Grasping Reality on TypePad, by Brad DeLong

John Maggs:

What do you think of Paul Krugman's lengthy and provocative argument "How Did Economists Get it So Wrong?" in Sunday's New York Times Magazine? Is his taxonomy of competing schools of macroeconomics a fair one? And his account of which failed and how? Krugman says the crisis points to a muddy future for economic theory and a greater legitimacy for behavioral economics, among other conclusions. Is he right?

The replies:

From the left: James K. Galbraith, Professor of Economics, University of Texas:

“Of course, there were exceptions to these trends: a few economists challenged the assumption of rational behavior, questioned the belief that financial markets can be trusted and pointed to the long history of financial crises that had devastating economic consequences. But they were swimming against the tide, unable to make much headway against a pervasive and, in retrospect, foolish complacency.” Paul Krugman, New York Times Magazine, September 6, 2009 Amen. In two sentences, Professor Paul Krugman, Nobel Laureate in Economics for 2008, has summed up the failure of an entire era in economic thought, practice and policy discussion. And yet, there is something odd about the role of this short paragraph in an essay of over 6,500 words. It’s a throwaway. It leads nowhere. Apart from one other half-sentence, and three passing mentions, it’s the only discussion of those economists who got it right. Only one is mentioned by name. Their work is not cited. Despite having been right on the greatest economic questions of a generation, they are unpersons in his ta...

From the sensible bipartisan center: Martin Baily, Senior fellow, Brookings Institution:

I agree with Krugman that academic macroeconomics went haywire some years ago.  Many economists got out of academic macroeconomics because there seemed to be no way to fight the emerging and mistaken consensus. One place that fought the good fight for sensible macroeconomics was Brookings, where the Brookings Papers on Economic Activity remained true to sensible macroeconomics at the price of losing credibility with the academic profession. What is less clear is whether actual macroeconomic policymaking in Washington was greatly influenced by the papers in the economics journals.  My experience in the Clinton Administration in the 1990s, including the interactions with the Federal Reserve, suggested that actual stabilization policy was governed by a pragmatic view of the economy that combined the important lesson from Keynes about the potential instability of the economy together with what we learned subsequently in the postwar period, including the substantial power of monetary policy—something that Keynes downplayed. The pragmatic consensu...

Also from the sensible bipartisan center: Isabel Sawhill, Senior fellow, Brookings Institution

Krugman is right that economics is now more about the elegance or beauty of ideas and their mathematical exposition than about shedding light on real world problems.  As he notes, even the pragmatists among us (“the saltwater economists”)  have not found a way to reconcile Keynesian theories with our continuing belief in the ability of individual markets to equilibrate supply and demand.  Behavioral economics has helped to wean a new generation of economists from the earlier fixation on perfect rationality along with full and unbiased information, equally available to both buyer and seller in a market, but the microeconomic foundations of macroeconomics still need shoring up. In the meantime, those of us who work in Washington in policy-advising or policy-making positions quickly learn that theoretical answers are nowhere near as useful as empirically-generated answers based on common sense conceptual frameworks.  The sad thing, in my view, is the resources that are wasted teaching the best and the brightest in today’s graduate s.....

Also from the sensible bipartisan center: Rob Atkinson, President, Information Technology and Innovation Foundation In thinking about the causes of the financial collapse I have been puzzled as to how so many knowledgeable people in Washington and on Wall Street did not realize that the long history of housing prices, at least since WWII, has followed a pretty steady trend and that the dramatic increase above trend that began in the early part of this decade simply could not be sustainable and had to revert to the mean – either gradually, or as we have seen, dramatically. Krugman provides the answer: the dominant neo-classical economics doctrine equates value with price.   If value equals price, then the price of housing – or any other commodity – is always priced appropriately. And if this is the case, then normal rules of lending and other financial tools generally will work. When it’s not, they don’t as we saw. As such, Krugman is right to call for bringing the reality of human irrationality, institutions, culture, and technology, back into economics, as they once were before the mathemetization of economcs drove them out.    But...

Also from the sensible bipartisan center: Ted Truman, Senior Fellow, Peterson Institute for International Economics:

Paul Krugman is broadly correct. Too many academic economists have been looking for truth under the lamppost rather than tackling the really difficult problems that do not lend themselves to elegant, mathematical solutions.  Of course, as an economist and in order to be clear, Krugman had to simplify his own argument, and some will say oversimplify.  The distinction between fresh water and salt water is broadly correct except that here on the Potomac the waters mix. I am sure that Krugman will offend many because some of the corrective trends, for example with respect to behavioral economics are already underway, but he has stirred up a good debate...

Also from the sensible bipartisan center: Jeffrey Frankel, Professor of Capital Formation and Growth, Harvard University:

The question “how did economists get it so wrong?” is a difficult one to answer, but Paul Krugman has it exactly right. In this case I would only add that he is modest in skipping over a point:  during Japan’s lost decade of growth in the 1990s he  forcefully made the inference that a severe economic breakdown was possible in a modern industrialized economy – a breakdown that was both reminiscent of the Great Depression and was outside the ken of modern macroeconomic theory.   But macroeconomics went on as before. 

From the right: Charles Calomiris, Professor of Financial Institutions, Columbia University:

Professor Krugman's article, like much of his journalism, was hastily drafted and factually incorrect. He presents a caricature of the finance and economics professions and shows little knowlege of what actually went wrong with the markets and how much the sources of the crisis had been causes of concern by economists prior to the crisis.   One of the most humorous aspects of the article was its view that the efficient markets hypothesis was at the heart of the inability to see the bubble coming. If Krugman had bothered to read any of the finance journals for the past two decades he would have noticed a remarkable transformation of the profession away from adherence to the efficient markets hypothesis. Behaviorism is in, as are theories of market imperfections due to asymmetric information, and theories of agency (how money managers make purposeful investment errors because of conflicts between their interests and their clients'). It is hard to combine these ideas into an overarching theory of asset pricing, but in the past decade many scholars are starting to inte...