Friday, January 2, 2009

The Celebrated Optimism of Economists

This NY Times headlinecalls to mind a favorite passage from ch. 3 of Keynes' General Theory:
But although the [classical] doctrine itself has remained unquestioned by orthodox economists up to a late date, its signal failure for purposes of scientific prediction has greatly impaired, in the course of time, the prestige of its practitioners. For professional economists, after Malthus, were apparently unmoved by the lack of correspondence between the results of their theory and the facts of observation; - a discrepancy which the ordinary man has not failed to observe, with the result of his growing unwillingness to accord to economists that measure of respect which he gives to other groups of scientists whose theoretical results are confirmed by observation when they are applied to the facts.

The celebrated optimism of traditional economic theory, which has led to economists being looked upon as Candides, who, having left this world for the cultivation of their gardens, teach that all is for the best in the best of all possible worlds provided we will let well alone, is also to be traced, I think, to their having neglected to take account of the drag on prosperity which can be exercised by an insufficiency of effective demand. For there would obviously be a natural tendency towards the optimum employment of resources in a Society which was functioning after the manner of the classical postulates. It may well be that the classical theory represents the way in which we should like our Economy to behave. But to assume that it actually does so is to assume our difficulties away.

The "economists" featured in the Times story are mostly corporate forecasters, and, indeed, Candide-like:

They base their forecasts on computer models that tend to see the American economy as basically sound, even in the worst of times...

Those models also take as a given that the natural state of a market economy like America’s is a high level of economic activity, and that it will rebound almost reflexively to that high level from a recession...

“Most of our models are structured in a way that the economy is self-righting,” said Nigel Gault, chief domestic economist for IHS Global Insight, a consulting and forecasting firm in Lexington, Mass.
That said, though I haven't hazarded any forecasts, I have also been of the belief that the gloominess has been overdone. My reason for optimism is that we seem to be re-learning our Keynesian lessons quickly (most of us, anyway - there are some exceptions of course) and enough of the madmen in authority are on board that we can expect monetary and (soon) fiscal policy to be conducted with due regard for the principle of effective demand.

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