Monday, December 29, 2014

Mark Thoma on what economics got wrong

Mark Thoma is an econ prof, and I was considering watching the video podcasts of his lectures soon.

Anyway, he wrote this:

Fiscal Times - why the next recession will be different.

And he picked out a lot of areas where not just politicians, but actual serious economists screwed up.


Prior to the Great Recession, I thought central banks could create inflation pretty much at will, even in a deep recession. All that was needed was to crank up the printing press, get the money into the hands of people who will spend it, and the extra demand will drive up the prices of goods and services. At the same time, inflationary expectations would increase driving down the real interest rate, and that would increase demand even more. If the increase in the money supply is sufficiently large, inflation would be the inevitable result.

But the Fed doesn’t create money directly, it increases bank reserves and it’s possible for those reserves to get stuck in bank vaults or in deposits held at the Fed. When that happens, the money supply doesn’t increase – balances held within the Federal Reserve System are not part of the money supply – and the desired increase in demand doesn’t occur.

The lesson for me is that if you want the inflation rate to increase, demand has to increase. That requires more than simply creating a bunch of reserves that sit idle in banks.

Seems like mainstream economics has to pull its invisible hand out of its monetarist animal-spirits ass and realize that politics and economics work together.


If monetary policy alone cannot turn things around when the economy is spiraling downward, it’s up to fiscal policy to come to the rescue. Increases in spending combined with targeted tax cuts can make a big difference in how quickly the economy recovers.

Prior to the recession, I never would have dreamed that Congress would all but turn its back on the unemployed, let alone turn to austerity, but that’s exactly what happened. Yes, there was a stimulus package just after Obama was first elected, but it was far from sufficient and more was needed to help the millions and millions of households struggling to make ends meet in the face of unemployment or reduced hours. Instead, we got budget cuts that made the problem even worse.

You could, like Krugman, say "well that's what happens when politicians don't understand economics". Then again, maybe they understand "economics" all too well, but just the silly kind - after all, the right-wing neocon think-tanks are whispering in their ears all day and night, and there's a whole heck of a lot of members of congress who've read Ayn Rand, right?

Maybe the problem is that serious economics isn't engaged with the public? Maybe economics needs something similar to the public sociology movement.

And third:

Recessions Affect Long-Run Growth: Prior to the Great Recession, many economists – myself included – believed that monetary and fiscal policy would have no impact on the full employment or natural level of output in the long-run. Policy could change the severity and duration of a recession; these actions were thought to be completely independent of our long-run productive potential.

The experience of the Great Recession shows that this is wrong. First, long-term unemployment has been a huge and persistent problem, and many workers have responded by dropping out of the labor force permanently. The decrease in the workforce lowers our potential output level. Second, public investment in infrastructure has fallen behind, and that hurts our long-run growth potential. Third, teachers and social services have been cut, and to the extent that our children are less educated, less healthy, less well-adjusted because of these cuts in the name of austerity, our long-run potential will fall.

Yup. So let me know if that permanent output destruction and degradation of human resources are ever included in economic models.

1 comment:

  1. He's right, the Fed mostly doesn't create money, banks do. Loans create deposits is a simple maxim of the modern monetary school of thought. Though when you have liar loans and a bubble economy you can have inflation but right now, not so much. As much as dipshits like that guy at shadowstats want to pretend there is some hidden, rampant inflation, there isn't. The billion prices project at MIT pretty much matches what the Fed reports right now.

    Of course, there is inflation in the plutocrat-o-sphere, where a guy I know who is a multimillionaire (so paltry in this age of billionaires!) whines that he is "priced out of the real estate market" in San Francisco. Tut tut!

    All that rentier-class dough sloshing around has to go somewhere, I'm afraid. Pity the poor plutocrats, nothing to do all day but shit on the poor because some bigger fish bought up the condo you wanted for more than your entire worth!