The great un-revolution

As much as I hate link farmers, I can’t help reposting this great paragraph from the Positive Economist. It just ties in so well to the recent discussion on this blog about rationality and behavioural economics!

Behavioral economics is possibly the least revolutionary revolution ever to hit an academic discipline, because, as Scheiber is alluding to, the behavioral school is absolutely not changing or abandoning the methodology of economics. As I’ve noted before, the “perfectly rational” economic man can happily do whatever the behavioralists want him to do to be more “realistic”; it’s therefore not necessary to come up with a whole new way of modeling people.

Instead the behavioral school is writing down models of “perfectly rational, utterly self interested maximizers” who act in accordance with the behavioral evidence. That is, writing rationalization of the “irrationality” we observe. Contrast this with the traditional criticism of economic man, which is to throw up ones hands and loudly reject the whole idea of trying to predict what people will do. I prefer the behavioral way.

Yeah, what he said 🙂

  • CPW

    Maybe this a more relevant comment for your previous post, but the rationality assumption might seem less weird to people if they realized that prior to that the assumption was that people could be systematically fooled over and over again. I think that a lot of macro models still assume that at least some people do act this way.

    And any model that doesn’t assume rational expectations, even if empirically valid now, is vulnerable to the criticism that eventually people will wise up and the model will stop working. While I like behavioural economics, I wonder sometimes whether the results are always applicable to real-world situations where rewards are substantially higher and “games” are played over and over again.

    (I’m know I’m glossing over the distinction between rational expectations and rational behaviour).

  • I think the distinction between rationality and rational expectations is quite important here. Rational expectations are the kind of thing I’d associate with the common notion of ‘hyper-rationality’. Matt knows this stuff far better than I do, but I believe that rational expectations models have been empirically falsified in numerous cases. Behavioural results’ applicability are often questioned; however, given a choice between a theory supported by lab results and a theory whose attractiveness rests almost entirely on its mathematical attractiveness and convenience, I don’t have trouble choosing which I prefer.

    You can criticise models which solely use adaptive expectations as unrealistic, but I don’t think rational expectations are much of an improvement as far as increasing the explanatory power of the models goes.

  • CPW

    Assuming that at least some agents have rational expectations certainly seems to improved explanatory power in macro models. I wouldn’t describe rational expectations as a convenient assumption, and I would say that the attractiveness is that, whether it improves explanatory power in sample or not, it remains an excellent robustness check on how useful a model will be out of sample. I may be biased by all the financial studies of anomalies that have vanished as soon as they were discovered. I could be equally glib about lab results and say they prove that people make bad forecasts when there are really weak incentives to make good forecasts.

  • snufsmumiken

    Okay TR, I’m really not getting the point here. First, you made the persuasive case that it is a semantic issue whether behaviouralists are dealing with irrationality or just a more realistic vision of rationality. But now you are giving approval to a (presumably substantive rather than semantic) claim; that the invasion of the behaviouralists doesn’t constitute a major change because – wait for it – it doesn’t violate the rationality assumption. Mate, it looks like you want to have your cake and eat it too.

    I am picking that the change is immense. But I’ll leave my reasons for later.

  • “that the invasion of the behaviouralists doesn’t constitute a major change because – wait for it – it doesn’t violate the rationality assumption”

    I think he means (correct me if I’m wrong though) that it doesn’t constitute a major ontological change, insofar as in either case economics is dealing with ‘rational agents’ who are ‘maximising utility’ (rule following can still be placed in a utilitarian framework).

    Furthermore, in terms of methodology will behavioural methods replace or add to current microeconomic analysis? I believe that it will add to the analysis – it will be more akin to the evolution of economic analysis rather than a revolution.

    Why you might ask? Well current economic models are built on the supposition that may of the assumptions are simplifying assumptions, ergo the changing of these assumptions was already part of the overall scope for the development of economic thought in the first place.

    If rauparaha sees it the same way I do, then we are not saying it won’t be an important change – but it just won’t be a ‘revolution’ in economic thought. If anything it illustrates that economic thought it developing.

  • snufsmumiken

    BTW Tim Harford is talking in Wellington today – presumably covering this topic. But as the rabble is kept out by the $90 charge, he will avoid any skeptical questions from me.

  • “But as the rabble is kept out by the $90 charge, he will avoid any skeptical questions from me”

    It is damn expensive isn’t it :P. I guess he has to pay for his airfare somehow 😉

  • snufsmumiken

    I am sure I will regret ever getting into this.

    Different assumptions play different roles in econ theory. Even to say they simplify is to cover a lot of diversity. For example, some simplifying assumptions are “negligibility assumptions” and some are “domain restrictions” in the language of Musgrave. These kind of assumptions are unlikely to insisted on as a matter of “rigour”. That is, you might be criticised for unnecessary complication, but that would usually only be a peccadillo. Then there are assumptions that embody the perceived core of the theoretical programme. Of course people will differ about what they think is in the core, just as we differ about what we think is socially acceptable in the real world. But it is my impression that a narrow conception of rationality was treated as part of the core by a majority of econ theorists.

    So is it a revolution when the core gets revised? Are we going to come up against a definitional dispute about “revolution” as well as about “rationality”?

    Any thoughts on whether the counterpart for the psychologists – the cognitive revolution – was misnamed?

  • “I am sure I will regret ever getting into this.”

    You shouldn’t, your comment are greatly appreciated.

    “But it is my impression that a narrow conception of rationality was treated as part of the core by a majority of econ theorists”

    I completely agree with your description of core and simplifying assumptions, and that it is changes in core assumptions that truly change the discipline.

    Here is where our view diverge though. Having been raised as a micro-economist I’ve always felt that the fundamental assumptions of the economic method were very weak – we merely added more restrictive assumptions in order to get results. The introduction of behavioural economics will simply give microeconomists more types of models to play with, rather than change they way they perform economics I believe.

    Macro-economics is a different story – again in this case I don’t believe that the introduction of behavioural economics will be as revolutionary as say the Lucas critique, however I do believe that models involving bounded rationality will help to continue the evolution of new classical models. Macro-economics is currently in flux – I think that the new classical methodology will remain and be built upon with increasingly realistic assumptions (that is what New Keynesian economics does).

    Fundamentally, I just see economics as a term for framing issues through the lens of methodological individualism. The introduction of behavioural economics will not change this, however it will definitely change many of the normative assumptions made using economic models – something that is outside of ‘the core’.