Re: market "socialism," etc.

[Doug Henwood <dhenwood@xxxxxxxxx>]

Excellent stuff, Jim.

I'm emerging from my shell to add one point. Justin's faith in the
informational content of prices is touching. Developments in
financial theory over the last 15 or so years should counsel a bit
more skepticism. Efficient market theory has been importantly
discredited, and Shiller-style analyses of excess volatility and mean
reversion are taken a lot more seriously, even by the likes of Eugene
Fama. There are good psychological reasons behind overreaction -
e.g., the human tendency to value the most recent piece of
information excessively, at the expense of earlier knowledge. You
also have herding, fads, crowd behavior, etc. So there's lots of
noise mixed in with signal.

This newer thinking about financial market prices is not without real
world implications. As Terry Marsh and Robert Merton wrote in 1986:
"To reject the Efficient Market Hypothesis for the whole stock
market...implies broadly that production decisions based on stock
prices will lead to inefficient capital allocations. More generally,
if the application of rational expectations theory to the virtually
'ideal' conditions provided by the stock market fails, then what
confidence can economists have in its application to other areas of
economics...?"

Less than Justin does, apparently.

Doug