Dumb and Dumber — the Chicago version

15 October, 2015 at 18:15 | Posted in Economics | 3 Comments


lucasbob-1Macroeconomics was born as a distinct field in the 1940s (sic!), as a part of the intellectual response to the Great Depression. The term then referred to the body of knowledge and expertise that we hoped would prevent the recurrence of that economic disaster. My thesis in this lecture is that macroeconomics in this original sense has succeeded: Its central problem of depression-prevention has been solved, for all practical purposes, and has in fact been solved for many decades.

Robert Lucas (2003)

In the past, I think you have been quoted as saying that you don’t even believe in the possibility of bubbles.

eugeneEugene Fama: I never said that. I want people to use the term in a consistent way. For example, I didn’t renew my subscription to The Economist because they use the world bubble three times on every page. Any time prices went up and down—I guess that is what they call a bubble. People have become entirely sloppy. People have jumped on the bandwagon of blaming financial markets. I can tell a story very easily in which the financial markets were a casualty of the recession, not a cause of it.

That’s your view, correct?

Fama: Yeah.

John Cassidy



  1. There never seems to be any recognition that financial markets get in trouble because of illegal transactions. In the 2008 fiasco, the rating agencies were irresponsible, many banks lending practices were irresponsible, the bundling of the securities or securitization was irresponsible, and the credit swap insurance schemes were irresponsible, and the banks were not holding enough equity which was irresponsible. The destruction of the underwriting rules was irresponsible.

    One question has to do with the decision-making and policy-formation of firms and banks. Another question has to do with government regulatory and supervisory agencies. And another question has to do with how people use the system of banking. Some banks permit people to do whatever they want without any foresight into the effects on social-economic conditions by these actions. The banks act as if there is no such thing as an ethical violation or a breaking of the rules!

  2. It is a very odd thing, this inability to see financial markets as institutional mechanisms, with a degree of technical efficiency related to their design and management. Fama plays a peculiar role in maintaining this blind-spot. His seminal paper outlining the efficient markets hypothesis seems to be a technician’s manual for devising a null hypothesis for research investigating financial market prices. It is perfectly reasonable to suppose that financial markets are somewhat efficient — otherwise what function would they have? The interesting questions would seem to be, “how efficient?” and more practically, “how does mechanism design or management relate to how efficient a financial market is at processing information and hedging uncertainty?” But, somehow, ideology — including Fama’s own political ideology apparently — dictate the wilful stupidity of asserting the null hypothesis as a positive and a priori assertion, unconditioned on any consideration of mechanism design or management. Nothing can be inspected; experience cannot be interpreted.
    We are tutored to believe that financial markets are efficient, with no qualification as to degree, and with no insight into what policies of market regulation or design contribute to efficiency. Literally, we are instructed “no body knows nothing” — the “lesson” of the efficient markets hypothesis is that nobody can beat the market, the market is magic, worship the market. We’re not supposed to say, “bubble”, because no one’s judgment is superior to that of the magically efficient market. The legions of investment bankers and fund managers raking in the big bucks is somewhere between a harmless (?) fraud and an illusion.
    Critics of the efficient markets ideology don’t help the situation by flat, unelaborated contradictions. Just saying financial markets are not-efficient is not the least bit useful or intelligent. Economists should be able to relate financial market efficiency to the design and management of the institution, to say how-efficient as a matter of quantifiable degree. Efficiency is not a quality of an actual institution, and thinking as if it is, just makes everyone stupid.
    Fama is not wrong to complain that “bubble” is often used loosely, to express subjective and ungrounded judgments. For many, manias are just the unwisdom of crowds and mobs — there’s even less consideration of institutional mechanism than in Fama’s agnotology and even a figure such as Schiller seems to resort quickly to a fatuous psychology. I really do not understand why the study of actual markets is so hard for economists, who prattle on about metaphoric and mythic markets at such length, but may be that’s the problem: they think math is a language in which to write poetry.

    • Perhaps, one question is why the price of a stock or stocks in a sector of the market are valued highly and sought. It may be that agency costs for a set of firms is decreased by shareholder agreement (?) which makes the stock value rise. The basic logic to picking stocks is to locate undervalued firms and buy their stocks.

      Wikipedia’s definition of “bubble:”


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