Sunday, October 16, 2011

Noah Smith disses REH


1. Unlike heliocentrism, we don't know yet that Rational Expectations is right. It is certainly not the case that Rational Expectations is the only "easily modeled system grounded in compelling theoretical considerations." There are plenty of alternatives!

[...]

2. The Rational Expectations people didn't just insist that macroeconomists use self-consistent, perfectly microfounded Theories of Everything. In fact, they didn't stop at insisting that people use Rational Expectations! They went so far as to insist that theories of business cycles should be driven by so-called "real shocks" - changes in technology, changes in government policy, or changes in people's willingness to work.

[...]

...the revolution has not yet led to a theory of business cycles that fits the data well. And it very well may never do so - especially, I predict, if its adherents keep insisting on including only "real shocks" in their models. Until RE gives us something constructive, I think that comparisons with Copernicus are premature.
Read the full post at Noahpinion, Rational Expectations vs. Heliocentrism by Noah Smith

For alternatives, economist should be looking at research in the life and social sciences. Rational expectations is contradicted by not so recent discoveries in cognitive science, for example. That is just not the way the brain functions, as Antonio Demasio and others have found.

1 comment:

Dan Kervick said...

People can also look at chaos theory and non-linear dynamics for insight, along with the thinking of Hyman Minsky. Minsky understood perfectly well that financial instability and fragility were inherent in the functioning of a capitalist system, and thus that a variety of regulatory measures must be taken to stabilize these systems.

RET seems to be another in a long line of approaches that treat stability and equilibrium as the norm, and thus look to shocks, black swans and extraordinary events to explain how things go wrong.