After a massive financial collapse, an ensuing deep economic slump from which the major capitalist economies are making an exceedingly slow and stuttering recovery, the Nobel Institute in Sweden has decided to award its much revered economics prize not to any economist who may have predicted or explained the crisis, but to two economists whose works have promoted the economic theories that ignore the existence of volatility or crises in modern capitalism.
Economists Thomas Sargent of New York University and Christopher Sims of Princeton were given the prize for their research on “the causal relationship between economic policy and different macroeconomic variables such as GDP, inflation, employment and investments.” That sounds good. Does this mean that the work of Sargent and Sims can help us understand why GDP suddenly contracts in an economy, why unemployment rises and why we can have an investment slump? Well, no. Sargent is a member of the so-called new classical school of economics and Christopher Sims is a econometrics guru. Both claimed to have demolished the basic ideas of Keynesian economics. Their econometric work is based on what is called the rational-expectations model, whereby individuals can be assumed to take rational decisions on buying, selling or saving. And they can anticipate future conditions and adjust according to their best interests. As a result, markets can efficiently allocate resources.
Sargent defended these assumptions recently, when he said that the ‘New Keynesian model’ (which supposedly reconciles neoclassical assumptions of market capitalism operating in equilibrium with Keynes’ view of a divergence between aggregate demand and supply in an economy) “was designed to describe aggregate economic fluctuations during normal times when markets can bring borrowers and lenders together in orderly ways, not during financial crises and market breakdowns.” So it’s not very helpful in the current economic crisis then?
Sargent’s theories are closely allied to the dominant mainstream economics theory, the Efficient Markets Hypothesis, that claims to prove that market prices reflect efficiently the decisions of individuals in the market place. So the price of any given asset is completely correct: it cannot be over or undervalued. It is the right price, nothing more nor less. Markets get things right as long as all the information for making decisions on buying or selling is available. Thus, the US housing bubble was not a bubble: housing prices were where they were – at that’s that. Am I making sense?
The conclusions drawn from the Great Recession by one of the key followers of the EMH, Eugene Fama, was that “we don’t know what causes recessions… we’ve never known. Debates go on about what caused the Great Depression. But economics is not very good at explaining swings in economic activity…. If I could have predicted the crisis, I would have. I’d love to know more about causes business cycles. ” Perhaps if Sargent and Fama adopted a completely different approach that did not assume equilibrium or that what an individual might do cannot be transposed to an economy, they may have been able to explain more about the cause (s) of ‘business cycles’. As another Nobel Prize winner and guru of neoclassical economics , Robert Slow admitted recently, “the macroeconomics that dominates serious thinking, certainly in our elite universities… seems to have absolutely nothing to say about the problem. Not only does it offer no insight or guidance, it really has nothing useful to say.”
That has not stopped Sargent and Sims coming up with policy proposals from their theoretical work. Both advocate the minimum interference by government in the market place, as the free market, driven by the rational decisions of individuals, will eventually establish equilibrium in markets and thus growth without crises in the economy. Using the most refined heights of mathematical economics, they have argued that governments usually cause inflation when budget deficits are massive. And Sargent has fiercely attacked Barack Obama’s stimulus packages and warned that social welfare would increase unemployment, while providing insurance for customer’s bank deposits only allows the banks to continue with excessive risk-taking.
Once again, the Nobel Institute has continued its honoured tradition of awarding prizes to ‘worthy winners’ – like the Peace Prize to Henry Kissinger in 1973, Mother Teresa in 1979, Yasser Arafat and Shimon Peres in 1994, Jimmy Carter in 2002 and Barack Obama in 2009. It won’t give you the grim list of economic winners.