Thursday, April 18, 2013

Reinhart/Rogoff: a symptom of more serious problem with economic profession

In a must read column in the Guardian, Heidi Moore lays out the serious problem with economics: it is unreliable as a policy tool yet central banks and the technocratic parts of government focused on fiscal policy are run by economic PhDs, i.e. true believers in the truth provided by economics.

This point cannot be repeated enough times.

It was not by chance that the global economics profession, with a small handful of exceptions, failed to predict our current financial crisis.

It was not by chance that the policies pushed forth by the global economics profession have failed to end our current financial crisis.
Economics is an inexact science, as any honest economist will tell you. 
It is based on unreliable numbers that measure relatively small swaths of the population. Whatever the number – unemployment, inflation, wages – it is almost always wrong the first time the government publishes them, and then it is revised later: once, twice, three times or more. The errors are usually large.
If it is not an exact science, what is economics?

A nice set of theories by which to express one's political biases without have to disclose these biases.

Reinhart and Rogoff demonstrated this.
Many Americans know that Washington lawmakers have been engaged in a two-year battle to the death over the federal deficit. ... 
This philosophical debate is not actually about philosophy. It has been, to a certain extent, about two activist economists who spent years preaching that high debt would destroy America's economy in the future, pitching us into certain recession. 
Here's how it happened: 
In 2011 Congress was engaged in a bitter battle over the direction of the US economy; a group of them seemed ready to default on the nation's debt and shut down the government, if necessary, to win their point: that the growing federal deficit would endanger America's economy for generations to come. Others were unconvinced. The stalemate brought Washington to a standstill on the issue. 
During this tense period, there was an important meeting. Nearly 40 Senators sat in neat rows to hear a presentation on debt from Carmen Reinhart and Ken Rogoff, two economists with faultless reputations and keen academic credentials. 
They were not just economists that day, however, bolstered by years of research and a 900-pound book full of graphs and complex economic data, Reinhart and Rogoff were also activists against debt. Their goal was to convince the assembled lawmakers to cut the amount of money the government owed....
Reinhart and Rogoff also demonstrated that faultless reputations and keen academic credentials are worthless when talked about in the context of economists.  

Had their article gone through the peer review process that exists for serious academic disciplines like the hard sciences or business operations, it would not have been published as the findings of their research had no statistical significance after fixing their Excel error and omission of relevant data.  

At the end of the day, regardless of their reputation or academic credentials, economists are simply shills for their political biases.
The travails of Rogoff and Reinhart show one thing conclusively: we put too much trust in economics to tell us how to run the country. 
Economics cannot actually bear this burden. It is largely a science of educated guesses. Economics is a useful science, but it is not an infallible one. 
It is, in particular, an unreliable policy tool.
Which brings us to central banks who have been pursuing zero interest rate policies and quantitative easing since the beginning of the financial crisis.

Bernanke and his colleagues have been coming up with new, innovative ways to stimulate the US economy. 
The Federal Reserve did things it had never done before: it lent money directly to certain kinds of banks, it increased access to cheap loans when banks wouldn't lend to each other, and it bought billions of dollars in Treasury bonds and mortgage-backed securities to take them off the market so banks would buy other kinds of bonds. 
How does the Fed, which has an encyclopedic command of every kind of economic indicator, know all of this is working? 
Spoiler: it doesn't. 
Bernanke has repeatedly said in press conferences that he believes this stimulus – known as quantitative easing – is working, but also implied that is hard to measure whether the Fed's stimulus moves are making enough of a difference in major economic indicators
As your humble blogger mentioned at the start of this blog, we have true believers taking action that influences the real economy and society based on their belief in an unreliable policy tool.

Does that sound like a recipe for success in ending the financial crisis?

Sounds to me more like Mr. Bernanke is adopting policies in defense of his PhD thesis and subsequent academic career.

No less an authority on the Great Depression and monetary policy than Anna Schwartz, Milton Friedman's co-author, said Mr. Bernanke learned the wrong lessons and adopted the wrong policies for our current financial crisis.  She identified our current financial crisis as a bank solvency led financial crisis.

There is one and only one proven way to end a bank solvency led financial crisis: adoption of the Swedish Model.  Under the Swedish Model, banks are required to recognize upfront their losses on the excess private and public debt in the financial system.

It is common sense why the Swedish Model works.  It does not require the real economy to divert capital it needs to support growth, reinvestment and the social contract to making debt service payments on the excess debt.

The drawback to the Swedish Model is it crushes banker cash bonuses for the next several years.

The Swedish Model originated in the US during the Great Depression (FDR implemented during the 1933 bank holiday and, according to the NY Fed, broke the back of the depression), was successfully used by Sweden to handle its 1990s crisis and was most recently successfully used by Iceland at the beginning of our current financial crisis.

I am not an economist.  Hence, I have a bias to adopting policies that have been proven to end a bank solvency led financial crisis.

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