Transcript Cepni - Project Anticipation

Using Foresight In Economic Thought Schools
Prof. Dr. Elif Cepni
Bahcesehir University, Istanbul
The
First
International
ANTICIPATION
Conference
on
5-7 November 2015, Trento (Italy)
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• The main aim of this paper is to show the role of
expectations (formulation of future decisions) in main
economic thought schools and
• the possible results of replacing the current ways of
formulating expectations with foresight or scenario
creation or adding the role of scenarios into the
theories of main economic thought schools.
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The paper is organized as follows:
•Firstly the importance of the topic will be
discussed.
•In the next section the brief summary of the
related theoretical literature of the formulation of
expectations in economic thought schools is
presented.
•This section is followed by the title discussing
“why prediction is not possible”.
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•Then the summary of foresight methodologies will
be presented.
•Finally the possible results of replacing current
assumptions of economic thought schools (on the
formulation of expectations) with foresight (scenario
planning) will be discussed.
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Combining economic literacy with intellectual
foresight may eliminate time inconsistency and
credibility problem for policy makers and can also
eliminate time lags of policies.
Using collective intelligence may create different
roadmaps for countries, societies and institutions.
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Both at macro and micro levels decision-making is
very difficult. Almost all decisions are taken under
a great risk or uncertainty.
The literature of economics is covering the
rational
irrationality
and
the
illusion
of
predictability terms now. The world is full of
information. Information is more complex,
interdependent, hectic, nonlinear, coevolutive and
less stable.
It is known that the occurrence of extreme events
cannot be predicted from past history.
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• Could it be possible to change our ideas about “what is
possible”?
• Is the wisdom of crowd (collective genius) possible?
Wisdom of the crowd requires trust, support by the
government, enforcement.
• Crowds can be mad as well. To be wise it needs to be
diverse in its membership (Goddard and Eccles, 2013).
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• There is one truth; our decisions are heavily affected
by our cultural heritage.
• Although there is no common definition of “culture” it
may be defined as “the unique combination of
expectations, written and unwritten rules, and social
norms that dictates the everyday actions and
behaviours of people”.
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• Economic life is full with uncertainties.
• Moreover three words characterise the orthodox
view of the economy; they are
• efficiency,
• stability and
• rationality.
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• We live in a turbulent world. Plans, strategies and
policies are based on fixed goals. But the environment
that we live and the conditions are changing very
rapidly.
• Corporate and government responsibilities are
changing very rapidly. We the human beings own
better social capital and can use collective
intelligence in a better way.
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Recently we hear more technical terms in economics
such as
“The Rational Irrationality” and
“The Illusion of Predictability”.
So how collective intelligence can dominate our
selfish neurons?
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2. Literature Review of The Formulation of
Expectations in The Economic Thought Schools
Economist generally categorize economic thought
schools under seven titles. These are
Orthodox Keynesian,
the Orthodox Monetarism,
New Classical Macroeconomics (Mark I),
New Classical Macroeconomics (Mark II) ( also it is
called the real business cycle theory),
New Keynesian Economics,
Austrian Economics (Von Mises, Von Hayek) and
Post Keynesian Economics.
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Within macroeconomics there is a great deal of
controversy about the causes of aggregate
fluctuations in economic activity.
Classical economists were aware that capitalist
market economy could deviate from its equilibrium
level of output & employment but they believed that.
Such disturbances would be temporary & short lived.
The market mechanism would operate quickly and
efficiently to restore full employment equilibrium.
(No need for stabilization policies). There is no
involuntary unemployment in these models and money
is neutral.
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Long run money neutrality is a crucial property of
the classical.
Contributers were
Cantillon, Hume, Ricardo,
Mill, Marshall, Fisher, Pigou, Hayek and even
Keynes.
More recently the Quantity Theory of Money has
been associated with the development of
monetarism and the work of Milton Friedman.
The term "monetarism" emerged in 1968.
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• Keynes sets out to discover "what determines at any
time the national income of a given system and the
amount of its employment (the national income). He
constructs Y (national income) depends on the volume
of employment.
• In Keynes's model
Investment depends on the
expected profitability and interest rate. Keynes
called expected profits “The Marginal Efficiency of
Capital”.
• In this model employment is dependent on an unstable
factor which is investment.
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• Investment decision is difficult. Machinery &
buildings are bought now, produce goods that will be
sold in a future which is uncertain.
• Expectations about future involves HOPES & FEARS
as well as hard facts.
• Given the VOLATILITY of EXPECTATIONS, often
driven by “ANIMAL SPIRITS". THE EXPECTED
PROFITABILITY of CAPITAL must also be HIGHLY
UNSTABLE.
• Investment Decisions could be influenced by tides of
"Irrational Optimism and Pessimism" causing large
swings in the STATE of CONFIDENCE.
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Expectations of the future profitability of investment
are far more important than the RATE OF INTEREST
in linking the future with the present.
The assumption underlying Orthodox monetarist
analysis is that; expected inflation adjusts to actual
inflation only gradually in line with the so- called
"adaptive" or "error- learning expectations" hypothesis.
In the adaptive expectations hypothesis which is called
backward looking approach, expectations will be biased.
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• Economic agents base their expectations of future
values (such as inflation) only on past values.
• The main reasons of these results (biased) are the
assumptions that they use.
• 1. Economic agents only PARTIALLY ADJUST their
expectations by a fraction of the last error made
• 2. The failure of agents to take into consideration
additional information available to them other than
past values of the variable, despite making repeated
errors.
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• In contrast, in the "forward looking approach" agents
will not form expectations systematically wrong over
time, that is, such expectations will be unbiased.
• Schools known as classical started to use “the
rational expectations hypothesis” associated with the
work of John Muth (1961) in the context of
microeconomics.
• It took almost 10 years before Lucas, Sargent and
other leading New Classical economists began to
incorporate the hypothesis into their macroeconomic
models. There are weak & strong versions. In the
strong version (the rational expectations hypothesis)
it is assumed that expectations of economic variables
“ON AVERAGE” will be correct.
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• Rational Expectations does not mean that agents can
for see the future exactly. "rational expectations"
is not the same as "perfect foresight".
• With rational expectations, agents expectations of
economic variables on average will be correct that is
will equal their true value.
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• The issue of whether individual agents operating in
DECENTRALIZED MARKETS will be able to "learn"
the true model of the economy has been the subject
of considerable debate.
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• 3. Why Perfect Prediction is Not Possible (The
Illusion of Predictability, Rational Irrationality)
• Nassim Nicolas Taleb presents the disorder family
(or cluster) in his book having the title “Black Swan”.
These are listed as follows;
• Uncertainty, Variability, Imperfect and Incomplete
knowledge, Chance, Chaos, Volatility, Disorder,
Entropy, Time, The Unknown, Randomness, Turmoil,
Stressor,
Error,
Dispersion
of
outcomes,
Unknowledge.
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• He also mentions about “negative empiricism”. Seeing
white swans does not confirm the nonexistence of
black swans.
• A thousand days cannot prove us right, but one day
can prove us to be wrong. We can get closer to the
truth by negative instances, not by verification. It is
misleading to build a general rule from observed
facts.
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• Most economic models rest on the assumptions that
shocks are normally distributed which means that
their distribution has the well-known “bell curve”
shape, with a given mean and standard error.
• There are, however circumstances in which this
assumption cannot hold; shocks may be skewed, in
which case their median value is not equal to their
mean, or their distribution may exhibit” fat tail”
meaning that very rare events are more likely to
occur than under normal distribution.
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• There are lots of economists who are arguing that
current assumptions of the theories of economics are
unrealistic. In many schools they use similar
assumptions. These are;
• agents aim to maximize utility and profit,
• agents form expectations rationally and do not suffer
information asymmetries,
• there is a price flexibility,
• there is a continuous market clearing
• so that equilibrium always prevail.
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• Although New Keynesians underline and accept the
importance of
•
•
•
•
•
imperfect competition,
incomplete markets,
heterogeneous labour and
asymmetric information
still they use the micro foundations of macro in a
similar way.
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• The economy is
• unfair (income distribution is unequal,
• unstable (asset prices are fluctuating very much like
oil and gold)
• and unsustainable (over-crowding, climate change etc)
and
• some economist like David Orrell claims
economics needs a scientific revolution.
that
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4. Literature
Methodologies
Review
of
Foresight
and
its
Scenario planning is generally attributed to Herman
Khan and the RAND Corporation in the 1950s.
Kahn developed “future-now” thinking technique and also
he used Hollywood’s term “scenario”.
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• He developed his scenarios as a part of military
strategy research conducted at RAND for the US
Government.
•
In the 1970s scenario planning spread outside the
RAND. Royal Dutch/ Shell and others started to
use.it.
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• In Europe the Copenhagen Institute for Future
Studies and the Swedish Secreteriat for Future
Studies started to use more qualitative and policy
oriented methods (Lindgren and Bandhold, 2009).
• The 1970s were the golden years. Many institutions
were added to the list of institutions promoting
future studies. Universities started to offer Master’s
degrees in the field.
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• While FORECAST is used as a term for predictions,
FORESIGHT describes a more open perspective on
futuristic thinking.
• FORESIGHTS focus on the identification of possible
futures,
potential
issues,
tendencies,
and
uncertainties, often using scenario methods.
Foresight is similar to the term prospective analysis.
• FUTURES STUDY means all types of studies
concerned with the exploration and analysis of future
states could be named futures studies. Traditionally,
the term applies to studies with a 10-30 year
horizon.
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• There are lots of technical terms created by
consisting foresight in it;
•
•
•
•
Private Foresight,
Social Foresight,
Strategic Foresight,
Participatory Foresight and more.
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• 5. Combining Foresight with Main Arguments of
Economic Thought Schools
• To predict the future is not only very important for
policy makers, but it is very important for all decision
makers, decision theorists and economists.
• Since the beginning of time people are trying to
predict the future by consulting to stars by observing
previous events to understand the possible trend and
some scientific methods and simulation models.
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• If we start using foresight in the formulation of
economic decisions can we avoid time inconsistency?
• Can we solve credibility problem?
• Can we eliminate Lucas Critique?
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• Lets assume government announces a policy which is
determined by scenario planning which means using
collective intelligence (so the probability of believing
is high) than there are two alternatives, either it is
believed or not.
• If it is believed by the public and government apply
the policies strictly and there occurs a deviation (to
understand the deviation economic literacy must be
applied) people may understand the role of external
and uncontrolled factors.
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• This will give us neutrality of economic and social
decisions.
• Without losing credibility governments can apply the
alternatives (which is more suitable for the new
current environment
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• If government cheats and apply totally different
policies then in the short run they may obtain some
gains but in the long run to gain credibility again will
be extremely difficult.
• Governments (institutions or corporates) will think
about intertemporal trade-off between the current
gains and the future costs.
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• If the announcement is not believed and a government
applies it correctly (using foresight and economic
and social literacy (due diligence) it could be
tested) governments can gain credibility within a
short time period
(so we need data and
measurement).
• If it is not believed and a government applies a
different policy (the public is right not to believe in)
than these scenarios cannot be applied for a long time
horizon.
• We will come back to today’s model.
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• Current role of expectations can be replaced by the
scenarios created by the collective intelligence.
• But this time another important issue will arise.
• Who will determine scenarios? Who will be these
intelligent people. Related with the formulation of
successful scenarios we need to develop more
methods (EPISTLE).
• Economy and market
• Politics
• Institutions and organizations
• Technology
• Legal changes
• Ecology and ethics
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• The problem here will be
• “whether governments/institutions/ corporates can
accept the loss of power (the decision making power).
• They will have execution power.
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• People may count on collective intelligence more than
politicians.
• The probability of believing will be high and even if
there appears a deviation from the planned scenarios
(by using economic literacy) they may see the role of
external factors and will keep believing in the same
things.
• So deviations will be short lived. Instead of using
adaptive or rational expectations we may use
collective expectations.
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• The shift from a mechanistic to a holistic and
ecological worldview can be seen as a paradigm shift.
The basic tension is one between parts and the whole.
The emphasis on the parts has been called
mechanistic, reductionist, or atomistic; the emphasis
on the whole, holistic, organismic, or ecological.
• To solve the complexities of globalization, to make
people happier healthier and wealthier ELIF
(Economic Literacy and Intelligence Foresight)
method could be a good alternative to current
traditional ways of decision-making.
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• THANK YOU
• FOR YOUR ATTENDANCE & PATIENCE
• Prof.Dr.ELIF CEPNI
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