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Saturday, January 09, 2010

The Chicago School and the financial crisis

New Yorker economics correspondent John Cassidy has a very balanced piece about the impact of the credit crisis on thinking at The Chicago School. He also uses the term apostasy to describe Posner's turn toward Keynes.

In the article, Heckman, Becker and Rajan seem the most reasonable. Fama is obviously clinging to his priors and Lucas refused to talk to Cassidy.

Cassidy makes additional remarks on his blog, and promises in the near future to publish more detailed notes on the interviews he did with the Chicago economists.

... For people interested in the subject, and there seems to be a lot of you, the good news is that I’m planning on posting here much fuller versions of the interviews I did in Chicago, with the likes of Gene Fama, Gary Becker, and Richard Posner, who recently converted to Keynesianism. It’s the nature of long-form magazine journalism that a lot of interesting stuff gets left out of the finished article, but, thanks to the Web, there’s no reason it shouldn’t appear in some form. Plus, I think it’s a good time to let the Chicago economists speak for themselves. Over the last couple of years, they have taken a battering at the hands of myself, Paul Krugman, Joe Stiglitz, and others. Having just finished writing a book entitled “How Markets Fail,” I went to the Windy City eager to learn first hand how the critiques of Chicago economics were being received. Some of what I was told, I don’t agree with, but at this time of intellectual tumult I think it makes fascinating reading.

In the article Posner notes that few economists knew anything about how real financial markets work. This is certainly true in my experience. In particular, they were naive about individual incentives within the system (see Greenspan comments), and very few academics (with perhaps one or two exceptions; video) had any idea what a CDO or CDS was before 2008. I can't resist a little sniping here. If you want to ask someone about electrons, or how to build a quantum logic gate, or how to fabricate nanostructures, you can't do much better than to head to your local research university and talk to a physics professor. Strangely, if I wanted to learn something about credit markets or securitization or the risk from speculative bubbles, I would have been better off talking to a former physicist on Wall St. than to almost any professor in an economics department or business school. I'm not exaggerating -- I've done both many times. Posner also says:

"Well, one possibility is that they [the economists] have learned nothing [from the financial crisis] ... Because -- how should I put it -- because market correctives work very slowly in dealing with academic markets. Professors have tenure. ... It takes a great deal to drive them out of their accustomed way of doing business."

For more, see my talk on the financial crisis.

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