The Great Moderation and the unravelling of a Great Myth

Abstract

In June 2007, investors’ aggregated view of the value of financial assets in both equity and credit markets demonstrated little sign that the economy was about to collapse, resulting in massive capital destruction. Economic forecasts across the board remained robust, from central banks through to financial market practitioners in the banking and fund management sectors. Equity valuations were fore-casting strong profit growth with the S&P 500 in July 2007 above the dot com boom levels of July 2000. Moreover, the market’s perception of credit risk was at an all-time low, with countries like Greece considered not much riskier than Germany (Figure 1.1).

Whenever a theory appears to you as the only possible one, take this as a sign that you have neither understood the theory nor the problem which it was intended to solve.

Karl Popper¹