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Sunday, February 13, 2011

The Wisdom of Muthian Crowds

Rajiv Sethi:

Belief Heterogeneity: ...The conference organizers described the rational expectations hypothesis as one "under which all agents are assumed to have common expectations, corresponding to the probabilities implied by the economist’s model." This is an accurate characterization as far as the contemporary implementation of the hypothesis is concerned, but it is important to note that this is not the hypothesis originally advanced by John Muth in his classic paper. In fact, Muth cited survey data exhibiting "considerable cross-sectional differences of opinion" and was quite explicit in stating that his hypothesis "does not assert... that predictions of entrepreneurs are perfect or that their expectations are all the same.'' In Muth's version of rational expectations, each individual holds beliefs that are model inconsistent, although the distribution of these diverse beliefs is unbiased relative to the data generated by the actions resulting from these expectations. It is a wisdom of crowds argument, rather than one based on individual rationality.

Viewed in this manner, there a sense in which the heterogeneous prior models (with diverse beliefs centered on a model consistent mean) represent both a departure from the rational expectations hypothesis as currently understood, as well as a return to the original rational expectations hypothesis as formulated by Muth. The history of economic thought is full of such rather strange twists and turns.

    Posted by on Sunday, February 13, 2011 at 12:33 AM in Economics, Macroeconomics, Methodology | Permalink  Comments (9)

          


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