Skidelsky attacks economists for not predicting the financial crisis, an accusation that Lucas deals with pretty well. Skidelsky wants to rebuild economics, but his attack is based on faulty premises and misunderstandings of what economists do.
For example, according to Skidelsky economics assumes an environment in which
uncertainty disappears to be replaced by calculable risk. Shocks and mistakes may occur but these will cancel each other out, so that, on average, people get what they expect. An important implication of this view is that shares are always correctly priced. This is the basis of the so-called efficient market hypothesis that has dominated financial economics. It led bankers into blind faith in their mathematical forecasting models. It led governments and regulators to discount the possibility that financial markets could implode.The Efficient Markets Hypothesis does not, however, predict that asset prices are always correct. Only, that all available public information is incorporated in them. This is very different from assuming the price is correct. It is possible to have rational bubbles in asset prices, and if Skidelsky looked at mainstream economics journals he would see plenty of articles analyzing them.
The efficient market hypothesis is simply an application of the recently triumphant New Classical school, which preaches that a decentralised market system is always at full employment. In their obsession with getting government out of economic life, Chicago economists claimed that any consistent set of policies will be learnt and anticipated by a population, and will therefore be ineffective.Is this just the creation of a straw man or complete ignorance of the last twenty years of macroeconomics? Very hard to tell. But even the most hard-line new classical economists never argued that the economy was at full employment at all times. Their argument was that systematic monetary policy could not permanently reduce unemployment below some natural rate consistent with frictions and structural change. And they certainly did not argue that tax policies could not change the level of unemployment. And the new classical types were only half of the profession anyway.
Skidelsky is making a straw man parody of the most hard-line new classical types and he even gets that wrong. In the last 20 years or so the differences between salt-water and fresh-water macro has decreased. Everybody deals with models with frictions and where policies can have effects.
This leads Skidelsky to the conclusion that economics must be rebuilt. His prescription sure goes opposite to where our profession is going:
In the past I have sometimes thought that the obsession to provide microfoundations for macroeconomics may have gone too far. Perhaps there are some areas where it is better to build models with aggregates and worry about microfoundations later. But after reading Skidelsky's plea I think I will try to drive that thought from my mind. What would Skidelsky macroeconomists do?
Beyond this, the postgraduate study of macroeconomics might with advantage be separated from that of microeconomics. Courses in microeconomics should concern themselves, as at present, with the building and testing of models based on a narrow set of assumptions. Their field of applicability lies in those areas where we have reliable views of the future. Macroeconomics, though, is an essential part of the art of government, and should always be taught in conjunction with subjects bearing on this.
The obvious aim of such a reconstruction is to protect macroeconomics from the encroachment of the methods and habits of the mathematician. Only through some such broadening can we hope to provide a proper education for those whose usefulness to society will lie as much in their philosophical and political literacy as in their mathematical efficiency.
Instead I am going to work out how to restructure postgraduate education in history.