If It Were a Fight, They Would Have Stopped It in December of 2008

I n the December 2009 issue of The Economists’ Voice, University of Chicago Professor Casey Mulligan rejected Paul Krugman’s rebuke of fresh water economics and reaffirmed his faith in the New Classical Economics. His defense was short. He offered up a super stylized macro model and pointed out that inclusion of a distortion term for his capital and labor market equilibrium conditions allow him to comfortably explain the 2008–2009 recession. Really? As a Wall Street economic practitioner, I am decidedly unconvinced. Practitioners and theorists, I think, are in agreement that a theory is supposed to help us understand how the world works. If a theory of gravity concludes that apples freed from trees tend to float to the heavens, one need not understand the math to reject the construct. And that is why, after the brutal events of the past year, I naïvely thought we would be able to end debate about the plausibility of real business cycle theory. It is worth looking back at Professor Mulligan’s op-ed piece in The New York Times from October of 2008. There, Professor Mulligan dismissed the notion of contagion in the financial sector. He looked for pension funds, university endowments, and newly created and capitalized banks to fill the lending gap: