Admit economic ignorance

By Edward Hadas
October 31, 2012

It is time for economists to admit that they are stumped. Four years after being blindsided by Lehman Brothers’ collapse, the profession is still stumbling in the dark. Policymakers and pundits still make confident pronouncements, but the conclusions are radically different. The expert disagreements give away the truth: ignorance reigns.

Here are six crucial questions which professionals should stop pretending they can answer:

1) What creates retail inflation?

If, as some economists think, ample supplies of money push up prices, then the current inflation rates of around 2 percent are inexplicably low. After all, monetary and fiscal policies have never been as generous. If, as other professionals believe, prices fall when there is excess supply of goods and labour, then inflation rates are inexplicably high. Production is still well below trend levels and unemployment rates have rarely been as high.

2) How do financial asset prices affect the real economy?

Before the credit bubble burst, most economists believed high prices in financial markets were a sign and a cause of a strong economy. Now bull markets seem more dangerous. But then again, low or falling asset prices seem to discourage economic activity, and they are presumably more dangerous when leverage levels are high.

3) Do big fiscal deficits damage the economy?

Austerity fans are persuaded that deficits are harmful, stimulus fans are equally certain they are not. The evidence, from Japan, Europe and the United States, is inconclusive. The largest government budget shortfalls ever in peacetime have neither clearly held back nor obviously increased either GDP growth or employment. The situation might have been much worse with smaller deficits, or the current high deficits may actually be storing up terrible trouble of some sort for later. No one really knows.

4) What does quantitative easing actually do?

Central banks’ balance sheets certainly expand when they use newly created funds to buy government debt. Other than that, nothing much is clear. The weight of the additional money may depress bond yields or the fear of inflation might eventually increase them. QE may encourage banks to increase lending, or it may not. Governments may feel less restraint on fiscal policy, or they may not.

5) How much leverage is too much?

Some amount of debt is desirable in an economy; the borrowing and corresponding savings reflect a beneficial shift of resources from those with too much to those in need. Some amount of debt is too much; when relatively small defaults can start a chain reaction of institutional failures. There does not seem to be any way to know when the boundary line between helpful and dangerous levels has been crossed.

6) How to deleverage without damaging the economy?

The debt danger line was certainly crossed sometime before the 2008 financial crisis and the subsequent euro crisis. Now policymakers are trying to reduce debt levels without harming the real economy. As yet, they have managed to do little more than shift debt from private to government balance sheets. That might prove more harmful than helpful, if the euro zone’s sovereign crises prove the first of many.

This list of economic mysteries is far from complete. The experts cannot determine whether or when capital controls are useful, how changes in foreign exchange rates effect production, what can reduce persistent high unemployment rates, or where confidence comes from. They are at a loss to explain the financial implications of the shift in the global economic balance to favour developing countries.

Economists who can answer any of these questions deserve Nobel prizes. There is a generation’s worth to be won. Unfortunately, while the prizes can wait, policy has to be made now, in confusion and ignorance.

The world has been here before, during the 1930s Great Depression. Then John Maynard Keynes provided helpful insights about the appropriate role of the government in the economy and the way that the supply of money and credit interacts with economic activity. He came late, though. If his insights had been believed after World War One, the second one might have been avoided.

Global war is not on the horizon, but the cost of ignorance about basic economic questions is still substantial: four years of disappointing growth and unacceptably high unemployment in most developed economies, without even a clear improvement in financial conditions. There are signs that the worst may be over, but the steady GDP growth that was taken for granted before the crisis remains a distant dream.

While waiting for definitive answers, economists should strive for humility. They have much to be humble about. Besides, the admission of ignorance can open the mind. Socrates, the father of Western philosophy, said that while he knew no more than his Sophist rivals, he was a “tiny bit wiser” because at least he knew that he did not know.

20 comments

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Excellent article.

Posted by reality-again | Report as abusive

>>The evidence, from Japan, Europe and the United States, is inconclusive.

I wholeheartedly disagree. The Keynesian economic philosophies have controlled our policy making in Washington for the better part of 90 years (introduction of The Fed and centralized banking, government intervention and safety nets for failed companies– all roots of what would become known as Keynesian economics).

We have yet to see a pure Austrian model in effect because politicians will always be in the pockets of businessmen as long as the politicians have power to shut down their competitors (through monetary policy, regulations and control).

What have we seen as a result of failed large government debts? The Brazilian hyper inflation in the 80′s and 90s, the stagflation in Japan, and the now eminent collapse of Greece (subsequent projected rise of the fascist/racist Golden Dawn party).

It’s clear we’ve exceeded the “healthy” levels of debt that I feel you naively and casually toss out as being acceptable, but if we don’t correct the current path– if our GDP becomes equal to the interest payment on the debt… there is only one way, down.

Posted by NorthernLight | Report as abusive

I think it is simple. Economists are still using 20th century, National economic models instead of creating new 21st century Global models. The old tricks don’t seem to work the way they used to eh?

Posted by tmc | Report as abusive

The problem with economics is that it is studied at all. Exchange value has always existed, but without money monopolies and legal tender laws, there would be no global economy, nor the need to study formal economics. Our jobs wouldn’t be going to the cheapest labor (China) if there was no ‘legal’ tender laws to create artificial exchange rates. Without money monopolies, debt and globalization would almost disappear, and for the better in terms of localization. Of all the economic theories of value, the most important, labor, has been cast aside and forgotten. A true Austrian, or laizze faire model cannot exist with monopoly of currencies. And because it has never existed in an unmolested form, it cannot be dismissed.

Posted by LysanderTucker | Report as abusive

There is but one primary “economic mystery”. That is how the average person is to “make his daily bread” in the 21st century. Already the American manufacturing sector produces much more than it did in 1979 with 40% more workers.

With the help of computers and software to enable more and more “hands on” tasks to be done by robots, what America NEEDS is more and more intelligent technicians of the sort this country trained in a few months during WW II. It is folly to continue to focus our public educational system on the idea that everyone should or will go to college.

We need a “technical path” for the more than half of our population that will never manage more than a hamburger or Pizza place, gas station, etc. We certainly don’t need the present endless supply of liberal arts majors with $40,000+ in student debt whose major difference from a can of Alpo is that the Alpo has CONTENT.

Our Armed Forces turned out a virtually endless supply of capable navigators, bombardiers, mechanics, bridge erectors, demolition experts, military police and firemen much faster and for much, much less that the private sector ever did and they got the job done around the globe under the most extreme conditions of weather, danger and supply whenever and wherever necessary.

We could double or triple what they were paid (in inflation-adjusted dollars) and still “get done what needs to be done” far, far cheaper than today’s union workers do. We are already looking at savvy business management that is rapidly shifting from full time employees to a greater number of part time ones.

“Jobs” that can be broken down into task that anyone off the street that can read at a sixth grade level with ninth grade skills can “master in two weeks or less will quickly reduce most “employment opportunities” into dead end slots with no path forward for which there will be ever-increasing competition. Such jobs will NOT pay enough to support a family without public subsidy.

I think economists are gazing into a toilet bowl instead of the dregs of a teacup if they truly believe there can be any “shift in the global economic balance to favor developing countries”. These places have no way to develop their own natural resources without outside help, no infrastructure or way to pay for same, abysmal educational or employment opportunities and NO assets with which to turn any of these things around.

“Policy” has always been pretty simple. Figure out a tax and regulatory system that rewards the things a society chooses to have “value” and discourages that which imposes disproportionate burden(s) upon it. The problem is that humans are hopelessly contradictory and fickle in what they think they need and want, and so no country has ever yet “got it right” in the long term.

Yesterday for the first time in my life I cast a vote against a party I feared could do a lot of damage to America for a long time if they simultaneously controlled the Legislature, the Senate and the White House versus the risk of four more years of divided government. A lifelong Republican, the religious right has taken “my” party hostage. I don’t WANT Roe v Wade overturned, and conservative judges have proven to be the mortal enemy of “we, the people” as day-to-day consumers.

It was a conscious choice for the “least worst”, but it seemed better to make SOME choice than to avert my eyes and just stay home. The lingering bad taste in my mouth is knowing without doubt that it is not in the interest of either major party to change a “status quo” of finger pointing and/or blaming the “other”, forever excusing their inability or unwillingness to lead America out of ever-increasing shadow and back into economic sunshine.

ignorance about basic economic questions is still substantial: four years of disappointing growth and unacceptably high unemployment in most developed economies, without even a clear improvement in financial conditions. There are signs that the worst may be over, but the steady GDP growth that was taken for granted before the crisis remains a distant dream.

Posted by OneOfTheSheep | Report as abusive

Correction to last paragraph:

“…ignorance about basic economic questions is still substantial…” Mr. Hadas, you sure got THAT right! Until there is more certainty as to a economically sustainable path forward, from WHAT, precisely would bring about “…a clear improvement in financial conditions?”

The “…signs that the worst may be over…” is sort of like the wildfire fighter saying “well, we’re getting the fire under control because the wind is dying down, rain is forecast and almost all brush in the area has already burned.” What could possibly go wrong, right?

What in the predictable future can you see to fuel a sustainable “steady GDP growth”? From here to the horizon I see nothing but nothing.

Posted by OneOfTheSheep | Report as abusive

ABOUT STIMULUS SPENDING

{It is time for economists to admit that they are stumped.}

But they aren’t. Perhaps bewildered but “stumped”? No.

The Keynesian Answer to the present economic doldrums is staring us in the face. Unfortunately, the obstreperous T-Party (T for troglodyte) refuses to admit it.

They have steadfastly stonewalled any Stimulus Spending to put Americans back to work since they took control of the HofR after the last mid-term elections.

Obama, having been presented with the worst recession in 80 years by Lead-head’s inept administration, immediately had passed legislation amounting to $756B in stimulus spending.

The result of this spending helped cap unemployment at 10%. I will remind readers that unemployment during the Great Depression reached nearly 25% in 1933. Are we grateful for Obama’s prompt response? Nope.

In 1929, unemployment was 3.2% – ten years later it was still at 19% – ten long years of excessively high unemployment. Despite Roosevelt’s Alphabet-Soup recovery spending, it took WW2 to end the Great Depression.

It’s amazing how people can be ignorant about economic history in a country where it begins 5 minutes ago and yesterday is ancient-history. So, the Great Depression? Who ever heard of that?

Nobody reads Steinbeck’s The Grapes of Wrath anymore in high-school? It’s never too late.

Obama does not walk on water. He’s no miracle-man. Never was, never will be. But the REAL REASON for the protracted high unemployment levels is the lack of stimulus-spending the cause of which is solely the Republican Party and its election strategy.

MY POINT?

How crass it is of a political party to incarcerate fellow Americans in unemployment, some in poverty, simply to obtain an electoral advantage.

POST SCRIPTUM

George Santayana (American philosopher): Those who refuse to understand history are condemned to repeat it …

Posted by deLafayette | Report as abusive

Good article, but the whole focus on financial machinations is illustrative of the problem with the field of economics. It focuses all of its attention there while maintaining its self-imposed ban on considering the effects of what is, by far, the biggest driving force behind economic trends today – population growth. If economists ever did consider the full range of effects – beyond mere resource issues – they might come to recognize the inverse relationship between population density and per capita consumption and its role in driving unemployment and global trade imbalances.

As rising population density chokes the life out of per capita consumption (which is inextricably linked to per capita employment), governments are becoming increasingly dependent upon deficit spending to maintain an illusion of prosperity. And even that tactic is rapidly becoming more impotent.

Pete Murphy
Author, “Five Short Blasts”

Posted by Pete_Murphy | Report as abusive

Greed is not easily expressed in equations …

Posted by tomwinans | Report as abusive

Clearly, your know absolutely nothing about economics, nor much about European history.

Economics is NOT rocket science. One of the main problems with “economists” is they are more sycophant than economist.

There are some who understand what is happening and can explain it quire lucidly, but the wealthy do not want advice that would take their punch bowl away.

By the way, in terms of history, we have been here before and the lessons learned then are still valid now.

Also, your remark about “If (Keynes) insights had been believed after World War One, the second one might have been avoided”. It was the catastrophe of the Versailles Treaty that caused WWII, which is roughly the same as what the wealthy are attempting to do in the eurozone right now, and the US will follow in 2013. I am not so optimistic we will not have a global war soon, probably a resource war, which will sort things out for us since we seem incapable of doing it ourselves.

Speaking of “humility”, perhaps you should try for some yourself.

Posted by Gordon2352 | Report as abusive

Years ago, this pseudo-profession was referred to as “Political Economy.” And it truly had some merits in describing what was necessary to promote the wisest, most efficient and effective course alternatives in the processes of getting, offering, saving, and spending.

Then Lord Marshall came along and injected math into this pool of common sense with the intention of raising its practice to the level of hard science, much like physics. At this point, the practice of economics went south in a hurry.

Not long after this careen into the fanciful, where all things could not be held equal, Keynes proposed using national income accounting measures to fine-tune the economies of major, complex nations: run deficits in slumps and surplusses in booms. But he forgot the political portion of the term, political economy. Since politicians will always and at all times do whatever is necessary to garner enough votes to be re-elected, their attempts at fine tuning tend to have a spending bias which, in time, suboptimizes – and finally crashes – the system.

Thats where we are now. A broken economic system with venal, self-serving politicians at the helm prescribing much more of the same to get us out of this mess. In a serious conversation, discussing the cure of too-much debt with additional doses of debt would be somewhat laughable – but the patient is much too sick for humor to be appropriate.

I fear that so much foul water has passed under our bridge polluting the workings of polite society and (certainly) political discourse that the traditional machinations of the Democratic process will not be sufficient to avert us from Nemesis’ severe decree merited by our chronic wastrelcy and hubris.

Posted by StevePhillips | Report as abusive

#3 is pretty preposterous. Do large deficits hurt an economy. Individual deficits make no difference one way or the other. It’s accumulation over time that is the question.

Does a large national debt hurt an economy is the proper topic for #3.

Posted by thesafesrufer | Report as abusive

Free market economics does not work when failing enterprises are bailed out by tax payers and savers, and when no one is held accountable for any mismanagement verging on morally wrong conduct.

Most mainstream economists are bought by think tanks to sell policy to Washington for nice donations and retainers.

Posted by XRayD | Report as abusive

Typo: In 1929, unemployment was 3.2% – ten years later it was still at 19% – ten long years of excessively high unemployment. Despite Roosevelt’s Alphabet-Soup recovery spending, it took WW2 to end the Great Depression.

Should read: In 1929, unemployment was 32% – ten years later it was still at 19% – ten long years of excessively high unemployment. Despite Roosevelt’s Alphabet-Soup recovery spending, it took WW2 to end the Great Depression.

Posted by deLafayette | Report as abusive

On “Keynes”. What is called Keynesian economics is more correctly labeled as a specific type of NeoClassical economics. Much of what Keynes theorized was simply dumped by the mainstream…or warped. Keynes died too early. The mainstream took those ideas of Keynes which were…easy. The ideas that were hard…were dropped like a rock. Minsky’s credit cycle views, and his instability hypothesis were essentially derived from Keynes…and yet Minksy is completely outside the mainstream…and only recently has he been paid attention to.

The abject failure of mainstream economics is very well explained in Steve Keen’s “Debunking Economics”. It is pretty stunning that Hadas could take the time to write this article, and not mention Keen or his book.

As for the main reasons that economists are clueless…here are the top three…in my opinion:
1. Rational Expectations. This bogus premise is wrong on both counts (rationality, and clairvoyance!), and virtually every ‘free market’ and finance theory is built on this foundation of quicksand.
2. The belief, by mainstream economists, that private sector credit growth (PRIVATE…not PUBLIC debt…which everyone is so worried about) is demand neutral. There was a great debate between Keen and Krugman a while back, during which Krugman made his ignorance plainly clear. The current economic malaise has NOTHING to do with public debt and deficits…it is a result of a 25 year private debt bubble (290% of GDP in 2008). In reality, we are in a depression much worse than the 30s (ALSO created by a private debt bubble…175% of GDP in 1929) and our current and temporary ability to plug the hole with public debt is masking reality. 100% of our growth since 2008 is due to deficits. It is borrowed “growth”. Until we liquidate our way down to private debt less than 100% of GDP…we will be dependent on public debt expansion to plug the hole. The problem, is that we will have a monetary crisis and systemic crisis before we get there. The hole created by private debt correction is too large to fill. Economists dont understand this…because they have been taught that private credit is demand neutral. It is NOT…and Kyndland and Prescott showed as much…even though they and all mainstream economists chose to forever ignore those findings…because they did not agree with NeoClassical dogma.
3. The complete intellectual bankruptcy of the academic economics establishment. I was an economics and engineering major. As an engineer..I had to take some pretty heady math. As an economics major, I observed how the economics ideology was taught as if it was mathematics. In math, you build theorems and new derivations on the back of existing PROVEN theorems. In economics….you are expected to do the same…but they part about building on ‘proven theorems’ is just left out. So you have sand built upon sand upon sand. It is an entire body of made up knowledge, the justification of which is really more the happenstance of history during a period of abnormally positive economic conditions (Post WWII – 2000)

Economics is a complete joke..and it should be no surprise that mainstream economists had no idea in 2006 what was coming…and still do not know what is coming.

Posted by Slagathor | Report as abusive

On “Keynes”. What is called Keynesian economics is more correctly labeled as a specific type of NeoClassical economics. Much of what Keynes theorized was simply dumped by the mainstream…or warped. Keynes died too early. The mainstream took those ideas of Keynes which were…easy. The ideas that were hard…were dropped like a rock. Minsky’s credit cycle views, and his instability hypothesis were essentially derived from Keynes…and yet Minksy is completely outside the mainstream…and only recently has he been paid attention to.

The abject failure of mainstream economics is very well explained in Steve Keen’s “Debunking Economics”. It is pretty stunning that Hadas could take the time to write this article, and not mention Keen or his book.

As for the main reasons that economists are clueless…here are the top three…in my opinion:
1. Rational Expectations. This bogus premise is wrong on both counts (rationality, and clairvoyance!), and virtually every ‘free market’ and finance theory is built on this foundation of quicksand.
2. The belief, by mainstream economists, that private sector credit growth (PRIVATE…not PUBLIC debt…which everyone is so worried about) is demand neutral. There was a great debate between Keen and Krugman a while back, during which Krugman made his ignorance plainly clear. The current economic malaise has NOTHING to do with public debt and deficits…it is a result of a 25 year private debt bubble (290% of GDP in 2008). In reality, we are in a depression much worse than the 30s (ALSO created by a private debt bubble…175% of GDP in 1929) and our current and temporary ability to plug the hole with public debt is masking reality. 100% of our growth since 2008 is due to deficits. It is borrowed “growth”. Until we liquidate our way down to private debt less than 100% of GDP…we will be dependent on public debt expansion to plug the hole. The problem, is that we will have a monetary crisis and systemic crisis before we get there. The hole created by private debt correction is too large to fill. Economists dont understand this…because they have been taught that private credit is demand neutral. It is NOT…and Kyndland and Prescott showed as much…even though they and all mainstream economists chose to forever ignore those findings…because they did not agree with NeoClassical dogma.
3. The complete intellectual bankruptcy of the academic economics establishment. I was an economics and engineering major. As an engineer..I had to take some pretty heady math. As an economics major, I observed how the economics ideology was taught as if it was mathematics. In math, you build theorems and new derivations on the back of existing PROVEN theorems. In economics….you are expected to do the same…but they part about building on ‘proven theorems’ is just left out. So you have sand built upon sand upon sand. It is an entire body of made up knowledge, the justification of which is really more the happenstance of history during a period of abnormally positive economic conditions (Post WWII – 2000)

Economics is a complete joke..and it should be no surprise that mainstream economists had no idea in 2006 what was coming…and still do not know what is coming.

Posted by Slagathor | Report as abusive

As for those saying we do not have enough stimulus…what in earth do you think running a deficit of 10%+ of GDP is. THAT is counter cyclical stimulus. So…what you are saying…is 10% is not enough.

Let me explain why we do not have enough…OK. The reason is that ALL our growth is due to the deficits. Today…virtually all Federal spending goes right back into the economy. Spending backed by borrowing is thus spending that otherwise would not have happened. The growth is fake. Yet people even now…credit for out tepid growth goes to “the economy”..what ever that means.

Cut the deficit to 5% of GDP…and we are in a recession of -4-5%. Increase the deficit to 13% of GDP…and we have 5% growth..and economists will pronounce the economy self sustaining…and we will cut the deficit…upon which growth will fail.

Why? Why can’t the economy self sustain? The reason why…is what we call economic growth, is essentially private sector credit expansion…and we have entered the 1st private sector credit down cycle vs GDP since…1929-1946.

The only way to not have this problem…is to not let private sector credit growth get out of hand, as it did from 1922-1929…and from 1980-2007. The reason that we repeated the mistake in 22-29…and made it much worse…is that we have taught economists for 50 years that private credit growth is demand neutral…and should be left to the ‘free market’ to sort out….

Posted by Slagathor | Report as abusive

The economists do not want regulate micro problems and indeed we have best politicians money can buy with little knowledge of the real world. But the reasons an economy fails are micro and corruption.

There no way around industries that are profitable and pay wages need to have their growth subsidized by those that re not.

Also we got into a ridiculousness system of trade where we depend on China, Korea, Japan and Germany to limit our imports to what we export. Obviously we have to do things to balance the two ourselves. Even if means getting different trading partners.

Posted by Samrch | Report as abusive

Wide scale financial corruption is the clear cause of their failure!
Corruption can not be forcasted and no model will ever take corruption into account! Economists will never be able to factor in or out this new government sanctioned wide scale financial and insurance corruption, and that fraud now defines the supposed Free Markets world wide.
Blind as a bat defines those beng stolen from, while the elite binge on power and ill gotten money!
When this all implodes they will scream the loudest.

Posted by DefiningQuality | Report as abusive

I believe that the Bankers and their government lackeys will be decorating trees and used as pinjatas sooner than they think. You cannot abuse the worlds population forever. You can run but you can’t hide. Being an econimist is a rather silly profession, reading Tea leaves makes more sense.

Posted by disbeliever | Report as abusive