Global Ethics Corner: The Power of Economic Models

Apr 22, 2011

Economic models were the basis for crucial practical decisions that led to the 2008-09 financial crisis. Yet government bailouts remain controversial because free market advocates see intervention as wrong. Do you agree with the need to manage markets? Or should the economy be guided only be the "invisible hand"?

Economic models become the basis for crucial practical decisions.

Models were at work in the 2008-09 financial crisis. Banks, automakers, and insurers were protected based on assumptions about economic consequences.

You cannot prove a negative. So we'll never be sure if President Obama's decisions prevented the Great Recession from turning into a second Great Depression.

The government bailouts remain controversial because free market advocates see intervention as wrong. Market models clashed with behavioral models. In hindsight, both seem inadequate.

John Authers in the Financial Times notes that "…economics' most basic assumption is flawed,"i.e. the idea that "all other things are equal," and markets are rational. This idea is behind the market model, and contends that, "Nobody has yet come up with a more efficient way to allocate capital than the market."

Authers continues, "Against this came the behaviouralists, who substituted the findings of behavioural psychology for the assumptions of rationality." These assumptions mandate "nudging" markets to correct for human bias and herd behavior.

Both sets of assumptions, market and behavioral, are just that, assumptions. Neither seems adequate. Authers suggests it's time "to break free from this debate and find a new way to model markets."

Yet, our perceptions lag far behind our economic challenges, and the dichotomy continues to animate political rhetoric.

What do you think? Do you accept the free market assumptions? Do you agree with behavioralism and the need to manage markets?

By William Vocke

For more information see:

John Authers, "We Need New Models in an Uncertain World," Financial Times, March 11, 2011.

Bhide, Amar. (2010). A Call for Judgment: Sensible Finance for a Dynamic Economy. New York: Oxford University Press

Frydman, Roman. & Goldberg, Michael D. (2011) Beyond Mechanical Markets: Asset Price Swings, Risk, and the Role of the State. Princeton: Princeton University Press

Photo Credits in order of Appearance:
Chiva Congelado
Mike McCune
Pete Souza
Public Citizen
Richard Thaler & Cass Sunsteien

Brian Hillegas

You may also like

MAY 6, 2022 Podcast

For Companies, Could China Be the Next Russia? with Perth Tolle

After Russia's invasion of Ukraine, the global financial backlash was swift and unprecedented: Dozens of financial institutions cut off their exposure to the Russian market ...

CREDIT: <a href="">pxhere (CC)/Public Domain</a>

JAN 31, 2020 Article

In Favor of the Public Interest: Social Media Should be Regulated

"The sheer size of the social media market in news delivery, as well as the numerous instances of social media being used for harmful ends, ...

Terms and Conditions. CREDIT: <a href=>Dave Goodman (CC)</a>.

JAN 31, 2020 Article

Sharing is Caring: Governing the Internet

This essay written by Sasa Jovanovic is the second prize winner of the undergraduate category in the 2019 student essay contest. What are the benefits of ...