As I have previously pointed out, most economists understand neither the cause of, nor the solution to, the economic crisis.
A new paper by an international group of economics professors now says the same thing.
The paper shows that the what the economics profession has adopted as gospel - that the economy is inherently stable - is utterly false.
The paper also says that mainstream economics has missed the fact that speculative bubbles lead to inevitable crashes, and that such popped-bubble-crashes can bring down the whole economy.
And the paper lambasts the risk models used to justify the casual buying and selling many trillions of dollars worth of credit default swaps and CDOs.
Why Did They Get It So Wrong?
Why did they get it so wrong? Why did mainstream economists stick to such faulty models and ignore basic truths about how the economy really works?
Certainly part of it is arrogance and ignorance.
But perhaps it is also because the wealthy make a lot of money in boom times, and in busts - as they understand that busts follow booms and invest appropriately ahead of time. By following the commonly-accepted dogma, the public is none-the-wise, and the elites can make a killing on both the boom and bust.
Mainstream economists have lapped up the theories of Keynes and Friedman as if they were proven beyond a shadow of a doubt. But Keynes and Friedman both conveniently ignored the fact that if the bubble is big enough, the resulting crash will take out the economy (like it is currently doing). Indeed, both Keynes and Friedman were faithful servants of those in power (that may, in fact, be one of the main reasons they were promoted to such an exulted status as the two leading economists of the twentieth century).
And both provided the illusion that problems can easily be fixed, without addressing the real, core problems:
- Keynesian economics implies that you can keep on blowing endless speculative bubbles so long as the government is willing to "stimulate" the economy when things crash
- Likewise, Friedman teaches that if you just increase the money supply enough, you can let business go wild and leverage itself into all the speculative bubbles it wants. That's why - even a couple of years ago - the economic big-wigs said that they had everything figured out, and everyone could go hog wild and the system would still remain stable
The powers-that-be do not like economists who say "Boys, if you don't slow down, that bubble is going to get too big and pop right in your face". They don't want to hear that they can't make endless money using crazy levels of leverage and 30-to-1 levels of fractional reserve banking, and credit derivatives. And of course, they don't want to hear that the Federal Reserve is a big part of the problem.
So Keynes and Friedman were elevated to the status of prophets, and those economists asking hard questions - like those in the Austrian school of economics - were ignored and sidelined. Likewise, those pushing voodoo theories justifying the tremendous increase in leverage and in the use of credit derivatives were lionized, while those questioning such nonsense were ridiculed.
Here are some excerpts to give the flavor of the paper:
The global financial crisis has revealed the need to rethink fundamentally how financial systems are regulated. It has also made clear a systemic failure of the economics profession. ... It is obvious, even to the casual observer that these models fail to account for the actual evolution of the real-world economy. Moreover, the current academic agenda has largely crowded out research on the inherent causes of financial crises. There has also been little exploration of early indicators of system crisis and potential ways to prevent this malady from developing. In fact, if one browses through the academic macroeconomics and finance literature, "systemic crisis" appears like an otherworldly event that is absent from economic models. Most models, by design, offer no immediate handle on how to think about or deal with this recurring phenomenon. In our hour of greatest need, societies around the world are left to grope in the dark without a theory. ...
The implicit view behind standard models is that markets and economies are inherently stable and that they only temporarily get off track. The majority of economists thus failed to warn policy makers about the threatening system crisis and ignored the work of those who did. ...