Eugene Fama and the Economics of Denial

27 August, 2012 at 11:26 | Posted in Economics | 3 Comments

George Soros has put generous funding behind the Institute for New Economic Thinking (INET). The Bank of England has also tried to stimulate fresh ideas. The proceedings of a conference that it organized earlier this year have now been edited under the provocative title What’s the Use of Economics?

Some of the recommendations that emerged from that conference are straightforward and concrete. For example, there should be more teaching of economic history …

Many conference participants agreed that the study of economics should be set in a broader political context, with greater emphasis on the role of institutions. Students should also be taught some humility. The models to which they are still exposed have some explanatory value, but within constrained parameters. And painful experience tells us that economic agents may not behave as the models suppose they will.

But it is not clear that a majority of the profession yet accepts even these modest proposals. The so-called “Chicago School” has mounted a robust defense of its rational expectations-based approach, rejecting the notion that a rethink is required. The Nobel laureate economist Robert Lucas has argued that the crisis was not predicted because economic theory predicts that such events cannot be predicted. So all is well …

We should not focus attention exclusively on economists, however.
Arguably the elements of the conventional intellectual toolkit found most wanting are the capital asset pricing model and its close cousin, the efficient-market hypothesis. Yet their protagonists see no problems to address.

On the contrary, the University of Chicago’s Eugene Fama has described the notion that finance theory was at fault as “a fantasy,” and argues that “financial markets and financial institutions were casualties rather than causes of the recession.” And the efficient-market hypothesis that he championed cannot be blamed, because “most investing is done by active managers who don’t believe that markets are efficient.”

This amounts to what we might call an “irrelevance” defense: Finance theorists cannot be held responsible, since no one in the real world pays attention to them!

Howard Davies



  1. Fama remains unapologetic and has launched a defence that is grounded in ignoring rather than addressing the empirical weakness of his theories. A brief summary from the orthodoxy in financial economics follows:

    Meanwhile, his Chicago School bretheren remain alive with dead ideas:

    Fama will probably be a recipient of The Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel in the future for no reason other than cementing the primacy of this form of analysis and propagating the ideas amongst future leaders in the establishment.

    • Nice links.And re Nobel prize – I’m afraid you ‘re gonna be right!

  2. And…Arjit Banik calls it.

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