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The Economist's New Clothes

Stephanie Flanders
This week's Analysis presenter Stephanie Flanders

BBC Radio 4's Analysis: The Economist's New Clothes is broadcast on Monday 2 November at 20.30 BST.

As an economist herself, Stephanie Flanders is well placed to ask some of the profession's most eminent participants - how could they get it so wrong?

Was it overly sophisticated models that only those with knowledge of higher mathematics could figure out? Or, could it have been the notion that risk had been permanently tamed that lulled many in the financial world into a false sense of security?

Part of the debate being conducted in the hallways of higher learning has to do with arguments between those who believe in the theories of John Maynard Keynes and those who would rather place their faith in the theories of efficient markets.

Alan Greenspan
Those of us who have looked to the self interest of lending institutions to protect shareholders equity, myself especially, are in a state of shocked disbelief
Alan Greenspan

Surprisingly, this isn't a new argument at all as Lord Robert Skidelsky, author of Keynes, The Return of the Master points out:

"I think Keynes would have said that the present state of economics is pretty bad. They're arguing about exactly the same things they were arguing about before, between the view that the market is self-correcting and between the view that it isn't. "

Perhaps it's how we measure human behaviours that needs to be changed. That's the thesis of one growing school of thought called behavioural economics. One of its most prominent proponents is Richard Thaler of the University of Chicago and co-author of the book Nudge.

"The models kept assuming people were smarter and smarter, but the world was getting harder and harder and so the models were getting further away from reality....when you have Citibank selling liquidity puts and the Vice Chairman of Citibank admitting later that he had never heard the term 'liquidity put', then you know you're dealing in a completely new world."

Maynard Keynes
It is better to be vaguely right than precisely wrong
John Maynard Keynes

However, if the profession is going to go forward - economists have to be realistic about what they can know and what they can teach the world. That is an idea expressed by Bank of England Deputy Governor, Charles Bean:

"Even though economists' understanding will often turn out to be misplaced, that doesn't mean to say that we're worse off using economic thinking than using gut reaction and all sorts of completely uninformed thinking."

The economics profession has taken quite a knock since the recession and it will take some time before the warring factions on either side of the debate come to any agreeable conclusions. But, while it may be a tough time to be an economist, it's an incredibly interesting time to study economics.


Contributors:

Danny Quah, Professor of Economics, London School of Economics

Charles Bean, Deputy Governor, Monetary Policy at the Bank of England

Richard Thaler, Professor of Behavioural Science and Economics, Chicago Booth School of Business, University of Chicago and co- author of Nudge

Lord Robert Skidelsky, Author, Keynes, The Return of the Master

Myron Scholes, Chairman, Platinum Grove Asset Management

Michael Sandel, Professor of Government, Harvard University and Author, Judge


Coming Up

Frances Cairncross explores the UK's options in the face of a growing deficit.




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SEE ALSO
Record recession for UK economy
23 Oct 09 |  Business
US consumer confidence takes hit
27 Oct 09 |  Business
Market crisis 'will happen again'
08 Sep 09 |  Business

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