THE ECONOMICS OF RATIONALITY 203

Friedman states that in most cases such realism is not necessary because economists can employ the hypothesis that agents:

behave as if they were seeking rationally to maximize their expected returns…and had full knowledge of the data needed to succeed in this attempt; as if, that is, they knew the relevant cost and demand functions, calculated marginal cost and marginal revenue from all actions open to them, and pushed each line of action to the point at which the relevant marginal cost and marginal revenue were equal.19

(Friedman 1953, pp. 21–2)

For the positivist, the test of an economic model is not how closely the assumptions correspond to the world but how accurately the model predicts future conditions. The decisive test is a pragmatic decision about how well the hypothesis ‘works’ for the phenomena it seeks to explain.

Friedman’s approach can be interpreted as a foundationalist methodology that consists of two types of basic beliefs: first, beliefs that support an instrumentalist procedure for verifying and falsifying theories; second, beliefs that justify a positivist method for specifying data.20 The initial set of basic beliefs justifies the use of a general rule for testing economic theories. This is the rule that predictions generated from a formal mathematical model should be compared to empirical observations. The second set of basic beliefs provides an epistemic justification for the objective, measurable observations that are incorporated into economic models and used to identify the numerical targets that predictive models are designed to hit.

Many economists implicitly attempt to solve the problem of epistemic regress when they adopt a methodology similar to Friedman’s. Consider, for example, two common beliefs that economists have about economic models. Each rests directly on the foundationalist qualities of methodological positivism. The first belief is that the method of testing models allows the use of unrealistic assumptions. The justification for this practice is not based on a comparison of assumptions with empirical observations. Instead, the positivist justification for making unrealistic assumptions stems directly from a rule for model-testing which is treated as a given. The second belief is that predictions made by the model can be treated as ‘selfevident’ givens that do not have to be interpreted by making reference to any beliefs other than those regarding the empirical data used in the model and the formal characteristics of the model itself.

Problems with positivism

As recent debates show, economists are beginning to question the mainstream view of what qualifies as economic data and how theories should be evaluated.21 These debates take on added significance when we consider whether positivism offers a viable solution to the problem of epistemic regress.