Forecasts vs. Policies

Arnold Kling, at EconLog, relates Scott Sumner’s simple query as to why the 2008 financial crisis has caused such low or negative growth down even unto the present day, and offers four possible answers. I will comment only on one of them:

Because the Fed made forecasting errors. Right-wingers are fond of brandishing charts showing that the unemployment rate with the stimulus is on a worse trajectory than what was forecast without the stimulus. That may or may not be evidence that the stimulus failed, but it is evidence that standard forecasts were not sufficiently pessimistic about the economy. Assuming the Fed used standard forecasts, that would explain the inadequate monetary expansion back then. It doesn’t explain their reluctance to expand now, though.

There are several places where this answer (which Kling does not favor) goes wrong. Most noticeable, to me, regards the possibility that the forecasts “were not sufficiently pessimistic about the economy.” This is not the only possibility. It is not even the most likely possibility.

The problem was that the forecasts were too negative, and the policy response too extreme and witless. Had financial collapse been allowed, and some major banks and other financial institutions — and a whole class of conceited Wall Street players — gone the way of the Brontosaur and the Dodo, the downturn would have been dramatic (housing prices would have collapsed, and a lot of real estate and credit default fortunes would have evaporated), yes, but the rest of us would have recovered pretty quickly. The nature of the boom-period pricing problems would have become apparent, since those who failed would have signaled their failure. Recovery would have started before the lawyers would have finalized the first few bankruptcies.

But that’s not what happened. Instead, we were forced to witness a self-fulfilling prophecy: The too-negative forecasts spurred on hysterical over-reaction, the bailouts. Which, in turn, covered up the semiotic function of markets, and generally disabled markets from clearing.

A more positive forecast — one untainted, say, by having friends in anguish at Goldman Sachs and Bear Stearns et al. — would have yielded saner policy, and better consequences.

This is a problem with the welfare state as it applies to government-businesss relations. You work regulatory expectations up to an unrealistic frenzy, where people think government is somehow “managing” things. This requires experts from the industries to get involved, with their own agendas. And they corrupt any reasonable attitude towards big business. They cannot help but pay favorites, because they — who live and breathe the industry the hail from — have favorites.

And folks in power becomes craven with fear, and foolish regarding policy. We lurch from an impossible-to-scale micromanaging regulatory scheme where businesses often are forced to endure expensive and crazy “oversight” by bureaucrats . . . to “welfare for the rich.” It’s absurd. Current policy could hardly be more idiotic.

Until we can let big businesses (including big financial institutions) fail, America will stagger among several competing policies, with no coherent sense. Consequently, the general signal to market participants will remain incoherent.

And, amidst such regime uncertainty, nothing like a thriving business environment, or “full employment,” will be achieved.

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  • There are more problems than that with this theory, such as the idea that there is any such thing as ‘inadequate monetary expansion’. This sort of wankiness is why EconTalk and FEE will always be dwarfed by Mises.
    The government’s policies are not idiotic, not in the slightest. They may be suboptimal (almost all actions, post facto, are) but they are rational, predictable and productive for the people initiating them – the politicians. You know as well as I do that if they even do give a flying fuck about ‘the public good’ or whatever fantasy rubric they’ve constructive for interpersonal utility comparisons that they have completely rationalized it to be compatible with the maximization of their own power.
    Policy wonking is stupid. The people who believe it are religious nuts immune to reason and we don’t control the bureaucrats, anyway. This sort of academic wheel-spinning is a product of government subsidized universities. Libertarian economists are just as useless as the rest of the Priests.

  • The efficacy of government policies for the political and functionary classes, as well as connected businesses, is obvious, I grant you. But I’m pretty sure they are only half-understood as productive in the way you specify. And, long-term — which may soon be short-term — they will be defeating to those classes, as the system comes tumbling down.

    And at that point those useless wonks and their wanky half-measures may prove some good, as their purse-strings are cut, and their ties to the status quo plummet with that status itself. They may, in fact, be the most likely candidates for good, if any candidates there be.

    So it makes sense, in my opinion, continually to engage with them. It does no good to dismiss them utterly. For all influence with them evaporates at that point.

    Still, most of your points were spot on.