“The profession has reached a cul-de-sac,” says one prominent economist, Andrew Lo of MIT. “Macroeconomists are scrambling to figure out what to do. So politicians are simply pushing whatever kind of economics they can.”
The New School
Efforts are afoot to update—even to overhaul—the ways that economists think about markets, regulation, and government fiscal policy. Washington just pays little attention to them. The National Science Foundation asked economists and social scientists last year to draw up “grand challenge questions that are both foundational and transformative.” The early-April conference in the melting snows of Bretton Woods drew hundreds of economists to debate those questions. (It was largely underwritten by billionaire—and major Democratic donor—George Soros. Many of the speakers tilted politically liberal, but a full spectrum of economic ideologists were included, such as prominent free-market champions Kenneth Rogoff of Harvard and Carmen Reinhart of the Peterson Institute for International Economics.)
Even at the University of Chicago, the fabled home to free-market theory—including the still-dominant “rational expectations” hypothesis—restless thinkers such as Raghuram Rajan, Douglas Diamond, and Anil Kashyap are winning plaudits for exploring new concepts about smart regulation. Rajan, in particular, saw before many other economists the flaws in the old, under-regulated financial system, warning as far back as 2005 that the markets were likely headed for a titanic crash.
The early consensus among self-styled new thinkers, to the extent there is one, is that the world is right to love markets and their power to effectively allocate people, prices, and resources. But the truly free market we thought we loved never existed. Our conception of it was too simple. Now we need someone to explain it to us, in all its glorious, dangerous complexity—at a time when we can ill afford another mistake, another crash, another unforeseen event.
New and emerging models try to explain economies with all their humanity involved. Some incorporate psychology; others, social norms; others still, the power of storytelling to move markets. One branch presumes that markets never have all of the information they need to function properly. Another uses supercomputing to aggregate enough information to begin to predict the sort of catastrophic market failures that other theories dismissed as impossible, that other models call “unpredictable”—the future bubbles that we would neglect until it’s too late, in the same way we neglected the Internet stock bubble in the late ’90s and the housing bubble of the 2000s.
None of those theories appears to have appreciably shaped the economic-policy proposals coming from the White House or Congress, where lawmakers draw much of their economic inspiration from think tanks built on dogma. “Washington is a place where people spend money on ideas in order to do policy,” says Thomas Ferguson, a political-science professor at the University of Massachusetts who writes extensively on economic policy. “It’s not a place where people spend money to find out anything.”
Neither party seems keen to search for orthodoxy-challenging economic answers. Before Rep. Paul Ryan, R-Wis., released the GOP’s budget blueprint in April, for example, he asked neoclassical economists at the conservative Heritage Foundation to predict how its mix of lower tax rates and hefty entitlement cuts would supercharge future growth. Heritage’s data-analysis chief, William Beach, initially said that Ryan’s budget would produce an overnight housing boom, massive growth in gross domestic product, and, by 2021, a 2.8 percent unemployment rate. “I think these are fairly conservative estimates,” Beach said the day that the numbers came out. Later, after scathing rebukes from economists and journalists, Heritage revised its unemployment projections upward.
The economy is simply too complex, and the global financial system too interdependent, to be viewed through the prism of old theories.
House Speaker John Boehner’s vaunted speech on Wall Street this month brimmed with simplistic—and oft-refuted—ideas of how the economy works. Among them: Government debt is “crowding out” private investment (when short- and long-term interest rates remain at historic lows); government-sponsored mortgage entities like Fannie Mae and Freddie Mac “triggered” the financial crisis; new regulations in response to the crisis made the banking system “less competitive”; and it would be economically preferable to allow the United States to default on its debt rather than raise the debt ceiling without trillions of dollars in spending cuts.
White House economic policy features its own inchoate concepts on achieving what Obama called a “balanced” policy between government investment in the nation’s future and immediate budget cuts. The president and his team believe that the economy has escaped the danger of a double-dip recession, and their goal is to manage a politically inevitable period of budget austerity without undercutting pillars of long-term growth. It’s a pragmatic approach but hardly grounded in anything close to a comprehensive theory of how America fell into the Great Recession and how it might avoid future crises.