(This is a re-worked section I cut from the bottom of the introductory episode of this fifteen-part serial, on May 17, at a time when I was more worried about the length of installments than I am now. See if it helps make sense of what you have already read. It is also an intermission, as I am traveling.)
Economics, at least in its dominant narrative tradition, is a story of human lifetimes. Its most vital concerns in the present day span no more than four or five generations: the lives of our parents and grandparents backwards in time, our own lives in the present, the lives of our children and grandchildren going forward – perhaps a hundred and twenty-five years altogether. That each of us has (or deserves to have) first-hand knowledge of five generations may be a basic fact of human existence. Perspectives shift with the passing of each succeeding generation. In due course, each new generation writes history anew.
When I started covering economics, in 1975, Paul Samuelson and Milton Friedman were preeminent. They had been born about the same time — Friedman in 1912, Samuelson in 1915. They led powerful university departments, at the University of Chicago, and the Massachusetts Institute of Technology, to which the brightest students flocked. They advised presidential candidates – Samuelson, John F. Kennedy; Friedman, Barry Goldwater and Ronald Reagan. For nearly twenty years, they argued with one another, each writing a column every two weeks about public policy in the pages of Newsweek. They were among the first winners of the new Nobel Prize for economic sciences funded by the Bank of Sweden and established in 1969.
The premise of the Nobel was that important lessons had been learned from the Depression, sufficient to constitute a phase change in what previously had been a nascent science. Those lessons were persuasive to most of those who took an active interest in the subject, not just the economists themselves, but the physicists, chemists, earth scientists, social scientists and others of the Royal Swedish Academy of Sciences who agreed to give the prize. They were useful, probably, for purposes of managing industrial economies.
This achievement was ascribed to the generation of scholars who had been called upon in the 1930s to parse the Great Depression as it unfolded. John Maynard Keynes is the best remembered of this community, along with Friedrich von Hayek, Joseph Schumpeter, and Irving Fisher. Edward Chamberlin, Joan Robinson, and Wesley Clair Mitchell are remembered for different reasons. Only Hayek lived long enough to share a Nobel Prize.
The Nobel Prize made it easier to follow the narrative. Samuelson received the second prize, in 1970 (the pioneering European econometricians Ragnar Frisch and Jan Tinbergen were first); Friedman, in its eighth year, in 1976. In between, a third major figure was recognized, and, at least within the profession, gradually came to be understood as being of importance comparable to Friedman and Samuelson. Kenneth Arrow (b. 1921) was cited in 1972, with Sir John Hicks (b. 1904), for work that at the time seemed abstruse: a mathematical proof of the existence and stability of general equilibrium in a system of market prices. It turned out to be the foundation of what we call microeconomics.
The decision to split the award was confusing: the two economists had worked on some of the same problems, but in different eras, with different tools. Hicks had done his important work in the 1930s; Arrow in the ’50s. But even then, Arrow’s accomplishments were much wider-ranging. They included his analysis of different voting systems, sufficient to establish a new sub-discipline called social choice; the tools he devised to incorporate uncertainty into economic analysis, imagining complete markets of options and futures for all manner of things in all conceivable states of the world; and his contributions to the theory of growth. Starting in the early 1960s, Arrow began a whole new skein of work, on the economics of information. He added to his Nobel autobiography in 2005 that, even before 1972, his research was moving in directions beyond those cited for the prize. Hicks died in 1989; Arrow, a Stanford University professor, is still active, editing, with his colleague Timothy Bresnahan, the Annual Review of Economics.
Slowly the narrative filled in. Prizes wet to theorists, and to refiners of theory; to practitioners of measurement: and measurement’s close cousin, the statistically-oriented field of econometrics; to economists who specialized in finance; and economists influenced by game theory, though the first ones weren’t given until 1994. Some economists of comparable achievement were mentioned only in citation for awards to others, some not cited at all; and those who had concerned themselves mainly with policy were left out altogether.
For the first twenty years of the Nobel survey, the dominant theme was macroeconomics. This was unsurprising, since macro was the essence of what was thought to have been learned from the experience of the ‘30s: that here was a way to characterize the behavior of the economy as a whole, using a handful of measurable aggregates, chief among them consumption, investment, and government purchases. It was easy, too, to divide the macro awards into camps, if not to reach conclusions about the fundamental differences between among them.
Keynesian laureates, led by Samuelson, included Wassily Leontief, Lawrence Klein, James Tobin, Franco Modigliani, Rober Solow, George Akerlof, Joseph Stiglitz, Edmund Phelps, Paul Krugman, Peter Diamond, and Robert Shiller. Monetarists, led by Friedman, included George Stigler, Robert Lucas, Robert Mundell, Edward Prescott, Thomas Sargent, and Eugene Fama.
Woven through the prizes was recognition of a different skein loosely related to work by Arrow and his intellectual collaborators, Gerard Debreu and Leo Hurwicz, in particular. Taken together, that new work added up to a working out of microeconomics to include strategic behavior: incentives, information, and human capability. Nobel laureates in this category included Herbert Simon, Michael Spence, William Vickery, James Mirrlees, Eric Maskin, Roger Myerson, and Alvin Roth. Lucas and Robert Merton used the tools of complete competitive markets that Arrow had contributed; Ronald Coase and Gary Becker lent support, relying less on formal methods.
For half a century then, all the time I’d been reporting on it, economics seemed to be thestory of three generations: of Keynes and others, those who were called upon during the emergency; of their students, Samuelson, Friedman, and Arrow, who entered grad school in ’30s and ’40s; and their students, who went to school in the ’50s and ’60s, during the of the Cold War. A fourth generation could be discerned, economists who entered graduate school in the ’70s and ’80s, in an age of innovation, restructuring and globalization.
The crisis of 2008 seemed to overturn all that. At its heart was a long global boom, punctuated by a panic, controlled by emergency leading by the world’s central banks. There seemed to be little in the panic, at least, that could not be understood in the new economics of information and incentives. The broad macroeconomic questions seemed to resolve decisively in favor of Friedman, who however warily, had put central banking at the center of his analysis. But the whole only made sense when placed in a grammar pioneered by Samuelson: models, measurement and operability.
Only slowly did it dawn on me that Samuelson, Friedman and Arrow, having long been economics’ own greatest generation, had themselves become so much History, superseded by events. Several members of that fourth generation played prominent roles in the crisis: Ben Bernanke, Austan Goolsbee, Lawrence Summers, Paul Krugman, in particular; economists of the third generation, John Taylor. Martin Feldstein, and Stanley Fischer were active, too, mostly behind the scenes: but all these were policymakers and advocates, not originators of profound new insights.
So I set out to tell the story of the collaboration of Gary Gorton, of Yale University’s School of Management, and Bengt Holmström, of MIT, as described in one way by Gorton, in Misunderstanding Financial Crises: Why We Don’t See Them Coming (Oxford 2012), and, in another, by Holmstrom in “Understanding the Role of Debt in the Financial System.” These two did a better job of analyzing and interpreting the crisis than any others I had seen. They have opened the door to a new financial macroeconomics. A growing coterie of monetary theorists; economic historians; and international economists are taking the next steps. Only the connections between finance and growth are so far missing.
It clearly wouldn’t be enough to trumpet the new results. The controversy between the Keynesians and Monetarists would have to be unscrambled, at least for those who remembered the history of economics in the twentieth century as I did — for one friend in particular. To do that I devised an account that went beyond the bounds of memory. I set out to tell a story with two threads: the accomplishments of practitioners, mostly bankers in this case, on the one hand; of economists on the other.
I started with Sir James Steuart, the all-but-forgotten Scottish rival to Adam Smith, whose verbose but coherent system of economics of 1767 — today we would call it a model— made an important place for the governmental institution of central banking. I showed how Smith eclipsed Steuart completely with the exciting research program of The Wealth of Nations, which contained not one but three promising lines of inquiry, and how Smith’s rich vision was itself eclipsed when subsequent economists chose to pursue the most promising of the three, the existence of an interdependent price system, symbolized by the metaphor of an Invisible Hand.
I then showed bankers coping with the situation on their own for 150 years, creating central banks and instruction manuals for their safe operation, until Milton Friedman and Anna Schwartz placed them at the top of the research agenda of macroeconomics — and then only on terms so old-fashioned that they had to be translated into the language devised by Samuelson and the economics devised by Arrow and his students before they could be properly understood. But here I get ahead of the story.