Five years before the financial meltdown of 2008, Robert Lucas famously declared that “the central problem of depression prevention has been solved . . . and has in fact been solved for many decades”.
The University of Chicago economist was not alone. Up to the eve of the worst crash in 80 years, America’s economic luminaries, including Alan Greenspan, former chairman of the Federal Reserve, and his successor Ben Bernanke insisted there was no cause for alarm.
Having failed to foresee the crisis, many badly misread its aftermath. As early as December 2008, Mervyn King, governor of the Bank of England, anticipated breakaway wage growth. We are still waiting.
Greenspan, meanwhile, predicted double-digit inflation. Eleven years into America’s weakest recovery on record, US inflation remains stubbornly below its two per cent target. As recently as last February, Jay Powell, the current Fed chairman, said it was a “bit of a puzzle” why wage growth had not yet taken off.
Why do economists continue to get it so wrong? One answer is that not all of them do. David Blanchflower, who was on the Bank of England’s monetary policy committee during the 2008 crash, insists that evidence of an impending crash was hidden in plain view long before it happened. Blanchflower, whose book Not Working: Where Have all the Good Jobs Gone? is a stinging rebuke to his profession, was consistently outvoted eight to one on the MPC, which sets UK interest rates. Unlike his colleagues, who were using models based on a 1970s-style economy, Blanchflower went out and talked to people. He calls this “the economics of walking about”.
His peers, meanwhile, were relying on “largely untested theoretical models that amounted to little more than mathematical mind games”. Paul Romer, the former World Bank chief economist, calls this “mathiness” — playing with regression to give a false sense of precision. Others might call it alchemy. Lucas, whose Chicago School housed the high priesthood of mathiness, won a Nobel Prize for his rational expectations theory. It demonstrated that the market was always right.
The rise and fall of the Chicago School is chronicled by Binyamin Appelbaum in his admirable book The Economists’ Hour. As he shows, economists were treated as little more than backroom statisticians until the late 1960s. That was when the Chicago School, led by the Nobel-prize winning Milton Friedman, took over.
The economists’ age of glamour had arrived, propelling them into the centre of power and on to our television screens. They drew inspiration from Friedrich Hayek, whose book The Road to Serfdom (1944) argued that almost any government role in the economy created a slippery slope to autocracy.
The “economists’ hour” contained many overlapping schools. Some, like Friedman, were monetarists, who believed that inflation was solely a function of money supply — control the latter and you tame the former. Others, like Arthur Laffer, were supply-siders, who argue that tax cuts always pay for themselves through higher corporate revenues. All believed that the markets know best. As Greenspan once quipped: “I have never seen a constructive regulation yet”.
