Why Did Economists Get It So Wrong?

Abstract

The purpose of this chapter is to explain the intellectual climate of macroeconomic thinking and policy that helped to foster in the period leading up to the crisis a belief in the inherent stability of finance capitalism, a relaxed regulatory regime for banking and finance and a widening in the scope of capital market activity. The three pillars of this framework were the emergence of a new macroeconomic consensus among new classical and new Keynesian economists, the efficient market theory of finance and the capital structure irrelevance assumption of corporate finance. Each of these pillars had a distinguished list of academic adherents and policy advocates but involved a number of analytical restrictions that limited their scope for clear practical applications.