Great piece by Krugman in the New York Times Sunday magazine: How did Economists get it so wrong?
Krugman gives an account of the development of the economics discipline familiar to anyone following his popular writings, and links the search for mathematical perfection in economic modelling to the failure of the economics profession to pick up the signs of impending meltdown. The problem is that beautiful harmonious models can't cope with the incoherence and irrationality of much human behaviour, and worse, often miss the real action.
Fundamental to the error is the belief that markets will tend to find the right prices for things - something that clearly didn't happen in the long 2000s bubble. Particularly amusing, the citation of 'ketchup economics' (attributed to Larry Summers of all people) - the belief that just because one price may make sense in comparison with another, then prices in general must make sense. Someone buying a house in summer 2007 may well have found the best deal in the market at that time, but the whole market was way out, so the price could not be right.
These are pretty fundamental issues, and show a future for a political economy which takes social and cultural institutions more seriously. After all, how could the housing boom have taken over without the cultural hegemony exercised by pro-bubble thinking ('Location, location, location' being my favourite example). Of course there is politics and material advantage in there too, but the really interesting question is how a whole society can embrace a self-destructive economic model without realizing what it's doing.