I seem to be getting overwhelmed with people asking about or commenting on Paul Krugman's article How Did Economists Get It So Wrong. Since we've posted on this blog about the crisis before, let me give a brief reply.

Dear Paul:

Who are these economists who got it so wrong? Speak for yourself kemo sabe. And since you got it wrong - why should I believe your theories?

Regards,

David

David:

His comment was that economists as a group got it wrong, not that all economists got it wrong. I think he is correct.

Yes, I am sure you that you were prescient and foresaw the catastrophe, and now you are wealthy because you invested accordingly (incidentally, I also foresaw the catastrophe, but nearly a year early - I moved all my money into fixed funds back in October 2007). However, INFLUENTIAL economists that serve as advisors to people like the president, other leaders of other countries, and companies like Citimortgage, etc. did get it wrong. So many of them got it wrong that it is easier to lump those who got it wrong into a group rather than listing the much smaller percentage who knew something was up.

So, congratulate yourself on being one of the few economists who saw the train miles before it appeared at the other end of the tunnel, and are therefore not one of the "economists as a group."

Economists do not act "as a group" or predict "as a group." They act and predict individually. But more to the point, who cares what economists, particularly academic economists, think of the future prospects of any asset market? They are no more equipped to know the future than a soothesayer, a taxi driver, a short order cook, or any one else.

There were lots of investors, many unknown to the public, who got the housing market (and other markets) right. Just as you didn't have to be a rocket scientist to see that equities were absurdly overvalued in 1999, you didn't have to be one to see a similar overvaluation in houses and related assets in 2005. In May 2005 (about four months before the XHB peaked), I sent a sharply worded email to Ron Mullenkamp, the PA-based proprietor of the Mullenkamp mutual fund and one-time bullish poster boy for home building stocks, telling him in no uncertain words what I thought of his bullish stance on the builders and housing in general. I said that if the builders ever got to his target of 15x earnings I'd be "selling them short and heading for the hills." He responded saying he still saw value in them.

Fast forward to October 2006, with the builders' stocks in decline (even though the market wouldn't peak for about a year) and Mullenkamp's investors still holding on (I gather) even though they were taking a pounding. Lon Witter, an astute partner at Witter and Westlake Investments and a non-economist!, pens The Big Bad House for Futures magazine. (The online version doesn't have two interesting charts, nor does it have his sidebar, "Trading Implications.")

These words across the top of p. 36 summarized the article:

"Even if you don't own your own home, as a participant in the financial markets your fortunes are directly tied to one of the most precarious housing markets of the last 20 years. The implications for the stock market are huge."

Indeed they were.

When it comes to predicting the future, I'll take an astute investor over an academic economist any day. I'd almost pay money to see what Krugman had in him portfolio the last few years. And remember it was none other than Krugman who issued a call in the New York Times in 2002 for the Fed to inflate a housing bubble.

A good Traders log article by Lon Witter. Notice what he says about taking investment advice from economists. For my money, the guy at the corner grocery store knows more about what's going on.

Do physicists get it wrong because their theory says that they cannot predict where a photon shot through a sufficiently narrow slit will land? Are they more wrong because one out of a million anonymous individuals happened to guess right? People - especially Paul Krugman - really ought to know what the theories they are criticizing. For example: the efficient markets hypothesis doesn't say that markets can't crash - it says that there can't be pure arbitrage opportunities. The theory of rational expectations doesn't say there can't be crashes - it says that if there are going to be crashes then we can't predict them. I feel a little like the physicist at the cocktail party being assured that everything is relative. That isn't what the theory of relativity says: it says that velocity is relative. Acceleration is most definitely not. So if Paul Krugman were to come forward with the puzzling discovery that acceleration is not relative...

Sorry to disappoint: economists are quite aware that we can't predict crises, and we don't pretend we can. We can sometimes see them a bit sooner than other people - the Fed was scurrying around trying to prop things up six months before the crash after all; and lots of economists were warning about the sustainability of the growth in housing prices. I knew there would be a crash - I think all economists did. But I had no idea when.

What economists do know a lot about is what to do after a crash - don't prop up failing banks like Japan did - force them into bankruptcy like Chile did. Sadly we have done all the things we know are the wrong things.

You might go read Tom Cooley's article - he provides a few more details.

By the way: I'm with Bill Stepp - don't take investment advice from economists. That isn't what we do.

Where do I sign in?

MB

P.S. To the Anonymous: not even PK claims that "getting it right/wrong" amounts to predicting when "it" (whatever "it" is) will happen, its magnitude and its pattern. Even for PK getting it wrong/right amounts to being able to explain what happened and providing some decent model of the causation chain that lead to it. From this point of view, PK, his models, the models of his buddies and so on, got it seriously wrong, while those of other (indeed, becauseI do not have a reputation for being humble, that may include even David and myself :-)) got it mostly right. Hence, what he writes is just plain nonsense.

There is not such a thing as the "average economist". There are "economistS", and, when he says they are wrong, PK should spend less time writing confused statements on the history of economic thought he does not seem to know, and more time documenting who got what wrong when and where.

I thought that some economists had been saying for decades that economy based on our current money system (monopolized and state-forced legal tender) is doomed. I'm speaking much worse crises than this one.

Bill:

You are correct that economists do not "act as a group." However, as you, being as well read as you are, know, analysts look at what economists are predicting and aggregate the result. Thus, when 80% of economists are predicting something, that prediction is considered significant. Few economists were predicting the huge downturn.

David:

As with economists, photons must be measured as a group. The situation mentioned in the article is equivalent to predicting a distribution of photons through a slit, only to find that not only do the photons not behave as electromagnetic waves or as particles, but behave in a way that the result does not follow predictive physics. Of course, with photons and economists, we would be modifying our theories to understand why the result was different from our expectation.

As for your other comment regarding prediction of crises, my comment was not directed to whether they could or could not, it was only directed to that fact that the majority of economists failed to predict the downturn - a statement of observation, and not even a statement of criticism. Economics is hardly an exact science given our ability - or perhaps it would be better to say our lack of ability - to gather and analyze information.

I am surprised at some of the defensiveness of people here. The author merely points out that most economists failed to predict the downturn and then people get upset. They should get no more upset about someone pointing out that 70% or 80% of economists failed to predict a certain outcome than they would about football analysts predicting that Baltimore was likely to win their division and would almost assuredly be in the Superbowl, only to find that that Baltimore failed to even have better than an even record. Prediction is like that - uncertain.

As for the other comments regarding whether economists know what they are doing, I leave that for others to hash over. Most of the time economists "get it right," or somewhat right - not that it is hard to predict the near future much of the time. When the bulk of economists fail to predict the future, someone somewhere is going to write about it. Perhaps they should talk to Bill Stepp's corner grocer and write a story about how he predicted the future - and profited by taking advantage of his prediction.

Let me try this again. Our models are like models of photons going through slits. Just as those models predict only the statistical distribution of photons, so our models only predict the likelihood of downturns - they do not predict when any particular downturn will occur, and in fact they assert that we cannot know exactly when any particular downturn will occur. So saying "most economists failed to predict the downturn" is exactly like saying most physicists failed to predict the impact of the twelfth photon passing through the slit. We haven't found that "not only do the photons not behave as electromagnetic waves or as particles, but behave in a way that the result does not follow predictive physics," we've failed to predict where the impact of the twelfth photon will be. If people think that downturn is generally inconsistent with our models, they should give reasons or evidence why they think that. Instead they point to the fact that we failed to predict the downturn, which - I repeat - is evidence in favor of our models, not against them.

David:

I see now what you meant earlier. Yes, when you shoot photons through a slit that are a large number of places any one photon may go (a continuum with limits, in fact). You can predict where the majority will go, and you can even predict, with enough photons, where all of them will eventually distribute themselves, but you will always fail to predict where any one photon will go.

Now that I understand that you were correlating prediction with a probability distribution (I must admit that I had never considered economics in a physics context, though I have a degree in the former and an MBA with a number of courses in the latter), I agree.

To some extent, I think the author of the article also kind of knew that, and perhaps the author might have been better marvelling at how the probability distribution did not suggest a downtown, even though a downturn was statistically possible. Often dialogue between individuals can arrive at a better outcome, or less controversy - maybe both.

From David Henderson's post "The Fed's Hold on Economists":

An invitation to the annual conference, or some other blessing from the Fed, is a signal to the economic profession that you're a certified member of the club. Even Krugman seems a bit burned by the slight. "And two years ago," he said in 2007, "the conference was devoted to a field, new economic geography, that I invented, and I wasn't invited."

Krugman invented economic geography like I invented the theory of anarchy. Doesn't his balloon ever land?

I don't think anyone is upset with Krugman's claim that x% of economists failed to predict the downturn. The problem is his seemingly implied message that, if only they had the right theory (i.e., Keynesianism), then maybe they would have done so. He also seems to think that economists are somehow uniquely qualified to opine on or to predict bubbles and busts. Poppycock!

Economists are no better at predicting accross-the-board declines in an asset class than baseball players or any other occupational group are. And there's no reason they should be. Successful speculation requires a whole lot more than a knowledge of economics, which Krugman apparently doesn't get. Like I said before, I'd like to see what he had in his portfolio the last few years.

And just for the record, I didn't read past p. 1 of Krugman's article.

You're right about investors. Asking economists about individual bubbles and busts is like asking climatologists about individual storms. Which is more likely to predict a thunderstorm next Thursday, though, a climatologist or a weatherman?

I usually like this blog, except when knee-jerk Libertarians start talking about economic analogies in sciences they know nothing about (I'm looking at you Stephan Kinsella), but this post is just idiotic narcissism. It's not all about you, David. Bill Stepp: it's obvious you didn't read the full article by the content of your comments. You didn't have to claim to read one page (I'm doubting you honestly got that far). You appear as a hanger-on to David's narcissism here.

Basing an opinion on the title of an article is an exercise for Fail Blog, not for anything more thoughtful. I didn't see the phrase "all economists" anywhere in the title or the article. Maybe a more appropriate title would have been "How Did The Economists In Power Get It So Wrong?", but that doesn't make the existing title inaccurate. Even if you read just the first paragraph, you could see that Krugman names and shames a specific list of Economists, Institutions, and "Schools" of Economic thought from the start. At worst, he uses generalizations like "most".

I guess if I want to read thoughtful rebuttals to Paul Krugman or other non-devout Keynesians, I'll have to look elsewhere. Your collective bias is all too evident here.

From the fact that I gave the link you might deduce that I read the entire article. Let's fisk it:

1. economists thought they had resolved their internal disputes: so?

2. "central problem of depression-prevention has been solved": and so it has

3. "More important was the profession's blindness to the very possibility of catastrophic failures in a market economy." See for example Kehoe and Prescott [2007], Great Depressions of the 20th Century, Sargent, Williams and Zhao [September 2008], "Conquest of Latin American Inflation". See it would be good if people had some idea of what was being written before criticizing it.

4. "the fault lines in the economics profession have yawned wider than ever"...meaning that Paul thinks he is part of a debate within the economics profession? Whatever...

5. "They turned a blind eye to the limitations of human rationality that often lead to bubbles and busts" This is pure unmitigated bullshit, it makes me feel physically ill that a distinguished economist is so ignorant of his own profession. As a random example, how about my student Felipe Zurita's thesis on speculation written in 1998. There are endless papers written about bubbles and busts - some assuming rationality, some not. Some are experimental, some are theoretical, some are empirical. There are economists who have devoted their entire careers to studying bubbles. Each crisis - in Mexico, in South-east Asia, in Argentina - had generated hundreds of papers examining how and why the crisis took place.

I see that my statements had an effect. ;) I appreciate the link to the original post, and the links to your backing material, Mr. Levine. I wish Krugman's article had more of the same -- that would be my main criticism of it. I understand the print version doesn't permit the room for back-links and online references, but I wish journalists would realize that the online medium permits these helpful references, without crowding the visual space. For all of Wikipedia's faults, journalists could learn a lot from their formatting standards.

My main point is: your 1-5 list should be in the original post, not so late in the comment thread. As it stands, your original post reads like a troll comment on the original article (it's too bad the NY Times site doesn't support comments properly, but this is probably why), akin to something that would show up in YouTube comments. This is not a stand-alone blog post, nor even thoughtful editorial commentary. Even your 1-5 list here shows signs of a bar yelling match, with helpful phrases like "so?" and "Whatever...". Aside from the cartoon image embed posts, I was under the delusion you all had better editorial standards here. Text mediums give you more time to elaborate your thoughts, especially when words are your employer (they're not mine right now, unfortunately). I suggest you utilize that time freedom in the future.

My counter-points to your own:

1 & 4. You are obviously not the audience for this article.

3 & 5. If anything, this article by PK is a call-to-arms to other economists (particularly those in government/political-mill power, which you are not) to pay more attention to the bubble-burst studies you mention here. It is a shame that he does not mention them directly. I will read them shortly.

2. Stating *why* you agree with this declaration would be more helpful. I don't think depression-prevention has been solved in the least. I would really like to see something like Real Bills doctrine applied to Keynesian theories of crisis distribution. In the mass-media version of the debate (of which PK is a participant, explaining many audience and tone differences), the phrase "paying people to dig a hole then fill it back up again" comes up far too often in discussing Keynesian theory. That phrase is more a description of modern-day Wall Street operations, than any real systemic economic fix.

To Fred McTaker,

Having read PK's article, I stand behind what I wrote. You didn't actually make a criticism of anything I wrote. And judging from your misguided belief that the real bills doctrine is true (see the devastating critiques by Larry White and George Selgin, to name only two of its grave diggers), I doubt you could.

On November 5, 2008, the day after he was elected, and January 20, 2009, when he assumed full responsibility, what policy advice should economists have given Mr. Obama, and what models, theories, insights, etc., should they have based it?

@Bill: Please provide a link or some traceable reference to the documents you speak of. I'm not subject to the same intellectual inbreeding you are, being neither a die-hard Austrian Economist nor Mises Institute staff, so I need more help finding these obscure references you throw around as if they're common knowledge. Google didn't help with the little information you provided.

The main criticism I directed at Mr. Levine suits you even better: context and audience are important in all writing (his HuffPo post on this post subject completely missed the mark as well). The last time I checked, this wasn't an Economist-only blog, and I've never claimed to be trained in the field. Also, I see you are on the "authors" list here, but I don't see you authoring anything here except crude forms of in-jokes, used against those who dare to comment on your dear friends' posts. Get a spine and write something original. You look like a defensive troll on your own blog.