Only a small minority of academic economists, notably Raghuram Rajan (2005) and Nuriel Roubini (2006), gave fair warning of the risks of an unchecked housing bubble in the early 2000s. Dani Rodrik (2007) and Barry
Eichengreen (2007a) cautioned against the negative fallout potential of the global imbalances built up over the 1990s. A majority in the economics profession, however, failed to recognize the impending storm. The cause of this academic oversight was the error in mainstream economics of believing that the economy is simply the sum of microeconomic decisions of rational agents. The efficient-markets hypothesis, which relied on the idea that deviations from equilibrium values cannot last, fuelled the idea that free markets are self-regulating and financial innovation is beneficial to everyone. Temporary assets and housing price hikes are not macro-economically harmful, as long as policymakers were able to tame inflation and stabilize public finances through rule-based fiscal and monetary policies. Theoretical and mathematical sophistication, moreover, moved professional economists away from empirically probing the underlying vulnerabilities of loose macroeconomics, financial deregulation, and the distorted bonus schemes in banking that exacerbated already existing economic instabilities. Having bid farewell to Keynesianism in the 1980s, academic economists completely forgot one of the most fundamental elements of financial crises: animal spirits (Akerlof and Shiller, 2009; De Grauwe, 2008). Left to their own devices, capitalist economies will experience manias followed by panics.
The factors of financial market deregulation and liberalization, loose monetary policy, global savings and trade imbalances, weakened social protection, and cognitive capture by short-sighted neoclassical economics, all conspired behind a growth model of overstimulation and overconsumption by debtfinancing, which ultimately proved unsustainable and triggered the 2008 credit squeeze and the subsequent global downturn.