The economics of radical uncertainty

In situations of what we now describe as radical uncertainty, the core model of agent behaviour, of rational autonomous agents with stable preferences, is not useful. Instead, a different principle, in which the decisions of an agent are based directly on the decisions and strategies of other agents, becomes the relevant core model. Preferences are not stable, but evolve. It is not a special case in such circumstances, but the general one. The author provides empirical evidence to suggest that as a description of behaviour in the modern world, economic rationality is applicable in a declining number of situations. He discusses models drawn from the modern literature on cultural evolution in which imitation of others is the basic strategy, and suggests a heuristic way of classifying situations in which the different models are relevant. The key point is that in situations where radical uncertainty is present, we require theoretical 'null' models of agent behaviour which are different from those of economic rationality. Under uncertainty, fundamentally different behavioural rules are 'rational'. The author gives an example of a very simple pure sentiment model of the business cycle, in which agents use very simple heuristic decision rules. It is nevertheless capable of approximating a number of deep features of output growth over the cycle.