Paul Krugman on How did Economists get it so wrong ?
nytimes.com
nytimes.com
http://en.wikipedia.org/wiki/Political_economy
Economics isn't a science. Physicists can agree on 99.99 percent of what they talk about, and the other .01 percent is agreed to be unknown or arguable. Economists can barely, just barely, hold a tenuous consensus on things like comparative advantage. The reason economists "get it wrong", is:
1. They want to direct the money into XYZ set of pockets instead of ABC set of pockets, thus they're always "wrong" as for as ABC is concerned, and
2. They don't have the predictive consistency typical of scientists because...they aren't scientists.
That does not mean that the social sciences are unimportant. In fact the amount of money (which you alluded to) means they are actually perceived as important. Once upon a time physics wasn't a science either.
Systems biologists can't, nor can climate scientists, oceanographers, ecologists, geophysicists or astronomers.
A few fields (namely the ones taught to physics majors) have a simple unified theory that every sane person can agree to. The rest are messy, much like economics.
Notably, all fields where you can't do controlled experiments.
Also, the work done in Econometrics and Statistics in the field is totally solid. So, I wouldn't say they're not scientists. Or take Game Theory etc. - a lot of fields in Econ could just as well be in AI.
Anyway, macro's set of classical assumptions of modeling aggregate decisions based on rationality/ price-taking is too simple. Eventually we'll have to embrace more ideas out of complex systems analysis... but then all those neat macro formulas might not work out so well.
My two cents.
Krugman's not bad, he writes good mainstream stuff, which is hard to do. I would be far more impressed if he had spent the last 5 to 10 years writing to the mainstream, screaming his head off about the dangers of the bubble we were in. And if his answer is that he wasn't certain is was a dangerous bubble, he can hand over his Nobel to me, because I sure as hell knew.
Sometimes I lament the fact that instead of running the show, he's left to opine about the policies of others.
There are always these rather ridiculous omissions and oversimplifications with krugman.
Also, I think your assertion that asset bubbles do not occur absent government interference is wrong; or at the very least leaves out the fact that often it is the speculators themselves who are most demanding that the government aid and assist the inflation of the bubble.
"He asked me to do {something stupid}" does not relieve you of the responsibility for the dumb things that you do.
More to the point, the "govt should fix things" belief leads to govt doing dumb things. These things never look dumb up front.
Take this paragraph...
"During the golden years, financial economists came to believe that markets were inherently stable — indeed, that stocks and other assets were always priced just right. There was nothing in the prevailing models suggesting the possibility of the kind of collapse that happened last year. "
That's a straw man if ever there was one. I don't think any economist has ever denied the reality of market corrections. In fact, while Krugman picks out a few choice quotes the fact is many, many economists have been warning about the housing bubble for years. He does eventually address this with one sentence on page 5 but then obscures the issue by quoting politicians denying the bubble (a politician is never going to predict doom and gloom even if they do see it coming)
In the end there were mistakes made in our economy but Krugman's using those mistakes to float a theory that the whole system is flawed even though the system created 26 years of relative prosperity. Just because deregulation went a little too far doesn't mean going in the complete opposite direction is wise.
For the record, there are plenty of bubbles that have not been caused by government manipulation. For example, the Tulip bubble that happened in the Netherlands (http://en.wikipedia.org/wiki/Tulipmania) (not to mention bubbles caused by people like Madoff and other con men).
Also be careful. The government is always involved with any economic crisis and you can always blame a government action for making a bubble worse. If you believe that without a doubt the government is the cause of all bubbles, then no one will ever "prove" you wrong. If you are open minded and use the simplest explanation for a given set of facts (i.e., Occam's Razor), then you will find that not all bubbles have happened because of government manipulation.
The story of Tulipmania is not only about tulips and their price movements, and certainly studying the "fundamentals of the tulip market" does not explain the occurrence of this speculative bubble. The price of tulips only served as a manifestation of the end result of a government policy that expanded the quantity of money and thus fostered an environment for speculation and malinvestment. This scenario has been played out over and over throughout history.
Still, I think it proves my point that you can always blame the government if you want to.
In my view, the reasoning has one major flaw. If money supply was the cause, then why weren't there other bubbles in addition to tulipmania?
If you correctly identify the cause, then it should be both sufficient and necessary for the result. If the cause was the Dutch monetary policy, then there should have been other bubbles contemporary with the monetary policy.
As far as I understand it, the tulipmania did not cause a recession or depression even if some very rich people lost all their money. If the author's reasoning was correct, then there should have been other bubbles caused by the same government policy.
But what made this episode unique was that the government policy did not expand the supply of money through fractional reserve banking which is the modern tool. Actually, it was quite the opposite. As kings throughout Europe debased their currencies, through clipping, sweating or by decree, the Dutch provided a sound money policy, which called for money to be backed one hundred per cent by specie. This policy, combined with the occasional seizure of bullion and coin from Spanish ships on the high seas, served to attract coin and bullion from throughout the world.
I do not know of any more of this monetary policy implemented. Perhaps you could illustrate some examples from history.
Also the tulip mania cannot be explained by an increase of money supply. If that is the reason than why only tulips? If there is inflation and the market behaves efficiently and rationally everything should have gone up in price not only tulips. Why for example did one contemporary state that tulips became more expensive than the ground they were grown in? If the only reason is inflation, than the ground the tulips were grown on would increase in price proportionally to the tulips.
Nevertheless, I think it's fair to say the government did play a major role in the housing bubble.
Well, let me identify some for you. The tulip bubble, which is the classical example of a bubble had absolutely nothing to do with government manipulation. The internet stocks bubble of the late 90s also was largely unrelated to government manipulation. The housing bubbles of some eastern european countries also had nothing to do with the government as those governments did not subsidise housing. Even with the US housing bubble government involvement was rather tangential, the most troubled assets were not in any way subsidized by the government.
" He goes on at length about Keynesian stimulus with no mention of its dismal failures, most notably in Japan."
Japan is not an example of failure of Keynesian economics, because it is not really an example of keneysian economics. There haven't been the large public works project perscribed by keneysian economics in japan. Japan has tried to get out of the recession mostly by secretly subsidizing its banks.
At one point Japan was the single largest concrete importer in the world. They were building roads and bridges and train lines like crazy. It temporarily juiced the markets but did nothing to sustainably restart the economy.
Japan didn't so much subsidize the zombie banks as simply allow them to float along insolvent forever. They never forced bankruptcy or write-downs.
> The internet stocks bubble of the late 90s also was largely unrelated to government manipulation.
The NASDAQ went parabolic in 1999 just after Greenspan cut interest rates as a precautionary measure to juice the economy in preparation for Y2K.
Tulips are addressed elsewhere. I don't know anything about Eastern European housing, but I'll bet its riddled with subsidies and tax advantages just like it is here.