Imperfect Knowledge Economics Research Articles

The Phillips curve and the role of monetary policy in Chile

ABSTRACTIn this paper, the empirical analysis finds that the dynamics of inflation and unemployment can be described by a Phillips curve when allowing for a positive co-movement between trend-adjusted productivity and unemployment. This suggests that improvements in productivity have been achieved by laying off the least productive part of the labor force. Furthermore, the natural rate of unemployment is a function of the long-term interest rate, indicating that monetary policy is not completely neutral in the long run. This result rejects the natural rate hypothesis and, at the same time, provides empirical support for the structural slump theory in a world of imperfect knowledge. The recent theory of imperfect knowledge economics (IKE) seems to address the problem that many economic models lack: persistence in the observed data. By combining IKE and the structural slumps theory it is possible to obtain predictions that are theoretically and empirically consistent.

Modeling Real Exchange Rate Persistence in Chile

The long and persistent swings in the real exchange rate have for a long time puzzled economists. Recent models built on imperfect knowledge economics seem to provide a theoretical explanation for this persistence. Empirical results, based on a cointegrated vector autoregressive (CVAR) model, provide evidence of error-increasing behavior in prices and interest rates, which is consistent with the persistence observed in the data. The movements in the real exchange rate are compensated by movements in the interest rate spread, which restores the equilibrium in the product market when the real exchange rate moves away from its long-run benchmark value. Fluctuations in the copper price also explain the deviations of the real exchange rate from its long-run equilibrium value.

Evaluating Exchange Rate Models Based on Rational Expectations versus Imperfect Knowledge Economics

Understanding the factors that explain the causes of exchange rate swings has been one of the major concerns in the international finance field. Conventional models, which utilize Rational Expectation Hypothesis (REH), are frequently tested and employed in the international finance literature to explain the exchange rate fluctuations. On the other hand, Imperfect Knowledge Economics (IKE) has recently been developed as an alternative approach to understand the same concerns on the exchange rate swings. This paper, for the first time, employs the Lakatosian framework of Scientific Research Programs (SRPs) to evaluate the main theoretical contributions of these models on the exchange rate fluctuations. First, the study evaluates the novel facts that are associated with each of the Lakatosian protective belts for both of these SRPs. In addition, the study evaluates the empirical evidence of each SRP related to these novel facts, and argues whether or not these are theoretically and empirically progressive in the Lakatosian framework.

A Kuhnian perspective on asset pricing theory

This article argues that the field of asset pricing theory is undergoing a scientific revolution in Kuhnian terms. The orthodox view is one of determinate change in causal processes and inherent stability whereby financial markets, left unfettered, allocate nearly perfectly society's scare capital. However, decades of mounting anomalous evidence against the implications of stable causal processes perpetuated by conventional models based on efficient markets and the rational expectations hypothesis have paved the way for alternative avenues of research. Although various approaches are being developed, the imperfect knowledge economics (IKE) class of models has emerged as a potential new paradigm in the field of macro-finance. By stopping short of fixing in advance the specification of individual forecasting behavior and the causal process, the IKE class of models has been able to reconcile many of the puzzles found within the literature on asset price behavior and risk.

Can structural change explain the Meese-Rogoff puzzle?

This paper provides empirical evidence suggesting that fundamentals matter for stock price fluctuations once temporal instability underpinning stock price-relations is accounted for. Specifically, this study extends the out-of sample forecasting methodology of Meese and Rogoff (J Int Econ 14:3–24 (1983)) to the stock market after explicitly testing for parameter nonconstancy using recursive techniques. The predictive ability of a present value model based on Imperfect Knowledge Economics (IKE) is found to match that of the pure random walk benchmark at short forecasting horizons and to perform significantly better at medium to longer-run horizons based on conventional measures of predictability and direction of change statistics. In addition, the presence of a cointegrating relation is found only within regimes of statistical parameter constancy. Augmenting the MR methodology in a piecewise linear fashion yields empirical results in favor of a fundamentals-based account of stock price behavior overturning the recent results of Flood and Rose (2010).

Irreducible complexities: from Gödel and Turing to the paradigm of Imperfect Knowledge Economics

The paper discusses synthetically an epistemological question in the field of economics: how to translate a real problem into formal terms without a substantial loss of significance for its solution in policy making. The discussion will challenge the plausibility of the basic assumption of ultra-rational subjects who act independently of each other and will propose a research programme in Imperfect Knowledge Economics (in an Appendix the latter is compared with the mainstream model founded on Rational Expectation Hypothesis). References to some results of the debate in mathematics, but also in computer science, are produced in support.

Fallibility in formal macroeconomics and finance theory

This note focuses on George Soros's challenge to macroeconomics and finance theory that any valid methodology of social science must explicitly recognize fallibility in a Knightian sense. We use a simple algebraic example to sketch how extant models formalize fallibility. We argue that contemporary theory's epistemological and empirical difficulties can be traced to assuming away fallibility in a Knightian sense. We also discuss how imperfect knowledge economics provides a way to open mathematical models to such fallibility, while preserving economics as an empirical science.

Change and expectations in macroeconomic models: recognizing the limits to knowability

This paper argues that contemporary macroeconomic and finance models suffer from insuperable epistemological flaws and that their empirical difficulties – which are particularly apparent in modeling market participants' expectations – can be traced to economists' core premise that they can adequately specify in probabilistic terms how individuals alter the way they make decisions and how the processes underpinning market outcomes unfold over time. We refer to such accounts of change as determinate. The first part examines how this core premise has derailed the development of macroeconomic analysis for the last four decades. The second part sketches how imperfect knowledge economics (IKE) jettisons conventional models' core premise and how doing so helps to overcome these models' epistemological flaws. By opening economic models to change, that is, at least in part, indeterminate, and by recognizing imperfect knowledge on the part of economists, IKE explores the frontier of what empirically relevant mathematical macroeconomic and finance models can deliver.

Imperfect Knowledge, Asset Price Swings and Structural Slumps: A Cointegrated VAR Analysis of Their Interdependence

This paper discusses interactions between speculative behavior in the currency markets and aggregate ‡uctuations in the real economy. It builds on the Structural Slumps theory in Phelps (1994) and the recent theory of Imperfect Knowledge Economics in Frydman and Goldberg (2007). The former emphasizes real interest rates and real exchange rates as potentially important determinants underlying the persistent ‡uctuations in aggregate activities, and the latter provides the conditions under which speculative behavior in currency markets generates such persistence. The paper argues that by combing the two theories we can shed new light on the two-way interdependence between persistent swings in asset markets and persistent ‡uctuations in the real economy. In particular, we may improve our understanding of the mechanisms behind the long recurrent spells of high unemployment that continue to mar our economies. � The views in this paper are strongly in‡uenced by previous and ongoing research with Roman Frydman, Michael Goldberg and Soren Johansen. I am deeply grateful to Roman and Michael for sharing with me their profound insight in international macro and how imperfect knowledge economics can resolve its many empirical puzzles and to my son, Mikael Juselius, for numerous valuable comments on an early version of this paper.

Imperfect Knowledge Economics: Exchange Rates and Risk, by Roman Frydman and Michael D. Goldberg

Imperfect Knowledge Economics: Exchange Rates and Risk, by Roman Frydman and Michael D. Goldberg

Financial Markets and the State: Long Swings, Risk, and the Scope of Regulation

The paper makes use of an Imperfect Knowledge Economics (IKE) approach to examine the rationale and scope of state intervention in asset markets. IKE recognizes that policy officials and market participants must cope with ever-imperfect knowledge of the causal mechanism driving market outcomes. In our IKE-based model of asset markets, price swings arise from participants' diverse interpretations of the effects of fundamentals on outcomes. Under IKE, the market is an imperfect mechanism for setting values. However, the paper argues that, within a range of prices, the market's allocation is superior to the allocation that would result if the state actively intervened into the price-setting mechanism. During periods of non-excessive prices, swings play an indispensible role in helping society to allocate scarce capital and the state should confine its intervention to setting the rules of the game, that is, ensuring transparency and eliminating other market failures. However, price swings can sometimes move far from levels consistent with most perceptions of longer-term fundamental values. If they do, the IKE approach calls for active intervention to dampen excessive movements. The paper proposes the use of official "guidance ranges" and discusses problems with their estimation. It also proposes an array of other excess-countering measures and concludes with ideas on how regulators can better measure and manage systemic risk in the financial system.

Macroeconomic Theory for a World of Imperfect Knowledge

We have recently proposed an alternative approach to economic analysis, which we call Imperfect Knowledge Economics (IKE). Although IKE builds on the methodology of contemporary macroeconomics by modeling aggregate outcomes on the basis of mathematical representations of individual decision making, it jettisons models that generate sharp predictions. In this paper, we elaborate on and extend the arguments that led us to propose IKE. We show analytically that in order to avoid the fundamental epistemological flaws inherent in extant models, economists must stop short of fully prespecifying change. We also show how acknowledging the limits of their knowledge may enable economists to shed new light on the basic features of observed time-series of market outcomes, such as fluctuations and risk in asset markets, which have confounded extant approaches for decades.

Laissez Faire: Pro and Con

Previous articleNext article No AccessLaissez Faire: Pro and ConFrank H. KnightFrank H. Knight Search for more articles by this author PDFPDF PLUS Add to favoritesDownload CitationTrack CitationsPermissionsReprints Share onFacebookTwitterLinkedInRedditEmail SectionsMoreDetailsFiguresReferencesCited by Journal of Political Economy Volume 75, Number 6Dec., 1967 Article DOIhttps://doi.org/10.1086/259359 Views: 73Total views on this site Citations: 31Citations are reported from Crossref Copyright 1967 The University of ChicagoPDF download Crossref reports the following articles citing this article:Ross B. Emmett What Can We Learn about Frank Knight’s Economic Theory from the Prefaces to the Reprints of Risk, Uncertainty and Profit ?, (Dec 2021): 55–73.https://doi.org/10.1108/S0743-41542021000039C004Mathieu Ginier-Gillet Les grands magasins de la médecine de Milton Friedman, Médecine & Droit 2020, no.165165 (Dec 2020): 150–152.https://doi.org/10.1016/j.meddro.2020.07.002Ross B. Emmett James M. Buchanan and Frank H. Knight on democracy as “government by discussion”, Public Choice 183, no.3-43-4 (May 2020): 303–314.https://doi.org/10.1007/s11127-020-00815-4Craig Freedman Roads Not Taken: The Coase Conundrum, (May 2020): 477–517.https://doi.org/10.1057/978-1-137-56815-1_16Milan Zafirovski Collective‐unconscious apologetics of plutocracy and oligarchy: Chicago economics' ideological preferences revealed by the sociology of knowledge, Journal for the Theory of Social Behaviour 49, no.44 (Dec 2019): 499–518.https://doi.org/10.1111/jtsb.12227Milan Zafirovski Economics and Apologetics—The Ideology/Utopia of Laissez-Faire and its Discontents, Journal of Economic Issues 53, no.33 (Aug 2019): 647–676.https://doi.org/10.1080/00213624.2019.1634455Mark R. Reiff The just price, exploitation, and prescription drugs: why free marketeers should object to profiteering by the pharmaceutical industry, Review of Social Economy 77, no.22 (Feb 2019): 108–142.https://doi.org/10.1080/00346764.2018.1551561Milan Zafirovski , The European Journal of the History of Economic Thought 26, no.55 ( 2019): 827.https://doi.org/10.1080/09672567.2019.1609056Douglas A. Irwin The Midway and Beyond, History of Political Economy 50, no.44 (Dec 2018): 735–775.https://doi.org/10.1215/00182702-7202548Milan Zafirovski Rational Choice Theory or Pretense? 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Kaufman The Theoretical Foundation of Industrial Relations and its Implications for Labor Economics and Human Resource Management, ILR Review 64, no.11 (Oct 2010): 74–108.https://doi.org/10.1177/001979391006400104Aliye Ahu Gülümser, Tüzın Baycan-Levent, Peter Nijkamp Measuring Regional Creative Capacity: A Literature Review for Rural-Specific Approaches, European Planning Studies 18, no.44 (Apr 2010): 545–563.https://doi.org/10.1080/09654311003593614D. Wade Hands Frank Knight and pragmatism, The European Journal of the History of Economic Thought 13, no.44 (Dec 2006): 571–605.https://doi.org/10.1080/09672560601025779Renee Prendergast The concept of freedom and its relation to economic development—a critical appreciation of the work of Amartya Sen, Cambridge Journal of Economics 29, no.66 (Nov 2005): 1145–1170.https://doi.org/10.1093/cje/bei081D. 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