TThe Dogs Bark, The Caravan Moves On

STOCKHOLM – I spent last week reflecting on the extent of public understanding of economic science. Where better than the grand lecture hall of the University of Stockholm? Nobel laureates in physics, chemistry, and the economic sciences deliver lectures on their work in one day, one after another, all day long, under the auspices of the Royal Swedish Academy of Sciences.

The physics and chemistry prizes were great hits, works of unmistakable significance, producing full houses, polished talks, standing ovations.  See for yourself if you have time (the lectures themselves aren’t up yet on the site): pioneering quantum information science; and bio-orthogonal testing and “click chemistry.” (The prize for physiology or medicine, for discoveries concerning the genomes of extinct hominins and human evolution, was similarly celebrated the day before at the Karolinska Institute, Stockholm’s medical school.) The economics lectures – improved understanding of the role of banks in the economy – were  more sparsely attended, filling less than a quarter of the university hall;  the talks less compelling; little exuberance on display at the close.

On one level, these differences in reception are easy enough to understand. Physics and chemistry are highly esoteric fields. News of their discoveries are inevitably surprising, arriving as bolts out of the blue. On the other hand, almost everyone interested in economics has a lifetime of experience with the subject in personal laboratories of their own. What can economists tell them that they don’t already think they know?

Oddly enough, though, it was the economics prize that hinted at the biggest news of all this year. Why hinted? Because underpinning the awards this year were eighty years of inquiry and hard work by the members of the profession into the causes of the Great Depression of the 1930s. The consensus in the present day, at least in the new-found subdiscipline of financial macroeconomics, is that a weak response by a decentralized and uncomprehending Federal Reserve System before and after 1929 was responsible for the Depression’s depth and length.

Suitably refined, these conjectures and refutations led to the collective action taken in the autumn of 2008 by central banks and treasuries around the world that prevented a second Great Depression of consequences great or greater than the first.  If ever there was a discovery in previous years that “conferred the greatest benefit to humankind” – the test for a medal under the Nobel will – this was  one such.

Yet the only discussion in Stockholm last week about what actually had happened in 2008 was behind the scenes. Instead, the laureates, Douglas Diamond, of the University of Chicago’s Booth School of Business; Philip Dybvig, of Washington University in St. Louis; and Ben Bernanke, of the Brookings Institution, were recognized for topics they raised in a trio of papers written forty years ago. (Economics Committee chair Tore Ellingsen, of the Stockholm School of Economics, supplied a little more connection between now and the long-ago in his presentation speech.)

Diamond and Dybig were cited for their formal model of the role of financial intermediaries in te economy – and for their description of the preventative effects of deposit insurance in forestalling financial crises.  To anyone who has seen It’s a Wonderful Life (1946), by Frank Capra, of CalTech; or Capra’s  darker,  less-well-known version of the same story, American Madness (1932); much less Mary Poppins (1964): these ideas  are not news.

But during middle decades of the twentieth century, in which mainstream economists set aside literary discourse in favor of using mathematics as a working language – the role of banks and bank-like institutions had been largely ignored. Similarly, Bernanke studied the role that a series of banking panics after 1929 had played in turning what today we might call an ordinary recession into something much worse. Earlier students of the Depression, relying on a more primitive theoretical framework, had emphasized contractions of money rather than credit.

The Nobel citation skated over the very different paths the laureates took in the years since they made their original contributions at the beginnings of their careers.   Diamond has spent forty years near the center of the community of well-paid specialists in financial intermediation in leading universities around the world to which the appearance of the Diamong/Dybvig papers gave rise. Dybvig drifted away to traditional macroeconomics. Bernanke rose to the upper ranks of the profession, to the President’s Council of Economic Advisers, the Board of Governors of the Federal Reserve, and to the chair of the Fed board. There he applied the know-how he had acquired over the years to the white-knuckles task of leading a desperate international lending campaign which, in the space of five weeks, spared the world a calamitous financial meltdown. Compared to that, the Nobel Prize is better than another plaque for the basement, but still….

I puzzled throughout the week about the low-key approach the committee took to giving its crisis prize. One obvious explanation was the one traditionally given: the science prize tradition likes to emphasize the beginning of things, their discovery. Then, too, the economics committee seeks to emphasize the extent to which university economics, like any other science, has become a team sport, despite the Nobel stipulation that no more than three persons can share any given prize.

Was there a third person who, had the Swedes felt able to drop Dybig from their citation (they didn’t), for having contributed little after that initial creative collaboration, who would have made sense? The obvious candidate was economic historian Barry Eichengreen, of the University of California at Berkeley, whose book Golden Fetters: The Gold Standard and the Great Depression 1919-1939  (Oxford, 1996), cinched the reasoning behind Bernanke’s arguments.

Another possible explanation of the modesty of the award occurred to me. Both skeins of work, Diamond/Dybvig and Bernanke, stemmed from A Monetary History of the United States:1867-1960 (Chicago, 1963), by Milton Friedman and Anna Schwartz. Diamond, in his lecture, recalled taking an entire course on the book as an undergraduate at Brown University.  In his remarks, Bernanke soft-pedaled the book’s influences on his thinking, but the connection is well-known.

The Milton Friedman of Capitalism and Freedom and Free to Choose is not a popular figure in much of Sweden. In order to reach the public, a prize has to gain acceptance of the class of social scientists within Royal Academy of Sciences, and then the 480 Swedish members and 175 foreign members of the Academy itself.  Perhaps the low-key approach was necessary to gain the consensus that is the hallmark of any genuine science.

The lengthy scientific background that accompanied this year’s award makes clear that the economics committee understood what happened during the Panic of 2008. There may be another prize to be given.  But for now, it seems to me the committee did as well as it could. It is asking too much to expect the analytic tradition of the Nobel Memorial Prize in Economic Sciences  to narrate the major events of our world, or even its own

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