Home > The Economics Profession > WSJ says “there is something profoundly wrong with the mainstream economics profession’s understanding of how modern economies work.”

WSJ says “there is something profoundly wrong with the mainstream economics profession’s understanding of how modern economies work.”

from Edward Fullbrook

Yesterday’s Wall Street Journal included an article ( A Dire Showing From a Dismal Bunch) that echoes arguments central to this blog and the RWER.  Here are sample passages.

Forecasting is by its nature a hit-and-miss affair; economics is not—despite the apparent dogmatic certainty of some of its practitioners—an exact science. But the track record of the profession in recent years—and last year in particular —is dire. Few economists spotted the boom and most hopelessly underestimated the bust. And it’s not as if the profession’s troubles in 2012 were limited to longer-range forecasts; it was getting it wrong virtually in real time with most forecasters forced to slash their projections every few months as each quarter turned out worse than expected.

What the dismal science’s dismal record suggests is that there is something profoundly wrong with the mainstream economics profession’s understanding of how modern economies work. The models on which its forecasts are built are clearly badly flawed.  

The scale of this analytical failure is increasingly worrying some policy makers at the sharp end of tackling the crisis . . .

But the most important contribution to the debate is an essay by Claudio Borio, deputy head of the monetary and economics department at the Bank for International Settlements, published last moth and titled: “The Financial Cycle and Macroeconomics: What have we learned?”

In Mr. Borio’s view, the “New Keynesian Dynamic Stochastic General Equilibrium” model used by most mainstream forecasters is flawed because it assumes the financial system is frictionless: Its role is simply to allocate resources and therefore can be ignored. Although many economists now accept these assumptions are wrong, efforts to modify their models amount to little more than tinkering. What is needed is a return to out-of-fashion insights influential before World War II and kept alive since by maverick economists such as Hyman Minsky and Charles Kindleberger that recognized the central importance of the financial cycle.

Mainstream economists have been so fixated on understanding ordinary business cycles that they ignored the role that years of rising asset prices and financial sector liberalization can play in fueling credit booms. They lost sight of the fact that the financial system does more than allocate resources: It creates money—and therefore purchasing power—every time it extends a loan.

“Macroeconomics without the financial cycle is like Hamlet without the Prince,” to Mr. Borio.

To many lay-people, it may seem astonishing after all the world has been through in the past five years that mainstream economic models continues to play down the financial system. Yet this analytical failure could be the source of potentially serious policy errors. According to Mr. Borio’s analysis, the challenge in a balance sheet recession caused by the end of a financial cycle is to rapidly reduce the “stock” of debt that has caused the crisis before it becomes a “flow” problem as the economy is dragged into a downward spiral through lack of funding for new investment—the problem that Japan has faced over the past two decades.

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  1. January 7, 2013 at 1:36 pm

    Did the article mention Steve Keen’s alternative model or anything like it?

  2. January 7, 2013 at 6:08 pm

    An answer to Claudio Borio’s call for a new explanatory model

    http://paulgrignon.netfirms.com/MoneyasDebt/Answer_to_C.Borio_21122012.pdf

    http://paulgrignon.netfirms.com/MoneyasDebt/twicelentanimated.html

    If money is created as debt to a bank, which Mr. Borio acknowledges, then savings are someone’s debt money that is NOT available to be earned and extinguished by the borrower who created it, unless it has first been borrowed into circulation as existing money, thus creating a Borrow from Peter to pay Paul and vice versa “perpetual debt”. Perpetual debt relies entirely on the timely creation of ever more new bank credit to avoid inevitable defaults. Thus Mr. Borio’s call for debt reduction and increased savings is precisely the WRONG prescription, according to his own logic. Savings need to be SPENT to eliminate perpetual debt. But… ultimately the math of this money-as-debt system does NOT work in the absence of continuous growth of debt and the economy, as we witness time and time again.

    originally posted at:

    http://www.economist.com/blogs/freeexchange/2012/12/reforming-macroeconomics

    A paper on the subject has been submitted to the WEA conference this month.

  3. January 7, 2013 at 6:59 pm

    I published two posts on this subject (in french), where I’m refering to Jean Gadrey’s post and also RWER manifesto to define the need of more democratic control in Science :

    http://conscience-sociale.blogspot.com/2012/12/les-reseaux-euro-brics-comme-reponse-la.html

    http://conscience-sociale.blogspot.com/2012/05/la-democratie-scientifique-comme.html

    I discussed this subject in an international seminar few months ago : (summary in english) http://www.europe2020.org/spip.php?article748&lang=en

  4. BC
    January 7, 2013 at 9:18 pm

    Shall we be frank? The Anglo-American, German, Swiss, and Italian banksters and their rentier Power Elite benefactors define the rules of the winner-take-all game described by economics, which is hardly more than an intellectual rationalization for a kind of neo-imperial, neo-fuedal system of land tenure, manorialism, and war in which the top 0.1% own claims on all labor, production, and gov’t receipts via ownership of banks and the creation of private fiat debt-money.

    The next 9.9% in turn have subordinate claims on the claims of the neo-feudal rentier overlords, leaving the bottom 90% owning nothing, and increasingly not even their labor product as automation accelerates and “austerity” takes hold in earnest.

    • Bruce E. Woych
      January 9, 2013 at 1:42 am

      Agreed BC: only we are not truthfully regressing back to feudal models, we are actually re-entering a scarcity model on a global scale with the same scenario being orchestrated in response. The appearances are deceiving us to interpret it as “some” familiar ground but:
      …milking the steamrolling trends of corruption is only the tipping of the cash cow for the opportunists’ working and churning the bandwagon fallacies into peer reviewed acceptable levels of business bad boys on steroids. The problem is that this is simply not a case of wild western business cycles spiraling out of control or, more precisely, that scenario is only the tip of the iceberg. Of course this root causal corruption does exist here, along with all the perverted incentives, moral hazards, control fraud, regulatory capture, “Executive Capture” and political cut outs placed in the right positions to serve private equity and sovereign wealth power systemics.
      But what is missing is history. The assault on the foundation of the New Deal began literally at its very onset. By the 1950s a cold war and Chicago universities Economics department began a global class war that bled from BCCI (only one example) to regime changes by assassination; through “free market” plundering to Savings & Loan Looting and finally to the actual Looting of the Treasury and the Privatization agenda against the American Domestic economy. This is the Dark side of the supply side, privateer Neo-American Agenda. the Century that is now, and the Saudi-American Banking Republic…and it is offshore profiteering that lacks…no, defies boundaries. Democracy is being bankrupted and we are being handed a storyline narrative about simple greed and blunder…when in fact it is schemes and plunder. The monetarization and militarization of America is essentially the privatization of empire. And the American Domestic Economy is possibly the ULTIMATE PRIZE ! But the New American Century Agenda is a strategic plan of economic and political supremacy that will feed upon strife and scarcity in the next 50 years. In fact it depends upon it to justify and legitimate its ruthless mission, methods and vision of a global depletion model and its political economic administrative controls.

      What they expect from us is not recapitulation under a neo-corporate fuedalism, but it may well be closer to “futilism” and total capitulation under some form of a military-political cartel. .

  5. Ken Zimmerman
    January 7, 2013 at 9:28 pm

    Duh! It took this long for the so-called “enlightened,” “smart,” and “top educated” experts to figure out prefessional economics and economists are screwed up? The longshoremen, day laborers, and construction workers I talk with each day figured this out years ago. More frightening is that hedge fund managers and bankers also know it and use the information each day to take advangage of just about every other actor in the economy, including government regulators. Something is seriously wrong with this picture.

    • Bruce E. Woych
      January 9, 2013 at 6:02 am

      Any discipline so close to the money measure is sure to embrace a group of people of mixed intent. I would speculate that those who are unethical about “How Close” to the money they practice has an advantage over those that might be considered constructive idealists. The market interests will dictate the flow of such advantages in line with their own interests, and the Universities are geared more and more towards the markets. Asymmetrical knowledge and information go hand in hand with asymmetrical society while metrics and ratios formulate the foundation for a power grid that demands a political economic ideology. Between professional myopia and specialized concerted interests. Economics becomes highly policy driven and politicized. As BC is indicating (in #7) the system is not really broken if the “intentions” are created to be off-set and asymmetrical in the first place. The system is actually working, and a great deal of financed Economics (via-a-vis the invisible market-handout from institutional wealth) is a service industry on that market. In that context, it works. In regard to society in general, these same workings that facilitate and sustain asymmetry is looking very screwed up to the rest of us…and to many educated economists who truthfully are not funded or instrumental in market driven social order and its consequences (that require continuous rationale to operate). Classical Economists, meanwhile, must be failing at their JOBS as stated…if the intellectual consensus at the WALL STREET JOURNAL are complaining openly about their incompetence.
      The truth is…that just maybe this is a VERY GOOD sign that they are actually fed up with class apologia and saluting wealth before peer influenced integrity and self esteem.

      I

  6. BC
    January 8, 2013 at 1:56 am

    Ken, if one is in the top 0.1% and has the power and privilege to make the rules, rig the game in one’s favor, and handsomely reward the priestly ministerial caste to devise dubious, self-serving eCONomic theories, models, and policies to keep the game rigged, there is absolutely nothing “wrong with this picture” for the top 0.1%; it’s designed to be right for the top 0.1% and the next 0.9%, and “wrong” for the bottom 99%.

    Games are for winners and losers. In a winner-take-all game, the top 0.1% winners rig the game so that the 99.9% are losers, while sharing enough of the plunder with the next 0.9% so that they think they are winners; and they are compared to the bottom 99%.

    A system that rewards only the top 0.1-1% winners ensures that everyone else loses, including being incapable of subsistence at a socially acceptable level of material consumption and psycho-emotional well-being.

    But again, if one is a winner and can rig the game, who cares about the bottom 99% losers; after all, they’re losers. Let them eat “austerity” and excrete hope.

  7. Ed
    January 8, 2013 at 4:22 pm

    The mainstream keeps these compelling price histories seldom seen

    http://www.showrealhist.com/yTRIAL.html

    thus keeping the people FOOLED. The mainstream are conpersons first.

  8. BC
    January 8, 2013 at 5:47 pm

    “Enough is Enough”: steadystate.org/central-concept-economics

    “. . . Soddy observed that humanity lives off the revenue of current sunshine that is gathered each day by plants with the aid of soil and water. Unlike manna some of the sunshine was accumulated and stored by geologic processes, and we have consumed it lavishly with mixed results. Today we also try to accumulate surplus solar income and exchange it for a permanent lien on future solar income. We then expect this surplus, converted into debt in the bank, to grow at compound interest. But the future solar-based revenue, against which the debt is a lien, cannot keep up with the mathematics of exponential growth, giving rise to debt repudiation and depression.”

  9. Bruce E. Woych
    January 9, 2013 at 1:48 am

    http://baselinescenario.com/2013/01/04/if-only/

    See comment BB12 for a down to earth assessment of ‘futility’
    ending with the line “…They would rather just give it up for…what else? Guns and religion. Because they’re scared.” (BB12)

  10. Bruce E. Woych
    January 10, 2013 at 7:36 pm

    This may or may not be precisely on the issue, but it does relate to Economics and its perspectives following World War II; and it is right on the money! It does indicate just how far we have come from authentic recognition of reality …. check this out!

    “In 1943, in an analysis of Hitler’s programme in the Quarterly Journal of Economics, the word ‘privatisation’ entered the academic literature for the first time. The author, Sidney Merlin, wrote that the Nazi Party ‘facilitates the accumulation of private fortunes and industrial empires by its foremost members and collaborators through “privatisation” and other measures, thereby intensifying centralisation of economic affairs and government in an increasingly narrow group that may for all practical purposes be termed the national socialist elite’.The gung-ho free marketeers who rode to power with Thatcher in 1979 don’t seem to have been aware of the Nazi prelude, although they would have known of later privatisations in Pinochet’s Chile.”

    From:

    http://www.lrb.co.uk/v34/n17/james-meek/how-we-happened-to-sell-off-our-electricity

  11. Bruce E. Woych
    January 13, 2013 at 1:42 pm

    Of interest to anyone / everyone:

    http://papers.ssrn.com/sol3/JELJOUR_Results.cfm?form_name=journalbrowse&journal_id=2126256

    SSRN eLibrary Search Results
    Singapore Management University School of Law Legal Studies Research Paper Series

    SINGAPORE MANAGEMENT UNIVERSITY SCHOOL OF LAW LEGAL STUDIES RESEARCH PAPER SERIES
    View Papers: http://www.ssrn.com/link/Singapore-Mgmt-U-LEG.html
    Subscribe: http://hq.ssrn.com/jourInvite.cfm?link=Singapore-Mgmt-U-LEG

    Founded in 2007, the Singapore Management University School of Law is a young and vibrant community of academics, students and alumni whose mission is to build a collegial team of excellent researchers and teachers to nurture lawyers who will lead and serve the community with distinction. The SMU School of Law is helmed by a dynamic and international faculty with a diverse range of research interests, ranging from the private law of obligations, international trade law, international criminal justice, to note just a few. The Singapore Management University School of Law eJournal contains abstracts, works in progress, and published papers from our faculty and visiting scholars. The papers are published electronically and are available online or through email distribution.

  12. Bruce E. Woych
    January 14, 2013 at 2:00 am

    (Something profoundly wrong…)

    http://thinktank-watch.blogspot.com/2007/12/sir-anthony-fisher.html

    Think Tank Watch
    “Litter the world with free-market think-tanks”
    Sir Anthony Fisher (1915 – 1988)

    (Something profoundly wrong…)
    Sir Antony Fisher (1915 – 1988) was one of the most influential background players in the global rise of libertarian think-tanks during the second half of the twentieth century, founding the Institute of Economic Affairs and the Atlas Economic Research Foundation.

    (Something profoundly wrong…)
    With the help of the rightwing Liberal Oliver Smedley, he set up the IEA in 1955. Two years later, it was handed over to Harris and Seldon.

    Other IEA founders included Friedrich von Hayek, who at this point was at the University of Chicago; Keith Joseph, and Ralph Harris, a fellow of the British Eugenics Society which had earlier helped draft Hitler’s race laws.

    (Something profoundly wrong…)
    (Ralph Harris, Baron Harris of High Cross (December 10, 1924 – October 19, 2006) was a British economist. He was head of the Institute of Economic Affairs from 1957 to 1987. The IEA’s brand of free market liberal economics was deeply unpopular when it was founded, but, some 20 years later, by combining the classical liberalism of the 18th and 19th centuries with Conservative principles, Harris became one of the men who invented Thatcherism.
    He was a director of Rupert Murdoch’s Times Newspapers company from 1988 to 2001 and chairman of CIVITAS from 2000.)

    (Something profoundly wrong…)
    It was through the Atlas Economic Research Foundation that Fisher was able to extend his beliefs worldwide. By 1984, Fisher was watching over eighteen institutions in eleven countries.

    Today, Atlas supports and works with around 150 libertarian think-tanks.
    It should be noted that his first venture the Social Market Foundation (TK) developed Margaret Thatcher as candidate and Thatcherism as governing philosophy.” Manhattan Institute 2003″

    http://thinktank-watch.blogspot.com/2007/12/sir-anthony-fisher.html

    Think Tank Watch
    “Litter the world with free-market think-tanks”
    Sir Anthony Fisher (1915 – 1988)

  13. January 14, 2013 at 4:47 pm

    Both #13 and #15 flesh out matters I was aware of but lacked detail. Thanks, Bruce.

    That Hayek was not only Thatcher’s mentor but also the originator of the flood of dishonest conservative think tanks does not surprise me, for Hayek’s “Road to Serfdom” plagiarised and deliberately misrepresented Belloc’s “The Servile State” (1912), which denounced both Capitalism as the problem and Socialism as an inadequate answer to it. (Belloc’s Distributist alternative became “small is beautiful” economics and “subsidiarist”/”bottom up” government).

    The aims of Hayek’s Mont Pelerin Society, as listed in Wikipedia, look good, but they are all undermined by failure of the third one:

    “Methods of re-establishing the rule of law and of assuring its development in such manner that individuals and groups are not in a position to encroach upon the freedom of others and private rights are not allowed to become a basis of predatory power”.

    Lack of concern about this suggests it was not wishful thinking but a downright Machiavellian lie, i.e. an inversion of the intended aim: to MINIMISE the rule of law without the two ‘not’s in the results sought.

  14. Bruce E. Woych
    January 14, 2013 at 5:26 pm

    compliments to you davetaylor1:

    http://thinktank-watch.blogspot.com/2007/12/sir-anthony-fisher.html

    If you read the entire article; you will find Milton Friedman also directly involved with Anthony Fisher and indirectly to Reagan’s influences globally. There was a time when academic integrity demanded an accounting of potential bias from finances, but the cold war rules of order demanded an alternative secrecy that pre-empted any such notion of objectivity. When we ask about economics as an institutional paradigm it ends up being pure propaganda heavily financed and politicized at its foundation since the 1950s. The true course of a real “economics” is left continually apologizing and fumbling with “alternative”
    explanations and models. Authentic economics is subverted into marginality and minimized by pseudo-institutionalization processes out of its control. The fact is that the history of economic thought has been usurped and controlled by self-interests that ironically brag about their “invisible hand” (making a virtue out of vice).
    WHAT A tragic JOKE ON US …

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