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Economists and Bubbles

More evidence that, to some economists, certain things don’t exist in the world unless they can not only be modeled, but be predicted by said models, comes via this story at Casey Research in which Doug French takes Nobel Prize winning dismal thinker Eugene Fama of efficient market hypothesis/theory fame to task for some ridiculous lack of common sense.

The New Yorker’s John Cassidy asked Fama how he thought the efficient-market hypothesis held up during the financial crisis. The new Nobel laureate responded:

Fama“I think it did quite well in this episode. Prices started to decline in advance of when people recognized that it was a recession and then continued to decline. There was nothing unusual about that. That was exactly what you would expect if markets were efficient.”

When Cassidy mentioned the credit bubble that led to the housing bubble and ultimate bust, the famed professor said:

“I don’t even know what that means. People who get credit have to get it from somewhere. Does a credit bubble mean that people save too much during that period? I don’t know what a credit bubble means. I don’t even know what a bubble means. These words have become popular. I don’t think they have any meaning.”

No matter the facts, Fama has his story and he’s sticking to it.

“I think most bubbles are 20/20 hindsight,” Fama told Cassidy. When asked to clarify whether he thought bubbles could exist, Fama answered, “They have to be predictable phenomena.”

This explains a lot – unfortunately…

How Wrong, Indeed

I don’t normally agree with Paul Krugman, the Nobel Laureate in economics and New York Times columnist, but the views on former Fed Chairman Alan Greenspan that he shared in this recent Playboy interview seem to be spot on:

PLAYBOY: Speaking of high-profile economic voices, you were pretty harsh about former Federal Reserve chairman Alan Greenspan and his role in the financial crisis. Should we be listening to him anymore?

KRUGMAN: No. I mean, how wrong do you have to be to get written out of the debate? He assured us that deregulation was making the system more stable. He was repeatedly wrong as the crisis unfolded. Look at Paul Volcker, whom I disagree with on some stuff but who is certainly an incredibly upstanding human being. When he left the Fed, he deliberately went silent to leave the field clear for Greenspan. Greenspan instead raced out to cash in personally on his role. He’s been so completely wrong at this point that the idea that some people still listen to him as a source of wisdom is awesome.

‘Ol Greenie is about due for another appearance on NBC (where his wife Andrea Mitchell works) or another Financial Times op-ed as some organizations still can’t seem to get enough of the guy who will surely not be treated kindly by history.

Quantitative Easing Revisited

This follow-up to the wildly popular original YouTube hit Quantitative Easing Explained covers such subjects as how quality improvements in the iPad 2 keep inflation low and how Fed money printing rewards the wealthy while punishing the poor.

Though its popularity pales in comparison to its predecessor (about 5 thousand views vs. 5 million views), it’s still worth a look if for no other reason than this quip:

I have figured out the formula for predicting the Fed’s actions. First, you take a past policy that has been a complete bust. Then you double the size and do it twice as long.

When Models Trump Common Sense

More evidence that U.S. economists are particularly ill-suited to run the U.S. economy comes via the fascinating exchange in recent days between St. Louis Federal Reserve President James Bullard and a small army of bloggers with PhDs in economics, nearly all of the latter ganging up on Bullard after he suggested that the “output gap” theory for what ails the U.S. economy may be fundamentally flawed and that attempts to boost overall demand to close that gap through freakishly low interest rates and other super accommodative Federal Reserve policies might end up doing more harm than good.

Bullard threw a cat amongst the pigeons in this speech(.pdf) when he noted the following:

The recent recession has given rise to the idea that there is a very large “output gap” in the U.S. The story is that this large output gap is “keeping inflation at bay” and is fodder for keeping nominal interest rates near zero into an indefinite future. If we continue using this interpretation of events, it may be very difficult for the U.S. to ever move off of the zero lower bound on nominal interest rates. This could be a looming disaster for the United States. I want to now turn to argue that the large output gap view may be conceptually inappropriate in the current situation. We may do better to replace it with the notion of a permanent, one-time shock to wealth.

Recall that I’ve railed on this subject a number of occasions over the years, the last time being this offering from about six months ago when it was noted:

The theory posits that it is not important what level of overall demand an economy has reached or how it got there, but that, when all the wheels fall off the wagon as they did back in 2008, the imperative is for the government to somehow restore that level of demand. Otherwise, you get another Great Depression.

It makes no difference if, back in 2005, people making $40,000 a year were buying no money down $500,000 homes and then, after the home’s value went up to $600,000 in 2006, pulling out their $100,000 in brand new home equity to put in a pool, buy a motor home, and install big screen TVs in every room of the house because, once you reach a certain level of demand and it begins to drop like a rock because everyone has become indebted up to their eyeballs, it must be restored.

At that point, it simply becomes a question of how much taxes must be cut or how much money must be borrowed or printed to accomplish that goal.

Of course, I don’t have any models to back up the contention that an unusually large portion of economic output we saw in the middle of the last decade was “artificial” due to the housing bubble, but economists do have models, and that’s the crux of the problem.

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