Almost 2,500 years ago, a man named Socrates said “the only thing I know is that I know nothing.” Records are surprisingly empty in detailing the response elicited from his friends, who must have seen him as stupid or pretentious, if not both. However, the actions taken by the Royal Swedish Academy of Sciences would make Socrates proud today, if dead people can be proud.
That is because this year the Academy has given their prize in economic sciences (colloquially, but incorrectly, referred to as the Nobel Prize in Economics; for simplicity, I will continue to do so here) to three economists whose works, to many, seem completely at odds with one another. In many ways, this action can be interpreted as one that suggests all of our research and theories really only indicate how little we know.
Although some might see this as problematic, I think this is the most brilliant selection for a Nobel Prize since we gave one to Teddy Roosevelt for his mustache — I mean peace efforts.
The prize was awarded to three professors — Eugene F. Fama, Lars Peter Hansen, and Robert J. Shiller. This is a rather unusual selection, not because it was awarded to multiple people (which is extremely common), nor because the committee stooped so low as to give the award to not one, but two professors from the University of Chicago. The real reason is because, though all three received the award for research and empirical analysis in asset prices, their conclusions are quite at odds.
The particulars of this research are extremely complicated — that it received the Nobel Prize might indicate as much — but the main crux of the conflict involves theories of efficiency. Fama, whose recognized research is the earliest conducted, laid the foundation for what we call the “efficient market theory.” He proposed that markets are generally efficient and daily price movements are random, which means it is virtually impossible for any investor to gain an advantage over others, and that assets such as stocks are properly valued.
Shiller, on the other hand (and the odd one out as a member of Yale’s faculty), is one of the most notorious critics of Fama’s theory. He suggested that due to “irrational exuberance,” investors behave in irrational ways that cause unsubstantiated run-ups in prices. For us plebeians who won’t be going to Stockholm this December, we generally call those “bubbles”; some of you might be aware of one that happened pretty recently.
In reality, the two aren’t completely at odds, but provide a picture of asset pricing that is very complex and nuanced. Their work suggests that an asset may be efficiently priced in the short-term, but not in the long run. This means that although it’s virtually impossible to predict price movements over the course of a few weeks, it is certainly possible to do so over a few years. Hansen’s contribution is a complex statistical method that allows people to test theories on what drives asset prices, and the notion of potential predictive power it provides further suggests that markets may not be completely efficient or inefficient. Although these contributions are not entirely contradictory, it’s easy to see that they are somehow at odds.
I recognize that some of you may not have that much faith in my understanding of economics or familiarity with the research of any of these economists to pass judgment. You are entirely correct. However, I’m not the only person to bring this up; Nobel Laureate Robert Solow did as well. Does that mean I’m as smart as Robert Solow? I’ll let you decide.
Given the economic whirlwind we’ve seen, not only in this nation, but also globally over the last half-decade, it seems fitting to recognize the work of these men. Though it’s true that we’ve made immense progress in understanding the world around us, not just in economics but in all of the Nobel categories and other disciplines as well, there is still so much we don’t know. In a world where politicians are spewing their predictions for Obamacare with a surprising amount of certainty, and pundits refuse to be wrong — even when they are — it’s easy to forget that much of the world in which we operate is uncertain. And that maybe it’s not so bad after all.