Monday, October 10, 2011

Tom Sargent On Rational Expectations and Efficient Markets

Tom Sargent won the "Prize In Honor Of Alred Nobel For Economic Sciences" or whatever it is really called, jointly with Chris Sims.  Sarget taught at the University of Chicago during my grad school years.  Few of Chicago's world famous faculty could be called great teachers.  I'd put him in that category with Gary Becker and Bob Lucas--truly great teachers.

Besides the incredible enthusiasm for and love of economics he tried to instill in all of us , two memories stand out.  First, he had a much deeper theory of rational expectations than most, but his own (unpublished) research provided significant evidence against it.  In his advanced macro class, the main question of our midterm exam came word-for-word from a homework assignment.  He very rationally heaped substantial abuse on a class that did not deliver near perfect scores.  He cautioned that we not make the same mistakes again.  Rationality improved dramatically by the final exam, but the distribution of final grades provided statistically significant evidence against rational expectations.

On efficient markets, I should note that I am a "Color Blind American" with great sympathy for my brethren.  I always assumed Sargent fell in that category.  I think most of us CBAs follow simple rules: lots of solids, not a lot of color variation.  We certainly don't do anything risky without our significant other close at hand.  Not so for Sargent.  As best we could understand, Sarget believed markets were so efficient that clothing that did not match all other clothing would not survive competitive pressures in the marketplace.

Here's to a great teacher and excellent economist, and two theories the Nobel Committee overlooked!