News of this year’s Nobel prize winners in economics came in today, against the backdrop of a possible second global economic crisis. Two American macro-economists, Thomas Sargent of New York University and Christopher Sims at Princeton, claimed victory for their work on how our expectations and policies actually impact the economy. So what can these economic gurus tell us about today’s economic malaise?
Let me first say that it certainly feels odd to be exalting anyone’s work in economics at a time like this. Our feeble economic system is, after all, a product of theories laid out by the Ivory Tower. And our faith in many of those theories is hitting rock bottom. The idea, for instance, that ultra-competitive markets can improve our lives doesn’t square so well with our stubbornly high unemployment rate or rising inequality. In fact, the whole concept of capitalism is being reconsidered, even by market-minded economists like Nouriel Roubini. As Roubini recently put it to the Wall Street Journal:
Karl Marx had it right. At some point capitalism can self-destroy itself because you cannot keep on shifting income from labour to capital without not having excess capacity and a lack of aggregate demand, and that’s what’s happening.
So what do our Nobel-prize winning economists think about these market failures? Sargant, whose work has focused on how people respond strategically (rather than passively) to economic policies, defends the work of macro economics in a recent interview as follows:
Far from taking the “efficient markets” outcomes for granted, important parts of modern macro are about understanding a large and interesting suite of asset pricing puzzles [...] puzzles about empirical failures of simple versions of efficient markets theories.
Sargant goes on to cite loads of recent research that targets the holes in efficient markets, but his response still begs the question: If the theorists are over the idea that efficient markets work, then how were they caught off-guard by the recent financial crisis? Sargant’s answer:
It is just wrong to say that this financial crisis caught modern macroeconomists by surprise. That statement does a disservice to an important body of research to which responsible economists should to be directing public attention. Researchers have systematically organized empirical evidence about past financial and exchange crises in the United States and abroad. [...]
One of the focuses of Gary Stern’s long tenure as president of the Minneapolis Fed was steadily to draw attention to financial fragility issues and what the government does either to arrest crises or, unfortunately as an unintended consequence, to incubate them.
Sargant’s ultimate point, it seems, is that good economic literature doesn’t always lead to good economic policy. Messy politics, after all, play a big role in policy making. Perhaps that’s why, when asked to explain how the economy got so bad, Sargant passes the buck: “Ultimately, that’s a question about politics, about which I know too little. But in purely economic terms, things could have gone differently.” And what about Sims? As David Wessel of the Wall Street Journal tweeted today: “Chris Sims refuses to say what implications his Nobel-winning work has for current policy.”
The bottom line: If the global economy comes to a halt again in the next few weeks, don’t expect our new Nobel economists to tell you what went wrong.