The important question is why policymakers didn't take the possibility of a major meltdown seriously.

Brad Delong quickly walks through changes in macroeconomic thought since 1960 and concludes...

Indeed, one way to view the 1980s is that both of the Samuelson-Solow predictions of the long-run consequences of a deflation--of the deliberate creation of a low-pressure economy by the Federal Reserve--came true but in different places. In the U.S. the Volcker Deflation caused a vicious recession, but a decade later unemployment was moderate and inflation was low as the long-run effects of the deflation on expectations improved the short-run inflation-unemployment tradeoff in the United States. By contrast, in western Europe the Thatcher Deflation and its continental cousins produced over a decade a huge rise in structural unemployment and a deterioration in the terms of the short-run inflation-unemployment tradeoff.

But while stagflation led to a serious rethinking of its visualization of the Cosmic All on the part of Cambridge, the Volcker Deflation did not lead to any similar rethinking on the part of Chicago. "I'm not interested in studying the latest residual..." was a not-atypical seminar parry.

And as in any dynamic Markov system subject to shocks in which one state is absorbing, over time that absorbing state will grow in mass and importance--whether or not it is in some sense true. There is a good sociological model of fundamentalism in there somewhere...

Posted via web from Jim Nichols