theoretical framework.

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    1. I might be irrational, but it is not nessesarely so just beucase I use a different model than you. If that is the case, there only exist one rational economist

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  5. Instead of 'Russel's chicken' I add Keynes on Newton's apple:
    „In chemistry and physics and other natural sciences the object of experiment is to fill in the actual values of the various quantities and factors appearing in an equation or a formula; and the work when done is one and for all. In economics that is not the case, and to convert a model into a quantitative formula is to destroy its usefulness as an instrument of thought. (…)
    I also want to emphasise strongly the point about economics being a moral science. (…) One has to be constantly on guard against treating the material as constant and homogeneous. It is as though the fall of the apple to the ground depended on the apple’s motives, on whether it is worth while falling to the ground, and whether the ground wanted the apple to fall, and on mistaken calculations on the part of the apple as to how far it was from the centre of the earth.” (Coll. Writings od JMK, XIV, 1973, S. 299 – 300)

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  6. In that context, have you got any thoughts on Roger Farmer's "belief function" approach? It looks to me like a very promising way of squaring this circle - his model is apparently "microfounded" enough to satisfy Tony Yates, but it also appeals to me, because it doesn't have the circular feel to it which gets people's backs up about rational expectations .

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    1. I think Roger Farmer's rereading of the General Theory is helpful. In particular, he points out rightly, that the reason you can have permanent disequilibria in the labour markets is not because of rigidities in price adjustment. Where Keynes, however, would not be happy is his desire to link macro with micro-foundations. He was always of the view that economics was eclectic in nature, and the economic analysis had to draw on wide-range of skills. A great article is his QJE article on uncertainty - when talking about "pretty and polite techniques" he is referring to the overuse of model, not just classical, but any that contain contestable foundations. For example,

      "Perhaps the reader feels that this general, philosophical disquisition on the behaviour of mankind is somewhat remote from the economic theory under discussion. But I think not. Tho this is how we behave in the market place, the theory we devise in the study of how we behave in the market place should not itself submit to market-place idols. I accuse the classical economic theory of being itself one of these pretty, polite techniques which tries to deal with the present by abstracting from the fact that we know very little about the future" (Keynes Quarterly Journal of Economics 1937 page 215).

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  7. I have to agree with Stiglitz. I think economists agree that the assumption of rational expectations isn't literally true. The argument is always that it is nonetheless useful. I think this is clearly a decision to ignore the results of introspection.

    I think introspection must be dismissed even if one doesn't assume full rationality with a subjective probability distribution corresponding to the objective probability distribution. When I introspect, I detect no subjective probability distribution. I sense things like "unlikely" "very likely" etc not numbers. The assumption that agents maximize the subjective expected value of something is always justified with an "as if" that is with the argument that, although this isn't at all what we sense when we introspect, it might be a useful modelling strategy.

    On another topic, I think that experiments are not so very central to the success of natural science. The first successful effort was predicting the apparent position of planets. The empirical work was purely observational. Later Darwin managed to discover a fundamental truth by observing things. Also Mendele'ev.

    Also economists just do not suffer from having so few data that there are competing hypotheses neither of which is rejected by the data. Rather we have competing models each of which is massively rejected by the data and the assertion that it doesn't matter because models are false by definition.

    I think the main problem is that economies are too complicated. But I also very strongly think that an additional problem is the canonical status of models based on implausible assumptions which have not yielded rnotably good predictions.

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  8. Thank you for explaining Casey Mulligan and, by default, the whole Chicago school of economics.

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  9. My problem with "rational expectations" and introspection is that an introspective but economically uninformed person would rationally conclude: 'I do not (and cannot possibly) know what tax rates will be in a few years' time." Further, I suspect that an informed, but humble, economist would probably reach the same conclusion. What either category of person would do having reached that rational conclusion, I do not know.

    I do accept that an economist chicken might usefully use her introspection and rationality.

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    1. True, Luke, though a Barro would immediately modify it to "'I can only guess what tax rates will be in a few years' time but I do know they'll probably be higher than I'd previously guessed because of this current tax cut ...".

      Your mileage may vary on how plausible that is, but RE is not as crude as a few people here assume. To say which, of course, is merely damning it with faint praise.

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    2. No, it is that crude - or abritrary. Lower taxes today might as well imply less spending in the future. Lower taxes today might imply higher growth (due to demand or supply or a million other reasons), and thus no need for higher taxes in the future. Lower taxes today might lead to a billion different things, and the only thing we know is that most of us disagree - so, no - not all of us share your model ,even if you are Barro.

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  10. I believe you are mostly wrong.

    Introspection wouldn't produce understanding of a relatively "complex" economic problem but an even simplified mathematical model could.

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  11. It is nice that you invoke philosophical insights from Hume and Russel. But too much introspection can sometimes beget too much agnosticism, most of it being unnecessary or wasteful. We know that there are certain natural laws or states taken for granted. Animals need fodder and water to survive. There is no reason to doubt that this holds tomorrow or the day after tomorrow.

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  12. Instead of fantasising about chickens, I suggest economists look at the REAL WORLD. I.e. why don’t they look at the EMPIRICAL EVIDENCE as to how far Ricardianism and rational expectations work? Mark Thoma “the empirical evidence does not support it.” See:

    http://economistsview.typepad.com/economistsview/2011/12/the-proposition-is-not-mainstream-in-the-sense-of-being-fully-accepted-by-most-economists.html?utm_source=feedburner&utm_medium=feed&utm_campaign=Feed%3A+EconomistsView+%28Economist%27s+View+%28EconomistsView%29%29

    And while households do indulge in some income smoothing, they are a long way from being “100% smoothers”. There is some evidence here:

    http://onlinelibrary.wiley.com/doi/10.1111/j.1745-6606.1984.tb00322.x/abstract
    http://www.nber.org/digest/mar09/w14753.html
    http://www.kellogg.northwestern.edu/faculty/parker/htm/research/johnsonparkersouleles2005.pdf
    http://finance.wharton.upenn.edu/~rlwctr/papers/0801.pdf

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  13. I've found your discussion on RE very interesting. I'm skeptical of RE but appreciate your attempts at clarity. I do think that sociologically speaking academically trained economists just see the world very differently.

    On all kinds of questions they are outliers. For example. most people when questioned think it's wrong to raise the price of snow showels during a blizzard but most economists see it differently.

    http://diaryofarepublicanhater.blogspot.com/2013/10/dont-feed-bears-or-smile-at-children.html

    In your chicken example though-does one have to assume RE to figure out what the farmer is really up to?

    I don't think not accepting RE means that you think that people are wholly irrational. RE it seems to me believes in a very specific type of 'rationality'

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  14. I greatly appreciate your discussion of these interesting issues, but I do not understand why introspection would lead to rational expectations. The chicken example that you give indicates that the chicken would contemplate the motivations of the farmer and build in some expectations of future changes, but why would those expectations be rational. Upon introspection, a person will see the limitations of his own knowledge and calculation, whereas rational expectations assumes none of these limitations on others. Simply assuming some form of expectations does not inevitably lead to rational expectations.

    Some comments above have mentioned Keynes, who is a particularly good reference here. Keynes believed in introspection and intuition as much as any prominent economist, yet I think that it is fair to say that he would have been horrified by the overreaching epistemology implied by rational expectations. Keynes' introspection and my introspection lead to reflection on the inherent limitations of economic theory and, especially, econometrics in the face of a complex world.

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    1. It does, but as I argue here, the question is one of choice between two evils: http://mainlymacro.blogspot.co.uk/2013/11/defending-rational-expectations.html

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    2. Surely, you can see why that is an false dichotomy

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    3. I think this justification for using rational expectations is as eloquent a defense as possible for using rational expectations as a directed analytical tool. If, for example, rational expectations are included in a model to show that an effect does not disappear with the introduction of an approximate model of expectations, then I believe that such expectations are a useful addition to the analysis. However, a lesser-of-evils assumption must be very carefully interpreted. If an analytical result happens because of rational expectations, rather than despite them, then we are on much shakier philosophical ground.

      I do not doubt that these careful interpretations are possible, but as Keynes noted in chapter 21 of the General Theory, it is extraordinarily difficult to keep careful interpretations in mind after pages of mathematical analysis assuming that they do not exist. Present company excluded, in my experience, few economists are so careful.

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  15. Given that human brains have an error rate, and so do computers, P(1+1=2) < 1.

    How confident are you that 11 is prime?
    How confident are you that 13 is prime?
    How confident are you that 17 is prime?

    What about 19? 23? 29? 31? Etc.

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  16. lazy that you don't provide a link to your prev post on rat expectations - bad academic
    and quick scan of list of prev posts didn't seem helpful

    am i being harsh and snarky ?
    to bad there is not a vote mechanism for blog posts; slashdot has a rating system, but i think it works only for large numbers of readers

    but tell me other readers - the professor says, my prev post...and doesn't provide a link
    is that or isthat not lazy ?

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  17. If the chicken was as stupid as the average economist, it would work out how to kill the farmer (which here stands for labour and nature, the source of all wealth), gorge itself on the bag of seeds until it was violently sick, and then die of convulsions.

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