the sad state of macroeconomics

Travel and jet lag have conspired to prevent me from commenting in opportune fashion on Paul Krugman’s long essay that was published in last Sunday’s New York Times Magazine. There is nothing new here, but the essay is well-written, in classic Krugman style, so very accessible to non-economists. Krugman covers a lot of ground, from Adam Smith to Keynes, to the New Classical and the New Keynesian schools. Do read the entire essay if you haven’t done so already. Even Greg Mankiw recomends it.

[B]elief in efficient financial markets blinded many if not most economists to the emergence of the biggest financial bubble in history. And efficient-market theory also played a significant role in inflating that bubble in the first place.


[E]conomists who inveighed against the stimulus didn’t sound like scholars who had weighed Keynesian arguments and found them wanting. Rather, they sounded like people who had no idea what Keynesian economics was about, who were resurrecting pre-1930 fallacies in the belief that they were saying something new and profound.

Paul Krugman, “How Did Economists Get It So Wrong?”, New York Times Sunday Magazine, 6 September 2009.

On the same subject, Willem Buiter last March drafted for his maverecon blog an excellent post, one that has been overlooked by many. Here is one brief quote from a long essay:

In both the New Classical and New Keynesian approaches to monetary theory (and to aggregative macroeconomics in general), the strongest version of the efficient markets hypothesis (EMH) was maintained.  This is the hypothesis that asset prices aggregate and fully reflect all relevant fundamental information, and thus provide the proper signals for resource allocation.  Even during the seventies, eighties, nineties and noughties before 2007, the manifest failure of the EMH in many key asset markets was obvious to virtually all those whose cognitive abilities had not been warped by a modern Anglo-American Ph.D. education.   But most of the profession continued to swallow the EMH hook, line and sinker, although there were influential advocates of reason throughout, including James Tobin, Robert Shiller, George Akerlof, Hyman Minsky, Joseph Stiglitz and behaviourist approaches to finance.

Willem Buiter, “The unfortunate uselessness of most ’state of the art’ academic monetary economics“, Maverecon, 3 March 2009.

Princeton economist and NY Times columnist Paul Krugman needs no introduction. LSE economist Willem Buiter, former chief economist (2000-2005) at the European Bank for Reconstruction and Development, has held academic appointments at Princeton University, the University of Bristol, Yale University and the University of Cambridge. Buiter’s schooling at Cambridge and Yale does not stop him from deriding Anglo-American PhD education.

Update: Via Nick Rowe, Casey Mulligan and Karl Smith, here is John Cochrane’s response to Paul Krugman’s essay in the NY Times Magazine. Cochrane’s response is a spirited defence of modern macroeconomics in general and the New Classical school in particular. Keep your eye out for Paul Krugman’s ‘response to Cochrane’s response’.

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