Bill Totten's Weblog

Monday, July 20, 2009

Why neoclassical economics is dead

by Steve Keen (May 30 2009)

In a classic case of 'they would say that, wouldn't they?', economic textbook authors McTaggart, Findlay and Parkin have recently defended economics {1} from the criticism that it failed in not predicting, let alone preventing, the financial crisis.

They claim that 'much economic research pointed to the emerging problem', note that evidence 'had started to accumulate from early 2007', and blame the crisis itself on 'egregious policy errors' by the Federal Reserve.

The implication of their article is that economic theory is healthy, and that what is needed is not change, but more of the same.

Bollocks. Economics is extremely unhealthy at all levels, from introductory pedagogy to high research.

It has become progressively sicker ever since the last great financial crisis - the Great Depression - because it actively retreated from the challenge the Great Depression posed to its belief in the innate stability of the market economy. Now, as the global economy enters what could well be the Second Great Depression, economic theory is as useless a guide to how the economy actually functions as it was in the late 1920s.

Just one name is enough to establish that McTaggart et al's claim about the health of economics is false: Hyman Minsky. Minsky long ago asserted that the true test of the relevance of a macroeconomic theory was its capacity to generate a Depression, since market economies had regularly found themselves in such a state.

Against such a measuring stick, every model discussed in a standard economics textbook, virtually every model in leading economic journals, and almost all the models that Treasuries and Reserve Banks around the world have constructed, are failures. They assume the economy tends to equilibrium (or worse, is always in it), making them incapable of explaining how a Depression - or even a recession - might occur. They are as useless as the theories of the 1920s which Keynes lampooned in his famous but misinterpreted statement about the long run:

'But this long run is a misleading guide to current affairs. In the long run we are all dead. Economists set themselves too easy, too useless a task if in tempestuous seasons they can only tell us that when the storm is long past the ocean is flat again.' (Keynes, A Tract on Monetary Reform, 1924).

Instead of being able to explain how this crisis came about, economists are reduced to blaming it on 'policy errors' by the Federal Reserve - precisely the claim that economists made about the last Great Depression.

Ironically, one of the most egregious such statements was made by Bernanke at Milton Friedman's ninetieth birthday {2}, when he said 'I would like to say to Milton and Anna: regarding the Great Depression. You're right, we did it. We're very sorry. But thanks to you, we won't do it again.' Now Milton Friedman's greatest disciple is becoming the whipping boy of neoclassical economists who are unwilling to consider the possibility that the model of the economy they share with Bernanke may be fundamentally flawed.

Will we have to go through a Third Great Depression before economists finally concede that it might not merely be 'policy errors' that cause such crises, but the innate workings of a credit-based market economy that they have manifestly failed to understand? On the record of articles like McTaggart et al's (and a curiously similar recent article by another textbook author, Gregory Mankiw {3}), this might well be the case.

As an economist outside the neoclassical mould, I predicted this crisis {4} in December 2005, using a non-equilibrium model of Minsky's Hypothesis that could generate a Depression. Such models have to become the mainstream in economics, which will require a revolution in economics: precisely what McTaggart et al and Mankiw are trying to forestall.

Related articles:

1. Too soon for obituaries: economics is alive and (reasonably) well {5}
2. The state of economics {1}
3. Whaling: What can law add to science, economics, ethics and politics? {6}
4. Rudd's Pacific plan: dead or alive? {7}

URLs in this post:

{1} defended economics:

{2} Milton Friedman's 90th birthday:

{3} Gregory Mankiw:

{4} predicted this crisis:

{5} Too soon for obituaries: economics is alive and (reasonably) well:

{6} Whaling: What can law add to science, economics, ethics and politics?:

{7} Rudd's Pacific plan: dead or alive?:

Copyright (c) 2009 East Asia Forum. All rights reserved.

Bill Totten


  • I would like to copy a short passage on flat earth economics from

    If The Earth were a flat plane extending to infinity in all directions, market forces would induce geologists to find sufficient fossil-fuel deposits to meet growing demand for primary energy simply by extending the frontiers of petroleum exploration. If the United States were a nation state the territory of which could be expanded indefinitely so as to capture infinite sunlight or wind or to discover arbitrarily many growing plants, renewable energy, too, could be harvested to any extent necessary to the economy. Presumably, part of the basement of the flat earth would be flooded with an extremely hot magma from which infinite energy might be withdrawn without more than infinitesimal cooling whereas the rest would be riddled with pockets of crude oil and natural gas that might be found by drilling deeper and deeper. Moreover, migrating animals driven from their original habitats by the expansion of the human population and its growing economy would find even better habitats safe from human incursion for as long as necessary. Regrettably, a nation with a finite territory in a finite world is the stage on which the Conservation-within-Capitalism Scenario is to be enacted. [snip]

    Please go to for the rest of the material that supports my principal thesis that the current crisis is caused by Peak Oil. All the rest is symptomatic of Peak Oil. Oil prices will rise dramatically again as our society becomes more feudalistic, unless, of course, a change occurs to a political economy that actually works.

    By Anonymous Tom Wayburn, at 3:47 AM, July 21, 2009  

  • P.S. For the sake of clarity, I would like to revise the last sentence in my earlier post:

    Oil prices will rise dramatically again as our society becomes more feudalistic, unless, of course, a political change occurs from the economy we have to an economy that actually works. Please see .

    Tom Wayburn, Houston, Texas

    By Anonymous Tom Wayburn, at 4:08 AM, July 21, 2009  

  • Dear Bill,

    I couldn't find an email to write to you so I comment on this post.

    I have worked for 15 years on economic depressions and, like you, I found out that its roots lies with credit.

    I would like you to join me in my implementation of my model: The Adjusted Credit Free, Free Market Economy.

    My blog is at

    and my email is

    By Blogger SPH, at 12:14 AM, August 04, 2009  

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