In 2008, the Queen of England asked the Economics profession why it hadn’t seen the financial crisis coming.  After mumbling a bunch of BS, the answer that emerged is macroeconomists had made themselves irrelevant over the preceding 4 decades.

How did they manage to do that?

They assumed away any linkage to the real world in order to make it possible to mathematically solve their models.

Unfortunately, having made their models irrelevant did not prevent this Priesthood of the PhDs from then offering their ill-informed opinion on how the crisis should be responded to.  Despite the fact they had no relevant expertise, the Priesthood claimed they were experts and engaged in the Big Distraction.  By attracting attention to their bad ideas, they took attention away from the real experts who understood how to end the financial crisis with minimal damage to borrowers and the real economy.

Not surprisingly, the Priesthood contributed to making a bad situation much worse than it had to be.

At this point, the burden is on me to provide the evidence to support the preceding paragraphs.

My starting point is the Economics profession’s preferred model for financial panics and bank runs by Diamond and Dybvig.  It is mathematically elegant.  It only has one short-coming.  Their model doesn’t move us any closer to understanding why bank runs occur.

Their model describes what happens once the bank run starts.  In order to make their model’s math work, the authors made the cause of a bank run a random variable that is outside of their model.

Is anyone surprised the Economics profession failed to see the financial crisis coming when their preferred model for thinking about financial panics and bank runs treats them as random events?

No!

Undeterred, once the financial panics and bank runs started the Economics profession leapt forward and said:  “look at what a great job our model does of describing the ongoing financial panics and bank runs.  You should listen to us when we tell you how to end them.”

Why exactly would the Economics profession have any relevant insight into how to end the 2008 financial panic and bank runs when their preferred model treats the cause as a random variable?  This was particularly true when most of the Priesthood of the PhDs couldn’t be bothered to investigate the cause before opening their mouth.  In fact, lead by Ben Bernanke, the Priesthood ignored the one economist who did have any insight into the cause:  Anna Schwartz.

If Economists had any insight, they would have seen the financial crisis coming in the first place.  More importantly,  they would have been busy saying what had to be done in the run-up to the crisis to prevent the crisis.  Yes, there were Economists who warned about the crisis (see William White et al at the BIS for example).  However, these Economists didn’t offer a solution that would have prevented the crisis they warned about.

Next up in the parade of irrelevant models is the Economics profession’s models for predicting the economy and how it will respond to changes in monetary or fiscal policy.  As Nobel prize winning Economist Joseph Stiglitz observed:

First, the models haven’t been good enough at predicting economic trends, particularly around crises, because they are built to detect short-term fluctuations and not large shocks. Second, they don’t sufficiently incorporate the significant influence of the finance industry, because the models are better at incorporating information about individuals instead of institutions. Third, shocks in DSGE-based systems assume that they are caused by external factors and don’t account for the fact that some crises arise from within.

Shorter: the models exclude the financial system and the financial instruments at the heart of financial crises.

Of course, the irrelevancy of their models meant Economists were free to tell everyone their pet bad idea.  And macroeconomists used every method possible for getting their bad ideas out.  They wrote books, gave speeches, published articles and blog posts, and never, ever turned down an opportunity to opine to the mainstream media.

All their communication effort didn’t turn their bad ideas into good ideas.  What these communication efforts did do was drown out the good ideas for how to handle the financial crisis provided by individuals who actually had the relevant expertise in how to end this financial crisis.

Macroeconomists still wonder why they are receiving so much blame a decade after the acute phase of the Great Financial Crisis.  Brad DeLong offered up

At the macro level, the story of the post-2008 decade is almost always understood as a failure of economic analysis and communication.

It was a failure of economic analysis.  Economists didn’t bother to take the time to actually analyze the situation.  Economists models were irrelevant.  Economists models still don’t explain why the financial crisis occurred.  [Here is an explanation of why it happened even a 6-year old understands.]

We economists supposedly failed to convey to politicians and bureaucrats what needed to be done, because we hadn’t analyzed the situation fully and properly in real time.

Who asked you to convey to politicians and bureaucrats what needed to be done?  Certainly not the 9+ million households who were foreclosed on.

Who wanted the Priesthood of the PhDs to open their mouths and say anything?

What prevented the Priesthood of the PhDs from saying “I don’t know” when asked how to respond to the financial crisis rather than to open their mouths and offer ill-informed opinions?

Speaking as someone who a) had the relevant expertise to and did predict the financial crisis and b) explained what had to be done to minimize the impact of the crisis, I know I certainly didn’t ask any member of the Priesthood of the PhDs to open up their mouth and ignorantly opine.

Some economists, like Carmen M. Reinhart and Kenneth Rogoff of Harvard University, saw the dangers of the financial crisis, but greatly exaggerated the risks of public spending to boost employment in its aftermath.

Their great exaggeration turns out to have been base on these Economists beliefs and not any real world reality.  The data they cited to support there was a risk from public spending was the product of an Excel spreadsheet error they made. [Remind me again why they didn’t lose their professorship for such shoddy scholarship….]

Of course, this wasn’t even the worst part of their analysis.  What was worse is they constructed a database covering centuries of financial crises and not only did they not realize how much of this database was irrelevant, but they drew a further fallacious conclusion from it.

In the 1930s, policymakers made responding to a financial crisis by saving borrowers and the real economy both easy and the response of choice for how to handle a financial crisis.  Policymakers did this by creating the combination of deposit insurance and the Fed as a lender of last resort. This combination meant when a crisis hit banks should recognize losses on all their bad debts.  This protects borrowers and the real economy.  As for the banks, they could continue in operation supporting the real economy indefinitely (see the 1980s US Savings & Loan for confirmation of this).

Of course, the fact the financial system had been designed to be used to save borrowers and the real economy was lost by these Economists.  Instead, of saying what the response  to the crisis should have been, they trotted the globe saying why it wouldn’t be different this time.

There were probably 9 million foreclosures in the US that could have been avoided had they not opened their mouths and let one bad idea after another barf out.

Others, like me, understood that expansionary monetary policies would not be enough; but, because we had looked at global imbalances the wrong way, we missed the principal source of risk – US financial mis-regulation.

Mis-regulation as in we didn’t have enough regulations?  Or was it the failure of the US financial regulators to enforce existing regulations?  These are very different.

Still others, like then-US Federal Reserve Chairman Ben Bernanke, understood the importance of keeping interest rates low, but overestimated the effectiveness of additional monetary-policy tools such as quantitative easing.

Since the models Economists used to forecast the economy in the immediate aftermath of the acute phase of the crisis were irrelevant, perhaps keeping interest rates low contributed to making the financial crisis worse.  After all, in the 1870s Walter Bagehot said rates less than 2% caused problems.  One of those problems is the explosion in wealth inequality.

The moral of the story is that if only we economists had spoken up sooner, been more convincing on the issues where we were right, and recognized where we were wrong, the situation today would be considerably better.

Economists spoke up way, way, way too soon. [A decade after the acute phase is probably still 3 to 4 decades too soon for them to be speaking up.]

Given the irrelevancy of their models, how could they possibly have known where they were right versus where they were wrong?

Paul Volcker observed we are in a hell of a mess everywhere you look.  This appears to suggest Economists have been wrong about pretty much everything they have said with regards to the Great Financial Crisis.

The reason anger is still directed at Economists is simple.  Those clueless, arrogant bastards made the financial crisis worse for everyone by drowning out the voices of the experts who actually should have been listen to.