In November last year, during a visit to the LSE, the Queen of England (and Australia to our eternal shame) asked some pointy heads why “if these things were so large, how come everyone missed them?” in relation to the apparent inability of the mainstream economics profession to foresee the crisis. Apparently, the Royal Academy then called a special workshop to discuss this and came up with an answer which they then relayed post haste … as “Your Majesty’s most humble and obedient servants” to Liz. The whole affair represents the standard massive denial that defines mainstream macroeconomics. There are no saving graces. It would be useful if they just desisted for a while and went and played gin rummy.
The Royal Academy pointy heads – all senior economists in Universities and elsewhere with links to monetary policy etc sent the Queen this letter, explaining how all of us bright things (economists) were all so concentrated on making wealth for our various spheres of influences (firms, banks, financial houses etc) and providing policy advice to our governments that was making consumers wealthy and free and everyone was so feeling, well, so “feel-good” and benefiting from what they call the “light touch” of self regulation thoughout the system … that, unfortunately, amid all this goodness and charity … although
Everyone seemed to be doing their own job properly on its own merit. And according to standard measures of success, they were often doing it well. The failure was to see how collectively this added up to a series of interconnected imbalances over which no single authority had jurisdiction. This, combined with the psychology of herding and the mantra of financial and policy gurus, lead to a dangerous recipe. Individual risks may rightly have been viewed as small, but the risk to the system as a whole was vast.
So in summary, Your Majesty, the failure to foresee the timing, extent and severity of the crisis and to head it off, while it had many causes, was principally a failure of the collective imagination of many bright people, both in this country and internationally, to understand the risks to the system as a whole.
Can you believe these guys? There was only one a female among them by the way – lots of Sirs, Rt Hons and Profs notwithstanding.
The failure goes back squarely to the theoretical structures that mainstream economics uses to determine whether a situation is sustainable or not. Nothing has been learned from this disaster as yet when you consider that these characters will be sipping on their tea in their tenured and very well paid jobs while unemployment and poverty sky-rockets and once growth returns they will emerge at various board meetings and government task forces working out how to cut more cake for themselves and their wealthy mates while admonishing the unemployed for not showing enough endeavour to dig themselves out of the poverty they are trapped in.
You could usefully trace the academic work of the signatories to the letter and the attendees at the conference in June this year to many statements that supported de-regulation of financial markets and labour markets; increased harshness of welfare systems; reduction of public sector involvement in the economy generally and more. You will struggle to find any statements from them advocating that the only sustainable growth path is for the government sector to run deficits of sufficient size to finance the non-government desire to save.
The general malaise of the profession is to be found in the text books that dominate and are insidiously imposed on the students.
In a recent edition of the Atlantic Magazine, veteran macroeconomist Paul Samuelson gave a two part interview – Part One and Part Two. Samuelson, for non-economists, is 94 years old and wrote one of the most influential macroeconomics textbooks in the 1950s and 1960s.
It was a Keynesian book but in the spirit of what became known as the neo-classical synthesis – a bastardised Keynesian approach that emerged in the 1940s as a result of poorly written sections of Keynes’ General Theory that gave scope for the mainstream to reinvent themselves within his framework but still recapture some of the ground that they should have rightly lost as a result of their dismal performance during the Great Depression. That is, they failed to understand it as a systemic failure of the macroeconomy and instead still considered it to be a problem of excessive real wages. It wasn’t and their policy prescriptions made things worse.
However, by comparison with today’s textbooks Samuelson was almost a reasonable depiction of the gold standard economy he wrote about. Anyway, Samuelson was asked in Part 1 of the interview – in the context of the current crisis revealing the failure of the dominant macroeconomic theories of today (which rejected Keynesian style fiscal policy intervention in favour of inflation-first monetary policy and passive fiscal policy (surpluses)) – whether “it time for the Keynesians to declare victory?”. He replied:
Well I don’t care very much for the People Magazine approach to applied economics, but let me put it this way. The 1980s trained macroeconomics — like Greg Mankiw and Ben Bernanke and so forth — became a very complacent group, very ill adapted to meet with a completely unpredictable and new situation, such as we’ve had. I looked up — and by the way, most of these guys are MIT trained; Princeton to MIT or Harvard to MIT — Mankiw’s bestseller, both the macro book and his introductory textbook, I went through the index to look for liquidity trap. It wasn’t there!
Mankiw’s text book in macroeconomics is one of the most popular among lecturers. It is an appalling rendition of how the macroeconomy works. You will find very little in it that will help you understand how a modern monetary system works despite its several versions (different levels and coverage). You will only learn that ultimately unemployment will converge on some natural rate as long as welfare payments are scrapped and unions butt out. You will learn that budget deficits are ultimately inflationary and drive up interest rates. You won’t gain any clue about the essential operations of the monetary system and the way the central banks interact with treasuries to facilitate net spending etc.
In the second part, apart from slamming the state of new-classical macroeconomics, Samuelson also takes aim again at Mankiw. He was asked and replied:
Are you happy with the way economics is being taught now? You’ve mentioned Greg Mankiw’s textbooks.
Well to say that I’ve read them would be an exaggeration. I looked into them, and I was disappointed that they were so bland. [Laughs] No, he’s a gifted writer. But an economist with a facile pen isn’t necessarily an overnight expert on the likelihoods in our inexact science.
Another macroeconomics text book writer, Bradley De Long at least had the wit to be honest about the state of play. He told a gathering in Singapore recently that:
This is also a bad time to be a macroeconomics theorist. Take any intermediate macroeconomics textbook – even mine and Marty Olney’s – try to use it to figure out what is happening to the world economy right now, and you come up dry. Take any introductory economics principles text: it is of no greater help. Perform the difficult and arcane task fo reading the technical papers that we make graduate students read in their first and second years of macroeconomics courses – you gain little if anything of use. The economic theories we professional economists typically teach do not do their job of helping us to understand the world in which we are now living.
Well the real problem is that mainstream macroeconomics is devoid of any real understanding of how the fiat monetary system operates. There is also a dangerous “sociology” within the economics profession.
It is well established that economists rarely refer to other social science research in their own work. This study provides an interesting (one of many) comparisons of cross-citations among sociologists, political scientists and economists. It concludes:
The most straightforward (sociological) interpretation of the above is the former: Economists ignore the other two disciplines because they regard them as lower in status, and they are able to get away with such attributions because the other disciplines implicitly accept their lower status (otherwise they would reciprocate by ignoring economics as well) … Another interpretation takes these data as evidence of the openness of a given discipline to intellectual exchange with other disciplines. Using this interpretation, both sociology and political science became much more open to other disciplines around mid-century, with the latter particularly notable for its openness to other influences. By contrast, economics has essentially been closed both to sociology and political science.
My profession is largely an arrogant and narrow-minded group. I recall when I was a graduate student that I was vilified for reading sociology and political philosophy. A well-known professor at the time (now dead) said to me once “you are very bright billy but why do you dabble in all this pop sociology?”.
There was intense pressure in university to toe the line presented. I never did but most do. There is a clear club that defines in the main progress – it is easier to publish, easier to get research grants and easier to get promotion. It is very hard for a non-orthodox economist to even get a tenured academic post.
The consensus permeates all the big international institutions like the IMF and the World Bank. I have written about this before – see my blog Bad luck if your poor.
The main policy advice given by economists is to promote fiscal surpluses supporting monetary policy centred on inflation control and then microeconomic policies such as deregulation and welfare stringency.
The policy framework has failed dramatically. Even in the growth period it failed to provide enough jobs or working hours to satisfy the preferences of the available labour. It also increased inequality in access to national income. The less developed countries have gone backwards over the neo-liberal period. In a world of plenty more people are poor now than before. And we have increasingly trashed our natural environment.
The fact is that modern monetary theorists have been writing about the coming crisis for years now – long before the debt explosion started to unwind. We developed our understandings from first principles about the relationship between the government and non-government sector and how net public spending supports high levels of private sector activity without forcing the private agents into increasing levels of indebtedness.
We predicted that once the private agents started to restructure their balance sheets to reduce their precariousness, then the fiscal drag in the system would drive it into a very deep recession.
So all you bright Royal Academy things seeking some “collective imagination” the first place to start is to go back to first principles and start understanding that a government surplus = a non-government deficit (and vice versa). Then start building from that beginning.