29 Jul 2009

Useful Economics

The Economist's cover article ("What went wrong with economics") discusses the failure of macro and financial economics in the recent financial crisis, but they caution against throwing the baby out with the bathwater:
In its crudest form—the idea that economics as a whole is discredited—the current backlash has gone far too far. If ignorance allowed investors and politicians to exaggerate the virtues of economics, it now blinds them to its benefits. Economics is less a slavish creed than a prism through which to understand the world. It is a broad canon, stretching from theories to explain how prices are determined to how economies grow. Much of that body of knowledge has no link to the financial crisis and remains as useful as ever.


These important caveats, however, should not obscure the fact that two central parts of the discipline—macroeconomics and financial economics—are now, rightly, being severely re-examined (see article, article). There are three main critiques: that macro and financial economists helped cause the crisis, that they failed to spot it, and that they have no idea how to fix it.
Since I am a environmental/resource economist who uses behavioral and institutional tools to do my analysis, I am not only unthreatened by the failure of macro/financial, but I am also (relatively) better off. "We" didn't make the mistakes that the macro/financial guys did.

(I am NOT happy that they did, since I am poorer as a result!)

Bottom Line: Economics has many useful tools, but none should be used blindly.


  1. There were only mistakes by permitting the "police" to live in the donut shops and stop arresting criminals. If the commodity regulators had done their job, there would have been no oil price spike. If the Fed had done its job, all bad loans would have been labeled as such, and there would have been no credit crisis. Unregulated markets need police more than anything, because their criminal greed can spoil things for the rest of us.

  2. @KW -- ALL unregulated markets will breakdown when the people with guns arrive. Put differently, no market will function without regulation (e.g., enforceable laws on property rights, contract, fiat money, etc.) The question is HOW MUCH regulation...

  3. David, i had left my comment after reading Economist's article. Macro economics didn't actually fail and there were economists who predicted and foresaw the financial crisis.

    Unfortunately what failed is understanding that humans can be greedy and that short term gains often are canceled by bigger long term losses. Horde behavior and movement by inertia added to the pile.

    "When your country trades derivates which exceed that country GDP by 50 times, well you got the point."

  4. @DS -- we (economists) KNOW that humans are greedy. The trouble came when SOME macro folks supported the delusions of finance professionals/regulators/politicians -- the delusions that "ever upward" is possible.


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