Debate Over the Very Principles of Economics

Today is the launch of the online version of my Economics 1 course (and namesake of this Blog and my Twitter handle) on the Principles of Economics for summer 2017. This year is also the tenth anniversary of the start of the Global Financial Crisis and the Great Recession which began in 2007.

During these ten years there has been great deal of hand-wringing among economists and others about the subject of Economics. This is an important debate, and the different positions deserve to be covered in the basic economics course.

As early as 2009, a cover of The Economist magazine showed a book titled “Modern Economic Theory” melting into a puddle to illustrate what the writers viewed as the problem with economics. It was the most talked about issue of the year.

Some economists have been calling for a complete redo of economics—or for a return to a version of the subject popular decades ago. They say that economics failed to prevent the Great Recession and the Global Financial Crisis or even led to them. Many of these economists argued for a change government policy, saying that John Maynard Keynes was right and Milton Friedman was wrong.

Paul Samuelson spoke this way in an interview in the New Perspectives Quarterly in 2009 saying, “today we see how utterly mistaken was the Milton Friedman notion that a market system can regulate itself… This prevailing ideology of the last few decades has now been reversed…I wish Friedman were still alive so he could witness how his extremism led to the defeat of his own ideas”.

Paul Krugman, in a piece in the New York Times Magazine in 2009, also faulted modern economics for bringing on the crisis. He said it focused too much on beauty over practicality and did not recognize the need for more government intervention to prevent and cure the crisis. His fix was to add more psychology to economics or to build better models of credit.

And over the years the debate has continued. Last year Thomas Sargent, in commenting on a Handbook by macroeconomists said the “collection belies uninformed critics who assert that modern macroeconomics was wrong footed by the 2007-2009 financial crisis….both  before and after that crisis, working  macroeconomists had rolled up their sleeves to study how financial frictions, incentive problems, incomplete markets, interactions among monetary, fiscal, regulatory, and bailout policies, and a host of other issues affect prices and quantities and good economic policies.”

But also last year Paul Romer, now chief economist at the World Bank, wrote a widely discussed piece called “The Trouble with Macroeconomics.” Then Ricardo Reis of the London School of Economics wrote a paper more supportive of economics with the title “Is something really wrong with macroeconomics?” My colleague John Cochrane commented positively on the views of Reis, and Noah Smith explained in a Bloomberg View column why “So Many Critics of Economics Miss What it Gets Right

So the debate moves on. My view, throughout this period, has been that the Great Recession and the Global Financial Crisis do not provide evidence of a failure of economics. Rather theses events vindicate the theory. The research I have done, here for example for the Fed’s Jackson Hole Conference in 2007, points instead to a deviation of economic policy from the type of policy recommended by economic principles–a deviation from the type of policy that was responsible for the remarkably good economic performance in the two decades before the crisis. Economists call this earlier period the Long Boom or the Great Moderation because of the remarkably long expansions and short shallow recessions. In other words, the crisis did not occur because economic theory went wrong. It occurred because policy went wrong.

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