Nobody Could Have Predicted...

Today I've read over a few articles talking about how economists got the economy wrong. Each, in some way, try to cast light on the obscurantist claim that nobody could have predicted the downturn by showing how a particular set of circumstances brought about the intellectual blinders worn by contemporary economists. Together, they make an interesting read First, Paul Krugman explains how the economics profession gradually shifted from Keynsian theory to neo-liberalism. Keynes can be simplified to two points: 1) that markets require regulations (especially finance), and 2) "he called for active government intervention — printing more money and, if necessary, spending heavily on public works — to fight unemployment during slumps."

The story of neo-liberalism is the story of the struggle against Keynes. Neo-liberalism reduces regulation to monetary policy. As Krugman writes:

Monetarists asserted, however, that a very limited, circumscribed form of government intervention — namely, instructing central banks to keep the nation’s money supply, the sum of cash in circulation and bank deposits, growing on a steady path — is all that’s required to prevent depressions.

This view is often associated with Alan Greenspan, but the policy was first introduced by Paul Volker during Jimmy Carter's presidency. Couple this with a blind faith in markets and an attack on regulations, and we're pretty close to neoliberal policy. If there is a general difference between the two approaches, it is that neoliberalism advocates Federal Reserve policy while Keynsians advocate government spending during market downturns (and note that neoliberal hegemony only occurred in the USA with heavy Keynsian-style military spending in the background).

And then, ideologically, neo-liberalism has one more particular quirk: any time that its policies fail, it is always, according to its partisans, because deregulation didn't go far enough. There is always some other government function that is interfering with the free market.

Krugman doesn't explain how neo-liberalism became hegemonic beyond the university and regulatory system. On its forced introduction across the globe, see Naomi Klein's The Shock Doctrine. In the USA, the neoliberals have been running the show for the last three decades, and while Alan Greenspan has 'admitted' to some mistakes, their ideology is still dominant. How were economists "seduced by the vision of a perfect, frictionless market system," as Krugman puts it?

Ryan Grim, at the Huffington Post, says we should follow the money. While through the mid-1970s the academics of economics were largely divorced from the Federal Reserve, today the Fed largely reinforces its own ideology through academic publications and funding:

The Federal Reserve's Board of Governors employs 220 PhD economists and a host of researchers and support staff, according to a Fed spokeswoman. The 12 regional banks employ scores more. (HuffPost placed calls to them but was unable to get exact numbers.) The Fed also doles out millions of dollars in contracts to economists for consulting assignments, papers, presentations, workshops, and that plum gig known as a "visiting scholarship." A Fed spokeswoman says that exact figures for the number of economists contracted with weren't available. But, she says, the Federal Reserve spent $389.2 million in 2008 on "monetary and economic policy," money spent on analysis, research, data gathering, and studies on market structure; $433 million is budgeted for 2009.

So while much of neoliberal ideology is discredited, it still has a strong academic industry behind it. Which is why, when the current administration turns to the question of new regulations for the financial sector, there will be strong resistance both ideologically (from PhDs whose careers are at stake) and financially (there is lots of money at stake in Wall Street, as we know). The difficult task is to legislate significant reform before Congress can be bought off, and before the President takes in too much bad advice from his economic advisers, who largely were responsible for getting us into this mess. And then, as Thomas Frank points out, we might not even get out of the clear with new regulation:

What if some future administration were to install as the chairman of the Federal Reserve—or as chief of whatever agency is made into the One Big Regulator—a man who really doesn't believe in the regulatory mission? What if control of the systemic regulator is handed over to a person who considers 19th-century economic arrangements to be a sort of aspirational ideal? A man who turns out to be a dedicated fan of Ayn Rand, that Nietzsche of the boardroom? A man who blows off warning signs because, in his perfect theoretical universe of rational markets, the only really systemic problem is government itself?

This is no hypothetical problem, because Frank is referring to Alan Greenspan, who presided over the Fed from 1987 to 2006, and was, for all the wrong reasons, ascribed to have deity-like powers.

Given these problems, it's difficult not to be skeptical and cynical about reform.