Issue 37, Fall 2009

William A. McEachern, Editor

MACROECONOMISTS IN THE DOCK

In the postmortem of past recessions, economists have lined up the usual suspects to identify the guilty parties. There is still some of that this time around. For example, John Taylor in his brief book Getting Off Track (Hoover Institution, 2009) blames the Fed for nurturing the housing bubble by keeping interest rates too low too long. And Luigi Zingales in "Capitalism after the Crisis" blames the inordinate economic and political power that financial institutions acquired after banking restrictions were lifted (National Affairs, Fall 2009). But for the most part, this recession is different in that capitalism and economists have been fingered by many as accomplices, if not prime suspects. The cover of Business Week asks: "What Good Are Economists Anyway?" Inside, the story notes that "Economists mostly failed to predict the worst economic crisis since the 1930s. Now they can't agree how to solve it" (5/27/09, p. 26). Likewise, the cover of The Economist depicts a melting tome titled "Modern Economic Theory." The story begins: "Of all the economic bubbles that have been pricked, few have burst more spectacularly than the reputation of economics itself" (7/24/09, p. 11).

Even Richard Posner, long a champion of markets, offers a broad indictment of the market economy and mainstream macroeconomists in A Failure of Capitalism: The Crisis of '08 and the Descent into Depression (Harvard, 2009). Chapter 8, entitled "The Economics Profession Asleep at the Switch," argues that "Even now, the profession seems adrift in uncertainty and irresolution, as if it cannot believe what has happened" (p. 255). He notes that the interrelated system of financial intermediaries bound together by financial instruments was a powder keg. Once it started to blow, markets fed a reinforcing loop that could not self correct. Writing later in The New Republic, Posner takes what he considers the next step, in "How I Became a Keynesian" (9/23/09).

Keynes, written off years ago as outdated, is gaining converts. Keynesian ideas such as "animal spirits" and the "paradox of thrift" seem more relevant today. And the size of fiscal multipliers will become an empirical issue as economists try to track the impact of the $787 billion stimulus package. The recent financial panic has also called into question our reliance on the rational underpinnings of market behavior. George Akerlof and Robert Shiller's new book, Animal Spirits (Princeton, 2009), was five years in the making but appears perfectly timed to question mainstream thinking about how well a market economy works, or doesn't work. They argue that "animal spirits" wrecked the housing market. And Justin Fox's engaging best seller, The Myth of Rational Markets (Harper Business, 2009) uses personal narratives of key players to trace the rise and fall of the efficient market theory of finance.

In the midst of such upheaval, what should we do as teachers? First, we should acknowledge that we don't know as much as we thought we did about how the macroeconomy works. Analyzing what has come to be called "The Great Recession," we can focus on what caused it, why it lasted so long, and what brought the economy back. Each is a loaded question, and we have only partial answers at this point. One useful account that focuses on the actions of the Fed through all this is David Wessel's new book In Fed We Trust (Crown Business, 2009). Wessel, economics editor of the Wall Street Journal, offers a behind-the-scenes look at the issues policymakers were facing and how they reacted.

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