Must-Read: Paul Krugman: That Old-Time Economics

…In the past few weeks, I’ve seen a number of speeches and articles suggesting that the problem lies in the inadequacy of our economic models–that we need to rethink macroeconomic theory, which has failed to offer useful policy guidance in the crisis. But is this really the story?… It’s true that few economists predicted the crisis…. Since then, however… basic textbook models, reflecting an approach to recessions and recoveries that would have seemed familiar to students half a century ago, have performed very well. The trouble is that policy makers in Europe decided to reject those basic models in favor of alternative approaches that were innovative, exciting and completely wrong…. In America, the White House and the Federal Reserve mainly stayed faithful to standard Keynesian economics…. Meanwhile, the Fed ignored ominous warnings that it was ‘debasing the dollar,’ sticking with the view that its low-interest-rate policies wouldn’t cause inflation as long as unemployment remained high.

In Europe, by contrast, policy makers were ready and eager to throw textbook economics out the window in favor of new approaches. The European Commission, headquartered here in Brussels, eagerly seized upon supposed evidence for ‘expansionary austerity’…. But while European policy makers may have imagined that they were showing a praiseworthy openness to new economic ideas, the economists they chose to listen to were those telling them what they wanted to hear. They sought justifications for the harsh policies they were determined, for political and ideological reasons, to impose on debtor nations…. Theory provided excellent guidance, if only policy makers had been willing to listen. Unfortunately, they weren’t. And they still aren’t. If you want to feel really depressed about Europe’s future, read the Op-Ed article by Wolfgang Schäuble…