So, for example, what do I say when I read something like this from someone who apparently considers himself a bold rebel against orthodoxy?
"Rational thinking is an important aspect of human nature, but we have imagination, we have ambition, we have irrational fear, we are swayed by other people, we get indoctrinated and we get influenced by advertising," he says. "Even if we are actually rational, leaving it to the market may produce collectively irrational outcomes. So when a bubble develops it is rational for individuals to keep inflating the bubble, thinking that they can pull out at the last minute and make a lot of money. But collectively speakingâ.â.â.â"
My answer, to put it in technical terms, is "Well, duh." Maybe grad students at some departments, who are several generations into the law of diminishing disciples, really donâ(TM)t know that rational behavior is at best a useful fiction, that markets arenâ(TM)t perfect, etc, etc. But does this come as news to Robert Shiller? To Ben Bernanke? To Janet Yellen? To Larry Summers? Would it have come as news to Irving Fisher or Walter Bagehot?
The question is what you do with this insight.
There is definitely a faction within economics that considers it taboo to introduce anything into its analysis that isnâ(TM)t grounded in rational behavior and market equilibrium. But what I do, and what everyone Iâ(TM)ve just named plus many others does, is a more modest, more eclectic form of analysis. You use maximization and equilibrium where it seems reasonably consistent with reality, because of its clarifying power, but you introduce ad hoc deviations where experience seems to demand them â" downward rigidity of wages, balance-sheet constraints, bubbles (which are hard to predict, but you can say a lot about their consequences).
You may say that what we need is reconstruction from the ground up â" an economics with no vestige of equilibrium analysis. Well, show me some results. As it happens, the hybrid, eclectic approach Iâ(TM)ve just described has done pretty well in this crisis, so you had better show me some really superior results before it gets thrown out the window.