How economics got it wrong: Formalism, equilibrium modelling and pseudo-optimization in banking regulatory studies

Mohamed Aldegwy and Matthias Thiemann

No 138, SAFE Working Paper Series from Leibniz Institute for Financial Research SAFE

Abstract: Since the outbreak of the financial crisis, the macro-prudential policy paradigm has gained increasing prominence (Bank of England, 2009; Bernanke, 2011). The dynamics of this shift in the economic discourse, and the reasons this shift has not taken place prior to the crisis have not been addressed systemically. This paper investigates the evolution of the economic discourse on systemic risk and banking regulation to better understand these changes and their timing. Further, we use our sample to inquire whether, and if so, why the economic regulatory studies failed to recommend a reliable banking regulation prior to the crisis. By following a discourse analysis, we establish that the economic discourse on banking regulation has not been suitable for providing the knowledge basis required for a dynamically reliable banking regulation, and we identify the underlying reasons for such failure. These reasons include the obsession of economic discourse with optimization and particular forms of formalism, particularly, partial equilibrium analysis. Further, the economic discourse on banking regulation excludes historical and practitioners' discourses and ignores weak signals. We point out that post-crisis, these epistemological failures of the economic discourse on banking regulation were not sufficiently recognized and that recent attempts to conceptualize systemic risk as a negative externality and to thus price it point to the persistence of formalism, equilibrium thinking and optimization, with their attending dangers.

Keywords: Sociology of Finance; Optimal Regulation; Dynamic and Reliable Regulation; Banking Regulation; Financial Crisis (search for similar items in EconPapers)
Date: 2016
New Economics Papers: this item is included in nep-cba, nep-hme and nep-pke
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Persistent link: https://EconPapers.repec.org/RePEc:zbw:safewp:138

DOI: 10.2139/ssrn.2786534

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