One thing we are not going to have, now or ever, is a set of models that forecasts sudden falls in the value of financial assets, like the declines that followed the failure of Lehman Brothers in September. This is nothing new. It has been known for more than 40 years and is one of the main implications of Eugene Fama’s “efficient-market hypothesis” (EMH), which states that the price of a financial asset reflects all relevant, generally available information. If an economist had a formula that could reliably forecast crises a week in advance, say, then that formula would become part of generally available information and prices would fall a week earlier.Or, as Bill Easterly puts it in his defense of economics: "[E]conomists did something even better than predict the crisis. We correctly predicted that we would not be able to predict it."
Lucas also argues that Ben Bernanke and former Fed governor Ric Mishkin did indeed see the potential for crisis in 2007, but:
[R]ecommending pre-emptive monetary policies on the scale of the policies that were applied later on would have been like turning abruptly off the road because of the potential for someone suddenly to swerve head-on into your lane. The best and only realistic thing you can do in this context is to keep your eyes open and hope for the best.The Economist's Free Exchange blog has an interesting "roundtable" of responses to Lucas. One of the participants, Brad DeLong, notes that Lucas was against Bernanke before he was for him.
Elsewhere - in the FT - Keynes' biographer Robert Skidelsky argues that macroeconomics needs to be radically reconstructed. He writes:
The reconstruction of economics needs to start with the universities. First, degrees in the subject should be broadly based. They should take as their motto Keynes’s dictum that “economics is a moral and not a natural science”. They should contain not just the standard courses in elementary microeconomics and macroeconomics but economic and political history, the history of economic thought, moral and political philosophy, and sociology. Though some specialisation would be allowed in the final year, the mathematical component in the weighting of the degree should be sharply reduced. This is a return to the tradition of the Oxford Politics, Philosophy and Economics (PPE) degree and Cambridge Moral Sciences.The point of this, Skidelsky says, is "to protect macroeconomics from the encroachment of the methods and habits of the mathematician." While I have some sympathy for his view that we need to broaden our thinking, I'm not convinced our methods are so fundamentally flawed. In this regard, Mark Thoma's post in the Lucas roundable gets it right:
Models are built to answer specific questions. When a theorist builds a model, it is an attempt to highlight the features of the world the theorist believes are the most important for the question at hand. For example, a map is a model of the real world, and sometimes I want a road map to help me find my way to my destination, but other times I might need a map showing crop production, or a map showing underground pipes and electrical lines. It all depends on the question I want to answer. If we try to make one map that answers every possible question we could ever ask of maps, it would be so cluttered with detail it would be useless, so we necessarily abstract from real world detail in order to highlight the essential elements needed to answer the question we have posed. The same is true for macroeconomic models.
But we have to ask the right questions before we can build the right models. The problem wasn't the tools that macroeconomists use, it was the questions that we asked.
Of course, we naturally prefer to ask questions that we think we can answer with the models we have...
I should add that, while I don't fully agree with Lord Skidelsky's assessment, I am looking forward to his forthcoming book, "Keynes: The Return of the Master" (the title causes me to imagine John Maynard Keynes, in silk pyjamas, taking out an army of new classical economists with badass ninja moves).