How has the Swedish Central Bank’s committee that awards prizes in Economics in honor of Nobel responded to the field’s abject failures regarding the recent financial crisis and the Great Recession? A lesser group would display humility, acknowledge its failures, and promise a fundamental rethink of the field. Neoclassical economists, however, are made of sterner stuff. The committee’s response is to praise the discipline for its theoretical advances and proposed policies related to finance, regulation, and corporate governance. Eugene Fama, Jean Tirole, Oliver Hart, and Bengt Holmstrm exemplify this pattern. This series of articles discusses the joint award in 2016 to Hart and Holmstrm. In this introduction to the series, I outline the major errors that I will address in this series.
The major errors fall into several categories. The awards, and the committee’s explanation for the awards, give us the ability to look at how the committee thinks of economics. The committee’s message is one of complacency. Economics is progressing brilliantly and now understands the key things that can go wrong in the economy and has developed optimal solutions to those problems. Given economists’ catastrophic policy proposals and predictive failures that were central to the financial crisis that is an extraordinary claim. At least one of two things must be true. Either CEOs are churlishly refusing to implement these wondrous policies, or those policies are disastrous rather than wondrous. This question never occurs to the committee. The committee is not aware of the paradox that at the same time (according to the committee’s fairy tales) economists were ‘taming the large corporation’ and creating ‘optimal’ CEO compensation contracts and governance that supposedly tame the CEO, the real world was going in the opposite direction. The policies pushed by the 2016 Laureates helped create the criminogenic environment that produced unprecedented levels of elite CEO frauds that hyper-inflated multiple bubbles, drove the global financial crisis, and produced the Great Recession.
This post was published at Wall Street Examiner on February 27, 2017.