After a good twenty-five years of sustained growth (from WW II to 1969) certain things in economics are going to happen. As assumptions abounded about the end of the business cycle, a new Nobel Prize was created for economics. This also came about as recognition of the third century mark of the world’s first central bank. It was thought that because economists mastered the workings of this fundamental central bank, this led to faster and more dependable growth.
Though there were differences in the economic field, economists were admired and things were at an all time high. Of course, as they say, all good things must come to end. Public opinion dramatically declined and there began to be “furious arguments” within the economic community. By the mid 1970’s “theorists were embroiled in something of a civil war.”
The differences quickly turned to theoretical orientation and what was to be modeled and how. The author tells us what was mostly missed was that these arguments were about new mathematical tools addressing familiar economic problems and none of the new tools were more valuable as the theory of general equilibrium.
A for Tom.
ReplyDeleteThe idea of general equilibrium was not new. It had been around since Walras' in the late 19th century. In fact, it gets mentioned in this blog around Valentine's Day. Did you read those posts, Tom?
General equilibrium had been used in macroeconomics since Hicks put together a model based on Keynes' book. The problem (largely beyond this book or this class) is that economists were figuring out at this time that the Keynesian model was in conflict with the general equilibrium framework being used to model it. The solutions kept pointing to the Keynesian model being wrong, not the general equilibrium framework.
The metaphor used for macroeconomics at this time of peak public belief was "fine tuning". This is in the sense of an old-fashioned radio with a dial that could be finely adjusted to tune in your station just right. The public and politicians believed that macroeconomists knew enough to fine tune the economy.
Milton Friedman was already famous, but in 1968 he asserted that we weren't that good, and outlined how it was all going to fall apart. Within a couple of years, the breakdown started occurring just the way he predicted (with accelerating inflation) and Friedman's place as the greatest economist of the second half of the 20th century was cemented.