Economists | timiacono.com - Part 3

On Economists and Psychopaths

After reading through some of the recently released transcripts from the 2006 Federal Reserve policy meetings, it occurred to me for about the thousandth time that economists are particularly ill-suited to oversee an economy where the financial system is, from time to time, run by psychopaths each trying to one-up the other.

During normal times, economists’ models of how the world works seem to function reasonably well, but when a multi-decade orgy of money and credit creation came to a head a few years back, they were completely unaware of how badly some people were acting and how contagious this was.

The central bank meets this week and is expected to revamp how they communicate their thinking about monetary policy to the world, but, maybe they should spend more time figuring out how to better observe what’s going on in the world – looking beyond the charts, tables, and models that they had their noses buried in back in 2006, oblivious to the looming crisis in housing and credit markets.

It was all there to see for anyone willing to make a modest effort to get out into the real world and look around.

Wild-eyed buyers lined up for blocks to buy new condos and mortgage brokers with barely a high school education were raking in hundreds of thousands of dollars a year in commissions by peddling all kinds of “exotic” mortgages to borrowers who, in many cases, didn’t really understand what they were signing.

As we’ve come to find out, there was a good deal of fraud involved here by both lenders and borrowers as few seemed to care about how their individual actions might affect others in the fullness of time.

You might say that a good asset bubble brings out the psychopath in many of us.

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Mishkin’s 2006 “Smidgen” Moment

Dean Baker’s commentary from last week that delved into the 2006 meeting transcripts of the Federal Reserve’s policy committee – Alan Greenspan’s ship of fools – contains this noteworthy section featuring former governor Frederic Mishkin that provides more evidence that economists are particularly ill-suited to run the economy.

Here’s what Frederick Mishkin, a Federal Reserve Board governor who later played a starring role in the movie Inside Job, had to say about the risks from the housing market in that same December 2006 meeting:

“I don’t see any indications that we will have big spillovers to other sectors from weak housing and motor vehicles.

In that sense, there’s a slight concern about a little weakness, but the right word is I guess a ’smidgen,’ not a whole lot.

At that last meeting of the year, the major concern expressed was about inflation. Several FOMC members expressed concern that the unemployment rate at the time (4.5%) was too low to keep inflation in check. They hoped that slower growth in 2007 would raise the unemployment rate to a level consistent with stable inflation. They certainly got their wish about a growth slowdown, although they did have to wait until 2008 to feel its full effect.

If you haven’t already clicked on the link to the Inside Job excerpt in the quoted text, you can do so here. I don’t know about you, but, I just never get tired of watching that clip.

The Fed’s Housing Bubble Laughter

The Federal Reserve transcripts from 2006 released ten days ago continue to reverberate around the internet as the central bank has become a laughing stock for being so unaware of the U.S. housing bubble that was inflating to dangerous levels throughout the year.

Dean Baker’s Alan Greenspan’s ship of fools from last week is well worth reading if for no other reason than to learn what former Fed governor Frederic Mishkin was thinking late that year and I recently came across this item at The Daily Staghunt blog that charted how much laughter appeared in the transcripts over the years.

While Fed economists are purportedly a funny lot, it does look pretty bad to see increasing joviality at a time when they could have been doing something about the housing bubble.

The FOMC (Federal Open Market Committee) meets this week and they are expected to announce of a new communication initiative with two key features – expanded interest-rate projections and an explanation of their objectives for inflation and employment. Fed Chairman Ben Bernanke will surely discuss these in detail in the press conference after the meeting and, though normally keen on audience engagement, he’ll probably be hoping that he’s not asked about the 2006 transcripts.

If we’re really lucky, someone will ask him about this chart.

On that Premature Tightening in 1937

I’ve never really gotten that argument about how the Federal Reserve and U.S. government tightened too soon in the late-1930s and, as a result, induced another recession. In his column today, Paul Krugman notes:

“The boom, not the slump, is the right time for austerity at the Treasury.” So declared John Maynard Keynes in 1937, even as F.D.R. was about to prove him right by trying to balance the budget too soon, sending the United States economy — which had been steadily recovering up to that point — into a severe recession. Slashing government spending in a depressed economy depresses the economy further; austerity should wait until a strong recovery is well under way.

Yet, anyone able to look at the data back in 1937 would hardly see the U.S. economy as “depressed”, not after three straight years of real GDP growth averaging 11 percent. While perhaps not a “boom”, a “strong recovery” was certainly underway by then.

To be sure, the 1930-1933 downturn was severe, but, according to the data from the BEA above, the U.S. economy had returned to its 1929 bubble output by 1937 when all the policy mistakes were supposedly made.

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