The crash of 2008 exposed deep failures at the core of macroeconomic policymaking and macroeconomic thinking in the United States. The crisis’s rapid spread from its epicenter on Wall Street to nearly the entire world underscored the interconnectedness of the global economy. The American purveyors of the ancien régime hope that a few superficial fixes will get us back on our way. This is not to be. Sustained and widespread future prosperity will require basic reforms in global macroeconomic governance and in macroeconomic science. Such reforms are never easy, as they require new ways of thinking. Yet business as usual could prove calamitous. This essay describes the reform path.

To set our new direction, we must understand how we arrived at the current impasse. The financial crisis of 2008 was not an accident. It was the result of a long period of political decadence in the United States aided and abetted by a growing hole in economic science. Decadence is a tough word, but the truth is that the US walked headlong into the fury. Because of the central roles of both the dollar and Wall Street in the global financial system, and because of the centrality of US economic thinking in shaping global economic policies and institutions, the rest of the world has been carried with it into the fury. This dominance will come to an end with this crisis, however.

From the Presidency of Ronald Reagan, beginning in 1981, until today, US economic policy has operated with a flawed set of assumptions, perpetuated by both Republican and Democratic Administrations and by the Federal Reserve Board. There have been heated debates, to be sure, between neo-Keynesians and free-market economists (variously grouped under the rubrics of supply-side, rational expectations, and efficient-market theories). These debates have, however, obscured a large and ultimately damaging consensus on economic thinking.

The differences between the two schools of thought are well known. Neo- Keynesian economists emphasize active aggregate demand management, with little attention to the uses of that spending. Free-market economists of various stripes (such as the rational expectations, efficient markets, supply-side, and real- business-cycle schools, all close cousins) generally call for tax cuts and deregulation, and believe in the stabilizing role of efficient financial markets and financial market expectations.

Yet these two broad schools of thought share five assumptions (often implicit) that are even more consequential than their differences. First, both the Neo-Keynesians and free-market schools believe that economic policy making should largely remain the purview of individual countries (or in the case of Europe, the purview of the Euro-zone). Global cooperation is not much needed, except perhaps to set a few regulatory standards. Second, both schools focus on price stability, low unemployment, and high economic growth as the main objectives of macroeconomic policy. Third, both schools regard the management of key macroeconomic aggregates as the way to achieve price stability and high growth. For Keynesians, the main aggregates are the budget deficit and monetary policy, managed so as to stabilize aggregate demand. The free-market school prefers low marginal tax rates and a predictable money supply. Fourth, both schools of thought view issues of income distribution as peripheral to macroeconomic management, perhaps interesting morally or politically but not especially relevant to growth and inflation. Fifth, both the neo-Keynesians and the free-market school regard structural issues such as energy, climate, and infrastructure to be of little macroeconomic significance. Perhaps these factors require a modicum of policy attention, but they are certainly not regarded as critical to restoring jobs, growth, and prosperity, and could even be a hindrance in the short term; for example, if climate-change policies hike up the price of energy.

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