The paranoid style in economics Raghuram Rajan August 8, 2013 – Project Syndicate

Why do high-profile economic tussles turn so every molecule to predict how a gas will be- quickly to ad hominem attacks? Perhaps the have under pressure. Economists cannot be so most well-known recent example has been the sanguine. Under some conditions, individual Nobel laureate Paul Krugman’s campaign behavioral aberrations cancel one another out, against the economists Carmen Reinhart and making crowds more predictable than individ- Kenneth Rogoff, in which he moved quickly uals. But, under other conditions, individuals from criticism of an error in one of their pa- influence one another in such a way that the pers to charges about their commitment to ac- crowd becomes a herd, led by a few. ademic transparency. The difficulties for economic policymakers do For those who know these two superb interna- not stop there. Economic institutions can have tional macroeconomists, as I do, it is evident different effects, depending on their quality. In that these allegations should promptly be dis- the run-up to the 2008 financial crisis, macro- missed. But there is the larger question of why economists tended to assume away the finan- the paranoid style has become so prominent. cial sector in their models of advanced econ- omies. With no significant financial crisis Part of the answer is that economics is an in- since the Great Depression, it was convenient exact science, with exceptions to almost every to take for granted that the financial plumbing pattern of behavior that economists take for worked in the background. granted. For example, economists predict that higher prices for a good will reduce demand Models, thus simplified, suggested policies for it. But students of economics will no doubt that seemed to work – that is, until the plumb- remember an early encounter with “Giffen ing backed up. And the plumbing malfunc- goods,” which violate the usual pattern. When tioned because herd behavior – shaped by pol- tortillas become more expensive, a poor Mex- icies in ways that we are only now coming to ican worker may eat more of them, because understand – overwhelmed it. she now has to cut back on more expensive So, why not let evidence, rather than theory, food like meat. guide policy? Unfortunately, it is hard to get Such “violations” occur elsewhere as well. clear-cut evidence of causality. If high nation- Customers often value a good more when its al debt is associated with slow economic price goes up. One reason may be its signaling growth, is it because excessive debt impedes value. An expensive handcrafted mechanical growth, or because slow growth causes coun- watch may tell time no more accurately than a tries to accumulate more debt? cheap quartz model; but, because few people Many an econometrician’s career has been can afford one, buying it signals that the own- built on finding a clever way to establish the er is rich. Similarly, investors flock to stocks direction of causality. Unfortunately, many of that have appreciated, because they have these methods cannot be applied to the most “momentum.” important questions facing economic policy- The point is that economic behavior is com- makers. So the evidence does not really tell us plex and can vary among individuals, over whether a heavily indebted country should pay time, between goods, and across cultures. down its debt or borrow and invest more. Physicists do not need to know the behavior of Moreover, what seem like obvious, com- dark. And it discourages younger, less creden- monsense policy solutions all too often have tialed economists from entering the public unintended consequences, because a policy’s discourse. targets are not passive objects, as in physics, In their monumental research on centuries of but active agents who react in unpredictable public and sovereign debt, the normally very ways. For example, price controls, rather than careful Reinhart and Rogoff made an error in lowering prices, often cause scarcity and the one of their working papers. The error is in emergence of a black market in which con- neither their prize-winning 2009 book nor in a trolled commodities cost significantly more. subsequent widely read paper responding to All of this implies that economic policymak- the academic debate about their work. ers require an enormous dose of humility, Reinhart and Rogoff’s research broadly shows openness to various alternatives (including the that GDP growth is slower at high levels of possibility that they might be wrong), and a public debt. While there is a legitimate debate willingness to experiment. This does not mean about whether this implies that high debt that our economic knowledge cannot guide us, causes slow growth, Krugman turned to ques- only that what works in theory – or worked in tioning their motives. He accused Reinhart the past or elsewhere – should be prescribed and Rogoff of deliberately keeping their data with an appropriate degree of self-doubt. out of the public domain. Reinhart and But, for economists who actively engage the Rogoff, shocked by this charge – tantamount public, it is hard to influence hearts and minds to an accusation of academic dishonesty – re- by qualifying one’s analysis and hedging leased a careful rebuttal, including online evi- one’s prescriptions. Better to assert one’s dence that they had not been reticent about knowledge unequivocally, especially if past sharing their data. academic honors certify one’s claims of ex- In fairness, given Krugman’s strong and pub- pertise. This is not an entirely bad approach if lic positions, he has been subject to immense it results in sharper public debate. personal criticism by many on the right. Per- The dark side of such certitude, however, is haps the paranoid style in public debate, fo- the way it influences how these economists cusing on motives rather than substance, is a engage contrary opinions. How do you con- useful defensive tactic against rabid critics. vince your passionate followers if other, Unfortunately, it spills over into countering equally credentialed, economists take the op- more reasoned differences of opinion as well. posite view? All too often, the path to easy Perhaps respectful debate in economics is pos- influence is to impugn the other side’s motives sible only in academia. The public discourse is and methods, rather than recognizing and poorer for this. challenging an opposing argument’s points. Raghuram Rajan, Professor of Finance at the Universi- Instead of fostering public dialogue and edu- ty of Chicago Booth School of Business, is incoming cating the public, the public is often left in the Governor of the Reserve Bank of India.