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Keynes versus the Classics: Round Two

Chicago School economics has never been more vulnerable than it is today – and deservedly so. But, as a recent exchange between two economic heavyweights showed, the attack on it will never succeed unless its Keynesian rivals are willing to work out the implications of irreducible uncertainty for economic theory.

LONDON – The economist John Maynard Keynes wrote The General Theory of Employment, Interest, and Money (1936) to “bring to an issue the deep divergences of opinion between fellow economists which have for the time being almost destroyed the practical influence of economic theory…” Seventy years later, heavyweight economists are still at each other’s throats, in terms almost unchanged from the 1930’s.

The latest slugfest features New Keynesian champion Paul Krugman of Princeton University and New Classical champion John Cochrane of the University of Chicago. Krugman recently published a newspaper article entitled “How Did Economists Get It So Wrong?” There was nothing in mainstream economics, Krugman wrote, “suggesting the possibility of the kind of collapse that happened last year.”

The reason was that “economists, as a group, mistook beauty, clad in impressive-looking math, for truth.” They purveyed an “idealized vision of an economy in which rational individuals interact in perfect markets.” Unfortunately “this sanitized vision of the economy led most economists to ignore all the things that could go wrong.” So now economists will have to accept “the importance of irrational and often unpredictable behavior, face up to the often idiosyncratic imperfections of markets and accept that an elegant economic ‘theory of everything’ is a long way off.”

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