Since the Queen of England asked why the economics profession had not seen the financial crisis coming, the profession has been in trouble.
The Bank of England’s Andrew Haldane described this trouble as nobody trusts what economists have to say about the impact of economic events in the real world.
The Bank of England’s chief economist has admitted his profession is in crisis having failed to foresee the 2008 financial crash and having misjudged the impact of the Brexit vote.
Andrew Haldane, said it was “a fair cop” referring to a series of forecasting errors before and after the financial crash which had brought the profession’s reputation into question.
Blaming the failure of economic models to cope with “irrational behaviour” in the modern era, the economist said the profession needed to adapt to regain the trust of the public and politicians.
Haldane described the collapse of Lehman Brothers as the economics profession’s “Michael Fish moment” (a reference to when the BBC weather forecaster predicted in 1987 that the UK would avoid a hurricane that went on to devastate large parts of southern England).
Yes Andy, economics is in bad shape when the very issue the profession is suppose to know something about, nobody trusts the profession to have expertise in.
Unfortunately, claiming people engaged in “irrational behavior” doesn’t move you or the profession closer to restoring trust.
Did people really engage in irrational behavior?
- Were Northern Rock depositors lining up to get their money that wasn’t guaranteed by deposit insurance behaving irrationally?
- Were bankers with deposits to lend behaving irrationally when they wouldn’t lend to banks looking to borrow because they couldn’t determine if these black box banks were solvent or capable of repaying the loan?
- Were investors really acting irrationally when they went on a buyers’ strike and stopped buying opaque structured finance securities because they could not assess the risk/reward of these investments?
All of this behavior was in fact extremely rational when faced with opacity.
Did people really engage in irrational behavior to the policymakers’ response to the financial crisis?
- Were individuals living off their retirement savings acting irrationally by cutting back on their consumption when the Bank of England and other central banks slashed their earnings by adopting zero interest rate policies?
- Were companies acting irrationally by not investing in expanding production capacity when they saw both a decline in demand driven by the central bank policies and no ability to raise prices since their overly indebted competitors were allowed to stay in business?
All of this behavior was in fact extremely rational when the policymakers decided to protect the lenders from their errors in extending credit.
Since behaving rationally wasn’t the problem, perhaps something else is the problem with economics?
In her column, Ann Pettifor, one of the few economists to predict the financial crisis, observed:
Economics, by contrast, is dogged by ideology.
It is ideology, not science, that leads economists to wrongly assert that the market in money is like the market in widgets, and must not be regulated or tampered with by governments. That financial flows across borders must be “free”, regardless of whether they cause instability. … That monetary and fiscal policies that serve the finance sector with bailouts are tolerable, while those that serve the poor must be resisted. …
Unsurprisingly, these flawed theories and models are a great comfort to financial elites – which is why so many economists are hired and funded by big banks, corporations and the wealthy. And it explains why their words and ideas are repeated by the media outlets that faithfully serve the status quo or “the establishment”.
Very little has been done to transform the dominant economic model of financial and trade liberalisation or to limit economists’ almost religious belief in the efficiency of markets and hostility to public intervention. Markets must be left, it is argued, to manage almost every aspect of modern life – and bailouts confined to bankers.
Now markets have been a feature of our societies and economies for at least 5,000 years, and can be a very good thing. But markets – in money, labour and goods – have always been subordinated to the interests of society, and governed by society.
One ideology economics is dogged by is a refusal to actually look at the facts. The economics profession prefers axiomatic-deductivist modeling to empirical evidence.
Had the profession let empirical evidence creep in since the financial crisis started on August 9, 2007, it really wouldn’t have been too hard to see the role opacity played in the financial crisis. The crisis occurred in those corners of the financial system that were opaque. In those parts of the financial system where there was transparency, people behaved as economic models expected.