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When Economists Change Their Minds

There is a known story about the famous American economist Irving Fisher that professors and their students like to tell jokingly whenever they gather in groups of three or more:

It was in early October 1929, when Fisher claimed publicly that the stock market had reached a “permanently high plateau”; he did so in the pages of the New York Times, and justified his enthusiasm with theories on growth and investment. His reputation was somewhat damaged only a few days later, when Black Thursday hit the stock market in what soon came to be known as the most devastating stock market crash in the history of the United States.

Since then, Fisher’s claim is remembered as one of the wrongest predictions in economic history. But Fisher was an optimist who lived through a decade of magnificent growth, and still insisted days after Black Thursday that it was just a mere bump on the road. After he lost a considerable portion of his fortune, and while witnessing the Great Depression hitting America, Fisher developed a new theory on what could have caused the crash, and ways to handle it. But people refused to listen; his reputation was so thoroughly damaged that his theories started to regain their deserved attention only in the 1950s, after he himself died in 1947. As we know, Fisher was neither the first nor the last economist to make wrong predictions. American growth in the 1990s was overestimated, Chinese growth was underestimated, and no recession was expected in the mid-2000s – all of these are predictions made in the past by economists.

People like asking how economists can make the wrong predictions so often. Especially when it comes to macroeconomic predictions, economists seem to be more off than on target. This sentiment intensified amongst the public and economists alike after the 2008 crash, which cast even more doubt on the discipline’s predictive capabilities. In 2009, Nobel Prize-winning economist Paul Krugman wrote an article in the New York Times called “How Did Economists Get It So Wrong?”, where he pondered on the predictive failures of economics. He claimed that since the memory of the Great Depression had faded, economists fell in love with the idealised version of the capitalist system — one that consists of many rational agents interacting perfectly. Many economists strive to make their discipline as accurate as possible, often emphasising the role of mathematics in the “physics of the social sciences”. But economics is not physics; there are simply too many historical, cultural, and psychological factors to consider when making a prediction. And yet, it is (often) evidence-based, ambitious in its attempt to describe human interactions — both an aspiring positive (what is) and a normative (what ought to be) science at the same time.

It is difficult to address economics as a “hard science” also because it is presumably intertwined with ideology. We see liberals and conservatives, Saltwater and Freshwater economists, socialists and libertarians — all of which argue ferociously over issues. A main difference between ideology and scientific theory lies in the treatment of facts; scientists are required to view new empirical evidence with an open mind and the intention to reach an objective truth, whereas ideologists often have their free choice of facts, ignoring what is inconvenient and adopting whatever supports their view of the world. As they encounter empirical facts daily, economists should have some form of flexibility, or at least the ability to adapt their mindsets to the prevailing facts. How often do economists change their minds? More often than you think, apparently. Krugman himself changed his mind on home market effect in international trade, on the ineffectiveness of monetary policy, and on the effect of minimum wages on employment — all of which are be politically charged issues.

Another economist who was known for the ability to change his mind was John Maynard Keynes. Even though it is argued that the British giant did not actually say “When the facts change, I change my mind” (and you must admit that it is somewhat ironic when the lack of empirical evidence is stopping us from attributing this quote to Keynes), he was known for his intellectual integrity and for his ability to review and re-evaluate his former conclusions. An article published in Life magazine in 1945 reported that “Keynes is always ready to contradict not only his colleagues but also himself whenever circumstances make this seem appropriate”. He was critically described as “consistently inconsistent”, although preserving a little inconsistency seems almost essential for an economist. He supported deflationary policies and then inflationary ones; he supported free trade and later advocated tariffs. After the Second World War, Keynes considered writing another book following his magnum opus “The General Theory” from 1936, with corrections and additions to his previous ideas.

A scientific theory should be supported by reality, or to be more accurate: hypotheses should be validated by available empirical evidence. An important principle in the construction of scientific theories is falsifiability: the possibility of proving a theory false. Ideology, by its nature, is unfalsifiable. But as we said earlier, economics deals with both what is and with what should be. Accepting what is can very well clash with what one thinks ought to be; stripping economic decisions from any normative or social judgments is naive at best, and mostly dangerous. Decisions regarding issues such as minimum wage are always political, but if economics aspires to be the physics of the social sciences, then how can it be politically charged? When the American economist Amy Finkelstein studied healthcare in the US, her conclusions were somewhat contradictory to what was predicted by standard economic thought. Her conclusions showed that people used less healthcare when moving to areas where people spend less on healthcare. Her careful combination of analytical work and empirical evidence had shifted her viewpoint that healthcare costs do not affect behaviour. For years, the American economist Narayana Kocherlakota criticised the Federal Reserve’s monetary stimulus, after which he changed his mind and urged for further stimulation and stronger action.

Changing your mind, abandoning previous research conclusions in light of new evidence, takes guts. But it is also essential, since the scientific discipline and methodology require an unbiased approach to theory and facts. Neither should we ignore the predictions of economists; they know what they are talking about, and they spend their lives studying vigorously both facts and theory. Perhaps it would be much more efficient to adopt a new set of assumptions — one that does not assume a perfect world, but instead a dynamic, ever-changing world in which we accept the idea that human behaviour cannot be fully predicted.


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