El-Erian on What’s Wrong with Economics

From a new post by Mohamed A. El-Erian:

“[…] the reputation of mainstream economists has taken a beating in the last 10 years. The bulk of them failed to predict the 2008 crisis that almost tipped the global economy into a multiyear depression. They also didn’t foresee the aftermath.

Most made the mistake of treating the crisis as a cyclical shock and forecast a V-type growth snapback. They were prisoners of an excessive mean-reversion mindset: They acknowledged that growth was taking a huge hit due to severe financial dislocations, but they forecast that economic activity would bounce back strongly and inclusively.

Instead, the experience of advanced economies more closely resembled an “L,” in which they got stuck in a “new normal” characterized by a prolonged period of low and insufficiently inclusive growth.

The damage goes well beyond lost output, diminished consumer welfare, widespread economic insecurity and a worsening of the inequality of income, wealth and opportunity. The shortfalls fueled the politics of anger, along with a heightened mistrust of the establishment, institutions and expert opinion.

This, in turn, has diminished the credibility of economics. Meanwhile, many students have complained to me that the mainstream economics they are taught is divorced from real-world relevance. It is only a matter of time before the funding for economic research risks becoming a casualty.

Yet this huge failure has not been the result of ignorance about the limitations of the discipline, nor is it the consequence of a lack of new, disruptive ideas.

Here are some reasons for the erosion of the insights and predictive powers of mainstream economics:

  • The proliferation of oversimplifying assumptions, including those that sideline many elements of real-world behaviors and interactions, in an effort to make models seem more “scientific.” This leads to overreliance on excessively abstract estimation techniques and approaches.
  • Insufficient consideration of financial linkages and little allowance, if any, for the possibility that financial dislocations can disrupt the economy.
  • Poor and grudging adoption of important insights from behavioral science, along with excessive hesitation to develop multidisciplinary approaches.
  • An oversimplification of uncertainty and the ways it influences economic interactions.
  • Overemphasis of equilibrium conditions and mean reversion, a trend that reduces the understanding of transitions, structural changes and tipping points.”

Posted by at 11:38 AM

Labels: Inclusive Growth, Macro Demystified


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