Tim Hartford says
In terms of how economics needs to change in light of the crisis, where I would put my emphasis is not so much in behavioural economics, though I have no problem with it – it’s a very interesting area and it’s producing really important insights – but I think it’s more about engaging with the world, and the institutions of the world as it is. Economists got too used to reasoning in fairly abstract ways, without looking at the details of what was actually going on.If, as an economist, you’d looked at the way sub-prime loans were being sold, and the kinds of contracts that were being written and the financial instruments that were being created, you don’t need any mysterious appeal to psychology to explain the disaster. You just need to have been paying attention.
Now its easy to say this in retrospect but I have the luxury of having said it at the time. Perhaps, that was just a lucky coincidence.
However, I am also saying something that differs from Hartford and just about everyone else that I know of. That is, the deeper and more careful folks look into the crisis the less obvious it will be that it was going to happen.
If you use information available before the crisis you will find it hard to build a model that is consistent with pre-crisis data, yet predicts that the crisis was about to happen.
My thesis was and still is the finance sector failed the Lucas Critique. Firms used models of the world to predict what would happen when you changed the rules by which the world worked. However, those models were only valid under the old rules.