An enjoyable spat among economists

It may seem about as relevant as those mediaeval metaphysical debates about angels dancing on pinheads,  but a number of economists have been having a dandy online spat about whether anyone can claim to have predicted the financial crisis.

It started here, on Noah Smith's excellent Noahpinion blog.  (That's quite a misnomer, by the way -- he's got a million of 'em).   Smith first of all defines what he means by "predicting the crisis"; fair enough.  Then, rather unusually, he tests his definition by looking at the pronouncements of another academic, Steve Keen, who's Australian.  In the original article, Smith explains his choice by noting that Keen claimed "more loudly and confidently than just about anyone else on the planet" that he predicted the financial crisis.  But it's also apparent that Smith dislikes Keen, and in response to one of the many reader comments on the article  he says Keen is "the most incredible jerk", at least based on his Twitter persona.

In any event, Smith concludes on the basis of his reading of Keen's writings and pronouncements that he can't really claim to have predicted the crisis, at least not in the way that Smith defines it, though he's happy to admit that Keen, who is outside the mainstream of economic thinking -- he's a "post Keynesian" with a good dash of Marxian thought thrown in -- certainly did better than most of the big names in the profession.

Unsurprisingly, this conclusion has attracted a lot of comments -- over 160 at the time of writing -- from friends a and foes of Keen.  If you like a side of ad hominem mudslinging along with your economic theory, the comments are well worth a look.  One particularly interesting anti-Smith/pro-Keen response, however, cropped up elsewhere, on the avowedly Marxist "Occasional links and commentary" blog.  (Yeah, snappy title, isn't it?)  The author of that blog, David Ruccio,  effectively calls out Smith, accusing him of cowardice in attacking Keen and concluding:

Either admit that mainstream economics is a failure because it didn’t successfully predict the crisis or give up on the idea that predictive power is one of the key criteria of economics, which has served as an excuse for attempting to demonstrate that what mainstream economists are doing is science and what the rest of us are doing is non-science. You just can’t have it both ways.

Let's think about those choices for a second. A better-known economist than Smith, Keen or Ruccio,  the Canadian John Kenneth Galbraith, commented years ago that economists didn't make predictions because they thought they could foretell the future; they did it because people asked them to.  I've always thought that economic forecasting is a lot like weather forecasting: you can make predictions till you're blue in the face, but if events don't unfold as they have in the past, you're going to be wrong.  For all the increases in computer power and the advances in modelling techniques, both weather forecasting and its economic equivalent rely on precedent.  Last time the wind was from the east, it rained, so that's what I think will happen tomorrow. Last time the Fed cut interest rates......

The thing about major once-in-many-decades events, whether we're talking housing market collapse or Superstorm Sandy, is that they tend to fall outside any range that can reasonably be modelled.  That's why the people who really can claim to have seen the financial crisis coming are generally not model-based economists -- they're market people like Steve Eisner, or big picture guys like Nicholas Nassim Taleb. Maybe if you want to forecast financial crises, you don't need a fancy set of equations; you just need a good nose.

So, I can't agree with Ruccio that failure to predict the crisis means mainstream economics is itself a failure, because I would never have placed much confidence in such a prediction anyway.  (And as Ruccio admits, his own Marxian strand of thought is no better, having "successfully predicted 15 of the last 5 crises".  Some of those predictions were made a long time ago, too -- remember the T-shirts that sprang up in about 2009, with a picture of Karl Marx and the caption, "I told you this would happen"?)

That doesn't make either the mainstream or the Marxists a failure.  The 2008-201?? crisis can now be worked into both sides' models, and we can hope that policymakers will thereby be able to avoid making the same mistakes again.  Which only means, of course, that they'll make new ones instead.

Anyway, there is one economist who can claim he saw all this coming:  me.  Back in August 2002, HM the Queen awarded Alan Greenspan an honorary knighthood, known as a KBE.  I was aghast, and for a few weeks afterward my Bloomberg message header was "Greenspan KBE?? Must stand for King of the Bubble Economy".  Do I get a prize?