The economists forgive themselves
from Dean Baker
The American Economics Association held its annual meeting in Denver last weekend. Most attendees appeared to be in a very forgiving mood. While the economists in Denver recognized the severity of the economic slump hitting the United States and much of the world, there were few who seemed to view this as a serious failure of the economics profession.
The fact that the overwhelming majority of economists in policy positions failed to see the signs of this disaster coming, and supported the policies that brought it on, did not seem to be a major concern for most of the economists at the convention. Instead, they seemed more intent on finding ways in which they could get ordinary workers to accept lower pay and reduced public benefits in the years ahead. This would lead to better outcomes in their models.
The conventional wisdom among economists is that the economy will be forced to go through a long adjustment process before it can get back to more normal rates of unemployment. The optimists put the return to normal at 2015, while the pessimists would put the year as 2018 and possibly even later.
Furthermore, many economists believe that the new normal will be worse than the old normal. The unemployment rate bottomed out at 4.5 percent before the housing bubble began to burst. If we go back to 2000, the United States had a year-round average unemployment rate of just 4.0 percent.
The optimists now envision that normal would be 5.0 percent unemployment, while the pessimists put the new normal at 6.0 percent unemployment and possibly even higher. As a point of reference, every percentage point rise in the unemployment corresponds to more than 2 million additional people without jobs.
The willingness of economists to so quickly embrace this darker future is striking. After all, one of the reasons that we have economists is ostensibly so that we don’t get such unpleasant news about a “new normal.” This is like a football team calmly accepted the sports writers’ prediction that they would have a winless season and deciding that their new goal was to minimize the margin of defeat.
The prospect of an extended period of higher unemployment would be easier to accept if there was a good argument as to why the economy cannot achieve the same levels of employment as it had in the recent past. Economists really don’t have much basis for this lowering of expectations of their own and the economy’s performance.
The main argument seems to stem from the work of two economists, Carmen Reinhardt and Ken Rogoff, who have examined financial crises around the world. Their analysis finds that in most cases it has taken countries roughly a decade to recover from the effects of a financial crisis and to return to a more normal growth path.
There is an important limitation in the Reinhardt and Rogoff analysis. Most of the crises they examine were in the distant past, before the development of modern economics and its bag of tools. If the thousands of economists gathered in Denver know anything more about economics than those not educated in the field, then it would be reasonable to expect better outcomes than in prior centuries.
After all, through most of human history a large portion of children died in their first years of life. However, with modern medicine and good nutrition, infant mortality is a rare event in wealthy countries. By the Reinhardt and Rogoff extrapolation we would still expect most children to be dying before the age of five based on the historical experience.
The methods for generating demand are not a mystery. It basically amounts to the government spending more money until the private sector is again in a position to fuel demand. The fears of deficits and debt that the pessimists promote stem from a misunderstanding of basic economics.
Deficits can be a problem when they crowd out private economic activity. In a severe slump like the current one, this crowding out is not a realistic fear; there are vast amounts of idle resources. Furthermore, there is no reason that the debt needs to pose an interest burden on taxpayers in the future. The Fed and other central banks can simply buy and hold the debt, refunding the interest payments to the government.
If economists did their job, they would be pushing policies to quickly get the economy back to full employment. Instead they just repeat lines about how “we” will just have to accept some rough times. Unfortunately, no one ever asks the economists who preach austerity how much time they expect to spend in the unemployment lines.
If they don’t know anything, then why should we listen to them.
Millions of jobs in the pre-crisis era originated in (a) construction of homes no one could pay for; (b) financial “services” that almost ruined the entire system, and (c)unsustainable trade deficit (see available literature re employment and trade deficit during the relevant period).
Therefore, reaching that level of employment is not just a matter of increasing demand by government spending, but a long process of structural change.
Indeed, government should engourage, also by increased spending, such change – let alone mitigating the misfortunes of unemployment.
This is beyond belief. I would think that economists would be turning over rocks looking for a new paradigm since the old one has proven such a failure. In 1957, when Sputnik went up, the Flat Earth Society called an emergency meeting. Proving that as wrong as they were, they had at least some connection to reality. But not these guys.
What about debt? Is there an upper limit on total debt per capita, or can it grow forever?
What about income inequality? Is there a mechanism that causes a crash once it gets too high, or can it, too, grow without limit? With what effect on society?
These are the questions I would think should dominate at any meeting of the profession these days.
You are right. The profession has failed. And behaves like it hasn’t.
“… they seemed more intent on finding ways in which they could get ordinary workers to accept lower pay and reduced public benefits in the years ahead. This would lead to better outcomes in their models.”
Something about this brings to mind that Charlie Kaufman film, Synecdoche – ya know, the guy who builds a life sized model of his life inside a warehouse; but since doing that is part of his life, that modeling is replicated in yet another bigger warehouse, and everybody in the smaller representing reality is modeled again in the bigger, until eventually he’s directed by the fictional portrayal of himself. It does not end well, and there’s a lot of self-absorption and pain – by the end, what’s real and what’s the model of what’s not true but believed and acted upon is indecipherable.
But the pain’s still there.
Dave – extraordinary analogy for current tendencies to become absorbed in models….
Dean says “Deficits can be a problem when they crowd out private economic activity.”
Agreed yet what appears to be so easily overlooked in modern times is that slavish adherence to budget surpluses (as recommended and overseen by private sector ratings agencies) also crowds out both private sector activity and public sector activity.
Why are economists ignoring this?
Just a quick report from the “front lines” of public opinion. On Thursday, Jan 13, I participated in a one-hour call-in radio show at WAMC radio in Albany, NY. Granted, the audience for this radio station is heavily weighted on the “progressive” side of the current political spectrum but I was very quick at the beginning of the show to ask that callers focus on what I believe (following Dean) is the extremely dangerous effort to continue the demonization of deficits with the goal to continuing to shrink government.
With possibly one exception, not ONE CALLER challenged me on my basic argument that today in an effort to put people back to work common sense and basic economic understanding means MORE DEFICITS not less — MORE GOVERNMENT SPENDING, not less.
I urge everyone reading this — take that experience to heart. Go out there are MAKE THE CASE that Dean and others have made so forcefully and persuasively. Get people writing letters and making phone calls — get the President and the Democrats to act like the “tax and spend liberals” that the Republicans has (falsely) accused them of being. If they were truly “tax and spend liberals” the recession would have ended sooner and we’d be seeing unemployment in free fall.
Please — we all have the capabilities — get out there and spread the word!