UCL Department of Economics


Germany's Frankfurter Allgemeine Zeitung on UCL's lead in curriculum reform using CORE

19 February 2015

Nichts gelernt aus der Finanzkrise—We haven’t learned anything from the financial crisis

Few economists were able to foresee the financial crisis. But where is the revolution at universities? Students are now becoming active after becoming fed up because nothing is changing.

By Lisa Nienhaus and Lena Schipper

translated from Frankfurter Allgemeine Sonntagszeitung, 15.02.2015


There was a time in the months following the Lehman-bankruptcy in October 2008, when it seemed as though everything had changed for macroeconomics. The financial crisis had affected academia heavily and induced a new era: the era of modesty. Until then, modesty was a rather atypical trait in economists. But all at once it seemed overdue. Only a handful of economists had thought possible a crisis this severe, let alone foreseen it.

Even the greats of the discipline were prepared to admit this. “The whole intellectual edifice collapsed with the crisis,“ said the former President of the Fed, Alan Greenspan, in October 2008. Celebrity-economist Paul Krugman observed in 2009 in a speech in London, “Most work in macroeconomics in the past 30 years has been useless at best and harmful at worst.“ In Germany, a group of academics attributed a “systemic failure“ to their own profession. Only a complete reorientation could save macroeconomics.

Today, more than six years later, not much of this is visible. There is no sign of reorientation, little has changed when it comes to research, and in lecture theatres things have remained almost completely unchanged. Professors readily admit this. “In teaching almost nothing has changed--unfortunately”, says Dennis Snower, president of the Kiel Institute for the World Economy. “Everything moves in one direction: upholding conservatism.“

Students are indignant at this point. While the world discusses the crisis in Greece and the incredible power the central banks have, they continue to study the neoclassical model. “We still study models in which all markets are efficient and crises don’t take place,” laments Bijan Kaffenberger, macroeconomics-student at the University of Freiburg. “As though the last ten years didn’t happen.“

This makes students of macroeconomics all over the world man the barricades. The International Student Initiative For Pluralism in Macroeconomics, a union of different student organisations, published an appeal last summer. In it, they demand a reform of the current teaching. “How should we do it better in the future, when we’re still being taught the models that got us into this crisis?“ asks Bijan Kaffenberger, who, along with fellow students, signed the appeal of the critical economists at the University in Frankfurt.

They don’t want to revolutionise macroeconomics. Their demands are more modest. “It would already be helpful if we learned more about what is currently being researched,“ says Kaffenberger, “and if our professors were honest and didn’t pretend that whatever we calculate were the answer to everything.“

The students are right. Students starting an undergraduate degree in economics would be gravely mistaken if they expected to learn why the economy crashed in 2008 to such an extent that it is still recovering seven years on. At most universities this is a side issue at most. In fact, in lectures like Macroeconomics I and II, one still is busy learning: curve sketching.

This isn’t because there are no new insights. There are a great number of them. The missing piece is the one big theory that ties it all together to a new world view. Academics that work in fields where something is changing, see this clearly. German economist at Princeton, Markus Brunnermeier says, “The academic revolution is yet to come.“

Three big moments took place in economics: the Great Depression in the 1930s, the great inflation in the 1970s and, well, the financial crisis. After the first two, economics changed fundamentally. Through the Great Depression Keynes came into fashion and the great inflation made for dynamic models and the dogma of the rational human. But what comes next this time? Who is the thought leader for new economics after the financial crisis?

This still remains unclear. “It takes time and a mighty event if you want to change a science“, says Dennis Snower. The event was there, sufficient time, too, at least six years. But the revolution is nowhere to be seen.

There’s one good thing at last that can be attributed to economists. They, by now, understand clearly, what went wrong in their science before 2008, the diagnosis is made. First of all, the financial markets were neglected. In the macroeconomic models--and this is the biggest problem--they don’t make an appearance most of the time. This is especially peculiar because they used to be very important. “Older economists have always emphasised that the financial markets could bring down the economy into a crisis“, says Brunnermeier.

Academics such as Hyman Minsky and Charles Kindleberger delineated centuries ago, how economic actors would, in allegedly secure times, take increasingly high risks, so that in the end a blink of insecurity would suffice to let everything collapse--like in the case of the Lehman-insolvency.

In the newer models this was neglected, in order to make them simpler. “One thought: Big bank-runs didn’t exist for quite some time, so we do not need to pay attention to them“ says Brunnermeier. “That was a mistake.“

In Germany this is made even more problematic as here financial- and bank-research is part of microeconomic/business research, not macroeconomic research. So their understandings and findings can almost not at all add to the models of the prognosticators. Because those usually carry out macroeconomic research, not microeconomic/business research.

The role played by money similarly dramatically seems more and more neglected since the 70s. Money is, in many models, understood as “neutral“, i.e. one can neglect it, it doesn’t carry any effect itself--at least not in the long run. And thus many economists at the famous research institutions didn’t really care to know how this money was brought into the world and what effect it has on the financial markets.

Experiencing how the world economy, for years now, follows what the Fed or the ECB does, how markets celebrate when ECB-President Draghi says the right word, one can only be surprised by this assumption. It may well be true that money, in the long run, doesn’t play a role. But when is the long run? And aren’t we--freely adapted from Keynes--not all dead by then?

Generally, the ivory-tower the economists live in. “Before the financial crisis, economists confused the beauty of mathematical models with truth“, wrote Nobel laureate Paul Krugman on year after the Lehman-bankruptcy. “In the future we must become accustomed again to live with chaos.“

For a long time it was sufficient to present a mathematically substantiated thought in a wonderfully logical, theoretical model to colleagues, obviously in a well-respected journal. You would then be assured the applause of the community. Testing all of this empirically, with data from reality, was a lot of work for relatively little fame. Especially since, in the end, the facts could very well disprove the beautiful theory.

It could have helped to look at reality more closely. Because the dangers that triggered the financial crisis came from it and not from theory. An inclination in this direction existed before the crisis: Empiricism became more important, statistics, econometrics. But it wasn’t enough,

The ivory-towerish nature of the academics manifested itself above all in their human conception. Their models had none to little place for irrational, unpredictable--simply human--behaviour. Admittedly, the microeconomists were already headed in the right direction before the financial crisis. They discovered--eureka!--that the perfectly rational human doesn’t exist, and they researched his irrationalities in the laboratory. With interesting results and successes. Economists like Robert Shiller described early on the way in which exaggerations and dangerous bubbles could form on markets.

But that wasn’t enough to change the models that the academics were using when they considered the entire economy. It definitely wasn’t enough to change teaching. Until today, Shiller is, at most, a sidenote.

For quite some time, students of economics have begun to doubt the purpose of their studies because of the distance to reality and the world. Their motto could be “under the gowns lies the musty smell of thirty years.” Some of those who teach are on their side. Wendy Carlin, professor of economics at University College London (UCL) says, “For me, the most important lesson learned was that we need to reconstruct our models in such a way that developments in the financial market and in the real economy can be described parallel to each other.“ Carlin added, “And we shouldn’t withhold these advances or this progress from our students.“ Together with her colleague, David Soskice, she has developed such a model--and explained it in a new textbook right away.

Within the framework of a project for the Institute for New Economic Thinking—founded in 2009 and financed by George Soros—Carlin is currently working on revising teaching methods. “Up until now, my students have always learned the mathematical models first, and sometime later we explained to them what you can actually apply the models to,“ she says. “Now we do it the other way around.“ First you learn about the economic problems. Then you develop the models that are needed for them.”

In addition, Carlin and her colleagues have also shifted the emphases. Traditional macroeconomic courses rarely deal with financial markets, irrationality, or economic history. In Carlin’s curriculum they play a central role very early on.

Although this is impressive, it is only a pilot project at selected universities. This method of teaching was implemented at UCL in the fall of 2014 with the anticipation that other universities will follow. But it might take time until it spreads widely.

Why will it take so long? As previously mentioned, there is still a lack of one overarching theory that combines all reforms. And who knows if that day will ever come. At this point, economics/or economists might have to settle for baby steps.

It also has to do with the extreme persistence in research--even against a small step. The rising stars are now economists who work in the interface between money, financial markets and macroeconomics—Brunnermeier and Marcel Fratzscher of the German Institute for Economic Research both belong to this group. Behavioural economists are also gaining ground, but they don’t determine the course of the science. Not yet.

There are also a couple of older macroeconomists who focus on the fundamental topics. These economists, including Robert Shiller—who recently won the Nobel Prize--and Martin Hellwig, are also becoming recognised. But the number isn’t quite big enough: “The corridors of power are filled with the older ones, and they continue to do what they’ve always done,“ taunts a young economist WHO doesn’t wish to read his name in the newspaper.

Changes in teaching would improve students’ situations as well. After all, students are interested in current economic developments and there are a variety of approaches. But in teaching the persistence is even stronger than in research. “Almost everyone is opposed to fundamental changes in teaching,“ bemoans Dennis Snower. “The professors who have finished writing their lecture scripts. The students who often learn by heart and don’t want to think in new ways.”

Wendy Carlin criticises, too, “The people that come to my seminars are sometimes incredibly conservative.“ When she started teaching the new curriculum last autumn, most students wanted to know one thing only: how could they pass the exam, without being able to use the exercises and model answers from previous years?