Paul Krugman’s New York Times article, How did economists get it so wrong? (September 6, 2009) was no doubt designed in part as a grenade to be lobbed at economics departments: to arouse anxiety and initiate discussion. In that aim, if no other, it succeeded. Last Friday, the grenade went off at Duke University, as the Center for the History of Political Economy hosted a department wide seminar to discuss the article. The gathering was marked by a general sense of unease and unhappiness: some were annoyed by Krugman’s hypocrisy and tone and some were annoyed with the economics profession. But many, as it turns out, still think that the greatest days of neoclassical economics are ahead of us and were very annoyed with Krugman for suggesting otherwise.
A macroeconomist, an economic historian and a historian of economics introduced the seminar. The macroeconomist, clearly angered, promised not to speak for long, save to tell those assembled that the article demonstrated ignorance and vitriol: most of Krugman’s accusations were not true: macroeconomists were always trying to incorporate money and the financial sector into theory. And as for Krugman’s argument that economists think that the more mathematically beautiful the model the better, nothing, we were told, could be further from the truth. Testing theory against reality is all that matters to this macroeconomist.
The economic historian was less personally offended. Krugman had raised some fair questions. After all economists had not been sufficiently vocal in alerting the world to the unsustainable nature of the past few years and perhaps the emphasis on modeling had produced a certain selective blindness. Finally, the financial sector had clearly not played the role in economists’ models that it should have done. Still, the question remained: what is the ‘real’ problem here for economists? Is this about the reputation of economists, a little bit of hurt pride; or is the economics profession actually part of the problem? After all, the question was posed, how much influence does university economics really have on policy anyway?
Well, of course, I don’t know the answer to this question. But judging from some of the comments from the room, it seems that most economists have a pretty high regard of their profession. Not least of all Krugman himself for, as the panel member representing the history of economics pointed out, Krugman’s tone did not lack in arrogance. For a start Krugman had placed himself above the profession even though he himself is as much implicated in his complaints as anyone else. Moreover, were economists really to blame for the financial crisis: wasn’t the real problem with failed regulation, rather than economic theory?
Now it’s a funny thing. Neoclassical economists working within the mainstream, either general equilibrium-ites or Chicagoans wouldn’t, I suspect, profess much love for Krugman, but they certainly do share his opinion when it comes to the importance of economics. Thus we were told: if only the incentive structures for risk managers had been right, then these managers would have flagged up the risks to their bosses that were, apparently, all too evident in the value-at-risk models. So the problem, it turns out, wasn’t the models (based as they were on only a few years data), but that economist hadn’t ALSO designed the internal management incentive structures. But if you remain unconvinced by this then there was even more hubris to come. It’s only a matter of time, we were told by another attendee, before the neo-classical approach can truly meet its destiny and provide a unified theory of everything (in the economy, just in case you wondered). House values, financial sector leverage and option pricing, just three problems that will in time be solved.
So there you have it. Perhaps those who thought that economists (including Krugman) were overstating their role in causing the crisis were right after all. But, never fear, in the future ‘the general neo-classical theory’ of economics would be there to guarantee that things could never get of control again. Well, that’s a relief. Alternatively of course, some might suggest that the real battle in the room was between relative delusions of grandeur: the delusions of those who think that economists had caused this crisis and those who think that economists will in the future ensure we have no more.
To be fair, there were some dissenting voices in the room. One contributor argued passionately that economics had reached such a level of arrogance that almost no economists were now taught basic skills, like how to read a balance sheet, a skill that would apparently have alerted many to the impending problems at the banks. Another contributor suggested that economics could never be equipped to be able to definitively say when an asset was overvalued. Modern economics after all is based on the idea that value is a function of the buyer’s personal assessment of value and utility. How could economics ever say for sure that someone was overestimating what something was worth to them? Were not questions about inflated asset prices moral and social questions beyond the realm of economics?
Still one suspects these comments fell on deaf ears. As another contributor pointed out, the incentive structures in the profession were all wrong. Such was the structure of modern universities that graduate students were so invested in current ways of thinking that they were always going to be unlikely revolutionaries in the discipline. Economists misunderstanding incentive structures, institutions do play a role after all?? Never! I refuse to believe it!
History of Economics Playground Redux 
Chris: Thanks for this first post of yours, detailed and thoughtful as we were expecting! Maybe I’ve read it too quickly but it seems to me that you mentioned the presence of one historian of economics, but you did not write anything about what he actually said during the meeting. Are you constrained to confidentiality?
There have been some debates on the role of HET in the crisis and one eminent CHOPE member argued – rightfully, I believe – that there is not much to learn from HET – at least for policy purposes. So I would be interested in knowing whether something has been said about this during the meeting.
Isn’t this is just re-generating press for the post-autistic movement from the early noughties? Delusions of grandeur, yes – but aren’t they somehow justified as the models eventually end up guiding the policy-makers’ hands?
I am not surprised to hear the argument that if only ‘we’ got incentives right for the managers we’d have a solution. I think this is the only framework economists use to approach problems, so they automatically go down that road for better or worse. Will an incentive oriented agent model of the 7 people on the UK Monetary Policy Board explain UK interest rates? I doubt it, but that’s what such an approach is suggesting… I fail to see why this debate is too ‘scholarly’ for us pedestrians Tiago?
Sunk costs and dependency paths probably explain a lot of the inertia in the discipline and has already (!) given explanations for the market crashes we’ve seen – the economics departments just don’t teach such material, and scoff at its authors. With Krugman being the latest nobel-high-priest the profession are committed to listen to him so that’s probably why everyone is up in arms… (I mean, we still pay attention to the Scholes-Merton guys who killed the financial system back in the 90s).
Finally, Yann, why do you say that HET cannot teach us much for policy purposes? I find that a very strange remark… What do we get from Keynes and post war re-construction? What lessons are there in the World Bank’s leap from Europe to The ‘third world’ using Harrod-Domar first, and later CGE models? Doesn’t the past provide a much richer environment for analysis than a counter-factual simulation?
I did a wordle of the text of the post:
http://bit.ly/CirMK
I had this impression that there were a lot of “incentive” talk in the report. (Of course, this means so little since i can only do this on the report not on the actual transcript of the event.)
The incentive talk is interesting to me because it internalizes the issues. It turns it into the a known language and problem setup, and invites an economics of economics. The issue is not obviously an economics of economics one, and more importantly economists have not always been willing to internalize professional controversy in this way (academic freedom for instance).
That’s maybe too scholarly to discuss here, so I have something more pedestrian: if the economics might explain Krugman’s abject behaviour or the failings of macroeconomics, can it explain economists’ reaction to Krugman’s criticism? Why don’t they react as passionately when worse is spoken by Naomi Klein or Nassim Taleb?
Chris, a very nice post indeed. I’m not sure how to react to many of the points Yann, Ben and Tiago discussed. However, one thing came to my mind: the weight of an authority’s argument. There has been economists reacting to Krugman in a vein apparently similar to part of the reaction of the Duke macroeconomist: people that have commented on the state of macro nowadays simply don’t quite know what macro is; are not knowledgeable about the many developments over the recent years and thus make assertions that are “untrue”. Only well trained insiders, who have effectively contributed to the development of macroeconomics, can fully appreciate the current state of macroeconomics—and Krugman is not considered an insider. You get, for example, instances of this in Lucas’s reaction to The Economist issue on economics and the crisis.
Just a few more points on the session. This was, as Chris noted, a CHOPE co-sponsored lunch; the other sponsor was the macro group here at Duke. About 40 people came; a much bigger crowd than the usual HOPE lunches. The crowd included some economists from the department, some profs from the business school as well as a guy who had worked in the Fed from N.C. State, the Center Fellows (all of whom contributed nicely to the discussion, keeping up the good image of the HOPE Fellows that was established last year), and about 10 grad students from the macro group.
I was pleased to have the Center co-sponsor something that attracted some of our colleagues in economics. I think that the discussion was fine as far as it went, but that some questions of interest were not addressed. Two ways I would have done it differently in retrospect would be to have asked the three people who gave introductory remarks to have consulted briefly with each other – this would have perhaps made the discussion more focused, and perhaps cover more issues. The other would be to spread the speakers out across the room. As it was, they were clustered on one side, and at times it turned into more of a Q&A rather than the group discussion that I had envisioned.
To respond to Yann: the history of thought speaker was Kevin Hoover. I assume that Chris was merely being diffident in not identifying anyone. No gag orders here.
I saw my role as facilitator of the discussion so I did not participate, except to make the joke that I wondered what a consensus forecast of where the economy would be in a year is something we could get out of the participants – a very Hayekian point (of course we couldn’t do that – no one has that kind of knowledge). Had I participated I would have asked the assembled group whether they thought business cycles were unfortunate but inevitable concomitants of a market economy, and that regulations that are backward looking – solving problems of the last crisis – were not going to do much to prevent the next one. I think both of these things are true but have no idea what macroeconomists think on these sorts of big questions.
Tiago – you can no longer say I have not posted to the Playground!
Bruce