Do you believe? Is economics on sound foundations?

As Congress investigates what went wrong with the banking and financial system that caused the current malaise, voices have arisen calling economics and the academic thought leadership of the discipline itself to task. Did economists fall in love with their own models and fail to heed the common sense signs that the groundrules and assumptions upon which they depended so heavily were crumbling? Did this failure of objectivity come, as some have accused, from a collective cultural flaw rooted in the vanity of intellectual elitism? Can economists, like bankers, eventually regain the public's confidence or will they become another group of nutty professors playing with flubber that doesn't bounce? The recession is over but one out of seven of you won't work for another year. Yay! Not!

The serious question of course is what practical safeguards make sense so that we are less likely to be blind sighted by this kind of failure to heed the obvious again? What say you?

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Permalink Reply by Gary Schurman on September 22, 2009 at 4:47pm: Wicked Witch: Mirror, mirror on the wall, who's the fairest of them all?
Mirror: Baby, you are!

How did the mirror come up with that answer? The mirror's first answer was "Baby, it ain't you". Being that this response was unacceptable the Witch had the mirror redefine "fairest" and then redefine "them all" until the Witch got the answer she wanted.

Do I think that economics is on a sound foundation? Yes, I do. Its the users of the models who aren't. Models are tools that help us to think, they don't do the thinking for us. I can't tell you how many times that I had to re-run a model with ever differing assumptions until I finally got "the right" answer.

Hey, blame the models and proclaim "I only did what it (the model) told me to do!" Is the math complicated? Yes, but you have to have some understanding of it to know when assumptions are being violated. Does the user have to be an expert in stochastic differential equations or Ito calculus? No, but if you are going to use the models and base decisions on the model results you at least have to know something about it.

At the end of the day its investors who have to be smarter. There is no one to blame but them. Investment Bankers want the models to give them the answer that allows them to sell product. The rating agencies want the models to give the answer that allows them to rate deals. These people don't care about "THE RIGHT" answer because they are not at risk. Investors are and they have to be smarter.

This reminds me of the Treasurer of Orange County who blamed Investment Bankers for selling him derivative products that he didn't understand. "They should have known I was an idiot!"; ▶ Reply to This