Explaining Southern California's economy

The day the economists failed

In this three photo combo, Professor of

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Paul Krugman isn't happy about how economists handled the financial crisis.

Just catching up with this. It's the text of Paul Krugman's speech upon receiving some honorary degrees in Spain. It's well worth a full read. There's some wonky econo-speak, but Krugman's labors as a New York Times op-ed columnist have enabled him to convey some complex ideas with admirable clarity. 

Quick summary: the economists failed when the financial crisis hit. When the economy isn't in crisis, economists are basically useless. But when it all goes to hell, they're urgently needed and must to be ready to offer the best possible advice. 

Krugman thinks he and his fellow economists blew it, mainly because they descended into ideological and intellectual squabbling after the initial, successful response to the crisis was mustered.

He starts by blaming himself. This small portion of the speech, to me, explains a lot about how even a public intellectual/academic economist like Krugman could be blindsided:

I was vaguely aware of the existence of a growing sector of financial institutions that didn’t look like conventional banks, and weren’t regulated like conventional banks, but engaged in bank-like activities. Yet I gave no thought to the systemic risks.

This is an astonishing admission. There is no economy without banks, so you might imagine that all economists, regardless of philosophy, would be fully conversant in "financial innovation." But they weren't. This of course is because the banking system — and in particular the "shadow" banking system that Krugman describes — had become too complex to fit with the abstract models that economists like to work with. They see banks as reservoirs of capitals and facilitators of exchange. They leave the study of financial products up to the business school folks.

I have one other takeaway from Krugman's speech, which is the narrowness by which he defines the economics profession. In the end, he's talking about economists who study governments and markets. In other words, economics that center on money, trade, policies, taxation, and so on. But there are other kinds of economics, which might from the outside look less rigorous than the version that wins Nobel Prizes.

Given how badly Krugman thinks the mainstream macroeconomics failed when the financial crisis arrived, maybe it's time to take a closer look at economic theories that aren't beloved and debated by politicians and bankers.

Follow Matthew DeBord and the DeBord Report on Twitter.

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