Tuesday, September 6, 2011

Equilibrium

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.