Krugman on 2008

 Frustrations of the Heterodox

It is true that economists failed to predict the 2008 crisis (and so did almost everyone). But this wasn’t because economics lacked the tools to understand such things — we’ve long had a pretty good understanding of the logic of banking crises. What happened instead was a failure of real-world observation — failure to notice the rising importance of shadow banking. Economists looked at conventional banks, saw that they were protected by deposit insurance, and failed to realize that more than half the de facto banking system didn’t look like that anymore. This was a case of myopia — but it wasn’t a deep conceptual failure. And as soon as people did recognize the importance of shadow banking, the whole thing instantly fell into place: we were looking at a classic financial crisis. 

What about the lousy policy response — austerity and all that? The key point here was that policymakers weren’t basing their decisions on conventional economics. On the contrary, they decided to blow off textbook macroeconomics and embrace exotic doctrines like expansionary austerity and a mysterious growth cliff at 90 percent debt relative to GDP. The disastrous policy responses that have perpetuated the slump are the result of mainstream economics having too little influence, not too much.