Editor's Introduction: Competing Theories of Economic Crisis

• Date: 01 March 2015
• DOI: http://doi.org/10.1111/ajes.12100
• Published date: 01 March 2015

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ECONOMICS and SOCIOLOGY

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Volume 74 March 2015 Number 2

Editor’s Introduction:

Competing Theories of Economic Crisis

The Great Recession that has gripped much of the world since 2008

was an event that was not supposed to happen, somewhat like the

sinking of the unsinkable Titanic in 1912. The officials in charge of

managing national economies were uniformly caught off guard

because their models predicted smooth sailing and continued eco-

nomic growth. Yet, the crash occurred, many businesses went bank-

rupt, millions of homes were lost in foreclosure, and millions of

workers lost their jobs.

Since there is universal agreement that periodic economic contrac-

tions should be avoided, if possible, there has been a great deal of

interest in reexamining the fatal flaw of capitalism to determine how

to avoid these socially damaging episodes. To that end, I invited

authors from various traditions to offer their wisdom on this subject.

Before reviewing the particular theories of economic crisis pre-

sented by the various authors, I wish to make some general com-

ments about the problem of developing such theories.

First, it is not clear to me if there is an existing theory that needs

to be displaced. The operative models of national economies are

known as dynamic stochastic general equilibrium (DSGE) models.

American Journal of Economics and Sociology, Vol. 74, No. 2 (March, 2015).

DOI: 10.1111/ajes.12100

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They clearly do not make accurate predictions, at least not of major

changes. Whether the problem lies with the particular modeling

methods or with the underlying concept of equilibrium is a more

complicated question. In any case, the state of macroeconomics is in

disarray, and the economists and government officials who should

be providing leadership to rectify that situation do not appear to be

doing so. The problem, it would seem, is that fixing the problems of

macroeconomics will require rethinking some fundamental princi-

ples of economics, which will inevitably meet resistance within the

profession.

Second, it is not clear what test an alternative theory of economic

crisis must pass to gain widespread acceptance among economists.

The general theory that Keynes proposed gained acceptance in part

because it aided the Allied governments during World War II to

make reliable estimates of the ability of the Axis powers to finance

their war effort. One might say it was tested in battle. Whether

Keynes, the Keynesians, or the new Keynesians have produced

models in the postwar era that have permitted effective management

of a national economy still remains in dispute. So we really have no

clear historical example of how a new theoretical framework can

gain acceptance purely on its own merits. Since DSGE models

remain in favor despite their poor track record, it is not plausible to

assume that a different framework will gain acceptance merely

because it makes better predictions. The politics of professional

knowledge is at work here, which means the status quo will likely

prevail long after a more effective theory and model are introduced.

Third, there are general questions about what constitutes a scien-

tific theory. A great deal of what passes for theory building in the

social sciences is nothing more than elaborate description. The dis-

tinguishing feature of the scientific method, sometimes referred to as

the Galilean method, in honor of Galileo, is that the hypothesis

must be derived independently of the evidence. Evidence tests theo-

ries; it does not generate them. In practice, that means one does not

develop a theory by gathering evidence.

Theories arise from the imagination, by making connections that

have not previously been recognized and that often seem absurd

from the perspective of the common sense of the time. For

The American Journal of Economics and Sociology188