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A Deficit Hawk Writes...

Economists Learning Nothing and Forgetting Nothing

Paul Krugman:

Bourbon Economics: Reading articles about New Ideas In Economics, I often have a sense of deja vu: haven’t we been through all this before? Justin Fox does the legwork, and finds a 1988 article about New Ideas that could, with a few tweaks, have been written today.

In this case, though, the problem is not with the new ideas of 1988, still being marketed as new ideas of 2010: in particular, Shiller was right about market irrationality then, and he’s still right now — with two big bubbles that he called correctly under his belt.

The question we should ask, however, is why the economics profession has been so resistant to the obvious.

I remember 1988; 1988 was a friend of mine. By 1988, it was already obvious that equilibrium business cycle theory had failed. Shiller had already circulated his devastating demonstration that asset prices were much too volatile to be explained by fundamentals, and the 1987 market crash had provided an object lesson in panic. Also, by the way, the savings and loan mess was illustrating the problems with inadequate financial regulation.

And nothing happened. Real business cycle theory continued to prosper, developing an increasing stranglehold over the professional journals. Behavioral finance stayed on the margins. The equilibrium guys had learned nothing and forgotten nothing; and by the time 2008 came around, the ravages of time had left people who actually understood demand-side shocks much thinner on the ground than they had been 20 years earlier.

Our problem, in short, isn’t lack of nifty new ideas; it’s the refusal of too many economists to face up to the fact that some of their preferred theories don’t work, a fact that has been obvious for decades.