What Went Wrong with Economics

The Economist this week takes a look at the general failure of economics to foresee the financial crisis, or to have a convincing answer to the question of what to do about it. It finds plenty of blame to spread around but also warns that “too many people, especially in Europe, equate mistakes made by economists with a failure of economic liberalism. ”

There are three main critiques: that macro and financial economists helped cause the crisis, that they failed to spot it, and that they have no idea how to fix it.

Add these criticisms together and there is a clear case for reinvention, especially in macroeconomics. Just as the Depression spawned Keynesianism, and the 1970s stagflation fuelled a backlash, creative destruction is already under way. Central banks are busy bolting crude analyses of financial markets onto their workhorse models. Financial economists are studying the way that incentives can skew market efficiency. And today’s dilemmas are prompting new research: which form of fiscal stimulus is most effective? How do you best loosen monetary policy when interest rates are at zero? And so on.

But a broader change in mindset is still needed. Economists need to reach out from their specialised silos: macroeconomists must understand finance, and finance professors need to think harder about the context within which markets work. And everybody needs to work harder on understanding asset bubbles and what happens when they burst. For in the end economists are social scientists, trying to understand the real world. And the financial crisis has changed that world.

Comments

[Pat Shuff:]

The error is in mistaking the faith-based beliefs of rival sects for science. The magazine should be titled The Economystic.

Jul 17 03:21 PM

[conceptwizard:]

Nows a good time to send them all in with a broom and dustpan to clean up this mess.

Just like we have to rethink "buy & hold" on a diversified portfolio, The continued morphing of our product lines, strategies to strip people of weath keep changing. The people that have the foresight to predict our next bubble, which is "cap & trade" (in my opinion) also have the knowledge to prevent it.

See...I am of the opinion that the next bubble is already being set into play, while everyones head is turned. I wonder why Goldman has loaded upon billions worth of carbon credits. They never lose remember.

Watch what they do not what they say.

Jul 17 06:10 PM

[morph366:]

The Economist doesn't answer the question it poses in this (lightweight) article - What went wrong with Economics?
Better to spend time on the hundreds of comments that their website received on this piece which are far more informative.

Jul 18 02:46 AM

[gollwoods22:]

If the economists could cure corruption, but we have a parabolic rise in corruption, How can a world run by backroom banking cartels ever hope to reform anything. this scenario is going to lead to a parabolic decline in living standards with the final descent ending in horrific destitution

Jul 18 08:10 AM

[CautiousInv...:]

My takeaway from the article is that even if the economists got it wrong it would be a mistake to think that the politicians would get it right. The other is that a failure of economics is not a failure of free market democratic capitalism.

Jul 18 09:31 AM

[sod:]

What made this article so enjoyable is a sentence in the last paragraph, "For in the end, economist are social scientist, trying to understand the real world." For me, that says it all.

Jul 18 11:07 AM

[Fighting Yoda:]

I think the economists have been corrupted by being on the payroll of Wall Street. Wall Street business model is sell stocks – if you are in the job – it becomes your job. There is not an asset class that was deemed undervalued – a story can always be cooked up around anything – dot com, housing, commodities. We have simultaneously created a culture of ‘hype springs eternal’.
Once you have the blessing and active support of the bubble master Greenspan, you can keep blowing bubbles. I think economists have lost complete credibility – they are worse than lemon selling car salesmen or even ambulance chasing lawyers. Let’s take the case of the Fed and Bernanke – even after the outset of this crisis all the calls were – no crisis, small crisis, subprime only, no recession, mild recession; suddenly there the super huge recession – but recovery predicted second half of 2008. The worst case scenario projected in the stress free stress tests was – 10.3% for 2010 – these predictions were made 2 months ago. Now they are getting revised to exceed 10.1% this year itself.
We have to get back to accountability – if you screw up you are fired, but who will fire whom – everyone is in the same game – politicians, bureaucrats, corporate. Free markets and Econ101 is the only solution, but right now the mantra is ‘we need to give up free markets to save the free market, and even worse (as articulated by Biden recently) – “we have to spend a lot more to save us from bankruptcy”.

No end in sight, no end to foolishness that economists and politicians can wreak, after ethanol they are getting into health care now.

Jul 18 12:17 PM

[Teutonic Kn...:]

To Research Recap -

There is nothing "wrong" with the field of economics itself per se. The word "science" in the definition of economics as a "social science" is perhaps a misnomer, in my opinion, just as in "political science". No offense of mine to those who majored in political science in their BA.

Granted, I know political science is a very popular major in American colleges. But to a lowly stoic engineer as myself, how could politics be categorized as a science? A science or an engineering discipline by defintion is predicated on the application of proven nature principles with predictable and measurable outcomes. Is politics predictable?

The problem of most of today's economists is corruption of power. The following excerpt from the Wikipedia sums it well : -

"...Economics per se, as a social science, is independent of the political acts of any government or other decision-making organization, however, many policymakers or individuals holding highly ranked positions that can influence other people's lives are known for arbitrarily using a plethora of economic concepts and rhetoric as vehicles to legitimize agendas and value systems, and do not limit their remarks to matters relevant to their responsibilities. The close relation of economic theory and practice with politics is a focus of contention that may shade or distort the most unpretentious original tenets of economics, and is often confused with specific social agendas and value systems.

Amen.
TK

Jul 18 01:50 PM

[LilBob:]

"Beware geeks bearing formulas..."

When you live in an abstracted world full of numbers and symbols it's easy to forget about reality. One of the primary shortcomings of academia in general is the attraction of complex forms of mental masturbation.

The irony is that for the last three to four years when I kept saying things were going to get really ugly and real estate wouldn't keep going up forever, people kept telling me that I was crazy and didn't know what the hell I was talking about. Now, I keep telling people that the economy is going to stabilize over the course of the next three to four years and, given continued declines in energy consumption on the part of the American consumer-especially nationwide declines in the number of registered motor vehicles; which will actually benefit the country in the long run-and people tell me that I'm out of my mind and I don't really understand anything about economics and have no idea what I'm talking about-which makes me think I'm onto something. It's not that economists as a whole failed to predict this mess, it's that the economists that most people choose to listen to and who are the chosen darlings of the mainstream media failed to predict this mess.

Jul 18 06:45 PM

[sethmcs:]

Economist are supposed to observe economic behavior, measure it and interpret the findings. I was researching the current foreclosure rate for a state were I own some regional bank stocks and I came accross an article predicting the housing crisis. It was dated 2005 and everything it said came to pass. Even if economist could predict the future (impossible) would anyone listen?

Jul 18 06:49 PM

[Teutonic Kn...:]

LilBob -

To me you are akin to a John the Baptist described in the Scriptures - A Voice Crying in the Wilderness.

Those economists you alluded to - using a Cliche, "they are part of the problem and not part of the solution". They would have to be rooted out ASAP.

On Jul 18 06:45 PM LilBob wrote:

> "Beware geeks bearing formulas..."
>
> When you live in an abstracted world full of numbers and symbols
> it's easy to forget about reality. One of the primary shortcomings
> of academia in general is the attraction of complex forms of mental
> masturbation.
>
> The irony is that for the last three to four years when I kept saying
> things were going to get really ugly and real estate wouldn't keep
> going up forever, people kept telling me that I was crazy and didn't
> know what the hell I was talking about. Now, I keep telling people
> that the economy is going to stabilize over the course of the next
> three to four years and, given continued declines in energy consumption
> on the part of the American consumer-especially nationwide declines
> in the number of registered motor vehicles; which will actually benefit
> the country in the long run-and people tell me that I'm out of my
> mind and I don't really understand anything about economics and have
> no idea what I'm talking about-which makes me think I'm onto something.
> It's not that economists as a whole failed to predict this mess,
> it's that the economists that most people choose to listen to and
> who are the chosen darlings of the mainstream media failed to predict
> this mess.

Jul 18 06:58 PM

[Research Recap:]

Thanks for your comments. With an economics background I am frequently reminded of the limitations of the field, whether you consider it a science or not. The use of "scientific calculations" can give economic forecasts an overstated sense of accuracy and validity, especially given the prevalence of assumptions. The Economist piece provides a valuable service in prompting discussion, whether you agree with it or not.


On Jul 18 01:50 PM Teutonic Knight wrote:

> To Research Recap -
>
> There is nothing "wrong" with the field of economics itself per se.
> The word "science" in the definition of economics as a "social science"
> is perhaps a misnomer, in my opinion, just as in "political science".
> No offense of mine to those who majored in political science in their
> BA.
>
> Granted, I know political science is a very popular major in American
> colleges. But to a lowly stoic engineer as myself, how could politics
> be categorized as a science? A science or an engineering discipline
> by defintion is predicated on the application of proven nature principles
> with predictable and measurable outcomes. Is politics predictable?
>
>
> The problem of most of today's economists is corruption of power.
> The following excerpt from the Wikipedia sums it well : -
>
> "...Economics per se, as a social science, is independent of the
> political acts of any government or other decision-making organization,
> however, many policymakers or individuals holding highly ranked positions
> that can influence other people's lives are known for arbitrarily
> using a plethora of economic concepts and rhetoric as vehicles to
> legitimize agendas and value systems, and do not limit their remarks
> to matters relevant to their responsibilities. The close relation
> of economic theory and practice with politics is a focus of contention
> that may shade or distort the most unpretentious original tenets
> of economics, and is often confused with specific social agendas
> and value systems.
>
> Amen.
> TK

Jul 23 01:01 PM