(h/t to Mr. Rozeff)
Howard Davies has written a piece entitled “Economics in Denial.” Of course, as a field of study cannot be in “denial,” it would seem to be safe to say that it is the economists themselves in denial, as Mr. Davies himself seems to be. Who is this Mr. Davies?
Howard Davies was Director of the London School of Economics (2003-11), and was the first chairman of the United Kingdom’s principal financial regulatory body, the Financial Services Authority (1997-2003), which he established at the request of the British government. Previously, he served as Deputy Governor of the Bank of England and Director-General of the Confederation of British Industry.
In case you are later confused about the blindness in his commentary, please refer back to this biography. It should clear things right up for you.
In an exasperated outburst, just before he left the presidency of the European Central Bank, Jean-Claude Trichet complained that, “as a policymaker during the crisis, I found the available [economic and financial] models of limited help. In fact, I would go further: in the face of the crisis, we felt abandoned by conventional tools.”
It was a remarkable cry for help, and a serious indictment of the economics profession, not to mention all those extravagantly rewarded finance professors in business schools from Harvard to Hyderabad
This is a very good place to start – recognition by one of the key insiders that everything he and his thousands of studied colleagues thought they knew…well, they didn’t know. Rarely does such a candid admission come from someone seated on such a high pedestal.
Trichet asked for help from unconventional corners of academia and science; he apparently found only a few volunteers:
Robert May, an eminent climate change expert, has argued that techniques from his discipline may help explain financial-market developments.
This is interesting. Advice is coming from the debunked “school” of climate change. Perhaps this is welcome, as this school is expert at manipulating data until the numbers portray the desired story. Sounds just like typical macro-economics.
Epidemiologists have suggested that the study of how infectious diseases are propagated may illuminate the unusual patterns of financial contagion that we have seen in the last five years.
Germs – the economy is like germs. Festering, boiling over, only controlled apparently by experts in white robes prescribing large doses of medication and intervention. Yes, just like typical macro-economics.
What a hoot!
These are fertile fields for future study, but what of the core disciplines of economics and finance themselves?
At least now he is getting warm.
Can nothing be done to make them more useful in explaining the world as it is, rather than as it is assumed to be in their stylized models?
Mocking the models. Boy he is really getting warmer. Pretty soon he will be burning up. Open your eyes, Mr. Davies. The answer is out there in the open, right in front of your face!
He moves on to review recommendations that came as a result of a conference funded by the Bank of England (Mr. Davies, you are getting colder):
...there should be more teaching of economic history. We all have good reason to be grateful that US Federal Reserve Chairman Ben Bernanke is an expert on the Great Depression….
Wait, you are getting colder.
Many conference participants agreed that the study of economics should be set in a broader political context, with greater emphasis on the role of institutions.
You are really freezing.
Students should also be taught some humility. The models to which they are still exposed have some explanatory value, but within constrained parameters. And painful experience tells us that economic agents may not behave as the models suppose they will.
Now you are getting warm again. Hot actually. You are almost on fire.
But it is not clear that a majority of the profession yet accepts even these modest proposals. The so-called “Chicago School” has mounted a robust defense of its rational expectations-based approach, rejecting the notion that a rethink is required.
The arrogance is like a stench. Nothing from this most famous school of monetary cranks ever came close to suggesting that the calamity seen in 2008 was possible. Nothing to see here folks, move along. If Freidman hadn’t died right before the crisis, this event likely would have killed him.
The Nobel laureate economist Robert Lucas has argued that the crisis was not predicted because economic theory predicts that such events cannot be predicted.
Now Mr. Davies – Robert Lucas has served you a real softball – you ought to be able to hit this one out of the park (wait, he is from London, maybe he won’t understand my colloquialism). There had to be some school that predicted these events….
And there is disturbing evidence that news of the crisis has not yet reached some economics departments. Stephen King, Group Chief Economist of HSBC, notes that when he asks recent university graduates (and HSBC recruits a large number of them) how much time they spent in lectures and seminars on the financial crisis, “most admitted that the subject had not even been raised.”
Of course it hasn’t been raised. The professors would then have to deal with questions that they are unable to answer – or if they answer them they will openly admit that much of the work of their profession has been a complete and utter failure, work designed only to provide cover for the politically connected.
Now, Mr. Davies could really bring this one home. Let’s see if he can figure it out:
We should not focus attention exclusively on economists, however. Arguably the elements of the conventional intellectual toolkit found most wanting are the capital asset pricing model and its close cousin, the efficient-market hypothesis. Yet their protagonists see no problems to address.
What!? Blame the other guy? That’s it? Wait, Mr. Davies has an answer:
Finding a new and stable relationship between the financial authorities and private firms will depend crucially on a reworking of our intellectual models.
Better regulation. That’s it. it all comes down to finding stable relationships via financial authorities. Really.
Davies recognizes that economic models are restrictive, and that economic agents won’t always act as models suggest. Let’s see, what school-that-shall-not-be-named has made these points for over one hundred years?
He takes unchallenged the notion that such events weren’t predicted because they could not be predicted. But they were predicted – both in theory (by every economist of the school-that-shall-not-be-named) and in fact (look up any of the dozens of videos by Ron Paul or Peter Schiff, just for two non-professorial practitioners of this school-that-shall-not-be-named).
Now, what is the missing word, the one that Davies defined so well yet couldn’t name? He was so warm – on fire- yet couldn’t open his eyes.
Davies does everything but dance on the head of Mises, yet he cannot say the word.
Let me help. Austrian.
Where are the Austrians – you know, the guys who said this would happen? Busts follow the boom, manipulation of interest rates causing distortions, all of that kind of stuff?
Where is the reference to Hayek’s "Pretense of Knowledge" – the lecture he gave describing exactly this shortcoming of macro…more than 35 years ago. Like Mr. Davies, Hayek even taught at the London School of Economics. Davies didn’t have to look to climate change scientists for answers – he just had to check his own school’s recent history.
Sadly for Mr. Davies, the genie is out of the bottle. All that commentaries such as this demonstrate is the hollowness of the economic profession.