Anatomy of the Global Economy
Economics in Crisis
J. Bradford DeLong
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BERKELEY – The most interesting moment at a recent conference held in Bretton Woods, New Hampshire – site of the 1945 conference that created today’s global economic architecture – came when Financial Times columnist Martin Wolf quizzed former United States Treasury Secretary Larry Summers, President Barack Obama’s ex-assistant for economic policy. "[Doesn’t] what has happened in the past few years,” Wolf asked, “simply suggest that [academic] economists did not understand what was going on?”
Here is the most interesting part of Summers’ long answer: “There is a lot in [Walter] Bagehot that is about the crisis we just went through. There is more in [Hyman] Minsky, and perhaps more still in [Charles] Kindleberger.” That may sound obscure to a non-economist, but it was a devastating indictment.
Bagehot (1826-1877) was a mid-nineteenth-century editor of The Economist who published a book about financial markets, Lombard Street, in 1873. Summers is certainly right: there is an awful lot in Lombard Street that is about the crisis from which we are now recovering.
Minsky (1919-1996) is best approached not through his collected essays, entitled Can “It” Happen Again?, but rather through the use Kindleberger (1910-2003) made of his work in his 1978 book Manias, Panics, and Crashes: A History of Financial Crises. Asked to name where to turn to understand what was going on in 2008, Summers cited three dead men, a book written 33 years ago, and another written the century before last.
Summers then enlarged his answer to include living economists: “Eichengreen, Akerlof, Shiller, many, many others.” He talked about “the revolution in finance as it was realized that asset prices show large volatility that does not reflect anything about fundamentals,” but added that “macroeconomics [did not] keep up with [this] revolution.” As a result, “to the great detriment of contemporary macroeconomics,” his fellow economists did not understand asset prices, manias, panics, and liquidity.
For Summers, the problem is that there is so much that is “distracting, confusing, and problem-denying in…the first year course in most PhD programs.” As a result, even though “economics knows a fair amount,” it “has forgotten a fair amount that is relevant, and it has been distracted by an enormous amount.”
I think that Summers’ judgments are fair and correct. And I count myself among those who had forgotten and been distracted, even though I have always assigned Lombard Street to my economic history courses and Manias, Panics, and Crashes to my macroeconomics classes, and have always paid close and respectful attention to Eichengreen, Akerlof, and Shiller.
But I was shocked by how large a panic was produced by what seemed to me – and still does – relatively small losses (in terms of the size of the global economy) in subprime mortgages; by the weakness of risk controls at the major highly-leveraged banks; by how deep the decline in demand was; by how ineffective the market’s equilibrium-restoring forces have been at rebalancing labor-market supply and demand; and by how much core-country governments have been able to borrow to support demand without triggering any run-up in interest rates.
It is the scale of the catastrophe that astonishes me. But what astonishes me even more is the apparent failure of academic economics to take steps to prepare itself for the future. “We need to change our hiring patterns,” I expected to hear economics departments around the world say in the wake of the crisis.
The fact is that we need fewer efficient-markets theorists and more people who work on microstructure, limits to arbitrage, and cognitive biases. We need fewer equilibrium business-cycle theorists and more old-fashioned Keynesians and monetarists. We need more monetary historians and historians of economic thought and fewer model-builders. We need more Eichengreens, Shillers, Akerlofs, Reinharts, and Rogoffs – not to mention a Kindleberger, Minsky, or Bagehot.
Yet that is not what economics departments are saying nowadays.
Perhaps I am missing what is really going on. Perhaps economics departments are reorienting themselves after the Great Recession in a way similar to how they reoriented themselves in a monetarist direction after the inflation of the 1970’s. But if I am missing some big change that is taking place, I would like somebody to show it to me.
Perhaps academic economics departments will lose mindshare and influence to others – from business schools and public-policy programs to political science, psychology, and sociology departments. As university chancellors and students demand relevance and utility, perhaps these colleagues will take over teaching how the economy works and leave academic economists in a rump discipline that merely teaches the theory of logical choice.
Or perhaps economics will remain a discipline that forgets most of what it once knew and allows itself to be continually distracted, confused, and in denial. If that were that to happen, we would all be worse off.
J. Bradford DeLong, a former assistant secretary of the US Treasury, is Professor of Economics at the University of California at Berkeley and a research associate at the National Bureau for Economic Research.
Copyright: Project Syndicate, 2011.
www.project-syndicate.org
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Jacksmith 08:10 29 Apr 11
Easy to understand why it falls into crisis. First, it's merely a human model that comprises too many assumptions. Second, it can't cover all colorful situations of life. So it contains countless errors that CAN NEVER BE HEALED by humans. This is guaranteed!
Economics is a science but never an exact science. What seems right today turns out to be wrong tomorrow.
That partially explains why most economists can hardly become rich.
EconStudent 01:28 30 Apr 11
"distracted, confused, and in denial"
Maybe economists should be practicing what they preach; that is, they should think about being more rational, self-interested and utility-maximizing
kitchentroll 07:01 30 Apr 11
Brad...Thank you for bringing the point home. Let's take it to the finish line. Perhaps what is needed is some business school training in humanity, at the expense of effieciency. Infaltion and unemployment per centages are not "targets" for policy makers to aim for...they represent real pain and suffering, to real people. The damage to "human capital", caused by this crises will surpass anything we have endured in the past century, and will last longer.
Extended unemployment benefits, jobs programs on the order of the WPA and CCC are needed now. Are these programs effiecient? Rarely. Will they save millions from abject poverty? Yes.
What exactly is the goal here?
Peace
Sasha 04:35 01 May 11
Truth.
Where do you place Economic Historians though? How do they fit into the world? The science of Economics is a social process within itself. How and where do you find a place (for profit) that will step outside of "itself" to hire a thoughtful Economist, rather than a purely analytical one? On second thought, I'm sure thoughtful Economist's are hired daily, but listened to? No.
mmeister 05:31 01 May 11
The ultimate problem is corporate sponsorship of supply side economics and says law advocates. A reorientation to demand side economics would be welcome after all this. Captatilsm needs workers to buy goods and real wages have stagnated in the West. All mainstream economists never mention this.
brianchoi107 04:57 02 May 11
Yes, indeed. Current mainstream economic model has failed in predictng and explaining the crisis, and yet most schools/scholars are reluctuant to move away from it
Jomo 04:34 04 May 11
The kind of changes in hiring that Prof. DeLong advocates here will take time. Ph.D. candidates take years to work themselves through the system and the crisis is too recent to have influenced career trajectories in the way Prof. DeLong would like to see. More importantly, the advisors who guide those students tend to be model builders. They will have a tremendous influence on the kind of candidates that hiring committees see. In fact, model builders probably make up a majority on most Econ hiring committees.
pdemetriades 07:00 08 May 11
Indeed economics is in crisis and risks becoming irrelevant.
Like you, I don't see much movement forward on this side of the Atlantic either, not just in terms of hiring but also in terms of promotion. Promotion in 'top' places in Europe, like hiring, is single mindedly focussed on publishing in a handful or two of 'top journals', instead of genuine innovation. The vast majority of papers in these journals recycle old ideas and are largely ignored by subsequent literature but succeed precisely because they threaten no one. Rather the whole exercise is frequently one of massaging established egos, instead og genuinely advancing the frontiers. I very much doubt it if Keynes, Minisky or Kindleberger would be publishing in those journals if they were alive today.
Even if top journal editors become more open minded (doubtful), the refereeing process itself stifles genuine progress, as it allows the academic establishment - most of which is firmly committed to the efficiency of markets paradigm - to shoot down serious innovation and dissenting views. Unfortunately new journals are not the answer, as they are sneered upon by promotion committees.
As a result, the future of economics is in the hands of the few, most of whom remain entrenched in defunct models and beliefs, and as such is gradually becoming an ideology instead of a social science.
Fortunately, if one cares to read widely - well beyond the 'top' journals - including books that remain a good forum for new ideas there is lots of good economics around. I do my best to highlight these, see:
http://givegoodeconomicsachance.blogspot.com/
Brenzle 01:51 14 May 11
"The fact is that we need fewer efficient-markets theorists and more people who work on microstructure, limits to arbitrage, and cognitive biases. We need fewer equilibrium business-cycle theorists and more old-fashioned Keynesians and monetarists. We need more monetary historians and historians of economic thought and fewer model-builders."
As someone about to enter grad-school economics I am determined to take-up this challenge!
nmaier 03:12 17 May 11
Perhaps economists should look at what works i.e Glass Stegall, gold backed currency, and an embrace of the free market principle that if you take extraordinary risk you may succeed or you may fail. The extraordinary intervention by the Federal Reserve has only delayed the inevitible, namely the collapse of the US dollar and an inflationary depression. Strange how all these highly educated economists don't understand the end result of our current economic policies. But, then again, they all missed the financial meltdown of 2008, so who should be surprised.
noam4prez 02:05 17 May 11
“Perhaps I am missing what is really going on.”
From the point of view of a non-economist, I would have to say, “obviously”. From the layman’s point of view, mainstream economists are tinkering with the minutiae of a system that serves the very few while exploiting everyone else - by design. An economic system designed explicitly to serve all of us would be unrecognizable to mainstream economists.
Much of what passes for economic thought, when you look past the specialized jargon, is simply justification and reinforcement of the existing system.
My suggestion to academic economics departments is to be more honest and plainspeaking about whom you serve. The public is more aware of what is “really going on” than you might think. Perhaps you are only fooling yourselves.
jsmith23 05:09 08 Feb 12
I agree that traditional Keynesian principles and monetarists are needed to put our economical crisis in perspective and set realistic expectations. online shopping
greenecon 07:39 29 Apr 11
Indeed, the discipline is in crisis. However, I'm surprised you did not mention economists who have carried forward in Minsky's tradition, in particular L. Randall Wray at UMKC. Or William Black who is working on the criminogenic aspects of the financial crisis, who is also at UMKC.
And I'm not sure we need more Reinharts and Rogoffs, at least as pertains to the policy implications from "This Time is Different." They don't seem to understand the relationship between the US and its currency.