Opinion

Edward Hadas

Depressions can be avoided

By Edward Hadas
June 6, 2012

Stability has been one of the most elusive economic goods. Despite more than a century of effort, economies remain prone to downturns, which often come after booms that proved unsustainable. Rich countries are currently stuck in one of the down periods, a seemingly endless Lesser Depression.

Economists argue about the details of what went wrong, but they often miss something basic: persistent instability is surprising. Surely, societies which summon enough economic ingenuity and organisation to develop smart phones, manage global supply chains and pay for a dozen years of universal education can manage to maintain a steady pace of overall economic activity? All that is required is the identification and early correction of imbalances, in both the real economy and the financial system.

In the pre-industrial age, good macroeconomic management was all but impossible. As long as agricultural activity was the economic mainstay, a poor harvest led not only to less food but to less spending by farmers. Their purchases of ploughs and shoe leather declined, even though a temporary spell of bad weather had no effect on production capacity.

Governments had neither the information nor the resources required to compensate. In any case, monetary counter-moves were impractical when the only reliable money was coins struck from a strictly limited supply of precious metals. Governments and banks could theoretically give farmers paper money to buy readily available goods, but the currency would not be trusted.

More recently, economic instability could be blamed on ignorance and immature institutions. In particular, the mechanisms of financial excess, the cause of most of the crises of the last century, were poorly understood. While economists knew that speculation was dangerous, their analysis was primitive. In addition, governments were slow to put detailed regulation of the financial system on their list of responsibilities.

Now, though, booms and declines are inexcusable. Farming plays a minimal role in advance economies, and no significant sector is subject to large natural variations of output. On the contrary, far more than half of GDP is spent on services, which tend to be purchased very steadily. Statistics are ample, so economists can easily identify anomalies. Governments are well informed, dominate the economy and have full monetary flexibility.

Twice in the last half-century, experts thought they had found the secret to good macroeconomic management. In the 1960s they put their faith in the “fine-tuning” of monetary and fiscal policy. In the 2000s, they saw a “great moderation” come from inflation targeting, relaxed central banks and unencumbered financial institutions. After the latest failure, the professionals have mostly fallen back to their previous belief in unavoidable cycles of exuberance and depression. Like mood swings in love affairs, economic ups and downs are considered unfortunate facts of life.

The defeatism is unnecessary. Motor vehicle fatalities provide a good precedent. Starting in the 1960s, a coordinated campaign, including both behaviour modification and improved engineering, has succeeded in reducing the death rate in the United States (as a fraction of the total population) by more than half. Economic deviations can be reduced by much more.

Drivers were cajoled to change their behaviour: stop drinking, wear seat belts and reduce speeds. Economic actors can also learn that excessive enthusiasm, like reckless driving, eventually leads to trouble. Anti-greed education can teach that immoderate financial gains are bad for society and are likely to be followed by even larger losses.

The lessons should be backed by corrective policies. The authorities must be committed to use regulation, taxes and fiscal and monetary policy to stomp hard whenever any significant financial and economic indicator moves in a dangerous direction. The short current watch-list of consumer inflation, GDP growth and unemployment should be lengthened to include the prices of property, debt, shares and commodities. Rates of change in lending and financial activity are also important.

The engineering of the financial and economic system needs the same sort of upgrade that car and road design got when safety became a higher priority. Errors, of both drivers and investors, are less dangerous on safer roads. The economic authorities should develop automatic stabilisers to limit herd behaviour. They have the tools. They can both create and destroy money and credit. In the face of mob gloom, they can create new jobs, either directly or indirectly.

Defeatism should be replaced by a firm commitment to economic safety. Sadly, there are few signs of such a change. For all the talk about “macro-prudential regulation”, economists and politicians are still reluctant to restrain financial dreams. Monetary authorities balk at taking full advantage of their powers.

Ultimately, something like moral cowardice lies behind this unnecessary restraint, and behind the recurrence of financial crisis. The pattern cannot be broken until the authorities decide to identify and attack reckless financial behaviour wherever it occurs. The failure is discouraging, but there’s no need to abandon hope. Like driver safety, and like the legal protection of workers and the restriction of pollution, economic stability is an idea whose time will come.

Comments
8 comments so far | RSS Comments RSS

Comparing driver safety to economic cycles has got to be the farthest out article I’ve seen. The last thing we need is some bureaucrat telling the public what it should do, or how much it should make for income. This article is just covering up for a socialist philosophy, where people should not be allowed to make more than their “fair” share (in this case for some purported ‘good of the economy’). I suspect the author doesn’t even realize he is coming from that angle.

The clue is his use of moral terminology in what should be an article on economics.

Posted by stevedebi | Report as abusive
 

“booms and declines are inexcusable … Governments are well informed, dominate the economy and have full monetary flexibility”

So if economist are well informed and governments rational depressions and excessive booms shouldn’t happen? Right? Is that your question?

Well, now that we’re off the sex debacle and back on well trodden soil, I’ll take a gander.

Perhaps, as the above quote illustrates, the problem is with the government’s themselves and the economists they choose to listen to?

Ask a dozen economists what the problem is and get 12 different answers, and they are all wrong.

I think Paul Krugman is RIGHT and everyone else is WRONG.

Why? Because of ideology. If your economics is informed by ideology it’s as bad as if your science is guided by religion or perhaps mysticism.

The NEO-CONS are crazy. They are literally INSANE. They are RAPING the people and attempting “social engineering” on a global scale, attempting to create some kind of hyper-capitalist utopia. A Brazil with 10% unbelievably wealthy 10% filthy rich and the remaining 80% dirt poor.

The new Aristocracy. The Plutrocacy.

This “depression” is all part of the plan.

And I know everyone said George Bush had nothing to do with 911 (and I tend to agree because the man is retarded) but I find it hard to be that no one knew and wanted it to happen.

And what was the Bush economic response to 911? To run huge deficits, give massive un-necessary tax breaks to the wealthy and the middle-class and effectively create a situation where WHEN the “depression” finally hit, the government would be so far in debt, it couldn’t fix it with keynesian economic theory.

And who wanted this?

The NEO-CONS and the right-wing (dare I say fascist) economists swho SHILL for them.

So, in summary. Yes, they have the information. They know the score. They know what to do right and they chose to do the WRONG thing, if it is politically self-serving.

They are, simply, pieces of shi’te.

Posted by Lord_Foxdrake | Report as abusive
 

One word: Regulation.

Implement the proper regulatory measures, to prevent markets from running amock, and creating market bubble conditions which would ultimately collapse.

Posted by KyuuAL | Report as abusive
 

I do not share Mr. Hadas’ faith in the government to make the right decisions. I believe the government has the ability to nudge the economy one way or the other, but it would take both parties working together against the river of influence the financial industry wields.

Right, wake me up when that happens.

Before the financial crisis, the top 5 banks controlled 40% of the money in the States. After it, the top 3 banks control 60%. Awesome.

Also, it is partly because of regulation that no one can get a loan to do anything, even well-qualified applicants (Read: capital ratio requirements).

Posted by smanchwhich | Report as abusive
 

The proposition that the clever people of previous generations were too stupid to uncover the underlying mechanisms while we can do this with ease seems frighteningly reminiscent of the faith people put in the correctness of option pricing models in the 1990′s and risk models in the 2000′s. Iif history proves anything, it proves that we are on average a lot dumber than the smartest people of previous generations.

And the road death analogy seems pretty irrelevant – there isn’t a cadre of people who stand to profit by gaming the system and increasing the number of road deaths. There are people who stand to gain from oscillations in the rate of growth.

Posted by IanKemmish | Report as abusive
 

I agree wholeheartedly that our economies can be managed far better, but we must be realistic about the barriers we face in achieving it. Defeatism is part of it, but far more fundamental is the anti-government hysteria that has infected us for decades now. When I say “anti-gevernment” or course I mean “anti-the-kind-of-gevernment-that-I-don’ t-like”. No problem to have government provide limited-liability, ludicrous intellectual property protectionism, “free” trade that protects my job but not yours, and don’t forget “tort reform” so that economic actors don’t have to be responsible for damage they do. But to regulate financial shenanigans? It’s against some sort of law of nature.

Posted by Sanity-Monger | Report as abusive
 

Driving is a type of activity where all citizens are exposed to risks regardless of sociodemographic standing while using public roads by miscreants who neither value their own lives nor others around them. Hence, a common objective to make the roads safer has been achieved over the decades.

Financial industry in the United States has consolidated very profoundly and as the result so did the power through lobbying and funding politicians to facilitate their objectives where the controllers agenda consists of nothing else besides impressing shareholders by beating quarterly earnings estimates and compensating themselves with extremely lucrative annual renumeration in salary and bonuses to the best of their abilities. 

In the first situation the collective goals of an  entire society are aligned and have been achievable. Although, in the past automobile manufacture did strive to cut corners by designing unsafe cars from structural engendering prospective to save on manufacturing expenses. Now automobile safety is a good selling point adventurous to the automobile manufactures interests. Therefore, the resistance to NTSB mandates has been largely eliminated. In the second arrangement,  the majority of American congressmen are reliant on campaign contributions from the financial sector to fund reelection campaigns and strive to water down the regulatory framework that is deemed undesirable to the interest of very valuable corporate constituents.  How do you see the reconciliation of objectives and interests  between public at large and a small number of individual whose entire mentality frequently is permeated with  a very short timeframe horizon? 

PS  I realize this is “slightly” off the topic because nowhere in this article can any reference to Canada be found. However,Canadian banking industry is safe and sound due to a very solid regulatory framework,  untainted by legalized corruption arrangement that is practiced in the US at this time. There is no doubt that if people in Canadian financial industry were given an opportunity to overleverage  and invent complex financial instruments with tax payers underwriting the risks in case of some “unforeseen” event such as sliding real estate assets valuation, then it would result in the same financial debacle which we have here in America now. People are fundamentally the same everywhere in the world. The vague notion of a moral hazard will never be taken into consideration in situations where people can generate vast sums of money quickly if the circumstances provide such opportunities.

Posted by SlavikSobol78 | Report as abusive
 

Driving is a type of activity where all citizens are exposed to risks regardless of sociodemographic standing while using public roads by miscreants who neither value their own lives nor others around them. Hence, a common objective to make the roads safer has been achieved over the decades.

Financial industry in the United States has consolidated very profoundly and as the result so did the power through lobbying and funding politicians to facilitate their objectives where the controllers agenda consists of nothing else besides impressing shareholders by beating quarterly earnings estimates and compensating themselves with extremely lucrative annual renumeration in salary and bonuses to the best of their abilities. 

In the first situation the collective goals of an  entire society are aligned and have been achievable. Although, in the past automobile manufacture did strive to cut corners by designing unsafe cars from structural engendering prospective to save on manufacturing expenses. Now automobile safety is a good selling point adventurous to the auto manufactures interests. Therefore, the resistance to NTSB mandates has been largely eliminated. In the second arrangement,  the majority of American congressmen are reliant on campaign contributions from the financial sector to fund reelection campaigns and strive to water down the regulatory framework that is deemed undesirable to the interest of very valuable corporate constituents.  How do you see the reconciliation of objectives and interests  between public at large and a small number of individual whose entire mentality is frequently permeated with  a very short timeframe horizon regardless of systemic risks that are taken in the course of business?

Posted by SlavikSobol78 | Report as abusive
 

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