Wikinvest Wire

Just dismal...

Friday, August 07, 2009

In a guest article at the The Economist, in response to at least three less-than-flattering assessments of the profession in recent weeks, Chicago University Economic Professor Robert Lucas defends economic models and their contributions to Mankind.

One thing we are not going to have, now or ever, is a set of models that forecasts sudden falls in the value of financial assets, like the declines that followed the failure of Lehman Brothers in September. This is nothing new. It has been known for more than 40 years and is one of the main implications of Eugene Fama’s “efficient-market hypothesis” (EMH), which states that the price of a financial asset reflects all relevant, generally available information. If an economist had a formula that could reliably forecast crises a week in advance, say, then that formula would become part of generally available information and prices would fall a week earlier.
How about throwing out all of the failed models along with efficient market theory and setting a modest goal of looking at how asset prices and people interact in an effort to spot the next giant speculative bubble before it destroys the world?

It didn't take any models or elaborate theories to conclude that when Fannie and Freddie couldn't file financial statements back in 2003 due to their use of derivatives, there was something seriously wrong and the correct remedy was not to outsource their operations to Wall Street, away from the prying eyes of regulators.

When in 2005 and 2006, mortgage lenders joked that "anyone who could fog a mirror could get a loan", it was already too late, but the damage done in 2008 might have been mitigted if these activities were not broadly characterized as "financial innovation" amongst economists.


Anonymous said...

It is ridiculous to suggest that economists cannot spot abnormalities - especially when they are likely more than 3 sigma deviations. That is the reason why don't think I would call Greenspan or even Bernanke an economist. They have to be first rate statisticians. What they do not display is commonsense, even forget about economics.

A liberal thinktank (Dean Baker) produced a study in 2002-2003 that showed that housing prices were producing gains from 1995-2002 that were not even closely comparable to last 40 years before that period. And, think about how much bubble we build after that period. It is just mindboggling to think about it. And, that is why I have no respect for these fed reserve economists who do not understand economics, and also do not seem to have commonsense. But, their actions can have profound impact in the long term. Of course, we were happy that they were bulding the bubbles for last 2 decades.

Anonymous said...

The logical flaw in the whole math-modeling wing of economics was exposed by F.A. Hayek, not Eugene Fama.

E.g. The Use of Knowledge in Society, F.A. Hayek, 1945.

Anonymous said...

Keynesians make a big deal out of differentiating between the short run and the long run. You can't spot bubbles by looking only at the short run. Keynesians follow short run policies that are a disaster in the long run. Keynesians don't worry too much about long run consequences.

The long run still eventually comes.

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