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Saturday, December 11, 2010

Dixit: Economics and the Crisis

This is from a profile of Avinash Dixit:

...Economics and the crisis Dixit ... rejects the agonizing of some chastened economists following the global economic crisis. He says they are wrong to blame the “dismal science.”
“Actually, I think that economic theory came out of this rather better than policy practice did. . . . Economic theory and economic analysis based on pretty standard theories told everybody that the situation was unsustainable, that there was going to be a house price bust sometime. The timing is always unpredictable, but pretty much everybody knew that things were going to go bad.
“But what we were not able to predict is the quantitative magnitude of it—how far, for example, house prices would fall. And secondly, we were not able to recognize how big an effect the financial crisis would have on the real economy.”
In light of the crisis, how should economic research adapt?
“Going forward, I think some of the most fruitful research will come from a better integration of financial theory and macroeconomic theory. It may be supplemented by better recognition of rare major events, something that already exists in financial theory, but is less assimilated into financial practice than it should be.
“But the real fault was not so much in economic theory as, if you like, in the political and business world, where people actually swallowed some of the simplistic views about the wonder of markets too much without recognizing the hundreds of qualifications that Adam Smith and a number of others have told us about, and we should all have known about.” ...

I wonder where "the political and business world" might have gotten the idea that getting the government out of the way and letting markets do whatever they want to do -- "the wonder of markets" -- is the cure for all of our ills? The disappointing part is not that the political and business world held these views to begin with, they were misled by people telling them what they wanted to hear. The disappointing part is that the financial crisis did not change this view and, worse, in some cases it has actually reinforced the idea that the key going forward is minimize government regulation and market oversight, to resist the temptation to bail out markets that pose systemic risk to the broader economy, and to resist the temptation to use monetary and fiscal policy to stabilize the economy. If these attitudes persist until the next crisis hits, as it will someday, then watch out. Although the crisis was bad this time around, the outcome could be very different -- and much, much worse -- if government takes a less active role and leaves it to the private sector to fix the problem.

    Posted by on Saturday, December 11, 2010 at 09:56 AM in Economics, Macroeconomics, Methodology | Permalink  Comments (21)


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