In one of his newest and provocative but excellent articles, Paul Krugman asks of the recent financial bubble of 2008, "How did economists get it so wrong?" For him, "the economics profession" went astray because economists, as a group, mistook beauty, clad in impressive-looking mathematics, for truth." And what was this beauty he's referring to? Neoclassical economics.
"Until the Great Depression, most economists clung to a vision of capitalism as a perfect or nearly perfect system. That vision wasn't sustainable in the face of mass unemployment, but as memories of the Depression faded, economists fell back in love with the old, idealized vision of an economy in which rational individuals intereact in perfect markets, this time gussied up with fancy equations."
Here afterwards, Krugman points at the downside of the neoclassical thought:
"They turn a blind eye to the limitations of human rationality that often leads to bubbles and busts; to the problems of institutions that run amok; to the imperfections of markets... that can cause the economy's operating system to undergo sudden, unpredictable crashes; and to the dangers created when regulators don't believe in regulation."
And so, among Krugman's recommendations for economists is:
"... [T]hey have to admit... that Keynesian economics remains the best framework we have for making sense of recessions and depressions."
Krugman has many excellent points in his article, particularly ont he part where all these neoclassical theories and finance theories have not been successful in explaining what happened during the recent crisis--or more importantly, predict it. I agree with his assessment that economists must take into consideration that the market is not all perfect and frictionless, and that economists may not even need to start from scratch when they begin to. As Krugman correctly refers to, behavioral economics, particularly behavioral finance, has already covered much on how human cognition can bias the decisions of what economists initially assume to be rational individuals.
But then again, maybe part of the solution would need not be the complete dismissal of neoclassical economics. If we follow Krugman word per word that the Keynsian doctrine is best in handling recessions and depressions, what about periods outside of these incidents? Maybe the solution is to find a way to reconcile both schools of thought--and this is what I consider perhaps the Holy Grail of economics (a very difficult one to accomplish, otherwise someone would have done it by now). Let's take Krugman's point exactly: individuals are rational, but certain cognitive biasses would make it appear they are irrational. And I think this kind of analysis that is within the heart of behavioral economics can still be analyzed within the framework of neoclassical economics.
Krugman would categorize me as a "freshwater" economist (and this is not simply because I'm associated with the University of Missouri), and that he expected me to always have a "reason to cling to neoclassicism." But I'm not among the "purists," and I can see the advantages of Keynesian theory. I just hope he also sees some advantages of neoclassical theory.