Roman Frydman

Professor of Economics
New York University

Roman Frydman is Professor of Economics at New York University and Chair of the Program on Imperfect Knowledge Economics (IKE) at the Institute for New Economic Thinking. He was one of the early critics of the Rational Expectations Hypothesis, arguing in the 1982 article in the American Economic Review that REH models do not provide an adequate representation of rational decision making.

Over the last decade, Frydman has worked with Michael Goldberg on a new approach to representing rationality in formal macroeconomic analysis that rests on the core premise that rational individuals recognize that they cannot fully anticipate the consequences of their decisions.They presented their approach in their book Imperfect Knowledge Economics (Princeton University Press, 2007).

In subsequent articles and a follow-up book, Beyond Mechanical Markets (Princeton University Press, 2011), Frydman and Goldberg developed an alternative approach to modeling rational decision-making and applied it to the analysis of a number of outstanding problems in macroeconomics and finance that have confounded the prevailing approaches for decades. They also showed how IKE leads to a new way of thinking about state intervention – and, more broadly, the market-state balance – in modern economies.

Recently, Frydman co-edited (with Edmund Phelps), Rethinking Expectations: The Way Forward for Macroeconomics (Princeton University Press, 2013), which examines alternative approaches that aim to shape the post-REH research agenda in macroeconomics and policy analysis.

My Content

We call attention to the class of models that serve as the foundation for the rational expectations hypothesis (REH). Models in this class rule out completely any structural change that cannot be fully anticipated with a probabilistic or other quantitative rule. REH models are abstractions of rational decision-making, but only in a hypothetical world in which participants can fully anticipate when and how they might revise their understanding of the process driving outcomes. We propose a new rational expectations hypothesis (NREH) as a way to represent rational decision- making in real-world markets. NREH builds on the insights of Muth (1961) and Lucas (1972, 2001) and imposes internal coherence between the economist’s under- standing of outcomes and that of the market.

Shiller (1981) and others have shown that the quantitative predictions of the REH present-value model are inconsistent with time-series data on stock prices and dividends. In this paper, we assess the empirical relevance of the model without explicitly representing how a rational market participant forecasts dividends and interest rates. We find that stock prices are driven largely by news about fundamental factors. Moreover, this news moves prices through changes in the market’s forecasts of dividends and/or interest rates in ways that are remarkably consistent with the present-value model.

Paradigm Lost: Rethinking Economics and Politics
Axica Conference Center, Berlin
April 12-15, 2012

My Video Content

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Keynote panel on "Time and Expectations in Economic Analysis" at the Institute for New Economic Thinking's "Changing of the Guard?" conference in Hong Kong. Featured panelists include Sheila Dow, INET Center on Imperfect Knowledge Economics Chairman Roman Frydman, INET Grantee Roger Guesnerie, and INET Co-founder George Soros, with INET Advisory Board member Axel Leijonhufvud moderating. 

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How do you model the unmodelable? By taking seriously the idea of non-routine change. Simply put, change in capitalist economies is to a significant degree non-routine, and thus cannot be adequately forecasted or represented in advance with mechanical rules and procedures. In this groundbreaking area of inquiry, four INET grantees lead the way.

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Roman Frydman, Professor of Economics, New York University speaks on panel entitled "What Can Economists Know: Rethinking the Foundations of Economic Understanding at the Institute for New Economic Thinking's (INET) Paradigm Lost Conference in Berlin. April 12, 2012. #inetberlin

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Discussion and Q&A at the panel entitled "What Can Economists Know: Rethinking the Foundations of Economic Understanding at the Institute for New Economic Thinking's (INET) Paradigm Lost Conference in Berlin. April 12, 2012. #inetberlin

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Roman Frydman, Philippe Aghion, William Janeway, William Lazonick, Ha-Joon Chang, and Peter Jungen, taking questions from the audience in the panel "The Market or the State? Can market Forces Deliver Innovation, Education, and Infrastructure?" at the Bretton Woods Conference on April 10, 2011.

My Grants

Instability is an inherent feature of financial markets, and more broadly of capitalist economies. Long before the financial crisis that began in 2007, leading economists acknowledged that contemporary models are of little help in understanding this instability.