Saturday, March 14, 2015

In which I look strangely at Paul Krugman

 - by New Deal democrat

Prof. Paul Krugman writes today: "When I tell people that macroeconomic analysis has been triumphantly successful in recent years, I tend to get strange looks."
Consider me looking strangely. Yesterday Krugman acknowledged that few macroeconomists saw the Panic of 2008 coming, but once it happened many (like him) immediately saw how it needed to be addressed:
"Well, very few [macroeconomists] saw the crisis coming — mainly, I’d say, for two reasons. First, most economists (me too) failed to understand how the growth of shadow banking, which lacked a deposit-insurance safety net, had recreated the possibility of old-fashioned financial panics. Second, we didn’t pay nearly enough attention to household debt. So the crisis came as a surprise. 
"But these were failures of observation, not fundamental conceptual problems, and the sensible half of the profession quickly took them on board — basically realized that we were seeing old issues in new bottles. Or as I tend to think of it, we collectively went “Aha! Diamond-Dybvig-Irving Fisher yowza!” and all was clear."
This is rather like an air traffic controller who allows two jumbo-jets to crash in midair, but afterward is really good at directing to which hospital to send the mangled living among the smoldering carnage.  You know, "sorry about that midair collision, but please have 30 ambulances on runway 15W to take the survivors to Metro Hospital STAT!"

Krugman excuses macroeconomists for failing to see the crash coming due to "failures in observation."  Well, this is me on November 30, 2007, describing the coming "Panic of 2008:"
 This is NOT the Great Depression II.  Nor is this the stagflationary 1970s.  It is going to unfold as some other Beast.  Only the broad outlines of this Beast appear discernable now:  it will likely feature (1) increasing import prices; (2) wage stagnation (that does not keep up with price inflation; (3) real asset deflation; and (4) possibly a Japan-style "liquidity trap."  In fact, while I believe we are already in a recession, I suspect there will be a business upturn late next year. 

Furthermore, I believe there will be NOT any "runs" on FDIC-insured bank deposits.  Period.  In fact, I suspect they will turn out to be the best havens in the storm.  But this slow motion bust, this Panic of 2008 (and thereafter), will be painful, and it will unfold.  I do not think it can be avoided any more."

I followed that up on January 7, 2008 with this description of a "slow motion bust."
"I constantly describe the era we are in as a "Slow Motion Bust."  A few days ago economist/blogger Prof. Brad DeLong published an excellent article that describes just what I have been trying to convey by that term."Whoever inherits the White House on January 20, 2009 is likely to confront serious and urgent economic conditions unlike any we have seen in our lifetimes.  For the mortgage crisis is only part of a bigger insolvency crisis that has already taken longer to unfold than most economic downturns in our history."...

"[T]he problem has slowly worsened over the last year -- in other words, it has become "a slow motion bust."  Let's first note that housing prices probably peaked nationwide by early 2006.  By February 2007, as noted by Calculated Risk, there were serious problems with subprime mortgage- backed investment paper.  By August, the problems had spread far beyond subprime mortgages, and banks and hedge funds were facing liquidity problems.
"Prof. DeLong's article describes perfectly why I have been calling this a "slow motion bust".  Very much unlike its 19th and 20th century predecessors, instead of going from boom to deflationary spiral suddenly, in a matter of mere months, this bust began to implode a year ago, and bit by bit financial assets (what blogger Russ Winter calls "fictitious capital") are being written down or written off entirely.  Only now are serious financial thinkers beginning to worry about the "third mode" of a deflationary spiral."
If not all the data was out there publicly, enough of it was to get an idea about the risks of what was coming.  Not just a point or two off of GDP, not just a little recession, but a modern variation on an old-fashioned bust, due to too much debt and leverage in the system.  If yours truly could see it - and could see how it was likely to play out - why couldn't, by Krugman's own admission, macroeconomists?
So consider this me giving Paul Krugman a strange look.