In 1874, at the age of seventeen, Max Planck began his studies at the University of Munich. His physics professor, Philipp von Jolly, attempted to discourage the future Nobel Prize-winner with the argument that, “in this field, almost everything is already discovered, and all that remains is to fill in a few holes.” Planck persisted.
In 1894, another future Nobel laureate, US physicist Albert A. Michelson, also expressed the view that there were no more fundamental discoveries to be made in physics. Quoting the eminent physicist, Lord Kelvin, Michelson remarked that, “The future truths of physical science are to be looked for in the sixth place of decimals.”
A short six years later, Lord Kelvin was forced to recant. He had to admit he saw “two clouds on the horizon” of theoretical physics. One was the challenge of calculating black-body (electromagnetic) radiation, solved a year later by Planck. The other was the famously failed Michelson-Morley experiment on the behavior of light. As it happened, these mere “clouds” heralded a revolution in physics that led the birth of quantum mechanics and relativity theory. Physics, it turned out, was not quite a closed book after all.
Economics is a much younger, softer science than physics. Despite this – or more likely because of it – economics is often prone to the “Jolly-Michelson-Kelvin” conceit that everything important has already been identified and explained.
In 1929, so-called “Classical” economic theory was triumphant. The astonishing stock market rally of the late 1920s did not inspire even a note of caution. Rather, it was taken as confirmation that all was right with the world. Indeed, in August 1929 one of the most renowned economists of the period, Irving Fisher, stated that, “The stock market has reached what seems to be a new permanent plateau.” Seven years and one Great Depression later, John Maynard Keynes published his “General Theory,” revolutionizing economic theory and practice for the next forty years.
In the early 1970s, the profession had another Jolly-Michelson-Kelvin moment, when US President Richard Nixon stated, “We are all Keynesians now,” a phrase already coined, although with some reservations, by economist Milton Friedman in the mid-1960s. Essentially Nixon meant that the anti-cyclical interventions of government in the economy, widely applied after the war, could continue to assure growth and prosperity.
All was well until several simultaneous forces exposed the limits Keynesian activism: the Bretton Woods system of fixed exchange rates collapsed, the 1970s oil shocks crippled the global economy, and a new phenomenon called “stagflation” (simultaneous high unemployment and inflation) emerged.
Once again economists had to reinvent themselves. By the early 1990s a new theoretical platform emerged for economists to stand on, one that can be defined as a Classical-Keynesian synthesis. Central bank policy was vital to this approach, which can be neatly summarized as inflation-targeting. Ben Bernanke, the current Fed President, co-authored a much-cited monograph on this subject in 1999, for example.
The economic environment seemed to confirm this new synthesis. In the twenty-five years between 1982 and 2007, the period now nostalgically called the Great Moderation, macroeconomic volatility was very low, with only two recessions in the US. Inflation was negligible and economic growth was relatively high, especially in the Anglo-Saxon countries.
And once again economists served up a Jolly-Michelson-Kelvin moment. In a speech in 2002 honoring Milton Friedman on his ninetieth birthday, Ben Bernanke, then a Federal Reserve governor, apologized for the mistakes the US central bank made in the 1930s: “Let me end my talk by abusing slightly my status as an official representative of the Federal Reserve. I would like to say to Milton: Regarding the Great Depression. You’re right, we did it. We’re very sorry. But thanks to you, we won’t do it again.”
And in 2003, economics Nobel Prize winner Robert Lucas, one of the most influential economists of the past thirty years, stated in his presidential address to the American Economic Association, “The problem of depressions has been solved. Macroeconomics should move on to other subjects.”
Finally, Olivier Blanchard, the current chief economist of the International Monetary Fund, a professor at MIT and perennially short-listed for the economics Nobel Prize, wrote a survey on the state of macroeconomic theory in 2007. His conclusion: “For a long while after the explosion of macroeconomics in the 1970s, the field looked like a battlefield. Over time, however, mainly because facts do not go away, a largely shared vision both of fluctuations and of methodology has emerged. [….] The state of macro is good.”
The 2008 financial crisis and its aftermath – which is still unfolding, with worrisome potential consequences – has once again left the dismal science of economics in shambles. So few of its practitioners saw this crisis coming that those who did can be described as statistical outliers.
“This time is different” have been called the four most expensive words in the English language. They also form the title of a compelling, if rather dully written, history of financial crises published last year by Carmen Reinhardt and Kenneth Rogoff. Given their track record, the second most expensive four-word sentence from economists is certainly, “Everything is under control.”
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