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The financial crisis in the West poses uncomfortable questions not just for economic policy but for the discipline of economics itself. For in the run up to the crash a consensus developed among economists about how to manage a market economy. And many of the key decision makers were trained economists who drew on the latest economic research and models to guide them. The consensus was that stabilizing the economy should be left to an independent Central Bank charged with keeping inflation low. Beyond that, market forces could be relied on to keep the economy near its sustainable growth path. Regulation should be confined to mitigating proven market failures.
When I joined the Bank of England in 2006, after a decade or more of the ‘Great Stability’, this approach seemed a proven success. It looks very different five years later. The modern economic models gave no warning of what was to come nor useful guidance on how to respond. And the broader limitations of modern economics, with its presumption of efficient markets and rational expectations, have been vividly exposed. Its simplifications distracted attention from many of the key facets of human behaviour that drive real markets.
The challenge now is to wrench economics from its narrow obsession with market efficiency to take account of a richer understanding of human behaviour. David Tuckett's book is an ambitious attempt to bring psychoanalytic theory to bear. Initially trained as an economist himself, Tuckett argues that ‘whatever else goes on in an asset price boom and bust, it looks primarily like an emotional sequence… in which unrealistic manic excitement takes over thinking, caution is split off,… which will inevitably collapse into panic and paranoia’.
As the crisis broke in 2007, Tuckett was completing a series of interviews with investment managers. He argues that their behaviour can best be understood in terms of ‘phantastic objects’, ‘divided states’ and ‘groupfeel’ and that financial markets are bound t