Economics in Denial

Howard Davies, former head of the British FSA and Deputy Governor of the Bank of England, says central bankers are frustrated with the state of economics. Trichet complained the standard models were of only limited help before he left the ECB. Worse, news of the financial crisis hardly seems to have reached some economics departments.

Davies says the Bank of England held a conference titled "What's the Use of Economics?" earlier this year (although I can't find a link).

Some of the recommendations that emerged from that conference are straightforward and concrete. For example, 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 and the authorities’ flawed policy responses then, rather than in the finer points of dynamic stochastic general equilibrium theory. As a result, he was ready to adopt unconventional measures when the crisis erupted, and was persuasive in influencing his colleagues.

Exposure to economic history is clearly essential. This is something I've thought before myself, in the context of explaining market success. 

Davies continues:

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. 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.

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 Nobel laureate economist Robert Lucas has argued that the crisis was not predicted because economic theory predicts that such events cannot be predicted. So all is well.

Of course people will not easily accept truths which threaten their prestige and livelihood. As Upton Sinclair once said, "It is difficult to get a man to understand something, when his salary depends upon his not understanding it!"

(h/t Justin Wolfers tweet)