1 Boring Old Man

This article is worth reading in toto, even though it’s 8 pages long and mentions a gaggle of economists that you’ve never heard of. It’s about the abject failure of academic and government economists to understand, regulate, or predict our economy: I’ve reprinted Krugman’s conclusions:

How Did Economists Get It So Wrong?
New York Times
By PAUL KRUGMAN
September 2, 2009

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VIII. RE-EMBRACING KEYNES

So here’s what I think economists have to do. 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.

Many economists will find these changes deeply disturbing. It will be a long time, if ever, before the new, more realistic approaches to finance and macroeconomics offer the same kind of clarity, completeness and sheer beauty that characterizes the full neoclassical approach. To some economists that will be a reason to cling to neoclassicism, despite its utter failure to make sense of the greatest economic crisis in three generations. This seems, however, like a good time to recall the words of H. L. Mencken: “There is always an easy solution to every human problem — neat, plausible and wrong.”

When it comes to the all-too-human problem of recessions and depressions, economists need to abandon the neat but wrong solution of assuming that everyone is rational and markets work perfectly. The vision that emerges as the profession rethinks its foundations may not be all that clear; it certainly won’t be neat; but we can hope that it will have the virtue of being at least partly right.

I’m reminded of Chaos Theory, that elegant bit of mathematics that throws a monkey wrench in our wished for orderly understanding of mathematical processes. It started with weather scientists who were trying to use all the weather stations left over from World War II to make long term weather predictions. Their mainframe computer models  didn’t work. One day, while crunching the numbers, the machine shut down. After it was fixed, they typed in the values from where they left off. That radically changed the output. What they learned was that it was due to rounding off. But more importantly, they realized that in the real world, tiny events could make alterations. The usual example [the butterfly effect] is that a butterfly flapping its wings on the west coast can markedly influence the path of a storm on the east coast.

As Krugman goes through the various economic models, he notes that they are all based on rational behavior of the markets, pricing, and investors – an obvious fallacy. He also talks about the economists’ personal investment in their pet theories – Greenspan takes a huge [well-deserved] hit. Robert Shiller [the bubbles guy] looks like a hero. Krugman remains enamored with John Maynard Keynes, the theorist who recommended big government spending as a response to Recession/Depression.