Home > The Economics Profession > The failure of mainstream economics

The failure of mainstream economics

David Ruccio

Mainstream economists failed, with respect to the economic crisis, on three counts: they failed to predict the crisis, they didn’t even include the possibility of a crisis in their theories, and they didn’t know what to do once it happened.

Personally, I don’t put a lot of stock in prediction. But they do. And that’s because, as an excuse for the lack of realism in the assumptions of their theory, they claim all that matters is their models correctly predict the future trajectory of the economy.

And boy did they get it wrong. Simon Potter, who has reviewed the forecasts of the staff of the Federal Reserve Bank of New York, found enormous errors in the forecasts of real GDP growth and unemployment. On the former, the forecasts were off by 5.9 percentage points (a forecast of 2.6 percent growth versus actual growth in 2008 of -3.3 percent); on the latter, 4.4 percent points (equivalent to an unexpected increase of over 6 million in the number of unemployed workers). Oops!

Potter goes on to explain why he thinks they got it so wrong: they misunderstood the housing boom (because they found no convincing evidence of overvaluation), they had no analysis of the rapid growth of new forms of mortgage finance (because they relied on the assumption of efficient markets), and they gave insufficient weight to the feedback loops between the financial system and the so-called real economy (they simply didn’t connect the dots).

In other words, they failed. And the rest of us are now paying the costs.

  1. Bruce E. Woych
    November 27, 2011 at 1:46 pm

    Failure is in the eyes of the benefactor.

  2. November 27, 2011 at 1:50 pm

    “Failed” only if the object of mainstream economics has something to do with helping an economic system maintain decent levels of wellbeing. The ditto heads populating the ranks of the profession may think that’s what they are about, but like millions of others, they are blinded by the ideology of bourgeoise economics. Some interesting insights aside, the principle function of economics-as-usual is to justify the existing social order via pseudo scientific methods of math, graphs and … as you point out … predictions. The professoriate is barely distinguishable from the Preist hood of the 11th thru 17th centuries: power-point v. pulpit, calculus v. catechism, savers v. savior, investment v. vestments etc.

  3. November 27, 2011 at 4:50 pm

    The central flaw is ongoing inattention to real asset price histories.
    At the start here
    there is:
    This was in the WSJ 3/30/1999:

    Would subsequent topping out and falling far down be well-precedented?
    This was in the NYT 8/27/2006:
    http://www.nytimes.com/imagepages/2006/08/26/weekinreview/27leon_graph2.html Would subsequent topping out and falling far down be well-precedented?
    Both up to date:

    My view: the main enabler of sizable asset price bubbles (very harmful!) is keeping the real price histories out of sight.

  4. Dunning-Kruger
    November 27, 2011 at 6:34 pm

    I am sure the one which warned before that they would fail with their theories were fired right after the crisis emerged.

  5. Paul Davidson
    November 27, 2011 at 7:18 pm

    As I point out in detail in my 2009 book THE KEYNES SOLUTION:THE PATH TO GLOBAL ECONOMIC PROSPERITY, Keynes overrthrew the classical ergodic axiom . In a non ergodic environment (as in Keynes’s General Theory of a monetary economy), the future is uncertain in the sense that past probability distributions are not statistically reliable estimates of the probability distribution that will govern outcomes on any specific future date. Thus in Keynes’s theory the future is uncertain in the sense that , as Keynes put it, there is no reliable way to predict the economic future..

    All mainstream theories presume the economic system is an ergodic stochastic system so that past probability distributions calculated from existing market data and history are statistically reliable estimates of future probabilistic risks.

    Paul Davidson

  6. Bruce E. Woych
    November 27, 2011 at 8:52 pm

    “The real difficulty in changing any enterprise lies not in developing new ideas,
    but in escaping from the old ones.”

    John Maynard Keynes

  7. November 28, 2011 at 2:32 am

    Why do mainstream economists studiously ignore the role of debt in their “analysis” when the whole system is based on debt generation?
    Answer: Because they have been deliberately conditioned to “look the other way”.
    And are richly rewarded for doing so.

  8. joe magner
    November 28, 2011 at 3:22 am

    I’m not an economist but I certainly have watched this all and tried to understand it, maybe not being an economist allows me to use what I do know a bit about, Physics and Engineering. Three things that seem never to be considered are:

    The effect of the charging of interest and transfer fees have on what might be called the current amount of money loaned into the system. This seems to require more money loaned into the system to cover the added money from charging interest or fees. Eventually this should accumulate until it is impossible to loan enough money out and then things would be forced to unwind. If there was no transfer charges it could all be unwound to zero but with transfer charges it will always be negative so someone must loose to adjust to zero.

    The second thing has to do with time and phase shifts and delays. If/when money is created by a loan it is almost always a lump sum but its paid back over time. This has the effect of producing errors when a system reacts slowly to change which all real world systems do so for the transient to be evened out there is a big delay unless the systems gain and frequency response is very high compared to the transient and then the system will be on the verge of oscillating. In real world servo systems there is usually a damping factor introduced electronically or sometimes mechanically to smooth things out.

    The third one is actually as important or maybe more important then the other two under a couple conditions. Lets say that at some point part of the system saturates and goes non-linear. When this happens all bets are off and the point it comes out of non-linearity is indeterminate so we have a chaotic (formal use of the term) system. This can happen by stress from one individual or component but can also happen if many individuals are present and depends if they are in step hitting all at once or phased together in some orderly fashion. What happens to an individual transfer and how it unwinds over time can be vastly different if many do the transfer at the same time. This can cause high non-linearity in the system by itself but can also cause something to saturate in the path with chaotic results.

    Seems to me all three have happened plus some other accounting tricks that have to do with trade.

  9. November 28, 2011 at 9:28 am

    As, the preceding poster, I am no economist, but have been trying to make sense of what happened, too. It seems to me that the acknowledged problem was “boom and bust”. These neocons appear to have persuaded people that they had solved that, and so we could have high growth without the inflation which leads to a crash. In reality the inflation was high, as is to be expected in a boom driven by increase in the money supply (though done by the private sector, very largely, which they seem to think makes some substantive difference): but the increased money was mopped up by high property prices and high remuneration for the top eaners. In other words the “solution” was to ensure that the majority of people got no benefit from the “boom”, and so inflation was called something else and confined to increase in the wealth of the few. The crash is therefore delayed because in practice the majority are practising austerity throughout:, but that is not sustainable, and when it crashes the crash is greater than it would otherwise be.

    That is the real meaning of “trickle down”: austerity for the many and indulgence for the few: It is worse than disease it purports to cure: and so we see long austerity when the middle and lower incomes are static over a long period of time: followed by depression when they actually fall dramatically, if we continue to believe those who claim to know about economics. So far as I can tell they either do know and care not at all: or they don’t know. Either way they need to be excluded from policy: but instead we are now abandoning democracy in order to give them even more power

    It is a funny old world …

  10. joe magner
    November 28, 2011 at 9:36 pm

    Their boom our bust, a zero sum game of chicken. The mortgages money went out to spike the economy but the foreclosures are real losses. The bank gets the land because of the transfer of money and looses some but the real looser is the property owner, now or in the future. The ones that have survived are those who paid down enough already and they bough before the big ramp up. The other losers are those who bought the bonds made from tranched up mortgages or loans and sold to people and groups that had money they NEEDED to invest. The mischief I see is that those tranched up losses dont include pieces of the deeds or titles and several banks are claiming the right of ownership intoto without consideration to how and who should own those deeds and titles.

    The banks get the houses and land and the profits from transferring the money risk to others who were trying to save for their retirements. 17.5 Trillion(?) – Now all the banks have to do (but will be disappointed in the end) is have the government or Fed bail them out enough to recover…yeh sure….the European collapse will do them in along with the rest of the entangled obligations. The unwinding of the books is gonna be interesting, wish it could happen in some sort of a global way other then behind closed doors in secert(?) locations or a court system.

    • November 29, 2011 at 12:23 am

      Yes, all goes to show that all land rent should be nationalised, as suggested by Marx.

      • joe magner
        November 29, 2011 at 5:13 am

        LOL – Marx is old school – there is an excellent class notes/review of Das Kapital done by David Harvey. I recommend this series and its on Harvey’s website under a link Reading Capital. I downloaded all 13 of them and listened and followed along with this internal yes going on in my mind on until he hit Surplus Labor and then it was all no’s from there on until i almost vomited. I never finished much past then but the lectures are amazingly clear. I want to read Schumpeter but have yet to do more then read what others have written about him and his work. I have a friend who married a lady from Denmark and lived over there for several years. He became close to her father who as a powerful engineer type who could live more wealthy (high taxes you know) anywhere else in the world and knows this. He chooses to live in Denmark where he is free to not have to have body guards or worrying about getting ripped off. There is a high value to personal security and trust and I dont think either a full out communist system nor a (supposedly) free market American system gives this.

  11. Bruce E. Woych
    November 29, 2011 at 4:28 pm

    Premise/ Axiom : Classical economics is a mainstream accomplishment of the enlightenment and represents best practices in the history of ideas. In fact, what goes by that name is merely a recapitulation of the business cycle theory where the indiscriminate measure of aggregate business flow charts become the standards of HEALTH in an economy of unspecified but glorified wealth as a standard bearer. Yet this only substituted one monarchy for a systemic practice of monopoly formation among competing nested systems.

    At the present time we are being digitized and monetized into grid units of controlled and tracked demographic markets that are essentially the same as market colonies floated by exploiters for capital production and society is seen as succession phases (as we once measured environments and ecological phases…gratis…coincidentally from the University of Chicago School). Social stability measured as per-occupational contribution to the revenue streams of the “healthy” economy essentially converts individuated labor markets into industrial systems to exploit in the competitive succession of wealth formation that progressively degrades the system (ranking stratification has demographic ramifications in the population that I have not seen measured…because no one is looking at the effects towards the base economy…only at the consolidated elite prosperity at the upper tiers of this distortion). In my opinion the theories are loaded and the “critical thinker” is immediately tagged marxist or in some school bank of default from the preferred platform or “narrative” that legitimates the process.
    It is a mistake to keep looking backwards with polemical theory from the past. Empirical reality is that basic subsistence systems are being supplanted with claims of inefficiency and even made illegal with patents and intellectual property claims among other items of crushing counter-pressures against the age old localized exchange and bartered world of community based self-reliance and independent self sufficiency…not grand scale invisable market claims of fiat efficiency endorsed by this “mainstream” and “class-driven” “classical” apologia for the laissez-faire global expansionists who are now targeting to coral all local markets and annihilate their authenticity with a scope and scale dependency upon their own imperial mandates for survival…and $ocial supremacy. And now we can thank technology for computational designs programed by the C-class orchestrates of power economics while the IRS tracks every dime for tribute and the air you breath at work time and wake up ultimately is subject to the efficiency of this market realism. A REAL’IS’M that, when you extract the “IS” emerges to reveal the same old “REALM” loaded kiss my ring that royalty once held over a submissive and terrorized set of subjects.

    Generic “CRITICAL” THINKING should not be instantaneously equated with still another realism of theoretical thought, no matter how humble. The turnover is still the same. If a true ECONOMICS” is to come to the forefront it will have to define its terms and thoise terms must reflect the empirical world of events in situ and in vitro; not in a test tube from bought and sold economic departments or a media tube of influence seeking vested interests buying advertising.

    • Bruce E. Woych
      November 29, 2011 at 4:34 pm

      sorry about the “thought streaming here…feel free to add your own periods, commas or whatever grammatical device brings out the chain of meaning for you. Always in a hurry…
      …can;t get good help anymore… Mea Culpa on the hasty posting.

  12. November 29, 2011 at 10:24 pm

    Great thread! Though I love all the powerful thinking & info of my fellow males, I must hand my highest esteem of the moment to the powerful wisdom of the feminine comments herein above. I distill their potent insights down to this:

    The problem is corruption, and all it entails in devolving over 5,000 years or so in a species like ours on a planet like this one.

    Yet, all else are mere symptoms of the causes:

    The 5 Poisons identified and described by Buddha…

    Foolishness (delusional ignorance, denial, etc.), Greed, Hostility, Jealousy, and Arrogance.

    The root cause seems to be delusional ignorance.

  13. December 6, 2011 at 4:39 pm

    Surely we are ALL familiar with the acronym GIGO, right?

    Their economic models worked only so long as the economy operated within a range of behaviors that they were confident our economy would always be within. Their MICRO risk assessment models worked perfectly well only so long as the MACRO-economy never woke up to the reality that the working classes were finally berift of ways of dealing with nearly 40 years of declining incomes.

    And since far too many economists forget that the working classes actually matter, well what was happening on Main Street finally effected the outcomes on an (up til that time) largely indifferent Wall Street.

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