By Roman Frydman & Michael D. Goldberg
Forward by Edmund S. Phelps
For more information, please go here.
Endorsements
“This marvelous book by Frydman and Goldberg documents . . . invaluable insights of the ‘early modern’ theory of capitalism that were lost when the profession endorsed rational expectations equilibrium. . . . Happily for me and, I believe, for the profession of economics, this deeply original and important book gives signs of bringing us back on track–on a road toward an economics possessing a genuine microfoundation and at the same time a capacity to illuminate some of the many aspects of the modern economy that the rational expectations approach cannot by its nature explain.” – from the foreword by Edmund S. Phelps, winner of the 2006 Nobel Prize in economics
“Anyone who has ever studied markets for financial assets such as currencies knows that it is very difficult to explain, much less predict, short to medium term fluctuations. In their innovative new work,Imperfect Knowledge Economics, Roman Frydman and Michael Goldberg make a strong case that it would be particularly helpful to improve our understanding of how financial markets process new knowledge and information. In addition, the book offers a useful guide to understanding existing empirical exchange rate models.” – Kenneth Rogoff, Harvard University
“The centrality of expectations in understanding economic fluctuations has long been recognized, but their formation has not been adequately described. The rational expectation hypothesis was a bold and ingenious attempt, but it has proved empirically very far from satisfactory, most strikingly, in the field of foreign exchange markets, where the good documentation makes the failure easier to establish. Frydman and Goldberg open new doors by a more realistic understanding of the process of forming expectations; by recognizing that universal rules are intrinsically impossible, they exhibit a more creative understanding of the recent history of foreign exchange spot and futures markets.” – Kenneth J. Arrow, Nobel Prize-winning economist
“If you are looking for a way to escape from the Procrustean bed of rational expectations equilibrium–and, if you pay attention to real-world data, you should be–try reading this imaginative and intelligent book. It will amply repay your efforts.” – Alan S. Blinder, Princeton University
“If you have been puzzled by the difficulty of reconciling uncertainty with the equilibrium models that economists use to explain market outcomes, this is the right book to read and reread. It launches a new approach,Imperfect Knowledge Economics, which highlights the long-recognized failure of prespecified general equilibrium modeling to account for the behavior of agents under changing conditions. Frydman and Goldberg are thus proposing models that are able to generate robust qualitative predictions, leading to a better understanding of short- and long-term swings in economic variables. In macroeconomics, there will undoubtedly be a ‘before’ and ‘after’ this book.” – Jean-Paul Fitoussi, president, l’Observatoire français des conjonctures économiques, Paris
“The record of contemporary economics in explaining the behavior of exchange rates is a sorry one. Frydman and Goldberg make the foreign exchange rate problem the particular object of a searching critique of current macroeconomics and use it also as the vehicle for demonstrating how they would break its methodological ‘stranglehold.’ Their own alternative, imperfect knowledge economics, is systematically worked out and persuasively argued. It is my hope that the book will be widely read and debated.” – Axel Leijonhufvud, UCLA and the University of Trento
You can read about the book in Anatole Kaletsky’s op-ed in The Times, “Now is the time for a revolution in economic thought,” John Kay’s Financial Times op-ed, “Beware the fruitless search for ‘sharp prediction’,” and in The Economist’s Economics Focus article, “A new fashion in modeling.”
Reviews
You can also read about the book in Financial Times Deutschland, “Angriff auf den Mythos der Rationalitat” (“Attack on the Rationality Myth”),
Il Sole (Italy), “Azzerare I rischi, l’illusione di una formula magica” (“No More Risks: The Illusion of a Magic Formula”),
Business and Finance (Ireland), “Kicking Over Former Models”,
Weekend Avisen (Denmark), “Glem alt om precision” (“Forget About Precision”),
L’Echo (Belgium), “La prevision parfaite n’existe pa” (“The Perfect Forecast Does Not Exist”),
Polityka (Poland), “Ekonomia niepewnosci” (“Economics of Uncertainty”),
Bloomberg Radio (USA), Bloomberg on the Economy,
The International Economy Magazine (USA), “Are Markets Rational?”.
Press Release
Why have economists’ models failed to account for what happens in real-world markets? What drives aggregate outcomes? Is “self-interest” really sufficient to understand economic rationality? What is the role of history, the social context and common values? How should economic models be used by policymakers and professional investors?
In his 1974 Nobel lecture, Friedrich Hayek appealed to fellow economists to resist the “pretence of exact knowledge” in economic analysis. Decades later, his experience as Federal Reserve chief led Alan Greenspan to recognize that contemporary economists’ models have limited usefulness in policymaking. Yet, over the last three decades, economists have come to believe that their models cannot be scientific unless they generate “sharp” predictions of market outcomes. Among finance professionals, the buzzword has become “financial engineering,” as if exact mathematical models could ultimately capture what real-world markets do.
But these models have consistently failed empirically. In their provocative new book, Imperfect Knowledge Economics (IKE), Roman Frydman and Michael Goldberg explain why, attributing conventional economic models’ shortcomings to their futile effort to make exact predictions. As John Kay, writing about the book in The Financial Times, put it, “the quest for exact knowledge gets in the way of useful knowledge.”
Drawing attention to the inherent limits of economists’ knowledge, the book begins a long overdue attempt to make rigorous economic analysis relevant for real-world problems, from trading in financial markets to formulation and discussion of public policy. Using the foreign exchange market as a testing ground for IKE, the book sheds new light on exchange-rate and risk-premium movements, which have confounded conventional models for decades.
Offering a fresh way to think about markets and representing a potential turning point in economic analysis, Imperfect Knowledge Economics will be essential reading for economists, policymakers, professional investors, and all who seek to understand the uses — and abuses — of economic and financial models.
For more information about Imperfect Knowledge Economics: Exchange Rates and Risk, please go here.