After winning a share of this year’s Nobel prize in Economics, Paul Romer repeated his called for intellectual honesty in Economics (apparently he feels it has been missing for several decades).  He equates intellectual honesty with constructing economic models based on assumptions that actually reflect reality.

Since an assumption about information lies at the heart of most, if not all, economic models, Professor Romer is a likely champion of the Information Matrix.  If not, he is a representative of exactly what he thinks is wrong with economists:  lazy, lacking in intellectual integrity and willing to use incredible assumptions that lead to bewildering conclusions in the hopes of winning a Nobel prize.

For those of you who are unfamiliar with the Information Matrix, here is the Matrix with a brief summary.

Information Matrix

The Information Matrix explains the design of the global financial system and financial crises.

The intent of the financial system’s design is to move the vast majority of investments from Wall Street’s preferred Blind Betting quadrant into the Perfect Information quadrant.

Moving investments into the Perfect Information quadrant makes sense on a number of levels.  First, the Perfect Information quadrant is where all the theories developed under standard economics about how the market optimally allocates resources work.  Second, it allowed investors to Trust, but Verify the story Wall Street tells them.

Keep in mind, behavioral economics’ observation people like a good story operates in both the Perfect Information and Blind Betting quadrant.  The key difference between the two quadrants is in the Perfect Information quadrant the story can be verified and in the Blind Betting quadrant the absence of the necessary information means the story cannot be verified.

Whether the story can be verified or not results in a vastly different response when Wall Street’s valuation story is called into doubt.  In the Perfect Information quadrant, the story can be verified and the doubt dismissed.  In the Blind Betting quadrant, the story cannot be verified.  Not only is the doubt not dismissed, but the logical follow-up question arises:  is the investment worth anything?  This too cannot be verified.  Investors recognize this and, as behavioral economics suggests, naturally panic.  The result is a “run” to get their money back.

Behavioral economics allows us to understand the classic financial crisis panic.  The Information Matrix framework shows why the financial crises always start in the Blind Betting quadrant.  Together they explain why if you want to minimize the chances of another financial crisis, you minimize the size of the Blind Betting quadrant.

But the Information Matrix does more than this.

From an economist’s perspective, it shows information asymmetry is an interesting market imperfection, but blind betting is a much more important market imperfection (after all, no reason to think blind betting yields the same optimal allocation of resources as informed decision making).

From a non-economist’s perspective, the Information Matrix lends itself to useful applications like the Transparency Label Initiative.  The Initiative in turn allows us to treat opacity as an asset class.

I could go on, but I think I have made the point of just how useful the Information Matrix is and how it is a game changer for the Economics/Finance profession.  It is its usefulness that is the reason Professor Romer should champion it.