Nobel Prize-winning economist blames depression on Obama scaring people

Brad DeLong points us to an interview with Nobel-winning macroeconomist Edward Prescott, in which he says:

I think the financial crisis has been greatly overstated as a problem... [it] has had virtually no consequences for the real economy...[P]eople got scared.... The press scared people. People running for office scared people. Bernanke scared people; Paulson scared people.... [P]eople began not to know what was going to happen. Then they stopped investing--by investing, I mean getting a new car or fixing up your house. And that led to the economy--it was depressed a bit that fourth quarter of last year...[With] benign neglect the economy would have come roaring back quite quickly[.]

Yes, this is the same Ed Prescott who thinks New Orleans is in Alabama.

A least the man is consistent, though. He got famous for creating and promoting the fallacious, misleading, and epically misnamed "Real Business Cycle" theory, which says that the economy always works as it should, and government policy can only hurt; and by holding to this nutty idea he's sort of putting his money where his mouth is (unlike his Nobel-winning colleague Robert Lucas, who says the economy is going to quickly recover but is holding his entire pension in cash).

But think what this says about economics as a field. Looking back over the list of physics Nobel winners, it's striking that there's not a single one who deserves to have his or her prize revoked. Not a single one of the theories they created has ever been shown to be wrong. Not a single one of the experiments they performed was found to have reached an erroneous conclusion.

Now look at the list of economics Nobel winners. I see:

Edward Prescott (2004), already mentioned

Robert C. Merton & Myron Scholes (1997) , who developed the Black-Scholes formula for option pricing (a formula that works only when agents behave in a certain way), and whose private hedge fund went spectacularly bankrupt and had to be bailed out by the U.S. government

Robert Lucas (1995), who won the prize for his theory of how government policy is ineffective if people have "rational expectations" (which they demonstrably don't)

All of these people created and promoted mathematically clever, conceptually simple economic theories with little or no basis in data. Some of the theories (Merton & Scholes') have been overused and misused on Wall Street to tragic effect. Others (Prescott's and Lucas') have been quite successful in holding back government policies that might have averted the financial and economic crises in which we now find ourselves floundering.

Even more damningly, Real Business Cycle and Rational Expectations theories have not, as the official description of Lucas' Nobel so blithely states, "deepened our understanding" of the way the economy works. There is a world of difference between understanding and oversimplification. When a physicist says "suppose we live in a frictionless world," she can then describe the effects of forces other than friction; but she knows she can do this, because we have experimental situations in which there is extremely little friction (and we've used other experiments to prove that we can add and subtract forces). Her simplification has increased our understanding.

But when Robert Lucas says "suppose people have rational expectations," he is describing a situation that may not be reproducible in the real world at all. We just have no evidence that people do form Lucas-type "rational expectations," in a lab or in the real world (and in fact we have a lot of lab evidence to the contrary!). Lucas' simplification has not increased our understanding of real-world economies, because it is merely a hypothetical.

Einstein said, "Make everything as simple as possible, but not simpler." The economics profession didn't get the last part of the message. When confronted with data that contradicted his Real Business Cycle theory, Prescott famously responded: "Theory is now ahead of measurement." As if such a thing could ever be true.

When defending the profession, some economists claim that the problem is just bad data - we can't run experiments on real economies, and statistics is generally a poor substitute. Piffle, I say. The fault lies squarely with the profession for confidently touting results in the absence of data. Scientific integrity requires that if you don't have the data to back up your theories, you consistently and loudly say that those theories are as yet only conjectures. If you don't do that, you're doing cargo cult science.

Unfortunately, we economists have been getting well-paid and well-respected for our mystical stick-waving and shamanistic mumbo-jumbo. Our leading sages get to say shit like "the depression happened because Obama scared people," and we treat them as if they're serious scientists. Life is surreal.