Economists versus the Economy

>Policymakers don’t know what to do. They press the usual (and unusual) levers and nothing happens. Quantitative easing was supposed to bring inflation “back to target.” It didn’t. Fiscal contraction was supposed to restore confidence. It didn’t.

>“Supposed to” according to whom? Not basic macroeconomics!

>Look, we had a more or less standard model of macroeconomics when interest rates are near zero — IS-LM in some form. This model said and says that (a) monetary policy is ineffective under these conditions (b) fiscal multipliers are positive and large — in particular, fiscal contraction is strongly contractionary. And these predictions have been borne out! Huge monetary expansion didn’t raise inflation; extreme austerity was strongly correlated with severe economic downturns.

>In other words, policy had exactly the effects it was “supposed to.”

Krugman actually used his ISLM model to decide to remortgage his house in 2003, and in a bout of epic predictive failure, foresaw skyrocketing interest rates:

http://www.nytimes.com/2003/03/11/opinion/a-fiscal-train-wre...

"With war looming, it's time to be prepared. So last week I switched to a fixed-rate mortgage. It means higher monthly payments, but I'm terrified about what will happen to interest rates once financial markets wake up to the implications of skyrocketing budget deficits."

Whoops

1) 'Economists don't know what is going on'. Yes, they do know what is 'going on'. They can measure it, and tell you.

The sneaky assumption in the question is the assumption that if "they knew what was gong on, then they would know how to solve it"

This is totally unfair.

Jobs and the economy were never entirely managed through centralized economic policy. Unless you are a country that is 'way behind others that are good examples to follow' - in which case you can make no-brainer investments in 'roads' and 'electricity' ... it's otherwise not possible.

No 'economist' would have ever thought 'we need a good search engine' or 'someone needs to re-jigger electric cars to make them work in our economy' etc. etc..

It takes entrepreneurs of various sorts - mostly of the 'boring' kind (carpenters, contractors, restaurant owners, parts manufacturers) etc. to form the basis of the economy. It's not and never will be managed by economists.

2) The failure of 2008 was not predicted by economists ergo their discipline is bunk.

This is not fair either. 100% of economists would have predicted the outcome if they knew the vast scope of homeowners lying on their applications, that banks were misleading others by packaging crap loans as good ones, that the ratings agencies were not doing their jobs and actually rating the loans properly.

Economists depend on 'valid data' in their understanding of the world. Were the data in 2008 to have been valid, predicting the outcome would have been trivial.

You could argue that Economists might need a different approach, i.e. to be more 'in the field' doing their own measurements - sure. But their models were not wrong, their data was.

In Canada (where I'm from as well) - we definitely are not an more sophisticated than anywhere.

Though your point about being 'smaller' I think is valid.

We are simply very conservative, behaviourally. We generally have stricter rules about most things, our finance execs aren't as aggressive, people are much less likely to lie on application forms.

We don't 'innovate' with finance, i.e. 'finding new ways to package crap mortgages to sell them as good' - that's an Anglo/American thing :)

America is the 'land of the free' Canada has always been about 'order, stability and peaceful coexistence' - so it's a cultural thing that exhibits itself systematically.

I should say one thing: we do have a wicked housing bubble in Toronto, and economists have been predicting demise for years, and it could very well happen if foreign buyers lose the ability to spend. A 'Chinese crash' combined with slightly higher interest rates - would put Toronto in a really, really dire situation. And we we can't blame economists for that one - the risks are clear.

Agreed, I personally hope it results in a new common sense that housing is not the perfect silver bullet investment for everyone. And hopefully it results in more capital going to entrepreneurship and business, rather than 90% of people betting on stable corporate jobs and mortgage payments for their future financial independence.

There are always economic tradeoffs made in bubbles, as capital is misplaced and used inefficiently, that are just as costly as the money lost on the actual investments.

The banks are just as responsible for this too, I've heard ridiculous stories of middle class people getting offered million dollar mortgages while small/medium businesses are shutting down at a faster rate than new ones are being started.