Any student of financial history would have to conclude that financial crises and the volatility created by the instabilities of finance in recent years are an organic and harmful element of our social system. Wars and financial crises are time and again the greatest sources of disruption of the social order. Since the power of finance and the disruptive forces of our financial system are so pervasive, it is perhaps surprising that the prevailing economic paradigm since the 1920s tended to model the financial sector as either nonexistent or as a finely tuned seer who can anticipate anchored expectations infinitely far into the future to render they system stable.
This is a Panglossian fantasy rather than science. Stability is assumed instead of being derived from scientific observation. In essence, the prevailing economic paradigm creates a parable of the financial sector that represents how we would like it to behave rather than explain how it does behaves. It looks like a reflection from Narcissus's pool.
There have been several thinkers and extraordinary investors over time that have challenged this absurd portrait of the financial process, including John Maynard Keynes, Frank Knight, Hyman Minsky, George Soros, Seth Klarman, and Charles Munger. But this alternative perspective did not flatter the powerful interests of the financial sector, and more importantly, it did not assuage the anxieties of a society that desperately yearns for the reassurance that the future will be understandable, stable, and orderly. These alternative visionaries may have created a perspective that better describes reality than the orthodox tenets of equilibrium finance, but their visions did not satisfy the emotional needs of society and were set aside. As John N. Gray once wrote:
Illusions aren't errors that can be corrected by an increase in the intellectual ability or understanding. Illusions are beliefs we have because we need to have them in some way.
In 2008, we realized that these illusions were dangerous and costly. The false reassurance they provided ironically proved to be a very destabilizing force. In light of the calamitous evidence, our needs have changed. The simple assumption that we can anchor the economic system with certainty in the future is a convenience for mathematical modeling. But it is absurd. It led to the creation of bad maps of financial behavior -- and in 2008 our ship slammed into the rocks.
In this, the first of a series of mini-documentaries from the Institute for New Economic Thinking (INET) that will focus on important areas of economic exploration, leading scholars such as Joseph Stiglitz, John Kay, Steve Keen, Stephen Kinsella, Dirk Bezemer, and David Weinstein, and anthropologist and writer Gillian Tett, discuss why economics has failed to capture the real, volatile nature of financial markets.
In this video, these new economic thinkers -- many of whom are INET grantees or prominent members of the INET community -- explain in plain English why the mechanical metaphors of neoclassical economic models are bad maps for the financial system. They recognize the need to create a more integrative and relevant economics that places real human beings and real institutions at its center, not the narrowly defined, misleading, and simplistic abstractions from reality that the profession has clung to in the recent past.
Some assumptions simplify and are helpful and illuminating. Others introduce harmful distortions. We need to move beyond blind faith in the presuppositions of these financial models. It is time to puncture the blind spots and explore the taboos that have together contributed to this false portrait of financial process and regulatory design. The foundations that have been implicitly accepted must now be vigorously challenged in light of the damage they enabled. We need new economic thinking, however unsettling. The most sophisticated and honest scholars know this.
INET is there to give this process support and a nudge. We believe that a renewed economics can help society address the challenges of financial instability, social incoherence, and sustainable resource use. Economics can emerge from this technocratic and mechanical phase to a better place. Economics can grow again and provide better maps. It will take hard work and courage to rebuild. It is the duty and the responsibility of expertise, if it is to play a meaningful role, to help society navigate to a safer, more humane, and more satisfying course than the one we have been on in recent years.