Is this paragraph the writing of some superficial blogger venting intemperate spleen, spitting on economists when they are down? Or perhaps some unreconstructed conspiracy theorist, eager to expose the nefarious plot behind the rise and fall of intellectual orthodoxies? Or instead, is it the rumination of some crude externalist sociologist of science, who can only explain the behavior of intellectuals as sock puppets for the interests they represent? Or yet one more Foucauldian exercise in ferreting out the subterranean connections between power and knowledge? I expect that few will recognize the author as the figure whose stock had briefly risen since 2007, John Maynard Keynes.28
In this book, I hold no brief for Keynesian economics as an automatic prescription for whatever ails us in the twenty-first century. Indeed, it has long been argued by an older generation of thinkers29 that Keynesian economics, or at least the version enshrined in the so-called neoclassical synthesis, has been a self-inflicted wound on the left from the 1950s onward. At minimum, it has been used to promote the short-sighted fallacious doctrine mooted in our first chapter, that financial crises could be unproblematically sequentially repaired by “reflation” and the state backstopping insolvent institutions by assuming their debts. This dogma has been the Achilles heel of otherwise interesting economists commenting on the crisis, from Joseph Stiglitz to John Quiggin to Jared Bernstein. However, leaving that aside for the nonce, it is striking the way that it could be taken for granted in the 1930s that the social position of economists might tend to lead them to exhibit biases in certain predictable directions, and that respected members of the profession could concede that those social structures would mount obstacles to serious analysis of economic breakdown. This was not flaming Marxism; it was just commonsense sociology of knowledge. Yet where are the comparable analyses today? Perhaps because we now have come to suspect that there is no direct lockstep connection between socialization and thought has it been given a wide berth, or is it something far more insidious, like unconscious capitulation to the neoliberal epistemic doctrine of the prevalence of an efficient marketplace for ideas?
As late as February 17, 2010, PBS Newshour provided a platform to the Chicago economist John Cochrane to roundly assert that government spending has no net effect on the economy. Insiders to the profession know this as “Ricardian Equivalence,” but that is tantamount to insisting, “You can’t fool Mother Market.” But fooling the market was how the crisis developed in the first place. You should view the segment for yourself to gain an impression of the smug demeanor of someone who has drunk the Kool-Aid a little too avidly. I had to check my browser to make sure I wasn’t watching a clip from The Colbert Report. Perhaps Cochrane and I had been living in parallel universes over the previous two years. Just one representative quote: “The economy can recover very quickly from a credit crunch if left on its own.” Maybe in the Chicago Wormhole Universe.30
But then again, maybe not. The New Statesman had the brilliant idea of reconnecting with the twenty U.K. economists who had signed an open letter in February 14, 2010, supporting Chancellor George Osborne’s strategy of producing growth through fiscal austerity and budget cuts.31 Since then, Britain had promptly entered further contraction, and the Treasury ended up far exceeding its borrowing limits: so much for deficit reduction. The respondents were astoundingly mealy-mouthed, avoiding comment on their clear error (John Vickers, Kenneth Rogoff) or vaguely distancing themselves from Tory cuts by mumbling about “investments” (Roger Bootle, Danny Quah, David Newbery, Hashem Pesaran, Tim Besley); only two opted for full-throated repudiations of Keynesian stimulus (Christopher Pissarides, Albert Marcet). No mea culpas from that quarter—they thought you ditsy folks had long forgotten that inconvenient letter!
Even a year or two later, it can be readily discerned that Cochrane was baldly in error. However, the question that haunts this chapter is: How can these people maintain such positions? How could 132 economists sign a public petition in November 2011 stating that fiscal austerity by the government will provide more jobs than fiscal stimulus in both the short and long term?32 Does the experience of Greece and Spain mean nothing? To a first approximation, one may subdivide the question in two: what psychological equipment permits people like Cochrane to persist so doggedly in their error; and second, what permits the various gatekeepers of the media and academic journals to continue to promote figures like Cochrane, Michael Boskin, Casey Mulligan and Douglas Holtz-Eakin as people worth reading and listening to? Our brief excursion into historical amnesia and social psychology in chapter 2 proffers a short answer to the first question: it is human nature not to relinquish deeply held beliefs in the face of contradictory evidence, especially if one never knew anything different. Lesson 1 informs us that the modern economist comes equipped with a trained incapacity for historical and philosophical reflection. However, the answer to the second question turns out to be far more complicated, and will connect us up with our primary concerns regarding the Neoliberal Thought Collective.33 It is insufficient to baldly assert, “Neoclassical economics has won, not because it describes reality accurately, but because it describes a reality which dominant interests want.”34 What sustains their stubbornness? What injects the steel in their steely confidence? That is the topic of the rest of this chapter.
Navigating Denial
I will return shortly to how the economics profession failed the journalists and the general public; but first, I want to insist that, contrary to urban legend, almost no orthodox economists warned how pervasive the crisis would be or the extent of its devastating character beforehand.35 The reason was simple: the orthodox models taught at the finest universities at their most advanced levels of macroeconomics had no room for fiscal policy or involuntary unemployment or financial crises or system-wide breakdown. Far from an oversight, this was a matter of common knowledge within the profession.36 Among other features, the economics of John Maynard Keynes had been thoroughly and emphatically repudiated by the orthodox profession since the 1980s. The Bank of Sweden Prize winner Robert Lucas was always good for a quote: “I think Keynes’ actual influence as a technical economist is pretty close to zero, and it has been close to zero for 50 years. Keynes was not a very good technical economist. He didn’t contribute much to the development of the field.”37 This should prove significant for our subsequent purposes, because some public intellectuals like Paul Krugman and Robert Skidelsky had misleadingly asserted back in 2008–9 that Keynesian theory still enjoyed broad-based theoretical legitimacy within the orthodox economics profession. By 2012 we can observe just how fleeting were Keynes’s allotted fifteen minutes of comeback fame.
The consensus macroeconomic model, called the “dynamic stochastic general equilibrium model,” could serve no useful function once the crisis hit, because it essentially denied that any such debacle could have materialized. (We document this in chapter 5.) And yet, respected figures within the economics profession could not be embarrassed into acknowledging the deep disconnect between textbook and reality. For instance, Olivier Blanchard, then chief economist at the IMF, pronounced in 2008, “The state of macro is good,” and the profession was enjoying “a broad convergence of vision.”38 Even that was not sufficiently ill-timed and imprudent to get him booted from the IMF.
It wasn’t just macroeconomists who were living in deep denial. Derivatives such as CDOs and CDSs were based upon a set of normative theories invented by financial economists, which asserted that their purpose was to repackage risk and retail it to those best situated to bear it. This theory was colloquially known as the efficient-markets hypothesis (again covered in chapter 5), and had undergone extensive mathematical elaboration by academics and their acolytes in the banks, known as “quants.” The efficient-markets hypothesis claimed to show that all relevant information for all parties to a transaction were already embodied in the market price of a financial instrument. As with the case of the macro models, there was no room for systemic failure in these theories, since they presumed that everything co
uld be subject to insurance due to the stochastic properties of portfolios constructed to mimic the movements of the entire market. Market designers subsequently went to work gilding the lily. Yet economic theory was so central to the construction of financial products that layer upon layer of derivative paper was concocted on top of some original debt instruments based upon nothing more than the scientific promise of the finance theory that underwrote the manipulations.
After the crash, the New Yorker reporter John Cassidy made a pilgrimage to the citadel of efficient-markets theory at the University of Chicago, as he said, “looking for apostasy.” As a service to the rest of us, he interviewed many of the major economists behind the theory at length, and then posted the verbatim transcripts online.39 The interviews are so chock-full of juicy quotes and wicked aperçus that it takes superhuman effort not to cut and paste the entire brace here. For instance, when Cassidy asked the father of efficient-markets theory, Eugene Fama, how the theory had fared in the crisis, Fama replied, “I think it did quite well in this episode.” When challenged by Cassidy, he responded, “We don’t know what causes recessions . . . We’ve never known.” When queried about the seemingly refuted Modigliani-Miller theorem, Fama responded: “The experiment we never ran is, suppose the government stepped aside and let these institutions fail? How long would it have taken to unscramble everything and figure everything out? My guess is we are talking a week or two” . . . Cassidy: So you would have just let them . . . Fama: “Let them all fail. (Laughs).” Lucas flat-out refused to talk to him about the crisis. He at least had the presence of mind to realize how outrageous his beliefs would appear to the vast majority of readers. Cassidy then approached John Cochrane to get him to engage in a little unintentional self-examination, asking him what Chicago doctrine remained after the crisis of the efficient-markets hypothesis and the rational-expectations theory. Cochrane answered, “I think everything. Why not? Seriously now, these are not ideas so superficial that you can reject them just by reading the newspaper.” When Cassidy began hinting at a certain zombie-like uniformity along the Midway, Cochrane retorted: “This is not an ideology factory . . . The Chicago of today is a place where all ideas are represented, thought out, argued. It is not an ideological place.” Of course, it is easy to cover the notional waterfront if everything else is banished. Cochrane: “Today, there is no ‘freshwater versus saltwater’ There is just macro. What most people are doing is adding some frictions to it.”
Cassidy then approached Raghuram Rajan, who was frequently portrayed by the media as one of the more open-minded economists at Chicago, given his reputation for warning about bank problems in 2005. Yet beyond ripping tales of an epic clash of Rajan and Lawrence Summers at the Fed conference at Jackson Hole in 2005, almost no one had bothered to actually read his academic papers. Perhaps Cassidy would have been better prepared if he had first perused a paper Rajan had written back in 1994 suggesting that the Glass-Steagall Act had constituted unnecessary regulation back in the 1930s, because commingling of investment and commercial banking had not ratcheted up the riskiness of the entire system, and in any event, “We find no evidence that commercial banks systematically fooled the public securities markets.”40 Rajan was True Blue Chicago, so of course he defended the home team to Cassidy: “Forget the public utterances: the research done at this place was, essentially, right on the ball.” When Cassidy asked about the behavior of the Federal Reserve and the Treasury in 2008, Rajan responded: “One doesn’t have to be corrupt or in the pay of the financial sector to say, hey, wait a minute: it’s not as simple as letting them all go under or taking them all over. That’s my rant about the business sector. By and large, I think we’ve done all the things that needed to be done.” Thus abides the Socratic diversity, the alpha to omega of public disputation at that great agora of the search for truth, that wholly owned subsidiary of the NTC, the University of Chicago economics faculty.
Actually, I need to credit Rajan with a bit more ingenuity than he claims for himself in these interviews. His book Fault Lines has managed to amalgamate what had by then become the neoliberals’ favorite stories about the crisis into one neat and tidy package. In caricature, it combines: fingering the Asian economies for seeking to accumulate dollar reserves after the Asian crisis of 1997, and therefore creating a world “savings glut”; luxuriant financial innovation (a phenomenon that was “natural”), which lulled bankers and others into taking on “excessive risk”; and technological innovation, which lowered wages and worsened income distribution in the United States, which in turn lured the government to ineptly try to counter it by screwing around with the household mortgage market. The financial sector got frisky, investors bought it, and the government foolishly sought to lean against the wind. The beauty of this narrative is that it mentions some of the major bugaboos of the left, but deftly subordinates them to the time-honored litany that the markets worked as they should, and it was all, in the final analysis, the fault of the government.41 This ingenious commingling of complaints about worsening income distribution and rapacious bankers with what is at bottom a unilateral denial that economists got anything wrong has been so effective that it often has inserted Rajan into critical leftish campaigns where the audience was oblivious to the true character of the analysis.42
I don’t want to especially pick on Chicago in this book; Berkeley’s Christina Romer, Obama’s first head of his Council of Economic Advisors, was just as embarrassing.43 Nevertheless, the sheer density of denial per square economist at Chicago does raise a more interesting issue, given voice by Donald Westbrook and others: “No doubt World War II would have occurred without Martin Heidegger, Carl Schmitt or the other Nazi intellectuals, but it is not so clear that the crisis could have occurred without the Chicago School of neoclassical economics.” Far from being the conventional generic blanket disparagement of “freshwater economics” (such as that spread by Paul Krugman, Brad DeLong, George Akerlof, and others), this points to the fact that Chicago was the prime initial incubator for modern finance theory, which has indeed provided direct intellectual inspiration and justification for most of the so-called innovation in financial derivatives and automated equity trading of the last three decades. There is also the Chicago inspiration for the theory of “public choice” and Stigler’s theory of regulation, so central in the modern development of government (anti)regulation. In other words, Chicago was the intellectual godfather of modern “securitization” and privatized regulation, among other activities.44
Academic economists of a certain persuasion might aver that they and their theories should not be blamed for economic debacles, since they were merely passive observers, and not actually in charge. Economists propose; politicians dispose; or so they say. Furthermore, floor traders flagrantly misuse Black-Scholes option-pricing theory as they employ it. Yet this excuse turns out to be implausible for the profession as a whole; economists had come to occupy many of the commanding heights of the governance of the economy prior to the crisis. Economists didn’t simply come up with some speculative ideas; they helped run many of the institutions, both public and private, that ended up being central to the inception and playing out of the crisis. Indeed, just like the notorious revolving door between Wall Street and the U.S. Government, there has been a twirling door between the economics profession and the large firms and banks that run the economy.45
To take just one crucial example: one of their illustrious own was put in charge of the U.S. Federal Reserve Bank precisely because he had expressed a brash confidence in his colleagues’ professional mastery, which reflected economists’ perceptions of their own powerful mojo just prior to the crash.
Bernanke, the Federal Reserve, and the Great Mortification
Benjamin Bernanke was appointed to the Federal Reserve Bank Board in 2002, and named chairman of the Fed by George Bush in 2005. Bush was persuaded that this avowed follower of Milton Friedman would make a suitable replacement for the previous chair, Alan Greenspan. Following his nomination a
s Fed chairman, Bernanke told the press that, if confirmed, his plan was “to maintain continuity with the policies and policy strategies established during the Greenspan years.” Although many are convinced they detect a repudiation of his predecessor in his subsequent activities, a case can be made that Bernanke was faithful to his original pledge. Much has been made in the interim that one of Bernanke’s academic specialties in his previous life had been the economic history of the Great Depression of the 1930s; but (tedious nag that I am), yet again, few have bothered to actually read his writings and speeches. As late as July 20, 2006, Bernanke was testifying before Congress thus: “The best way to achieve good oversight of hedge funds is through market discipline . . . I think that market discipline has shown its capability of keeping hedge funds well disciplined.” The record discloses Bernanke channeling Greenspan with a tonier Ivy League pedigree.46
Beyond continuity of approach, another reason for his accession was that Bernanke had begun in 2004 in speeches and writings to proclaim the onset of a “Great Moderation” in the macroeconomy since 1984.47 Briefly, his was an assertion that economists had attained such an acute understanding of the economy, infused with such subtle perspicuity of analysis, that macroeconomic fluctuations had been tamed relative to previous experience, and consequently, we had entered unto a new era of capitalist stability and prosperity. With the shallow hindsight of seven years, these assertions still hold the power to cause the toughest orthodox neoclassicist to cringe with embarrassment:
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