The Realism of Assumptions Does Matter: Why Keynes-Minsky Theory Must Replace Efficient Market Theory as the Guide to Financial Regulation Policy
AbstractThe radical deregulation of financial markets after the 1970s was a precondition for the explosion in size, complexity, volatility and degree of global integration of financial markets in the past three decades. It therefore contributed to the severity and breadth of the recent global financial crisis. It is not likely that deregulation would have been so extreme and the crisis so threatening had most financial economists adopted Keynes-Minsky financial market theory, which concludes that unregulated financial markets are inherently unstable and dangerous. Instead, they argued that neoclassical efficient financial market theories demonstrate that lightly regulated generate optimal security prices and risk levels, and prevent booms and crashes. Efficient market theory became dominant in spite of the fact that it is a fairly-tale theory based on crudely unrealistic assumptions. It could only have been adopted by a profession committed to Milton Friedman’s fundamentally flawed positivist methodology, which asserts that the realism of assumptions has no bearing on the validity of a theory. Keynes argued persuasively that only realistic assumptions can generate realistic theories. Keynes-Minsky theory, which is derived from a realistic assumption set, should be the profession’s guide to regulation policy.
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Bibliographic InfoPaper provided by Political Economy Research Institute, University of Massachusetts at Amherst in its series Working Papers with number wp255.
Date of creation: 2011
Date of revision:
efficient financial market theory; Keynes-Minsky financial theory; Friedman's positivism; financial regulation; financial crises;
Other versions of this item:
- James Crotty, 2011. "The Realism of Assumptions Does Matter: Why Keynes-Minsky Theory Must Replace Efficient Market Theory as the Guide to Financial Regulation Policy," UMASS Amherst Economics Working Papers 2011-05, University of Massachusetts Amherst, Department of Economics.
- B41 - Schools of Economic Thought and Methodology - - Economic Methodology - - - Economic Methodology
- B5 - Schools of Economic Thought and Methodology - - Current Heterodox Approaches
- G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)
- G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
- G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
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