I hear frequently that economics needs to change, and it has, at least in the questions we economists ask.
Twenty years ago, the dominant conversation in economics was about the wonder of markets. Trade barriers needed to come down to make everyone better off. We needed to free the banking system from regulations so it could do its important job of turning saving into productive investment unfettered by government interference.
Economists saw little need to worry about monopoly power because markets are "contestable" -- the threat of new firms entering a market would prevent existing firms from exploiting their monopoly power, allowing the problem to take care of itself. Unions simply get in the way of an innovative, dynamic economy and needed to be broken so the market could do its thing and make everyone better off.
Inequality was a good thing: It created the right incentives for people to work hard and try to get ahead. Markets would ensure that everyone, from CEOs on down, would be paid according to their contribution to society.
The problem wasn't that the markets somehow distributed goods unfairly, or at least in a way that's at odds with marginal productivity theory (the idea that inflation-adjusted wages should move one-to-one with changes in workers' productivity), it was that some workers lacked the training to reap higher rewards. We simply needed to prepare people better to compete in modern, global markets -- nothing was fundamentally wrong with markets themselves.
The move toward market fundamentalism wasn't limited to Republicans; Democrats joined in, too.
That view is changing. Inequality has burst onto the economics research scene, and it's raising questions economists not long ago ignored: Is rising inequality an inevitable feature of capitalism? Does the system reward people fairly? Can inequality actually inhibit economic growth?
A similar change is happening in the financial sector. The profession has moved from singing the praises of the financial system and its ability to channel savings into the most productive investments to asking whether the sector produces as much value for society as it claimed in the past.
We now ask whether banks are too big and powerful, whereas in the past that size was praised as a sign of how giant banks can do fantastic things for the economy and compete with banks around the world.
We've gone from saying the shadow banking system can self-regulate as it provides important financial services to homeowners and businesses to asking what types of regulation would be best.
Economists used to pretty much ignore the financial sector altogether. It was a black box that simply turned S (saving) into I (investment), and did so efficiently, leaving no need to get into the details. Our modern financial system couldn't crash like those antiquated systems from the days before the Great Depression. We had no need to include it in our macro models, at least not in any detail, or even ask questions about what might happen if there was a financial crisis.
Other changes have occurred, too. Economists now question whether markets reward labor according to changes in productivity. Why is it that wages have stagnated even as worker productivity has gone up? Is it because bargaining power is asymmetric in labor markets, with firms having the advantage over workers? What's the best way to expand and elevate the working class?
In the past, an argument was made that the best way to help everyone is to cut taxes for the wealthy, and all the great things they would do with the extra money and the incentives that tax cuts bring would trickle down and help the working class. That didn't happen, and although this argument still echoes on the political right, the questions have certainly changed.
Much of the current research agenda in economics is devoted to understanding why wage income has stagnated for most people and how to fix it. We've moved beyond "technology is the problem, and better education is the answer" to asking whether the market system itself and the market failures that come with it (including political influence over policy) have something to do with this outcome.
Fiscal policy -- the use of government spending and taxation to achieve economic goals -- is another example of change within the profession. Twenty years ago, nobody (well, hardly anyone) was doing research on the impact of fiscal policy and its use as a countercyclical policy instrument. All of the focus was on monetary policy -- primarily how the Federal Reserve sets interest rates.
Fiscal policy was thought to be needed only in a severe recession, but that wouldn't happen in our modern economy, and in any case it wouldn't work (not everyone believed fiscal policy was ineffective, but many did).
That has changed. Fiscal policy is now an integral component of many modern macroeconomic models, and -- surprise -- the models don't tell us fiscal policy is ineffective. Quite the opposite -- it works well in deep recessions (though as the economy nears full employment, its effectiveness wanes).
Monetary policy has also come under scrutiny. In the past, the so-called Taylor rule (linking the Fed's target interest rate to inflation and output) was praised as responsible for making the period from 1982 through 2007 to become known as the Great Moderation. During this period, inflation fell dramatically, and the variation in output and employment fell to about half of previous levels.
We had discovered the key to a stable economy.
But the Great Recession changed that. We now wonder if other policy rules might serve as a better guidepost (e.g. nominal GDP targeting), we ask about negative interest rates, unconventional policy, all sorts of questions that were hardly asked or even imagined not so long ago. We wonder about regulation of the financial sector, and how to do it correctly (in the past, it was about how to remove regulations correctly).
The view about international trade has also changed. In the past, the dominant view within economics was that trade is good, it makes everyone better off and the more trade restrictions that are removed, the better.
But that view has become much more nuanced. Economists still believe trade is good, though with far more qualifications to that statement than before, and economists are much more likely to recognize that trade deals have winners and losers. Those who lose their jobs or businesses due to increased imports are rarely compensated for their losses.
I don't mean to suggest that economics is now fully on the right track. The old guard is still there, and still influential. But it's hard to deny that the questions we're asking have gone through a considerable evolution since the onset of the Great Recession. And when questions change, new models and new tools are developed to answer them.
The models don't come first -- they aren't built in search of questions. Models are built to answer questions -- and the fact that we're asking new (and, in my view, much better) questions is a sign of further change to come.