Economics In Crisis?

Peter Warburton - 11 January 2017

Bank of England chief economist Andrew Haldane’s recent remarks in public conversation for the Institute of Government have already caused a minor storm of protest among, mainly, economic professors.  Haldane opined that the economics profession “is, to some extent, in crisis.” He blamed the poor forecasting record on inadequate models, group-think and a failure to make the most of the data available.  He spoke of a “methodological monoculture” which thrived during a period of relative stability but was woefully exposed during the financial crisis of 2007-09.

While Andy, for whom I have great respect, makes some valid observations on, and criticisms of, the prevailing state of (macro-) economics, I am disappointed by the glaring omissions of debt and financial innovation. Back in 2007, in what turned out to be a deeply ironic seminar at the Bank of England to commemorate 10 years of the Monetary Policy Committee, I tackled Mervyn King, then governor, on the neglect of debt accumulation in the MPC’s analytical framework.  I was fobbed off, as so often before, by a polite but non-committal reply.

If you really want to know what has brought macroeconomics to its present disreputable state, then look no further than the failure to incorporate debt – in its totality – in macro models and forecasts. Excessive debt accumulation has complex, non-linear effects on real economic outcomes, such as output and employment. The distributional characteristics of debt accumulation are complicit in surprising frequency of fat-tail events. In a progressively highly-indebted economy, the proportions of over-stretched and insolvent individuals and companies rise exponentially.

There is a degree of professional acknowledgement that debt, though a nominal variable, is capable of real effects – but it creates too many problems for the modellers so they keep ignoring it. The lack of a coherent integration of all debt – loans, bonds, consumer credit etc. – into the forecasting framework lies at the heart of the crisis of economics. A failure to incorporate massive institutional change and innovation in the financial sector would be next on my list.