Krugman thrashing economics and economists

Paul Krugman this time in this very long article. Though much of what Krugman says is well known by now and discussed by many . But is still a must read. And when Krugman writes purely on economics you can just push everything for laters. He is such a gifted writer and economist. In this he takes you on a journey of economic history and how the various  thoughts shaped up.

The focus of the article is on Monetarists vs Keynesian (moves later in the article to freshwater econs vs saltwater econs) and how the first group just doesn’t understand second one.  He says how the economic profession has been blinded by the idea of free/perfect markets with rational beings ignoring recessions/crisis from the models. He points to important research papers which led to the beliefs which had captured all. He also points to those key ideas which argued otherwise but were ignored.

He says the way out is to re-embrace Keynesian ideas:

So here’s what I think economists have to do. First, they have to face up to the inconvenient reality that financial markets fall far short of perfection, that they are subject to extraordinary delusions and the madness of crowds. Second, they have to admit — and this will be very hard for the people who giggled and whispered over Keynes — that Keynesian economics remains the best framework we have for making sense of recessions and depressions. Third, they’ll have to do their best to incorporate the realities of finance into macroeconomics.

He has some kind words for behavioral economics as well:

Economics, as a field, got in trouble because economists were seduced by the vision of a perfect, frictionless market system. If the profession is to redeem itself, it will have to reconcile itself to a less alluring vision — that of a market economy that has many virtues but that is also shot through with flaws and frictions. The good news is that we don’t have to start from scratch. Even during the heyday of perfect-market economics, there was a lot of work done on the ways in which the real economy deviated from the theoretical ideal. What’s probably going to happen now — in fact, it’s already happening — is that flaws-and-frictions economics will move from the periphery of economic analysis to its center.

There’s already a fairly well developed example of the kind of economics I have in mind: the school of thought known as behavioral finance. Practitioners of this approach emphasize two things. First, many real-world investors bear little resemblance to the cool calculators of efficient-market theory: they’re all too subject to herd behavior, to bouts of irrational exuberance and unwarranted panic. Second, even those who try to base their decisions on cool calculation often find that they can’t, that problems of trust, credibility and limited collateral force them to run with the herd.

It is a Krugman Special on the crisis. Especially his summarising (to be precise making fun of) of key papers which have led to much of eco thinking is quite a read. Sample this on Ed Prescott works on business cycles:

By the 1980s, however, even this severely limited acceptance of the idea that recessions are bad things had been rejected by many freshwater economists. Instead, the new leaders of the movement, especially Edward Prescott, who was then at the University of Minnesota (you can see where the freshwater moniker comes from), argued that price fluctuations and changes in demand actually had nothing to do with the business cycle. Rather, the business cycle reflects fluctuations in the rate of technological progress, which are amplified by the rational response of workers, who voluntarily work more when the environment is favorable and less when it’s unfavorable. Unemployment is a deliberate decision by workers to take time off.

Put baldly like that, this theory sounds foolish — was the Great Depression really the Great Vacation? And to be honest, I think it really is silly. But the basic premise of Prescott’s “real business cycle” theory was embedded in ingeniously constructed mathematical models, which were mapped onto real data using sophisticated statistical techniques, and the theory came to dominate the teaching of macroeconomics in many university departments. In 2004, reflecting the theory’s influence, Prescott shared a Nobel with Finn Kydland of Carnegie Mellon University.

🙂

Must must read. And yes don’t miss the cartoons on top of the page.

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4 Responses to “Krugman thrashing economics and economists”

  1. Why is it so hard to regulate Wall Street? « Mostly Economics Says:

    […] back after a week of break, there are 2 hot issues I see on most blogs (three actually, third being Krugman’s article on state of economics, but is not really an issue) […]

  2. Pravin Says:

    the shameful adhomimen krugman indulges in is partisan hackery at its most sublime.not only is his article full of mischaracterization as Cochrane’s riposte shows,it ignores the only people who foresaw and correctly and consistently explained the financial crisis -the austrian economic school. obviously in krugman’s ivory tower,praxeology is taboo.

  3. Central Banker chips on state of macro and modelling « Mostly Economics Says:

    […] tons of articles these days on the state of macro/eco. The fire has been ignited in  particular by Krugman NYT article but before this also there were a few thoughtful pieces – (see this, this, this, this etc […]

  4. Ketchup Economics and Financial Economics « Mostly Economics Says:

    […] Economics and Financial Economics By Amol Agrawal Krugman in his long overview on state of macro […]

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