Tuesday, August 31, 2010

What Current Economics Got Wrong About the Current "Great Recession"

Paul Krugman does an excellent job of summarizing the failures of current economists. He points out that economic theory is up to the task, but unfortunately economists have unlearned the economic lessions of the 1930s so their policy prescriptions have been all wrong.

Here is the key bit out of a recent NY Times blog posting by Paul Krugman:
Contrary to what you may have heard, there’s very little that’s baffling about our problems — at least not if you knew basic, old-fashioned macroeconomics. In fact, someone who learned economics from the original 1948 edition of Samuelson’s textbook would feel pretty much at home in today’s world. If economists seem totally at sea, it’s because they have carefully unlearned the old wisdom. If policy has failed, it’s because policy makers chose not to believe their own models.

On the analytical front: many economists these days reject out of hand the Keynesian model, preferring to believe that a fall in supply rather than a fall in demand is what causes recessions. But there are clear implications of these rival approaches. If the slump reflects some kind of supply shock, the monetary and fiscal policies followed since the beginning of 2008 would have the effects predicted in a supply-constrained world: large expansion of the monetary base should have led to high inflation, large budget deficits should have driven interest rates way up. And as you may recall, a lot of people did make exactly that prediction. A Keynesian approach, on the other hand, said that inflation would fall and interest rates stay low as long as the economy remained depressed. Guess what happened?

On the policy front: there’s certainly a real debate over whether Obama could have gotten a bigger stimulus. What we do know, however, is that his top advisers did not frame the argument for a small stimulus compared with the projected slump purely in political terms. Instead, they argued that too big a plan would alarm the bond markets, and that anyway fiscal stimulus was only needed as an insurance policy. Neither of these arguments came from macroeconomic theory; they were doctrines invented on the fly. Samuelson 1948 would have said to provide a stimulus big enough to restore full employment — full stop.

So what we have here isn’t really a lack of a workable analytical framework. The disaster we’re facing is the result of the refusal of economists, both in and out of the corridors of power, to go with the perfectly good framework we already had.
It is utterly tragic that these kinds of mistakes are being made. All the unnecessary suffering. All the lost production. Gone and for no good.

I look at the US over the last 10 years and I see a series of utterly incomprehensible mistakes made by government: wars of "choice" that are presented as tiny things that end up taking ten years and thousands of lives and trillions of dollars, a hurricane disaster that was completely foreseen a year before it happened and was allowed to happen and for a week the governments at all levels did nothing while people died, and the biggest financial crash since the Great Depression and the only "mobilization" that has been done is to pump a trillion dollars onto the balance sheets of banks that party on giving their top execs obscene "bonus payments" while Main Street goes down and millions of Americans are thrown out of work and tens of millions of houses go "underwater" and foreclosed.

This is an unmitigated disaster and not a politician in sight who will stand up and declare "This is a disaster! We can do better! This must not be allowed to stand!". Nope. Instead you had a president in Bush who would crow "Heck of a job, Brownie!" or "Mission Accomplished!" showing a complete ignorance and indifference to the real situation on the ground. You have another president who trots out a "Change we can believe in slogan" and then promptly changes nothing. What a disaster!

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