I[John Cassidy] spoke to Posner in his chambers at the Federal courthouse in downtown Chicago, where he sits on the United States Court of Appeals for the Seventh Circuit. I began by telling him that I was researching an article about how the financial crisis had affected Chicago economics, and, indeed, economics as a whole.
At this distance from the financial blow up, what was the nature of the intellectual challenge it presented?
I think the challenge is to the economics profession as a whole, but to Chicago most of all.
Has there been much self-analysis, or critical reassessment of long held positions, here in Chicago?
I don’t think so. There are people here who are not part of the orthodox Chicago School—the Bob Lucas/Gene Fama crowd—people like Raghu Rajan, Luigi Zingales, and Dick Thaler. But I don’t think there has been much in the way of re-examination.
What about your critique of some aspects of Chicago economics, which you detailed in your recent book, “A Failure of Capitalism?” Have you received much of a reaction to that?
I’ve had an exchange with Lucas and Fama—some of it on my blog at The Atlantic. It’s all very civil: not angry. But I think they are pretty much sticking to their guns. (Laughs.) Even before this, macro was seen as quite a weak field, and the efficient markets theory had taken a lot of hits: the behavioral finance school—Andrei Shleifer, Bob Shiller. Already, the orthodox Chicago position had been under criticism. But last September’s financial collapse came as a big shock to the profession.
What is Chicago macroeconomics? And what went wrong with it?
Going back to Milton Friedman, there was the idea that the Great Depression was a product of inept monetary policy and could have been avoided if only the Fed had not tightened the money supply. That remains very controversial, but also it didn’t prepare anybody for what has happened recently. The concern then was that the Fed had raised rates prematurely during the Depression. But now the concern is that the interest rates were too low during the early 2000s, and that is what precipitated all the trouble. For that, the monetarists were unprepared. When the crisis began Bernanke reduced the federal funds rate essentially to zero and nothing happened. That was the point at which Friedman’s macro theory, along with Lucas’s macro theory, did not have a clue as to what had happened. That was pretty bad.
Also, and more interesting to me, it called into question a whole approach to economics—one that is very formal, making very austere assumptions about human rationality: people have a lot of information, a lot of foresight. They look ahead. It is very difficult for the government to affect behavior, because the market will offset what it does. The more informal economics of Keynes has made a big comeback because people realize that even though it is kind of loose and it doesn’t cross all the “t”s and dot all the “i”s, it seems to have more of a grasp of what is going on in the economy.
In the fall, you wrote a big piece in The New Republic in which you declared yourself to be a Keynesian. What was the reaction to that article?
I haven’t got much of a reaction from my colleagues. Bob Barro (a conservative economist at Harvard) sent me an email in which he referred me to an early article of his. It was a good article.
I think there is a question of whether modern economics, including Chicago economics, is too formal and too abstract. Another question is whether modern economists have lost interest in or feel for institutional detail that might be very important. I don’t know how many of these economists really knew anything about how modern banking operates, how the new financial investments operate—collateralized debt obligations, credit default swaps, and so on.
So modern economics is too formal, and it has lost interest in institutional reality: is that what you are saying?
You don’t want to characterize all of economics in that way. What we tend to think of as the Chicago approach is great skepticism about government and faith in the self-regulating characteristics of markets: that’s the essential outlook of Chicago. In addition, there is the increasing mathematization of economics. That is not necessarily Chicago-led. Chicago once resisted that—people like Ronald Coase and George Stigler. Even Gary Becker—he’s more mathematical than they are, but he’s not as mathematical as, say, M.I.T. and Berkeley economists.
Modern economics is, on the one hand, very mathematical, and, on the other, very skeptical about government and very credulous about the self-regulating properties of markets. That combination is dangerous. Because it means you don’t have much knowledge of institutional detail, particular practices and financial instruments and so on. On the other hand, you have an exaggerated faith in the market.
That was a dangerous combination.
But that is not all there is in economics. There is also behavioral economics, which has made a lot of progress. It’s about challenging the assumptions about markets because of human irrationality. I don’t much like it myself, because I think they are very vague about what they mean by rationality. They use terms like “fairness,” which are really contentless. But some of their skepticism is warranted. And behavioral finance, I find very convincing. It’s obvious if you look at how people trade in markets: they are not calculating machines that flawlessly discount future corporate profits.
I put a lot of emphasis on the Frank Knight (a famous Chicago economist who taught at Chicago from the nineteen-twenties to the nineteen-sixties) and Keynes view of uncertainty. That makes economists very uncomfortable, because it is very hard to model. Once you introduce uncertainty, it means that a lot of consumer behavior is not going to be easily modeled as cost-benefit analysis.
In that sense, then, your version of Keynesianism is what some professional economists would refer to as “Post-Keynesianism”?
Yes. I’ve read Davidson. (Paul Davidson, a professor at University of Tennessee is a leading post-Keynesian.) I’ve read some of those people. But I don’t really get much out of it that isn’t in Keynes. I’m kind of stalled in the General Theory and his essay in the Q.J.E. (In 1937, a year after the publication of The General Theory of Employment, Interest, and Money, Keynes wrote an expository article in the Quarterly Journal of Economics.)
So, in sense, you see yourself reviving an older Chicago tradition—Knightian economics—which in some ways is closer to Keynes?
Not only that, but there is a curious link between Keynes and Coase, even though they are at opposite ends of the political spectrum. I never heard Coase mention Keynes, but I am sure he would have regarded him as a dubious left-wing character Coase is very, very conservative. But they are very similar in their informality. Coase was always saying that he didn’t believe in utility maximization. He didn’t believe in equilibrium. Both of them, they are not concerned with the kind of axiomatic reasoning where you start with human beings assumed to have rational calculators inside them. They are much more likely to take people as they are.
And Knight was not at all a formal economist. His book “Risk, Uncertainty, and Profit,” I read it for the first time. It really was excellent. There’s no math. Coase in his later work: no math. Keynes in the General Theory: some math, but it’s not central to his argument.
Do you regard yourself as an economist?
No. (Smiles) I’m not a professional economist. I don’t have any economics training. But I’m interested in it. I’m not bashful about writing about it.
You’ve received some criticisms from professional economists—from Brad De Long, of Berkeley, and from others.
Yes. These people are impossible. I haven’t read (DeLong’s) academic work, just his blog. His criticism of me was crazy. He had me fighting a last-ditch stand for Chicago—the exact opposite of what I wrote.
It does bother me about economists—not just (Paul) Krugman and De Long; it’s not just a liberal versus conservative thing. Some conservative writing bothers me also. They are not at all reluctant about taking extreme positions in an Op-Ed, or in blogs, and so on. It really demeans the profession. Krugman is obviously a good economist. He’s got this book, “The Return of Depression Economics.” It’s very good...But his column for The New York Times is really irresponsible, nasty. Sometimes on his blog he makes accusations. In one of his columns, he suggested that conservatives were traitorous. He used the word “treason.” I’m bothered by that. If you have a very politicized academic profession, you lose your confidence in their objectivity
Well, some Chicago economists also express very strong views. John Cochrane (a professor at Chicago’s Booth School of Business) for example, says that government stimulus programs don’t have any impact at all on unemployment and G.D.P.
That’s another reason to be distrustful of the profession. You have irresponsible positions about the stimulus on both sides. What are people supposed to believe?
Has your critique of the efficient markets hypothesis made you rethink your view of markets outside of finance?
Even before this, I had become less doctrinaire about markets. For example, one of the topics Gary Becker and I debated on our blog was New York City’s ban on transfats. I supported that. The country has an obesity problem. I didn’t think that just listing the amount of transfats on a menu would deal with it—people don’t know this stuff. I thought a ban, even though it violated freedom of contract, made sense.
What has been Becker’s reaction to your views?
You mean about the economy, about Keynes. I think he disagrees. We had a debate before the university women’s board some months ago. He’s very down on the stimulus. Some of the things we agree about. I thought the cash-for-clunkers program was quite pointless.
Now that we appear to be coming out of the recession, the right is saying things aren’t too bad after all, and that markets are resilient. The left is saying without government intervention we would be back in the nineteen-thirties. What do you think?
It depends what you mean by government intervention. If the government had limited itself to reducing the federal funds rate and had not bailed out the banks, we could easily have gone down the route of the nineteen-thirties. On the other hand, if there had just been a bank bailout and no stimulus, then, no, we would not have gone down as far as the nineteen-thirties, because the economy is different now. In particular, (there’s been) the shrinkage of the construction and manufacturing industries. That is where unemployment was highest in the Depression. And we have the automatic stabilizers—unemployment insurance, and so on. It wouldn’t have been as bad, but it could have been considerably worse without the stimulus. You can never be certain how far down an economy will spiral.
After all the federal government has done, does the amount of public intervention in the economy not worry you?
I think it is worrisome. A lot of things they have done, I don’t approve of. I don’t like the idea of taking an ownership stake in General Motors: I think that’s very bad. I don’t like this messing with compensation: that’s unhealthy. And I’m particularly concerned about the deficits, and what health reform will do to what are already massive deficits. So I don’t think the government’s handling of this has been flawless, by any means. But I think the stimulus probably was essential.
As a result of all that has happened, what has the economics profession learned?
Well, one possibility is that they have learned nothing. Because—how should I put—it market correctives work very slowly in dealing with academic markets. Professors have tenure. They have a lot of graduate students in the pipeline who need to get their Ph.Ds. They have techniques that they know and are comfortable with. It takes a great deal to drive them out of their accustomed way of doing business.
Robert Lucas takes a very hard line on this. He says the theory of depressions is something economics isn’t good at. He hasn’t been doing depression economics, so he’ll stick with what he’s doing and unapologetically.
But isn’t Lucas still offering policy advice on the basis of his theories?
Yes, he is occasionally. But he’s a real academic. He’s content with his academic career and his models and so on. And it isn’t very clear what replaces his modern vision. It isn’t as if there is a school of economics that has great ideas and techniques for dealing with our economic situation.
What about Chicago economics in particular? At this stage, what is left of the Chicago School?
Well, the Chicago School had already lost its distinctiveness. When I started in academia—in those days Chicago was very distinctive. It was distinctive for its conservatism, for its 1968 fidelity to price theory, for its interest in empirical studies, but not so much in formal modeling. We used to say the difference between Chicago and Berkeley was Chicago was economics without models, and Berkeley was models without economics. But over the years, Chicago became more formal, and the other schools became more oriented towards price theory, towards micro. So, now there really isn’t a great deal of difference.
Ronald (Coase) is alive, but he’s very, very old. He’s not active. Stigler is dead. Friedman is dead. There’s Gary (Becker) of course. But I’m not sure there’s a distinctive Chicago School anymore. Except there are probably a higher percentage of conservative people here, but not all. Jim Heckman—not particularly conservative at all. He’s very distinguished. Steve Levitt—he’s very famous. I don’t think he’s conservative. You’ve got people like (Richard) Thaler. So probably the term “Chicago School” should be retired.
There were people—people like Stigler and Coase, Harold Demsetz, Reuben Kessel, and people at other schools like Armen Alchian. They were people rebelling against the very liberal economics of the nineteen-fifties—very Keynesian, very regulatory, very aggressive anti-trust, little faith in the self-regulating nature of markets. Francis Bator, who’s a very distinguished Harvard economist, he wrote a famous essay entitled “The Anatomy of Market Failure.” And he gave so many examples of market failure that you couldn’t believe a market could exist. You have to have an infinite number of competitors, full information, you can’t have any economies of scale, and so on. It was too austere. That was what the Chicago people, with their more informal approach, rebelled against. So we had our moment in the sun, but by the nineteen-eighties the basic insights of the Chicago School had been accepted pretty much worldwide.
Where the divide continues is in macro—in business cycle economics. That’s where you have these very liberal people at Berkeley, Harvard, M.I.T., and so on, and very conservative people like Lucas, Fama, and so on, in Chicago.
You are famous for extending economic analysis, and a free-markets approach, to the law. Has the financial crisis undermined your faith in markets and the price system outside of the financial sector?
No. But of course one of the more significant Chicago (positions) was in favor of deregulation, based on the notion that markets are basically self-regulating. That’s fine. The mistake was to ignore externalities in banking. Everyone knew there were pollution externalities. That was fine. I don’t think we realized there were banking externalities, and that the riskiness of banking could facilitate a global financial crisis. That was a big oversight. It doesn’t make me feel any different about the deregulation of telecommunications, or oil pipelines, or what have you.
Talking of banking externalities, isn’t that an application of traditional price theory? Going back as far as Pigou, economists have talked about externalities in many parts of the economy.
There’s nothing inconsistent with basic economic theory in externalities. Of course, you have to know a lot about banking, and that was not the case with economists. Odd in a way, because macroeconomists and finance theorists have always been interested in banking, but I don’t think they really understood a lot about it.
Fonte: New Yorker
