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What have we learned from the Global Financial Crisis?

First published in 2011 as Quiggin, John. ‘What Have We Learned from the Global Financial Crisis?’ Australian Economic Review 44: 355–65. doi.org/10.1111/j.1467-8462.2011.00661.x.

Introduction

The Global Financial Crisis (GFC) that brought the world’s financial system to the brink of failure in September 2008 was the most significant economic event since the breakdown of the Bretton Woods system in the 1970s. Three years on, unemployment rates in the USA and the EU remain close to 10 per cent. The expenditure required to salvage the system has pushed public debt to dangerously high levels in many countries. Millions of households have faced bankruptcy or foreclosure, and millions more are still at risk.

The crisis was not anticipated by the great majority of the economics profession. Even as the financial system began to collapse in 2007 and 2008, central banks insisted that the situation was under control, and that the modest measures they had undertaken would be sufficient to maintain financial stability and economic prosperity. Admittedly, central banks are more or less obligated to maintain a confident stance in public, but there is little evidence of any private misgivings, let alone preparation for a crisis on the scale that ultimately emerged.

Meanwhile, academic macro-economists were celebrating the convergence between Real Business Cycle and New Keynesian schools (aka ‘freshwater’ and ‘saltwater’), symbolised by the development of dynamic stochastic general equilibrium (DSGE) theory. Dynamic stochastic general equilibrium is the idea that macro-economic analysis should not be concerned with observable realities like booms and slumps, but with the theoretical consequences of optimising behaviour by perfectly rational (or almost perfectly rational) consumers, firms and workers. This convergence of the two schools fitted nicely with the ‘Great Moderation’, a reduction in the volatility of output and other economic variables beginning in the 1980s and first noted in the early 2000s. The results may be seen in the proceedings of a conference on the topic (Woodford 2009). I discuss the Great Moderation and DSGE theory later in this chapter.

It is of interest, then, to consider how policymakers and academic economists responded to the shock of September 2008. A large and unexpected macro-economic crisis, originating in financial markets, might be expected to yield important lessons about economic policy, economic theory and the behaviour of crucial economic variables, reflected in substantial changes in the research program of academic macro-economics, the settings of economic policy and the way in which economics is taught.

In reality, however, such changes have been modest to the point of invisibility. After a brief, though intense, embrace of Keynesian stimulus policies in the immediate aftermath of the crisis, policymakers have largely returned to the policies that produced the crisis.

Within academic economics, the effects were even more limited. While Keynesian economists such as Paul Krugman had more influence in the policy debate than before, their criticisms have had little or no impact on the practice of academic economists. Reading recent issues of the leading general journals, it would be virtually impossible to infer that the world economy had approached collapse in late 2008, that US unemployment remains near 10 per cent or that economic theory had been affected in any way by these events.

The aim of this article is to examine the lessons of the GFC, considered in terms of three different questions:

1. What should we (the economics profession) have learned from the GFC?
2. What, if anything, have we actually learned about economic theory and policy?
3. What have we learned about ourselves as a profession?

My answer to the first of these questions will be, in large measure, a summary and update of the arguments presented in Quiggin (2010). My answers to the second and third questions are thoroughly dispiriting. The lessons of the crisis have been at best half-learned, and in some cases, profoundly mistaken conclusions have been drawn.

What should we have learned?

A massive financial macro-economic crisis, largely unforeseen by the economics profession, should, at a minimum, cast doubt on the validity of the ideas that guided financial and macro-economic policy in the years leading up to the crisis. In the case of the GFC, the crisis arose in financial markets that had undergone a massive expansion as a result of economic theories and policies that arose in the 1970s, following the breakdown of an earlier consensus-supporting financial regulation and Keynesian macro-economic policies. These ideas have been variously, and mostly pejoratively, referred to as ‘neoliberalism’, the ‘Washington Consensus’ and ‘economic rationalism’. In Quiggin (2010), I used the more neutral term, ‘market liberalism’.

Quiggin (2010) listed five ideas central to market liberalism. Some are economic theories, some policy prescriptions, and some claims about the way the economy works. The ideas I discussed and dissected were as follows.

The Great Moderation

This is the idea that the period beginning in 1985 was one of unparalleled macro-economic stability that could be expected to endure indefinitely. Even when it was alive, this idea depended on some dubious statistical arguments and a willingness to ignore the crises that afflicted many developing economies in the 1990s. But the Great Moderation was too convenient to cavil at.

Of all the ideas I have tried to kill, this one seems most self-evidently refuted by the crisis. If double-digit unemployment rates and the deepest recession since the 1930s do not constitute an end to moderation, what does? Yet, academic advocates of the Great Moderation hypothesis, such as Coibion and Gorodnichenko (2010), have stuck to their guns, calling the financial crisis a ‘transitory volatility blip’.

More importantly, central banks and other policymakers are planning a return to business as usual as soon as the crisis is past. Here, ‘business as usual’ means the policy package of central bank independence, inflation-targeting and reliance on interest rate adjustments that have failed so spectacularly in the crisis. Speaking at a symposium for the 50th anniversary of the Reserve Bank of Australia earlier this year (2010), the president of the European Central Bank (ECB), Jean-Claude Trichet, offered the following, startlingly complacent analysis:

We are emerging from the uncharted waters navigated over the past few years. But as central bankers we are always faced with new episodes of turbulence in the economic and financial environment. While we grapple with how to deal with ever new challenges, we must not forget the fundamental tenets that we have learned over the past decades. Keeping inflation expectations anchored remains of paramount importance, under exceptional circumstances even more than in normal times. Our framework has been successful in this regard thus far.

The efficient markets hypothesis

This is the idea that the prices generated by financial markets represent the best possible estimate of the value of any investment. In the version most relevant to public policy, the efficient markets hypothesis states that it is impossible to outperform market valuations on the basis of any public information.

Support for the efficient markets hypothesis has always relied more on its consistency with free-market ideas in general than on clear empirical evidence. The absurdities of the dotcom bubble-and-bust of the late 1990s ought to have killed the notion. However, given the explosive growth and massive profitability of the financial sector in the early 2000s, the hypothesis was too convenient to give up. Some advocates developed elaborate theories to show that the billion-dollar values placed on companies delivering dog food over the internet were actually rational. Others simply treated the dotcom bubble as the exception that proves the rule.

Either way, the lesson was the same: governments should leave financial markets to work their magic without interference. That lesson was followed with undiminished faith until it came to the edge of destroying the global economy in late 2008.

Even now, however, when the efficient financial markets hypothesis should be discredited once and for all, and when few are willing to advocate it publicly, it lives on in zombie form. This is most evident in the attention paid to rating agencies and bond markets in the discussion of the so-called ‘sovereign debt crisis’ in Europe, despite the fact that it was the failure of these very institutions, and the speculative bubble they helped to generate, that created the crisis in the first place.

Dynamic stochastic general equilibrium

The DSGE macro arose out of the breakdown of the economic synthesis that informed public policy in the decades after World War II, which combined Keynesian macro-economics with neoclassical micro-economics. In the wake of the stagflation of the 1970s, critics of Keynes, such as Lucas (1980), argued that macro-economic analysis of employment and inflation must instead be derived from, and therefore be consistent with, neoclassical micro-economic foundations.

The result was a thing of intellectual beauty, compared by the IMF’s Chief Economist, Olivier Blanchard (2008), to a haiku. By adding just the right twists to the model, it was possible to represent booms and recessions, at least on the modest scale that prevailed during the Great Moderation. Moreover, modestly Keynesian twists yielded support for the dominant monetary policy framework, based on Taylor rules (Taylor 1993). But, when the crisis came, all this sophistication proved useless. It was not just that DSGE models failed to predict the crisis; they also contributed nothing to the discussion of policy responses, which has all been conducted with reference to simple Keynesian and classical models that can be described by the kinds of graphs found in introductory textbooks.

Krugman (2009) has written that the profession has mistaken beauty for truth, a sentiment shared by many others. We need macro-economic analysis that is more realistic, even if it is less rigorous. That said, the supertanker of an academic research agenda is hard to turn, and the DSGE approach has steamed on, unaffected by its failure in practice. As of September 2011, Google Scholar lists more than 5,000 articles on DSGE macro-economics published since 2009, and many more are on the way.

The trickle-down hypothesis

The trickle-down hypothesis holds that policies that benefit the wealthy will ultimately help everybody. Unlike some of the zombie ideas discussed here, trickle-down economics has long been with us. The term itself seems to have been coined by cowboy performer Will Rogers (1932), who observed Herbert Hoover’s tax cuts of 1928: ‘The money was all appropriated for the top in the hopes that it would trickle down to the needy. […] Mr Hoover … dident [sic] know that money trickled up’ (Rogers, 1932).

Trickle-down economics was conclusively refuted by the experience of the postwar economic golden age. During this ‘great compression’, massive reductions in inequality brought about by strong unions and progressive taxes co-existed with full employment and sustained economic growth.

Whatever the evidence, an idea as convenient to the rich and powerful as trickle-down economics cannot be kept down for long. As inequality grew in the 1980s, supply-siders and Chicago school economists promised that, sooner or later, everyone would benefit. This idea gained more support during the triumphalist years of the 1990s, when, for the only time since the breakdown of Keynesianism in the 1970s, the benefits of growth were widely spread, and when stock-market booms promised to make everyone rich.

The GFC marks the end of an economic era and provides us with a position to survey how the benefits of economic growth have been shared since the 1970s. The answers are striking. Most of the benefits of US economic growth went to those in the top percentile of the income distribution. By 2007, just one out of 100 Americans received nearly one-quarter of all personal income, more than the bottom 50 per cent of households put together (Saez 2009).

The rising tide of wealth has conspicuously failed to lift all boats. Median household income has declined in the USA over the last decade and has been stagnant since the 1970s. Wages for men with high-school education have fallen substantially over the same period.

Whatever the facts, there will always be plenty of advocates for policies that favour the rich. Sowell (2010, 283) provides a fine example, observing:

If mobility is defined as being free to move, then we can all have the same mobility, even if some end up moving faster than others and some of the others do not move at all.

Translating to the real world, Sowell is saying that if we observe one set of children born into a wealthy family, with parents willing and able to provide high-quality schooling and ‘legacy’ admission to the Ivy League universities they attended, and another family whose parents struggled to put food on the table, we should not be concerned that members of the first group almost invariably do better. After all, some people from very disadvantaged backgrounds achieve success and there is no law preventing the rest from doing so.

Contrary to the cherished beliefs of most Americans, the USA has less social mobility than any other developed country. Haskins and Sawhill (2009) show that 42 per cent of American men with fathers in the bottom fifth of the income distribution remain there, as compared to Denmark (25 per cent), Sweden (26 per cent), Finland (28 per cent), Norway (28 per cent) and the UK (30 per cent). The American dream is fast becoming a myth.

Privatisation

This is the idea that nearly any function now undertaken by government could be done better by private firms. The boundaries between the private and public sectors have always shifted back and forth, but the general tendency since the late 19th century has been for the role of the state to expand in order to correct the limitations and failures of market outcomes. Beginning with Margaret Thatcher’s government in 1980s Britain, there was a concerted global attempt to reverse this process. The theoretical basis for privatisation rested on the efficient markets hypothesis, according to which private markets would always yield better investment decisions and more efficient operations than public-sector planners.

The political imperative derived from the ‘fiscal crisis of the state’ arose when the growing commitments of the welfare state ran into the end of the sustained economic growth on which it was premised. The crisis manifested itself in the ‘tax revolts’ of the 1970s and 1980s, such as California’s Proposition 13, the ultimate source of the state’s current crisis.

Even in its heyday, privatisation failed to deliver on its promises. Public enterprises were sold at prices that failed to recompense governments for their loss of earnings. Rather than introducing a new era of competition, privatisation commonly replaced public monopolies with private monopolies, which have sought all kinds of regulatory arbitrage to maximise their profits. Australia’s Macquarie Bank, which specialises in such monopoly assets and is known as the ‘millionaires’ factory’, has shown particular skill in jacking up prices and charges in ways not anticipated by governments undertaking privatisation.

Privatisation has failed even more spectacularly in the 21st century. A series of high-profile privatisations, including those of Air New Zealand and Railtrack in Britain, were reversed. Then, in the chaos of the GFC, giants like General Motors and American Insurance Group sought the protection of government ownership.

Sensible proponents of the mixed economy have never argued that privatisation should be opposed in all cases. As circumstances change, government involvement in some areas of the economy becomes more desirable, in others less so. However, the idea that change should always be in the direction of greater private ownership deserves to be consigned to the graveyard of dead ideas.

What have we learned?

The ideas that drove the crisis are not dead. They continue to roam the landscape in undead, or zombie, form. Nevertheless, some lessons have been learned, or at least half-learned. Among these are the following.

The business cycle is with us forever

The Great Moderation was far from the first version of the claim that the business cycle had been tamed once and for all. Keynesians made the same claim in the 1960s, the strongest version being the claim (commonly attributed to Walter Heller) that the instruments of fiscal and monetary policy could be used to ‘fine-tune’ macro-economic performance. Shiller (2000) points to earlier examples.

Belief in the Great Moderation, along with the ideology of neoliberalism, led most economic policymakers to ignore, or view benignly, economic imbalances that would previously have created great alarm. This was most obvious in relation to large trade imbalances, which were seen by advocates of the ‘consenting adults’ hypothesis as inherently benign, even at levels well outside previous experience, such as those that characterised the so-called Icelandic miracle. As I observed at the time (Quiggin 2006):

Iceland seems like an ideal, if somewhat extreme, test case for this viewpoint. The government has maintained consistent budget surpluses, and pursued liberal economic policies, just as the consenting adults view suggests. On the other hand, even allowing for the volatility associated with a small economy, Iceland’s current account deficits are far beyond the level which should, on traditional views, lead inevitably to an economic crisis.

The subsequent collapse of the Icelandic financial sector, and with it the entire economy, showed that the traditional view was correct.

Financial markets are valuable but dangerous

The dangers of unfettered financial markets have been evident ever since the early 18th century, which saw the South Sea Bubble in Britain and the Mississippi bubble in France. The lessons of these early bubbles have been forgotten and relearned repeatedly over subsequent centuries. Economists as diverse as Fisher, Keynes and Hayek produced analyses of financial market instability. Nevertheless, every new boom produced a new crop of theorists eager to proclaim that ‘this time is different’ (Reinhart and Rogoff 2009).

No episode of forgetting was as complete and consistent as that of the 1990s and early 2000s. Not only was the standard claim that ‘this time is different’ repeated with new vigour, but an intellectual cottage industry arose to explain away previous disasters such as the Dutch tulip mania (Garber 2001) and even the Great Depression (Cole and Ohanian 2004). The efficient markets hypothesis, in its various forms, enabled defenders of financial markets to shift between ultra-strong claims, on the one hand, that financial markets provide the best possible guide to investment and asset value, and ultra-weak fallback positions on the other, such as the observation that it is impossible for everyone to bet successfully against the market.

The GFC has shattered these beliefs, but progress towards a better understanding of financial markets has been very limited. The result has been a set of contradictory policies. On the one hand, the obvious failures of the light-handed systems of regulation epitomised by the Basel II framework¹ have produced a series of initiatives at the national and global level designed to prevent a repetition of these failures. Most notably, the Basel III framework has tightened up capital requirements across the board. On the other hand, moves towards more fundamental reform, aimed at reducing the size and cost of the financial system, have gone nowhere. On the contrary, the main concern of policymakers has been to restore pre-crisis ‘normality’ as rapidly as possible.

We are all Keynesians in a crisis

Finally, it seems that we have learned that, whatever the theoretical case for nonintervention, no government or central bank will permit a complete economic collapse of the type that threatened national economies in late 2008. Unlike the conditions of ‘ordinary’ recession governments are willing to tolerate at present, such a collapse threatens everyone, not merely the unemployed.

The initial reaction to the crisis was a return to Keynesian fiscal stimulus, even by governments like that of Germany, where Keynesianism has had little support. Broadly speaking, the experience of the crisis supported the Keynesian view. Countries that adopted a large discretionary fiscal stimulus, notably, including China and Australia, performed much better than those that did not.

Unfortunately, it is difficult to obtain a clean experiment in fiscal policy. Discretionary fiscal policy is designed to be countercyclical, and automatic stabilisers are countercyclical by definition, meaning that fiscal stimulus will be positively correlated, over time, with recessions. Deriving lessons from comparative performance in the GFC raises a different kind of problem. The strongest discretionary fiscal stimulus was undertaken in countries such as China and Australia, where the shock was entirely external and where policymakers had some warning of its arrival. The good outcomes experienced in these countries might be, and have been attributed to, the absence of a domestic shock. A rather less convincing counterargument, often heard in the Australian debate, is that our relatively good performance depended on strong demand from China rather than on policies of fiscal stimulus. Since China adopted the same policies, this appears to be a claim that Keynesianism works, but only in China.

More importantly, perhaps, the fiscal stimulus policy adopted by the Obama Administration in the USA was half-hearted and poorly targeted, and it became confused, at least in the minds of the public, with the equally poorly designed bailout of the US banking system undertaken in the dying days of the Bush Administration. As a result, the US fiscal stimulus has been widely regarded as a failure.

Unfortunately, therefore, the Keynesian lessons were only half-learned. As soon as the immediate crisis was past, there was a resurgence of anti-Keynesian and, to a large extent, pre-Keynesian thinking. However, the picture is not entirely bleak. In Australia, the Treasury has adopted a consistently Keynesian analysis. International bodies such as the IMF have also tended to look at the evidence more broadly and to support an expansionary stance in both fiscal and monetary policy. Nevertheless, the dominant trend in policy has been towards a rapid reversal of Keynesian stimulus.

The wrong lesson: austerity

As the crisis has continued, the main focus of attention has turned away from the evident failure of financial markets and towards the alleged failings of governments. The underlying ideas can be seen as a revival of the ‘Treasury view’ of the 1920s.

The Treasury view embodies two key elements. In fiscal policy, the Treasury view embodies a predominant—indeed, near-exclusive—focus on keeping faith with bondholders, rejecting not only default but any tolerance of inflation as a way of sharing the burden of unsound debt. This position is intertwined with a contractionist macro-economic analysis, in which cuts in budget deficits are supposed to promote ‘business confidence’, particularly if they are achieved through reductions in expenditure.

Austerity policies have been adopted even where there is no immediate crisis in public debt, as in the UK and the USA, but the problem has been sharpest in Europe. In the process of bailing out the financial systems and responding to the sharp downturn in economic activity, European governments guaranteed private debt and took on substantial debts of their own. For many peripheral countries, such as Portugal, Ireland, Greece and Spain, these debts have proved unsustainable. Now, the bondholders are demanding that full repayment of their claims should be ensured by the adoption of ‘austerity’ measures that are virtually certain to produce a new recession if implemented as planned.

Over the last year and a half, Europe has taken a set of stop-gap measures aimed at protecting its weaker economies against pressures from bond markets. European states have sought to propitiate bond markets through enforcing economic austerity and ruthlessly cutting spending. There is considerable pressure, notably from the German government and the ECB, to institutionalise austerity.

Institutionalised austerity will badly damage European economies in the short term. However, its long-term consequences will be much, much worse. Even if these measures somehow calm bond markets, they will utterly destroy the EU’s remaining political legitimacy. European politicians worry about the economic consequences of failure. They should be far more worried about the political consequences. The system they are drifting towards is a thinly disguised version of the gold standard that wreaked havoc in the 1920s and will have the same toxic political fallout.

The situation in the USA is equally dire. At the state and local level, the combination of declining revenues and balanced-budget requirements has necessitated large-scale reductions in both employment and services. This, in turn, has contributed to the length and depth of the US recession.

At the federal level, the same pattern is now emerging. After the initial round of fiscal stimulus in 2009, the Obama Administration took the view that the economy would recover without additional intervention. By the time the falsehood of that view became clear, the 2010 elections had produced a Republican majority in the House of Representatives.

The new Congress was resolutely opposed to any further fiscal stimulus. Moreover, by threatening to enforce a default on US government debt, the Republicans were able to negotiate a policy package involving large-scale expenditure cuts. The efforts of the Obama Administration to negotiate a ‘grand bargain’, in which these and further cuts would be combined with modest increases in tax revenue, cemented a consensus on the need for immediate adoption of austerity policies, despite weak economic growth and a continuing decline in the US employment–population ratio.

Experience under austerity policies has confirmed the validity of the Keynesian analysis. There has been no general recovery, and performance has been particularly disappointing in the USA and UK, where austerity measures have been chosen, even in the absence of an immediate budgetary crisis.

What have we learned about ourselves?

The experience of the crisis suggests some unflattering lessons about the economics profession, taken broadly to include academic economists, policymakers, central bankers and commentators. The collapse of the Great Moderation, and the near-collapse of the global financial system, provided the profession with an opportunity and, indeed, an urgent imperative for a fundamental reconsideration of ideas that had been taken for granted for 30 years or more.

Unfortunately, like the Bourbon monarchs returning after the fall of Napoleon, we have, for the most part, learned nothing and forgotten nothing. Across a broad spectrum, the economics profession has sought the fastest possible return to pre-crisis normalcy, ignoring the obvious evidence that it was precisely the ‘normal’ assumptions of neoliberalism that produced the crisis.

The problems are most evident in the behaviour of central banks, which remain the dominant force in the determination of macro-economic policy. In the years leading up to the crisis, central bankers were congratulating themselves on the creation of an inflation-targeting system that had finally hit both the explicit target of low and stable inflation and the implicit target of steady and stable growth in real output (that is, the Great Moderation).

It is a simple matter of record that the policies adopted by central banks during the Great Moderation did not prevent its catastrophic collapse. More seriously, there is a good deal of evidence to suggest that long periods of low and stable inflation are actually conducive to asset price bubbles such as those that led to the GFC.

At a minimum, this experience should have suggested a rethinking of the system of inflation targeting. Even assuming a continuation of inflation targeting, the current debt deflation clearly calls for a higher inflation target, at least in the short run. Looking beyond this purely technical adjustment, the use of alternative targets, such as the price level or nominal income, might help to avoid the potential for deflationary liquidity traps inherent in the inflation-targeting approach.

A more serious response to the crisis would be the recognition that a single instrument, such as a short-term interest rate, is insufficient when the central bank must not only achieve a balance between inflation and output growth, as proposed by the Taylor rule, but must also maintain the systemic stability of the financial system. The latter requirement suggests the need for a reconsideration of the separation between monetary policy and prudential regulation that was a central feature of the reforms of the neoliberalism era.

The general policy community, including economic commentators, think tanks and policymakers, has done little better. The fact that Australia escaped the GFC largely unscathed has meant that economic commentators have felt free to ignore it. As Terry McCrann (2009, 21) wrote in dismissing proposals for an inquiry into the financial system: ‘Not many dead or even injured in Australia. From any systemic fault, that’s to say.’

As the GFC has faded further into memory, attention has returned to the tired micro-economic reform agenda of the 1980s. Misleading statistics on productivity have been used to argue the need for a new round of reform. It would be far more useful to focus attention on the macro-economic risks that still face us, most notably in the event of a slump, or even a slowdown, in China’s economic growth.

Turning to the academic economics profession, it would be unfair to say that economists have ignored the evidence of the financial crisis. On the contrary, vast numbers of papers are now being written to incorporate financial shocks into econometric and macro-economic models. But there is no suggestion, as there was in both the 1930s and the 1970s, that the GFC necessitates any reassessment of the ideas that have dominated economic thinking since the 1970s or any significant change in the way in which economics is done.

In terms of the way in which economics is done, the selection of articles published in economics journals today is almost indistinguishable from that of, say, 2007. The central focus is on incremental contributions on topics of fashionable interest. The aesthetic criteria on which articles are judged (focussed primarily on theoretical rigour) means that there is no place in the journals for the reconsideration of fundamental issues. Almost the only exception is the publication of presidential addresses and the like, where the most firmly established members of the profession are given some licence to speculate.

As far as content is concerned, the majority of economic research deals with issues that are, while not necessarily irrelevant to policy concerns, far removed from the most pressing issues of the day. This has probably always been true to some extent,² and the need for external funding for most research has only exacerbated the problem.

An obvious difference between the GFC and the crises of the 1930s and 1970s is the absence, at least so far, of a well-developed alternative to the dominant model rendered problematic by the crisis. Keynes (1936) offered an alternative to the orthodoxy of classical and neoclassical economics, which maintained the impossibility of sustained high unemployment, except as the product of distortions in the labour market. Keynes also offered a solution—the use of fiscal policy to stabilise aggregate demand—and this policy was adopted, with great success, after 1945.

When Keynesian economics itself ran into difficulties, beginning in the late 1960s, the monetarism of Milton Friedman (1968) presented itself as an alternative. No such alternative is yet available to us. Our position is most analogous to that faced by economists in the early years of the Great Depression before the emergence of the Keynesian alternative to the dominant Treasury view. It is, perhaps, too much to hope for the emergence of a new Keynes or Friedman who can present a comprehensive analysis of the failures of the current model and point the way forward to a new one.

Rather, we must look for a synthesis, recovering the central insights of the Keynesian revolution while retaining what was valuable in Friedman’s counterrevolution, and incorporating the insights of more recent work on behavioural economics. That is a demanding research program, and it is far from clear where it will lead. All the more reason, then, for the profession to make a start along these lines—if necessary, at the expense of established research programs whose inadequacies have been shown up by the GFC.

Less hubris?

The central theme of Quiggin (2010), reflected in the title Zombie Economics, was that, although the ideas and policies central to neoliberalism³ had been refuted by events, they nonetheless remain influential. Less than a year since the book appeared, the resurgence of these zombie ideas is now almost complete.

Despite being spectacularly discredited by the GFC, the ideas of neoliberalism continue to guide the thinking of many, if not most, policymakers and commentators. In part, that is because these ideas are useful to rich and powerful interest groups. In part, it reflects the inherent tenacity of intellectual commitments. Most importantly, though, the survival of these zombie ideas reflects the absence of a well-developed alternative. Economics must take new directions in the 21st century if we are to avoid a repetition of the recent crisis.

Most obviously, there needs to be a shift from rigour to relevance. The prevailing emphasis on mathematical and logical rigour has given economics an internal consistency that is missing in other social sciences. However, there is little value in being consistently wrong.

Similarly, there needs to be a shift from efficiency to equity. Three decades of neoliberals pushing policies based on ideas of efficiency, and claims about the efficiency of financial markets, have not produced much in the way of improved economic performance, but they have led to drastic increases in inequality, particularly in the English-speaking world. Economists need to return their attention to policies that will generate a more equitable distribution of income.

Finally, with the collapse of yet another economic ‘new era’, it is time for the economics profession to display more humility and less hubris. More than two centuries after Adam Smith, economists have to admit the force of Socrates’s observation that: ‘The wisest man is he who knows that he knows nothing.’

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1. 1 The Basel Committee on Banking Regulations, headquartered at the Bank for International Settlements in Basel, was established to enhance financial stability by improving the quality of banking supervision worldwide. The Committee has established a series of international standards for bank regulation, most notably its landmark publications of the accords on capital adequacy, commonly known as Basel I, Basel II and, most recently, Basel III. See www.bis.org/bcbs/history.htm.

2. 2 Many years ago, I was struck by reading a survey of the articles published in economic journals during the Great Depression, which found that only a small proportion addressed the problems of unemployment, macro-economic policy and other issues related to the economic crisis that had engulfed the world. Unfortunately, I did not record the reference and have never again been able to locate this article. Nevertheless, it had a significant impact on my own research priorities.

3. 3 I used the term ‘market liberalism’.