[Marxism] What good are economists?
lnp3 at panix.com
Mon Apr 20 07:24:29 MDT 2009
What Good Are Economists Anyway?
Why they failed to predict the global economic crisis—and why their help
is still crucial to a recovery
By Peter Coy
Economists mostly failed to predict the worst economic crisis since the
1930s. Now they can't agree how to solve it. People are starting to
wonder: What good are economists anyway? A commenter on a housing blog
wrote recently that economists did a worse job of forecasting the
housing market than either his father, who has no formal education, or
his mother, who got up to second grade. "If you are an economist and did
not see this coming, you should seriously reconsider the value of your
education and maybe do something with a tangible value to society, like
picking vegetables," he wrote on patrick.net.
Take that, you pointy-headed failures! Go jump off a supply curve!
To be fair, economists can't be expected to predict the future with any
kind of exactitude. The world is simply too complicated for that. But
collectively, they should be able to warn of dangers ahead. And when
disaster strikes, they ought to know what to do. Indeed, people pay
attention to economists at times like this precisely because of their
bold claim that they know how to prevent the economy from sliding into a
repeat of the Great Depression. But seven decades after the Depression,
economists still haven't reached consensus on its lessons. The debate
has only intensified in recent weeks.
To fight the downturn, Federal Reserve Chairman Ben Bernanke, Treasury
Secretary Timothy F. Geithner, and National Economic Council Director
Lawrence Summers are attempting an unprecedented combination of massive
fiscal stimulus and extreme monetary policy. If it produces a sustained
recovery—and there are some early signs of hope—they will look like
heroes. For now, though, it's disturbing that they've had to resort to
policy measures that in scale and scope are way outside what the
economics profession had studied or even contemplated in recent years.
The rap on economists, only somewhat exaggerated, is that they are
overconfident, unrealistic, and political. They claim a precision that
neither their raw material nor their skill warrants. Too many assume
that people behave like the mythical homo economicus, who is
hyperrational and omniscient. And they take sides in quarrels that
freeze the progress of research. Those few who defy the conventional
wisdom are ignored.
Critics are scathing. Nassim Nicholas Taleb, the scholar of rare events
who wrote Fooled by Randomness and The Black Swan, says: "We have to
build a society that doesn't depend on forecasts by idiotic economists."
Says Paul Wilmott, a quantitative finance expert: "Economists' models
are just awful. They completely forget how important the human element is."
In the face of such withering criticism, it's tempting to ignore the
whole profession. But that won't do. For one thing, getting out of this
mess and making sure it doesn't happen again will require the very best
thinking of a generation. Macroeconomists—that is, those who specialize
in business cycles and growth—have made important contributions. For
example, research in the 1970s helped many countries eliminate chronic
high inflation by highlighting the importance of having a strong,
independent central bank.
Even now, progress is being made. Scholars of all stripes are belatedly
getting up to speed in modern finance. Because they are trained to think
of financial markets as efficient, most economists weren't primed to
spot the dangers posed by lax mortgage lending, overleveraged financial
institutions, and impenetrably complex derivatives. "The time is
absolutely right for
new ideas to come in, much as they did in the 1930s and the 1970s," says
Roger E.A. Farmer of the University of California at Los Angeles.
Besides, even if you're suspicious of economists' value, they are
impossible to ignore. Here's why: Every idea you can think of for coping
with this crisis is based on some supposition about the way the world
works. Whether you realize it or not, all of those suppositions come out
of one school of economics or another. As the British economist John
Maynard Keynes wrote: "Practical men, who believe themselves to be quite
exempt from any intellectual influence, are usually the slaves of some
So we had all better hope that the profession can get its act together.
It won't be easy, because this crisis is rubbing salt in old wounds. It
is reopening debates about one of the most contentious questions in
macro, namely, the ability of government deficit spending (i.e., fiscal
policy) to stimulate demand and get people back to work.
In January the fight over fiscal policy broke out in public after
then-President-elect Barack Obama made what probably seemed to him a
safe claim, saying: "There is no disagreement that we need action by our
government, a recovery plan that will help to jump-start the economy."
Not long after, some 250 conservative economists, in an open letter
published in major newspapers, wrote: "With all due respect Mr.
President, that is not true." Middlebury College economist David C.
Colander, who himself is suspicious of the stimulus package, says: "The
debate is reasonable. What's unreasonable is that we're undertaking it
at this time" rather than decades ago.
Economists' worst sin is hubris. In the 1960s, free-market economist
Milton Friedman persuaded virtually the entire profession that the Great
Depression was caused by the Federal Reserve. That seemed to imply that
better policy by the Fed, guided by economists, would prevent a
recurrence. Bernanke, then a governor of the Federal Reserve, said as
much in a 2002 speech for Friedman's 90th birthday that acknowledged the
Fed's role in the Depression. He told Friedman: "You're right, we did
it. We're very sorry. But thanks to you, we won't do it again." Famous
Believing in the power of the Fed, economists mostly stopped researching
the use of fiscal policy to fight recessions or depressions. What's
more, recessions had become rarer and milder—the so-called Great
Moderation. So who needed stimulus? Says New York University economist
Xavier Gabaix: "Up until a year ago, you would look very old-fashioned
if you were talking about optimal fiscal policy."
Mainstream economists' adherence to orthodoxy was also apparent in their
casual dismissal of worries about bubbles in housing and stocks. Former
Fed Chairman Alan Greenspan denied that a national housing bubble was
even possible, since housing was not a single national market. He also
brushed off the dangers of Wall Street concoctions such as derivatives.
Only last year did he concede he was wrong. In Senate testimony, he said
he was shocked to have found a "flaw" in his ideology, adding: "I have
been going for 40 years or more with very considerable evidence that it
was working exceptionally well."
Politics compounded the trouble. As a rough first cut, you can divide
macroeconomists based on how concerned they are about economic
instability. One group, in the tradition of Keynes, worries about
self-perpetuating economic declines that leave the economy in a deep
trough it can't escape. Members of this group say government needs to
break downward spirals with the kinds of aggressive policies the U.S. is
following now—cutting interest rates and raising government spending.
The group includes Paul R. Krugman, the Princeton University economist
and Nobel laureate; NYU's Nouriel Roubini, who was early in predicting a
severe recession; and Yale University's Robert J. Shiller, who predicted
the housing bust and the tech-stock bust.
Other economists have more confidence that the economy is
self-equilibrating. They believe low interest rates and heavy deficit
spending will be ineffective while leaving the U.S. with a mountain of
debt. Count Harvard's Robert Barro in this camp, along with Chicago's
Robert E. Lucas Jr., Arizona State University's Edward C. Prescott, and
the University of Minnesota's Patrick J. Kehoe and V. V. Chari. No
surprise, the equilibrium school mainly leans Republican, and the
interventionist school seems to be crawling with Democrats.
Before this crisis, it seemed that economists might resolve their
differences. The oft-combative Krugman, in the first edition of his
textbook Macroeconomics in 2006, wrote that "the clean little secret of
modern macroeconomics is how much consensus economists have reached over
the past 70 years."
The mood now is uglier. On the left, Krugman says: "This is really
fairly shameful, that we should be wasting precious months as a
profession retracing debates that were settled 70 years ago." On the
right, John H. Cochrane of the University of Chicago dismisses those who
advocate Keynesian stimulus, saying: "Professional economists, the guys
I hang out with, are not reverting to ancient Keynesianism any more than
physicists are going back to Aristotle when they can't understand how
fast the universe is expanding." There are some middle-of-the-roaders,
such as Columbia University's Michael Woodford, who argue that
macroeconomists are converging on a methodology for asking questions.
But even Woodford agrees that "recent debates don't particularly make
the field look unified."
The easiest criticism of macroeconomists is that nearly all failed to
foresee the recession despite plenty of warning signs. In early
September 2008, the median growth forecast for the fourth quarter was
0.2%, according to a survey by Blue Chip Economic Indicators. The actual
outcome was a 6.3% annualized decline. The Fed didn't do any better. In
July 2008, Fed officials projected unemployment in the fourth quarter of
2008 would end up between 5.5% and 5.8%. The actual number was 6.9%.
Their projection for the fourth quarter of 2009, done at the same time,
was for a range of 5.2% to 6.1%. Today, with unemployment at 8.5%, most
forecasters expect the rate to be nearing double digits by the end of 2009.
Now that fiscal policy is back on the table, economists are fighting
over the size of the ripple effect—or "multiplier"—of increased
government spending. Interventionist economists think multipliers are
large when the economy is operating below capacity—and it certainly is
now. According to a Fed report on Apr. 15, one-third of manufacturing's
productive capacity is going unused, the biggest share on record back to
Obama Administration officials believe that their fiscal policy is on
the right track. The stimulus program "is putting a little more energy
into the consumer," National Economic Council Director Summers told
Maria Bartiromo. "Two months ago you couldn't find anything positive."
Christina D. Romer, Obama's chief economic adviser and a historian of
the Depression, said in March that "at some point, recovery will take on
a life of its own." Until then, she said, government should watch
closely "to make sure the private sector is back in the saddle" before
Other economists say increased government spending may actually depress
private employment. At a Council on Foreign Relations event on Mar. 30,
Chicago's Lucas called the Administration's multiplier math "kind of
The truth is, even backers of stimulus can't be sure it will work. As
World War II ended, many economists worried that growth would lapse as
military spending fell. Sewell Avery, the CEO of Montgomery Ward, was so
anxious about a postwar depression that he refused to open new stores.
Economists still aren't sure why he was wrong, so they can't say
reliably whether fiscal stimulus will end this recession or just
interrupt it. "Is it possible to engineer a durable recovery with fiscal
expansion, or are you just buying time?" asks Krugman, who favors
coupling stimulus with drastic action to fix the banks.
What, then, is the way forward? Once this crisis is past, the next
agenda for macroeconomists will be to help make the economy far more
robust—enough to survive the blunders of politicians, bankers, and
economists of the future. Taleb, the scholar of unpredictability, notes
that nature achieves robustness through a redundancy that economists
would consider wasteful: two hands, two eyes, etc. Blake LeBaron of
Brandeis University suggests preventing huge crises by tolerating small
disturbances, the way foresters use controlled burns to eliminate
flammable underbrush. Perhaps out of the ashes of failure will emerge a
better macroeconomics profession.
With Jane Sasseen and Theo Francis
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