There was a bubble in housing -- everybody knows that now. There was a bubble in finance itself -- the financial share of national income reached an all-time high just before the crisis; not too many people know this. There was even an academic bubble in the field of economics: the perceived quality of results in the field, reflected in the salaries and number of positions for economics professors, was as inflated as the price of any McMansion -- surely every dean must understand this now? (Bayesian / Machine Learning comment: do these guys ever update? Or is it "All priors, all the time"?)
I suggest reading the whole thing. I've only excerpted the last three paragraphs below. (See also related essay by Richard Posner and this interview with Bill Janeway.)
How Did Economists Get It So Wrong?: ... So here’s what I think economists have to do. First, they have to face up to the inconvenient reality that financial markets fall far short of perfection, that they are subject to extraordinary delusions and the madness of crowds. Second, they have to admit — and this will be very hard for the people who giggled and whispered over Keynes — that Keynesian economics remains the best framework we have for making sense of recessions and depressions. Third, they’ll have to do their best to incorporate the realities of finance into macroeconomics.
Many economists will find these changes deeply disturbing. It will be a long time, if ever, before the new, more realistic approaches to finance and macroeconomics offer the same kind of clarity, completeness and sheer beauty that characterizes the full neoclassical approach. To some economists that will be a reason to cling to neoclassicism, despite its utter failure to make sense of the greatest economic crisis in three generations. This seems, however, like a good time to recall the words of H. L. Mencken: “There is always an easy solution to every human problem — neat, plausible and wrong.”
When it comes to the all-too-human problem of recessions and depressions, economists need to abandon the neat but wrong solution of assuming that everyone is rational and markets work perfectly. The vision that emerges as the profession rethinks its foundations may not be all that clear; it certainly won’t be neat; but we can hope that it will have the virtue of being at least partly right.
It takes some effort to assess and respond to a magnus opus like this one, but Jane Smiley, the Pulitzer Prize-winning novelist and essayist, has had a good go, setting forth her views in the Huffington Post.
Krugman, who as we all know is an economist himself who clearly thinks his trade is still a valid discipline, uses “failure” in the broadest sense - we suspect mainly to get a catchy headline. After all, economist-bashing is a popular sport these days, after banker-bashing and bonus rage, for politicians, regulators and the general public.
While Smiley she says she doesn’t “disagree” with any of Krugman’s assertions, she goes much, much further in slamming economists as the root of all evil, concluding:Unless and until these economists look within (do they have a “within”?) and understand the destruction they have caused, they will continue to tell an eager audience (the ruling class) that everything is fine, or soon will be, or ought to be, or…whatever. What has created our mess is arrogant no-nothingism at the highest levels, and as long as that obtains, there is no hope for the rest of us.