The Hodgson Petition

23 October 2009 at 8:33 am 9 comments

| Peter Klein |

Several friends and colleagues urged me to sign Geoff Hodgson’s petition on the financial crisis, but I declined. I agree with Krugman that economists have tended to mistake mathematical beauty for truth, but think this has little to do with the financial crisis. As discussed in previous posts, I view the financial crisis and recession as the (predicable!) result of government failure — massive credit expansion by the central bank, mortgage-lending rules and policies designed to inflate the housing market, a state-sponsored cartel of securities-rating agencies — not market failure resulting from unrealistic behavioral assumptions.

I respect many of the signatories to the petition, but statements like this (from Krugman), at the heart of the petition, are preposterous:

[Economists] turned a blind eye to the limitations of human rationality that often lead to bubbles and busts; to the problems of institutions that run amok; to the imperfections of markets — especially financial markets — that can cause the economy’s operating system to undergo sudden, unpredictable crashes; and to the dangers created when regulators don’t believe in regulation. . . . When it comes to the all-too-human problem of recessions and depressions, economists need to abandon the neat but wrong solution of assuming that everyone is rational and markets work perfectly.

“Regulators who don’t believe in regulation?” Paul, what color is the sky on your planet (1, 2, 3)? Notably absent from the petition’s list of villains is the Fed, Fannie and Freddie, the Treasury, or indeed anyone remotely connected with a government body.

Keep in mind it was Krugman himself who wrote in 2002: “To fight this recession the Fed needs more than a snapback; it needs soaring household spending to offset moribund business investment. And to do that . . . Greenspan needs to create a housing bubble to replace the Nasdaq bubble.” St. Alan followed Krugman’s advice to the letter, and here we are today.

Entry filed under: - Klein -, Bailout / Financial Crisis, Myths and Realities. Tags: .

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9 Comments Add your own

  • 1. Per Bylund  |  23 October 2009 at 9:00 am

    Hear, hear!

  • 2. Steve Horwitz  |  23 October 2009 at 9:46 am

    I also refused to sign it for exactly the same reasons Peter. I agree with the complaints about too much math and beauty over truth, but Krugman’s guilty of a disregard for the truth as well, even without the math.

  • 3. Dick Langlois  |  23 October 2009 at 10:23 am

    This post arrived just as I was also contemplating Geoff’s petition. I saw that it is possible to explain oneself in a comment section when signing the petition, and I was deliberating about whether I should do that or post here instead (or both). But, as usual, Peter has beaten me to the punch.

    Had it been a petition just about the need to reform the theory and practice of economics away from the pursuit of mathematical beauty for its own sake, and about the redirection of economics towards institutions and history, I would have signed in a flash. But I too find objectionable not only the tone but the substance of Krugman’s comment. I think it’s simply not true that most economists, including those in power, believe (blindly or otherwise) in the perfection of rationality and of markets (whatever that means). And the contention that the crisis resulted from imperfections in rationality and a failure to regulate is as unreasoned and dogmatic as the straw man Krugman sets up. I agree with Peter that, when economic historians of the future have had time to study our era carefully, they will locate the origins of this crisis, like those of the Great Depression, principally in monetary and regulatory policy.

  • 4. badabing  |  23 October 2009 at 11:59 am

    I agree with you in general, but I would also see the culprit in deficient or absent regulation when it comes to securitization. I wouldn’t blame math per se, that is way to easy…

  • 5. srp  |  23 October 2009 at 1:40 pm

    Enough with the math-bashing already. It’s become a tic rather than a critique.

    I’ve seen zero evidence that adherence to mathematical models had anything to do with what just happened in the economy (although anecdotal evidence says that the bosses ignored the quants’ warnings at at least some of the I-banks). We managed to have very similar bubbles and crashes in the past without any black magic at all. The only thing that changed was the language used to rationalize the various public and private decisions that turned out badly.

  • 6. liberty  |  24 October 2009 at 12:03 am

    “predictable” can mean different things. Every economist can correctly predict that there will be more recessions in the future. Every economist can predict that prices will change in the future. They can’t predict exactly what will happen exactly when in a way that would enable them to make money off of it consistently.

    If some economist argues that the financial crisis was “predictable”, but they didn’t make million of dollars from it, then I assume “predictable” means “something of vaguely such and such general nature will happen at some time in the future”. Any economist who says the financial crisis was predictable in the sense of a *real* prediction must have made a lot of money last year, or else I can’t take him seriously.

  • 7. Job Daemen  |  24 October 2009 at 4:02 am

    Anyone who is contemplating signing the petition should read the complete NYT column where Krugman’s statement comes from. I reckon that a substantial number of the respected academics who signed would reconsider given the silly argumentation and plain old sneering that Paul engages in. But, as can be encountered frequently enough in academia, people do not do their homework

  • 8. simone  |  24 October 2009 at 9:53 am

    Well said. The challenge we face is that the public and its elected officials fail to recognize how policy and regulators are shaping markets. Krugman and many of his ilk care little for reality. They are chasing childhood fantasies.

    We need the economic profession as well as the larger scientific profession to respect the divide that separates theory and practice. Crossing the divide in an academic paper (conclusions to managerial implications) is usually difficult and clumsy (if not tortured). Why then do we expect it to be easier to cross the divide to the real world? (Krugman’s nobel winning work has shed little light on reality.)

    If we are afraid of making the inference in front of our peers, why do we boldly proclaim it to the media and the masses? Only arrogance and pride can account for the failure to behave correctly.

  • 9. Mistaking Beauty for Truth « Permutations  |  12 November 2009 at 8:27 pm

    […] Beauty for Truth Peter Klein agrees with Paul Krugman that economists have mistaken beauty for truth, but disagrees that it has anything to do with the financial crisis so he won’t be signing […]

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