“Memento”, the Meltdown and the Mainstream

Gerald Epstein

In “Up to Speed, but Still Lagging Behind” Matias Vernengo presents an important critique of Gary Gorton’s and Andrew Metrick’s (GM) “speed read” survey, “Getting up to Speed on the Financial Crisis” which is to be published in the Journal of Economic Literature, the predominant U.S. general literature survey journal in the economics profession. As Vernengo shows in his Triple Crisis blog piece, the Gorton and Metrick piece demonstrates just how far behind mainstream economics is in its understanding of the causes, dynamics and impacts of the financial crisis, both in an absolute sense, and also – and this was Vernengo’s main point – compared with the rich heterodox literature that both predicted the crisis and has been analyzing it dynamics since it has broken out.

In fact, the Gorton and Metrick piece presents an even more devastating picture of the ability of mainstream economics to “get up to speed” than Vernengo suggests. For it essentially admits that mainstream economics, which, for the last several decades, has cost society millions and millions of dollars on highly paid economists’ salaries at elite universities and prominent public institutions such as the IMF, the Federal Reserve and all the Federal Reserve Banks which have armies of economists– to say nothing of the high priced economists working in financial institutions themselves – completely missed the financial crisis and, according to Gorton and Metrick, are just now getting up to speed.

The first sentence of the piece, which justifies the authors’ quickie guide to the financial crisis, makes this crystal clear:

“Many professional economists now find themselves answering questions from their students, friends, and relatives on topics that did not seem at all central until a few years ago, and we are collectively scrambling to catch up. (p.1, emphasis added).”

Note how damning of mainstream macroeconomics this statement is: the key dynamics of the crisis – massive leverage and credit expansion, fed by the shadow banking system, that contributed to a housing bubble and crash – all elements of a macroeconomic dynamics well known to more than one generation of economists trained in the economics of Keynes and Minsky. They have studied many of these topics for decades, which to the mainstream are topics that “did not seem at all central until a few years ago”, that is after the meltdown and crash! Of course heterodox economists did not get everything right. But one can list, as did Matias Vernengo, many names of non-mainstream economists who discussed key elements of these factors and dynamics: Jane D’Arista and Tom Schlesinger identified the “shadow banking system” and the dangers there-in (they called it the “parallel banking system”) twenty years ago; Robert Pollin, working in a broadly Keynesian and Minskian framework, around the same time identified increasing household debt, partly driven by stagnant wages, as a concern; James Crotty, one of the world’s preeminent scholars of Keynes, and a close reader of Marx and Minsky has long identified credit as a key variable for determining the dynamics of income, employment and crisis; economists from the Levy Institute, (in addition to Wynne Godley mentioned by Vernengo) have long used Minskian concepts to discuss the dangers of financial instability; Charles Kindleberger, MIT economist and premier financial economic historian has identified over several centuries, the key role of credit in economic crises;  Lance Taylor and structuralist macroeconomists working in the Keynesian tradition broadly defined have identified leverage cycles and financial and macroeconomic forces that lead to economic crises; and the issue of fraud, stressed by William K. Black is of central importance, but ignored by the mainstream. And this is just a very short list of the many heterodox economists, in addition to the ones listed by Vernengo, that have seen these problems as central issues for decades.

What is particularly odd about the inability of mainstream economics to address these issues ex ante as opposed to after the fact (and then scramble to make little changes to their models to deal with them) is that after every big financial crisis there is, in fact a flurry of research where economists “re-discover” this issues, seemingly over and over again. After the so-called third world debt crisis, for example, there was a good deal of interesting work, for example by financial economists Guttentag and Herring on cognitive and institutional errors that lead to over-lending and crisis; or the dangers of financial liberalization as pointed out by Carlos Diaz Alejandro respected Columbia University Economist; or the key importance of historical episodes of excessive credit expansion re-discovered by well known mainstream economic historian Barry Eichengreen and his colleagues. There was a similar reexamination and rediscovery after the Asian Financial Crisis.

As Economist Phil Mirowski pointed out to me, the problem is that, like the protagonist in the movie Memento , who has no memory but is trying to solve the mystery of his wife’s murder, and has to remind himself every minute about what happened the minute before by writing notes and even tattooing himself , mainstream macroeconomists’  write themselves articles and books after every crisis and they then promptly forget what they wrote (no tattoos as far as I know).

I believe there is a reason for this: the mainstream never changes its underlying theory which is based on the erroneous ideas that financial markets are, by and large, perfectly self-governing and efficient and that the market economy has strong self-equilibrating forces that always bring the economy back to full employment, as Lance Taylor, James Crotty and others have forcefully explained. Since they won’t change their basic framework, they have no where to put the new information they get after each crisis. So, they forget it just as soon as they can. And they have no interest in reading the work of others whose framework naturally incorporates those matters that to them, did not seem at all central before. The tragedy is that it is these same economists who still control the elite economics departments, the main economics journals and hold the key policy making and research positions in our public institutions such as the Federal Reserve. Their stranglehold must be broken if we are going to break the Memento syndrome that is hindering sensible economics and economic policy.