Tag: economics jokes

From Keynes (1937), “The General Theory of Employment”:

We have, as a rule, only the vaguest idea of any but the most direct consequences of our acts. Sometimes we are not much concerned with their remoter consequences, even though time and chance may make much of them. But sometimes we are intensely concerned with them… The whole object of the accumulation of wealth is to produce results, or potential results, at a comparatively distant, and sometimes indefinitely distant, date. Thus the fact that our knowledge of the future is fluctuating, vague and uncertain, renders wealth a peculiarly unsuitable subject for the methods of the classical economic theory. … 

By ‘uncertain’ knowledge, let me explain, I do not mean merely to distinguish what is known for certain from what is only probable. The game of roulette is not subject, in this sense, to uncertainty… Even the weather is only moderately uncertain. The sense in which I am using the term is that in which the prospect of an European war is uncertain, or the price of copper and the rate of interest twenty years hence, or the obsolescence of a new invention, or the position of private wealth-owners in the social system in 1970. About these matters there is no scientific basis on which to form any calculable probability whatever. We simply do not know.

Better late than never, I suppose…

UPDATE: OK, ok, Sargent has written a lot about uncertainty and expectations.  Harry Konstantidis points out this 1972 article Rational Expectations and the Term Structure of Interest Rates, which is … really interesting, actually. It’s an empirical test of whether the behavior of interest rates over time is consistent with bond prices being set by a process of rational expectations. The conclusions are surprisingly negative:

The evidence summarized above implies that it is difficult to maintain both that only expectations determine the yield curve and that expectations are rational in the sense of efficiently incorporating available information. The predictions of the random walk version of the model are fairly decisively rejected by the data, particularly for forward rates with less than five years term to maturity. … 

It is clear that our conclusions apply with equal force to the diluted form of the expectations hypothesis that allows forward rates to be determined by expectations plus time-invariant liquidity premiums. … On the other hand, it would clearly be possible to determine a set of time-dependent “liquidity premiums” that could be used to adjust the forward rates so that the required sequences would display “white” spectral densities. … While this procedure has its merits in certain instances, it is essentially arbitrary, there being no adequate way to relate the “liquidity premiums” so derived to objective characteristics of markets… 

An alternative way to “save” the doctrine that expectations alone determine the yield curve in the face of empirical evidence like that presented above is to abandon the hypothesis that expectations are rational. Once that is done, the model becomes much freer, being capable of accommodating all sorts of ad hoc, plausible hypotheses about the formation of expectations. Yet salvaging the expectations theory in that way involves building a model of the term structure that … permits expectations to be formed via a process that could utilize available information more efficiently and so enhance profits. That seems … extremely odd.

In other words: Observed yields are inconsistent with a simple version of rational expectations. They could be made consistent, but only by trvializing the theory by adding ad hoc adjustments that could fit anything. We might conclude that expectations are not rational, but that’s too scary. So … who knows.

One unambiguous point, though, is that under rational expectations interest rates should follow a random walk, and your best prediction of interest rates on a given instrument at some future date should be the rate today. Just saying “I don’t now” is not consistent with rational expectations — for one thing, it gives you no basis for deciding whether a product like the one being advertised here is priced fairly. Sargent’s “No” is consistent, though, with fundamental uncertainty in the Keynes sense. In that case the decision to buy or not buy is based on nonrational behavioral rules — like, say, looking at endorsements of recognized authorities. (Keynes: “Knowing that our individual judgment is worthless, we endeavour to fall back on the judgment of the rest of the world which is perhaps better informed.”) So I stand by my one-liner.