If we want to have anything of interest to say on real economies, financial crisis and the decisions and choices real people make [in a non-ergodic world not amenable to stochastic modeling], it is high time to replace the rational expectations hypothesis with more relevant and realistic assumptions concerning economic agents and their expectations.The post shows why.
Simon Nixon: "the most important contribution to the debate is an essay by Claudio Borio, deputy head of the monetary and economics department at the Bank for International Settlements, published last moth and titled: “The Financial Cycle and Macroeconomics: What have we learned?”Lars P. Syll's Blog
"In Mr. Borio’s view, the 'New Keynesian Dynamic Stochastic General Equilibrium' model used by most mainstream forecasters is flawed because it assumes the financial system is frictionless: Its role is simply to allocate resources and therefore can be ignored. Although many economists now accept these assumptions are wrong, efforts to modify their models amount to little more than tinkering. What is needed is a return to out-of-fashion insights influential before World War II and kept alive since by maverick economists such as Hyman Minsky and Charles Kindleberger that recognized the central importance of the financial cycle."
