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.