COWLES FOUNDATION FOR RESEARCH IN
ECONOMICS Box 208281
COWLES FOUNDATION DISCUSSION PAPER NO. 1647 The Virtues and Vices of Equilibrium and the Future of Financial Economics J. Doyne Farmer and John Geanakoplos March 20, 2008 The use of equilibrium models in economics springs from the desire for parsimonious
models of economic phenomena that take human reasoning into account. This approach has
been the cornerstone of modern economic theory. We explain why this is so, extolling the
virtues of equilibrium theory; then we present a critique and describe why this approach
is inherently limited, and why economics needs to move in new directions if it is to
continue to make progress. We stress that this shouldn’t be a question of dogma, but
should be resolved empirically. There are situations where equilibrium models provide
useful predictions and there are situations where they can never provide useful
predictions. There are also many situations where the jury is still out, i.e., where so
far they fail to provide a good description of the world, but where proper extensions
might change this. Our goal is to convince the skeptics that equilibrium models can be
useful, but also to make traditional economists more aware of the limitations of
equilibrium models. We sketch some alternative approaches and discuss why they should play
an important role in future research in economics. |
