Tag Archives: Phelps

A Final Word on Uncertainty

Gabriel responds in the comments to the previous post (my thoughts are in bold):

So, what are you _practically_ going to do about it? A stylized model that you might think is literally wrong is better than no model at all.

I staunchly disagree with this assertion.  To paraphrase Keynes, “I’d rather be somewhat correct than completely wrong.”  That point, however, is not as important as your first question.  Practically, there are many things that we can do about it.  The work of Roman Frydman and Michael Goldberg in Imperfect Knowledge Economics represents a step in the right direction as does the work of the complexity theorists who are devising models with realistic expectations.

The world might be non-ergodic (I happen to think that it’s not, properly conceived, but whatever) but even if it isn’t, it might still make sense to model it as if it were.

I disagree here as well.  To quote Frydman and Goldberg (ibid, 4):

“To construct such models, which we refer to as fully predetermined,  contemporary economists mus fully prespecify how market participants alter their decisions and how resulting aggregate outcomes unfold over time.  By design, contemporary models rule out the importance of individual creativity in coping with inherently imperfect knowlege and unforeseen changes in the social context.”

Even if the world is ergodic, individuals do not possess the perfect knowledge assumed by rational expectations (a non-ergodic world would undoubtedly imply imperfect knowledge).  The a priori assumptions that we use in the current choice-theoretic framework are flawed.  This need not suggest that we abandon such modeling, but rather modify it to be more in touch with reality.

There are many economists who are trying to give meaning to uncertainty and imperfect knowledge in contemporary theory.  The work of Ned Phelps, Axel Leijonhufvud, Robert Clower, Arthur Okun, Armen Alchian and others were the first wave of such theorists and it has since spread to Roman Frydman, Michael Goldberg, Brian Arthur, Barkley Rosser, and countless others.  I would recommend reading Ned Phelps’s Nobel Prize lecture, specifically the sections on knowledge and uncertainty.