Saturday, December 4, 2010

According to the Journal, Maybe Economics Isn't So Dismal After All

Did you ever feel that a Corvette could chase the blues away? Mon dieu! The Wall Street Journal has actually begun exploring different theories of how the economy functions based on the concept that people are driven by emotion, especially when it comes to money.

Neo-classical belief which has been the prevailing theory for years, posits that people are rational actors and make stolid, price-based decisions on every purchase, which enables the markets to work smoothly. The beauty of this theory is that the workings of the economy can be reduced to the inexorable logic of mathematical equations. Very elegant. Not the real world.

Unfortunately, such logic did not work in terms of the ongoing housing crisis. Models were created by MIT PhD's best and brightest, but the data that girded these paradigms had cracked foundations. They had 20 years of housing data to work with, so they fed those 20 years into the gaping maw of their machines. Because housing prices did not fall during that time, the assumption of the model was the housing prices would NEVER fall. The beauty and comfort of mathematics smacked headlong into unforeseen events (which include many things too numerous to mention, like fraud, greed, lying and other criminal behavior).

After all, it's statistically impossible to feed every conceivable variable about thousands of mortgages that comprised one mortgage backed security. One person may pay his/her bills on time, the other may be on welfare, another is profligate (you get the picture).

So the Journal has given three economists who would be considered on the fringes a chance to explain their theories, which include real-life human behavior. I will take them up in another post.

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