Finance and economics What's wrong with finance

An essay on what economists and financial academics learned, and haven't learned, from the crisis. The best hope lies with the behavioural school

BOTH financiers and economists still get the blame for the 2007-2009 financial crisis: the first group for causing it and the second for not predicting it. As it turns out, the two issues are connected. The economists failed to understand the importance of finance and financiers put too much faith in the models produced by economists.

If this seems like an ancient debate, and thus irrelevant to today's concerns, it is not. The response of central banks and regulators to the crisis has led to an economy unlike any we have seen before, with short-term rates at zero, some bond yields at negative rates and central banks playing a dominant role in the markets. It is far from clear that either economics or financial theory have adjusted to face this new reality.

The best hope for progress is the school of behavioural economics, which understands that individuals cannot be the rational actors who fit neatly into academic models. More economists are accepting that finance is not a “zero sum game”, nor indeed a mere utility, but an important driver of economic cycles. Indeed, finance has become too dominant a driver.

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