In a few words Keen argues that economists have created so many myopic models that they and our increasingly sycophantic media don't understand how our economic world really works. Keen looks specifically at two "modelling" areas that have led economists off track: (1) a continued belief in Milton Friedman's monetary theories, which don't adequately account for credit and debt creation, and (2) a disturbing belief that economies tend toward disequilibrium.
How did these two beliefs impact our (mis)understanding of the world before last year's meltdown? Keen responds:
Because neoclassical economists treated any economic variable generated by a market economy as being in equilibrium, they fantasised that stock and house prices were in equilibrium when clearly they were in a bubble, and they ignored rising levels of private debt in the belief that whatever level of debt applied was an equilibrium one – and therefore justified by market fundamentals.
In a few words what we have is market arrogance coupled with ideological blinders working to create - as I have described elsewhere - a fairytopian world of perfect competition and fluid decisions that somehow work themselves out ... as if some mythical and magical invisible hand make things work in harmony all the time.
What a bunch of crap.
I wrote about this in my book when I described how markets really work, whether through favorable legislation or money policies that benefit specific groups. Specifically, I pointed to economists like Hyman Minsky (who saw debt as both good and bad, and tried to make sure that we understood the difference too) and John Maynard Keynes (who saw disequilibrium). Both understood and saw the flaws Keens writes about. Still, modern economists try to explain away favorable legislation, or downplay disequilibrium, as aberrations because they don't fit the model.
This is why I especially like what commentator Raymond D'Hollander has to say about economists depending too much on mathematical models:
Mathematics is simply a tool to be used in engineering systems. Nothing more, nothing less. Every engineer knows that the world is not perfectly normal (in the statistical sense) so no engineer worth his salt would base his entire design on some untested mathematical formulas. Boeing or Airbus would never design an airplane in a computer, manufacture it from the computer-generated instructions, and then immediately load it up with 300 passengers on its maiden flight. On the other hand economists and the global financial sector appear to believe that this is a perfectly viable way of approaching the world's economy.
In my view, economists and market players believe in the models they create for two, self-serving, reasons.
First, models - especially in CDS, CDO, and other ABS markets - allow(ed) economists to believe that they are "scientific" and are in control of what they see. Second - and simply put - the models that have been created allow market players to get rich. They buy enough time to squeeze money and profits that don't really exist. The bailout funded counterparty payouts (thank you Ben Bernanke and Tim Geithner) show this to be true. The money wasn't really there, unless you were always banking on a bailout.
Steven Keen does a good job of explaining what went wrong with the models and assumptions of economists (though some might find it somewhat technical). I encourage you to read it if you get the time. The comment section is especially good too.