What do Economists Actually Know?

Author: M.A. Kevin Capuder

Position: Chair of Business Administration Department

When a former Goldman Sachs’ managing director, the former head of the U.S. Central Bank and the former U.S. Treasury Secretary all begin to talk about ideas considered far  outside the economics mainstream just a few years ago, one could be excused for thinking the world is losing its collective mind. Or perhaps we are seeing the beginning of a new, and radical, way of viewing macroeconomics.  

To begin with we have Bill Dudley, the former Goldman director and partner, and current President of the New York Federal Reserve bank, saying in a recent speech: “We still don’t have well developed macro-models that incorporate a realistic financial sector. We don’t understand fully how large-scale asset purchase programs work to ease financial market conditions….”. To translate that quote into English means that macroeconomists don’t understand the financial world and therefore can’t predict the future with any acceptable level of accuracy. So they continue to make policy without knowing how those policies will work.

Moving forward (backward?), we come to Alan Greenspan the former Chairman of the Federal Reserve System who is quoted in a recent Harvard Business Review interview. He states, “But the problem is it’s true. I had at my call 250 first-rate PhDs in economics. They’re building this thing we called FRB/US, this extraordinarily clever set of the most advanced econometrics that you can imagine. With every bell and whistle that anybody suggested, it was in there. It missed the crisis. The IMF missed the crisis. My friends at J.P. Morgan put out a weekly forecast. They’ve been doing it for years. And three days before September the 15th, they had the economy going straight up.” For Mr. Greenspan, those are unusually clear expressions of his thought. So no translation is required. If this resulted from what Dudley has said, he doesn’t directly address in the interview, but it is strongly implied.

Lastly, we come to Larry Summers, the former U.S. Treasury Secretary. Writing for Reuters on the stagnation in most developed economies today he offers, “The implication of these considerations is that the presumption that runs through most policy discussion – that normal economic and policy conditions will return at some point – cannot be maintained.”  Again, a translation might help. Policy makers are still using very out-of-date thinking to draw up their predictions about economic policies. The chances, therefore, of successful policies are slim to none.

For more than fifty years economic policy makers have claimed both to know what they are doing and the ability to guide economies to better times. It might perhaps be better if they simply admit that they don’t know much. Blindfolded by mathematics, they have ignored some very clear lessons of economic history. Among those lessons are the ideas that excessive borrowing and the incentive structure in the financial industry are destructive. Even Alan Greenspan would now agree. After swallowing those ideas, the economics profession might know something useful.

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