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By Joseph Stiglitz
Published: August 19 2010 22:18 | Last updated: August 19 2010 22:18
The blame game continues over who is responsible for the worst recession since the Great Depression "“ the financiers who did such a bad job of managing risk or the regulators who failed to stop them. But the economics profession bears more than a little culpability. It provided the models that gave comfort to regulators that markets could be self-regulated; that they were efficient and self-correcting. The efficient markets hypothesis "“ the notion that market prices fully revealed all the relevant information "“ ruled the day. Today, not only is our economy in a shambles but so too is the economic paradigm that predominated in the years before the crisis "“ or at least it should be.
It is hard for non-economists to understand how peculiar the predominant macroeconomic models were. Many assumed demand had to equal supply "“ and that meant there could be no unemployment. (Right now a lot of people are just enjoying an extra dose of leisure; why they are unhappy is a matter for psychiatry, not economics.) Many used "representative agent models" "“ all individuals were assumed to be identical, and this meant there could be no meaningful financial markets (who would be lending money to whom?). Information asymmetries, the cornerstone of modern economics, also had no place: they could arise only if individuals suffered from acute schizophrenia, an assumption incompatible with another of the favoured assumptions, full rationality.
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