Monday, Sept 7th, 2009
Paul Krugman, in attempting to defend Keynesian doctrine, calls most modern economists idiots or fools, including a slew of recent Nobel prize winners:
It’s hard to believe now, but not long ago economists were congratulating themselves over the success of their field. Those successes — or so they believed — were both theoretical and practical, leading to a golden era for the profession…in the real world, economists believed they had things under control: the “central problem of depression-prevention has been solved,” declared Robert Lucas of the University of Chicago in his 2003 presidential address to the American Economic Association. In 2004, Ben Bernanke, a former Princeton professor who is now the chairman of the Federal Reserve Board, celebrated the Great Moderation in economic performance over the previous two decades, which he attributed in part to improved economic policy making…
Few economists saw our current crisis coming, but this predictive failure was the least of the field’s problems. More important was the profession’s blindness to the very possibility of catastrophic failures in a market economy. During the golden years, financial economists came to believe that markets were inherently stable — indeed, that stocks and other assets were always priced just right. There was nothing in the prevailing models suggesting the possibility of the kind of collapse that happened last year. Meanwhile, macroeconomists were divided in their views. But the main division was between those who insisted that free-market economies never go astray and those who believed that economies may stray now and then but that any major deviations from the path of prosperity could and would be corrected by the all-powerful Fed. Neither side was prepared to cope with an economy that went off the rails despite the Fed’s best efforts…
The renewed romance with the idealized market [which bears little resemblance to reality] was, to be sure, partly a response to shifting political winds, partly a response to financial incentives. But while sabbaticals at the Hoover Institution and job opportunities on Wall Street are nothing to sneeze at, the central cause of the profession’s failure was the desire for an all-encompassing, intellectually elegant approach that also gave economists a chance to show off their mathematical prowess.
Unfortunately, this romanticized and sanitized vision of the economy led most economists to ignore all the things that can go wrong. They turned a blind eye to the limitations of human rationality that often lead to bubbles and busts; to the problems of institutions that run amok; to the imperfections of markets — especially financial markets — that can cause the economy’s operating system to undergo sudden, unpredictable crashes; and to the dangers created when regulators don’t believe in regulation…
By 1970 or so, [d]iscussion of investor irrationality, of bubbles, of destructive speculation had virtually disappeared from academic discourse.
In other words, modern economics ignores just about all aspects of the real economy and the government’s effect on it.
Numerous Nobel prizes were received based on ridiculous theories:
The theoretical model that finance economists developed by assuming that every investor rationally balances risk against reward — the so-called Capital Asset Pricing Model, or CAPM (pronounced cap-em) — is wonderfully elegant. And if you accept its premises it’s also extremely useful. CAPM not only tells you how to choose your portfolio — even more important from the financial industry’s point of view, it tells you how to put a price on financial derivatives, claims on claims. The elegance and apparent usefulness of the new theory led to a string of Nobel prizes for its creators, and many of the theory’s adepts also received more mundane rewards: Armed with their new models and formidable math skills — the more arcane uses of CAPM require physicist-level computations — mild-mannered business-school professors could and did become Wall Street rocket scientists, earning Wall Street paychecks.
Indeed, as I have previously pointed out, many economists now admit that their assumptions and theories were wrong. And studies show that the what the economics profession has adopted as gospel – that the economy is inherently stable – is utterly false.
Krugman lambasts Bernanke and Summers as being key members of the club of foolish economists, who denied any problem with bubbles or leverage. For example, Krugman quotes Bernanke as follows:
Home-price increases, Ben Bernanke said in 2005, “largely reflect strong economic fundamentals.”
And he points out that Summers completely missed the boat on risk:
There was a telling moment in 2005, at a conference held to honor Greenspan’s tenure at the Fed. One brave attendee, Raghuram Rajan (of the University of Chicago, surprisingly), presented a paper warning that the financial system was taking on potentially dangerous levels of risk. He was mocked by almost all present — including, by the way, Larry Summers, who dismissed his warnings as “misguided.”
(As I have repeatedly pointed out, Bernanke and Summers – as well as Geithner – have been wrong about just about everything)
While Krugman is a dyed-in-the-wool Keynsian, he shows that both modern Keynesians and Friedmanites ignored reality and accepted 2-dimensional theories which failed to reflect reality. Indeed, I believe that both camps are wrong, and that both camps have been promoted largely because they serve the interests of the powers-that-be.
Austrian economist Ludwig von Mises said:
“There is no means of avoiding a final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as a result of a voluntary abandonment of further credit expansion, or later as a final and total catastrophe of the currency system involved.”
Economist Hyman Minsky described a “Ponzi finance” system during prolonged expansions and economic booms. Misky said that speculative excesses create bubbles, triggering structural instability, then asset valuation collapse that turns euphoria to revulsion and market crashes.
But modern economists ignore von Mises and Minsky’s wisdom, and pretend that we can blow bubble after bubble, and cook up bigger and better Ponzi schemes, to ensure an economic recovery.
Krugman does a reasonably good job of criticizing other economists, but does not admit that his brand of Keynesianism is worthless as well.
This article was posted: Monday, September 7, 2009 at 4:39 am