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Rational Econometric Man
Rational Econometric
Man
Transforming Structural Econometrics
Edward J. Nell
Malcolm B. Smith Professor of Economics, The New School
for Social Research, USA
Karim Errouaki
Special Advisor, The Foundation for the Culture of Peace,
Spain
With a Foreword by Lawrence R. Klein, Nobel Laureate in Economics
Edward Elgar
Cheltenham, UK • Northampton, MA, USA
© Edward J. Nell and Karim Errouaki 2013
All rights reserved. No part of this publication may be reproduced, stored in a
retrieval system or transmitted in any form or by any means, electronic,
mechanical or photocopying, recording, or otherwise without the prior
permission of the publisher.
Published by
Edward Elgar Publishing Limited
The Lypiatts
15 Lansdown Road
Cheltenham
Glos GL50 2JA
UK
Edward Elgar Publishing, Inc.
William Pratt House
9 Dewey Court
Northampton
Massachusetts 01060
USA
A catalogue record for this book
is available from the British Library
Library of Congress Control Number: 2010930124
This book is available electronically in the ElgarOnline.com Economics Subject
Collection, E-ISBN 978 1 84980 962 7
ISBN 978 1 84980 154 6 (cased)
Typeset by Servis Filmsetting Ltd, Stockport, Cheshire
Printed and bound in Great Britain by T.J. International Ltd, Padstow
Contents
Foreword by Lawrence R. Klein vi
Acknowledgments viii
Introduction xvii
PART I FROM RATIONAL ECONOMIC MAN TO
RATIONAL ECONOMETRIC MAN
1 Re- reading Hollis and Nell 3
2 Haavelmo reconsidered as rational econometric man 35
3 Induction and the empiricist account of general laws 61
4 Variables, laws and induction I: are there laws of nature? 79
5 Variables, laws and induction II: scientific variables and
scientific laws in economics 111
6 The concept of the ‘model’ and the methodology of model
building 151
PART II THE CRITIQUES AND THE FOUNDATIONS
7 Debating the foundations: a new perspective? 189
8 Scientific issues in structural econometrics 251
9 Haavelmo and beyond: probability, uncertainty,
specification and stochasticism 291
PART III STRUCTURAL ECONOMETRICS IN ITS PLACE:
MAPPING NEW DIRECTIONS
10 Conceptual analysis, fieldwork and the methodology of
model building 353
11 Working with open models: lawlike relations and an
uncertain future 401
Conclusion 484
References 489
Index 523
v
Foreword
The New School For Social Research has played an important role,
contributing to many fields of advanced study in the United States – for
example, a recent conference on the work of Franco Modigliani in rela-
tion to the prevailing economic situation. This book starts from much
earlier work at the New School, the early 1940s Seminar of Marschak and
Haavelmo on econometrics, which laid the foundations for the work at
Cowles.
Nell and Errouaki have written a very welcome book, coming at a good
time. Its message is one of support for the original Cowles approach,
agreeing that our work then was on the right track. They correctly under-
stand the intention of the founders, which was to bring mathematics
together with economic theory, so as to develop precise hypotheses that
could be confronted with data, using methods of statistical inference. The
idea was to expand and develop economic theory, making it more realistic,
so that it could be put to use to solve some of the world’s problems. We felt
we had all the answers from a statistical point of view and from the point
of view of econometric methodology and economic content; we could
make it easy to have a well- organized, well- run economy after the war. It
was generally expected that econometric investigations would build up a
large body of agreed- upon findings, and that different investigators would
normally replicate – or improve on – each other’s results.
In fact agreement has been hard to come by; what Jacob Marschak
very early on called the ‘model selection’ problem has stood in the way.
Statistical inference alone will not do the job; but it is not necessarily a
step forward to try to solve the difficulties by introducing hard-t o- justify
assumptions – normality in probability distributions, ergodicity in time
series. What is needed is greater realism, closer and more systematic atten-
tion to what economic agents are actually thinking, planning and doing. I
have advocated the use of survey data; the authors here call for fieldwork
and drawing on vernacular knowledge.
When the big models, along with every other form of economic inves-
tigation, ran into trouble in the 1970s, many investigators turned against
the approach. Nell and Errouaki rightly deplore this; structural econo-
metrics got a lot of things right, and presented a reasonable picture of
vi
Foreword vii
the macroeconomy. People have said that the models failed to predict the
effects of supply shocks on the inflation of the 1970s, and that they didn’t
predict the changes in structure. I believe the economy didn’t change in
structure; instead exogenous inputs changed a great deal within a largely
unchanged structure. And the large- scale models did a good job of predict-
ing recession and inflation.
This book is massive; it covers a great deal of ground, starting from phi-
losophy of science, extending to methodology, and foundations of prob-
ability and statistical inference. It then goes on to the basics of structural
econometrics and the Cowles approach, especially Keynesian econometric
models, and finally covering the critiques of the Cowles approach and
Keynesian econometrics, including the critiques of those critiques. The
book also presents a number of the authors’ own contributions. These
include their proposal to overcome the problem of induction and establish
the existence of lawlike regularities in economics, justifying the assumption
of a ‘data generating mechanism’; this leads them to their methodological
triangle- circle (MTC) diagram, which summarizes their methodology.
In addition to methodology they propose some specific modelling – for
example, in regard to wage-p rice spirals, the analysis of money supply
and demand, Keynesian uncertainty, and Minskyian financial instabil-
ity. These ideas may seem unorthodox in today’s context; but they would
not have seemed out of place to many of the early econometricians, for
example at the Oxford Institute of Statistics. In developing econometric
models some people became slaves of the neo-C lassical behavioural for-
mulations; in their fear of being ‘ad hoc’ they chose theoretical lines which
were not always well conceived. Many have forgotten, if they ever knew,
the lessons of Keynes. Our authors propose to correct this, drawing on
their program of fieldwork and conceptual analysis, and suggest some
concrete steps along the path to reconceptualizing difficult and controver-
sial areas of macro theory. The authors have succeeded in orchestrating
a lively debate over the scientific foundations of structural econometrics.
Their book deserves a broad readership.
Lawrence R. Klein
Gladwgne, PA, USA
Acknowledgments
HOW IT ALL BEGAN IN NELL’S OFFICE AT THE
NEW SCHOOL
A little over 25 years ago a graduate student, who had previously studied
mathematics, econometrics and philosophy of science in Paris and had
worked at INSEE, turned up in my office. He had just finished his studies
with us, with perfect grades, and he wanted to work on a doctoral thesis.
He had a straightforward project in mind: to rewrite Hollis and Nell’s
Rational Economic Man (1975). It was a great book, he said, but focused
on the wrong target. It was not so much economic theory that was distorted
and undermined by the assumption of rational economic agents as it was
econometrics. That was where the real problem lay. The arguments should
be adapted and redirected before econometrics got lost any further in a
morass of misspecifications and unrealistic assumptions. Quite a project!
But Karim was persistent and I decided he was right. So we began work,
and now Rational Economic Man (it was always ‘man’; feminist economics
has generally been free of ‘rational’ fundamentalism) has become Rational
Econometric Man. It took a long time, but we hope it’s worth it!
INFLUENCES AND PATHS THAT LED TO THIS
BOOK
Professor Edward Nell was the principal PhD thesis advisor and long-
standing mentor of Karim Errouaki, along with his two supervisors and
mentors, the late Nobel Laureate Wassily Leontief and the late Professor
Camilo Dagum at the New School (NY) in the late 1980s. Errouaki owes
a great debt to his learned professor and humane friend Professor Nell
for his constant help, critical guidance and generous encouragement;
and is greatly indebted to all his mentors during the writing of his doc-
toral thesis and he thanks them for sharing some of their reflections on
the scientific standing of econometrics. They were always open to his
questions and ideas about econometric methodology, were a constant
stimulus for his own thinking in economics, and gave him confidence that
viii
