http://www.theglobeandmail.com/news/pol ... le2202027/
Rational-expectations theory and its corollary, the efficient-market hypothesis, have been central to mainstream economics for more than 40 years. And while they may not have “wrecked the world,” some critics argue these models have blinded economists to reality: Certain the universe was unfolding as it should, they failed both to anticipate the financial crisis of 2008 and to chart an effective path to recovery.
The economic crisis has produced a crisis in the study of economics – a growing realization that if the field is going to offer meaningful solutions, greater attention must be paid to what is happening in university lecture halls and seminar rooms.
While the protesters occupying Wall Street are not carrying signs denouncing rational-expectations and efficient-market modelling, perhaps they should be.
My objections to the efficient market model are slightly different than those above... they're based on rejecting the principle of efficiency as a virtue... but even if it could be argued that efficiency is sometimes a virtue (say, in situations where something needs to get done without getting caught in red tape. An example might be FEMA... though this is arguable... and it may turn out that efficiency is a red herring here), this article shows why it's problematic to assume efficiency without real-world data.Many critics of neo-classical economics argue that it has a powerful pro-market bias that's provided an intellectual justification for politicians ideologically disposed to reduce government involvement in the economy.
The rational-expectations model, for example, assumes that consumers and producers all inform themselves with all available data, understand how the world around them operates and will therefore respond to the same stimulus in essentially the same way. That allows economists to mathematically forecast how these “representative” consumers and producers would behave.
During a recession, say, a well-meaning government might want to enhance benefits for the unemployed. Prof. Sargent, for one, would caution against that, because a “rational” unemployed worker might then calculate that it's better to reject a lower-paying job. He's blamed much of the chronically high unemployment in some European countries on the presence of an army of voluntarily unemployed workers, and spoken out against the Obama administration's recent efforts to extend unemployment benefits.
Indeed, under the rational-expectations model, most market interventions by governments and central banks wind up looking counterproductive.
Meanwhile, the efficient-markets hypothesis, developed by University of Chicago economist Eugene Fama in the 1970s, has dominated thinking about financial markets. It posits that the prices of stocks and other financial assets are always “efficient” because they accurately reflect all the available information about economic fundamentals.
By this reasoning, there can be no speculative price bubbles or busts in the stock or housing markets, and speculators with evil intentions cannot successfully manipulate markets. Conveniently, since markets are self-stabilizing, there's no need for government regulation of them.
Critics point out that both these theories tend to ignore what John Maynard Keynes called the “animal spirits” – playing down human irrationality, inefficiency, venality and ignorance. Those are qualities that are hard to plug into a mathematical equation that purports to model human behaviour.
These models also have failed to take into account the profound changes wrought by globalization, and the growing importance of banks, hedge funds and other financial institutions. Yet they have successfully provided a “scientific” cover for an anti-regulatory political agenda that is popular on Wall Street and in some Washington political circles.
