After Thomas Sargent learned on Monday morning that he and colleague Christopher Sims had been awarded the Nobel Prize in Economics for 2011, the 68-year-old New York University professor struck an aw-shucks tone with an interviewer from the official Nobel website: “We're just bookish types that look at numbers and try to figure out what's going on.”
But no one who'd followed Prof. Sargent's long, distinguished career would have been fooled by his attempt at modesty. He'd won for his part in developing one of economists' main models of cause and effect: How can we expect people to respond to changes in prices, for example, or interest rates? According to the laureates' theories, they'll do whatever's most beneficial to them, and they'll do it every time. They don't need governments to instruct them; they figure it out for themselves. Economists call this the “rational expectations” model. And it's not just an abstraction: Bankers and policy-makers apply these formulae in the real world, so bad models lead to bad policy.
Which is perhaps why, by the end of that interview on Monday, Prof. Sargent was adopting a more realistic tone: “We experiment with our models,” he explained, “before we wreck the world.”
Rational-expectations theory and its corollary, the efficient-market hypothesis, have been central to mainstream economics for more than 40 years. And while they may not have “wrecked the world,” some critics argue these models have blinded economists to reality: Certain the universe was unfolding as it should, they failed both to anticipate the financial crisis of 2008 and to chart an effective path to recovery.
The economic crisis has produced a crisis in the study of economics – a growing realization that if the field is going to offer meaningful solutions, greater attention must be paid to what is happening in university lecture halls and seminar rooms.
While the protesters occupying Wall Street are not carrying signs denouncing rational-expectations and efficient-market modelling, perhaps they should be.
They wouldn't be the first young dissenters to call economics to account. In June of 2000, a small group of elite graduate students at some of France's most prestigious universities declared war on the economic establishment. This was an unlikely group of student radicals, whose degrees could be expected to lead them to lucrative careers in finance, business or government if they didn't rock the boat. Instead, they protested – not about tuition or workloads, but that too much of what they studied bore no relation to what was happening outside the classroom walls.
They launched an online petition demanding greater realism in economics teaching, less reliance on mathematics “as an end in itself” and more space for approaches beyond the dominant neoclassical model, including input from other disciplines, such as psychology, history and sociology. Their conclusion was that economics had become an “autistic science,” lost in “imaginary worlds.” They called their movement Autisme-economie.
The students' timing is notable: It was the spring of 2000, when the world was still basking in the glow of “the Great Moderation,” when for most of a decade Western economies had been enjoying a prolonged period of moderate but fairly steady growth.
Some economists were daring to think the unthinkable – that their understanding of how advanced capitalist economies worked had become so sophisticated that they might finally have succeeded in smoothing out the destructive gyrations of capitalism's boom-and-bust cycle. (“The central problem of depression prevention has been solved,” declared another Nobel laureate, Robert Lucas of the University of Chicago, in 2003 – five years before the greatest economic collapse in more than half a century.)
The students' petition sparked a lively debate. The French minister of education established a committee on economic education. Economics students across Europe and North America began meeting and circulating petitions of their own, even as defenders of the status quo denounced the movement as a Trotskyite conspiracy. By September, the first issue of the Post-Autistic Economic Newsletter was published in Britain.
As The Independent summarized the students' message: “If there is a daily prayer for the global economy, it should be, ‘Deliver us from abstraction.'”
It seems that entreaty went unheard through most of the discipline before the economic crisis, not to mention in the offices of hedge funds and the Stockholm Nobel selection committee. But is it ringing louder now? And how did economics become so abstract in the first place?