What’s Wrong with Today’s Economics?The CurrentCrisis Calls for an Approach to Economics Rooted Moreon Data Than on Rationality

Focardi and Fabozzi argue that current mainstream economics is not a science in the sense of the physical sciences, and they draw some conclusions from the point of view of asset management. Their key point is that economics as embodied in the general equilibrium theories describes an idealized rational economic world as opposed to one based on empirical data. Although this argument has already been made, it has been virtually ignored by economists. The current crisis, however, requires an economic understanding anchored on a solid empirical basis. The authors review a number of facts, including the following: 1) market efficiency is a quantitative concept, with efficiency defined in terms of the magnitude of realistic profit opportunities; 2) the dynamic vector-like nature of inflation challenges current theories about inflation and the generation of money, making growth path-dependent; 3) economic conservation laws are key to understanding growth; and 4) a market economy cannot support an unbounded level of wealth and income inequality because they become a destabilizing factor. The overall lesson for asset management is that economics matters and that the culture of pure speculation would be replaced profitably for society as a whole with a true culture of investment. TOPICS:Financial crises and financial market history, volatility measures, big data/machine learning