In his piece in the New York Times: “How Did Economists Get It So Wrong?” (On my flight yesterday I read the shorter version in the International Herald Tribune; this one is more interesting.) The following point jumped out at me:
How did they miss the bubble? To be fair, interest rates were unusually low, possibly explaining part of the price rise. It may be that Greenspan and Bernanke also wanted to celebrate the Fed’s success in pulling the economy out of the 2001 recession; conceding that much of that success rested on the creation of a monstrous bubble would have placed a damper on the festivities.
That’s followed by:
But there was something else going on: a general belief that bubbles just don’t happen.
In Krugman’s words, “Few economists saw our current crisis coming, but this predictive failure was the least of the field’s problems. More important was the profession’s blindness to the very possibility of catastrophic failure in a market economy.” As if, somehow, deliberate state intervention into the economy through manipulation of interest rates by a state institution was somehow consistent with the existence of a free market. (And it’s interesting that the similarly deliberate policy of pumping up home ownership through the FHA, Fannie Mae, and Freddie Mac — all state enterprises — is not mentioned as perhaps having something to do with the housing bubble.) It’s as if an economist were to claim that shortages are a proof of the failure of the “free market” — five years after price controls had been imposed. What’s doubly interesting is that among the many economists who failed to see “our current crisis coming” was….Paul Krugman.
Krugman wrote about Fannie & Freddie : http://www.nytimes.com/2008/07/14/opinion/14krugman.html but, for ideological reasons it seems, he tends to downplay their role.
he also wrote this : http://www.slate.com/id/9593, criticizing the Austrian theory of business cycles.
Ironic today.
Didn’t he also call for the Fed to inflate a housing bubble to make up for the Nasdaq bubble popping?
But all this “it isn’t / wasn’t a real free market” stuff — isn’t it a bit like socialist apologists’ saying (of any given failed statist project) “that isn’t / wasn’t real socialism”?
Or: can any actual economy ever be “free” enough to satisfy the criteria? And if not, what’s the point of banging on about it?
Such discussions are important, because they help us to determine what caused what. Was the crisis caused by instabilities inherent in free markets, or was it induced by interventionism? Those are not irrelevant questions. Krugman’s concession, which he made in a very offhand way, is indeed quite important.
If the Fed, FHA, Fannie and Freddie, had not intervened so extensively, we wouldn’t have had the huge housing bubble and financial crash. But the economy would likely have slowed sooner. Free market advocates would have reasonably explained such slowing as the result of high taxes, expanding regulations, and ongoing complex federal and state government interventions. It is just that some government interventions (the monetary kind) can cause economy-wide disruption.
To J.D. Fleming: “it wasn’t a real free market” is a well defined argument. The Federal Reserve manipulations were criticized *at the time* by Austrian economists, as well as by mainstream proponents of central banking (e.g. John Taylor, Ken Rogoff). No one should mistaken Fed policy for the free market, that simply makes no sense.
Similarly, Community Re-investment Act and the GSE’s (Freddie & Fannie) are in no way market phenomena; they are creations of the Federal government.
The waves of control fraud that all of this induced weren’t free market phenomena either. But the Feds did fail in the one legitimate task they do have, that of policing against fraud.
Without massive government interventions and failures on multiple fronts, there’d be no asset bubble and no collapse.
Tom et al.: I agreed with Krugman on a number of his points, especially his arguments against the New Classical macro. The NC approach begins by assuming that markets always clear and that agents are never fooled and never make mistakes. Given these starting assumptions, you’ve ruled out most of the interesting questions in economics. Starting with Lucas, macro has just been about trying to develop complex models that fit the data, essentially w/o any genuine economic sense to them. It’s hokum.
Not that PK’s preferred alternative, Old Keynesianism is good. But at least it sorts of looks like economic reasoning.
I agree with you Charles, on much of the critique of the new macro. The “bubbles are impossible” meme should be put to rest now. (I tried to indicate my agreement with that idea, obviously much too indirectly, with my quick note above that “this one is more interesting,” which was undoubtedly opaque to everyone other than me. The IHT version did not include all of the material on bubbles, which was, indeed, a useful corrective. I wasn’t thinking clearly when I wrote it, or I would have written that “his critique of the new macro hits the target fairly well.”) Of course, all that Keynesian policy was supposed to stop this sort of thing, and it didn’t. But I digress.
Your point is well taken.