Archive for April 12th, 2009

Christopher Waller (Economics and Econometrics Department, University of Notre Dame) in 2007:

The Fed finally raised the white flag and gave the financial markets what they wanted – a big cut in the Fed funds rate. Despite all of the Fed claims that this was done for ‘broader’ economic reasons, in the end this is a bailout for all the financial entities that took big bets on risky sub-prime mortgages and lost.

I actually had Waller for class at that time. I’ve told this story a number of times, but I remember him coming into class that day, and I asked him what he thought about the rate cut. He said that the subprime thing was a tiny fraction of the economy, was extremely contained, and he couldn’t believe they had cut rates (to 4.75%). Anyways, I believed him at the time and remember adamantly telling my roommate, a fellow econ major, how stupid this rate cut was. Well, I’ll admit it: I was wrong (and so was Waller).

Waller wasn’t the only ND Econometrics prognosticator. When the Fed did an even bigger rate cut in early 2008, Nelson Mark, DeCrane Professor of International Economics, said:

“The headline inflation rate for 2007 was around 4 percent,” Mark said.  “Setting the real Fed funds rate at 3.5 percent has a good chance of accelerating inflation in 2008, which could turn out to be a huge problem for the Fed down the road…If we have another round of cheap credit that adds to consumer demand, we run the risk that firms will raise prices by even more in the future.”

The thing that grabs my attention is that both of these profs are badasses in their fields. They both hold endowed chairs at ND. Waller, starting in June, will be Senior VP and Research Director at the St. Louis Fed. They are both experts with the neoclassical macroeconomic toolkit. I think, then, that what these quotes reveal is not individual stupidity or lack of foresight, but the sheer limitations of those toolkits. Whereas economists like Keynes, Polanyi, and even Marx chose to make crises a focal point of their analysis, these macroeconomists have been trained to ignore the so-called black swans.

Thoma had a good post yesterday about this very subject. He wrote,

Without solid theoretical models and the associated empirical evidence, we really have no choice but to fall back upon older models that were “built to answer the questions that are important at the moment,” i.e. the old-fashioned Keynesian model, and to rely upon loose, but solid theoretical principles rather than a tightly constructed model and vast amounts of empirical evidence. It’s quite understandable that economists who have been striving to push the profession in a positive, scientific, solidly theoretical and evidence based direction would resist going backward, and resist strongly, but what choice do we have? Until we have a better mousetrap, the simple, old fashioned one will have to suffice.

I take this sentiment well, but I’m not sure it reaches far enough. It still avoids the question, “What if capitalist economies are inherenly unstable?” I don’t expect mainstream economists to take the Marxian or Polanyian leap, but I wonder when this view will work its way back into the mainstream. I’m doubtful that it will anytime soon. Can this crisis last long enough for the deep introspection that would shatter the mainstream hegemony over macroeconomic thought? How much longer before the current crisis runs out and the second Great Moderation is hailed by the next Robert Lucas?


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