Economists Made Astrologers Look Good Again: They Failed to Predict the Great Recession
“How could economists be so wrong, so often, and so clearly at the expense of the working people in the United States, yet still ultimately triumph so totally?
- Robin Kaiser-Schatzlein, The New Republic
This is the third in a series on those who enable the ever-increasing wealth gap. The series starts here.
I owe the title to economist Ezra Solomon who quipped in 1988: “The only function of economic forecasting is to make astrology look respectable.”
* In 1929, on the brink of the collapse of our entire economic system, economists were predicting boom times ahead.
* In 2008, until one minute after the near total financial system collapse, all economists of influence were doing the same.
On the eve of the meltdown Fed Chair Ben Bernanke famously said he was, “moderately optimistic” about the future of the US economy. He described it as being in “good shape” with steady growth for the last six or seven years. “The troubles in the subprime sector seem unlikely to seriously spill over to the broader economy or the financial system,” he elaborated. It was June 5, 2007.
In 2009, a self-deprecating economist with a sense of humor drew a meme based on that iconic scene of Wiley Coyote, who, while chasing Road Runner, discovers that he has run off a cliff and is treading air — depicting the moment when economists realized that a financial bubble has burst.
It was early in the 21st century. An unforeseen financial system calamity had already happened. What next for the new millenium? The US Senate was so perplexed by this continuing failure of America’s greatest economic thinkers, that it held a special inquiry into this recurring phenomenon.
They summoned the teacher of economic teachers, Professor David Colander, who has so many achievements in the economic field that it would bore you if I listed them. Among his 35 books and over 100 articles are two textbooks dedicated to the education of economists. Colander could give little comfort to the distraught Senators. He really had no idea why economists failed to predict bubbles. He speculated that maybe there was too much reliance on mathematical formulas or, perhaps economic students should be taught common sense.
Economists in Denial
In 2010, Alan Greenspan, the former chairman of the Federal Reserve, proclaimed that no one could have predicted the housing bubble.”Everybody missed it,” he said, “academia, the Federal Reserve, all regulators.”
Not everybody.
* Journalist Cameron Cooper writing for In the Black listed six economists who had warned that the economic system was on the verge of collapse.
* Dutch economist Dirk J Bezemer Listed 10 more (he listed 12, but two overlapped with Cameron’s list).
One who made both lists, Raghuram Rajan, an economic counsellor at the International Monetary Fund, presented his warning at the Jackson Hole meeting of the economist elite in 2005. Democrat influencer economist Larry Summers dismissed him as, “slightly luddite”. Of Larry Summers you will hear frequently as he continues to have a major influence on Democrat policies. Of Rajan you won’t.
Add to this list the number of hedge fund managers who correctly understood the fragility of the system and won bets with bankers that the housing market would collapse necessitating the bailout. A few of the colourful ones were portrayed in Michael Lewis’ The Big Short.
Lewis gave the key difference in the approach of the hedge fund managers and the academic and regulator economists. They don’t leave their offices but rely solely on mathematical models based on data originally supplied by the banks. How did the hedge fund managers draw the right conclusions? In the opening pages of his book, Lewis says it in two words: “They looked”. As an example, his fictional character, Mark Baum (based on Steve Eisman) went out into the real world and knocked on doors to see the quality of the borrowers. He did not rely on what the banks or rating agencies said.
Facilitators of the Wealth Gap
The influential economists’ record shows their predictive ability is no better than if they read financial tea leaves. How do they stay in powerful positions in the government? Why have the ones who got it right been relegated to obscurity?
Robin Kaiser-Schatzlein writing a review of New York Times editorial board member Binyamin Appelbaum’s The Economists’ Hour: False Prophets, Free Markets, and the Fracture of Society for the New Republic, gave a disturbing answer: “It’s likely because what economists’ ideas did do, quite effectively, was divert wealth from the bottom to the top. This entrenched their power among the winners they helped create.”
In a New York Times article, Appelbaum adds a related and equally troubling idea: “The rise of economics is a primary reason for the rise of inequality.”
In The Economists Hour, Appelbaum describes the correlated rise of economists’ influence with the rise of income inequality:
“In the four decades between 1969 and 2008, economists played a leading role in slashing taxation of the wealthy and in curbing public investment. They supervised the deregulation of major sectors, including transportation and communications. They lionized big business, defending the concentration of corporate power, even as they demonized trade unions and opposed worker protections like minimum wage laws. Economists even persuaded policymakers to assign a dollar value to human life — around $10 million in 2019 — to assess whether regulations were worthwhile.”
And Appelbaum notes, among these economists — that governments favor — many expressly oppose the idea that fair distribution of a nation’s wealth should be an important consideration in economic policy. He quotes the Nobel laureate in economics, Robert Lucas. In 2004, Lucas warned against efforts to reduce inequality. “Of the tendencies that are harmful to sound economics, the most seductive, and in my opinion the most poisonous, is to focus on questions of distribution.”
In testimony before Congress in 1997, Federal Reserve Chair, Alan Greenspan, made it clear that creating job insecurity in workers is a major federal policy objective.
“Workers have been too worried about keeping their jobs to push for higher wages”, he said, “and this has been sufficient to hold down inflation without the added restraint of higher interest rates”.
Economists had little influence on the solutions to the Wall Street Crash of 1929. Ferdinand Pecora, a lawyer not an economist, laid the foundation for those reforms. They facilitated the economic equality that continually increased from thr 1930s until the 1970s. And they gave rise to government regulations that reduced abuses in the financial industry such as:
* the Glass-Steagall Banking Act of 1933
* the Securities Act of 1933, and
* the Securities Exchange Act of 1934.
These regulations provided a stable financial system from the 1930’s until the Clinton bank deregulation spree that revoked Glass-Steagall in the 1990s. The deregulation that laid the basis for the meltdown in 2008.
Appelbaum quotes William McChesney Martin’s (Fed Head 1951–1970) distaste for economists’ advice during until 1970. (Economist Milton Friedman published his article promoting shareholder value in the New York Times in 1970.) Martin once told a visitor that he kept a small staff of economists in the basement of the Fed’s Washington headquarters. “They were in the building”, he said, “because they asked good questions. They were in the basement because they don’t know their own limitations.”
What else could be wrong with this profession that has been wrong so often but has so much influence on deciding government policies. Plenty! Next.
Acknowledgement: Astrology image by SDJ on pixabay
[1] Binyamin Appelbaum, (2019) The Economists’ Hour: False Prophets, Free Markets, and the Fracture of Society, Little Brown and Company,
Originally published at https://jandweir.substack.com.
