How Economics Got It Wrong: Formalism, Equilibrium Modelling and Pseudo-Optimization in Banking Regulatory Studies

SAFE Working Paper No. 138

41 Pages Posted: 2 Jun 2016

See all articles by Mohamed Aldegwy

Mohamed Aldegwy

Goethe University Frankfurt, House of Finance, Students

Matthias Thiemann

Goethe University Frankfurt

Date Written: May 30, 2016

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

Suggested Citation

Aldegwy, Mohamed and Thiemann, Matthias, How Economics Got It Wrong: Formalism, Equilibrium Modelling and Pseudo-Optimization in Banking Regulatory Studies (May 30, 2016). SAFE Working Paper No. 138. Available at SSRN: https://ssrn.com/abstract=2786534 or http://dx.doi.org/10.2139/ssrn.2786534

Mohamed Aldegwy

Goethe University Frankfurt, House of Finance, Students ( email )

Frankfurt
Germany

Matthias Thiemann (Contact Author)

Goethe University Frankfurt ( email )

Grüneburgplatz 1
Frankfurt am Main, 60323
Germany

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