How Did Economists Get It So Wrong?

Paul Krugman writes on this topic in a long article for the NYT magazine: you can read it here.

16 replies on “How Did Economists Get It So Wrong?”

I think this may have been posted before but it is interesting to contrast the Krugman article with Lucas’ piece in the economist

It is also worthwhile to reread this 2002 piece by Krugman particularly the section
“To fight this recession the Fed needs more than a snapback; it needs soaring household spending to offset moribund business investment. And to do that, as Paul McCulley of Pimco put it, Alan Greenspan needs to create a housing bubble to replace the Nasdaq bubble.” hmmm

A lengthy article indeed. It provides a useful insight for anyone unfamiliar with the different strands of economic theory that have sought to influence governments over the past hundred years.

I would agree with his basic principle, that there is a need for economists to take account of irrational behaviour. How you evaluate that is a different matter entirely.

He fails to address what I believe has become a major problem.

Yesterday, when congratulating Prof Honohan on his new appointment, I made reference to a paper he co authored when working for the world bank.

Beyond capital ideals : restoring banking stability.

The paper was In response to the collapse of financial markets in emerging economies. A lot of the problems they identified could equally apply to what we have witnessed in first world economies over the past decade.

How do economists evaluate the patronage and pure corruption that at times seems endemic in many Western economies. How do economists evaluate for the lightweight regulatory authorities that punish global entities with flea bite fines.

The current crisis has damaged reputations without doubt. But I fear that nothing will change. The economists who are shouting money money money in a period of boom will always attract the most attention and plaudits.

At times like we are now experiencing, the media will look at what they have derisevly termed the doom and gloom merchants and say maybe they were right.

I think economists are ultimately swayed by their own sense of justice and morality.

Economists got it so wrong because they got lost in a sea of figures. Economics became far too mathematical and full of models, it lost sight of the overall economy, basic principles were forgotten.

Krugman is good, very good, Nobel prize and all, but, good American that he is, he still doesn’t get Keynes and what he was about. Akerlof and Shiller got closer in “Animal Spirits”, but being American, still didn’t get it. Economists who thought they understood Keynes boiled him down to a watery stock with the Hicks-Hansen IS-LM and got slurped up by the Chicago School when they tried to refine, intellectualise and matemathicise it.

Keynes was confronting a spectacular failure of capitalism, collectivism in all of its guises (from west Asian neo-Bolshevism to the pinkish British variety) and a corporatism tinged with Catholicism from De Valera’s Ireland, through Salazar’s Portugal, Franco’s Spain, Mussolini’s Italy to Hitler’s adopted Bavaria that was exacerpated by the Nazis’ amorality and barbarianism and Japan’s militarism and abuse of Shintoism and Bushido.

He saw his task as defending civiilisation which was “handed down by our fathers, hard-won, but easily lost”. From an economic and political perspective he saw it as a purely technical task which, while granting the state power to decide the level of aggregate demand and permitting certain abuses, entrenched individual liberty in detemining the allocation and pricing of individual good and services. And, accompanying this, he recognised the inevitable irrationality and uncertainty that would have to be constrained and managed.

Skidelsky’s attempt in his latest book “Keynes: the Return of the Master” to update his description of Keynes’s legacy in the third volume of his masterly biography falls short of what is required. Skidelsky, as an economic historian, is not up to the task. Economists need to delve into the richness, breadth and depth of Keynes’s writings during the’30s and early ’40s – and not just the “General Theory” – and re-fashion and mould his insights for this genuine “age of uncertainty”.

All the intellectual nourishment one might need is there and all economists, irrespective of nationality, have a role to play – it can’t be left to the Americans and the Brits (the former don’t know what’s required and the latter might know, but couldn’t be bothered). It is clear that the Scandinivian economies have absorbed some of Keynes’s insights. There is no reason why Ireland can’t take this a step further.

Keynes had the skill of communicating with non-economists in his writings, even though in person, he apparently came across as arrogant (Bertrand Russell commented: “Annihilating arguments darted out of him with the swiftness of an adder’s tongue.”)

Keynes also saw the merit of communicating with the public as he did in his “open letter” to FDR in 1933.

“You have made yourself the Trustee for those in every country who seek to mend the evils of our condition by reasoned experiment within the framework of the existing social system. If you fail, rational change will be gravely prejudiced throughout the world, leaving orthodoxy and revolution to fight it out.”

“In the past orthodox finance has regarded a war as the only legitimate excuse for creating employment by governmental expenditure. You, Mr President, having cast off such fetters, are free to engage in the interests of peace and prosperity the technique which hitherto has only been allowed to serve the purposes of war and destruction.”

From a recent “Lunch with the FT”

Skidelsky does not appear to like economists very much, I say. “Not true. But there is an imperial benevolence about them; they are not interested in people, they are very impersonal. I cannot imagine having a bosom friend who is an economist.”

This is akin to saying all accountants are boring – – some are of course.
The economics profession has been damaged by the small number who have been masquerading as mortgage salesmen.

In the Irish media, a reference to an economist, invariably has the prefix “leading” irrespective of the track record.

When economic forecasts are made, a range should be used, which is likely over time to enhance credibility with the public.

A group of economists wrote in a paper earlier this year on their profession: “It has failed in its duty to society to provide as much insight as possible into the workings of the economy and in providing warnings about the tools it created. It has also been reluctant to emphasize the limitations of its analysis.”

Finally, a lively rant from veteran Australian journalist and former political editor of The Sun-Herald, Alex Mitchell, who wrote in early 2009: “For many years it was my conscientious belief that the worst practitioners in the media were celebrity reporters who did little more than rewrite press handouts supplied by agents for limelight-seeking B-grade actors and pop stars.

I’ve now revised my views and am convinced that the media’s bottom-feeders are the economics writers.

In so-called normal times, these erudite commentators wrote very little and not very often. Indeed, they rarely came to work and weren’t seen around newsrooms. They sat at home in their book-lined studies mousing their way through international websites looking for ideas for something to write about.

Having plagiarised a letter from The Economist, an editorial from the Washington Post, an article from the Far East Economic Review or the in-house report from a leading investment bank, they appeared in print, glowing with wisdom.

But when the world economy turned nasty, these charlatans and hucksters were quickly unmasked and regular reporters started asking each other: has that bald-headed egomaniac on three times my salary got any clothes on or not? Answer: No!”

Some economists got it very right.

Consider this comment from the IMF’s 2005 Global Financial Stability Report: “Low short-term interest rates and low volatility are encouraging investors to move out along the risk spectrum in their search for relative value … if history is any guide, the single most important risk factor for financial markets in good times is complacency … current risk premiums for inflation and credit risks leave little or no margin for error …”

Or consider this 2005 comment from Paul Volcker, a former chairman of the US Federal Reserve and now senior economic advisor to President Obama: “under the placid surface, there are disturbing trends: huge imbalances, disequilibria, risks – call them what you will. Altogether the circumstances seem to me as dangerous and intractable as any I can remember, and I can remember quite a lot. What really concerns me is that there seems to be so little willingness or capacity to do much about it.”

In June 2005, The Economist magazine wrote “The IMF has warned that, just as the upswing in house prices has been a global phenomenon, so any downturn is likely to be synchronised, and thus the global effects of it will be shared widely. The housing boom was fun while it lasted, but the biggest increase in wealth in history was largely an illusion.”

The question is not “why did economists get it wrong?” but “why was so little attention paid to those who got it right?” The answer to that question can be found in the antiquities (Latin) … mundus vult decipi ergo decipiatur … the world wants to be deceived, therefore let it be deceived.

@Michael H,

Well observed as usual, but I think Krugman is more concerned about the role of economists in analysing economic reality and, in so far as they impact on policy and regulation, in altering the economic reality than the role of the media in conveying key features of this reality to the public.


I agree. Very few people of influence in these matters had the guts or the gumption to turn up at the party like an Old Testament prophet in sackcloth and ashes foretelling doom and destruction. And even if they had, they would have been pilloried.

But, before widespread public disillusion, disaffection and disengagement take hold, there is a small window of opportunity to recast the landscape of economics. “The Spirit Level: Why More equal Societies Always Do Better” by Richard Wilkinson and Kate Pickett demonstrates the unambiguously beneficial outcomes from a particular configuration of economic and social policies. The challenge for economics is to develop the theory and practice that will generate these outcomes.

Few economists saw our current crisis coming, but this predictive failure was the least of the field’s problems.

A quote from a deservedly obscure nobel prize winner.

Condemned by his own twittering?

He is actually trying the FF excuse of I (the profession) was incompetent, not a naughty boy. Many knew what was coming. The PNAC wanted a new Pearl harbour in 1999. They got it and they got the housing bubble. But for the ordinary american their wages did not go up at all. Instead they were encouraged to borrow.

Guess they may have learned something from that, but will that matter? The widespread failure to alert amounts to a tacit, or worse overt, conspiracy to delude to allow the knowledgable to pass liabilities onto a sucker, usually a would be flipper or a pension fund or best of all a quasi governmental body.

NaMa anyone? Repeat history until the sucker wakes up and walks away?

Cormac Lucy
I agree that this trick is an old and handy one and it is also a good way of defending an accused, to vilify the deceased. I have no pity on those who believed in advertizing, banks lending money or media playing up the greed paradigm.

But I do feel for their children who will grow up warped and who may mug you as you try to hail a taxi some dark night. Let me know if it happens and I will give you a ditty that will console the victim.

Economics may also be regarded as a victim?

Paul Hunt
Governments tend to lie to voters about their abilities to perform economic miracles. I recall the Hitler person who was goin to provide guns and butter. He did well. Almost too well. But he eventually left the place in ruins …..

I believe Keynes has been deliberately underrated, particularly as the american right keep inequality going and the rape of mercantilism is ever popular in those climes.

My point is that economics is worthless if it does not enable students and the public, to see what is happening before it becomes a disaster. Krugerrand or whoever is just another mouthpiece for those who believe that the ignorant deserve to be fleeced.

There’s one born every minute. Is that a worthy school of economics?

@Pat Donnelly
You make many interesting points in your blogposts.

But you consistently seem too sure of your own view and dismissive of other perspectives. Every politician isn’t corrupt nor is every economist stupid. This cynical view leaves out common human attributes such as loyalty to your group, herd behaviour, misunderstanding, ideological conditioning and others.

Cynicism is not necessarily realism. Cynicism is a way of interpreting the way things are which is as fallible as other worldview.

If economists got it so wrong would cynicism have done better job? Maybe it would;maybe not.

@Pat Donnelly,

Like Aidan C I fear I am beginning to weary of your pessimism verging on cynicism. The initiating posters on this site (aka the named contributors) have demonstarted a clear desire to steer clear of party politics and of any politics (whether lower case or upper case “p”). This I find to be a deficiency, but I am permitted to state my case. And for this this I am grateful.

However, I yearn for contributors (i.e., initiators of discussion threads – in addition to the occasional guest post) who are not rewarded from the public purse. I am not alleging that public sector funding is constraining the nature or substance of the views expressed, but those of us who are on the outside must be excused the indulgence of some unease about how the balance between public patronage and independent thinking is played out.

No society is irredeemably corrupt. The Irish electorate is poised to apply the power hose – they simply are being deprived of the opportunity to use it.

I suspect the Austrian School of Economics would approve the deprival of public funding for all levels of education, but, unfortunately, mankind is defined by more than von Mises’s praxis. In fluid, non-homogenous and multi-cultural societies it may be neccesary to provide public goods before the bonds are developed to provide them from the bottom up.

It’s 40 years after the Moon landing and Krugman got his PhD in 1977. What has he said about the planned obsolescence of automobiles? How much have Americans lost on the depreciation of crapmobiles every year since 1969?

Our so called economic system depends on economists that can’t do algebra. Double-entry accounting is 700 years old. How hard can it be with today’s computers? When have our economists suggested that it be mandatory in the schools?

NO! We need to keep the consumers $tupid. That would screw up our game theory.

Economic Wargames

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