May 16, 2013
George Akerlof on the Response to the Financial Crisis and Great Recession
He makes the following observations:
- Not only are financial recessions deeper and slower in recovery than in normal recessions. They also have slower recovery the greater is the credit to GDP ratio.
- ... a measure of credit based on loans outstanding, even including the role of the shadow banks, yields a conservative measure of our benchmark for where we should now be.
- We should have led the public to understand that we should measure success not by the level of the current unemployment rate, but by a benchmark that takes into account the financial vulnerability that had been set in the previous boom. We economists have not done a good job of explaining that our macro-stability policies have been effective.
- [The bailout expenditures] will probably be positive, and run to a few billion dollars. But they did literally stop a financial meltdown which was in progress.
- In sum, we economists did very badly in predicting the crisis. But the economic policies post-crisis have been close to what a good sensible economist-doctor would have ordered.
There is much more to the post, and it should be read in its entirety.
I think bullet point 3 merits additional stress. The magnitude of the calamity that unfolded in 2007 and 2008, and the difficulty in re-establishing growth, should have been placed in the context. In my view, that context includes the decade long (at least) buildup of distortions in the economy, from deregulation, non-regulation, and out-of-control fiscal policy. The challenge of educating the public remains, as attested to by the all too common refrain by some "that the recovery should have been stronger", even while demanding austerity.
Posted by Menzie Chinn at May 16, 2013 10:06 AMdigg this | reddit
But isn't the problem in part that many don't agree for whatever reason about the causes? I have CRA thrown at me all the time, no matter that the existence of CRA lending has a tiny and convoluted connection to the huge housing bubble or securitization, etc. in this regard, you spend your time arguing with idiots here. You can't convince. There is no formula which does.
Posted by: Jonathan at May 16, 2013 01:15 PM
Not only are financial recessions deeper and slower in recovery than in normal recessions. They also have slower recovery the greater is the credit to GDP ratio. Duh - When banks run up their tab without adequate reserves, of course they have to shrink their loan portfolio more.
... a measure of credit based on loans outstanding, even including the role of the shadow banks, yields a conservative measure of our benchmark for where we should now be. I assumes this means that we have "recovered" when the loan portfolio gets just as big as it was in 2008, including derivatives, swaps, and securitization? This is a totally irresponsible statement! From my perspective, the biggest regulatory failure is the lack of regulatory traction on the securitization and derivative markets. The "Financial Services Modernization Act" remains in affect allowing subordination of all conventional financial contracts to unreported derivative exposures.
We should have led the public to understand that we should measure success not by the level of the current unemployment rate, but by a benchmark that takes into account the financial vulnerability that had been set in the previous boom. We economists have not done a good job of explaining that our macro-stability policies have been effective. RIGHT ON POINT! How about specifying those vulnerabilities?
[The bailout expenditures] will probably be positive, and run to a few billion dollars. But they did literally stop a financial meltdown which was in progress. Quantitative Easing has totaled more than $2 Trillion, millions of depositors and investors are getting screwed with negative real yield on their savings, tens of millions are out of work, 25% of real estate valuation went up in smoke... On what planet will costs only run to a "few billion dollars?"
In sum, we economists did very badly in predicting the crisis. But the economic policies post-crisis have been close to what a good sensible economist-doctor would have ordered. Idiocy!!! We are still in crisis! close to no one has been prosecuted for the fraud that instigated the crisis. We have increased monopolistic concentration in investment banking. The Federal Fiscal Deficit remains above $1 Trillion per year... The Central Bank is in a liquidity trap, and we have another 20 years of financial repression on tap, all because we don't want to rock the boat and replace the incompetent oligarchs and corrupt public administration that drove the economy into a wall.
Don't get a cramp, patting yourself on the back. The IMF, the FED, the Obama Administration, and Congress are a bunch of Keystone Cops.
Posted by: Anonymous at May 16, 2013 02:09 PM
But the economic policies post-crisis have been close to what a good sensible economist-doctor would have ordered.
Hmmmm....I'm not convinced. Some economists did themselves proud, but others...not so much. In the latter group I would include Casey Mulligan, Robert Barro, Greg Mankiw, Marty Feldstein, John Taylor, Ken Rogoff, Alberto Alesina, Ed Prescott, and...well, you get the picture. And while the IMF did finally get it right, it was a little slow to come around. It wasn't that long ago that the IMF proudly wore the austerity badge.
Part of the problem is that bankers and finance professors are going around posing as macroeconomists. This causes a lot of confusion in the lay public. And way too many macroeconomists fell in love with analytically tractable models that assumed away the real world at the expense of neglected inelegant heuristics that somehow got it mostly right. For example, it's intuitively obvious that the costs of unemployment and inflation are not symmetric, but too many economists with very comfortable lifestyles managed to convince themselves that a good utility function should treat unemployment and inflation risks symmetrically.
One thing Akeroff did not mention is a call for greater reliance on capital financing by banks and less reliance on debt.
Posted by: 2slugbaits at May 16, 2013 03:53 PM
Before 1982, labor would regain lost income share during the expansion after a recession. Now we are seeing that labor loses share during the expansion, while capital greatly increases share. Then when labor starts to gain back some lost share at the end of an expansion, the economy goes into a recession. Is this what a good-sensible economist doctor would order? Obviously we need a second opinion.
If labor share continues to drop after the next recession, economics will learn a big lesson.
Posted by: Edward Lambert at May 16, 2013 04:28 PM
But the economic policies post-crisis have been close to what a good sensible economist-doctor would have ordered.
I don't agree with this statement. I could perhaps agree with it until 2010, but certainly not after that. The western world went into premature austerity mode, especially in Europe, which is now very widely shown to have been (and is) very damaging to the economy. This is not just not close to what should have been done, it is diametrically opposed to it.
Posted by: Christiaan Hofman at May 17, 2013 04:15 AM
My son attends the American Boychoir School.
They are recording for NPR this weekend at Princeton University. I encourage those in the area to attend what will no doubt be an excellent concert.
Those interested in the school shouldn't hesitate to drop me a line. It is one of the truly unique educational institutions for middle school boys in the country.
American Boychoir to tape concert for National Public Radio broadcast
Posted by: Steven Kopits at May 17, 2013 08:00 AM
Humility and the lack thereof. Witness the macroeconomist.
Why can't the profession come clean. Why can't they admit our models don't work,we don't know why, and we have to go back to the drawing board and start over.
When I see more of this: http://keplerianfinance.com/2013/05/what-is-keplerian-finance/
and less of folks patting themselves on the back and saying "....The lesson for the future is that good economics and common sense have worked well...."
Stuff like that is easy to say when you have a job and get to go to neat conferences.
Posted by: anon2 at May 17, 2013 03:44 PM
I didn't understand what Akerlof is talking about in some of this. What point is he trying to make on CDS trades? I wonder why he thinks securitization of mortgages was inherently flawed but we haven't seen similar problems in securitization of auto loans or credit cards?
What's with the cat?
Posted by: Rick Stryker at May 17, 2013 05:52 PM
bullet point 3 : Seems the establishment (Akerlof incl.) tries to convince us, that high unemployment (esp. long-term unemployment) is not that bad.
Posted by: Johannes at May 18, 2013 12:57 AM
Quite an interlope world, this world of economists where the debts pushers are rubbing shoulders with the « faux monnayeurs «
The accounts swindlers meeting with the specialists of creative accounting and false accounts in all kinds public, central banks, private. When uninspired calling for the Neo Keynesian at the rescue, one variable at the time, like the Nouvelle cuisine one vegetable at the time. The best and the most efficient are the savings robbers, a little story on inflation expectation that is and the savings have evaporated. When ready to be caught flagrant delicto a tear falling from eyes already closed, they were lacking instruments of measures. Less noisy than the housing kidnappers, the gold addicts, the bonds alcoholics declaring a new order.
They congratulate each other as the balance of payments are in deficit the public coffers are empty, they go in congregation to meet with the new boss and close the meeting , Neros staring at Pompeii in flames satisfied to have achieved a better performance. Their protectors, the politicians are relieved, they will stay on the public pay roll a little while longer
« Alan thank you for raising the level of esteem that others have for the field of economics and the profession of central banking »
As for the perishes and from the height of their tribunes they declare « we can and we will do some more »
Posted by: ppcm at May 18, 2013 01:17 AM
Anonymous at May 16, 2013 02:09 PM got it exactly right.
Posted by: fresno dan at May 18, 2013 02:32 AM
Rick Stryker I had the same feeling regarding the cat.
First, what separates mortgages from credit card or auto loans is that it's a lot harder to disguise the underlying risk. People default on auto loans and credit cards all the time, but the interest rates reflect the higher risk. Second, initiators of credit cards don't depend on origination fees. Credit cards generate income not only from interest payments, but also from transaction fees from businesses who accept those cards. So the credit card issuer has an incentive to make sure people actually continue to use their cards. Credit card companies bend over backwards to get people to keep using their cards. Monthly payments are pretty flexible...at a significant interest penalty. And finally, there aren't any quasi-government agencies like Fannie Mae or Freddie Mac implicitly guaranteeing the auto and credit card loans.
Posted by: 2slugbaits at May 18, 2013 05:49 AM
"buildup of distortions in the economy, from deregulation, non-regulation, and out-of-control fiscal policy"
Check, check, check, check. Today, I mean. Whose up for a re-match?
Posted by: John Smith at May 18, 2013 06:29 AM
Ok. I haven't read the complete paper, but the summary seems to be a mish-mash of mea culpas and a good solid pat on the back...for what...oh yeah, it could have been a lot worse.
Posted by: Samuel at May 22, 2013 05:15 AM
Samuel: It's just a blogpost so shouldn't take you any time to read. Context would be provided by his book (with Robert Shiller), Animal Spirits.
Posted by: Menzie Chinn at May 22, 2013 08:45 AM