Rational expectations – the triumph of ideology over science – Editor

Lars Syll has reproduced in a recent blog [1] the following quote from Prof Joseph Stiglitz: Research shows not only that individuals sometimes act differently than standard economic theories predict, but that they do so regularly, systematically, and in ways that can be understood and interpreted through alternative hypotheses, competing with those utilised by orthodox economists.

To most market participants — and, indeed, ordinary observers — this does not seem like big news … In fact, this irrationality is no news to the economics profession either. Long ago, John Maynard Keynes described the stock market as based not on rational individuals struggling to uncover the market fundamentals, but as a beauty contest in which the winner is the one who guesses best what the judges will say ..

Adam Smith’s invisible hand — the idea that free markets lead to efficiency as if guided by unseen forces — is invisible, at least in part, because it is not there …

For more than 20 years, economists were enthralled by so-called “rational expectations” models which assumed that all participants have the same (if not perfect) information and act perfect- ly rationally, that markets are perfectly efficient, that unemployment never exists (except when caused by greedy unions or government minimum wages) and where there is never any credit rationing.

That such models prevailed, especially in America’s graduate schools, despite evidence to the contrary, bears testimony to a triumph of ideology over science. Unfortunately, students of these graduate programmes now act as policymakers in many countries, and are trying to implement programmes based on the ideas that have come to be called market fundamentalism … Good science recognises its limitations, but the prophets of rational expectations have usually shown no such modesty. ”

1. https://rwer.wordpress.com/2017/10/05/rational-expectations-the-triumph-of-ideology-over-science/

Prof Joseph Stiglitz