Monday, April 22, 2013

Why Does Anyone Listen To Conservative Economists Anymore?

Last week, we learned that the Reinhart and Rogoff paper which provided one of the strongest pedestals for the austerity debate was deeply flawed.  Mike Konczal at the Next New Deal summarizes the basic problems here.  Several other people added their commentary (see Dean Baker, Paul Krugman and Marginal Revolution).  In addition, the IMF issued a paper in 2011 wherein they recognize that austerity -- especially in a time of economic weakness -- is bad policy.  We also have actual evidence from Europe and the UK that austerity does not work.

But just as importantly, an entire branch of economic thought has been wrong for the entire post recession period.  Starting in 2008 with the Fed's QE program, we were told that we'd see hyper-inflation and rising interest rates.  In fact, we've seen the exact opposite in countries that implemented these policies.  (Oddly enough, we are seeing inflationary pressures in countries with high interest rates (India and Brazil being prime examples).  We've also been told that the dollar would collapse, when in fact the dollar has become a safe haven currency.  In short, literally every single prediction and prognostication made by conservative economic thought over the last four years has been wrong, leading to this question: why are we still listening to them?

Let's start with the Art Laffer WSJ editorial wherein he predicted that expansionary austerity would lead to hyper inflation. He made this prediction in the Wall Street Journal on June 11, 2009.  He noted that there had been a huge expansion in the monetary base as a result of QE and that this explosion would lead to hyperinflation.  Invictus (from the Big Picture Blog) and I responded to this prognostication in an article on the Huffington Post, where we argued that while bank reserves had increased there was no transmission mechanism for those reserves to enter the economy.  Excess reserves would lead to inflation if consumers took out the requisite number of loans.  But in an economy that is de-leveraging, loan demand is nil.  Four years later, Art Laffer's predictions are, well, laughable.

But Laffer is not the only economist who's been wrong about inflation.  John Cochrane of the University of Chicago was also concerned about inflation in a post on his blog on June 12, 2012, where he wrote:

The Federal Government has about $15 trillion of formal Federal debt outstanding. It has uncountable trillions more unfunded promises and credit guarantees. Right now it takes in about $1.5 trillion and spends about $3 trillion a year.

We must, by arithmetic, either pay off this debt, default on it, or inflate it away. Which will we do?

I hope we pay it off. The only hope for paying it off is to return promptly to strong long-run growth, and to reform entitlements. Doubling Federal revenues by raising income tax rates on "the rich," or by cutting discretionary spending by more than $1.5 trillion per year, forever, seem unlikely.  That's arithmetic too.

Notice that in the same post he says inflation's a danger not a prediction.  Yet, at that time QE was in play for three years.  And we're nearly a year after that statement from him with no inflationary pressures.

Notice that neither Laffer nor Cochrane have changed their minds or offered any mea culpa's regarding their statements.

John Taylor of Stanford holds a PhD.  Yet he has continually compared this recovery to the early 1980s recovery.  As I noted on May 3rd of last year, this comparison was ill-founded for several important reasons.  The early 1980s recession was caused by the Fed increasing interest rates to kill inflation whereas this recession was caused by the popping of an asset bubble.  Additionally, we have a massive debt overhang which means overall demand spending is low.  He has recently issued a paper arguing for a massive budget consolidation over a 10 year period despite the clear evidence from the EU, UK and the IMF's updated research that this would be a very bad policy.

And finally, there is Mish, who in spite of the deep flaws in the R&R research still clings to his beliefs.  However, now he's bolstering them with the Treasury View:

Empirical studies cannot be used to settle points about economic theory. It should be obvious that deficit spending is nothing but deferred taxation. And obviously, since government spending has no concept of the categories of profit and loss, such spending is typically a mindless waste of scarce resources. No bureaucracy has any inkling of opportunity costs or consumer wishes. The spenders are saying: government bureaucrats know better how to allocate resources than the private sector. Perhaps, but certainly not in this universe.  

Here's the bottom line with all of the above individuals.  While they've all proven themselves to be highly educated individuals with impressive credentials, they all share another, less-flattering common trait: they've all be universally wrong in their predictions and prognostications regarding the current recoveryAs NDD pointed out on Thursday, this makes their basic profession a philosophy, not a science.   In most other disciplines, this record of inaccuracy would mean their advice was no longer sought.  However, they still have an audience and, most importantly, still exert an influence over policy proscriptions.  The money question is now, "why are people seeking this advice when they have been this wrong?"