Economists Take it on the Chin

Three articles in the July 16 issue of The Economist magazine criticize the economics profession for its failure to anticipate the financial crisis of last September, and the ensuing economic crisis, and for its inability to agree on what should be done to speed recovery. These articles, which can be found at, and,

are well worth reading. Both the economists and government officials (often both) have received too small a share of the blame for the current economic troubles. This is a theme I sounded in my book and in several of my blog entries, but it has received little attention. The Obama Administration, with its ambitious public programs, does not want to accuse government of incompetence, and the economists who manage and advise the government's economic policies, many of whom were complicit in the failures of anticipation and response, do not wish to acknowledge their errors and those of their fellow economists. Furthermore, Congress and the public, and much of the media, do not understand macroeconomics or financial economics, and so they are drawn to a populist theory in which the economic crisis is attributed to the avarice and folly of financiers and the vulnerability of gullible consumers. The populist theory suits the Administration and the economics profession just fine, as it directs attention away from government failure and the failure of professional economists inside and outside the government.

Congress has just appointed a 10-member Financial Crisis Inquiry Commission, headed by a former treasurer of California named Phil Angelides, to investigate the origins of the financial crisis. The commission is bipartisan rather than nonpartisan; there are six Democrats and four Republicans, and most of them have strong partisan affiliations, as revealed by their campaign contributions. There is anxiety about how searching and professional the commission's inquiry will be. See, e.g., I share that concern. None of the members, I believe, is a professional economist, and this will make the commisson's choice of a staff director critical. But if the economics profession does not understand the financial crisis, where is the commission going to find a competent staff director? It will be difficult, but there are a number of competent young economists who have not yet taken sides on the burning issues of macroeconomics and finance theory and could guide a neutral inquiry into the causes of the crisis.

My worry is that, because of the complexity of the economic issues and the difficulty of finding economists who are not committed to one side or the other of the methodological and ideological divides that permeate macroeconomics, the commission will devolve into an investigation of frauds and errors (and there were plenty of both, I am sure) of lenders and borrowers during the housing and credit bubbles. There may be some value in such an investigation, but it will not get to the root causes of the crisis or point the way toward economically sensible reforms. There are plenty of legal tools already for dealing with fraud, and errors (for example in assessing the risk of securitized debt) tend to be self-correcting. An investigation that does not delve into the failures of regulation (including the Federal Reserve's monetary policies and the SEC's regulation of broker/dealers) and of responses to the crisis will be severely truncated.