Symposium | Has Economics Failed Us?

‘Why Did Nobody Notice It?’

By Jared Bernstein

Tagged Economics

The essays that follow, on the current state of macroeconomic analysis, were motivated by at least two developments.

First, consider the question posed by Queen Elizabeth, who, on visiting the London School of Economics after the housing bubble and market crash that ushered in the Great Recession, asked “Why did nobody notice it?”

It is certainly an indictment of the economics profession that so few identified the conditions leading to a recession that wiped out trillions in wealth, led to the loss of millions of homes and jobs, and put economies across the globe into a hole from which most, including the United States, are still climbing out.

But it’s not just that the economists didn’t “notice it.” As one of our three essayists, Ben Friedman, underscores, quoting no less than Alan Greenspan, the most prominent economist of that era, they assumed away its possibility: “Those of us who have looked to the self-interest of lending institutions to protect shareholders’ equity, myself included, are in a state of shocked disbelief.”

This may sound naïve to many readers, but Greenspan was reflecting the practice and dominant assumptions of much of contemporary macroeconomics, which are the source of our second motivation. In early 2016, Paul Romer, a leading American macroeconomist currently with the World Bank, gave a lecture entitled “The Trouble with Macroeconomics,” wherein he, not to put too fine a point on it, tore contemporary macro a new one.

His essay argued that the discipline has been sliding backwards for three decades, smitten with mathematical models that have little to do with reality. And every time reality reared its head in contradiction to the models, the profession repeatedly chose to reject reality, leading to Romer’s label: “post-real macroeconomics.”

Just as Greenspan’s assumption of self-regulating banks seems dangerously divorced from a reality understood by economists since Adam (Smith), Romer excoriates modern macro for assuming away the impact of monetary policy, bubbles, persistent irrationality, and most damningly, actual data. As the economist Narayana Kocherlakota efficiently summarized Romer’s critique: “Macroeconomists are pretty comfortable with non-evidence-based approaches to modeling.”

Perhaps if macro were an obscure, harmless hobby that nerds got together to play on weekends, like Dungeons and Dragons, there’d be “no harm, no foul” from this disconnect from reality. But many of the macroeconomists pilloried by Romer won Nobel prizes for these theories, and people and policymakers listen to them. As Dean Baker stresses in his essay, that’s no accident: Post-real macro does not take place in a political vacuum.

The essays

Are Romer and Queen Elizabeth correct? Is the discipline of economics in serious trouble? If they ever had it, have economists lost the ability to make useful, positive contributions to society? It seems unarguable that macroeconomics has failed us, at least in terms of seeing, preventing, and adequately offsetting the Great Recession (though, to be fair, “offsetting” was negatively influenced by politics). But has it shown a capacity to learn from its mistakes? Economics and economists still hold considerable sway in our public debates. Is that as it should be?

We asked three prominent economists—Dean Baker, Ben Friedman, and Jason Furman—to weigh in on these questions, and they thoughtfully and provocatively responded to our request. Usefully, each gave different answers to the question of whether the discipline is in trouble, ranging from a hard “yes” from Baker, a “no” from Furman, and a “yes, but it can be fixed” from Friedman.

Baker is a rare economist who early on identified and warned about the formation of the housing bubble and the damage it was likely to mete out. In this light, it is revealing that, of our three essayists, he’s the most pessimistic about economists’ ongoing contributions. His personal experience in trying to warn others in the profession about the coming crash, along with other debates he relates wherein muscular, evidence-based arguments he brings to the table are routinely dismissed, leave him with little hope that economists can learn from our mistakes. I fear he may be right.

Friedman’s essay is somewhat more optimistic about the possibility of self-correction. Both he and Furman make the case that missing the housing bubble and financial crisis, while a “spectacular miss” (Furman’s phrase), just confirms what we should already have known: Economists are bad at forecasting. But Friedman argues that should not yield too harsh a judgment: “It is simply not true that predictive ability is our only test of scientific validity.” I address this assertion below.

He goes on to provide a particularly clear explanation of where macro has gone wrong. In this sense, he builds on Romer, but his granularity is elucidating. If your model ignores financial markets and excludes debt instruments (in post-real macro, money matters, mortgages don’t), your economics will be “unequipped to anticipate, or to address . . . the phenomena at the root of what happened.” If your model, like Greenspan’s, assumes rational behavior, then you will be blind to systemic irrationality, like the persistent underpricing of risk in mortgage lending.
Furman doesn’t disagree with any of that. He just views it as one unfortunate corner of macro, a bad neighborhood in an otherwise vibrant city. If anything, the crisis, which forecasters missed because they’re bad at forecasting, led to “good neighborhood” economists doubling down on the big questions of the day, from slow productivity growth, to the “zero lower bound” problem in monetary policy, to a sort of enlightened, contemporary Keynesian approach to fiscal policy. In his view, if there’s a problem in current macro, it’s that policymakers “are . . . insufficiently attentive to that research in crafting their policies.”

Who’s right?

Is Baker correct that today’s economists are analogous to incompetent firefighters such that our best and only hope is that we don’t have any fires? If so, we’re in trouble, because economic “fires”—imbalances, bubbles, shocks, recessions—are inevitable. Or is Friedman right? If the firefighters are willing to toss a bunch of deeply misleading models and assumptions, they could learn to prevent or at least recognize and put out fires. What about Furman’s view that much macro is more informative and useful than ever, if only policymakers would take notice?

I’m sorry to say I think Baker’s view is most correct in the broadest sense, though Furman and Friedman are correct in narrower senses. As a consumer of the same work Furman favorably cites, and I’d put some of his own recent output at the top that list; his point that some economists are breaking useful ground is axiomatic and important. For example, his work on what he calls the “new view” of fiscal policy is exciting, empirically solidly grounded, and shows the way forward in terms of offsetting all-too-common periods of weak aggregate demand.

Yet, as noted, Furman himself admits that too few actual purveyors of fiscal policy show any interest in, much less subscribe to, this “new view.” He fails, however, to ask the pressing question: Why not?

That’s a question with which Baker would be very comfortable, because while Furman and Friedman provide important and at least somewhat optimistic assessments of contemporary macro, Baker puts economics in the context of the power relationships that dominate our institutions, and most notably, our politics. That is, he’s doing political economy, and in doing so, he gets to the nub of the question of whether contemporary economics adds value, on net.

As Friedman argues, some economists are improving their models based on what went wrong. As Furman argues, others are coming up with good ideas on how to address some of our biggest economic challenges. But where does the rubber meet the road in economics? Is it in the journals and blogs that Furman finds to be so rich and vibrant, or is it in the halls of Congress, the Fed, the IMF, the Bundesbank, the EU, and so on?

While Furman is correct that some of our conferences are increasingly interesting, Baker’s essay stresses the ways in which post-real economics remains highly influential, as it interacts with politics to give policymakers and their funders the information and “evidence” they need—and to suppress inconvenient facts—to press the case that continues to redistribute income their way. Once you recognize this reality, it is not a head-scratcher why Greenspan assumed that financial institutions would self-regulate, or why Stolper-Samuelson “factor-price-equalization” theories (which predict some U.S. workers will be hurt by trade with lower-wage countries) get short shrift, or why a more Keynesian-oriented fiscal policy doesn’t get a close look. Post-real macroeconomics isn’t just alive and well. It is made-to-order for the age of alternative facts.

What about Furman and Friedman’s claim that the “big miss” is no reason to discredit macroeconomics? While it would be rash to completely write off economists based on this miss, I found both authors too forgiving. First, I wouldn’t call this a “forecasting” error, analogous to predicting first quarter GDP to come in at 3 percent when it came in at 1 percent. That’s not just because the “big miss” was so much more consequential than the typical forecasting error. It’s also because the miss was precipitated by ignoring economic imbalances that top economists, including Greenspan, believed could not exist.

A forecast error calls for recalibrating a model. Missing the housing bubble calls for rethinking, if not rejecting, the model, as per Romer’s critique. Furman and especially Friedman argue for recalibrating, pressing for more realistic assumptions, less “model-gazing” (Furman), more evidence-based economics. These are great suggestions, but do they go far enough?

As I write, President Trump, with the support of his “economics team,” is pushing to roll back regulation, cut taxes, and repeal the Affordable Care Act to inject more market competition into health care. Of course, since the late Ken Arrow’s 1963 essay, pre-post-real economists knew that the health-care market was not, by a long shot, a regular market. Even Greenspan, to his credit, admitted, albeit after the fact, that self-regulation doesn’t work in financial markets. As for the alleged growth effects of trickle-down tax cuts, it’s remarkable we’re still even arguing about them.

Trust me when I tell you, because I’ve testified alongside them (as recently as a few weeks ago), post-real economists provide support for these ideas. And this, to me, is how economics continues to fail us. Every good, progressive idea—a higher minimum wage, single-payer health care, Keynesian stimulus, direct job creation in perennially weak places, more progressive taxation, an expanded safety net—runs into some version of post-real critiques, amped up by simple greed and money in politics, in ways that are under-recognized, even by Romer and those who echo his discontent. The problem with post-real, non-evidence-based macro is not simply its implausible assumptions, its failure to fit actual data, its refusal to entertain the possibility of persistent irrationality, mispricing, bubbles, and its denial of the utility of policies to correct these imbalances. It’s the way it so effectively and damagingly interacts with the unrepresentative politics and crushing inequities that characterize our contemporary economy.

From the Symposium

Has Economics Failed Us?

The question isn’t simply why most economists didn’t see the meltdown coming. It’s whether they were even looking in the right places to begin with.


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Jared Bernstein is a senior fellow at the Center on Budget and Policy Priorities and was formerly chief economist to Vice President Joe Biden.

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