Economists Debate: Krugman Vs. Cochrane

There's an interesting debate between economists regarding the economics profession as it relates to the events of the past couple years. At the center of the debate is the question: Did economists fail to see the events we have recently experienced?

On one side is Paul Krugman, a Princeton University professor who won the Nobel Prize in economics in 2008. On the other side is John Cochrane, a professor with the University of Chicago Booth School of Business.

Krugman wrote an article for the September issue of New York Times Magazine titled "How Did Economists Get It So Wrong?" His basic premise is that today's economists should have foreseen the economic problems we're currently fighting. His conclusion: "When it comes to the all-too-human problem of recessions and depressions, economists need to abandon the neat but wrong solution of assuming that everyone is rational and markets work perfectly. The vision that emerges as the profession rethinks its foundations may not be all that clear; it certainly won't be neat; but we can hope that it will have the virtue of being at least partly right."

Cochrane wrote a strong rebuttal to Krugman's piece, challenging a number of assertions. For example, Krugman argues that events such as the most recent housing bubble were predictable events, but no one was listening to those who were shouting warnings. He noted that economist Robert Shiller had been warning about such a bubble for years.

In his rebuttal, Cochrane notes that it doesn't help to know which prognosticators are correct after the fact: "Krugman rightly praises Robert Shiller for his warnings over many years that house prices might fall. But advice that we should listen to Shiller, because he got the last one right, is no more useful than previous advice from many quarters to listen to Greenspan because he got several ones right. Following the last mystic oracle until he gets one wrong, then casting him to the wolves, is not a good long-term strategy for identifying bubbles."

My own opinion is that Cochrane presents the more reasoned view, but what do you think about the debate between these two? Should economists have predicted the events of the past two years? Have they been wrong about the Efficient Market Hypothesis? Please leave comments and let me know what you think about their arguments.