The Man Who Won a Nobel Prize for Helping Create a Global Financial Crisis

I wanted to share this thoughtful article with readers of this forum.

The nobel prize in economics went to three different economists. Two who have very different models of reality.

Having little understanding of economics specifically but a fair understanding of General Systems theory it concerns me when an economist can be awarded, arguably, the height of scientific honors when his assumptions are not scientific in the least, when they contradict the basic ideas of how Systems work.

I remember a finance class in college, I had a running debate with my proffessor on the very Basis of the "Science". Oh the math was easy and added up, but the staring point (in ALL cases) was based on "Somebodies Best Guess" not on factual or verifiable reality. It flustered my professor, he couldn't offer a counter argument other then "They are experienced".

Is economics a science? Does a science need to be based in fact, empirically verifiable fact?

My conclusion: Our economic "science" is based, it's assumptions, are fantasy, delusion.

The Man Who Won a Nobel Prize for Helping Create a Global Financial Crisis
by James Crotty

www.commondreams.org...

One might think that the whole financial market-efficiency project should have been rejected out of hand because it is founded on a large set of unrealistic assumptions about how financial markets work. Yet not only is it still the dominant theory of financial markets, Nobel Prizes have been awarded to its originators. Why would an academic profession sanction the use of theories based on such unrealistic assumptions? The answer given by proponents of efficient financial markets theory is that the economics profession relies on the theory of “positivism” associated with Milton Friedman as its guide to the acceptance and rejection of theoretical propositions. Friedman’s positivism states that the realism of assumptions does not matter: it has no relation whatever to the acceptability of a theory or its derived hypotheses. As Friedman put it, “[T]ruly important and significant hypotheses will be found to have assumptions that are wildly inaccurate descriptive representations of reality.” The only acceptable test of a theory “is comparison of its predictions with experience.”

There are at least three serious problems with this method. First, if patently false assumptions are adopted, as in efficient financial market theory, and impeccable logic is used to deduce hypotheses from them, they cannot—as a matter of logic—be accurate reflections of reality. Fairy-tale assumptions can only generate fairy-tale hypotheses.

Third, when positivist economists insist that econometric “prediction” is the sole judge of the acceptability of a theory, they put the entire burden of proof on econometric tests. But when the preponderance of such tests turns out to be inconsistent with their favorite theory, they never reject the theory, as their methodology says they must.

Then I add this for good measure from the NYtimes of all places:

www.nytimes.com...

Mr. Fama’s seminal theory of rational, efficient markets inspired the rise of index funds and contributed to the decline of financial regulation. Mr. Shiller, perhaps his most influential critic, carefully assembled evidence of irrational, inefficient behavior and gained a measure of fame by predicting the fall of stock prices in 2000 as well as the housing crash that began in 2006.

reply to post by FyreByrd


I wanted to add a little more from James Crotty's article:

(James R. Crotty is a Professor Emeritus of Economics and Sheridan Scholar at University of Massachusetts.)

www.commondreams.org...

Why would an academic profession adopt a methodology such as positivism that supports theories that are based on unrealistic assumptions?

After all, there is an obvious alternative—begin with a realistic assumption set and use it to derive realistic hypotheses about the behavior of financial markets. This is the method used by Keynes and Minsky to show that financial markets have no efficiency properties and are properly thought of as gambling casinos.

The answer is that the economics profession is committed ideologically to a defense of the proposition that financial markets are efficient, yet it is impossible to derive this proposition from a realistic assumption set.

Thus, the profession had no choice but to adopt a positivist methodology that sanctioned the use of even absurdly unrealistic assumptions in theory construction. Since realistic assumptions lead to theories that show the strengths, but also the myriad dangers and failures of unregulated capitalism revealed in the historical record, they had to be replaced by the large number of absurd assumptions required to sustain support for economists’ inherent belief that unregulated or lightly regulated markets create the best of all possible worlds, maximizing both economic efficiency and individual liberty. Positivism is the magic that makes it possible to construct a “scientific” defense of the proposition that free-market capitalism has no serious flaws and dangers.

reply to post by FyreByrd


Let me explain what Friedman was saying:

Economics is not a science. It's not even mathematical because it involves too many reliances on psychology and sociology. In economics for instance, 1+1 = 2 .. unless someone in the room says it equals 3, and if enough people agree, it equals 3, regardless of whether or not it does or does not. In 2008 for instance we violated nearly every economic norm that existed within our economic model. Today the economy operates in a way that defies most traditional theories .. our economy should not be growing, there should be massive inflation, corporations should have spent their massive stores of capital. But because of Human Nature, none of the came to pass, in fact the opposite happened. It's like waking up one day and up is down and down is up. The fact that the economy survived the economic crash of 2008 is more a psychological mystery than an economic one. It was like the entire World shrugged their collective shoulders and said "we'll just listen to whatever you say and go with it." And ... it worked. Even though theoretically it shouldn't have.

So an economic model that makes no sense cannot be wrong until it's tried. If it's tried through experience we can determine if it works, and whether it works primarily has to do with social acceptance instead of mathematical precision.