In the business section of today's New York Times, Greg Mankiw, a prominent economist at Harvard, offers the following defense of his profession's disappointing performance with regard to the current depression: "It is fair to say that this crisis caught most economists flat-footed. In the eyes of some people, this forecasting failure is an indictment of the profession. But that is the wrong interpretation. In one way, the current downturn is typical: Most economic slumps take us by surprise. Fluctuations in economic activity are largely unpredictable. Yet this is no reason for embarrassment. Medical experts cannot forecast the emergence of diseases like swine flu and they can't even be certain what paths the diseases will then take. Some things are just hard to predict."
There is reason for embarrassment; "caught flat-footed" may be unconscious acknowledgment of the point. Mankiw's defense of the economics profession misses the point, which is is not forecasting error but obliviousness to danger. The medical profession knows that it can't predict the emergence of a new pandemic, and knowing this takes appropriate precautions, such as the creation of a global early-warning network, the adoption of protocols for minimizing the spread of a new contagious disease, and the development of new vaccines and treatments. And when a new disease appears, the profession swings into action.
The Federal Reserve is not on a par with the Centers for Disease Control, or macroeconomics comparable as a scientific field to public health, medicine, and biology. An economic disease that was not new--namely, the emergence and expansion to bursting of a housing bubble--appeared in the early 2000s and was ignored by the economics profession as a whole, though a few economists saw what was happening. The bubble burst in 2007 and a recession ensued, the gravity of which was missed by the profession. The near collapse of the banking industry in September of last year came as a shock to economists, both in and out of the government, as did the failure of the economy to respond to the conventional treatment--the reduction of the federal funds rate. The stock of the monetarists, such as Milton Friedman, fell; that of the fiscalists, notably Keynes, who had been in the economics doghouse, rose. Mankiw's dismissal in 1992 of Keynes's great book The General Theory of Employment, Interest and Money (1936) as "outdated" turned out to be itself outdated. Throughout the fall of last year, most leading macroeconomists were strangely silent as the crisis deepened; they seemed to have no idea of what should or could be done to arrest the downward spiral. (As late as last September, the immensely distinguished macroeconomist Robert Lucas was unsure whether the nation was in a recession.) They are continuing to disagree over whether the government has done too much or too little to try to put the economy on the path to recovery.
We have discovered that despite the centrality of banking to the macroeconomy, macroeconomists know little about modern banking and that an understanding of the business cycle continues to elude them. If I may again quote Mankiw, writing in his blog on February 16 of this year, "I don't pretend to be enough of an expert, or to be close enough to the facts, or to have a large enough staff, to know what should be done with the banking system, which is at the center of our current economic turmoil. But I am confident that fixing it should be the main focus of policy efforts." According to Spiegel Online, "When asked the question: 'Can you explain what has happened?' Robert Solow, a winner of the Nobel Prize in Economics, simply shakes his head and says: 'No, I don't think that normal economic thinking can help explain this crisis.'"
Economists can't be blamed for having an imperfect understanding of depressions; these are immensely complex events. But they can be blamed for exaggerating their understanding of them. In 2002, referring to Milton Friedman's theory that mistakes by the Federal Reserve had turned a recession triggered by the stock market crash of October 1929 into the Great Depression, Ben Bernanke stated: "Regarding the Great Depression. You're right [Friedman and his collaborator, Anna Schwartz], we [the Federal Reserve] did it. We're very sorry. But thanks to you, we won't do it again." It has done it again. And the following year, 2003, in his presidential address to the American Economic Association, Robert Lucas announced that the problem of depressions had been solved and macroeconomists should move on to other subjects, such as economic growth.
Economists thus had assured us that they knew how to prevent depressions and that there would never be another one. But now that a depression (or a "recession" of such unprecedented severity as to make the word a euphemism for depression) is upon us they say they never actually knew how to prevent a depression or dig us out of one. One wishes they had told us that earlier.