1. Economists did not see the financial crisis coming, therefore there is something wrong with economics.
2. It's not hard to see what is wrong with economics - it got seriously sidetracked, roughly in 1970.
3. What to do? According to Krugman:
First, they have to face up to the inconvenient reality that financial markets fall far short of perfection, that they are subject to extraordinary delusions and the madness of crowds. Second, they have to admit — and this will be very hard for the people who giggled and whispered over Keynes — that Keynesian economics remains the best framework we have for making sense of recessions and depressions. Third, they’ll have to do their best to incorporate the realities of finance into macroeconomics.So, what's changed since 2009, at least in Krugman's mind? Not much, apparently. Krugman's Monday NYT column was titled "How to Get it Wrong." Now it's not just the economists who are stupid/misguided/nefarious - it's the policymakers as well. Maybe this is good news if you are an economist. If you are an economist and a policymaker, not so good, I'm afraid.
Not one to shy away from hyperbole and invective, Krugman tells us about an "enormous intellectual failure" in economics, and the "sins of economists, who far too often let partisanship or personal self-aggrandizement trump their professionalism." Economists are clearly a group of bad people, and if you follow the links in his piece, you can figure out who some of the bad guys are. Bob Lucas, for example, who played a starring role in Krugman's 2009 piece. Apparently Lucas was one of those people who imagined an "idealized vision of capitalism, in which individuals are always rational and markets always function perfectly."
So, let's start with that. Part of Krugman's game is to convince you of the moral inferiority of the people he disagrees with, which serves to excuse his name calling. That's what he says in this post:
And if you look at the uncivil remarks by people like, well, me, you’ll find that they are similarly aimed at people arguing in bad faith ... what I’m doing is going after bad-faith economics — economics that keeps trotting out claims that have already been discredited.The problem of course, is that "discredited" is in the eye of the beholder - Krugman's eye basically. If I follow those rules, I can "discredit" someone, then abuse them all I want.
So, what do the "discredited" economists do? Apparently, those bad people think that "individuals are always rational and markets always function perfectly." First, on rationality, I don't think Krugman has a published paper with irrational economic agents in it (someone please point one out to me, if this is incorrect). So, if we follow what Krugman does, rather than what he says, that might actually conform to my defense of rationality in economics:
In my view, irrationality is the great cop-out, and simply represents a failure of imagination. Rationality is so weak a requirement that the set of potential explanations for a particular phenomenon that incorporate rationality is boundless. If the phenomenon can be described, and we can find some regularity in it, then it can also be described as the outcome of rational behaviour. Behaviour looks random only when one does not have a theory to make sense of it, and explaining it as the result of rational behaviour is literally what we mean by ‘making sense of what we are seeing’.Second, modern macroeconomics (which Krugman detests) is replete with frictions - it's hardly about markets functioning perfectly. For example, Evil Ed Prescott did some work, with Finn Kydland, on models in which markets work really well. RBC models are basically special cases of Arrow-Debreu. The whole idea is to see how much you can explain without having to resort to frictions. But Kydland and Prescott received the Nobel Prize in 2004, in part for their work on time consistency. The basic idea is that the ability of a policymaker to commit is critical. Even a benevolent policymaker could choose bad policies if there is nothing to stop him or her from breaking promises. So, that's a world that doesn't work perfectly, and the time consistency idea has been highly influential in policy circles and in macroeconomic modeling. Indeed, it's very important in New Keynesian economics. That's an example of specific research by someone in Krugman's bad-person camp, that doesn't fit the profile. More generally, if you look through this year's SED program, you're going to find a lot of frictions - more frictions than you can shake a stick at. And this is from the society founded by the Minnesota macros, basically.
A new complaint of Krugman's is that the academic economic journals are ignoring good work:
...starting in the 1980s it became harder and harder to publish anything questioning these idealized models in major journals.By "idealized models," I think he means Arrow-Debreu. That's quite a charge - apparently the economics profession is so ill that scientific progress is grinding to a halt. So, what's the evidence for the charge? Krugman quotes Ken Rogoff, who has a gripe:
There are more than a few of us in my generation of international economists who still bear the scars of not being able to publish sticky price papers during the years of new neoclassical repression.Yes, and poor Rogoff was so repressed that he carried his scars from UW-Madison, to Berkeley, to Princeton, and now must reside, scarred, in that intellectual backwater, Harvard University. Complaints about academic journals are universal. There is no shortage of whining about the nasty Keynesians, the nasty theorists, the nasty new old non-neoclassical whoevers who reject one's papers. Being misunderstood comes with the territory in economics, I'm afraid. Best have a thick skin if you want to survive. If the best Krugman can come up with is a complaint from 13 years ago about what happened 30 years ago, this isn't worth much.
If there is an important change in Krugman's approach from 2009 to today, it's in what he expects from the profession. In 2009, he wanted people "to admit that Keynesian economics remains the best framework we have for making sense of recessions and depressions." Presumably "Keynesian economics" includes New Keynesian economics. Further, Krugman was willing to recognize, at that time, that there was interesting work going on outside of what we might call Keynesian thought:
One line of work, pioneered by none other than Ben Bernanke working with Mark Gertler of New York University, emphasized the way the lack of sufficient collateral can hinder the ability of businesses to raise funds and pursue investment opportunities. A related line of work, largely established by my Princeton colleague Nobuhiro Kiyotaki and John Moore of the London School of Economics, argued that prices of assets such as real estate can suffer self-reinforcing plunges that in turn depress the economy as a whole.That seemed promising. At least Krugman was aware of some of the work, preceding the financial crisis, which dealt with financial frictions. A lot of that work continues, and there is much more of it now, propelled of course by the financial crisis experience. Some of that recent work was presented at a conference that I organized, with Mark Gertler (see above) at the St. Louis Fed late last year. The people at that conference were from both sides of the fence that Krugman imagines divides the macroeconomics profession. The papers were very interesting, and they went some way toward helping us understand the causes and consequences of the financial crisis. Progress!
The 2014 Krugman has lowered his sights considerably.
...the world would be in much better shape than it is if real-world policy had reflected the lessons of Econ 101.This isn't a call for refurbishing macroeconomic thought with irrationality and frictions. What Krugman wants is a reversion to the technology of 1937. Why? From this blog post:
Why is output so low and jobs so scarce? The simple answer is inadequate demand — and every piece of evidence we have is consistent with that answer...there is a deep desire on the part of people who want to sound serious to believe that big problems must have deep roots, and require many hours of solemn deliberation by bipartisan panels.So, now I'm confused. Krugman says macroeconomics went wrong after 1970, and one of the primary culprits was Lucas, who apparently told us that economies work perfectly, and don't need help from policymakers. Krugman also links to this 2003 paper by Lucas from which this quote is extracted:
Macroeconomics was born as a distinct field in the 1940’s, as a part of the intellectual response to the Great Depression. The term then referred to the body of knowledge and expertise that we hoped would prevent the recurrence of that economic disaster. My thesis in this lecture is that macroeconomics in this original sense has succeeded: Its central problem of depression prevention has been solved, for all practical purposes, and has in fact been solved for many decades.This quote is intended as an example to show us how out to lunch mainstream economics was before the financial crisis. Obviously, Krugman is telling us, these guys didn't have a clue what was in store. But, in the conclusion to his paper, Lucas also tells us:
If business cycles were simply efficient responses of quantities and prices to unpredictable shifts in technology and preferences, there would be no need for distinct stabilization or demand management policies and certainly no point to such legislation as the Employment Act of 1946. If, on the other hand, rigidities of some kind prevent the economy from reacting efficiently to nominal or real shocks, or both, there is a need to design suitable policies and to assess their performance. In my opinion, this is the case: I think the stability of monetary aggregates and nominal spending in the postwar United States is a major reason for the stability of aggregate production and consumption during these years, relative to the experience of the interwar period and the contemporary experience of other economies. If so, this stability must be seen in part as an achievement of the economists, Keynesian and monetarist, who guided economic policy over these years.This sounds nothing like the Lucas that Krugman is telling us about. In fact, he seems to have a lot in common with Krugman. Seems the 2003 Lucas thought that important inefficiencies exist in the absence of government intervention, and that "stabilization or demand management policies" can and did fix these problems. Lucas also tells us that the Depression problem has been fixed. We don't have to worry about it anymore - because stabilization and demand management are at the ready. Krugman says our current problems, as he sees them, can be fixed by standard "Econ 101" stabilization and demand management. Apparently Lucas was a dummy for thinking the depression problem had been solved by stabilization and demand managment. You idiot, our modern depression problem needs to be solved by stabilization and demand management.
Krugman is right, in a sense. The solutions to economic policy problems can indeed be simple - once you know the answer. It's determining the answer that is hard. If the solution to our policy problems was all in Econ 101, we wouldn't hire economists with PhDs to do economic policy. We wouldn't spend all the time we do hashing over policy problems, or arguing with Paul Krugman about why it's not as easy as he claims. Further, to say that the solution is in Econ 101 is actually an insult to Econ 101 students. Econ 101 students, if they are taught properly, know that the inefficiencies resulting from price and wage rigidity, if they exist, don't last forever, and if they lasted 6 years after a financial crisis occurred, we would be very surprised. Thus, a smart Econ 101 student might question why conventional demand management is going to solve whatever problem exists. Well-trained Econ 101 students also understand that, if we want to solve an economic problem, it will help a lot to understand the cause of the problem. If as Krugman tells us "textbook economics...didn't predict the crisis," or indeed tell us anything about what a crisis is, or what would cause it, what's it going to say about how to fix things up once the crisis hits, or six years after it went away?