There’s a fascinating article in today’s NY Times that encapsulates so much of what has been going on in the economics community over the past few months and underlines the amazing pace of fundamental shifts in this profession that holds so much power over all of our financial lives. The annual gathering of the American Economics Association recently concluded. If the reporter is accurate then a seismic change is underway.
Frightened by the recession and the credit crisis that produced it, the nation’s mainstream economists are embracing public spending to repair the damage — even those who have long resisted a significant government role in a market system.
At their last annual meeting, ideas about using public spending as a way to get out of a recession or about government taking a role to enhance a market system were relegated to progressives. The mainstream was skeptical or downright hostile to such suggestions. This time, virtually everyone voiced their support, returning to a way of thinking that had gone out of fashion in the 1970s.
“The new enthusiasm for fiscal stimulus, and particularly government spending, represents a huge evolution in mainstream thinking,” said Janet Yellen, president of the Federal Reserve Bank of San Francisco.
I have posted about the outright hostility that many faced when warning in early 2008 or before about the looming economic dangers. Mainstream economists, even Alan Greenspan, found it incomprehensible that 2008 could see the near collapse of our economy. Now, “Nearly all argued that public spending can be more effective than tax cuts in getting out of a bad recession.” This is a huge shift. Equally telling,
…at the formal sessions and in more than a dozen interviews, many said that once the recession ended, the nation should not go back to the system that held sway from Ronald Reagan’s election in 1980 to the present crisis. It was one in which taxes, regulation and public spending were minimized.
For Peter Gottschalk, a labor economist at Boston College, who earned his Ph.D. in 1973, the transition has not been easy. Keynesian economics, with its emphasis on a government role in the marketplace, was losing its grip when he started his career. Indeed, the present upheaval has been outside the theoretical boundaries of mainstream economics as practiced for a generation by most of the nation’s economists.
“Our models are built on the assumption that on average people behave rationally and they do the right thing,” Mr. Gottschalk said, “but this time people did very much the wrong thing. It’s like thinking you have a disease under control and then being hit with a new strain of it.”
Again, to go back to Alan Greenspan, he recently stated in Congressional hearings that “the whole intellectual edifice” that he had built over the past 40 years and upon which he had based his policy decision had proven to be false! He was “shocked” to discover that enterprises would engage in activities that were not primarily for the benefit of shareholders and that they did not properly self-regulate.
It seems that the past few months have been very trying times for “experts” and investors alike.
Update: there’s a somewhat rambling but worthwhile discussion of this very idea at The Baseline Scenario today. Discussing the current economics crisis and the “crisis in economics” that it is spawning provides an excellent overview of the tensions currently being felt and debated within the economics community. You might be tempted to dismiss all this as egg-head noise, but these people have our fate in their hands. One policy misstep at this point and we will be in GDII. An excerpt:
Third, what is the deeper cause of this crisis? A supersized financial system – the obesity of banks and shadow banks – helped create the vulnerabilities that made the September crisis possible. This financial system captured its regulators and took on far more risk than it could manage (or even understand). And this is a statement not just about US banks, but also about most parts of the global financial system.
The answer lies with the political economy of the US financial system, including the power politics of large financial firms. These grew large relative to the institutions that support and constrain them. In effect, we created an emerging market-type of structure. There is nothing in the mainstream textbooks or working papers about this – the general working assumption has been that institutions in the US were significantly better than in emerging markets. The time has obviously come to question in what sense this is really true.
This sort of attack on the structure of capitalism as it has existed in the US over the past 20 years would not have been leveled by mainstream economists until very, very recently.