How Did He Get It So (Largely) Right?

Paul Krugman's article last week in the Times "How Did Economists Get It So Wrong" was remarkable in two ways.

First, it neatly captured the essence of how two schools of economists (which includes finance academics) differ in their approach to markets. Krugman presented this so skillfully that it can be grasped by readers without a background in economics. At the same time it was immensely useful and interesting as a recap and to put issues in perspective even for practitioners in the field.

Second, the article is fully eight pages long - much longer than his Op-Eds, and I thought it would be too "heavy" for most readers. Yet to my surprise it was the most popular and emailed article for a couple of days. That's as much of a tribute to the caliber of the Times' readership as to Krugman's writing. I strongly recommend this piece to anyone who wants to get an insightful overview (admittedly from Krugman's eyes) of the rival schools of thought and of the issues separating them.

Though I studied at Chicago, I find myself agreeing with much of what Krugman says. This is particularly so in regard to the Keynesian belief in helping the economy through temporary stimulus spending, and events showing markets can be grossly inefficient for long periods of time. In fact, in my post back on Feb. 10 I had voiced strong misgivings about the statements of some prominent Chicago professors who opposed the fiscal stimulus plans.

However, Krugman is still a little unfair to the Chicago school by painting them as largely unified against Keynesian beliefs, firmly believing in efficient markets, and lumping them all as "freshwater" economists. Krugman did acknowledge that the danger of a financial market meltdown was first pointed out by another Chicago economist, Raghuram Rajan. But Krugman didn't mention that a leading academic of the theory of "behavioral economics" (rival to efficient markets theory) also belongs to the Chicago school. That professor is Richard Thaler who is at least as well known as the other proponent of behavioral economics, Robert Shiller, whom Krugman repeatedly mentioned.

In fact, during my time there I had found it great about Chicago that rival theories could be freely and vigorously debated in the weekly finance workshops and other academic forums. I remember how Eugene Fama (dubbed "the father of the efficient market theory") in his highly popular fnance class had included Thaler's papers as required reading. And though a lot of friendly riffs about opposing beliefs were exchanged, Thaler used to be invited to Chicago's finance workshops to discuss his papers even when he taught at MIT or Cornell. Then about 10 years ago he was welcomed into Chicago as a tenured professor.

But apart from setting the record straight about Chicago and other other schools (about their not having monolithic, misplaced beliefs) I really like and commend Krugman's article.