[R-G] [BillTottenWeblog] Why neoclassical economics is dead

Sun Jul 19 21:21:42 MDT 2009

by Steve Keen

eastasiaforum.org (May 30 2009)

In a classic case of 'they would say that, wouldn't they?', economic
textbook authors McTaggart, Findlay and Parkin have recently defended
economics {1} from the criticism that it failed in not predicting, let
alone preventing, the financial crisis.

They claim that 'much economic research pointed to the emerging problem',
note that evidence 'had started to accumulate from early 2007', and blame
the crisis itself on 'egregious policy errors' by the Federal Reserve.

The implication of their article is that economic theory is healthy, and
that what is needed is not change, but more of the same.

Bollocks. Economics is extremely unhealthy at all levels, from
introductory pedagogy to high research.

It has become progressively sicker ever since the last great financial
crisis - the Great Depression - because it actively retreated from the
challenge the Great Depression posed to its belief in the innate stability
of the market economy. Now, as the global economy enters what could well
be the Second Great Depression, economic theory is as useless a guide to
how the economy actually functions as it was in the late 1920s.

Just one name is enough to establish that McTaggart et al's claim about
the health of economics is false: Hyman Minsky. Minsky long ago asserted
that the true test of the relevance of a macroeconomic theory was its
capacity to generate a Depression, since market economies had regularly
found themselves in such a state.

Against such a measuring stick, every model discussed in a standard
economics textbook, virtually every model in leading economic journals,
and almost all the models that Treasuries and Reserve Banks around the
world have constructed, are failures. They assume the economy tends to
equilibrium (or worse, is always in it), making them incapable of
explaining how a Depression - or even a recession - might occur. They are
as useless as the theories of the 1920s which Keynes lampooned in his
famous but misinterpreted statement about the long run:

'But this long run is a misleading guide to current affairs. In the long
run we are all dead. Economists set themselves too easy, too useless a
task if in tempestuous seasons they can only tell us that when the storm
is long past the ocean is flat again.' (Keynes, A Tract on Monetary
Reform, 1924).

Instead of being able to explain how this crisis came about, economists
are reduced to blaming it on 'policy errors' by the Federal Reserve -
precisely the claim that economists made about the last Great Depression.

Ironically, one of the most egregious such statements was made by Bernanke
at Milton Friedman's ninetieth birthday {2}, when he said 'I would like to
say to Milton and Anna: regarding the Great Depression. You're right, we
did it. We're very sorry. But thanks to you, we won't do it again.' Now
Milton Friedman's greatest disciple is becoming the whipping boy of
neoclassical economists who are unwilling to consider the possibility that
the model of the economy they share with Bernanke may be fundamentally
flawed.

Will we have to go through a Third Great Depression before economists
finally concede that it might not merely be 'policy errors' that cause
such crises, but the innate workings of a credit-based market economy that
they have manifestly failed to understand? On the record of articles like
McTaggart et al's (and a curiously similar recent article by another
textbook author, Gregory Mankiw {3}), this might well be the case.

As an economist outside the neoclassical mould, I predicted this crisis
{4} in December 2005, using a non-equilibrium model of Minsky's Hypothesis
that could generate a Depression. Such models have to become the
mainstream in economics, which will require a revolution in economics:
precisely what McTaggart et al and Mankiw are trying to forestall.

Related articles:

1. Too soon for obituaries: economics is alive and (reasonably) well {5}
2. The state of economics {1}
3. Whaling: What can law add to science, economics, ethics and politics?
{6}
4. Rudd's Pacific plan: dead or alive? {7}

URLs in this post:

{1} defended economics:
http://www.eastasiaforum.org/2009/05/21/the-state-of-economics/

{2} Milton Friedman's 90th birthday:
http://www.federalreserve.gov/boarddocs/speeches/2002/20021108/default.htm

{3} Gregory Mankiw:
http://www.nytimes.com/2009/05/24/business/economy/24view.html?_r=2&ref=business

{4} predicted this crisis:
http://www.debtdeflation.com/blogs/wp-content/uploads/2007/04/JPKE1995PageImage9509152794.pdf

{5} Too soon for obituaries: economics is alive and (reasonably) well:
http://www.eastasiaforum.org/2009/06/04/too-soon-for-obituaries-economics-is-alive-and-reasonably-well/

{6} Whaling: What can law add to science, economics, ethics and politics?:
http://www.eastasiaforum.org/2008/07/04/whaling-what-can-law-add-to-science-economics-ethics-and-politics/

{7} Rudd's Pacific plan: dead or alive?:
http://www.eastasiaforum.org/2008/10/03/rudds-pacific-plan-dead-or-alive/

http://www.eastasiaforum.org/2009/05/30/why-neoclassical-economics-is-dead/

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