Henry Kaufman Says Hard-to-Measure Economic Behavior Has Caused Wide Swings in Interest Rates - WSJ.com

By the 1980s, many economists had embraced the theory of "rational expectations," which essentially held that markets were all knowing and infallible. All of this infused the profession with an aura of authority, authenticity and accuracy.

The computations were correct, but far too often the conclusions drawn from them were not. This is because the models rely on historical data but fail to take into account the profound impact of structural changes in our economy and in financial markets that have unfolded in the postwar decades.

These structural changes -- including securitization, globalization and the explosion of debt -- have altered financial behavior in ways that the econometric models miss. In the decades since World War II, they have liberated financial risk-taking, as markets learned to game the system beyond the parameters of quantitative models. That is a critical difference between now and the last time interest rates were comparably low six decades ago.

Henry Kaufman Says Hard-to-Measure Economic Behavior Has Caused Wide Swings in Interest Rates - WSJ.com