"When philosophy paints its grey in grey then has a shape of life grown old. By philosophy's grey in grey it cannot be rejuvenated but only understood. The owl of Minerva spreads its wings only with the falling of dusk." -- G.W.F. Hegel, 'Preface', Philosophy of Right.
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'Constant revolutionizing of production, uninterrupted disturbance of all social conditions, everlasting uncertainity and agitation distinquish the bourgeois epoch from all earlier ones ... All that is solid melts into air, all that is holy is profaned.' Marx
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idealised economics
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September 29, 2008
Modern economics has three strands according to John Cassidy in He Foresaw the End of an Era in the New York Review of Books. The benign and idealised view ofderegulated financial markets owes much to three Chicago economists: Milton Friedman, Eugene Fama, and Robert Lucas.
Cassidy says that although best known for his work on monetary theory and his enthusiastic espousal of capitalism, early in his career Friedman had played a key part in developing the "efficient markets hypothesis," which, together with its younger sibling the "rational expectation hypothesis"provided the intellectual underpinning for more than two decades of financial deregulation.
Briefly put, the efficient markets hypothesis states that prices of stocks, bonds, and other speculative assets necessarily reflect everything that is known about economic fundamentals, such as inflation, exports, and corporate profitability. The proof proceeds by contradiction. Suppose stock prices have risen above levels justified by the fundamentals. Then clever speculators, such as Soros, will step in and sell them, thereby restoring prices to their proper levels. If stocks fall below their fundamental value, speculators will step in and buy them.
Friedman actually formulated the efficient markets hypothesis in an analysis of currencies. It was Fama, one of his students, who applied it to the stock market and pointed out an interesting corollary:
if stock prices already reflect everything that is known and knowable, then investors can't hope to outperform the market using trading strategies based on publicly available information. Rather than wasting time and effort trying to pick individual stocks, they would be well advised to place their savings in a broadly diversified mutual fund that tracks the daily movement of the market. Largely thanks to Fama and his followers, so-called index funds today have a central part in many Americans' retirement planning.
Lucas, the third member of the Chicago triumvirate, was arguably more influential even than Friedman. He extended the hyperrational methodology underpinning the efficient markets hypothesis to other parts of the economy, such as the job market, the output decisions of firms, and the formulation of economic policy.
By the time they were done, Lucas et al. had invented a new way of doing macroeconomics, known as the rational expectations approach, which enshrined in higher mathematics the stabilizing properties of unfettered markets. You don't have to spend much time on Wall Street to recognize that expectations are what drive the markets. If investors anticipate good news, they buy; if they expect bad news, they sell. Where, though, do these economic expectations come from? According to Lucas, they reflect a predefined, externally grounded, and commonly agreed upon reality. ... Utilizing this common knowledge, people form "rational expectations" of things like inflation and interest rates. They don't always get things right—a certain amount of randomness is allowed for—but they are precluded from making systematic errors. If in one period the economy gets out of sync, in the next period it jumps back to the "equilibrium" defined by the model.
However, outside this idealized world knowledge is imperfect, people stick to wrongheaded ideas, and there is no agreed version of how the economy works. The response is to make the world conform to the theory since the problem is in the world not in the theory.
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| | Posted by Gary Sauer-Thompson at 12:22 AM | Permalink |
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