Chicago After The Crisis

If you haven’t already, check out the latest John Cassidy piece in the New Yorker on the Chicago School of Economics post-crisis, After the Blowup (not available online). Cassidy talks to those still very attached to the Efficient Markets Hypothesis as an explanation for the current crisis (Fama, Cochrane), and a new guard that is much more interested in the “plumbing” of the banking sector and financial markets, and uses Richard Posner’s turn to Keynesian thought as the driver.

Justin Fox and Ryan Avent have excellent follow-up.

Two quick things. First: there’s always a bit of headbutting between the finance people and the macroeconomics people, the “ketchup economists” versus “economics of ketchup” people if you know that old Larry Summers gag. I have to beg, as someone whose replicated many Fama/French papers, keeps the factors bookmarked, and even started drafting the why Fama should get the Nobel article when it seemed likely it would go to finance this year, that Eugene Fama stops talking about macroeconomics. He makes all academic finance people look like they don’t know what they are talking about, and finance has enough headaches with the credibility of their theories (to put it gently) than trying to take on Macro people with the Treasury View.

Second: I do want to point out this section about Raghuram Rajan (whose Saving Capitalism from the Capitalists is a book that I enjoyed and is relevant today). It’s pretty interesting:

In a new book he is working on, entitled “Fault Lines,” Rajan argues that the initial causes of the breakdown were stagnant wages and rising inequality. With the purchasing power of many middle-class households lagging behind the cost of living, there was an urgent demand for credit. The financial industry, with encouragement from the government, responded by supplying home-equity loans, subprime mortgages, and auto loans. (Notwithstanding the government’s involvement, this is ultimately a traditional Chicago argument: in response to changing economic circumstances, the free market provided financial products that people wanted.) The side effects of unrestrained credit growth turned out to be devastating-a possibility that most economists had failed to consider.

I didn’t expect to read that line of thought from Rajan. I’ve talked about this before, both housing equity as the new social contract, as well as the way excessive debt smoothed out the high-risk income-trapped structure of current families. Rather than focusing on how nice of a refrigerator the poorest can buy, it might be worthwhile to look at how inequality has played out in the middle-and-working classes here (which ultimately effects mobility among the poorest too). I’m curious as to the drivers he finds between inequality and a middle-and-working-class squeeze. Spending on housing and education are the obvious ones. As I eventually want to work on a “yes, we really do need to worry about inequality” piece, I’m really interested in seeing what Rajan finds; his book is out in June.

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11 Responses to Chicago After The Crisis

  1. J.P. says:


    While we’re on the subject of the EMH and the state of macro, I was wondering what you think about attempts at “Macro that takes the EMH seriously” like Scott Sumner’s nominal GDP targeting proposal:

  2. Want to point out that capitalism collapsed last September when Paulson, former CEO of Goldman Sachs, threw the TARP out to protect investment bankers from their failure.

    Am beginning to get fairly irritated with the rather enormous disparity in income we see today, and in the money set aside for the financial sector. In the “interview issue” of Newsweek, the Geithner interview includes the salacious detail that the financial system in 2007 represented 35% of corporate profits in 2007. That’s an unbelievable and unsustainable allocation of resources in a sector that is now setting aside quite a large fortune in bonuses.

    (More on that here:

    This, as the employment situation in the other economy – that economy outside of Wall Street, continues to languish. No TARP for THAT economy!

    Income for most people in America failed to grow at an appreciable rate in the last quarter century. (Reagan’s “trickle down” theory didn’t work as promised.) And many retirement and college funds have lost significant value. And upside-down mortgages are now around 25% of all mortgages in America today. And under- and unemployment is anywhere from 17 – 25%, depending on who you read.

    And yes, some consumer debt was irresponsible.

    But the millionaires on Wall Street were even more irresponsible (can’t claim stupidity defense and simultaneously claim to be the best and brightest who deserve large bonuses!) Today, they’re patting themselves on the back and getting a hefty bonus for their efforts. This after an amazing bailout of the financial sector involving billions of tax dollars.

    What we need to worry about is the financial sector-government partnership that is clearly so incredibly destructive to our economy.

  3. Here’s why Fama shouldn’t get a Nobel Prize in Economics:

    It would just be so harmful to the world.

    He would say all of these really harmful things, advocate all of these really harmful policies, and a lot of people would take them seriously because a Nobel Prize winning economist is saying it.

    Whenever smart economic policy is being advocated by economists who really know what they’re talking about in that area, Fama could come out against it, and really hurt its odds, because people and the press would think maybe it’s not good, the case isn’t clear, some Nobel Prize winning economists are against it.

    In addition, the things he would say, some based on the results of just ridiculous assumptions, and then the conclusions are literal or close to literal, would really embarrass the field of economics and hurt its credibility, and that would be very harmful too.

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  5. In general, something that really hurts the credibility of academia is overly literal interpretation, or otherwise poor interpretation, to reality, of models. And this goes for statistical as well as theoretical models.

    How often do academics say embarrassing things because they interpret literally to reality the results of a regression with five, or even ten variables, and an assumed linear data generating process, or any data generating process that can be written in one line, or even 50 lines. There’s a lot of simplification from reality and a lot of assumptions, often some very unrealistic. You have to then not assume reality will be exactly the same, or very close. You have to think carefully about how reality differs in making conclusions to reality from the model. You have to use all of the substantial information you have about reality in making your conclusions regarding it, formal and informal. Unfortunately, many academics don’t’ do this and say things which embarrass academia and hurt its credibility.

    I had a post on this, at:

    In fact, one of these days I want to do a post about this kind of thing with a fable. It will go something like this:

    Three economists are hiking, a high level thinking one, named Paul Klugman, an overly literal, mechanical thinking one named Chi Cago, and some other dude named Fred. They get hungry. So Fred eats a berry from a bush. He immediately keels over and dies. Then, Chi Cago grabs a berry. Paul Klugman says, stop don’t eat that, but Chi says why not, the berry that killed Fred was only a sample of one. You can’t tell anything from a sample of one.

    The moral: You should consider far more about your conclusions to the real world than just the formal information in your model. You can construct completely solid logic chains with additional information about the real world both formal and informal, logic chains that are anchored to much more realistic, or less strong assumptions.

    As you can see the story needs at the very least a lot of polish before I post it. This is why I comment far more than I post, lack of time to polish, check, double check, etc. Commenting I consider more like dinner conversation among colleagues.

    • Seth says:


      Your “Fable of the Berries” (apologies to Mandeville) does illustrate one key thing about Chicagoans — they never update their priors.

      • An important point, which I hope to make very clear if I ever get this good and vetted enough publish it as a post, is that some academic economists are very snobby about using informal evidence, including anecdotes, or even case studies (still a sample of one, they say). And this is the case even when you can, nonetheless, construct rock solid logic chains to important conclusions, or probabilities, that are anchored to very realistic or reasonable assumptions (like in the berry fable, in making a case for high probability of death). Assumptions that are often far more realistic than those depended on in regressions, advanced fancy statistical techniques, and theoretical modeling.

    • Seth says:

      If you were a young Dustin Hoffman adrift after graduation, I’d pull you aside and say: “One word: Bayes” (or maybe two words: “Bayesian statistics”). Normal human beings are intuitive Bayesians, and if the one and only berry eaten from a bush resulted in near-instant death, that would cause a pretty dramatic forward looking bias: “DANGER, WILL ROBINSON!”

      Naturally any properly trained Chicagoan would object that the policy matters we are discussing involve lots of data, not contrived one data-point fables, and the real problem is that of drawing the correct inferences. But again, any worthwhile answer involves “Bayes”. Go read anything by the invaluable Judea Pearl, and think a bit about the problem of constructing a convincing *causal* explanation out of noisy data sets.

      Our social scientists are so habituated to a world full of correlations but bereft of causality that they have altogether lost track of the necessary role of causal explanation in achieving reliable scientific knowledge. Instead, they just cheerfully tell ‘just so stories’ with causality pointing bass-akwards whenever it fits their ideological priors. Then mockingly challenge the rest of us to prove them wrong. Case in point, the whole urban legend about the Community Reinvestment Act causing the whole financial crisis.

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  8. Magpie says:

    I’ve just read Eugene Fama’s interview.

    God knows I’m opinionated and love lecturing people. But, for once, I’m completely speechless…

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