How/If Economists Got the Crisis All Wrong

Financial Crisis brought down not only the banks but led to questions on whether economists are to blame for all this mess. Below are two very different views of whether Economists are at fault for the crisis in a highly politically charged essays from a Nobel Laureat and a Professor of Economics at Princeton University Paul Krugman and a Professor of Economics at the University of Chicago Booth School of Business John Cochrane.

On September 2, 2009 PAUL KRUGMAN in an article How Did Economists Get It So Wrong? wrote:

"It’s hard to believe now, but not long ago economists were congratulating themselves over the success of their field. Those successes — or so they believed — were both theoretical and practical, leading to a golden era for the profession... Last year, everything came apart. Few economists saw our current crisis coming, but this predictive failure was the least of the field’s problems. More important was the profession’s blindness to the very possibility of catastrophic failures in a market economy."

Krugman then goes on to answer "What happened to the economics profession? And where does it go from here?" questions, and concludes that

"It’s much harder to say where the economics profession goes from here. But what’s almost certain is that economists will have to learn to live with messiness. That is, they will have to acknowledge the importance of irrational and often unpredictable behavior, face up to the often idiosyncratic imperfections of markets and accept that an elegant economic “theory of everything” is a long way off. In practical terms, this will translate into more cautious policy advice — and a reduced willingness to dismantle economic safeguards in the faith that markets will solve all problems." (to read more click here)


John Cochrane responded to Paul Krugman's accusations on September 11th, 2009 saying that

"Paul Krugman has no interesting ideas whatsoever about what caused our current financial and economic problems, what policies might have prevented it, or what might help us in the future, and he has no contact with people who do. “Irrationality” and “spend like a drunken sailor” are pretty superficial compared to all the fascinating things economists are writing about it these days."

he goes on to say:

"Again, what is the alternative? Does Krugman really think we can make progress on his – and my – agenda for economic and financial research — understanding frictions, imperfect markets, complex human behavior, institutional rigidities – by reverting to a literary style of exposition, and abandoning the attempt to compare theories quantitatively against data? Against the worldwide tide of quantification in all fields of human endeavor (read “Moneyball”) is there any real hope that this will work in economics?

No, the problem is that we don’t have enough math. Math in economics serves to keep the logic straight, to make sure that the “then” really does follow the “if,” which it so frequently does not if you just write prose. The challenge is how hard it is to write down explicit artificial economies with these ingredients, actually solve them, in order to see what makes them tick. Frictions are just bloody hard with the mathematical tools we have now." if you wan to read more click here.