John Mauldin on Paul Krugman and Paul on the State of the Economics Profession

The best thing I can say about the following extremely riveting and astounding "non-conversation" between two men who exist at the poles of economics is that I've always agreed with them both - on this subject (but am nowhere near so naif (tremble!) as to the causes of this crisis). Are the KGB (ex-members) grimacing yet? If they'd only been able to keep it together a little bit longer . . . . (Click on the link and enter your email address for full access.) (Emphasis marks added - Ed.)

Among the economists and writers I regularly read, there are some who, if they agree with me, I go back and check my assumptions - I must have been wrong. Paul Krugman is one of those thinkers. I admit to his brilliance, but his left-leaning philosophy does not particularly square with mine, and I find that most of the time I disagree.

That being said, I strongly encourage you to read his essay in the New York Times Magazine, which comes out this weekend. It is worth the high price of the Times to read it, if you can't get it online. It is a very hard critique and analysis of the failure of current macro and financial economic thought, which didn't even come close to predicting the current financial malaise. Indeed, as he points out, most schools of thought said the state we are in could not happen. You can read at the essay if you are a member, or register for free if you are not (here).

Krugman writes, as I have in repeated columns, that we have taught two generations of economists and financial practitioners faulty theories. Even now, believers in the Efficient Market Hypothesis and CAPM hold to their beliefs in the face of clearly contrary evidence. It is a very thought-provoking piece and worthy of a long weekend read. He names specific names and pulls no punches.

This is as close to starting a barroom brawl as you get in economic circles.

And Professor Krugman's essay says it even more clearly (and loudly!).

It’s hard to believe now, but not long ago economists were congratulating themselves over the success of their field. Those successes — or so they believed — were both theoretical and practical, leading to a golden era for the profession. On the theoretical side, they thought that they had resolved their internal disputes. Thus, in a 2008 paper titled “The State of Macro” (that is, macroeconomics, the study of big-picture issues like recessions), Olivier Blanchard of M.I.T., now the chief economist at the International Monetary Fund, declared that “the state of macro is good.” The battles of yesteryear, he said, were over, and there had been a “broad convergence of vision.” And in the real world, economists believed they had things under control: the “central problem of depression-prevention has been solved,” declared Robert Lucas of the University of Chicago in his 2003 presidential address to the American Economic Association. In 2004, Ben Bernanke, a former Princeton professor who is now the chairman of the Federal Reserve Board, celebrated the Great Moderation in economic performance over the previous two decades, which he attributed in part to improved economic policy making.

Last year, everything came apart.

Few economists saw our current crisis coming, but this predictive failure was the least of the field’s problems. More important was the profession’s blindness to the very possibility of catastrophic failures in a market economy. During the golden years, financial economists came to believe that markets were inherently stable — indeed, that stocks and other assets were always priced just right. There was nothing in the prevailing models suggesting the possibility of the kind of collapse that happened last year. Meanwhile, macroeconomists were divided in their views. But the main division was between those who insisted that free-market economies never go astray and those who believed that economies may stray now and then but that any major deviations from the path of prosperity could and would be corrected by the all-powerful Fed. Neither side was prepared to cope with an economy that went off the rails despite the Fed’s best efforts.

And in the wake of the crisis, the fault lines in the economics profession have yawned wider than ever. Lucas says the Obama administration’s stimulus plans are “schlock economics,” and his Chicago colleague John Cochrane says they’re based on discredited “fairy tales.” In response, Brad DeLong of the University of California, Berkeley, writes of the “intellectual collapse” of the Chicago School, and I myself have written that comments from Chicago economists are the product of a Dark Age of macroeconomics in which hard-won knowledge has been forgotten.

What happened to the economics profession? And where does it go from here?

Don't stop reading now (when it's just getting hot)!

Suzan _________________________