<dweeby econo-skepticism follows>
The New York Times Magazine today has an article on the past, present and future of the Obama administration’s economic policy. It is a good if long read and chock full of inside baseball, political speaking points delivered with some repetition lest you miss them and, most entertaining, anonymous score-settling amongst the recently departed economics team. The narrative is mostly cheerleading, ex post facto rationalization and blame-shifting for the last two years. And despite an intent to paint a positive picture going forward, specific points of the story are quite damning:
- In a dramatic meeting December 16, 2008 before taking office, the new team was “warned the country was in far worse shape than anyone realized.” Despite this deliberately seeded anecdote, one excuse offered is they didn’t understand the true magnitude of the crisis: “The problem was that the baseline economy was in worse shape than even the grim assessment of that Chicago meeting in late 2008.”
- Economists from both the left and the right are quoted saying the strategy and guiding principles for recent economic policy are unclear: “This was all new to Obama, who, unlike Bush or Clinton, had never managed even a state economy.” The lack of strategy is charitably described as evidence of pragmatism.
- The stimulus package was a failure, despite being enacted in January 2009 with the prediction “that if the stimulus passed, unemployment would be at 7 percent at the end of 2010.” Stimulus proponents continue to defend the strategy but say the particulars were simply “inadequate and poorly targeted”. The inside-the-beltway crowd views this as a problem in expectations-setting rather than actual policy.
- Unemployment is obviously still distressingly high and government statistics underreport the pain: “Counting those who are seeking full-time jobs while working part time and those how have stopped looking altogether, it’s closer to 17 percent.”
- The economic team was “fractured” and “the word most commonly used by those involved is ‘dysfunctional’”. Larry Summers bears the brunt of it (you know him from his appearance in The Social Network). Budget Director Peter Orszag says, “Unfortunately I think the environment often brought out the worst in people instead of the best in people. And I’d include myself in that.” I have a gift suggestion for the new team.
- They continue to flail for ideas and a strategy. As recently as the week before Christmas, the President replies, after being presented with “familiar and uninspired” proposals, with “I’ve told you before, I want you to come with ideas that excite me.”
- The primary speaking point, voiced by Treasury Secretary Timothy Geithner, is “it could have been so much worse.’” Despite the litany of screw-ups mentions in the article, no one had the temerity to suggest that it could have been better as well.
My purpose in writing this is not to score partisan points (one can easily argue that Obama’s core economic policy differed little from Bush’s, and both were paltry in impact compared with the Federal Reserve), but rather to indict the whole macroeconomic-industrial complex (a sentence which to me evokes this clip starting at about 1:45). What set me off is the implication in the article that the administration is looking not just to rejuvenate the economy, but also to salvage the reputation of government management of the economy.
Creating millions of jobs is one thing, but redeeming faith in the Keynesian dream of technocratic micromanagement of something as ridiculously complex as our economy after the last few years certainly qualifies as a big hairy audacious goal. Especially after the economic policy team responsible admits they weren’t guided by a clear strategy or set of principles, didn’t understand quite what was going on in the economy, implemented a program that was ineffective and badly missed its predicted impact, don’t know what to do next, and were the poster child for a dysfunctional team, there is some real work necessary to believe they’ll get it right next time. The basic problem is the economic models that underlie all these policy prescriptions seem to work better in every universe except our own. The Times article mentions a model supporting the “it could have been so much worse” school:
Without the actions taken by Bush, Obama and the Federal Reserve, the economy was headed to what Bernanke called “Depression 2.0,” in which unemployment potentially would peak at 16.5 percent, according to a later study by Blinder and Mark Zandi, chief economist at Moody’s Analytics.
“Like a mantra, officials from both the Bush and Obama administrations have trumpeted how the government’s sweeping interventions to prop up the economy since 2008 helped avert a second Depression. Now, two leading economists wielding complex quantitative models say that assertion can be empirically proved.”
Empirically proved! You see, Misters Blinder and Zandi have a model of the US economy. They can type in some parameters and find out what would have happened in the absence of the fiscal and monetary actions of the last couple years. This model is so good, it can tell us how much worse it could have been to three significant figures. They “empirically proved” that by the end of 2010, real GDP is 6.61% higher, there are 8.40 million more jobs, the unemployment rate is 5.46 points lower and the Low Income Home Energy Assistance Program has a Keynesian multiplier of 1.13 thanks to various government actions.
Conveniently, this counterfactual is set in an alternative universe which no one can disprove. When it comes to forecasting things in our universe, this model and its cohorts don’t do so well. This model that so accurately predicts events in that alternative universe didn’t predict the global financial crisis nor does it accurately predict what will happen next in our universe. And there seems to be some kind of agreement amongst polite company not to point out the huge role of failed economic models in causing the global financial crisis (Michael Lewis’ The Big Short is a great read and a very accessible introduction to wayward economic models). And I probably shouldn’t point out that Zandi and this model both come from Moody’s which of course used its various models to rate all those mortgage securities that blew up as AAA risks (and Moody’s of course has no incentive to pander to the government in order to keep their Federally mandated position in the bond rating oligopoly…).
The epistemic arrogance, to use Nassim Taleb’s phrase, of the macroeconomics profession is staggering. They still have the keys to the car and are trying to pass their driver’s test by pointing to how they would have parallel parked in another universe, despite having hit the cars in front and behind them as well as sideswiping the parking meter in this universe.
The Times story does offer two bright spots. One is perhaps they have figured out economic growth is the only hope. The new head of the Council of Economic Advisors says “We’ve shifted out of the rescue mode. We’ve got to move into full-fledged growth mode.” And This Time is Different: Eight Centuries of Financial Folly makes an appearance. I highly recommend this book, even if you just read the first and last two chapters (though you’ll miss cool things like how Newfoundland lost its sovereignty and the fact Greece has been in default roughly every other year since it gained its independence from the Ottoman Empire). This Time is Different suggests tendencies in economic behavior and the consequences of various government policies without pretending to be able to accurately predict or control them. The concluding paragraphs:
“The lesson of history, then, is that even as institutions and policy makers improve, there will always be temptation to stretch the limits. Just as an individual can go bankrupt no matter how rich she starts out, a financial system can collapse under the pressure of greed, politics, and profits no matter how well regulated it seems to be.
Technology has changed, the height of humans has changed, and fashions have changed. Yet the ability of governments and investors to delude themselves, giving rise to periodic bouts of euphoria that usually end in tears, seems to have remained a constant. No careful reader of Friedman and Schwartz will be surprised by this lesson about the ability of governments to mismanage financial markets, a key theme of their analysis. As for financial markets, Kindleberger wisely titled the first chapter of his classic book “Financial Crisis: A Hardy Perennial.”
We have come full circle to the concept of financial fragility in economies with massive imbalances. All too often, periods of heavy borrowing can take place in a bubble and last for a surprisingly long time. But highly leveraged economies, particularly those in which continual rollover of short-term debt is sustained only by confidence in relatively illiquid underlying assets, seldom survive forever, particularly if leverage continues to grow unchecked. This time may seem different, but all too often a deeper look shows it is not. Encouragingly, history does point to warning signs that policy makers can look at to assess risk – if only they do not become too drunk with their credit bubble-fueled success and say, as their predecessors have for centuries, “This time is different.”
In the meantime, I await the Nixonian proclamation that “We are all Hayekians now.”