by From Lars Syll If I ask myself what I could legitimately assume a person to have rational expectations about, the technical answer would be, I think, about the realization of a stationary stochastic process, such as the outcome of the toss of a coin or anything that can be modeled as the outcome of a random process that is stationary. I don’t think that the economic implications of the outbreak of World war II were regarded by most people as the realization of a stationary stochastic process. In that case, the concept of rational expectations does not make any sense. Similarly, the major innovations cannot be thought of as the outcome of a random process. In that case the probability calculus does not apply. Robert Solow ‘Modern’ macroeconomic theories are as a rule founded on the
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from Lars Syll
If I ask myself what I could legitimately assume a person to have rational expectations about, the technical answer would be, I think, about the realization of a stationary stochastic process, such as the outcome of the toss of a coin or anything that can be modeled as the outcome of a random process that is stationary. I don’t think that the economic implications of the outbreak of World war II were regarded by most people as the realization of a stationary stochastic process. In that case, the concept of rational expectations does not make any sense. Similarly, the major innovations cannot be thought of as the outcome of a random process. In that case the probability calculus does not apply.
‘Modern’ macroeconomic theories are as a rule founded on the assumption of rational expectations — where the world evolves in accordance with fully predetermined models where uncertainty has been reduced to stochastic risk describable by some probabilistic distribution.
The tiny little problem that there is no hard empirical evidence that verifies these models — cf. Michael Lovell (1986) and Nikolay Gertchev (2007) — usually doesn’t bother its protagonists too much. Rational expectations überpriest Thomas Sargent has the following to say on the epistemological status of the rational expectations hypothesis:
Partly because it focuses on outcomes and does not pretend to have behavioral content, the hypothesis of rational epectations has proved to be a powerful tool for making precise statements about complicated dynamic economic systems.
Precise, yes, in the celestial world of models. But relevant and realistic? I’ll be dipped!
And a few years later, when asked if he thought “that differences among people’s models are important aspects of macroeconomic policy debates”, Sargent replied:
The fact is you simply cannot talk about their differences within the typical rational expectations model. There is a communism of models. All agents within the model, the econometricians, and God share the same model.
Building models on rational expectations either means we are Gods or Idiots. Most of us know we are neither. So, Gods and Idiots may share Sargent’s and Lucas’s models, but they certainly aren’t my models.