How did Paul Krugman get it so Wrong?
faculty.chicagobooth.edu
faculty.chicagobooth.edu
A Chicago school economist decides that the cause of the crash was regulation, there's a surprise. It's difficult not to ad hom him here, but the article drips with scare quotes, special pleading, straw men and appeals to authority, so what's one more fallacy?
In fact, although I imagine he wants it to be taken seriously, it reads like little more than an angry forum comment dressed in academic robes. He's obviously heated and insulted by Krugman, and given that Chicago is broadly seen as discredited by the recent crash he is also concerned for his image, and is responding in kind.
The real economic lessons of the past few years are not to be found here, or anywhere. They will emerge in years to come. The difficulty is we only have the ability to really push through changes and learn from them now, so everyone's trying to be a part of that action. At least it's clear from both Krugman and Cochrane that the incentives enjoyed by bankers are very badly designed, and that's one issue we can address.
I don't think that's the point he was making with that quote. What he was getting at was that extensive regulation and oversight did not stop the problem from occurring in that sector. Ergo, extensive government regulation and oversight and intervention throughout the economy is also unlikely to prevent major problems.
If our choices as a society are: 1) major government intervention and problems, or 2) little government intervention and problems, I think I'd prefer the latter.
A position that regulation either failed or was absent from banking adds a third choice, which isn't far from Krugman's: 3) better government intervention and fewer problems.
The other major problem is that it wasn't regulation that failed, it was regulators. Many regulations that already existed weren't enforced. Looking at the rate of regulation increase it isn't hard to see why. How do you propose to solve this problem with more regulations? There's a real engineering problem here or even a computer science-style information theory problem with information flows totally exceeding the ability of the processing nodes to handle. Clearly, adding more processing work to be done isn't the answer to that problem, and we probably can't afford enough processors to make even our current set of regulations actually get enforced.
After a regulated industry undergoes regulatory capture you will see is a steady growth in the amount of regulation, and a simultaneous decrease in how much the regulation prevents that industry from doing what it wants. The regulations are added because they benefit the industry in some way, for instance by creating barriers to entry for potential competitors.
That is what happened in finance. Glass-Steagall really kept companies from doing what they wanted to do, and got dropped. But we got new "regulations" like the optional alternative way of calculating net capital ratios introduced in 2004 that allowed the 5 major broker dealers to double their leverage. The result? More lines of "regulation" that reduced how much actual regulating there was. Oh right, and a few years later a bunch of failed broker dealers. See http://www.nysun.com/business/ex-sec-official-blames-agency-... for verification of that.
Therefore a steadily increasing number of lines of regulation is not evidence that there wasn't major deregulation in the same time period.
Most so-called deregulation could be better termed re-regulation, it's just changing the rules to benefit different parties, not abolishing them.
(Having said that, btilly above uses deregulation in its new derogatory sense, much like the euphamism downsizing had to be replaced with rightsizing once everyone realised it still meant redundancies. Relatedly the depression was named that by people who thought it wouldn't be as bad as a proper recession, now depression means a really bad recession)
And in light of the inability of regulators to enforce the regulations and the plain failure of them to do so, who cares what the regulations actually said anyhow?
Additionally the Gramm-Leach-Bliley Act of 1999 that removed the last vestiges of Glass-Steagall (the parts that are related to this argument) happened under Clinton. The trend of financial market deregulation started in 1980, due to a shifting tide in economic though in the neoclassical (chicago school) vein and a multi million dollar banking lobby.
Eliot wrote: “After all, your pigs are far more intelligent than the other animals, and therefore the best qualified to run the farm – in fact there couldn’t have been an Animal Farm at all without them: so that what was needed (someone might argue) was not more communism but more public-spirited pigs.”
http://entertainment.timesonline.co.uk/tol/arts_and_entertai...
Economic systems need to be designed so that mediocre government regulation doesn't lead to catastrophes.
If this summation was accurate, I would tend to agree with your conclusion that little government intervention is preferable. However, I respectfully disagree with the premise, pointing to the success of Glass-Steagall (read 'government intervention') in maintaining a healthy separation of depository/commercial financial intermediaries and their investment bank counterparts. It was, clearly, the deregulation and removal of said safeguard that allowed for the conditions of 'too big to fail' and gave meaningful, even disastrous implications for the average citizen. Finally, the author is either misinformed or intentionally ignoring the causal relationship between deregulation embodied in the Gramm-Leach-Bliley Act and the financial meltdown.
By whom exactly? Mostly by those who tend to propagate further government influence on the markets. There are equally valid arguments which were made that government intervention in mortgage markets, fed policy etc. caused the crisis and the crisis could have been averted by having a truly free market.
I just want to point out that you seem to be influenced by biases as well. To point out other people's biases but not to acknowledge your own seems unfair.
That is why that whole 'lessons from the crash' thing is so difficult to grasp. Because everyone's analysis is ridden with pre-conceived notions and biases, it's hard to make out the actual truth.
http://delong.typepad.com/sdj/2009/02/why-do-we-economists-t...
http://delong.typepad.com/sdj/2009/01/time-to-bang-my-head-a...
Of course, the author of those blog posts, Brad DeLong, is also known as the author (only somewhat jokingly) of the Efficient Krugman Hypothesis (Postulate 1: Paul Krugman is always right. Postulate 2: If your analysis suggests Paul Krugman is wrong, see Postulate 1.),
Maybe economics really has gone wrong in the past 40-80 years, and there's no salvageable content in all the research since then. But a lot of economists (particularly the behavioral school) are doing real empirical science lately, and I'd bet that they're likely to be onto something.
The debate being doctrinal seem to make the debate seem unimprotant especially when people don't know what it is about. The debate is about how to study the science of economics and the proper use of the scientific method. That's a pretty improtant debate that has been waging on for years.
Note: Edit to correct inaccuracy in the presentation of my comment's intention.
Although, it's easy to argue that neither is macroeconomics.
Can you show me a goldbug with a Nobel Prize in Economics and a column in a New York Times-class newspaper or other similar venue?
I know what you're saying, and it is literally true, I don't deny that. But Krugman should be held to a higher standard.
Personally, I find him very disappointing. A guy with a Nobel Prize in Economics ought to be making compelling arguments that are a surprise to me, and thus contain information in the information theoretic sense. (That's my favorite way of looking at information in an English context.) Instead, I can predict in advance what Krugman's position on a topic will be now with virtually 100% confidence, which should not be possible if he's actually writing with insight that someone of such stature should be bringing to topics, as I most assuredly hold a Nobel Prize in absolutely nothing. Even if he chooses doctrinaire liberal choices completely reliably, he should be able to defend them with far more interesting arguments than I actually see from him, the kind of interesting that even when you disagree you at least stop to think.
But yes, I am also disappointed in Krugman.
Martin Neil Baily: http://www.brookings.edu/opinions/2009/0908_krugman_baily.as...
Barry Eichengreen: http://www.nationalinterest.org/PrinterFriendly.aspx?id=2127...
Mankiw linked to all of these (including Cochrane) on his blog a while back: http://gregmankiw.blogspot.com/2009/09/how-did-economists-ge...
This is not the case. Your assumption is invalid.
Look at it this way: if economists could predict the markets, economists would all be filthy rich.
Markets are inherently chaotic. That's why they work.
One concrete example, when the fed raises or lowers interests rates it's based on a prediction of where they believe the market is going, where they believe it's at, and a prediction of the effect of the rate change. Otherwise what is the profession doing?
The Fed makes forecasts but monetary policy is based on consensus among various schools of thought, not models. It doesn't work like NOAA.
If you could reliably predict the markets you'd make a fortune -- and the markets would adjust and become unpredictable again. This is a basic feature of markets, agreed to by all comers, last I checked.
IANAE, but I'm hearing over and over again that Krugman is making political points, not economic ones. That's fine, but it makes it difficult for laymen like myself to determine if we're having a political discussion or an economic one.
Second, if you read the article in question he specifically talks about this particular school of economists using rigorous mathematical models, and the problems he has with those models (in laymans terms). Did you miss that part or did you not read the article in question?
(For some reason, I had no reply button on lil_cain's comment).
Cochrane even notes that Krugman's actual econ work was brilliant. I'm old enough to remember when Krugman was young, working out the interactions of game theory and increasing returns in international trade for which he won the Nobel Prize...He once wrote eloquently about how only math keeps your ideas straight in economics." I would agree with lil_cain -- Krugman's econ work was brilliant -- while point out that Cochrane's critique was largely that Krugman is no longer practicing economics.
"If a scientist, [krugman] might be a global-warming skeptic, an AIDS-HIV disbeliever, a creationist, a stalwart that maybe continents don’t move after all."
"Krugman wants to be Rush Limbaugh of the Left"
But there is an arguably logical thought process behind the post itself
1. The chicago school economists were incredibly influential in the bush government to the exclusion of all other economists.
2. It all ended in disaster.
I think Krugman is correct in pointing out that there is something very wrong with the advice these guys were providing.
You're also assuming that the advice acted upon by the POTUS was based on the Chicago school.
For the former point, it leaves out FNM/FRE, housing speculation, easy credit by the fed, a weak dollar, increasing debt from foreign wars, the piss-poor rating agencies, the asset bubble driven by chinese liquidity, etc.
For the latter point, there were economic decisions made that do not align with that school of thought.
tl;dr -- Post hoc ergo propter hoc.
1. Correlation is causation? 2. It is all the Bush adminstration's fault.
Krugman is not offering up a hypothesis that is better at explaining observations than his opponents. He is making an argument based on an ideological position while ignoring evidence suggesting, at a minimum, that his hypothesis is not supported. This is not science.
As Cochrane notes in one of his "minute points", *Pretty much all we have been doing for 30 years is introducing flaws, frictions, and new behaviors, especially new models of attitudes to risk, and comparing the resulting models, qualitatively to data." This set of "we" includes the behaviorists and "complexity economists" (i.e. people who really enjoy massive simulations of simple agents).
Accusing people of "deliberate obtuseness" is no way to have an argument.
The author of the article discusses not just Chicago School monetarism, but also the many other strains of economic thought over the past decades, including the 'New Keynesians.' Krugman apparently also disagrees with the New Keynesians, and the rest of the economic mainstream of the past 30 years, not just the Chicago School.
What the author is getting at is that Krugman doesn't seem to be reading economics anymore, from any school of thought.
Looking at the author's CV (http://faculty.chicagobooth.edu/john.cochrane/research/Paper... [DOC]), he appears to be a libertarian. Libertarians weren't exactly well-represented in the Bush administration, and CATO were among its fiercest critics on financial and foreign policy issues.
The anger over Krugman's piece doesn't seem to be limited to Cochrane or Chicago School economists either. Cochrane's personal web page also links to a similar piece featured on Huffington Post rebutting Krugman: http://www.huffingtonpost.com/david-k-levine/an-open-letter-...
Here's a link for you: http://worthwhile.typepad.com/worthwhile_canadian_initi/2009...
I think economics is fascinating, but ultimately it serves, and is very closely related to what a society's goals and values are, which is politics.