To his credit, economist Brad DeLong “who stands here repentant” lists “five things that I thought I knew three or four years ago that turned out not to be true.” I would like to visit each of them, since I think highlights economics’ need for ‘economic natural history’ and sociology. Over to DeLong:
1) I thought that the highly leveraged banks had control over their risks.
My take on this is very different. First, my personal experience: back when I was a post-doc and living on Long Island, shortly after the turn of century (Eek….), I went to the bank for some other business, and they tried to convince me to take out a loan to buy an apartment. While I wasn’t in ninja terrority (no income, no job, approved), they had no business whatsoever offering me that loan, especially since they could easily see which direction my (
small marginal) account balance had been trending. On top of that, I knew a lot of people who were refinancing or using their homes to buy crap they didn’t need–they too were credit risks. Caveat mutuor was not the operating principle. You can have all of the supposed hedges you want, but a steaming pile of shit is still a steaming pile of shit. It seemed like a bubble to me.
The second is bubbles burst, and it seemed this one would too (housing kept going up, while wages were stagnating). Third, when you’re living paycheck to paycheck, experiencing the ‘fist-end’* reality of the rent extraction economy–and the morality of the Masters of the Universe who enabled that rent extraction–it was pretty obvious they didn’t care about long-term consequences, since they thought (wrongly, in many cases) they could cash out before things went pop. It was also pretty clear they would have no ethical problems with fraud and perjury (I am surprised that they didn’t have smarter lawyers, however) The last two points are nothing new to anyone familiar with John Kenneth Galbraith’s work; they’re endemic to a large financial sector.
However, Galbraith the Elder is often looked down upon by many economists since he was essentially a historian and sociologist. The bias towards mathematical deduction and away from natural history and sociology is a real problem for economics (don’t worry, your Big Swinging Calculus Penis won’t turn into a Sociology Vagina. AAIIEEE!!!). I would argue some really good Wall Street sociology would have been far more useful in mitigating Big Shitpile than another mathematical modeling paper. In fairness, DeLong has repeatedly called for more history in macroeconomics. Then again, he’s one of the few who, to use his own phrase, is repentant.
2) I thought that the Federal Reserve had the power and the will to stabilize the growth path of nominal GDP.
I don’t know about power, but it seemed pretty clear to me that the Fed, during the last decade, was allergic to full employment. In other words, they would fight like hell to stop inflation, but wouldn’t even be able to recognize, until it was too late, an imploding economy.
3) I thought, as a result, automatic stabilizers aside, fiscal policy no longer had a legitimate countercyclical role to play.
The reason I never thought this was largely fortuitous (the intellectual equivalent of the Decline Effect). Long-time readers will know that I discuss poverty often. While U3 unemployment (the strict measure) was around 4-5% for much of the last decade, in many places and for certain socioeconomic groups, it was much higher. Throw into the mix stagnating median incomes, and underemployment, and I always thought we needed more stimulus. We were not at full employment by a long shot (living in a decaying Northeastern industrial town or two made that abundantly clear). We needed a stimulus a decade ago. Besides, even if it’s not ‘stimulatory’, our infrastructure was falling apart. It needed to be fixed.
4) I thought that no advanced country government with as frayed a safety net as America would tolerate 10% unemployment. In Germany and France with their lavish safety nets it was possible to run an economy for 10 years with 10% unemployment without political crisis. But I did not think that was possible in the United States.
I have to admit I screwed the pooch harder on this one than DeLong did. I still can’t wrap my head around this. Even during the Reagan Era, there was more outrage over high unemployment. I failed to understand two things:
a) The political system in this country is almost completely disconnected from the consequences of the actions taken by that system.
b) I underestimated the effect of the massive ‘D.C stimulus’ (e.g., all of the federal contractors) on the Washington area. The Washington area has been booming, and has been recession proof. Not only that, the Washington area’s wealth and incomes have been skyrocketing. This has denied the political class (and pundits) any sense of how bad things are. Further exacerbating the problem was the Wall Street ballout which meant that the news media capital of the U.S., New York City, wasn’t as hard hit as it could have been.
Having said that, it amazes me that employees for JP Morgan or Goldman-Sachs don’t continuously feel like they’re painted with bullseyes (I’m not advocating violence at all, but there are a large number of armed and angry people out there, and eventually some of them are going to stop blaming ‘feminazis’, blacks, or Unitarians (?!?), and go after these guys). It’s astonishing.
5) And I thought that economists had an effective consensus on macroeconomic policy. I thought everybody agreed that the important role of the government was to intervene strategically in asset markets to stabilize the growth path of nominal GDP. I thought that all of the disputes within economics were over what was the best way to accomplish this goal. I did not think that there were any economists who would look at a 10% shortfall of nominal GDP relative to its trend growth path and say that the government is being too stimulative.
I think this relates to #4 above, although this didn’t surprise me. There are a lot of people, including economists, who really don’t see ten percent U3 unemployment as a crisis. If that’s your starting point, then a shortfall in GDP isn’t really a problem. That’s the key for me: DeLong, to his credit, views our problems as a nine-alarm fire, that our current economy borders on the catastrophic. A lot of people don’t. I don’t know what we do to fix that.
To sum up, I think economics hasn’t focused enough on the economy as a human enterprise, although behavioral economics has. More natural history and sociology would have allowed economists to test their ideas more concretely. I bring this up not to be snarky (that’s just a bonus), but because we need economists to get it right (or at least, get it less wrong).
*By which I mean, rent extractors have their fist all the way up your ass.