Chapter 3: Uncertainty and Reality in Economic Models
3. 3.1 Uncertainty and reality in economic models A PARABLE: THE FABLE OF THE P’S, OR WHAT MORTALS THESE P’S FOOL! Many years ago in the never-never land of Chicago where the busy P’s of economic theory often ﬂourish, there dwelt a wise and famous Knight (Frank H.) who recognized the sterility of using a classical economic theory that presumed the economic future could be reliably predicted by the use of probability theory. This Knight attempted to redirect the economics profession toward the study of relevant economic problems where the future was uncertain and therefore incapable of being reliably forecasted. If the future is merely risky, this Knight maintained, then these risks are measurable and by using probability theory the economic future is actuarially knowable. An uncertain economic future, however, is incapable of any measurement. Hence the term uncertainty must be restricted to ‘non-quantitative’ views about the future and it is this ‘true’ uncertainty, and not risk, the Knight insisted, that forms the basis of economic decision making.1 At about the same time, in a distant land across the seas, the brave and intelligent warrior, Keynes, who had also labored in the ﬁeld of probability and nonmeasurable uncertainty, took up the cudgel and attempted to produce a revolution in economic thinking by developing a taxonomic structure that diﬀerentiated an uncertain future from a probabilistic risky one. Now it came to pass that with the upheaval of the Great Depression and the Second World War, politicians were open to Keynes’s...
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