This is a short appendix for our earlier post, “Never Mind Their Distrust of Data and Forecasts; Austrians Can Help You Predict the Economy,” in the usual Q&A format.
[O]f all the economic bubbles that have been pricked, few have burst more spectacularly than the reputation of economics itself.
– From The Economist, July 16, 2009.
It’s been five years since the The Economist magazine published the critical commentary excerpted above. In hindsight, the noted reputational damage was neither lasting nor spectacular. As of today, we’d say it’s almost non-existent.
Mainstream economists continue to dominate their profession and wield huge influence on public policies. They merely needed to close ranks after the financial crisis and wait for people to forget that their key theories and models were wholly discredited.
Meanwhile, heterodox economists who stress credit market risks and financial fragilities – the Austrians, the Minskyites – remain stuck on the fringes of the field. It doesn’t much matter that the crisis validated their thinking.
This is a short appendix for our earlier post, “Planning for Future Rate Hikes: What Can History Tell Us that the Fed Won’t?,” presented in Q&A format.
It stands to reason that when the Fed eventually lifts interest rates, we’ll see the usual effects. After a sustained rise in rates, you can safely bet on:
- Fixed investment and business earnings dropping sharply
- GDP growth following investment and earnings lower
- Many people losing their jobs
- Risky assets performing poorly
These consequences follow not only from the arithmetic of debt service and present value calculations, but also from the mood swinging psychology of entrepreneurs, lenders and investors.
Ever since an über-strong U.S. dollar crushed the export sector in the mid-1980s, the U.S. economy hasn’t looked quite the same.
Exports picked up towards the end of the decade, helped along by the G-7’s historic 1985 powwow at New York’s Plaza Hotel, which led to a coordinated effort to slam back the dollar. Nonetheless, some export industries never fully recovered.
Fast forward to the present, and export performance may soon be as noteworthy as it was 30 years ago. Risks to the global economy (and exports) include turmoil in oil-producing nations, credit markets that are teetering in China and comatose in Europe, and the backside of Japan’s April sales tax hike.
Worse still, export growth already lags behind every one of the past ten expansions, even the 1980s, thanks to a drop in the first quarter:
So this week, President Obama’s populist, class-warring, shut-out-the-legislature, ignore-the-long-term-consequences romp through every corner of life turned to the education sector.
His new policies on student loans include greater access to both payment reductions and loan forgiveness.
And, needless to say, his Rose Garden speech oozed election year politics.
As the Boston Herald put it: “This is nothing more than politics as official policy … the president’s shout-out to U.S. Rep. John Tierney, a vulnerable Democrat, at yesterday’s White House ceremony was just one of the clues.”
To be clear, student debt has become a huge problem that demands attention. Alongside other challenges, such as finding a decent job in a stagnant economy, student borrowers face daunting payment burdens that they’re failing to meet at record rates.
But the problem requires more than just a political instinct to bail out a wide swath of the voting public.
In a better world, policymakers would take a cold, hard look at the effects of federally-funded student loan programs, including the good and the bad. Here are a few such observations that you’re unlikely to hear from your president:
“We don’t understand fully how large-scale asset purchase programs work to ease financial market conditions.”
- New York Fed President Bill Dudley
“I don’t think there’s any doubt that quantitative easing enabled the rich and the quick. It was a massive gift… It was deliberate in the sense that we were hoping to create the wealth effect… I hope that we do indeed succeed in being able to say in the end the wealth effect was more evenly distributed. I doubt it.”
- Dallas Fed President Richard Fisher
“Just as I thought it was going alright, I find out I’m wrong when I thought I was right, it’s always the same it’s just a shame, that’s all.”
- Genesis front man Phil Collins
Sometimes the most interesting results are the ones you didn’t see coming.
We recently picked through financial flows data looking for clues about where a dollar of quantitative easing (QE) ends up.
For example, we wondered who parts with the bonds that find new homes on the Fed’s balance sheet. Dealers sometimes pass bonds straight from the Treasury to the Fed, but are they buying other QE-ready bonds mostly from households, pension funds, foreigners or other financial institutions? Also, can financial flows help us to guess at how much (if any) a dollar of QE adds to spending?
We didn’t expect clear answers and were surprised to stumble across this:
This is an appendix to our earlier post, “Banking Buffoonery, Modeling Mysticism and Why Krugman Should Be Sweatin’ Bullets.” We discuss the Bank of England report and IS-LM model in more detail, using a Q&A format.
We have a few things to say about the recent debunking of established monetary theories.
In case you missed it, the Bank of England issued a report in March explaining that standard textbooks get money and banking all wrong.
The authors point out that banks don’t wait for deposits before making loans, as often claimed by academics. It’s the other way around. Banks create new deposits when loans are made, for this is how loan proceeds are delivered to the ultimate recipients. The fact that deposits then slosh around from bank to bank has no bearing on future loan issuance, which is always matched with newly-created, not old, deposits.
Moreover, the role of bank reserves is badly botched by academics. Central banks don’t use the monetary base (currency plus reserves) as a tool to constrain lending, contrary to textbook descriptions of the so-called money multiplier. Rather, bank reserves are supplied by central banks “on demand”. The authors explain that policymakers normally don’t “fix the amount of money in circulation, nor is central bank money ‘multiplied up’ into more loans and deposits.”
The media conveyed these points with unusual excitement for such a bland topic. But the bigger story goes beyond banking fallacies to a between-the-lines message about economic modeling.