The global financial crisis took the vast majority of the economics profession by surprise. Though there were individual mainstream economists — such as Robert Shiller and Joseph Stiglitz — who claim to have warned of the crisis, no mainstream economic model foresaw anything like what eventuated in 2007. In fact, mainstream model predictions led to politicians being advised to expect tranquil economic conditions ahead. The OECD’s advice in its June 2007 Economic Outlook was typical:
“Indeed, the current economic situation is in many ways better than what we have experienced in years. Against that background, we have stuck to the rebalancing scenario.Our central forecast remains indeed quite benign: a soft landing in the United States, a strong and sustained recovery in Europe, a solid trajectory in Japan and buoyant activity in China and India. In line with recent trends, sustained growth in OECD economies would be underpinned by strong job creation and falling unemployment.” (“OECD forecasts gentle turn for global economy”)
After being so disastrously wrong, one might expect that this modeling approach would now be subject to serious revision. But while New Keynesian DSGE model-builders are starting to add “financial frictions” to their repertoire of factors that prevent the economy from almost instantly attaining a competitive equilibrium (as in New Classical models), the core paradigm — of an economy which, left to its own devices, will ultimately reach equilibrium, and in which money and financial institutions generally play non-essential roles — has not been challenged.
Instead, the challenge that is occurring in academic institutions is the survival of the handful of proponents of an alternative paradigm — one that sees capitalism as fundamentally both unstable and monetary. Before the crisis, economists who followed that broad tradition — including myself — were largely ignored by the mainstream. After the crisis, the mainstream could have accepted that this perspective has merit, and made more room for it in the academic curriculum. But instead, what little space was devoted to alternative approaches to economics has been reduced.
(PS This post was written before an amicable exchange with Tony Yates on Twitter over the weekend, in which we exchanged references on our different approaches to macroeconomics)