Equilibrium is a concept that economists believe in so that they can get their easy math to work, so they can publish. The truth is that the economy and financial markets are always outside of equilibrium.? Capitalist economies are complex, and do not fit the models of neoclassical economists.? Goods and services come and go.? Improvements in offerings are common.
For those that work in the asset markets, it should be abundantly clear that equilibrium is a weak concept at best, reacting slowly over many years.? Mean reversion is slow — four years or so seems to be the periodicity.
Let the economists demonstrate that most markets display equilibria.? It is such an important element of their system, and yet so unproven.
My view is that markets are almost always not in equilibrium.? Being outside equilibrium causes economic actors to allocate or deallocate assets in order to maximize gains or minimize losses.?? But the lengths of time for the information to flow, and production decisions to adjust are too long.
The same applies to theories in finance.? There is no equilibrium, so why argue for it?? Let the finance theorists step forward and show the times where the market was in equilibrium.
Personally, I think that disequilibrium is far more realistic.? This includes actions driven by the Fed or the US Government.
I agree entirely. It’s connected with the ideas of Newtonian physics, which Adam Smith admired but have been outmoded in physics for 100 years now.
I wrote about this in a paper called ‘Markets, Prices and Market Power’, which can be downloaded at http://www.tomlines.org.uk/page2.htm.
I have a degree in Chemistry and Mathematics and have worked in applied math and analytics for decades. The scientific principle has been key to tremendous advances in almost every area of study since the time of Newton. And yet we have economics with only the beginnings of a solid mathematical and analytical foundation. Hint – http://en.wikipedia.org/wiki/Scientific_method
Just as alchemy sought the mythical philosopher?s stone to turn lead into gold and grant youth and immortality, we see the modern economist trying much the same. There are only a handful of modern day equivalents to Robert Boyle (who attacked the alchemy that was taught at every major university around the world).
David, I don’t know anyone that believes that the markets are truly in equilibrium. Markets (and economies) are dynamic, adjusting, organic wholes, that respond to incentives and stimulus. They’re more like a dynamic ecosystem than a machine.
But equilibrium can be a useful hypothesis to show you where the flows in and out must come from. Case in point: I once built a dynamic model of an aquatic ecosystem that higher-order math (Kolmogoroff’s Theorum of Limit Cycles figured prominently). But I still initiated the model in equilibrium, which I could solve with simple algebra. Why? to make sure that my inputs balanced my outputs.
When I solved that trivial mathematical model, I realized that I had left out a critical output. After including this element, I then initiated the disequilibrium and used the model to evaluate various proposed experiments.
The equilibrium wasn’t “correct,” but it was analytically useful. If I started with the gyrations, I never would have realized what I was missing.
I think of neo-classical economics in the same light. Not “right,” but useful. Not “precise” but “accurate.” We all construct mental models that help us make decisions. The simplifying assumptions of equilibrium conditions can give us information we wouldn’t otherwise have.