Herding – again

I haven’t got time for much of a post, but here’s a marker in the sand. There’s an interesting conversation going on at Mainly Macro on the Lucas Critique. Amid much discussion about the merits of internal consistency (pretty much everyone thinks it’s great. In a messy science, I’m not so sure consistency isn’t overrated, but I’ll leave that to one side for now). In any event as ‘Jed’ comments, in the debate about micro-foundations often ‘micro-foundations’ is code for ‘rationalistic’ micro-foundations of some kind.

1gents may not believe anything about the future, not even that it will be like the present, they may just spend based on their income and endowment.
Note that there are many mechanisms that can produce the appearance of (some approximation to) rational choice — for example imitation of surviving actors. But the intertemporal implications are of course different.
Looking at the financial crisis, which is a more credible explanation of the actual choices of financial actors?
1) Make a rational decision based on all the information available.
2) Do what seemed to work recently for other actors “near” you.
And, to repeat, you can get simple tractable equilibrium models just fine with assumption (2). So why is it ignored?

His next comment then goes to herding in the economics profession.

Actually we can rework the point about how actors make choices to address the question of why more modest assumptions about rationality don’t get traction in economics:
Looking at the economic profession, which is a more credible explanation of how economists choose models and assumptions?
1) They make rational decisions based on all the information available.
2) They do what seemed to work recently for other actors “near” them.
So unfortunately this approach predicts its own lack of adoption.

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David Walker
11 years ago

I’m not sure whether this is a new point 3 or an abstraction of point 2, but Gary Klein’s research on decision-making (set out in the classic “Sources of Power”) suggests that in actual fact people generally choose the first course of action that they think of.

The surprise is that this simple approach seems to work surprisingly well in most circumstances. I presume this is why the world is not full of careful optimisers.

Point 2 is, I presume, the micro-foundations of Hyman Minsky’s work.