Did economists “get it all wrong” during the Great Recession?
Certainly a lot of economists have made a lot of mistakes. Ben Bernanke, former Professor of Economics at Princeton, thought the problems in the sub-prime mortgage market were limited and contained in March of 2007. Greg Mankiw, Professor at Harvard, predicted that housing prices would stop rising so fast back in 1995, because most baby-boomers now owned a home. When you analyze something as complex and multifaceted as an economy with billions of prices and trillions of interactions every day, you’re bound to get some things wrong.
But what is the point of economics? Is it supposed to predict the future, or analyze the present? The economics profession has debated this point since the mid-19th century, with the rise of the German Historical School. These scholars objected to the analytical approach of the Classical economists like Alfred Marshall and Adam Smith. Smith’s claimed that his principles were universal, applying to all people in all nations. The Historical School thought that economics should result from careful historical analysis rather than logic and mathematics. Max Plank, the famous German scientist, once considered studying economics but found the combination of historiography, sociology, and psychology too difficult, so he went on to win a Nobel Prize in Physics instead!
At its heart, this debate over method contained a broader question: is the economist a student, or a savior? Karl Marx demonstrated his impatience with analysis when he wrote, “The philosophers have only interpreted the world in various ways; the point, however, is to change it.” His economic works certainly did change the world, although his analytical errors led to tragic outcomes for hundreds of millions of people.
Many economists have taken up the challenge, however, advocating for or against various public policies. And when it comes to government taxes, spending, and regulation, we want laws that are logical and provide the right incentives and constraints. But economics is a social science, not a physical science. Its principles are general and provisional—although some are more provisional than others. And economic predictions are—or should be—always tentative and subject to revision.
In the end, I believe that an economist should be a student of history and should seek to understand the world, not change it. Because if they get it wrong, the consequences can be dire. And, as another Nobel prize winner, the physicist Niels Bohr once said, predictions are hard, especially about the future.
Douglas R. Tengdin, CFA
Chief Investment Officer