Don't Ask An Economist!

Source: Decline of the Empire

I love to give economists grief. They’re so optimistic! And so wrong! It’s a bad habit, I know, but when they positively beg to be given a hard time, I can not resist the temptation to give them what they want. Such is the case with Mark Thoma’s What Caused the Financial Crisis? Don’t Ask An Economist.

What caused the financial crisis that is still reverberating through the global economy? Last week’s 4th Nobel Laureate Meeting in Lindau, Germany – a meeting that brings Nobel laureates in economics together with several hundred young economists from all over the world – illustrates how little agreement there is on the answer to this important question.

Surprisingly, the financial crisis did not receive much attention at the conference. Many of the sessions on macroeconomics and finance didn’t mention it at all, and when it was finally discussed, the reasons cited for the financial meltdown were all over the map.

It was the banks, the Fed, too much regulation, too little regulation, Fannie and Freddie, moral hazard from too-big-to-fail banks, bad and intentionally misleading accounting, irrational exuberance, faulty models, and the ratings agencies. In addition, factors I view as important contributors to the crisis, such as the conditions that allowed troublesome runs on the shadow banking system after regulators let Lehman fail, were hardly mentioned.

Ah, c’mon, Mark! You’re making life way too easy. When times are good, as they apparently were—note that I say apparently—during Ben Benanke’s Great Moderation (1983-2007), everybody looks like a genius, including economists. What’s the expression? Everybody is a genius in a bull market. But when the shit hits the fan, and it always does eventually, Life presents yet another opportunity to separate the men from the boys. And now we have our answer—economists are the callow youth in this game.

Thoma’s self-flagellation continues…

Macroeconomic models have not fared well in recent years – the models didn’t predict the financial crisis and gave little guidance to policymakers, and I was anxious to hear the laureates discuss what macroeconomists need to do to fix them. So I found the lack of consensus on what caused the crisis distressing. If the very best economists in the profession cannot come to anything close to agreement about why the crisis happened almost four years after the recession began, how can we possibly address the problems?

How indeed? So what’s the problem?

How can some of the best economists in the profession come to such different conclusions? A big part of the problem is that macroeconomists have not settled on a single model of the economy, and the various models often deliver very different, contradictory advice on how to solve economic problems.

The basic problem is that economics is not an experimental science.

We use historical data rather than experimental data, and it’s possible to construct more than one model that explains the historical data equally well. Time and more data may allow us to settle on a particular model someday – as new data arrives it may favor one model over the other – but as long as this problem is present, macroeconomists will continue to hold opposing views and give conflicting advice.

Mark, I fear the situation is even worse than you’ve stated here. First, you need to use the right historical data. You’ve got to acknowledge The Bubble Era (1995-2007). That’s a start, but it’s not nearly enough. Instead of building models using misleading variables like GDP, aggregate income and the like, why don’t you look at the destruction of the Middle Class. Take a hard look at the skewed distribution of the wealth and income. Consider the financialization of our society, the political power of the banks, and the enormous household debt mountain. Read my post This Time Really Is Different. A flawless or even “good” model of how economies function does not exist. Got it? Does not exist.

Worse yet, such a model can not exist, because there is another big problem, a real showstopper. As Thoma implies, economists live in the dark, but the main reason they shun the light is that they have entirely mischaracterized the Human Element. Humans are not rational maximizers or whatever they’re called. They are overreaching fuck-ups. They are chimpanzees crazy drunk on money & power. Unfettered greed blew up the financial system. Sociopaths running wild. Pride goeth before the fall. Give a Capitalist enough rope and he will hang himself with it. And so on. Is there a variable called “greed” in the macroeconomic models?

This problem is not just of concern to macroeconomists; it has contributed to the dysfunction we are seeing in Washington as well.

When Republicans need to find support for policies such as deregulation, they can enlist prominent economists – Nobel laureates perhaps – to back them up. Similarly, when Democrats need support for proposals to increase regulation, they can also count noted economists in their camp. If economists were largely unified, it would be harder for differences in Congress to persist, but unfortunately such unanimity is not generally present.

This divide in the profession also increases the possibility that the public will be sold false or misleading ideas intended to promote an ideological or political agenda.  If the experts disagree, how is the public supposed to know what to believe? They often don’t…

Let me summarize my older post The Utter Failure of Macroeconomic Theory.

Politics always drives policy. Economic theories are always post hoc (after the fact) rationalizations of pre-conceived agendas. Any policy, no matter how unfair or crazy, will always find economists to support it. Thus are careers established, good salaries made, high appointments in government achieved. Economics is always the handmaiden of politics, not the other way around. Note well that the adoption of “New Classical” macroeconomic theory followed the “Reagan-Thatcher revolution” according to Skidelsky. Governments after Reagan simply continued or implicitly endorsed the same policies.

Thus Thoma has the situation ass-backwards. Macroeconomic theories justify political agendas after the fact. These theories never lead. One could say that economists are whores, but that would be impolite, and would denigrate real life prostitutes who make an honest living. Thoma finishes up.

When the recession began, I had high hopes that it would help us to sort between competing macroeconomic models… But, disappointingly … the crisis has not propelled us toward a particular class of models as would be expected in a data-driven, scientific discipline.

Instead, the two sides have dug in their heels and the differences – many of which have been aired in public – have become larger and more contentious than ever.

You are ever so close, Mark, to the right conclusions. Can you make the necessary leaps?  Economics is not a data-driven scientific discipline. Economists are all-too-human, deeply flawed despite their inflated view of themselves. Hard lessons for hard times.

Read more at Decline of the Empire