A super introspecting column by Brad Delong. He nicely titles it as Perils of Prophecy.
He says economists steeped in history knew what was coming but no one really cared.
In sum what all did historians know:
- The house price bubble coupled with leverage was a serious macroeconomic concern.
- The bubble burst would lead to large losses in books of leveraged financial institutions. This would cause a flight to safety. It would lead to deep depression kind of situation and require active official intervention as a lender of last resort.
- Monetarist cures were likely to prove insufficient;
- Sovereigns need to guarantee each others’ solvency;
- Withdrawing support too soon implied enormous dangers.
- Premature attempts to achieve long-term fiscal balance would worsen the short-term crisis – and thus be counterproductive in the long-run.
- Threat of a jobless recovery, owing to cyclical factors, rather than to structural changes.
The opposite camp said there will be quick recovery, central banking alone will resolve the crisis, fiscal austerity will push growth etc. were all wrong.
So, who got things right?
So the big lesson is simple: trust those who work in the tradition of Walter Bagehot, Hyman Minsky, and Charles Kindleberger. That means trusting economists like Paul Krugman, Paul Romer, Gary Gorton, Carmen Reinhart, Ken Rogoff, Raghuram Rajan, Larry Summers, Barry Eichengreen, Olivier Blanchard, and their peers. Just as they got the recent past right, so they are the ones most likely to get the distribution of possible futures right.
Unlike others, Delong says he got three things wrong:
But we – or at least I – have gotten significant components of the last four years wrong. Three things surprised me (and still do).
- The first is the failure of central banks to adopt a rule like nominal GDP targeting or its equivalent.
- Second, I expected wage inflation in the North Atlantic to fall even farther than it has – toward, even if not to, zero.
- Finally, the yield curve did not steepen sharply for the United States: federal funds rates at zero I expected, but 30-Year US Treasury bonds at a nominal rate of 2.7% I did not.
The possible conclusions are stark. One possibility is that those investing in financial markets expect economic policy to be so dysfunctional that the global economy will remain more or less in its current depressed state for perhaps a decade, or more. The only other explanation is that even now, more than three years after the US financial crisis erupted, financial markets’ ability to price relative risks and returns sensibly has been broken at a deep level, leaving them incapable of doing their job: bearing and managing risk in order to channel savings to entrepreneurial ventures.
Neither alternative is something that I would have predicted – or even imagined.