Frydman & Goldberg on Hayek & Rational Expectations

Two more economists weigh in on the “what is wrong with macroeconomics” question:

The economics literature is full of different models, each one assuming that it adequately captures how all rational market participants make decisions. Although the free-market Chicago school, neo-Keynesianism, and behavioural finance are quite different in other respects, each assumes the same REH-based standard of rationality.

In other words, REH-based models ignore markets’ very raison d’etre: no one, as Friedrich Hayek pointed out, can have access to the “totality” of knowledge and information dispersed throughout the economy. Similarly, as John Maynard Keynes and Karl Popper showed, we cannot rationally predict the future course of our knowledge. Today’s models of rational decision-making ignore these well-known arguments.

The unreasonableness of this standard of rationality helps to explain why macroeconomists of all camps and finance theorists find it hard to account for swings in market outcomes. Even more pernicious, despite these difficulties, their models supposedly provide a “scientific” basis for judging the proper roles of the market and the state in a modern economy.

But incoherent premises lead to absurd conclusions …

Note well that Hayek also showed that we cannot predict the future course of our knowledge, quite independently of Keynes and Popper.

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I am afraid I have become more and more skeptical of the instructive value of the constructions [of mathematical economics] by which at one time I was greatly fascinated. — F. A. Hayek

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