Future Scenarios for Economics

"What the public wants is a theory of control."

I hope they don't get what they want.

Having seen how unwisely, short-termistly, and corruptly economic controls have been and are being used, my 'want' is precisely the opposite: that market mechanisms related to creative destruction will prove too strong for politicians to control.

http://www.econtalk.org/archives/2008/08/john_taylor_on.html
On econ talk John Taylor argued that monetary policy was too loose from 2000 to 2004 and that was a major cause of the current problems.

A few months ago, the Wall Street Journal profiled three economists who studied bubbles. Unfortunately, I can't remember their names.

Two of them specifically said that markets that can't be shorted or for which shorting is very expensive are more bubble prone. Also, illiquid markets are more bubble prone.

I can't help but worry that current government machinations are going to cause another bubble.

So why isn't Roger Garrison's reputation going up?

Or Hayek's?

And why are modern economists so incapable of understanding Hayek's work?

Is every part of their brain dead, except the "math jock" pseudo-science math-game playing part?

Arnold, I think it's worse than you think.

In the current crisis, there are economists have proven incapable of distinguishing between these two questions:

"I think that there are two questions. First, what are the generic causes and consequences of bubbles? Second, why did the specific bubble in real estate and mortgage finance occur? The first question is harder."

I think there is a consensus now: "The self-regulating market has failed; it needs to be kept in check by a wise manager. No, not that one!"

Arnold,

What would you think is the significance for Libertarianism of the statement;

"To me. the logical thing for the economics profession to do is admit that we are nowhere near understanding what is happening."

Or perhaps Bryan would comment?

I read Blanchard's summary in light of the current financial distress and wanted to cry. Macro economists still don't have a clue as to how the economy works. Isn't it strange that capitalism since the industrial revolution has made the West incredibly rich and no one knows how it works? But instead of searching everywhere to find the answer, they can only do as the drunk in the joke--search under the street lamp.

It seems obvious to me that what is missing in macro is a general theory to tie all of the minor theories together and that theory is Austrian econ.

Arnold,

Can you please make a post on what areas of economics there is broad based consensus on?
As a lay reader, it will help me place credibility on the different pronouncements by your compatriots.

A list of what is set in stone would be great.

I would like to see the Fed concentrate on keeping currency stable, and leave the "bubble bursting," if needed, to some other organization.

In a world of increasing technology and globalization, we should be wary of ANY FIXED ASSET THAT INCREASES IN VALUE. Because fixed assets should be getting cheaper, not more expensive. (Hat tip to Julian Simone...)

Isn't the economists argument that all is efficient markets and bubbles therefore cannot exist? Bubbles require deviations in prices and values whose very existence is denied.

There's going to be a shift. There's a growing void in economics, and now its a struggle between the more leftish theories and the far right ABCT people.

Didn't Niccolo Machiavelli write a reasonably excellent theory of control a long, long time ago? ;)

It's not that we don't have a theory of control. It's that what everyone is really saying is "I want a theory of controlling everybody except me, preferably one which I can abuse and exploit for my own benefit".

More tangentially, the Freakonomics fad has taken a big hit. The notion that we should listen to economists lecture us on stuff way outside there fields only made sense when they seemed to be doing such a bang-up job on their own field.

I think that there are two questions. First, what are the generic causes and consequences of bubbles? Second, why did the specific bubble in real estate and mortgage finance occur? The first question is harder.

At first I was embarrassed that I could answer the first question but not the second. But then I realized that you are committing an elementary fallacy, I think. You're saying it's easier to explain what could cause a bubble, period, rather than explaining what could cause a bubble in real estate?

"I think that there are two questions. First, what are the generic causes and consequences of bubbles? Second, why did the specific bubble in real estate and mortgage finance occur? The first question is harder. But I would say that 99 percent of the economics profession cannot even correctly answer the second."

I have answered both questions. I may only have a MA in economics from Johns Hopkins, but I have written on both questions at my blog, and at RealMoney.com. My quick summary is that bubbles occur because people as a group mis-estimate on the high side the cash flows from an asset class relative to the financing rate that they borrow at. Bubbles are products of debt financing. When the asset cash flows can no longer pay the interest payments, the bubble is on borrowed time.

As for the second question, I have an extensive article at RealMoney on the question, but it boils down to loose monetary policy and crummy underwriting stemming from an originate to securitize model.

I agree, macroeconomics has crashed, and most of the advice being offered today is hooey. Optimistically, maybe this could lead to the dislodging of the intellectually bankrupt neoclassical paradigm? I hope so, and let there be real debate between schools of thought that are more than the sterile mathematics of the economics journals that have nothing to do with the real world.

Arnold,

I believe that the real-estate “bubble” was caused by the rise to sacred status, in government and in the public, of home ownership. Government put in place mechanisms to encourage home buying and the assumption of debt: tax deductibility of mortgage interest; negligible capital gains tax for the sale of a home; pressure to relax lending standards for first-time buyers; and sponsorship of Fannie Mae and Freddie Mac to create a secondary market for mortgages to reassure otherwise cautious lenders. The sacred status of homeownership in the general public only fed the rise in prices; if we don’t buy now, we may never be able to afford a home, but since real-estate prices always go up, we’ll be fine. The rest is pretty obvious: we reached a plateau where the number of buyers who could not make payments and suffered foreclosure joined forces with the buyers who had already concluded that the market was too rich, and those forces of higher supply and lower demand joined to drive price back down. The imperative now, at least in congress, is to repeal the law of supply and demand, but it sounds as if the president-elect is reluctant to promise that.

As for tulips, you had to have been there.