Part of the Answer is Hubris

In today’s Financial Times we find yet one more in a long series of not-so-flattering assessments of economists and their role in guiding both policy makers and titans of finance in this review($) of Gary Gorton’s new book Misunderstanding Financial Crises: Why We Don’t See Them Coming.

There is, of course, substantial economic literature on financial fragility … that seeks to explain credit bubbles in behavioural terms – exploring how, for example, prudent creditors are driven from the market as others disregard low-probability hazards and fail to charge appropriate risk premiums.

The interesting question is why diminishing attention was paid to these disaster myopia hypotheses and why financial stability experts in many central banks saw their status heavily downgraded in recent years.

Part of the answer is hubris. Developed world central bankers tended to believe that the “great moderation” – the period of uninterrupted growth that prevailed in the years before the crisis – was a reflection of their own sagacity in monetary management.
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The impact of these institutional changes was exacerbated by a lack of historical perspective. Here, Gorton hits an important bull’s eye, quoting approvingly a paper by economic historian Deirdre McCloskey, who noted in 1995 that “40 years of investment in mathematising economics has made it less acceptable among economists to admit to ignorance of mathematics than to admit ignorance of history”.

This looks like it’s worth reading, though, I’m afraid it may be more depressing than illuminating as five years after the financial crisis, little seems to have changed in how economists see the world.