(…) the heterodox need to realize that they have, to an important extent, been working with the wrong story line.
Here’s the story they tell themselves: the failure of economists to predict the global economic crisis (and the poor policy response thereto), plus the surge in inequality, show the failure of conventional economic analysis. So it’s time to dethrone the whole thing — basically, the whole edifice dating back to Samuelson’s 1948 textbook — and give other schools of thought equal time.
Unfortunately for the heterodox (and arguably for the world), this gets the story of what actually happened almost completely wrong.
It is true that economists failed to predict the 2008 crisis (and so did almost everyone). But this wasn’t because economics lacked the tools to understand such things — we’ve long had a pretty good understanding of the logic of banking crises. What happened instead was a failure of real-world observation — failure to notice the rising importance of shadow banking. Economists looked at conventional banks, saw that they were protected by deposit insurance, and failed to realize that more than half the de facto banking system didn’t look like that anymore. This was a case of myopia — but it wasn’t a deep conceptual failure. And as soon as people didrecognize the importance of shadow banking, the whole thing instantly fell into place: we were looking at a classic financial crisis.
What about the lousy policy response — austerity and all that? The key point here was that policymakers weren’t basing their decisions on conventional economics. On the contrary, they decided to blow off textbook macroeconomics and embrace exotic doctrines like expansionary austerity and a mysterious growth cliff at 90 percent debt relative to GDP. The disastrous policy responses that have perpetuated the slump are the result of mainstream economics having too little influence, not too much.
Now, to be fair, there is a civil war within academic macroeconomics, and what I’m calling “mainstream” is the saltwater side of that civil war. But the critics want much more than to boost saltwater macro at the expense of the new classical guys — they want to drive people like me out of the temple, too. And the thing is that they want to do this even though, as Wren-Lewis says, Keynesian macro has actually performed very well since 2008.
What about the new respect given to heterodox thinkers like Minsky, and heterodox ideas like secular stagnation? I agree that mainstream economists didn’t pay enough attention to such people — way back, one of my principles for working in economics was “listen to the Gentiles.” But it’s hard to claim that such work is deeply incompatible with mainstream economics when Janet Yellen embraces Minsky and Larry Summers becomes a secular stagnationist.
And what about inequality? Some people are annoyed at Thomas Piketty by presenting his data and ideas in a form that is fairly comfortable for conventional economists, at least those of eclectic disposition. But doesn’t that show that conventional economics is indeed capable of accommodating big concerns about inequality? You fairly often find heterodox economists insisting that to accept the idea that capital and labor are paid their marginal products, even as a working hypothesis to be modified when you address things like executive pay, is to accept that high inequality is morally justified. But that’s obviously not the case: there are plenty of economists who are willing to use marginal-product models (as gadgets, not as fundamental truth) who don’t at all accept the sanctity of the market distribution of income. So this complaint is, in its own way, as much of a distortion as the right-wing claim that anyone who so much as mentions inequality is a Marxist.
How should the crisis and the reemergence of very high income inequality affect how we do and teach economics? For sure, it says that we need to do a lot more history, including deep history. Events have also reflected very badly on the style of economics that prizes “microfoundations” based on ultra-rational behavior over evidence, and rules any kind of ad hockery out of bounds. But the heterodox want more than that; they want to interpret recent events as a refutation of the kind of economics Wren-Lewis, or Janet Yellen, or Larry Summers (as economist, not public official), or yours truly does. And that interpretation just doesn’t work. By all means, advance heterodox ideas if you believe they’re right. But don’t claim vindication from events that didn’t actually follow the script you wish they did.