Paul Krugman recently published a piece in the Eastern Economic Journal on the state of economics as a result of the economic crisis. He makes the very accurate argument that the profession of economics has failed to accurately predict and respond to the economic crisis. In the piece, he concludes:
“I’m sorry if I have painted a bleak picture of the role of economists in the crisis. Unfortunately, that’s the way it looks to me. So what can be done to improve that picture?
Some economists are pushing forward with new macroeconomic models that incorporate the lessons of the crisis. Me too! And by all means, let’s do that. But as I’ve said, our big problem was not lack of models.
There are also many calls for new economic thinking; there’s even an institute dedicated to that project. Again, fine — but the biggest problem we had as a profession wasn’t failure to keep up with a changing world, it was failure to remember what our fathers learned.
What we really need is a change in the destructive social dynamics that brought us to this point. And I wish I knew how to do that. But my problem is obvious: I’m an economist, and it seems that we need some kind of sociologist to solve our profession’s problems.”
I am afraid that I just can’t agree entirely. This “new macroeconomics” is really just more neoclassical economics with a slightly different message. It’s just more of the same economics that helped get us into this mess and is failing to get us out. The truth is that the profession of economics has been working under a completely false paradigm for much of the last century. And it took a crisis to begin to expose the many flaws in this thinking. Whether it be the myth of the money multiplier, the myth that single currency systems are good or the myth that a sovereign currency issuer has a solvency constraint that is comparable to that of a household or business. These are just a few of the myths that this “new macroeconomics” fails to provide accurate answers for.
On the other hand, there is one school of thought that not only accurately predicted the crisis, but also described in vivid detail why the policy responses would fail. This school of thought is still largely regarded as “heterodox” and “theoretical”, but it is gaining traction for good reason – it is the new reality of macroeconomics. And the accurate one. The real lesson of the crisis is that macroeconomists have been working under a false paradigm. One based on the teachings of the gold standard era. That era is extinct. And for the betterment of the world, we should hope that the old ways of macroeconomic thinking become extinct as well.