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Rethinking ExpectationsThe Way Forward for Macroeconomics$
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Roman Frydman and Edmund S. Phelps

Print publication date: 2013

Print ISBN-13: 9780691155234

Published to Princeton Scholarship Online: October 2017

DOI: 10.23943/princeton/9780691155234.001.0001

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The Imperfect Knowledge Imperative in Modern Macroeconomics and Finance Theory

The Imperfect Knowledge Imperative in Modern Macroeconomics and Finance Theory

(p.130) Chapter Four The Imperfect Knowledge Imperative in Modern Macroeconomics and Finance Theory
Rethinking Expectations

Roman Frydman

Michael D. Goldberg

Princeton University Press

This chapter examines the imperfect knowledge imperative in modern macroeconomics and finance theory. It argues that the Rational Expectations Hypothesis (REH) has nothing to do with how even minimally reasonable profit-seeking individuals forecast the future in real-world markets. It attributes REH's insurmountable epistemological difficulties and widespread empirical problems to a single, overarching premise that underpins contemporary macroeconomics and finance theory: nonroutine change is unimportant for understanding outcomes. It also suggests that contemporary behavioral finance models rest on the same core premise as their REH-based counterparts. Finally, it introduces an alternative approach to modeling individual behavior and aggregate outcomes: Imperfect Knowledge Economics, which opens macroeconomics and finance models to nonroutine change and the imperfect knowledge that it engenders.

Keywords:   imperfect knowledge, macroeconomics, finance theory, Rational Expectations Hypothesis, nonroutine change, behavioral finance models, individual behavior, aggregate outcomes, Imperfect Knowledge Economics

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