Long, but excellent reading on the recent (last few decades) of the history of macro thinking. I think Krugman understates some issues, but much of it is good. I recommend.
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. On the theoretical side, they thought that they had resolved their internal disputes. Thus, in a 2008 paper titled “The State of Macro” (that is, macroeconomics, the study of big-picture issues like recessions), Olivier Blanchard of M.I.T., now the chief economist at the International Monetary Fund, declared that “the state of macro is good.” The battles of yesteryear, he said, were over, and there had been a “broad convergence of vision.” And 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.
Last year, everything came apart.
For the complete article, see: http://www.nytimes.com/2009/09/06/magazine/06Economic-t.html?_r=1&pagewanted=all
Krugman’s article caused quite a stir in academic and professional economics. Many have agreed with him, such as Jeff Frankel who posted this:
The Queen of England during the summer asked economists why no one had predicted the credit crunch and recession. Paul Krugman points out that, inasmuch as economists can almost never predict the timing of recessions (and don’t claim to be able to), the real questions are worse. The real questions are, rather how macroeconomists (most of us) could have gotten it so wrong as to believe that: (i) a severe recession like this was not even looming ahead as a danger, and (ii) a breakdown of many of the world’s most liquid financial markets, in New York and London, was not possible.To anyone wondering about these questions, I recommend Krugman’s essay in the New York Times Sunday magazine, September 6: “How Did Economists Get it So Wrong?” . I think he has it exactly right.
I would only add that he is modest in skipping over one point: during Japan’s lost decade of growth in the 1990s Paul forcefully drew from the Japanese experience the implication that a severe economic breakdown was, after all, possible in a modern industrialized economy – a breakdown that both was reminiscent of the Great Depression and was outside the ken of modern macroeconomic theory. But macroeconomics went on as before. (Likewise with the stock market correction of 1987, the LTCM crisis of 1998, and the dotcom bust of 2000-01. I do think, however, that our field did a better job with the emerging market crises of 1994-2001, in part because it was considered permissible to argue that financial markets in this case were highly imperfect.)
Even the cartoons in the NYT article are good… except that I have never seen Olivier Blanchard in a double-breasted suit. But Robert Lucas definitely merits a place there: when given one page to defend orthodox economists regarding the crisis in a recent Economist essay, he actually thought it was a useful rebuttal to point out that critics are repeating arguments they have made before. And he also thought it was useful to explain: “The term “efficient” as used here means that individuals use information in their own private interest. It has nothing to do with socially desirable pricing; people often confuse the two.” — as if it is not the latter question that the public is wondering about.
I am pleased that at least some in the profession are waking to the serious methodological and intellectual problems that have crept into economics (not just macro) in recent decades. There’s a long way to go though before we return to math only being a tool to check/explore the logic instead of the centerpiece. We need to put real-world economies back in focus as the topic of our theorizing and research.