“Not only have individual financial institutions become less vulnerable to shocks from underlying risk factors, but also the financial system as a whole has become more resilient”. Those were the words of Alan Greenspan, then Chaiman of the Federal Reserve of the United Stated (Fed) in 2004. Without the shadow of a doubt, the ravaging financial crisis that started in 2007 proved him wrong. How was that possible? Because every prognosis depended on the best case scenario.
Physics professor Jean-Philippe Bouchau argues that “the current financial crisis highlights the crucial need of a change of mindset in economics and financial engineering”. In this very interesting article, he proposes a scientific revolution. As he explains, in physics, the modus operandi is simple: if empirical observation is inconsistent with the model, the model is either amended or excluded. As a consequence, a multitude of strong assumptions have been proven wrong and discarded. There is no place for dogmas. In economics on the other hand, the case is quite different.
There is an array of assumptions that obsesses academics, policy-makers and financial institutions to the point that “the concepts are so strong that they supersede any empirical observation”. The only way to reach long-run financial stability would be if economics evolved to be more realistic and scientific. That is what the field of econophysics is all about. It tries to apply the methodology of physics to the study of economics. Some even propose the complete replacement of economics by econophysics. Could this be the future? Or do the empirical evidences searched by physicists don’t always exist in economics?