What caused the financial crisis that is still reverberating through the global economy? Last week’s 4th Nobel Laureate Meeting in Lindau, Germany – a meeting that brings Nobel laureates in economics together with several hundred young economists from all over the world – illustrates how little agreement there is on the answer to this important question.Pathetic. It is like a meeting of aeronautical engineers that can't decide what might possibly make "heavier than air" machines fly. Could it be the wings? The propeller? The colour of the paint? The direction you pointed the nose of the craft in? The height of the cliff from from which you pushed your invention? Gee... that aerodynamics is a tough field. But the good news is that we have this simulation called Angry Birds which lets our top scientists simulate flight and uncover Mother Nature's darkest secrets.
Surprisingly, the financial crisis did not receive much attention at the conference. Many of the sessions on macroeconomics and finance didn’t mention it at all, and when it was finally discussed, the reasons cited for the financial meltdown were all over the map.
It was the banks, the Fed, too much regulation, too little regulation, Fannie and Freddie, moral hazard from too-big-to-fail banks, bad and intentionally misleading accounting, irrational exuberance, faulty models, and the ratings agencies. In addition, factors I view as important contributors to the crisis, such as the conditions that allowed troublesome runs on the shadow banking system after regulators let Lehman fail, were hardly mentioned.
Macroeconomic models have not fared well in recent years – the models didn’t predict the financial crisis and gave little guidance to policymakers, and I was anxious to hear the laureates discuss what macroeconomists need to do to fix them. So I found the lack of consensus on what caused the crisis distressing. If the very best economists in the profession cannot come to anything close to agreement about why the crisis happened almost four years after the recession began, how can we possibly address the problems?
When the recession began, I had high hopes that it would help us to sort between competing macroeconomic models. As noted above, it's difficult to choose one model over another because the models do equally well at explaining the past. But this recession is so unlike any event for which there is existing data that it pushes the models into new territory that tests their explanatory power (macroeconomic data does not exist prior to 1947 in most cases, so it does not include the Great Depression). But, disappointingly, even though I believe the data point clearly toward models that emphasize the demand side rather than the supply side as the source of our problems, the crisis has not propelled us toward a particular class of models as would be expected in a data-driven, scientific discipline. Instead, the two sides have dug in their heels and the differences – many of which have been aired in public – have become larger and more contentious than ever.
I can understand squabbling for 80 years after the Great Depression. There wasn't a lot of data back then and "economics" was still a primitive field. But to fail to understand the current situation, to identify what caused it, and to give sound consistent specific advice to policy makers to get the world out of this rut? That isn't a science. That is a bunch of fumblers at an acrobatic school pretending they have the secret of the "dark arts" of balance and control but when asked just can put on even a minimal performance to demonstrate expertise.
I think universities should disband their economics departments and offer up the space to some useful sciences.