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http://www.project-syndicate.org/commentary/the-perils-of-prophecy
BERKELEY – We economists who are steeped in economic and financial history – and aware of the history of economic thought concerning financial crises and their effects – have reason to be proud of our analyses over the past five years. We understood where we were heading, because we knew where we had been.
In particular, we understood that the rapid run-up of house prices, coupled with the extension of leverage, posed macroeconomic dangers. We recognized that large bubble-driven losses in assets held by leveraged financial institutions would cause a panicked flight to safety, and that preventing a deep depression required active official intervention as a lender of last resort.
Indeed,
we understood that monetarist cures were likely to prove insufficient;
that sovereigns need to guarantee each others’ solvency; and that
withdrawing support too soon implied enormous dangers. We knew that
premature attempts to achieve long-term fiscal balance would worsen the
short-term crisis – and thus be counterproductive in the long-run. And
we understood that we faced the threat of a jobless recovery, owing to
cyclical factors, rather than to structural changes.
On
all of these issues, historically-minded economists were right. Those
who said that there would be no downturn, or that recovery would be
rapid, or that the economy’s real problems were structural, or that
supporting the economy would produce inflation (or high short-term
interest rates), or that immediate fiscal austerity would be
expansionary were wrong. Not just a little wrong. Completely wrong.
Of
course, we historically-minded economists are not surprised that they
were wrong. We are, however, surprised at how few of them have marked
their beliefs to market in any sense. On the contrary, many of them,
their reputations under water, have doubled down on those beliefs,
apparently in the hope that events will, for once, break their way, and
that people might thus be induced to forget their abysmal forecasting
track record.
So
the big lesson is simple: trust those who work in the tradition of
Walter Bagehot, Hyman Minsky, and Charles Kindleberger. That means
trusting economists like Paul Krugman, Paul Romer, Gary Gorton, Carmen
Reinhart, Ken Rogoff, Raghuram Rajan, Larry Summers, Barry Eichengreen, Olivier Blanchard,
and their peers. Just as they got the recent past right, so they are
the ones most likely to get the distribution of possible futures right.
But
we – or at least I – have gotten significant components of the last
four years wrong. Three things surprised me (and still do). The first is
the failure of central banks to adopt a rule like nominal GDP targeting
or its equivalent. Second, I expected wage inflation in the North
Atlantic to fall even farther than it has – toward, even if not to,
zero. Finally, the yield curve did not steepen sharply for the United
States: federal funds rates at zero I expected, but 30-Year US Treasury
bonds at a nominal rate of 2.7% I did not.
The
failure of central banks to target nominal GDP growth remains
incomprehensible to me, and I will not write about it until I think that
I have understood the reasons. As for wages, even with one-third of the
US labor force changing jobs every year, sociological factors and
human-network ties appear to exercise an even stronger influence on the
level and rate of change – at the expense of balancing supply and demand
– than I would have expected.
The
third surprise, however, may be the most interesting. Back in March
2009, the Nobel laureate Robert Lucas confidently predicted that the US
economy would be back to normal within three years. A normal US economy
has a short-term nominal interest rate of 4%. Since the ten-year US
Treasury bond rate tends to be one percentage point above the average of
expected future short-term interest rates over the next decade, even
the expectation of five years of deep depression and near-zero
short-term interest rates should not push the 10-Year Treasury rate
below 3%.
sIndeed,
the Treasury rate mostly fluctuated between 3% and 3.5% from late 2008
through mid-2011. But, in July 2011, the ten-year US Treasury bond rate
crashed to 2%, and it was below 1.5% at the start of June. The normal
rules of thumb would say that the market is now expecting 8.75 years of
near-zero short-term interest rates before the economy returns to
normal. And similar calculations for the 30-year Treasury bond show even
longer and more anomalous expectations of continued depression.
The
possible conclusions are stark. One possibility is that those investing
in financial markets expect economic policy to be so dysfunctional that
the global economy will remain more or less in its current depressed
state for perhaps a decade, or more. The only other explanation is that
even now, more than three years after the US financial crisis erupted,
financial markets’ ability to price relative risks and returns sensibly
has been broken at a deep level, leaving them incapable of doing their
job: bearing and managing risk in order to channel savings to
entrepreneurial ventures.
Neither alternative is something that I would have predicted – or even imagined.
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