Economist Covers

The lead article this week discusses the damage done to the reputation of economics by "the biggest economic calamity in 80 years" that has resulted in the current worldwide recession.

It says that the core of economic theory is being re-examined. Too much emphasis has been placed on controlling inflation whilst ignoring asset bubbles like the housing market. Also at fault is the assumption of perfectly efficient capital markets used in most economic models. Human behaviour can result in asset values that do not reflect all available information, particularly when influenced by significant financial incentives in the form of large, short term bonus payments.

Another article blames mark-to-market accounting rules for the mess. These rules forced banks and insurance firms to book exaggerated losses as prices fell, in turn pushing them into insolvency and sending the financial system spiralling towards hell. If assets had been held at cost and only written down when losses were likely, things wouldn't have been so bad.