Beyond Mechanical Markets: Asset Price Swings, Risk, and the Role of the State (Book Review)

In its opening section, Frydman and Goldberg’s book lays out important methodological contributions questioning the hypothesis of rational expectations, constructed on the basis of the writings of Knight, Keynes and Hayek. But in the second part, it does not propose a convincing model that would help avoid the formation of new financial bubbles. While accepting to some extent that the government entity has no greater knowledge than economic agents, it ignores the perverse public-sector incentives that James M. Buchanan and the School of Public Choice have explored in recent decades. Furthermore, although the repeated reference to Hayek is encouraging, the authors seem to have misunderstood the implications of his most important insight, namely the knowledge problem as it affects public sector decision making. Paradoxically, this oversight leads Frydman and Goldberg themselves to adopt the “pretence of knowledge” (Hayek 1978), despite explicitly criticizing traditional models for this very same error.