Economics should never waste a good crisis
Max Planck, the Nobel-prize winning theoretical physicist, had it that “science advances one funeral at a time”. By that he meant that rather than anyone changing their mind — in response to reasonable argument or the presentation of novel data — younger generations with new ideas gradually replaced the older ones with fixed ideas.
With a little modification the same principle can be applied to economic theory: it advances one crisis at a time. The failure of policymakers to bring the Great Depression to an end in the 1930s spurred the adoption of Keynesian demand management. Then the Great Inflation of the 1970s led to the adoption of monetarism and its focus on controlling the quantity of money. The 2008 crisis led to a re-evaluation of theories of financial instability and a renewed focus on banking. As recently as this week America’s bout of inflation has sparked discussion about competing theories of its origin.
Crises offer opportunities partly because they show how economies react to a source of stress. Social scientists struggle compared with the physical sciences because there is no way of running an experiment on a whole society — you cannot get a research grant to shut down face-to-face economic activity for months at a time and then compare it to another economy that did not receive such a shock. While it has been by no means a controlled experiment, the experience of the pandemic can provide some evidence. There is much to learn, too, from pathology: early neurologists examined people with brain injuries to learn what function was carried out by the damaged part. Similarly seeing what causes recessions shows how economies behave when healthy.
The pandemic, of course, was originally a public health crisis rather than an economic one: it was not generated, internally, by the actions of businesses, consumers and policymakers, but externally, by a virus. Still there is much to learn, not least from the inflation that has followed the reopening and the policy response to it. One avenue is the possibility of “multiple equilibria”, an agenda that was being pursued before the shutdowns but looks at how there are different possible steady states for an economy and how it transitions between them — for instance, a low growth, low inflation one and a higher growth, higher inflation one.
Perhaps, instead of generating purely new ideas, each crisis leads to a re-evaluation of old ones. Keynesianism had something in common with earlier, previously rejected, mercantilist ideas. The 2008 financial crisis led to a re-evaluation of the work of Hyman Minsky, an oft-ignored American economist who was writing from a Keynesian perspective when the monetarism of the Chicago School held sway. The quantity theory of money, revived by Milton Friedman to become the bedrock of monetarism, was first articulated by the Polish astronomer Nicolaus Copernicus. Some argue the first version was in the Guanzi, a fourth century BCE Chinese text.
Crises not only lead to intellectual shifts but also political ones. The failure of a group of scholars helps promote the ideas of a new set while the poor response of one political party can lead to a different group taking over. The progressive supply-side policies advocated by US Treasury secretary Janet Yellen — arguing that economic capacity as well as demand can be reshaped by an activist state — would not have got much of a hearing in Donald Trump’s administration. Perhaps economists should reflect that they, like their subject of study, are prone to cycles, shocks and even scarring.