Forgive the
numbered note form. For some reason it seems appropriate to me in
this case
- The financial crisis in the UK was the result of losses by banks on overseas assets, originating from the collapse in the US subprime market. It was not a result of excessive borrowing by UK consumers, firms or our government. As the Bank’s Ben Broadbent points out, “Thanks to the international exposure of its banks the UK has been, in some sense, a “net importer” of the financial crisis.” This overseas lending caused a crisis because banks were far too highly levered, and so could not absorb these losses and had to be bailed out by the government.
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This is why UK macroeconomists failed to pick up the impending crisis. They did routinely monitor personal, corporate and government borrowing, but not the amount of bank leverage. Macroeconomists generally acknowledge that they were at fault in ignoring the crucial role that financial sector leverage can play in influencing the macroeconomy. There has been a huge increase in the amount of research on these finance-macro linkages since the crisis.
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But supposing economists had ensured that they knew about the increase in bank leverage and had collectively warned of the dangers of excessive risk taking that this represented. Would it have made any difference? There are good reasons for thinking it would not.
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The main evidence for this is what has happened after the crisis. Admati and Hellweg have written persuasively that we need a huge increase in bank capital requirements to bring the ‘too big to fail’ problem to an end and avoid a future banking crisis, and the work of David Miles in the UK has a similar message. I have not come across an academic economist who seriously dissents from this analysis, but it has no impact on policy at all. The power of the banking lobby is just too strong.
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So the response of economists to the financial crisis has been as it should be. The error in neglecting bank leverage is being addressed. Economists have come up with clear proposals about how to avoid the crisis happening again. And these proposals have been pretty well ignored.
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In terms of conventional monetary and fiscal policy, academic economists got the response to the crisis right, and policymakers got it very wrong. Central banks, full of economists, relaxed monetary policy to its full extent. They created additional money, rightly ignoring those who said it would bring rapid inflation. Many economists, almost certainly a majority, supported fiscal stimulus for as long as interest rates were stuck at their lower bound, were ignored by policymakers in 2010, and have again been proved right.
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So given all this, why do some continue to attack economists? On the left there are heterodox economists who want nothing less than revolution, the overthrow of mainstream economics. It is the same revolution that their counterparts were saying was about to happen in the early 1970s when I learnt my first economics. They want people to believe that the bowdlerised version of economics used by neoliberals to support their ideology is in fact mainstream economics.
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The right on the other hand is uncomfortable when evidence based economics conflicts with their politics. Their response is to attack economists. This is not a new phenomenon, as I showed in connection with the famous letter from 364 economists. With austerity they cherry picked the minority of economists who supported it, and then implemented a policy that even some of them would have disagreed with. (Rogoff did not support the cuts in public investment in 2010/11 which did most of the damage to the UK economy.) The media did the rest of the job for them by hardly ever talking about the majority of economists who did not support austerity.
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The economic costs of Brexit is just the latest example. Critics have focused on the most uncertain and least important predictions about Brexit, made only by a few, to attack all Brexit analysis. The fact that this prediction involved an unconditional macro forecast, while the assessment made by a number of groups about the long term cost involves a conditional projection based largely on trade equations, seems to have completely escaped the critics. More important, the fact that the predicted depreciation in sterling happened, and is in the process of already causing a large drop in living standards, is completely ignored by these critics.
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Attacking economists over Brexit is designed to discredit those who point out awkward and uncomfortable truths. Continuing to attack economists over not predicting the financial crisis, but failing to ignore their successes, has the effect of distracting people from the group who actually caused this crisis, and the fact that very little has been done to prevent a similar crisis happening in the future.
I would add that it is also unfair to blame the majority of economists anyway, as they work on micro rather than macro, and many serious economists did predict the crisis but were ignored by people with power who should have been more on the ball and could have at taken at least some pre-emptive action or planned more effective reactions to the inevitable. Greenspan admitted himself that he had put too much faith in a flawed model and the main failing was from the official watch-dogs rather than economics per se- including the Bank of England- though it's action after the crisis was praiseworthy, unlike that of government from 2010. A valid criticism of economics remains though that it largely ignores the societal impacts of policy and hence does too little to warn of how policies can exacerbate discontents that may grow and overwhelm the scope for rational policy. http://blog.policy.manchester.ac.uk/posts/2017/01/economics-is-not-enough/
ReplyDelete'Berating the Raters', Paul Krugman, APRIL 25, 2010
ReplyDelete"When Goldman Sachs employees bragged about the money they had made by shorting the housing market, it was ugly, but that didn’t amount to wrongdoing.
No, the e-mail messages you should be focusing on are the ones from employees at the credit rating agencies, which bestowed AAA ratings on hundreds of billions of dollars’ worth of dubious assets, nearly all of which have since turned out to be toxic waste. And no, that’s not hyperbole: of AAA-rated subprime-mortgage-backed securities issued in 2006, 93 percent — 93 percent! — have now been downgraded to junk status.
What those e-mails reveal is a deeply corrupt system."
There are people out there, some with influence, that are adamant that it is possible to have unlimited QE which can be covered simply by issuing parallel amounts of government debt. At very low interest, of course. It is a persuading idea for politicians and others who want the votes and the spend now and what happens later will be somebody else's problem. My view of history is that the bigger the spend that is uncovered then the bigger the ensuing crash.
ReplyDeleteThere is a subtle difference between what you are talking about and what appears in the media.
ReplyDeleteYour points about the banks and leverage is I'm sure quite correct and provides a necessary, not merely useful, input into policy decisions and this shows economics at its most useful.It is easy to see that such proposals are based on robust analysis grounded in practicality and do not involve prediction to any extent.
However, a large amount of economic comment concerns prediction and this appears to be where most of the criticism comes from. Unfortunately almost any prediction (GDP growth; inflation; unemployment etc) is bound to be wrong; the only question is by how much? Perhaps one of the reasons is that a large part of the commentary originates from the City which has a vested interest in demonstrating its omniscience - and fails to do so - and academic economists get tarred with the same brush.
Even hedging forecasts around with notions of probability is I suspect lost on the majority so it's no good trying to be too sophisticated in that regard (how many understand the BOE fan charts?).
It might be an idea to highlight the empirical success and forecasting accuracy of gravitational models and also the benefits of trade.
ReplyDeleteI don't think you can blame it all on banks. They were only doing what they were supposed to do in a capitalist market-based system and looking to maximise profits. The real problem is economic policy. There is a private sector debt problem in the UK and no-one appears to be willing or able to solve it.
ReplyDeleteSo it is also not true that the crisis was just about the banks. At the heart of all bad lending was property and consumer debt. Both were at record levels before the crash and now they are even higher. You shouldn't need to look at bank leverage to see that there is a problem. If most of the banks' customers are borrowing in the danger zone then it is inevitable that the whole banking system is in trouble as well. Yet even now the BoE is in denial.
When he took up his current post Carney said he wanted to control house prices. He said he was prepared to limit mortgage lending. Well house prices have increased by about 40% since then and no action has been taken.
The real problem is that we have been conned into believing that high house prices, low interest rates and low inflation are good for the economy. And the real problem is low inflation. That in effect caused the financial crash. Yet no-one in mainstream macro is advocating increasing the inflation target, or even demanding action to get inflation back up to the current target of 2.5%. Instead all we hear is that we must stop inflation rising, or Brexit will cause inflation to rise above 1.5% as if that was a bad thing.
Low inflation = low growth. It leads to low interest rates, low wage growth, low investment and rising inequality and asset prices. The result is financial instability and catastrophe. It is classic Hyman Minsky.
No, no, no. Read the post. Read Broadbent. Banks took too much risk (high leverage) because they had an implicit subsidy from the state (TBTF).
DeleteI have read the post. Have you and Ben Broadbent read Hyman Minsky? In the end it comes down to the Financial Instability Hypothesis.
DeleteBanks will always try to circumvent the regulatory framework.
Banks will always have an implicit subsidy from the state (TBTF) because they trade solely in a commodity (i.e. currency) that is only created by the state.
So blaming the banks doesn't get you anywhere.
The Financial Instability Hypothesis states that a prolonged period of stability (e.g. low inflation) will lead to a catastrophic financial crisis. I outlined the causal linkage above.
And then there is the question of government surpluses as L. Randall Wray points out here:
https://www.youtube.com/watch?time_continue=64&v=Sfm8PUMVeSI
Virtually every major depression in the US was preceded by a period of government surplus which therefore forced, via sectoral balance, the private sector to run a deficit. As Wynne Godley noted, no single sectorial balance is independent of any other. And as Hyman Minsky noted, the real economy is not independent of the financial system. So the behaviour of banks is therefore NOT independent. It is conditioned. So you can't just blame them.
' many serious economists did predict the crisis but were ignored by people with power '
ReplyDelete"In December 2007, economists in the Wall Street Journal forecasting panel predicted only a 38 percent chance of recession in 2008. The Survey of Professional Forecasters is a survey of economists’ predictions done by the Federal Reserve Bank that includes uncertainty measurements. In November 2007, the Survey showed a net prediction by economists that the economy would grow by 2.4% in 2008, with a less than 3% chance of any recession and a 1-in-500 chance of it shrinking by more than 2%."
:
:
"If the economists’ predictions were accurate, the 90% prediction interval should be right nine years out of ten, and 18 out of 20. Instead, the actual growth was outside the 90% prediction interval six times out of 18, often by a lot. (The record back to 1968 is worse.) "
So who's right here?
Yet again: unconditional economic forecasts are not much better than guesswork. Economists know this, and the reputable ones will happily tell you. So you need to ask why you don't know this. (Hint. Its not your fault.)
DeleteThe problem with Brexit and the financial crisis is exactly the same. UK has nothing to sell except financial services and after Brexit nobunny except those trying to hide ill gotten gains will be buying. At that point no real country will deal with the UK and the British Virgin Islands have better weather.
ReplyDeleteDear Mr. Lewis:
ReplyDeleteWhat you miss, I think, is that something I've frequently noticed in my roughly a decade of reading economic blogs on the Internet. Economists have blinkers on. They want to view the economy as an isolated scientific subject, like the interior of a test tube, and treat politics and policy as a sort of exterior force, that can be isolated from the test tube and pushed off-to-one side. It seems fairly clear to me that the two elements--politics and the economy--are obviously not only continuously co-mingled, but they have all sorts of feedback loops running between them. Yet the discipline really seems to consistently and deliberately choose to blind itself to politics and the dynamics of power, despite the deep entanglement of politcs with everything economic. You admit that macroeconomists "missed" the impacts of very high financial sector leverage, but you find that, even now when economists have noticed it, and suggested remedies, that the power of bank lobby prevents those remedies from being enacted. But shouldn't the political power of the finance lobby--readily observable many years before the crisis--been a part of economic analysis of the world along with the dangers of the financial sector's use of extreme leverage? Do you actually think the two phenomena are unrelated? Shouldn't economics pay much more attention to the ongoing activity of various groups to orient government policy in their favor, just like they pay attention to the trade deficit and GDP numbers and market clearing prices? I look at politics and the economy and see one thing, not two things, and I am astonished at the extent to which economists choose to focus on the part they like to play with intellectually, while deliberately looking away from what is probably the more important part. Its like economists obsessively focus on the part that can be studied via numbers (money) and don't want to think about the part that is harder to quantify (political policy).
And there is a political issue there, which you keep ignoring in your defense of "mainstream economics." The neoclassical economics tendency of not looking at power relationships makes power imbalances and their great influence on economics seem like "givens" or "natural endowments", which is clearly an intellectual sin of omission. Many people,even within the halls of mainstream economics, note economists are "uncomfortable" with distributional issues. Whether they like the implication or not, economists need to acknowledge that this discomfort has a profoundly conservative intellectual bias, in the sense that it make the status quo arrangement of society seem "natural" and "normal", when it is obviously humanly constructed and not in any sense "natural." So when left-wing people say that economists are defenders and supporters of the current order of things, they have a point: ignoring power relationships and their impact on the world supports the contined existence of those relationships. You seem like a nice guy, and don't take it seriously, but I reall think you need to take that simple home truth in. I'm not sure why you seem to struggle so with acknowledging it.
This is exactly right. The sad irony is that heterodox left wingers are being (unconsciously) co-opted to serve the purpose of the financial sector.
ReplyDeleteI like this piece. However, on the sociological and political side, it doesn't come fully to grips with the question of what counts as fair/representative sampling of econ opinion vs. what counts as unconstructive cherrypicking.
ReplyDeleteOn one side of the debate, there is a view that statements about "opinions of economists" should try to match what the majority view of some learned group - e.g. all people holding a Ph.D. in Economics - would say. The public, on the other hand, thinks it is valid to reference a representative sampling of people who appear on their TV/cellphone screens to give "informed" economic opinions. As Mr. Wren-Lewis points out, this latter group can be "biased" by selection for the set of opinions that the sponsoring commercial interests want to have expressed. So how is the public to know "the opinions of economists"? That's not an interesting problem to the majority of economics in the first group...they have real work to do. Thus, the issue of valid cherrypicking remains unsolved, on a practical level.
It is also valid to point out that insofar as points 1 through 6 are true (and I agree that they are true) they do not necessarily support the claims made in point 9 & 10.
ReplyDeleteThe pro cyclical policy bias has not only been stronger within the EU - it is constitutionally mandated by EU treaty. The consequences were indeed as dire as the mainstream school of economists said they would be and they continue to be dire. The small GDP improvements that have recently been made have been the consequence of ignoring the letter of EU rules and winking at violations. It is precisely because the EU rules are being broken that some semblance of life is now finally twitching the EU out of its long wasting coma.
This should lead to a more critical assessment ( certainly more critical than anything offered on this blog) of whether the EU's governing model of embalming critical economic policy in treaty clauses is not itself central to the chronic under performance of the whole region.
Since, in the EU dispensation, public opinion has no political traction and cannot alter policy via the ballot box then why wouldn't mainstream economists have forecast a sharp deterioration in the public economic welfare? If the public have no policy leverage then by what alternative agency is public welfare to be defended? To a sceptic the EU's policy failures have everything to do with the lack of accountability built in to the EU's policy making structures.
The sceptic will assert that the EU proves that there isn't a technocratic "politically independent" vanguard who will selflessly protect and extend the public welfare. The sceptic will add that mainstream economics has nowhere been as disregarded as it has in the policy set actually prescribed by the least politically accountable governing agencies of the developed world.
The sceptic would therefore conclude that a mass popular vote to terminate the policy prerogatives of so unaccountable an authority is an economically rational response....
Please reply to Tony Maher's excellent comment Prof WL. I think it nicely sums up the concerns that I have with your analysis of the possibel effects of Brexit in that I don't think you pay sufficient attention to the 'facts on the ground' of the post Lisbon & Fiscal Compact EU.
DeleteIf, as you say, we shouldn't attack 'economics' as it did not prescribe a particular, deliterious set of policies then surely it is right to attack - and maybe leave - any institution where those policies are baked-in and which is run in the interest of those who caused the crisis.
I think pretty well everywhere Tony talks about the EU he actually means the Eurozone, and of course we are not in the Eurozone. While I agree with a lot of this criticism of the Eurozome, I don't think it would ever have a sufficiently unfavourable impact on the UK to compensate for the obvious costs of leaving the Single Market.
DeleteThe very useful link to the Ben Broadbent speech in point 2, repays close study. Its particular focus and analysis on the construction industry reinforces and provides evidential underpinning to the case that increased public investment applied to support a future higher - and a more steady - level of construction industry output in economically productive infrastructure (including housing) is both desirable and necessary if the sustainable growth rate is to be both raised and realised.
ReplyDeleteSuch investment could and should incentivise the improved training and productivity outcomes that are so needed within the industry - while recognising the measurement difficulties involved.
It also links to the remit of the Infrastructure Commission in terms of project pipeline selection and resource planning.
There is a general cross party political consensus that we should be building 300,000 new homes a year, roughly double the present level: need I make the obvious point?
Increased public investment in housing- efficiently delivered, and sensibly spread and stretched in tenure terms- would provide relatively quick economic and political terms relative to transport with its longer lead in times, notwithstanding the crucial long term importance of that sector.
More nonsensical talk from mainstream economist. Financial crisis were mere symptom when real crisis was the wealth crisis. When house prices tanked, so did wealth of the consumers and so did their ability to consume.
ReplyDeleteYou guys are so far off reality it is not even funny. We need new economics that is based on balance-sheet analysis of the macroeconomy.
Delusions of useful idiots
ReplyDeleteComment on Simon Wren-Lewis on ‘Attacking economics is a diversionary tactic’
1. When economists daydream they fancy that practical men/politicians/heads of state are the intellectual ‘slaves of some defunct economist’. Keynes’s closing sentence in the General Theory is a fine example of self-delusional grandiosity: ‘... it is ideas, not vested interests, which are dangerous for good or evil’.#1
2. The fact of the matter is that practical men/politicians/heads of state DO NOT listen to economists: “Late in life, moreover, he [Napoleon] claimed that he had always believed that if an empire were made of granite the ideas of economists, if listened to, would suffice to reduce it to dust.” (Viner)
3. Practical men/politicians/heads of state do not take economists seriously but use them as testimonials for already decided policy measures in order to anoint them with some scientific prestige. This is NOT different from selling toothpaste with the testimonial of a man in a white lab coat.
4. In their self-delusion, economists get the causality wrong. Mrs. Thatcher did NOT for one moment intend to put Hayekian economics into practice but employed him as ‘scientific’ legitimation for her union crushing agenda. The same causality holds for FED chairs and their decorative staff of cutting-edge economists.
5. It is of utmost importance to distinguish between political and theoretical economics. The main differences are: (i) The goal of political economics is to successfully push an agenda, the goal of theoretical economics is to successfully explain how the actual economy works. (ii) In political economics anything goes; in theoretical economics scientific standards are observed.
6. Economists never got out of political economics. In other words, theoretical economics (= science) ultimately could not emancipate itself from political economics (= agenda pushing). And this is how economics became one of the most embarrassing scientific failures of all times.
7. Economics is NOT part of science but of Circus Maximus. Political economics has produced nothing of scientific value in the last 200+ years. The four main approaches ― Walrasianism, Keynesianism, Marxianism, Austrianism ― are mutually contradictory, axiomatically false, and ALL got the foundational concepts of the subject matter, i.e., profit and income, wrong.
8. The point is this: “In order to tell the politicians and practitioners something about causes and best means, the economist needs the true theory or else he has not much more to offer than educated common sense or his personal opinion.” (Stigum) Economists do NOT have the true theory and this means that economic policy guidance has NO sound scientific foundation.
9. In economics, everything and the exact opposite has already been said sometime, somewhere, by somebody. So it is very easy after every economic calamity to present somebody who ‘saw it coming’ and to shift the blame: “Economists have come up with clear proposals about how to avoid the crisis happening again. And these proposals have been pretty well ignored.” (SWL’s intro)#2
10. It is NOT a divisive attack on economics but a statement of fact that (i) economics is a failed science, (ii) both orthodox and heterodox economists are incompetent scientists, (iii) economic policy guidance never had a sound scientific foundation, (iv) economics is useless except for political agenda pushing or sitcom entertainment.
Egmont Kakarot-Handtke
#1 References, further details, and proofs are given elsewhere, see blog http://axecorg.blogspot.de/ or papers https://papers.ssrn.com/sol3/cf_dev/AbsByAuth.cfm?per_id=1210665
#2 See also ‘Science does NOT predict the future’
http://axecorg.blogspot.de/2016/08/science-does-not-predict-future.html
1. Experts have a staff-role, and the line decides.
ReplyDelete2. The annual report 2004 of the NL central bank (DNB) on 'the search for yield'; well there was no crash in 2005, was there ?
3. Market-imperfection one can see at the labour-market, section: economists. The law of large numbers guarantees, that quality averages on mediocrity; many pearls, and even more pig-droppings. Oops, I would be incompetent if I would give you the whole list for free!
you won't like this but you should read it ...
ReplyDeletehttp://ngdp-advisers.com/2017/01/23/obvious-wren-lewis-really-poor/
I did and regret it. Targeting NGDP has some advantages but it does not avoid a financial crisis.
DeleteLots of countries had similar financial leverage and apparent housing bubbles but at least had formally flexible IT, if not implicit NGDP Targeting. They avoided financial crises. As a result they never got to near zero rates or the unusual but never insurmountable problems that near zero rates bring.
ReplyDeletePS It's so tempting to dismiss your claims about fiscal policy as just a figment of your overall left wing bias, but I resist. You should try harder too the other way, rather than just go all ad hominem and conspiracy theorist about "the right".