Bubbles and bailouts: Why some economists failed

Economists have been criticized for their performance during the financial crisis, rightly at times, but not all of the criticism has been fair.

By The Fiscal Times Jul 20, 2012 1:28PM
By Mark ThomaThe Fiscal Times

Economists have been criticized for their performance during the financial crisis, rightly at times, but not all of the criticism has been fair.

It's true that macroeconomists, as a group, did not see the signs of the disaster that was about to hit the economy. There were a few lonely voices who warned that a dangerous bubble was building in the housing market, but they were mostly ignored. And even after the economy’s troubles became evident, it took macroeconomists longer than it should have to correctly diagnose the problem as a balance sheet recession.

But once macroeconomists understood the nature of the difficulties we were experiencing, policies to effectively battle this type of recession were proposed. Unfortunately, the proposals were mostly ignored.

The banks got plenty of attention from both monetary and fiscal policymakers, but efforts to replace the lost demand hurting businesses, to help households repair their balance sheets, to create jobs for the unemployed, and to help state and local governments avoid cutbacks forced by balanced budget requirements fell far short of what was needed.

But I don't think this failure can be blamed on economists. There was no shortage of effort from many of us to get policies like these enacted. The question is why nobody listened.

For fiscal policy the answer is clear and simple. Congress is broken, and it no longer has the ability to work for the common good. Perhaps eliminating the filibuster, removing money from politics, reversing Citizens United, and so on would help – that remains to be seen – but as it stands, Congress is clearly dysfunctional.

And that dysfunction coupled with the influence of big money interests caused Congress to listen to the wrong voices. Instead of paying attention to economists who had been right about the recession all along, Congress listened to the voices that had mostly gotten things wrong. In large part, the people who favored deregulation of the financial sector, assured us there was no housing bubble, and told us problems could be easily contained even if there was a bubble are the very same people who brought us the push for austerity, the fear of inflation, the fear of bond vigilantes, and so on, none of which was helpful.

These economists told Republicans and centrist Democrats in Congress what they wanted to hear, things that allowed them to avoid difficult policy choices or pursue ideological agendas, and they were given prominence in policy discussions. The economists who got it mostly right disagreed with these policies in no uncertain terms, but Congress didn't want to hear what they had to say and fiscal policy suffered because of it.

But how can we explain the problems with monetary policy? The Fed is supposed to be free of the political constraints that make it so hard for Congress to put the proper policies in place, and the members of the FOMC are mostly economists so the problems can’t be blamed on politicians or others outside the economics profession. Yet the Fed has been much too timid and apprehensive in its response to the recession, presumably because it is worried about how an outbreak of inflation might affect its credibility and independence.

For example, the Fed is presently missing both its inflation and unemployment targets, and economists outside the Fed from both the right and the left are largely united on the need for more aggressive policy. But even though there is little evidence to support the Fed’s worries about inflation, the Fed has been sitting on its hands in the “wait and see” mode that has left it behind the curve again and again over the last several years.

There are hopes that will change at the next FOMC meeting, but the Fed is unlikely to be as aggressive as outside critics would like it to be. And it’s particularly disturbing to read in the minutes from the last FOMC meeting that “Several participants commented that it would be desirable to explore the possibility of developing new tools to promote … a stronger economic recovery.” They are just now thinking about exploring alternative policies? We’re in a crisis situation, and this hasn’t been fully explored already?

So while I can offer a partial defense of economists – Congress has ignored the economists it ought to be listening to – a full defense is impossible. The continued push from some economists for austerity, interest rate increases, and other policies that satisfy political and ideological goals but work against the recovery, and the failure of economists in charge of monetary policy to adopt policies consistent with the Fed’s mandate undermine any attempt to fully defend the economics profession.

We can fix our economic models, at least I hope we can, and maybe we can fix our political institutions, we shall see, but how do we fix the economists standing in the way of better policy?

Mark Thoma is a columnist at The Fiscal Times. Subscribe to The Fiscal Times' FREE newsletter.

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Jul 21, 2012 11:37AM
Now what would our economists say had they gotten all the spending and monetary manipulation they had asked for and the economy still didn't pick up after the sugar high wore off?  Would they step back and reevaluate their assumptions?  Their models?  Hell no, they would simply say they did not recommend enough spending and monetary manipulation and that if only we would take it up another notch things would be great.
These people, these Keynesian, including this author, are intellectually and numerically bankrupt.  Not one of them write anything about fundemental economic drivers, reduction cost of work and reduction of cost of information; these are the drivers of wealth creation.  None of them examine the 10% Global GDP expansion from the reduction of costs of information; the root driver of the last 25 years of economic expansion.  They don't examine how and why that rate of growth it is now waning.  Has their pretzel logic finally taken them to a point that the now longer believe wealth can be created?  Can no longer be expanded?
They constantly confuse economic effect, like housing or consumerism, with root economic drivers, like cost of information or energy.
They seem to believe that debt simply does not matter, no number is too big, they are ok with infinite debt I suppose.  They seem to believe monetary manipulation IS the economy.

All I can say is our schools of economics in America need a major enema to wash out the atrophied, decaying minds of these "intellectuals".
The author is comical in saying that most of our esteemed economists missed the crisis, but now they no what to do, they see clearly now, as if their Keynesian solutions are hard, verifiable facts,  like the laws of physics.  What delusional claptrap.  The Keynesians are an arrogant, delusional collection of miscreants perpetrating economic genocide on the unborn.

Jul 21, 2012 4:25PM
Glass-Steagall worked for decades!.... and yet some people think we should have less regulation?

It's OUR money they're playing with, by the way.

Jul 21, 2012 10:40AM

I am not an economist, however, I'm going to give you worthless PhD's in economic some damn good ideas of where to start.

1. Reduce debt - bankruptcy, pay it off(that is not possible), whatever. Both government and consumer debt.

2. Stop inflation. Keep the inflation rate between deflationary 1/2% and 0% inflation. American money must have value.

3. Use tariffs to promote free trade. America is part of a world economy and we are at war to keep jobs in America. Use the tariff income to pay down debt.

4. Final Consumption sales tax only, no person or item exempt. People must understand that government cost money, socialism cost money. Than give the American people the direct right to decide what they are willing to buy though government. (Bypass congress, let the people cut government spending)

5. Take taxes off business and reduce regulations. Also, remove government subsidies of any kind from business. If business can't make it in the free market, we don't need them.

6. Energy - same as above - drill baby drill.

7. Change the philosophy of our educational system. "Socialism doesn't work, we are on this earth to solve our own problems."

Get off your **** economists or get a job cleaning latrines in a Greyhound bus depot.

Jul 21, 2012 10:55AM

Economic is not a science, it is a joke!!!

Jul 21, 2012 10:01AM
Sorry Economists I don't buy this argument. Why haven't you come up with a plan to get America out of our financial problems and get our economy up and going again. Economists have been educated in socialist instructions and haven't got the courage to tell the world that hard decisions that people are not going to like have to be made. (Raise taxes, cut spending, stop inflation, congress is brought and paid for by vested interests, representative government is a farce) Most economists believe that socialism is free and that government is God.
Jul 23, 2012 6:34PM
we have had to much monetary manipulation. I came with better monetary system called relative gold standard rates form central bank are base on this equation  (1-the peg price of gold/(market price of gold))*100*percent of what lent out+50/saveing rate.  inflation is sign of monetary malinvestment inflation happen when credit is spent but no wealth is created.
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