Posted by: Dirk | January 26, 2010

The long run of the Black Swan

Nassim Nicholas Taleb is back, having added more than 100 pages to a 2nd edition of his Black Swan book. Here is an interesting extract:

There is no such thing as a “long run” in practice –what happens
before the long run matters. The problem of using the notion of “long run”, or what mathematicians call the “asymptotic” property (what happens when you extend something to infinity), is that it usually make us blind to what happens before the long run, what I will discuss later as “pre-asymptotics”. Different functions have different pre-asymptotics, according to speed of convergence to that asymptote. But, unfortunately, as I keep repeating to students, life takes place in the pre-asymptote, not in some Platonic long run, and some properties that hold in the pre-asymptote (or the short run) can be markedly divergent from those that take place in the long run. So theory, even if it works, meets a short term reality that has more texture. Few understand that there is generally no such thing as a reachable long run except as a mathematical construct to solve equations – to assume a long run in a complex system you need to assume that nothing new will emerge. In addition, you may have a perfect model of the world, stripped of any uncertainty concerning the analytics of the representation, but have a small imprecision in one of the parameters to input in it.

This issue tackles the very fundament of economics, which has been build on mathematics. After WWII, mathematical modelling as that of Paul Samuelson was used as a neutral way of settling discussions that were and still are very political. Taleb points out that the choice of methods cannot be neutral, and therefore Economics as a discipline lacks scientific method. This is especially so in macroeconomics, I’d say, where mathematical models ruled.

People with models drove the policies, while the people with logic were ignored. Too bad it turned out that the people using logic had it right. Economists will have to think hard about where they want their field to go. Until now, almost nothing has changed. If you can’t put your ideas into the form of a model, than you won’t get anywhere. The discipline is full of people with a mathematical background and not much understanding of how an economy functions. How can I tell? Well, just check the assumptions of the models. How about the idea that you can always shift your consumption around in time, as stated in the Woodford book “Interest and Prices”? If you are unemployed in 2010, try to get a loan from your bank explaining them that you want to smooth your lifetime income.

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