OPEN SYSTEM ECONOMICS VS CLOSED MATH CONSTRUCT ECONOMICS

Or, adaptive Hayekian judgment vs rational expectations — Axel Leijonhufvud knocks macroeconomic heads with some obvious facts about the difference between the real world and the math constructs fashionable among the professorial elite — under the (false?) assumption that macroeconomists can be reached using such primitive tools as reasoned argument and empirical evidence. Quotable:

“The impetus to “closure” in modern macroeconomics stems from the commitment to optimising behaviour as the “microfoundations” of the enterprise. Models of “optimal choice” render agents as automatons lacking “free will” and thus deprived of choice in any genuine sense.6 Macrosystems composed of such automatons exclude the possibility of solutions that could be “disequilibria” in any meaningful sense. Whatever happens, they are always in equilibrium. The extension of this formal program to “in time” behaviour required assuming that economic agents possessed the knowledge of the future required for the calculation of intertemporal optima. Previous generations of economists had shied away from assuming perfect foresight (Hicks 1938 and 1985). In the 1930s, theorists like Hayek, Lindahl and Hicks began dealing systematically with the role of expectations in the business cycle. To them, expectations about the future induce actions in the present that create the future – but the future realised seldom corresponds to what was generally anticipated. The economy is an open system in Lawson’s sense. The multiplier-accelerator models that were developed a decade or so later embodied this same perspective. It is a practical matter. George Soros’ analysis of financial markets starts from the realisation that present beliefs about the future induce actions that create the future. He calls this conception “reflexivity” (Soros 2008). The investor who can assess current market sentiment and infer how it will produce a future different from what is generally expected can make a profit. If he reads the market incorrectly or makes the wrong inference, he will suffer a loss. Rational expectations is the special, degenerate case of reflexivity where the future actually realised is always a random draw from the universally believed and true Gaussian distribution of possible futures. This assumption makes the economy a closed system.7 Agents are supposed to possess (probabilistic) knowledge of an objective reality – a reality that they have been able to learn. The Gaussian lottery might produce a gain or a loss. But the quality of the individual investor’s information about the state of the market and his ability to draw the proper inferences from it have no bearing on the outcome of the lottery.”

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