Few economists saw our current crisis coming, but this predictive failure was the least of the field’s problems. More important was the profession’s blindness to the very possibility of catastrophic failures in a market economy. During the golden years, financial economists came to believe that markets were inherently stable — indeed, that stocks and other assets were always priced just right. There was nothing in the prevailing models suggesting the possibility of the kind of collapse that happened last year. Meanwhile, macroeconomists were divided in their views. But the main division was between those who insisted that free-market economies never go astray and those who believed that economies may stray now and then but that any major deviations from the path of prosperity could and would be corrected by the all-powerful Fed. Neither side was prepared to cope with an economy that went off the rails despite the Fed’s best efforts.The blindness of a whole field was possible because of a wholesale "retreat from Keynesianism and a return to neoclassicism."
There's some handy simplified intellectual history here, but the best feature of the piece is Krugman's linking of even those liberal economists who rejected hard core neoclassicism (and its key mathematical axiom, the efficient market hypothesis) to a debilitating consensus.
But the self-described New Keynesian economists weren’t immune to the charms of rational individuals and perfect markets. They tried to keep their deviations from neoclassical orthodoxy as limited as possible. This meant that there was no room in the prevailing models for such things as bubbles and banking-system collapse. The fact that such things continued to happen in the real world — there was a terrible financial and macroeconomic crisis in much of Asia in 1997-8 and a depression-level slump in Argentina in 2002 — wasn’t reflected in the mainstream of New Keynesian thinking.The lesson here is that moderation is blindness. Moderation enforces the intellectual limits of the consensus. In this case, "the New Keynesians, unlike the original Keynesians, didn’t think fiscal policy — changes in government spending or taxes — was needed to fight recessions. They believed that monetary policy, administered by the technocrats at the Fed, could provide whatever remedies the economy needed."
Then there's the not so good. The first weakness is the total lack of novelty in the critique of economics as delusionally neoclassical. People outside economics have been saying this for years or decades. They are often called sociologists or anthropologists, and have always thought that the models had lost touch with institutions, people, and also of course power and coercion, which played huge roles in setting up actual economies. In addition to the recent book by Curious Capitalist Justin Fox, there is also Doug Henwood, longtime editor of Left Business Observer, whose classic 1996 book Wall Street offered a much more thorough intellectual history and critique than Krugman even hints at here.
More importantly, Krugman blames "beauty" for leading economics astray. He offers the philistine tag line, "As I see it, the economics profession went astray because economists, as a group, mistook beauty, clad in impressive-looking mathematics, for truth." In reality, economists mistook money for truth. Models that made important people lots of money had to be true. Krugman only superficially considers the possibility that financial incentives corrupted the heart and soul of the economics profession. Some of this corruption was personal and some was collective - it's hard to argue with what seems to be success. But economists are like all scholars in being paid to look past the surface of things to the real forces at work. They have flopped big time, and they
Finally, Krugman's cure is little more than a weaker form of the disease:
So here’s what I think economists have to do. First, they have to face up to the inconvenient reality that financial markets fall far short of perfection, that they are subject to extraordinary delusions and the madness of crowds. Second, they have to admit — and this will be very hard for the people who giggled and whispered over Keynes — that Keynesian economics remains the best framework we have for making sense of recessions and depressions. Third, they’ll have to do their best to incorporate the realities of finance into macroeconomics.These are three ways of saying that economists have to admit that markets aren't perfect. This may well get them into a freshman sociology or culture or history course, but it won't get them to the point of explaining how our economies actually work or how to keep them from being giant factories of social inequality and environmental destruction. Moderation is blindness, even when it comes from Krugman.