How did economists get it so wrong?
In September, an argument broke out as to whether economics really works, triggered by Professor Paul Krugman of Princeton University, last year's Nobel laureate in economics. He criticized almost the whole of modern economics in his long essay "How Did Economists Get It So Wrong?" which appeared in the online version of The New York Times on September 6.*1 This not only stirred up controversy but also threatened the credibility of economics. This article reviews the challenge made to Krugman by Prof. John Cochrane of the University of Chicago, a mainstream economist, and the result of their argument.
Put simply, Krugman's article states, "And yet, Keynes is right!" Pandering to readers, he claims that modern macroeconomists have proved to be incompetent after trying to drive out Keynesian economics over the last three decades. Citing anti-Keynesian remarks of major mainstream economists throughout his article, he distorts their views to make them sound absurd, as if their theories are unrealistic and hollow. Buoyed by the fact that few economists foresaw last year's financial crisis, let alone prevented it, Prof. Krugman flatly rejects almost all academic developments that macroeconomists have achieved since the 1970s and derides these towering economists.
His article is intended to titillate readers with tales of battles within the closed world of economists. Krugman's argument in the article is simple: modern macroeconomics is wrong because it failed to predict the current global financial crisis. So, why don't we get back to the sweet home of Keynesian economics?
This argument may appear to be straightforward and seductive, but a moment's consideration will show it to be nonsense. Modern economics is no more wrong because of its failure to predict the financial turmoil than aerodynamics is because of an aircraft accident. We must simply investigate the specific causes and refine the theory, not simply refute the theory. Furthermore, compared to his attack on economics, Krugman is rather vague about how to reconstruct it. Krugman's conclusion towards the end of the article is to learn the lesson of dysfunction due to information asymmetry from the financial markets and well-known observations from behavioral economics (to fundamentally reconstruct economics). I was surprised to find that his conclusion or suggestion for the reconstruction of economics was so moderate and lacking originality, while he aggressively refuted modern economics.
Although this ill-tempered argument is unlikely to have a great impact on the community of professional economists, it is worrying that the public, rather than economists, may find it orthodox since Krugman has authority as a Nobel laureate in economics (and, to be fair, he made similar remarks in one of his books more than a decade ago). The controversy has continued to rage on the Internet. Just when I was wondering whether economists would be able to control the escalating argument, Prof. John Cochrane of the University of Chicago, who was among those ridiculed, wrote a countering article.*2
Political motive beneath the criticism of economics
Incidentally, I studied under Prof. Cochrane as a student at the University of Chicago. If I remember correctly, he was a tall and powerful sportsman fond of surfing, looking more like a Californian surfer than a scholar, and more like a cowboy in nature who, if a guy were to hit him, would hit back. Prof. Cochrane's article provided such a logical objection that it is useful for studying the criticisms against recent economics, although I don't agree with him entirely.
Firstly, Prof. Cochrane makes a counter-argument that "Paul Krugman has absolutely no idea about what caused the crash, what policies might have prevented it, and what policies we should adopt going forward." Krugman and other Keynesian economists insist that modern economics is wrong because it failed to suggest any causes or prescription for the financial crisis and that Keynesians' fiscal policy dependent on government bonds is effective. Krugman and his friends do not identify the causes of the financial crisis by their own analysis and propose specific countermeasures. Nor does Krugman say why fiscal action to stimulate demand will solve the financial crisis, fix its causes, and decisively restore the economy (though it may provide temporary pain relief).
The second objection is more fundamental. Prof. Cochrane contends as follows: "Prof. Krugman wants people to swallow his arguments" of fiscal action. For this political purpose, "he tries to discredit" modern economics and the adherents "who disagree with him" and urges people not to trust them. He therefore dares to write "without rigorous logic or evidence" though he is aware of it. And Prof. Cochrane concludes "Krugman isn't trying to be an economist, he is trying to be a partisan, political opinion writer."
I am not saying that Cochrane is correct and Krugman is wrong, for I don't agree with some of the details of Cochrane's argument that fiscal stimulation would not work. However, I think Cochrane is right that Krugman has a political agenda beneath his criticism of economics. That would be serious, and I wonder whether Krugman's political motive of fiscal stimulation will set the world economy and economics in the right direction.
(To be continued)
* Translated by RIETI from the original Japanese article in the series, "Gödel's money" published in the October 5, 2009 issue of Kinzai Financial Weekly
