Olivier Blanchard, the chief economist of the IMF during the financial crisis, is now leaving that organization for the Peterson Institute. Monday’s Wall Street Journal contains excerpts from his reflections on the state of the world–and of macroeconomics as a discipline–that are contained in full in the most recent IMF Survey (the WSJ has all the high spots, I think).
What caught my eye was Mr. Blanchard’s admission that macroeconomics was caught flat-footed by the recent global financial crisis.
My paraphrase of his explanation, with which he might not want to agree, is that:
–the discipline believed that a small, highly abstract set of theoretical relationships among the main moving parts of national economies and their external links, a set fleshed out in the wake of the 1930s depression, was enough to ensure they had complete understanding of the 21st century world. That has turned out to be completely wrong. In particular, the idea that economic policy makers need not bother to learn the details of the functioning of the banking system or about the inner workings of the small number of global mega-banks proved to be a costly error.
Yes, it took a humongous crisis to shake macroeconomists’ core beliefs and to begin to lessen their contempt for microeconomics.
What strikes me the most is that there is, as far as I can detect, no similar crisis of conscience on the part of academic finance. The theoretical underpinnings of this discipline lie in quasi-religious beliefs of the 18th century and are far more suspect. Its theoretical framework has no failed to predict or explain any of the financial crises that have occurred since its creation in the 1960s-70s. In fact, the speculative frenzy and subsequent financial meltdown of the early 1970s, one of the greatest counterexamples to academic financial theory postulates, was occurring outside the windows of the ivory tower as academics were nailing down its main planks.
It takes a lot of intellectual fortitude for a researcher spending a lifetime dealing with abstractions to admit that knowledge of the “plumbing” behind the walls of his theoretical house actually matters. A renaissance of macro thinking appears to be in the offing, as a result, of this realization in economics. One can only hope that the same light one day shines on academic finance. I’m not willing to bet, however, that this will happen any time soon.