Abstract

Economists not only failed to anticipate the financial crisis; they may have contributed to it—with risk and derivatives models that, through spurious precision and untested theoretical assumptions, encouraged policy makers and market participants to see more stability and risk sharing than was actually present. Moreover, once the crisis occurred, it was met with incomprehension by most economists because of models that, on the one hand, downplay the possibility that economic actors may exhibit highly interactive behavior; and, on the other, assume that any homogeneity will involve economic actors sharing the economist’s own putatively correct model of the economy, so that error can stem only from an exogenous shock. The financial crisis presents both an ethical and an intellectual challenge to economics, and an opportunity to reform its study by grounding it more solidly in reality.