2023 FUTURE OBSERVATORY

5124 MODEL FRAMEWORKS

In a number of fields, most notably in that of economics, frequent attempts have been made to model behaviour of key variables. Indeed, it has even been claimed that the individual economic agent must possess a formal model in order to generate his or her expectations. In view of the prevailing uncertainty, it is not surprising that many of these models, especially econometric attempts to model the macro-economy but even the less complex ones which are used in rational expectations work, have been doomed to ultimate failure. Even reference to elements of chaos theory, for example by Dopfer, is unlikely to unlock the solution to this problem. In the context of expectations theory, this failure should primarily be seen as that of trying to accurately predict (mathematically) the dynamic outcomes of essentially non-rational processes, which are based on the aggregation of individual decisions, by the use of (typically static) rational models ,which are based upon discrete macro-variables. 

MODELS AS COMMUNICATION DEVICES 

The Aggregated Expectations Hypothesis would posit, however, that these models do still have an important, albeit different, role - as potentially powerful elements of the communication process. Some models, in this context, can offer a very potent means of influencing expectations; as is now recognised by those governments which use interest rates to communicate (signal) their own expectations of future changes in inflation.  Paradoxically, one of the best examples was to be seen in the influence of the Chicago School of economists in general, and of Friedmann. in particular; arising from their promotion of the simple model(s) behind monetarism. Their theories were eventually accepted by the majority of decision-makers; and built into their own expectations - in the terminology of our hypothesis - of future developments. Under those circumstances, monetarist theory was able to predict outcomes, for the relatively short time that these expectations were shared by the wider world, and enabled governments to influence those outcomes.  

The nature of the model, as a communication device, becomes most apparent when we compare the success of  this (monetarist) model with the equal success of that of the previous period - covering several decades - when the very different theories previously put forward by Keynes were just as well accepted. In their time, they as powerfully influenced expectations, with an even better track record in terms of predictability and of government use. 

The change from Keynesianism to Monetarism also illustrated another feature applying to the hypothesis of aggregated expectations: 

MODEL DISSONANCE 

When there is a general shift in expectations from a basis in one model to that in another - paralleling Kuhn's paradigm shift - relative stability (in terms of predictability, at least) is replaced by a period of uncertainty; as the proportion of the population supporting the two competing models progressively shifts from one to the other (and the strength of their individual belief in the new model grows, as that of the old one wanes).  

This may, thus, be seen as one contributor to the uncertainty which has been a characteristic of the macro-environment in recent decades. It has been compounded by the need for 'monetarists' to regularly modify their earlier, over-simplistic, theories to allow for discrepancies in the observed outcomes. The shifting nature of this recent (‘monetarist’) theory has possibly been one contributor to the on-going dissonance. In the context of stable, and predictable, expectations it is even arguable that it is better for a government to be consistently wrong - as in retrospect the Thatcher governments were - than to be inconsistently right - as John Major's governments have sometimes been subsequently. 

MODEL POWER 

This (expectations) communications aspect of modelling imposes rather different requirements. Previously, models were deemed most academically worthwhile - and supposedly more effectively productive - if they were reducible to exact mathematical equations [as, indeed, has been the case with rational expectations] - as, for the benefit of my fellow academics, my own work at the beginning of this paper has been. Indeed, they were sometimes thought to be even more worthwhile if such equations were so complex ('mirroring the complexity of nature') that only the most erudite elite could understand them.  

In the new context, of communicating expectations, such mathematical complexity should be seen to work against many models - not least those developed by econometricians. Instead, in line with the parallel requirements in the commercial sector for 'conviction marketing', the key parameters for a persuasive model - one which most effectively influences expectations - are: 

simplicity and clarity - the concepts have to be easily grasped by the population at large. The very simple message of monetarism, that of the devaluation caused by  governments 'printing money', was easy to understand at a superficial level - even if it did not attempt to fully describe the complex issues involved. 

distinctive, rich identity - the ideas have to be clearly differentiated from competitive offerings, as was monetarism, but ideally should also tap into a much richer 'value system', as was monetarism supported by the panoply of the (Chicago School) free-market debate. 

believability, especially of the champions - the model must ultimately be believed by the majority of the population. This typically occurs because the promoter is believable, as was Friedmann on behalf of monetarism - where his 'opponent', Keynes, was dead. 

strength of opponents - indeed, the comparison with the old paradigm, and especially with its supporters, is a key element in the battle for hearts and minds. The Keynesians were handicapped not just by the fact that their leader was no longer there to defend his theories, but - even worse - by the fact that they had foolishly also espoused the Phillips J Curve as a core element of their expanded theory (even though Keynes himself had written his theories, and died, before Phillips had propounded his). They were, therefore, highly vulnerable when Friedmann proved this particular theory to be false! 

match to 'consumer' needs - finally, the concept(s) have to resonate with the population on which they are targeted. The main target of monetarism was the business community, and the economists who aspired to mediate between it and government, both of whom found the notion of the free-market emotionally, and practically, satisfying at a time when it was increasingly claimed that there was too much government intervention. 

In addition, if such a model is to survive the ravages of time, it needs to incorporate: 

ambiguity - such that it can be progressively reinterpreted to meet changing circumstances. This has happened to an extent with monetarist theory - and rational expectations itself can be viewed as one such reinterpretation. Most notably, though, it has also happened to the longest lived models of all; religious texts - such as the bible - which have been interpreted very differently by different sects at different times in history.

1 April 2003 

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