Columnist John Kay writes about the quest to develop a macroeconomic theory of everything, "based on extreme rationality and market efficiency" — and why economists mostly failed to anticipate the failure of financial markets.
That people respond rationally to incentives, and that market prices incorporate information about the world, are not terrible assumptions. But they are not universal truths either. Much of what creates profit opportunities and causes instability in the global economy results from the failure of these assumptions. Herd behaviour, asset mispricing and grossly imperfect information have led us to where we are today.
There is not, and never will be, an economic theory of everything. Physics may, or may not, be different. But the knowledge we can hope to have in economics is piecemeal and provisional, and different theories will illuminate different but particular situations. We should observe empirical regularities and – as in other applied subjects such as medicine and engineering – we will often find pragmatic solutions that work even though our understanding of why they work is incomplete.
— John Kay, "How economics lost sight of the real world," Financial Times
(h/t Hal Davis, via Adrian Monck)
