tag:blogger.com,1999:blog-2546602206734889307.post4280983652212584159..comments2024-03-19T05:54:16.651+00:00Comments on mainly macro: Defending rational expectationsMainly Macrohttp://www.blogger.com/profile/09984575852247982901noreply@blogger.comBlogger50125tag:blogger.com,1999:blog-2546602206734889307.post-68580967860440582632013-12-02T13:00:15.831+00:002013-12-02T13:00:15.831+00:00The theory of rational expectation seems to have b...The theory of rational expectation seems to have been undone by the success of central banks' efforts in fighting inflation. The result being that people in general no longer worry about inflation. Things such as hikes to energy bills or train fares make headlines but the rising cost of living is just a fact of life at such low levels that it is not a concern. It is only economists (and bond investors) that seem to worry about inflation and it warps their sense of priorities due to their reliance on rational expectations theory which has been shown to be increasingly outdated. An increase in the scope of oversight by central banks is a good thing and even more might help ensure more stability and a better understanding of the workings of the economy. For more on this argument, see http://yourneighbourhoodeconomist.blogspot.co.uk/2013/11/not-so-great-expectations.htmlYour Neighbourhood Economisthttps://www.blogger.com/profile/00096015895608337029noreply@blogger.comtag:blogger.com,1999:blog-2546602206734889307.post-37453052879019632412013-11-12T16:11:43.419+00:002013-11-12T16:11:43.419+00:00How about this kind of thing, Simon?
http://facul...How about this kind of thing, Simon?<br /><br />http://faculty.som.yale.edu/nicholasbarberis/bgjs9.pdfNoah Smithhttps://www.blogger.com/profile/09093917601641588575noreply@blogger.comtag:blogger.com,1999:blog-2546602206734889307.post-69621566762021842462013-11-12T00:01:33.248+00:002013-11-12T00:01:33.248+00:00For what it’s worth, Keynes appears to pretty clea...For what it’s worth, Keynes appears to pretty clearly reject the ‘rational expectations’ of ‘representative agents’ as a worthwhile exercise in his response to Viner’s criticism of The General Theory (as quoted by Hyman Minsky in his book, “John Maynard Keynes”):<br /><br />"By uncertain knowledge…, I do not mean merely to distinguish what is known for certain from what is only probable. The game of roulette is not subject, in this sense, to uncertainty; nor is the prospect of a Victory bond being drawn. Or again, the expectation of life is only slightly uncertain. Even the weather is only moderately uncertain. The sense in which I am using the term is that in which the prospect of a European war is uncertain, or the price of copper and the rate of interest twenty years hence, or the obsolescence of a new invention, or the position of private wealth owners in the social system in 1970. About these matters there is no scientific basis on which to form any calculable probability whatever. We simply do not know. Nevertheless, the necessity for action and for decision compels us as practical men to do our best to overlook this awkward fact and to behave exactly as we should if we had behind us a good Benthamite calculation of a series of prospective advantages and disadvantages, each multiplied by its appropriate probability waiting to be summed. ” [QJE, pp. 213-14]<br /><br />Thus the use of certainty equivalents,- much beloved by academics- is to practical men a convention, to which lip service may be paid, but which is abandoned when evidence inconsistent with the polite convention emerges. <br /><br />In the face of uncertainty and “the necessity for action and for decision” (QJE, p. 214), we devise conventions: we assume the present is a “serviceable guide to the future” we assume that existing market conditions are good guides to future markets and “we endeavor to conform with the behavior of the majority or the average” (QJE, p. 214). Given these flimsy foundations, the view of the future “is subject to sudden and violent changes” (QJE, pp.214-15). “All these pretty, polite techniques made for a well-paneled Board Room and a nicely regulated market, are liable to collapse” (QJE, p. 215)<br /><br />Also, in The General Theory, “Business men play a mixed game of skill and chance, the average results of which to the players are not known by those who take a hand” (GT, p.150) <br /><br />George Soros obviously <a href="http://www.ft.com/intl/cms/s/2/0ca06172-bfe9-11de-aed2-00144feab49a.html#axzz2kNXWFZaq" rel="nofollow">got the memo</a> Of course, he is no philosopher, and certainly no economist, but one should never underestimate the power of accountability to ground an intellectual exercise in reality.Majorajamhttps://www.blogger.com/profile/12726411902275032723noreply@blogger.comtag:blogger.com,1999:blog-2546602206734889307.post-5010756386284573052013-11-12T00:00:39.148+00:002013-11-12T00:00:39.148+00:00Throughout human history, at least as long as ther...Throughout human history, at least as long as there have been market oriented economies, there have been cycles of boom and bust corresponding with credit-fueled speculation into assets financial and otherwise. Without fail during these periods of time, large quantities of savings have been directed toward investment with little or no economic value (or at least, none where no such spigot is wide open), guaranteeing socially expensive losses. In practice, these episodes are of paramount importance to any understanding of the functioning of an economy, both because their answers hold out the promise of more enlightened policy regarding boom and bust, but also because these extremes should be revealing about the nature of things, like a particle accelerator is to physicists.<br /><br />Given that is the case, one might think it meaningful to a post such as this that these most pertinent and beguiling of economic phenomena are entirely <i>inconceivable</i> in a world where RE determines the expectations of representative agents. And yet, this is nowhere to be found in Professor Wren-Lewis’s case for “one of [mainstream economics’] greatest achievements” (granted, that could’ve been damning with faint praise). Something tells me that when Buitler talks about, “Research tended to be motivated by the internal logic, intellectual sunk capital and esthetic puzzles of established research programmes rather than by a powerful desire to understand how the economy works – let alone how the economy works during times of stress and financial instability”, exactly this is what he had in mind.<br /><br />Of course to the extent that they do, heterodox economists are wrong to focus on RE, in part for the issues raised here. How information is assimilated by the representative agents of represent agent models does not account for the catastrophic model failure of those models nearly so much as the (mis)specification wrought of the original abstraction. Put another way, there's a reason why hoocoodanode counts as sardonic humor.Majorajamhttps://www.blogger.com/profile/12726411902275032723noreply@blogger.comtag:blogger.com,1999:blog-2546602206734889307.post-38763139245364632692013-11-11T18:16:49.373+00:002013-11-11T18:16:49.373+00:00"In the real world people think about what th..."In the real world people think about what the central bank is going to do when they take decisions. As pointed out, there are industries using such information to predict inflation (etc.) who then sell this information to firms, governments and so on. This is happening in the real world and it is a feature of the world approximated by RE better than adaptive expectations."<br /><br />Is that really true? Take, for example, the influence of the new Help To Buy policy against the warnings of possible imminent interest rate rises. Is it a rational decision to take out a loan on a deposit of 5% when you couldn't afford a deposit of 10% if interest rates might rise? Or more esoterically, when the unwinding of Help to Buy might depress future house prices. Do consumers look much further than their immediate "needs"?<br /><br />gastro georgeAnonymousnoreply@blogger.comtag:blogger.com,1999:blog-2546602206734889307.post-70057312143900270442013-11-11T12:11:11.512+00:002013-11-11T12:11:11.512+00:00It's all a question of degree, I think. Everyo...It's all a question of degree, I think. Everyone makes simplifying assumptions. But I just get the impression from some of the material produced by economists that they're interested primarily in erecting pretty models, and have next to no regard for the empirical evidence or the real world.Ralph Musgravehttps://www.blogger.com/profile/09443857766263185665noreply@blogger.comtag:blogger.com,1999:blog-2546602206734889307.post-59580236394582148872013-11-11T09:39:00.529+00:002013-11-11T09:39:00.529+00:00@ Barkley Rosser,
Yes, I know. But this was a com...@ Barkley Rosser,<br /><br />Yes, I know. But this was a common enough justification from Chicago/Minnesota, and while Sargent moved on, Lucas and Prescott did not. Sargent later even called ratex religion, and this I am told was one the the main reasons for the rift between Lucas and him.<br /><br />Incidentally, thanks for the pointer to the Lovell paper. He quotes Sargent.<br /><br />Learning:I might be wrong on this but my understanding is that learning is mostly used to rule out certain ratex equilibria or as a test for stability. For at least some economists, the 'infinity' presumably comes instantly, so the system is always in some RE equilibrium. Hermannoreply@blogger.comtag:blogger.com,1999:blog-2546602206734889307.post-34391785372113998942013-11-11T08:29:18.632+00:002013-11-11T08:29:18.632+00:00Just for the record, Herman, in case you did not k...Just for the record, Herman, in case you did not know, Sargent gave up on that line of argument in 1993 with his book on Adaptive Expectations in Macroeconomics.<br /><br />Barkley Rosserrosserjb@jmu.eduhttps://www.blogger.com/profile/09300046915843554101noreply@blogger.comtag:blogger.com,1999:blog-2546602206734889307.post-7107911263705133212013-11-11T06:19:17.734+00:002013-11-11T06:19:17.734+00:00@weareastrangemonkey
Danny:"The argument tha...@weareastrangemonkey<br /><br />Danny:<i>"The argument that making this assumption enables you to construct elegant models runs the risk.."</i><br /><br />weareastrangemonkey:<i> "I hope nobody does make that argument. The correct argument is ..." </i><br /><br />Sorry to dash your hopes, but this has been a fairly standard argument.<br /><br />Sargent (AER, May1982):<br />Research in rational expectations and its dynamic macroeconomics has a momentum of its own. That momentum stems fom the <i>logical structure</i> of rational expectations as a modelling strategy ..."<br /><br />SW-L is neither making nor defending this line of reasoning, but it has been and, in many circles, still remains a core argument for ratex. <br /><br />Hermannoreply@blogger.comtag:blogger.com,1999:blog-2546602206734889307.post-35950117680727239072013-11-10T21:43:48.448+00:002013-11-10T21:43:48.448+00:00Simon,
Please answer two questions: 1) What is ...Simon,<br /><br />Please answer two questions: 1) What is the empirical evidence for ratex? and 2) Does the learning lit you cite actually say that agents are currently using ratex? <br /><br />The answer to 1) has been around for a long time. An early summary of the widespread evidence available then was Michael C. Lovell's March 1986 paper in the AER, "Evidence on the Rational Expectations Hypothesis." His survey found that it had been overwhelmingly rejected. The subusequent lit has done nothring to overturn what was found in that now rather old paper.<br /><br />2) Maybe you read different papers than I did, but that entire learning lit has people using AR during the transition to ratex, which comes about asymptotically at infinity, in short, not during any time we are actually observing. Am I misinterpreting this lit? <br /><br />So, really, I do not see how you have provided even a remotely serious argument for ratex. Even if I have misinterpreted the theoretical learning lit, there remains the hard empirical evidence lit. Ratex is simply empirically false. Were you one of the economists that the Queen was annoyed with, perchance, sir?<br /><br />Barkley Rosserrosserjb@jmu.eduhttps://www.blogger.com/profile/09300046915843554101noreply@blogger.comtag:blogger.com,1999:blog-2546602206734889307.post-13224777741377718792013-11-10T21:35:02.879+00:002013-11-10T21:35:02.879+00:00Yes, Simon, and I even used it once in an empirica...Yes, Simon, and I even used it once in an empirical paper. The theory of rational bubbles if agents are risk averse leads to a particular empirical prediction, that such bubbles accelerate rapidly prior to peaking, after which they crash all the way down. The problem, is that very few bubbles ever observed have conformed to this. So, yes, there is a theory, but it does not remotely explain the reality of actual bubbles. Thank you very much.rosserjb@jmu.eduhttps://www.blogger.com/profile/09300046915843554101noreply@blogger.comtag:blogger.com,1999:blog-2546602206734889307.post-49866551987972187782013-11-10T21:31:27.858+00:002013-11-10T21:31:27.858+00:00Danny,
There is a vast empirical and experiment l...Danny,<br /><br />There is a vast empirical and experiment lit on this, some of it published in JEBO when I edited the journal. The answer is very simple and has been known for a long time to anybody who has spent more than three seconds looking at it. Rational expectations does not hold, except for a minority of the population some of the time. Those insisting on continuing to assume ratex are doing so for reasons other than empirical evidence, such as trying to use theoretical models that themselves at most suggest people are using adaptive expectations on an asymptotic path to a state where they will eventually use rational expectations. Why someone (who am I talking about???) would make such a completely silly and ridiculous argument is quite beyond me.<br /><br />Barkley Rosserrosserjb@jmu.eduhttps://www.blogger.com/profile/09300046915843554101noreply@blogger.comtag:blogger.com,1999:blog-2546602206734889307.post-30262929745536507392013-11-10T15:32:11.405+00:002013-11-10T15:32:11.405+00:00"why don't you do some proper empirical w..."why don't you do some proper empirical work on how people form their expectations? "<br /><br />There is a lot of work on this: using experimental data and survey data. <br /><br />"why do you assume that it's expectations that are key for behaviour" <br /><br />"The argument that making this assumption enables you to construct elegant models runs the risk.."<br /><br />I hope nobody does make that argument. The correct argument is:<br /><br />Most of the time it is correct to assume that if A causes B and a person values B more than the cost of doing A then they will do A. For example, I want food, housing etc. I believe if I work I will get paid for my work and that the amount I get paid will be sufficient to provide me with food, housing etc. Consequently, I choose to work. If I did not believe that the work would provide me with sufficient money to buy these things then I would not work. <br /><br />We are not always rational, but most of the time we are. <br /><br /><br />weareastrangemonkeyhttps://www.blogger.com/profile/07725580843974605480noreply@blogger.comtag:blogger.com,1999:blog-2546602206734889307.post-5496527635738809842013-11-10T15:07:07.817+00:002013-11-10T15:07:07.817+00:00"RE can hardly explain hoarding in financial ..."RE can hardly explain hoarding in financial markets"<br /><br />This is not true. See, for example, Kiyotaki-Moore 2012 for a rational expectations model with hoarding of liquid assets. It is not the only one. The reason hoarding is less common in standard models is because we do not have a good model of money, the use of rational expectations is not the issue. weareastrangemonkeyhttps://www.blogger.com/profile/07725580843974605480noreply@blogger.comtag:blogger.com,1999:blog-2546602206734889307.post-76068482671152515152013-11-10T14:54:34.147+00:002013-11-10T14:54:34.147+00:00"I do not understand why you call rational ex..."I do not understand why you call rational expectations one of the "major achievements""<br /><br />He explains in the article why he calls rational expectations on of the major achievements. Reread from:<br /> "The reason why mainstream economics replaced adaptive.." <br /><br />to <br /><br />"..and can include the fact that information is both costly and incomplete."<br />You claim RE has<br /><br />" - zero relevance to the real world."<br /><br />In the real world people think about what the central bank is going to do when they take decisions. As pointed out, there are industries using such information to predict inflation (etc.) who then sell this information to firms, governments and so on. This is happening in the real world and it is a feature of the world approximated by RE better than adaptive expectations. <br /><br />RE has shortfalls, but it certainly has some relevance to the real world.<br /><br />weareastrangemonkeyhttps://www.blogger.com/profile/07725580843974605480noreply@blogger.comtag:blogger.com,1999:blog-2546602206734889307.post-43559262113094336612013-11-09T18:13:47.349+00:002013-11-09T18:13:47.349+00:00Sorry, bad chest cold. That should read: Why isn...Sorry, bad chest cold. That should read: Why isn't what economists have thought and done in the past included your AE inputs?Anonymousnoreply@blogger.comtag:blogger.com,1999:blog-2546602206734889307.post-40747369226404859972013-11-09T18:11:43.138+00:002013-11-09T18:11:43.138+00:00Why isn't what economists have thought and don...Why isn't what economists have thought and done in the past not included your AE inputs?Anonymousnoreply@blogger.comtag:blogger.com,1999:blog-2546602206734889307.post-55919877025008560682013-11-09T12:37:34.078+00:002013-11-09T12:37:34.078+00:00One interesting thing I would note is that MMT eco...One interesting thing I would note is that MMT economists (at least, not sure about the rest of the Post-Keynesians) do believe in expectations with regards to interest rates. They argue that expectations of the path of short rates is the main determinant of bond yields. Interestingly enough, it's often been the more pro-capitalism economists who have been worrying about how rising debt levels will raise interest rates.<br /><br />But let's return to the problem of models providing policy guidance. As an example, take a look at what happened in the U.S. pre-2008, and Canada now. The economy is unbalanced by massive construction of housing units. Growth will continue as long as an excess of units is built. When the music stops, you end up with a massive surplus of workers in construction that somehow have to find employment elsewhere.<br /><br />I believe that the final result from the mainstream approaches is to end up with a analysis like this: "if we shock input x by 1%, the impulse response of economic variable y will look like trajectory z over two years". Decisionmakers have been conditioned to expect analysis like this; it sounds very authoritative. However, it skips over the fact that we do not really have a good grasp of the trajectory the economy is going to take absent the shock. If we return to the example of the Canadian housing market, I have not seen this style of analysis offering much in the way of useful policy guidance. The advantage of a Godley-style stock-flow consistent model is that you can at least set up an ad hoc model to examine scenarios without being locked into a rigid framework that is needed to support the rationality assumption.Brian Romanchukhttps://www.blogger.com/profile/02699198289421951151noreply@blogger.comtag:blogger.com,1999:blog-2546602206734889307.post-41540086030885880072013-11-09T09:53:58.384+00:002013-11-09T09:53:58.384+00:00There are a lot of important points here so let me...There are a lot of important points here so let me respond to a few<br /><br />1) I'm sorry you do not like my use of terms like stupid or naive to describe adaptive expectations, but this is just the mirror image of terms like 'superhuman' that heterodox economists use all the time.<br /><br />2) Of course we are not limited to these two extremes, but the learning literature bridges that gap. Within that literature you can make assumptions about the availability of information or the frequency with which it is used.<br /><br />3) Yes, I do speak to non-economists! But people do not need to know about economic models in order to make rational predictions: they can read the newspapers. And here I think you fall into a trap that the heterodox rhetoric encourages. You say "but surely if people have rational expectations they don't need a forecasting industry as they already know what will happen". Of course not! The forecasting industry is how rational expectations get made.<br /><br />4) You say it "is unfair to criticise the heterodox school for lacking a literature to match that of rational expectations". I think it is very fair. Rational expectations replaced adaptive expectations 40 years ago: not because of any horrible conspiracy, but because economists saw that it made more sense. The concern within that mainstream that RE was too extreme led to the learning literature. So what heterodox economists should be doing is applying their insights and those of behavioural economics to that literature. No one is excluding them from doing that. Yet what I read from most heterodox economists is the same misguided criticisms that were directed at RE 40 years ago. <br /><br />5) If I want to find the strongest and most effective criticisms of, say, current macro policy in the EZ - and hence Ireland - I think you will find it within the mainstream, not heterodox economics. The most telling criticisms of any orthodoxy come from those inside who really understand it.Mainly Macrohttps://www.blogger.com/profile/09984575852247982901noreply@blogger.comtag:blogger.com,1999:blog-2546602206734889307.post-19794436985182460392013-11-09T07:50:26.911+00:002013-11-09T07:50:26.911+00:00I guess it comes down to this. We have had RE for ...I guess it comes down to this. We have had RE for three decades. Has this led to better policy formulation? If these models have been used and they have clearly failed (macro-policy is not clearly not successfully dealing with structural long term unemployment - and I doubt they would if you ended austerity and called for an AD expansion right now), case closed. If these models have not even been used by governments or central banks or international agencies for policy formulation because basically they are useless and they have been using things like the equally discredited ISLM model, the case against it is even stronger. How many more decades do we need?Anonymousnoreply@blogger.comtag:blogger.com,1999:blog-2546602206734889307.post-58249973531320024502013-11-09T05:33:20.211+00:002013-11-09T05:33:20.211+00:00What if economic agents form their expectations in...What if economic agents form their expectations in a random manner where some expectations are rational while others are irrational. In the light of this mixture of rational and irrational expectations, can we possibly consider expectations as a random or stochastic variable? Do random expectations have any practical usefulness?Antonionoreply@blogger.comtag:blogger.com,1999:blog-2546602206734889307.post-82151271990739970142013-11-09T00:26:40.286+00:002013-11-09T00:26:40.286+00:00The real problem is that rational expectations bec...The real problem is that rational expectations becomes "real" among the political class and they use it to assume that nothing needs to be done to adjust, from a policy standpoint. You may realize it is just the most useful assumption for modeling that we have at this time, but politicians and pundits don't. They are abusing the concept.Mary Robinsonhttps://www.blogger.com/profile/12953349287856947944noreply@blogger.comtag:blogger.com,1999:blog-2546602206734889307.post-82177375619042416062013-11-09T00:18:42.046+00:002013-11-09T00:18:42.046+00:00Its good that you are engaging in alternative view...Its good that you are engaging in alternative views but you ruin the effect somewhat with a condescending manner. If adaptive expectations is "naive" then how would you describe a theory that people can see the future before it happens?<br /><br />It is unfair to criticise the heterodox school for lacking a literature to match that of rational expectations. When you are excluded from the main academic centers and academic papers this is alternative. Also, no one will listen to an alternative before they are convinced we need one. Step one is to show why rational expectations is flawed. Step two is replacing it. You can't get to step two before step one.<br /><br />"seems to assume that agents are stupid"<br />When you come out with comments like this perhaps the mystery of why heterodox economist don't engage with you becomes a bit clearer. Are you telling me there is no middle ground? Either people can accurately predict the future or else they are "stupid"? Perhaps it is because I am one of those idealistic students who wants to change economics, that you deride but I don't think we are limited to such extremes. Maybe we are predictably irrational as Dan Ariely has written. Maybe we use heuristics, not because we are stupid or random but because there is a limit on our computing powers. After all, we are human not computers.<br /><br />"These agents ignore everything that economists and the media say about inflation: they ignore monetary policy, and whether the economy is in a boom or recession."<br /><br />When was the last time you spoke to ordinary non-economists? I don't mean that as a samrt arse comment, but a genuine point. I was talking to my friends who don't study economics the last day. They don't know any economic theories, can't name any major economists, don't read newspapers or watch the news. They find economics talk a mixture of boring, irritating and depressing (the last point is specific to Ireland and our youth unemployment). They don't even know what monetary policy is, let alone what the ECB is doing and whether it is good or bad. Let me clear that these are not ignorant backwoodsmen, they're all college students and smarter than me in their own way (at science not economics). The point is that vast majority of people don't understand economics and don't even care.<br /><br />"Now if getting expectations right did not matter too much to these agents, then maybe such naivety would be understandable. But in this case making expectations errors can mean getting real wages or profits wrong, so it matters."<br /><br />Something I found surprising was that the concept of real wages is very important in economics but is unknown to ordinary people who suffer from the money illusion. They also may not be able to do anything about their real wage without a union, but that's another issue.<br /><br />"This is an empirical claim."<br /><br />I would agree that we should look to the real world, however I think it reveals the opposite answer. I would recommend the blogger Lord Keynes who blogs on the topic a lot. For example this post has a nice example of businessmen saying how they actually set prices (short answer, fix price mark up beats marginal cost).<br />http://socialdemocracy21stcentury.blogspot.ie/2013/08/lees-post-keynesian-price-theory_17.html<br /><br />"But how else do you make sense of a whole forecasting industry,"<br /><br />Perhaps I have a different concept of the forecasting industry, but surely if people have rational expectations they don't need a forecasting industry as they already know what will happen?<br /><br />Anyway this reply is longer than I intended, hope you give it some consideration and thanks for at least engaging with heterodox economics rather than ignoring it like most.Anonymousnoreply@blogger.comtag:blogger.com,1999:blog-2546602206734889307.post-39917680428513667342013-11-08T18:51:44.350+00:002013-11-08T18:51:44.350+00:00Indeed, the technology of RE can be used to explai...Indeed, the technology of RE can be used to explain bubbles: so called rational bubbles. <br /><br />I am sure it can. I guess what may concern non-economists is whether reality is being conveniently interpreted to suit a model (or two intersecting diagonal lines or a mathematical theorem), rather than going to primary historical facts and evidence and then building up the explanation from that. Ie is the balance too much on the former rather than the latter?Anonymousnoreply@blogger.comtag:blogger.com,1999:blog-2546602206734889307.post-42611777753229432882013-11-08T18:14:37.012+00:002013-11-08T18:14:37.012+00:00I think this is a good example of confusing who is...I think this is a good example of confusing who is doing the fighting with the weapons being used. There is nothing in rational expectations that says bubbles do not exist. Indeed, the technology of RE can be used to explain bubbles: so called rational bubbles. So I suspect the arguments you are worried about are just incorrect.Mainly Macrohttps://www.blogger.com/profile/09984575852247982901noreply@blogger.com