Believe it or not, economists were, until about a year ago, congratulating themselves on a job well done. Now the dismal science is in shock, and Paul Krugman thinks he knows why. Economists, he writes in the New York Times Magazine, “mistook beauty, clad in impressive-looking mathematics, for truth.” They began to believe, as they had before the depression, that people were perfectly rational and markets perfectly efficient, allowing them to build elegant mathematical theories.
At the same time, they devalued or forgot about Keynesian economics, reverting to Adam Smith-esque free market ideologies with new, mathematically impressive veneers. They ignored even the possibility of bubbles. Going forward, the field will have to accommodate irrational behavior, return to Keynes’ ideas, and incorporate the grimy realities of finance. “Economists," Krugman counsels, "will have to learn to live with messiness.”