Friedman, Krugman and iceberg economics

The late Milton Friedman, as the Huffington Post reports, said this about the U.S. Federal Reserve in 1993:

"Having something like 500 economists is extremely unhealthy. As you say, it is not conducive to independent, objective research. You and I know there has been censorship of the material published. Equally important, the location of the economists in the Federal Reserve has had a significant influence on the kind of research they do, biasing that research toward noncontroversial technical papers on method as opposed to substantive papers on policy and results."

This is the Federal Reserve that brought you the Greenspan bubble and the "Bernanke Put" (and Bernanke has just been re-appointed) and the online newspaper's extensive investigations into the matter have revealed that

"The Federal Reserve, through its extensive network of consultants, visiting scholars, alumni and staff economists, so thoroughly dominates the field of economics that real criticism of the central bank has become a career liability for members of the profession."

The full article is well worth reading: it notes, for example, that the Fed has budgeted an astonishing $433m for "analysis, research, data gathering, and studies on market structure;" much of this is doled out to consulting assignments, papers, presentations and so on and it "keeps many of the influential editors of prominent academic journals on its payroll."

"Try to publish an article critical of the Fed with an editor who works for the Fed," says (economist James) Galbraith. And the journals, in turn, determine which economists get tenure and what ideas are considered respectable.

As TJN officials have found for years, leading journals have tended to shun the "let a thousand flowers bloom" approach, in favour of a "our way or the highway" one.

The Fed has a lock on the economics world," says Joshua Rosner, a Wall Street analyst who correctly called the meltdown. "There is no room for other views, which I guess is why economists got it so wrong."

This is alarming enough. Then, link this to what the bomb-throwing Willem Buiter called the "‘cognitive regulatory capture’ of the Federal Reserve by Wall Street.

So you have two things happening here: first, Wall Street captures the Fed; then the Fed captures the economics profession. Houston, we have a problem.

And don't get us started on the Bank of England. As it happens, David Blanchflower, former member of the Bank's Monetary Policy Committee, has been speaking out about it in the New Statesman, noting that:

"Why did the committee get it so wrong? From my perspective, it was hobbled by "group think" - or the "tyranny of the consensus". Governor Mervyn King, the old iron fist of the Bank of England, with his hawkish views on rates, dominated the MPC. Short shrift was given to alternative, dovish views such as mine."

And he adds that:

"The Bank of England may more suitably be called "the Bank of Economic Theory". Unfortunately, the economic theories failed just when we needed them most.
. . .
There were too few regulators on the staff. Instead, the Bank was stocked full of mathematical modellers who had never seen the inside of a commercial bank or a hedge fund - and the models they used failed to pick up on the greatest financial crisis in a century."

And what has been the result? Well, I think we all have some kind of idea. If you want a thoughtful and intelligent, fresh perspective on this, try Paul Krugman's latest long article on the subject, who asks

"What happened to the economics profession? And where does it go from here?"

The answer seems to be - we need to tear up, or at least rewrite, most of our textbooks. Krugman's article is a very good read, if a bit long, and it explores the hubris of economists such as Robert Lucas of the University of Chicago, who declared in 2003 that the

“central problem of depression-prevention has been solved.”

You might call it iceberg economics. Everyone was focusing on this stuff that was going on the surface, while ignoring the darker, deeper and bigger "don't look under the water" realities - offshore and the overlapping shadow banking system, for example -- underneath.

And let's not forget another important ingredient: the deafening social silence.