Saturday, 15 August 2009

More on the efficient markets hypothesis and modern macroeconomics

An interesting point by Krugman here (and here) about a comment made by Emanuel Derman:
But the EMH, if you don’t take it too literally and get carried away about axiomatically defining strong, weak and other kinds of efficiency as though you were dealing with axiomatic quantum field theory, does recognize one true thing: that it’s #$&^ing difficult or well-nigh impossible to systematically predict what’s going to happen. You may think you know you’re in a bubble, but you still can’t tell whether things are going up or down the next day. The EMH was a kind of jiu-jitsu response on the part of economists to turn weakness into strength. “I can’t figure out how things work, so I’ll make that a principle.”

(This relates to my previous blog on what Lucas said.) Krugman agrees that the idea you can't predict the future is a rather weak scientific idea to turn into a principle. In fact he quotes an old piece by Jeff Frankel:
It used to be that the goal in econometric work was to get results that were statistically significant, to reject the null hypothesis. In order for an author to stand up in front of a conference proudly, or to expect to publish his paper in a journal, he or she sought to get significant results. This is difficult to do in macroeconomics. The world is a complicated place; it is unlikely that the few key variables that emerge from the particular theory that one has developed will actually go far toward explaining a real-world time series. So what we have done — quite cleverly — is to redefine the rules. Now the goal is to fail to reject the null hypothesis, to get results that are statistically insignificant — in essence, to find nothing. It is far easier to find nothing than to find something. Typically one fails to reject many hypotheses every day, even in the shower or on the way to work.

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