Should the financial crisis inspire normative revision?

The paper evaluates the claim, made by a range of commentators but most prominently by Akerlof and Shiller in Animal Spirits, that the recent financial crisis illustrates gaps in the normative picture incorporated into standard macroeconomics that are plugged by insights due to behavioral economics. It is argued that Akerlof and Shiller's contention that we cannot understand what happened unless we supplement macroeconomic theory with social-psychological theory is convincing only after being so heavily qualified that most of the surface excitement drains out of it. However, this is argued to be compatible with the idea that each recession or depression is a unique historical episode from which specific lessons can be learned; rejection of calls for paradigm shifts does not imply that each business cycle merely offers another observation to confirm a settled and stable understanding of macroeconomic dynamics. Discussion of factors that made the recent crisis unusually dangerous - the extreme global savings imbalance and the very rapid shifts occurring in the composition of the global labor force - leads to identification of a quite specific normative recommendation. This recommendation, that wealthy and middle-income people who care about efficiency, growth and prosperity should be willing to be taxed at higher levels to fund investments in human capital development, is certainly far from novel. However, I contend that the recent events have provided a new and newly specific reason to urge it. The reasoning in question owes nothing to behavioral economics or to any new advances in empirical psychology, which are indeed argued to obscure the most important implications of the recent crisis, and of recessions in general.