Over on his blog, Brad DeLong is asking where modern macro economics went off the rails and started ignoring well-understood economic history.
I stuck an opinion in the comment thread. This, though, is a bit too much for a comment.
If the efficient markets hypothesis doesn't hold (and I think you have to accept that it doesn't hold at this point; the Great Recession is a direct result of treating the efficient markets hypothesis as true), money isn't a good proxy for value.
Remember that value is the ratio between performance and price. In economic models, value is usually approximated as price, both because that's a whole lot simpler than attempting to determine value directly and because people have more or less lost the distinction; "what's that worth?" and "what's that cost?" are not inherently synonymous statements, but could certainly be used that way in conversation without anybody looking at you funny. Now, price is important; figuring out the price point to sell something at is a lot of what's involved in commercial success, and the price of money does constrain economic activity, and so on, but price and worth (value) aren't the same thing.
If money is not a good proxy for value -- and if the efficient markets hypothesis isn't true, it can't be -- all the arguments from models related to money break. Some things, like the notion of the velocity of money, continue to work because they're focused on spending, which is safely distinct from what the economy as a system is doing. But on the whole the models are modelling something subtly false of fact and will fail where they fall into the crevasse between the map and the territory.
An economy can be a machine to create general prosperity, or it can be a machine to concentrate wealth. Brad would know better than I which time periods represent which modes in the US economy, but I think it's pretty easy to point out that 1946 through 1970 or so represent a "generate prosperity" period and 2000 through the present represent a "concentrate wealth" period. 1970 through 2000 represent an interesting tussle intended to move the economy away from generating prosperity and toward concentrating wealth.
These two kinds of economy are not the same system, and while I am not an economist, I've never seen any popular or public discussion of economic policy which either directly address the question of what an economy is for, or treated the change from a basically level income distribution to a sharply tilted income distribution as a change in fundamental system (like the switch from steam to diesel-electric in railway locomotives, say) rather than as a side effects in shifts in marginal utility of different skills. Not thinking in terms of system lets you avoid "the purpose of a system is what it does" and treat policy as a question of operating within axiomatic constraints, rather than testing the axioms. (Anyone want to bet that the efficient markets hypothesis was the only busted axiom?)
So I think there's three problems:
- not asking what an economy is for
- attempting to model in terms of money, rather than value
- no systematic attempt to test axioms
Science is about knowing how wrong you are. Until it starts being science, nobody's going to know who is wrong; not knowing who is wrong has enormous social utility on both the individual and political levels.