By Matthew Rock.
Rewind to 2006, and you will find the state of affairs in elite universities’ economics departments far different from the one we observe today. Economists had by and large resolved their discipline’s great theoretical disputes, and they pointed to the previous twenty years of steady global growth and low inflation, known as the Great Moderation, as evidence of their perfected ability to guide policymaking decisions.
Oliver Blanchard of M.I.T, the chief economist at the IMF since 2008, declared that “the state of macro[economics] is good.” In his 2003 presidential address to the American Economic Association, Robert Lucas of the University of Chicago boldly declared, “[The] central problem of depression-prevention has been solved.” Indeed, a young, good-looking economist could easily rocket to fame if he or she contributed a new mathematical model to buttress the prevailing impression of economics as a flawless framework.
Eight years, 8.7 million lost jobs, 1.2 million foreclosed homes, and several government bailouts later, and the world’s previous favorite social science has re-adopted its old nickname—“the dismal science.” When the U.S. housing bubble burst in late 2007 and the U.S. subprime mortgage and financial crisis ensued, the world welcomed its greatest economic disaster since the Great Depression, aptly dubbed the Great Recession. The public devastation and outcry compelled complacent economists to descend from their high pedestals, which too seemed to have rested upon a fragile bubble.
When citizens and policymakers asked them why they had not identified the ballooning price of real estate and the risky lending practices of banks as symptomatic of a looming bubble burst, they balked. “Our discipline does not give us a crystal ball,” some defended; “The current recession is but a hiccup,” insisted others. All the while, the collection of Nobel medals for economics in the offices of university faculty began to collect dust (since universities could not afford to hire cleaning staff to polish them).
As antiestablishment economists began to analyze the causes of the recession, they mounted increasingly well-supported attacks on the beliefs of the main establishment, the members of which came under increasing strain. In their pursuit to establish economics as a paradigm-driven science comparable to physics, economists had produced complex, multi-variable formulae and highlighted their power to predict the course of the economy.
Unfortunately, according to Paul Krugman of The New York Times, economists depended on sweeping generalizations in order to derive such mathematical outcomes, beautiful in their reductionism. As Alex Rosenberg, the R. Taylor Cole Professor of Philosophy at Duke, explains, one of the most egregious of these generalizations was the assumption people’s behavior tends to settle along the mean of a Gaussian curve—that is, some people might err high and some people might err low, but on average they land on the mean correct value. This reasoning served as the foundation for economists’ insistence on financial market’s self-correcting nature.
This insistence provided the economic argument for the repeal of the 1933 Glass-Steagall Act in 1999, which had separated commercial and investment banking for seven decades. Because the repeal of this act has largely been cited as a cause of the Great Recession, economists in the sole pursuit of reductionist beauty bear a great deal of the blame for the crash.
The underlying conventions of contemporary economics came undone in the wake of the disaster as policymakers worked to stoke the embers of recovery. People discovered important economic variables, such as housing prices and loan rates, had strayed much too far from their assumed mean, and no self-correcting mechanism had been present to stem the tide.
Keynesian economics, a doctrine of demand-stimulated government intervention in the economy and long since declared ineffective by the Chicago School, made a full-throttle comeback as Barack Obama ushered his stimulus package into law. The government boosted spending and cut taxes in an attempt to stimulate aggregate demand, despite the collective outcry from the neoclassical economists of the long-run uselessness of this policy.
In a similarly audacious move, the Federal Reserve abandoned conventional monetary policy and embarked on an unprecedented purchase of trillions of dollars worth of U.S. Treasury notes, in a policy known as Quantitative Easing. Although mainstream economists warned of inevitable hyperinflation and a collapse of the decades-long institution of stable monetary policy, the determined Federal Reserve Chair Ben Bernanke was relentless in his pursuit to cut long-run interest rates and to stimulate investment.
Even in full light of today’s recovery, people in the U.S., the epicenter of the global disaster, have little faith in economic indicators and in the people who tout them. The unemployment rate has plummeted to 5.9%, GDP growth rate has risen to 2%, corporate profits have soared, and the stock market is bullish. Despite this, Americans feel as insecure as four years ago, reflected in the rout of the Mr. Obama’s party in the recent midterm elections. While some of the discontent is attributable to growing amounts of inequality in the American economy, a great deal lies in people’s perception of these economic figures as unfounded and of their belief in a prolonged downturn.
What Comes Next?
Given the world’s economists have made so many false assumptions and have so often ended up wrong, it is interesting to note the most detailed address of economics’ woes have come not from a self-critical economist but from a philosopher of economics. In his paper “Start the Revolution Without Me: the Future of Economics,” Dr. Rosenberg addresses the problem he believes to be at the root of economics: radical, non-probabilistic uncertainty. As explained in his paper, the course of the economy depends on the rate of technological change, the prevalence of entrepreneurship, and occurrence of changing tastes, and these in turn interact in complex reflexive relationships among buyers and sellers in order to determine the present state of the economy. Because uncertainty is implicit in invention, entrepreneurship, and tastes, Dr. Rosenberg argues that economics’ inability to wrestle with uncertainty undermines its ability to predict tomorrow’s equilibrium. Predictive models depend on expectations; uncertainty unsettles these expectations; and thus, uncertainty unsettles predictive models.
Insofar as economics identifies its main objective as making policy-informing predictions, the discipline is ripe for a paradigm-shifting revolution, lest it lose its status as “a predictive science.” Somewhat wryly, Rosenberg adds that economics faculty instead could opt to change its mission to more of a historical approach, where they settle for after-the-fact explanation of past events. Indeed, their usefulness as policy advisors would diminish to nothing, but their discipline would forgo the need for a revolution.
Since I would find it much too painful to explain to my parents why my selected major of a B.S. in economics truly became BS, I pray the “dismal science” does not become the “even more dismal history.” In order to avoid this, economists must no longer marginalize the role of uncertainty in the economy and should begin to better explore the intersections of the macro-, micro-, and financial sub-fields in search of a ruling paradigm better able to take uncertainty into account. Beautiful reductionist models must be erased from the pages of advanced textbooks, and the single-minded logical economist must give way to ones who are less straightforward and more variable in their approaches. Although I am no scientist, I will still make a prediction of economists’ future: adapt, or face extinction.
Acknowledgements: For the writing of this article, I am indebted to Dr. Alex Rosenberg of Duke University, who provided me much counseling on the topic and allowed me use of his yet-to-be-published paper “Start the Revolution Without Me: the Future of Economics.”