Economic models become the basis for crucial practical decisions.
Models were at work in the 2008-09 financial crisis. Banks, automakers, and
insurers were protected based on assumptions about economic consequences.
You cannot prove a negative. So we'll never be sure if President Obama's decisions
prevented the Great Recession from turning into a second Great Depression.
The government bailouts remain controversial because free market advocates
see intervention as wrong. Market models clashed with behavioral models. In
hindsight, both seem inadequate.
John Authers in the
Financial Times notes that "…economics' most
basic assumption is flawed,"i.e. the idea that "all other things are equal,"
and markets are rational. This idea is behind the market model, and contends
that, "Nobody has yet come up with a more efficient way to allocate capital
than the market."
Authers continues, "Against this came the behaviouralists, who substituted
the findings of behavioural psychology for the assumptions of rationality."
These assumptions mandate "nudging" markets to correct for human bias
and herd behavior.
Both sets of assumptions, market and behavioral, are just that, assumptions.
Neither seems adequate. Authers suggests it's time "to break free from this
debate and find a new way to model markets."
Yet, our perceptions lag far behind our economic challenges, and the dichotomy
continues to animate political rhetoric.
What do you think? Do you accept the free market assumptions? Do you agree
with behavioralism and the need to manage markets?
By William
Vocke
For more information see:
John Authers, "We Need New Models in an Uncertain World,"
Financial
Times, March 11, 2011.
Bhide, Amar. (2010).
A Call for Judgment: Sensible Finance for a Dynamic
Economy. New York: Oxford University Press
Frydman, Roman. & Goldberg, Michael D. (2011)
Beyond Mechanical Markets:
Asset Price Swings, Risk, and the Role of the State. Princeton: Princeton
University Press
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