From the Economic Crisis to the Crisis of Economics

Abstract

Neoclassical economic theory has been blamed for not having even considered the possibility of the type of collapse that the subprime mortgage meltdown unleashed. The purpose of this chapter is threefold. First, it seeks to clarify what economics is guilty of; second, to spell out what sort of science economics is, what is legitimate to expect from it, and what is not; and, third, to discuss the flaws of economics and how to correct them. It is argued that what happened was a case of malpractice by hundreds of professionals in banks and rating agencies that created and certified as virtually risk-free securities assets that were actually highly risky, as the events after 2007 overwhelmingly demonstrated. Such a massive case of malpractice exposes deep failures in the regulatory system. The deregulation movement that took place during the 1980s and 1990s was inspired by an almost religious belief in the power of market forces to solve any economic problem. Neoclassical economics can be blamed for creating the ideological climate that stimulated the deregulation movement in the USA during those decades. After discussing aspects of economic methodology, this chapter argues that economists’ primary objective should be the study of economic illness, rather than economic health.

So in summary, Your Majesty, the failure to foresee the timing, extent and severity of the crisis and to head it off, while it had many causes, was principally a failure of the collective imagination of many bright people, both in this country and internationally, to understand the risks to the system as a whole.

(Letter to the Queen of England by the British Academy, July 2009)