Chicago defends itself against Keynesian attacks

So in the battle for the soul of economics, Nobel prize-winner Paul Krugman declares victory for the New Keynesians.

In a 6,700 word article for the New York Times magazine, Krugman uses the experience of the last two crisis-ridden years not just to pin some of the blame on the Chicago school of free market mathematical economics. He seems to be heralding a new era.

I covered some small part of this ground in a report a fortnight ago, putting some of the Krugman-style criticisms directly to Robert Lucas, also a Nobel prize winner, and one of the leading lights of the dominant economic tradition in the past 30 years.

In the report, Nassim Taleb reveals that he is in talks with the King of Sweden to get the Nobel prize scrapped on account of “the damage done to society by incompetent economists”.

Given Robert Lucas is mentioned repeatedly in Krugman’s tome, I thought it might be useful to hear more fully from the man himself. So here are longer chunks of the interview I did with him in Chicago last month.

Key insights (interview, part 1)

• Ben Bernanke has avoided a depression by following the Milton Friedman prescription
• Inflation is a worry, because reversing printing money is ‘hard to do politically’ when unemployment is high
• Responds to the suggestion that the US is in the middle of a Keynesian frenzy

Here Lucas (interview, part 2)

• Defends the “efficient markets hypothesis” as a law of nature, but says Eugene Fama may have been wrong to use the word “efficient”
• Admits that he did not think that the fragile state of the US financial system was “worth thinking about”, but says neither did anyone else
• Defends the mathematisation of economics. ‘”It’s nonsense. A lot of people hate maths. They’re missing the boat and they’ve been missing it for centuries. You don’t need modern maths to have a financial crisis
• “Milton Friedman was right about some things, wrong about others, but maybe we should all apologise for not grasping the fragile nature of the banking system. I don’t see why Chicago in particular [should apologise]”
• Responds to the suggestion that Friedman might be turning in his grave, but points out that he would have backed a more tightly regulated banking system with “100 per cent reserves”

Finally Lucas talks about the crisis in economics (interview, part 3)

• A lot of it is economic positioning, he says, challenging Joe Stiglitz to point out when he predicted the fragility of the banking system
• admits that some economists overestinmated their abilities: “You had a bunch of guys who thought they knew a lot. It turns out we didn’t know a damn thing about the stability of the banking system, so it’s back to the drawing board and we’ll see what comes out of it.”

So I detect some sliver of academic recalibration in the brain of one of the nine Chicago economics Nobel laureates. But when it comes to it, Lucas pretty much stands behind most elements of the dominant economic consensus.

This debate is the academic backdrop to huge political decisions soon to be made in Britain and the US about whether and when to withdraw government stimuli.

In the UK, for example, in last week’s interview with Jon Snow, George Osborne said he backed monetary stimulus but was sceptical of fiscal stimulus, an approach in keeping with the Friedmanite tradition outlined by Lucas.

Gordon Brown is pretty much in the Krugman tradition. Alistair Darling is probably somewhere in the middle.

PS Anyone concerned about the lack of Austrian school will find plenty in Jim Rogers and hefty praise from Nassim Taleb too.