In late 2008 the US credit market froze. How affected the „gravity problem“ the working of the economy and markets in the US during the financial crisis? What prevented market equlibrium from being realized?
What gravity is for scientists, equilibrium is for economists: a central and undeniable force. But what happens if this force doesn’t exist? The physicist Dr. Verlinde questions existence of gravity in science. Regarding economy the question about gravity is in the end a question about an existing market-equilibrium in the economy, the point where supply equals demand in a competitive market. In reality this point cannot be reached easily, due to the fact that the models are made under many assumptions and simplify reality. A lack of economic “gravity” means therefore uncertainties, market failures like asymmetric information and moral hazard or failed assumptions in economic models that keep supply from equaling demand.
The financial crisis and the Great Recession showed that economic theories might not entirely be true: Explanation why nearly nobody — neither economists nor regulators or investors — saw the risks in the always rising housing prices and the always getting more complicated financial instruments will keep economists and students occupied for the following years and decades. How could the crisis occur? Were there hints of a lack of gravity? In the following I want to show what influenced the markets during the financial crisis — uncertainties, market failures and failed assumptions — to loose its “gravity” during the four phases of the crisis: The bubble, the collapse, the recession and the recovery.