Should we change the way we teach economics?

Because of the recent financial crisis, teaching the basic principles of economics is harder than ever.

The New York Times opinion page recently ran a series of short pieces on Rethinking How We Teach Economics, making the point that we need to change our economics instruction to be able to account for the financial crisis. There are several articles in the “debate,” but I would like to consider Alan Blinder’s contribution. In addition to being a Princeton economist, Blinder was on President Clinton’s Council of Economic Advisors and he was also a member of the Board of Governors of the Federal Reserve, so his take on this is not surprising.

Blinder argues that we must change the way we teach economics. In his words,

We must now teach students how we got into the mess of the last five years and how we got partially out. For that reason, teaching elementary economics just got harder. Our teaching about monetary policy must be completely revamped. Specifically, students must now learn something about “unconventional” monetary policies.

And,

Remember “conventional” monetary policy? The Federal Reserve shortens recessions by creating more bank reserves (“printing money”), which fuels a multiple expansion of the money supply and credit because banks don’t want to hold excess reserves. So they get rid of them making more loans and deposits, which also lowers short-term interest rates. Compare that to current reality: Banks are content to hold over $1.6 trillion in excess reserves, short-term interest rates are stuck near zero, and Fed policy often works on long-term interest rates instead. No, this is not your father’s monetary policy, and the old ways of teaching about it simply won’t do.

Blinder is right in saying that many instructors should change the way they teach economics, but it’s not because of the crisis. The crisis has exposed some of the failures of mainstream economic theory, namely the failure to explain the cause of the business cycle.

Austrian theory fully explains how Federal Reserve policies triggered the financial crisis. Austrians understand that the Fed does not counter the business cycle and instead it should be blamed for creating this meltdown.

Some instructors do not need to revamp their teaching methods. Those who teach Austrian business cycle theory can use the current crisis as another example of the failure of “conventional” monetary policy. Instructors that use Austrian readings such as Murray Rothbard’s “The Mystery of Banking” to explain business cycle theory do not need to “rethink how we teach economics.”