Last week I praised the Swedish academy for turning its back on hydraulic Keynesians and awarding the 2011 Nobel Prize in Economic Science to two rational expectations scholars – Thomas Sargent and Christopher Sims. Today I devote a column to the insights of John Kay, who confirms my own view, expressed in earlier columns, that the rational expectations approach must not be pushed too far, as its practitioners are only too prone to do.
“In their world, the validity of a theory is demonstrated if, after the event, and often with torturing of the data and ad hoc adjustments that are usually called ‘imperfections’, it can be reconciled with already known facts – ‘calibrated’. Since almost everything can be ‘explained’ in this way, the theory is indeed universal; no other approach is necessary, or even admissible” John Kay, ‘The random shock that clinched a brave Nobel prize’, Financial Times, October 19, 2011R
Rational expectations scholars are far from shy in pressing the universality of their approach:
“Asked ’do you think that differences among people’s models are important aspects of macroeconomic policy debates’, Prof 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.” John Kay, ibid.
When mere academics talk this way, one knows instinctively that they have lost a lot of contact with reality. I realized that many years ago at a meeting of the American Economic Association when Robert Hall accused me of challenging ‘the revealed truth of the profession’ because I had the nerve to mention the Austrian economics critique of the rational expectations approach.
Now John Kay makes exactly the same point about Thomas Sargent:
“Rational expectations consequently fail for the same reason communism failed – the arrogance and ignorance of the monopolist. In their critique of rational expectations, Roman Frydman and Michael Goldberg employ Hayek’s critique of planning; the market economy, unlike communism, can mediate different perceptions of the world, bringing together knowledge whose totality is not held by anyone. God did not vouchsafe his model to us, mortals see the present imperfectly and the future dimly, and use many different models.” John Kay, ibid.
Perhaps the only characteristic that hydraulic Keynesians and the rational expectations economists share in common is a belief in the communism of belief in their respective models. In both instances, that is why they should be treated with extreme caution by doubters whose intelligence and insight they are so wont to despise and summarily to reject.
Models that purport to explain everything, but that fail to predict anything correctly, are not exactly the Gold Standard for an economics profession that does not fare well in predicting the future of the macroeconomy. In truth, such modelers have helped enormously to put the ‘con’ into economics.