(Roughly) Daily

Bill Janeway, with sage advice– for businesses, but easily extensible to our personal lives– on how to live, and succeed, in an environment of radical uncertainty…

… From John Maynard Keynes at the University of Cambridge 90 years ago through Robert Lucas at the University of Chicago in the mid-twentieth century, economists have placed expectations at the core of market dynamics. But they differ on how expectations are formed. Are the data we observe the outcome of processes that are as “stationary” as physical laws, like those determining the properties of light and gravity? Or do the social processes that animate markets render future outcomes radically uncertain?

For a long generation starting in the 1970s, Lucas and his colleagues dominated economic theory, giving rise to different strands of Chicago School economics. While the Efficient Market Hypothesis asserted that prices in financial markets incorporate all relevant information, the Real Business Cycle Theory of New Classical Economics held that the macroeconomy is a self-equilibrating system whose markets are both efficient and complete. The system may be subject to external shocks, but it is not amenable to fiscal or monetary management.

This assumption of complete markets implies that we can overcome our ignorance of the future. It suggests that we could, at any moment, write contracts to insure ourselves against all the infinite possible future states of the world. But since perfect, complete markets obviously do not exist, the Chicago School’s Rational Expectations Hypothesis (REH) proposes that market participants will guide their forward-looking decisions by reference to a (generally implicit) model of how, on average, the world works and will continue to work. As a result, expectations will be tamed and aligned with efficient market equilibria.

For their part, Kay and King look further back to the pre-REH period, when Frank Knight and then Keynes correctly showed that our ignorance of future outcomes is inescapable. As Keynes famously put it in 1937:

By ‘uncertain knowledge’ … I do not mean merely to distinguish what is known from what is merely probable. … The sense in which I am using the term is that in which the prospect of a European war is uncertain, or the price of copper and the rate of interest twenty years hence, or the obsolescence of a new invention, or the position of private wealth owners in the social system in 1970. About these matters there is no scientific basis on which to form any calculable probability whatever. We simply do not know.

The shockingly unanticipated Global Financial Crisis of 2008 brought this insight back to the fore.

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The central question remains: Where can we find guidelines for mitigating the consequences of radical uncertainty? What basis is there for purposive action in the face of “We simply do not know”?

I see three paths forward. The first two are defensive, and the third is proactive. All three reject an exclusive focus on efficiency in the allocation of resources. Thus, they stand outside what remains the dominant paradigm of mainstream economics.

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Success in the real world demands a recognition that the future is unknowable. Three strategies: “What to Do About Radical Uncertainty,” from @billjaneway in @ProSyn. Eminently worth reading in full.

* James Baldwin, Sonny’s Blues

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As we contemplate complex contingency, we might recall that it was on this date in 1910 that George Herriman‘s signature characters, Krazy Kat and Ignatz Mouse, made their first appearance in the bottom of the frames in Herriman’s The Dingbat Family daily comic strip.  They got their own strip three years later, scored a Sunday panel in 1916– and delighted readers with the surreal philosophical questions they raised until 1944.

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