The economy is in a bad place–as are the (mainstream) economists who failed to see it coming. The discipline hasn’t taken a hit this hard in almost 80 years.
An entire field of experts dedicated to studying the behavior of markets failed to anticipate what may prove to be the biggest economic collapse of our lifetime. And, now that we’re in the middle of it, many frankly admit that they’re not sure how to prevent things from getting worse.
For a long time, (mainstream) economists have enjoyed an authoritative voice in many important economic and policy debates. They have advised presidents and dictators and have held key government and financial positions. But this crisis has brought a moment’s pause amongst today’s economist, inviting a turn towards self-reflection as the discipline must assess what went wrong, and where they went wrong.
“Everyone that I know in economics, and particularly in the worlds of academic finance and academic macroeconomics, is going back to the drawing board,” says David Laibson, a Harvard economist. “There are very, very, very few economists who can be proud.”
A few are suggesting, as well, that there are deeper problems in the discipline. Economists are asking aloud whether the field has grown too specialized, too abstract – and too divorced, in some sense, from the way real-world economies actually function. They argue that many of the models used to explain and predict the dynamics of financial markets or national economies have been scrubbed clean, in the interest of theoretical elegance, of the inevitable erraticism of human behavior. As a result, the analytical tools of the trade offer little help in a crisis, and have little to say about the sort of collapses that led to this one.
“We have a very restrictive set of language and tools, and we tend to work on the problems that are easily addressed with those tools,” says Jeremy Stein, a financial economist at Harvard. “Sometimes that means we focus on silly questions and ignore greater ones.” [emphasis mine]
The article calls for a return to the “economics of everyday life” a la Steven Levitt, Richard Thaler, and the bandwagon of behavioral economists.
Today there is a move to hone and rethink the models that describe the huge interlocking wheels of the economy, and to find a way to include the human tendencies that can bring them grinding to a halt. Some economists are looking to the methods and findings of psychology, others are applying themselves to the tricky task of modeling bubbles, a relatively neglected topic. Whatever the approach, the study of financial crises is likely to be a predominant question for the newest generation of economists.
Of course, this sort of openness and concern with the “real” effects of the economy are important. Instead of calling for a “revolutionary” paradigm shift, this article merely amounts to an enthusiastic endorsement for behavioral economics. Though there is a lot that we can learn at the intersection of psychology and economics, still more can be done to breach the limits enacted upon mainstream economics. Freakanomics is not enough….