Uncertainty and Economics: A Paradigmatic Perspective

135 Pages·2019·26.485 MB·English

by  Christian Müller-Kademann

Uncertainty and Economics
“Essentialreadingforeveryonewhoiswillingtotake‘uncertainty’ineconomics
seriously!”
Prof.Dr.JoachimGüntzel,Baden-WürttembergCooperativeStateUniversity,
Ravensburg,Germany
This book is set against the assumption that humans’ unique feature is their
infinitecreativity,theirabilitytoreflectontheirdeedsandtocontroltheiractions.
Theseskillsgiverisetogenuineuncertaintyinsocietyandhenceintheeconomy.
Here,theauthorsetsoutthatuncertaintymusttakecentrestageinallanalysesof
humandecisionmakingandthereforeineconomics.
Uncertainty and Economics carefully defines a taxonomy of uncertainty and
argues that it is only uncertainty in its most radical form which matters to
economics. It shows that uncertainty is a powerful concept that not only helps
toresolvelong-standingeconomicpuzzlesbutalsounveilsseriouscontradictions
within current, popular economic approaches. It argues that neoclassical, real
businesscycle,ornew-Keynesianeconomicsmustbeunderstoodasonlyoneway
tocircumventtheanalyticalchallengesposedbyuncertainty.Instead,embracing
uncertainty offers a new analytical paradigm which, in this book, is applied to
standard economic topics such as institutions, money, the Lucas critique, fiscal
policyandassetpricing.
Through applying a concise uncertainty paradigm, the book sheds new
light on human decision making at large. Offering policy conclusions and
recommendations forfurther theoreticaland applied research, itwillbeofgreat
interesttopostgraduatestudents,academicsandpolicymakers.
ChristianMüller-KademannisPrivatdozentofEconomicsatJacobsUniversity
in Bremen, Germany. He received his first degree from Hull University,
UK before graduating from Humboldt University, Berlin with a diploma in
economics,afterwhichhebeganhisPhDineconomicsandeconometrics.
RoutledgeFrontiersofPoliticalEconomy
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AParadigmaticPerspective
ChristianMüller-Kademann
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Uncertainty and Economics
A Paradigmatic Perspective
Christian Müller-Kademann
Firstpublished2019
byRoutledge
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Contents
Preface ix
Acknowledgements xi
Introduction 1
1 What’suncertainty,afterall? 3
1.1 Institutions,eventsandactions 3
1.2 Determinism,risk,ambiguityanduncertainty 5
1.2.1 Determinism 5
1.2.2 Chance,riskandambiguity 6
1.2.3 Uncertainty 9
2 Uncertaintyineconomics 15
2.1 Theoriginsofuncertainty 15
2.1.1 Themainassumption 15
2.1.2 Uncertainty:ahumantrait 16
2.2 Rationality,uncertaintyanddecisionmaking 19
2.2.1 Subjectivity,objectivityandrationality 19
2.2.2 Decisionmakingunderuncertainty 23
2.3 Theepistemologyofeconomics 29
2.3.1 Abrieflookintherearmirror 29
2.3.2 Positivist-falsificationistepistemology 32
2.4 Paradigmaticuncertainty 42
2.4.1 Puzzles 43
2.4.2 Rationalexpectationsanduncertainty 46
2.4.3 Rationalityanduncertainty“measurement” 50
2.4.4 Elementsofanuncertaintyparadigm 53
2.5 Economicepistemologyanduncertainty:anapplicationto
theLucascritique 56
viii Contents
3 Uncertaintyintheeconomy 63
3.1 Uncertaintyandinstitutions 63
3.2 Money 66
3.3 FiscalpolicyandKeynes’sbattles:lostandwon 75
4 Theempiricsofuncertainty 80
4.1 Amodelforassetpricingunderuncertainty 81
4.1.1 Theinvestor’sobjectivefunction 81
4.1.2 Theinvestmentrule 82
4.1.3 Themedianinvestor 82
4.1.4 Propertiesofthesubjectivemedianmodel 84
4.2 Testingforuncertainty 85
4.2.1 Conventionalassetpricingmodelanduncertainty 85
4.2.2 Theempiricalapproach 86
4.2.3 Theempiricalevidence 90
5 Conclusion 106
Bibliography 111
Index 119
Preface
Asanundergraduatestudentinthe1990sIattendedacourseinmacroeconomics
that offered the exciting prospect of teaching the determination of foreign
exchangerates.Foreignexchangerates,Iknew,werepinneddownbyacobweb
of myriads of trades and traders spanning the whole world, 24/7. Extracting the
lawsaccordingtowhichthesehundreds,maybethousands,ofpeoplesetforeign
exchangepricesseemedtobebeyondhumancomprehension,Ithought.Andyet,
economicshadananswerthemacroeconomicsyllabuspromised.
When the magic lecture finally commenced, the professor – after some
elaborationoninternationalbondarbitrage–cameupwithanequationlikethis:
(cid:3)st+1=it−it∗.
There is very little that could describe the scale of my surprise, if not outright
disappointment. Should it be possible to squeeze all those individuals into
one, simple function like that? No, it was not, we were comforted, since a
no-less-magical(cid:2) wouldtakecareofall“random”individualmishapsbysimply
t
addingittotheotherwiseperfectanswer:
(cid:3)st+1=it−it∗+(cid:2)t.
Still gasping for air, the lecture proceeded too fast and too authoritarian for
any critical reflection to take root. After all, scribbling down high-speed and
swallowing what was served proved to be the most efficient way of preparing
forthefast-approachingexams.
Nevertheless, theinitialshockneverfullywaned. So, fifteenortwentyyears
later, alongnightcamewhenIwrotedowntheequationonceagainandstarted
to think about (cid:2). What if we do not squeeze all the traders into it, but free the
t
tradersfromtheirdistributionalchains? Theanswerwasbotharevelationanda
curse.
In fact, never had I come closer to the feeling of having to choose between
Morpheus’redpillsandbluepills.Theshiningblue(cid:2) withallitsperfectlyshaped
t
probability distribution functions had all the advantages of a reputable, admired
default choice. Conferences are organised in its honour and prestigious keynote
lectures by the industry’s most renowned scholars address its beauty. And yet,