Why was the financial crisis of 2008 so surprising to so many macroeconomists (but from my experience, a little less so for international finance economists familiar with financial crises in emerging markets…)? From the conclusion to George Akerlof’s “What They Were Thinking Then: The Consequences for Macroeconomics during the Past 60 Years” in the latest JEP.
The adaptation of The General Theory into the Keynesian-neoclassical synthesis neglected multiple vulnerabilities of the resultant model. Of course, there were reasons for this adaptation, prominently including a desire to build a professional consensus in support of activist Keynesian fiscal policy. By creating a model with an aggregate supply side that was classical in nature, and that allowed plentiful opportunities for economists to practice one-deviation-at-a-time analysis, support was indeed bolstered for Keynesian policy. But Keynesian economists became overly attached to their paradigm. They were dismissive of anomalous observations that indicated the need for new, more nuanced economic thinking.
The Keynesian-neoclassical synthesis that had emerged by the early 1960s put constraints on macroeconomics. Foremost, it divorced macroeconomists from working on financial stability. Luckily, after the crash of 2008, the prior work of finance economists has been belatedly acknowledged, and the subfield of macro stability has also emerged as quite possibly the most vibrant research frontier in economics. Nevertheless, macroprudential concerns remain as back matter in the textbooks. Correspondingly, macroprudential policy is undervalued in the councils of government. Yet its importance remains, given the likelihood of another crash. Inthese consequential ways, macroeconomists’ dismissal of “satiric entertainment” in the decades after The General Theory still lives with us. …
The assumption that “the plumbing” would work was a little less pervasive amongst economists trying to delve into why emerging market economies periodically experienced financial crises — think Thailand and Korea, and the revelatory balance sheet induced recessions of the 1990’s. What was surprising was that the valuation and contingent liability issues so pervasive in emerging markets could also arise in the US.