Eichengreen on How Economists Went Astray

Michael Giberson

When Paul Krugman wrote about “how economists got it wrong” in the New York Times Magazine, after a few preliminary remarks the story became all about Keynes, Keynesians, and New Keynesians.  By my count the name “Keynes” or some variant of it shows up over 50 times in the essay. He talks a lot about “saltwater” economists and “freshwater” economists as well, with “saltwater” in essence another name for Keynesian-style economics.  His concluding section is titled “Re-embracing Keynes,” and he said, “Keynesian economics remains the best framework we have for making sense of recessions and depressions.”  Keynes is the foundation in Krugman’s view.

Greg Mankiw points out on his blog an essay by Barry Eichengreen that addresses the same question – how did economists get it so wrong. I couldn’t help but notice as I read that essay, Eichengreen manages to mention “Keynes” or some variant name exactly zero times.  Lest you think Eichengreen is some anti-Keynesian “freshwater” economist that Krugman warns about, note that Eichengreen is firmly planted at the “saltwater” bastion of the University of California-Berkeley.

Part of the difference is explained by Krugman’s focus on macroeconomic theorizing and Eichengreen’s stronger attention to financial economics and its applications.  Krugman attends more to the academic theorist to public policy maker connection, while Eichengreen looks more at links between academia and business.  To some degree they are telling different parts of the story, so different characters feature in the narrative.

But the Eichengreen story provides richer institutional details, discussing frankly the role that financial incentives and a kind of peer pressure within economics played in diverting attention away from the growing financial problems. All in all, I felt better informed about what went wrong, and maybe what should be done, after reading it.

And in a way, Eichengreen’s essay reminded me of Jane Smiley’s execrable scribblings in the Huffington Post. Discussed here. Smiley, too, believes corporate money biases economists. But now that I’ve said that, I should clarify that Eichengreen has obviously observed carefully and thought deeply and to good effect, with the result that Eichengreen’s essay is very much worth reading.  In each of these ways his essay is very nearly the exact opposite of Smiley’s.

But Keynes name-dropping aside, Krugman and Eichengreen share much: both urge more attention to behavioral economics and particularly behavioral finance; both urge more attention to the real economy at the expense of elegant mathematical models.  As Eichengreen points out, both efforts are already well on there way.

The shifts do not guarantee that economists won’t get it wrong again someday, but at least we can hope not to repeat the same mistakes.