More From This User
Related Docuements
Financial or Multidimensional Crisis?
The article examines the present financial crisis (2008/2009). It urges us to...
From M. Nadarajah
2
nature physics
| VOL 5 | JANUARY 2009 | www.nature.com/naturephysics
commentary
Economics crisis
Thomas Lux and Frank WesterhoffEconomic theory failed to envisage even the possibility of a nancial crisis like the present one. A newfoundation is needed that takes into account the interplay between heterogeneous agents.
O
nce viewed as mystic monetary engineer, Alan Greenspan, ormerChairman o the US FederalReserve, has been re-cast as irresponsible villain, one who laid the ground or thepresent worldwide nancial catastrophe.Asked whether his ‘ideology’ had pushedhim to make decisions he now regrets,Greenspan conessed
1
that he would havedeemed impossible the ongoing disruptionsto the nancial system and that “his belie in deregulation had been shaken”.He is not the only one who has beentaken entirely by surprise. Most economistsdid not in any way oresee the depth o the current crisis, or even consider itpossible. Even those who warned
2
o over-exuberance in the US housing market didnot have any clue about the impendingmeltdown, which, to the shocked public,looks as i some Dr Strangelove on WallStreet had pushed the button on a nancialDoomsday Device. Greenspan’s supposedideology certainly coincided widely withthat o mainstream economists who believein the sel-regulating orces o unrestrainednancial markets, the ‘eciency’ o asset-price ormation, and the increasedeciency in risk allocation and sharingthrough the introduction o ever morenancial instruments.All o this is just the nance versiono that textbook economic paradigm,‘homo economicus’, who has unlimitedinsightulness and capability o deliberation(economists typically speak o ‘rationality’).Tis admirable person manages hisnancial aairs as a side-aspect o hisutility maximization problem, taking intoaccount all potential uture happeningswith the correct probabilities. As thereis only one way to be perectly rational,this agent is usually the lone actor ineconomic models — a representativeRobinson Crusoe.O course, this Crusoe has been oenderided as a straw-man illustration o the dominant paradigm, criticized by non-mainstream economists, unbelievingnatural scientists and a similarly unbelieving public. Still, the straw manis alive, and was well — at least until thecurrent nancial crisis started to unold.Although the principles outlined aboveare still the basis o most contemporary scholarly activity in economics, there areother trends. Tese include innovativework in ‘behavioural economics’ andexperimental work with human subjects —recognized in the award o the 2002Nobel Prize to Daniel Kahneman andVernon L. Smith — which have revealeda plethora o behavioural patterns thatcontradict the assumption o perectly rational behaviour.However, these developments still occupy only a marginal position. Te widespreadperception within our proession is thatbehavioural research delivers a curious set o anomalies or exceptions that lack coherence,and whose impact gets washed out in theaggregate. In contrast, the mainstreamparadigm is seen as a more solid andconsistent ramework. Economic policy advice, particularly in nancial economics,will thereore typically be based on a set o axioms and hypotheses derived ultimately rom the Robinson Crusoe scenario. Asthe prevailing nancial crisis cannot beexplained using these standard tools,economic theory basically oers policy makers little guidance about what to do inthe current situation.A major problem is that despite many renements, this is not at all a system basedon and conrmed by empirical research(as the naive believer in ‘positive science’might expect). Te vision (or ideology)encapsulated in the mainstream approachis o a more ‘pre-analytical’ nature and issupported mainly by elegant but idealisticmodels o the economy. Perect rationality and optimizing behaviour are used sopervasively in economics education thattheir basic tenets are taken or grantedas the principles ruling the real world,despite all o the anomalies and exceptionsdiscovered in empirical research.For instance, it would be hardto nd supporting evidence or thermly held belie that more derivativeinstruments — which should allow agentsto insure themselves better against thestochastic wheels o ortune — lead to abetter allocation o resources and thusan increase in market eciency. Tisassertion is based entirely on the benetso contingent claims in the textbook general-equilibrium model. Derived inthe abstract, the eciency gain throughderivatives is only a hypothesis, yet this isnot how economists are used to thinkingo such theorems: it is the mathematicalproo within the model economy that isconsidered its validation, rather than any empirical evidence.A glance at real-lie operations inderivative markets easily shows why thetheory ails: instead o hedging away risk,many market participants use derivativesin an ‘anomalous’ way, to build upspeculative positions so as to prot romhigher returns, as long as the downsiderisk does not materialize. Te near disasterbrought about in the late 1990s by thecollapse o notorious hedge und Long-erm Capital Management (intellectually based on modern derivative theory) shouldhave raised some doubts. I that was notcompelling enough, the present crisisshould constitute its ultimate rejection.Te dominance o the rational-agentparadigm is intimately intertwined withan even more cumbersome ‘conceptualreductionism’. As there can only be oneway to act ully rationally, everyoneshould display exactly the same behaviour.Tereore, a representative agent would besucient. aking both aspects together,the typical ormat o current economicmodels is that o a single household or rmmaximizing its utility or prot over a niteor innite liespan. echnically, this is adynamic programming problem.
To the shocked public, it looksas if some Dr Strangeloveon Wall Street had pushedthe button on a nancialDoomsday Device.
© 2009 Macmillan Publishers Limited. All rights reserved
of 00
Economics Crisis
400 Reads
Info and Rating
| Category: | Uncategorized. |
| Rating: | |
| Upload Date: | 12/02/2009 |
| Copyright: | Attribution Non-commercial |
| Tags: |
Leave a Comment