What Was the Failure of Economics?

Macroeconomists have been taking a lot of heat for the failure of the sub-discipline to forecast and/or forestall the crisis. This has often been enlarged to suggest that there is something wrong with the economics discipline as a whole.

This suggests an attitude that I am increasingly running into when I identify myself as a professor of economics: that somehow 'economists' run the economy. Ummm, no. The most important thing to understand is that the economy exists as a natural artifact of human interaction. We don't create it, pull the levers, etc. What we strive to do is understand it, and through this understanding, help governments manage it better.

And here there was a failure. However, I don't think it was with macroeconomics in general, but in the failure of the IO principal-agent and contracting folks to interact enough with the finance and macro types. In other words, there was a trust of the internal incentives of the firm (in this case banks) on the part of finance/macro types that was misplaced. It shouldn't have been: there is a lot of research on incentive problems in CEO compensation, in principal-agent contracts and the like. But macro-types that set policy ignored the lessons of this literature in pushing too far on bank deregulation, trusing the internal incentives to do the trick.

Alan Blinder says something similar in an op-ed in the Wall Street Journal but he blames the corporate boards. But again, we know the incentives were/are skewed there too. Still, his answer is along the same lines, get the incentives right through increased regulation.