David K. Levine Responds to Krugman

At the Huffington Post:

More to the point: our models don’t just fail to predict the timing of financial crises – they say that we cannot. Do you believe that it could be widely believed that the stock market will drop by 10% next week? If I believed that I’d sell like mad, and I expect that you would as well. Of course as we all sold and the price dropped, everyone else would ask around and when they started to believe the stock market will drop by 10% next week – why it would drop by 10% right now. This common sense is the heart of rational expectations models. So the correct conclusion is that our – and your – inability to predict the crisis confirms our theories. I feel a little like a physicist at the cocktail party being assured that everything is relative. That isn’t what the theory of relativity says: it says that velocity is relative. Acceleration is most definitely not. So were you to come forward with the puzzling discovery that acceleration is not relative…
Of course some people did predict the crisis. Some might even have been smart enough to know that if they consistently predict the opposite of a consensus point forecast, eventually they will be right when everyone else is wrong. If I say every year: there will be war; there will be an asset market crash; there will be a recession; there will be famine; we will run out of oil – eventually I’ll be right. These kind of predictions are only meaningful if more people than can be attributed to random good luck got it right at the right time or if whatever method they used to reach that conclusion is replicable. Or does the ability to replicate results fall under the category of “not very interesting because that would be an elegant theory?”

Posted by on September 19th, 2009 at 12:19 pm


The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or other interests in securities mentioned in the Blog, please see my Disclaimer page for my full disclaimer.