Recently Krugman has been defending textbook economics, arguing that if policy makers had simply followed their advice, the crisis would have been far less severe.
It is deeply unfair to blame textbook economics either for the crisis or for the poor response to the crisis. (Krugman, The Trouble with Economics is Economists)
I don’t dispute that austerity has made the crisis far worse, and that conventional IS-LM analysis argues for government stimulus, not austerity, in a severe recession. But the extrapolation that therefore mainstream economics textbooks are fonts of wisdom is nonsense. They are instead enormous exercises in often unintentional mendacity–omitting huge swathes of economic research or empirical data when that research or data contradict mainstream beliefs.
Lars Syll has written a very good, brief post on this point:
It details probably the most egregious way in which standard textbooks–Krugman’s included–commit effective fraud by omitting important results from economic research–often because the textbook writers themselves don’t even know of this crucial research because they weren’t taught it by their teachers. This is the “Sonnenschein-Mantel-Debreu Theorem”, which establishes that the “Law of Demand” does not apply even at the level of a single market. And yet Neoclassical macroeconomists believe it is valid to start with a model in which the entire economy is a single “representative agent”.
The whole is more than a sum of parts. This fact shows up already when orthodox – neoclassical – economics tries to argue for the existence of The Law of Demand – when the price of a commodity falls, the demand for it will increase – on the aggregate. Although it may be said that one succeeds in establishing The Law for single individuals it soon turned out – in the Sonnenschein-Mantel-Debreu theoremfirmly established already in 1976 – that it wasn’t possible to extend The Law of Demand to apply on the market level, unless one made ridiculously unrealistic assumptions such as individuals all having homothetic preferences – which actually implies that all individuals haveidentical preferences.
This could only be conceivable if there was in essence only one actor – the (in)famousrepresentative actor. So, yes, it was possible to generalize The Law of Demand – as long as we assumed that on the aggregate level there was only one commodity and one actor. What generalization! Does this sound reasonable? Of course not. This is pure nonsense!
How has neoclassical economics reacted to this devastating findig? Basically by looking the other way, ignoring it and hoping that no one sees that the emperor is naked.
Having gone through a handful of the most frequently used textbooks of economics at the undergraduate level today, I can only conclude that the models that are presented in these modern neoclassical textbooks try to describe and analyze complex and heterogeneous real economies with a single rational-expectations-robot-imitation-representative-agent.
I recommend reading all of Lars’ post. And if you want the Full Monty, you could try my Debunking Economics.