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.