You should, of course, read Paul Krugman’s article on the state of macroeconomics and its failures during the recent crisis. That said, if I were going to try to compose a master account of the situation, I would want a bit less of an economist-explaining-economics to describe what went wrong intellectually than I would an economist-doing-economics — or perhaps the better discipline would be sociology — to look in more detail at what’s actually going on in the profession qua profession, in which people’s life and work is embedded in institutions and incentives. Something like what Barry Eichengreen offered in April (via Brad DeLong):
For economists in business schools the answer is straightforward. Business schools see themselves as suppliers of inputs to business. Just as General Motors provides its suppliers with specifications for the cold-rolled sheet it needs for fabricating auto bodies, J. P. Morgan makes clear the kind of financial engineers it requires, and business schools deem to provide. In the wake of the 1987 stock-market crash, Morgan’s chairman, Dennis Weatherstone, started calling for a daily “4:15 Report” summarizing how much his firm would lose if tomorrow turned out to be a bad day. His counterparts at other firms then adopted the practice. Soon after, business schools jumped to supply graduates to write those reports. Value at Risk, as that number and the process for calculating it came to be known, quickly gained a place in the business-school curriculum.
And academics, too:
But what of doctoral programs in economics (like the one in which I teach)? The top PhD-granting departments only rarely send their graduates to positions in banking or business—most go on to other universities. But their faculties do not object to the occasional high-paying consulting gig. They don’t mind serving as the entertainment at beachside and ski-slope retreats hosted by investment banks for their important clients.
Generous speaker’s fees were thus available to those prepared to drink the Kool-Aid. Not everyone indulged. But there was nonetheless a subconscious tendency to embrace the arguments of one’s more “successful” colleagues in a discipline where money, in this case earned through speaking engagements and consultancies, is the common denominator of success. [...]
Sociologists may be more familiar than economists with the psychic costs of nonconformity. But because there is a strong external demand for economists’ services, they may experience even-stronger economic incentives than their colleagues in other disciplines to conform to the industry-held view. They can thus incur even-greater costs—economic and also psychic—from falling out of step.
This seems at least as important to me as the intellectual arguments. We know that Larry Summers is not a believer in the efficient markets hypothesis and, indeed, 25 years ago was capable of being quite scathing and funny about the sort of people who would believe in that sort of thing. But when financiers start cutting you earning multi-million dollar paychecks you’re probably going to know how to be polite.