Saturday, 30 March 2013

The absent-minded psychic

Neo-classical economics makes dramatically different assumptions for how the head of an economic agent works when looking into the future than when looking into the past.  This looks like mathematical expediency to me.  Looking backward.  The efficient market hypothesis says that there's no point looking at any point beyond the most recent price, since that market price fully reflects all of the information available to rational agents.  This fits nicely with Markov model mathematics, memoryless sources of randomness.  On the other hand, when looking into the future, the rational expectations theory suggests that the agent has perfect (in the sense of being as good as it could ever be) foresight of the downstream consequences of hypothesised economic choices.  This fits nicely with optimisation mathematics, calculus, iterated game theory. Insofar as, for them everything is a market within which they make long term equilibrium-oriented decisions, they can operate with no memory and ideal foresight.