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interestrateripoff

How Did Economists Get It So Wrong?

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http://www.nytimes.com/2009/09/06/magazine...ml?ref=business

I. MISTAKING BEAUTY FOR TRUTH

It’s hard to believe now, but not long ago economists were congratulating themselves over the success of their field. Those successes — or so they believed — were both theoretical and practical, leading to a golden era for the profession. On the theoretical side, they thought that they had resolved their internal disputes. Thus, in a 2008 paper titled “The State of Macro†(that is, macroeconomics, the study of big-picture issues like recessions), Olivier Blanchard of M.I.T., now the chief economist at the International Monetary Fund, declared that “the state of macro is good.†The battles of yesteryear, he said, were over, and there had been a “broad convergence of vision.†And in the real world, economists believed they had things under control: the “central problem of depression-prevention has been solved,†declared Robert Lucas of the University of Chicago in his 2003 presidential address to the American Economic Association. In 2004, Ben Bernanke, a former Princeton professor who is now the chairman of the Federal Reserve Board, celebrated the Great Moderation in economic performance over the previous two decades, which he attributed in part to improved economic policy making.

Last year, everything came apart.

Few economists saw our current crisis coming, but this predictive failure was the least of the field’s problems. More important was the profession’s blindness to the very possibility of catastrophic failures in a market economy. During the golden years, financial economists came to believe that markets were inherently stable — indeed, that stocks and other assets were always priced just right. There was nothing in the prevailing models suggesting the possibility of the kind of collapse that happened last year. Meanwhile, macroeconomists were divided in their views. But the main division was between those who insisted that free-market economies never go astray and those who believed that economies may stray now and then but that any major deviations from the path of prosperity could and would be corrected by the all-powerful Fed. Neither side was prepared to cope with an economy that went off the rails despite the Fed’s best efforts.

And in the wake of the crisis, the fault lines in the economics profession have yawned wider than ever. Lucas says the Obama administration’s stimulus plans are “schlock economics,†and his Chicago colleague John Cochrane says they’re based on discredited “fairy tales.†In response, Brad DeLong of the University of California, Berkeley, writes of the “intellectual collapse†of the Chicago School, and I myself have written that comments from Chicago economists are the product of a Dark Age of macroeconomics in which hard-won knowledge has been forgotten.

What happened to the economics profession? And where does it go from here?

As I see it, the economics profession went astray because economists, as a group, mistook beauty, clad in impressive-looking mathematics, for truth. Until the Great Depression, most economists clung to a vision of capitalism as a perfect or nearly perfect system. That vision wasn’t sustainable in the face of mass unemployment, but as memories of the Depression faded, economists fell back in love with the old, idealized vision of an economy in which rational individuals interact in perfect markets, this time gussied up with fancy equations. The renewed romance with the idealized market was, to be sure, partly a response to shifting political winds, partly a response to financial incentives. But while sabbaticals at the Hoover Institution and job opportunities on Wall Street are nothing to sneeze at, the central cause of the profession’s failure was the desire for an all-encompassing, intellectually elegant approach that also gave economists a chance to show off their mathematical prowess.

Unfortunately, this romanticized and sanitized vision of the economy led most economists to ignore all the things that can go wrong. They turned a blind eye to the limitations of human rationality that often lead to bubbles and busts; to the problems of institutions that run amok; to the imperfections of markets — especially financial markets — that can cause the economy’s operating system to undergo sudden, unpredictable crashes; and to the dangers created when regulators don’t believe in regulation.

It’s much harder to say where the economics profession goes from here. But what’s almost certain is that economists will have to learn to live with messiness. That is, they will have to acknowledge the importance of irrational and often unpredictable behavior, face up to the often idiosyncratic imperfections of markets and accept that an elegant economic “theory of everything†is a long way off. In practical terms, this will translate into more cautious policy advice — and a reduced willingness to dismantle economic safeguards in the faith that markets will solve all problems.

II. FROM SMITH TO KEYNES AND BACK

The birth of economics as a discipline is usually credited to Adam Smith, who published “The Wealth of Nations†in 1776. Over the next 160 years an extensive body of economic theory was developed, whose central message was: Trust the market. Yes, economists admitted that there were cases in which markets might fail, of which the most important was the case of “externalities†— costs that people impose on others without paying the price, like traffic congestion or pollution. But the basic presumption of “neoclassical†economics (named after the late-19th-century theorists who elaborated on the concepts of their “classical†predecessors) was that we should have faith in the market system.

This faith was, however, shattered by the Great Depression. Actually, even in the face of total collapse some economists insisted that whatever happens in a market economy must be right: “Depressions are not simply evils,†declared Joseph Schumpeter in 1934 — 1934! They are, he added, “forms of something which has to be done.†But many, and eventually most, economists turned to the insights of John Maynard Keynes for both an explanation of what had happened and a solution to future depressions.

Keynes did not, despite what you may have heard, want the government to run the economy. He described his analysis in his 1936 masterwork, “The General Theory of Employment, Interest and Money,†as “moderately conservative in its implications.†He wanted to fix capitalism, not replace it. But he did challenge the notion that free-market economies can function without a minder, expressing particular contempt for financial markets, which he viewed as being dominated by short-term speculation with little regard for fundamentals. And he called for active government intervention — printing more money and, if necessary, spending heavily on public works — to fight unemployment during slumps.

Another 7 pages at the link.

Not read the entire article yet but the problem was groupthink. People had become convinced by their own formula's and academia rewards those who follow the crowd and are prepared to champion the groupthink paradigm. This reinforcement continues to rewards those who follow the groupthink theories.

If you think outside the group you are ridiculed.

Roubini warned the group and was essentially laughed at because he didn't bring the mathematical equations. These equations may work on paper and may for a time reflect reality but this doesn't mean that they fully predict, however once groupthink has taken hold the belief is that these equations have become reality, in essence economists have faith just like a religion. Anyone who questions this belief is clearly a non-believer and cannot be trusted and must be excluded.

Economics wasn't a science it was a religion where those that believed got rewarded with becoming Professors and Doctors in the subject and got to teach others. Want to pass you had to believe, thus groupthink becomes embedded in the system and no one can challenge this even when the evidence clearly suggests the groupthink ideology is wrong.

Edited by interestrateripoff

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who are the biggest idiots

the economists who speak this drivel

or the masses who think they know what they are talking about

The Austrian Economists (common sense economics) predicted it

The Austrian theory of economics has one significant problem - it does not allow governments to create bubbles for political purposes without it being absurdly clear who is responsible. It will never catch on because they would not be able to spend your money without you knowing it.

Edited by IMHAL

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I can only assume the professional economists had the wrong type of armchair, whereas the amateurs were comfy in the more traditional type of armchair.

Armless would be better.

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One of my favourite subjects, "group-think", the basis of not only economics, but human culture and civilisation. For an interesting read on the subject I recommend, "Going to Extremes" by Cass R. Sunstein.

People it would seem base their decisions, not on information, but what other's think. It explains financial mania and the so-called "free market" perfectly. Information cascades are the basis of HPI.

Economist's will always think what other economist's think, if they don't, they won't be rewarded.

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One of my favourite subjects, "group-think", the basis of not only economics, but human culture and civilisation. For an interesting read on the subject I recommend, "Going to Extremes" by Cass R. Sunstein.

People it would seem base their decisions, not on information, but what other's think. It explains financial mania and the so-called "free market" perfectly. Information cascades are the basis of HPI.

Economist's will always think what other economist's think, if they don't, they won't be rewarded.

Very prevalent in medical and surgical practice too, I'm ashamed to say.

Nick

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Thanks Nick, the book I mentioned does touch on the effects of "group-think" within the medical sphere. I think if I have a heart attack I will want a big group of medical professionals in the room at the time.......

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If the little boy who shouted "The King is in the altogether" had been on a 100K a year, a big pension, bonuses and/or hand tenure at a top university then I suggest that he would have paused before opening his mouth, looked around at all the rich bigwigs at the court in their fine attire and emblems of office, shrugged his shoulders and then cried:

"Look at the King! Look at the King! The King is in the finest clothese that anyone has ever seen!"

If you can't beat them... :(

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What amazes me is the fact that all these idiots are still in place- with zero credibility and yet, it seems the tribe would rather have a failed witchdoctor than no witchdoctor at all- to stand naked to the winds of chance is just too horrible to accept.

So the economists continue to get paid and now fulfill the same role a child's teddy bear fullfills, a source of comfort in an uncertain universe.

perhaps that is all that was ever really aksed of them.

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Guest happy?
who are the biggest idiots

the economists who speak this drivel

or the masses who think they know what they are talking about

The Austrian Economists (common sense economics) predicted it

Not an Austrian:

Three distinct income-debt relations for economic units, which are labeled as hedge, speculative, and Ponzi finance, can be identified.
Hedge financing units are those which can fulfill all of their contractual payment obligations by their cash flows: the greater the weight of equity financing in the liability structure, the greater the likelihood that the unit is a hedge financing unit. Speculative finance units are units that can meet their payment commitments on 'income account' on their liabilities, even as they cannot repay the principal out of income cash flows. Such units need to 'roll over' their liabilities: (e.g. issue new debt to meet commitments on maturing debt). Governments with floating debts, corporations with floating debts of commercial paper, and banks are typically hedge units
For Ponzi units, the cash flows from operations are not sufficient to fill either the repayment of principal or the interest on outstanding debts by their cash flows from operations. Such units can sell assets or borrow. Borrowing to pay interest or selling assets to pay interest (and even dividends) on common stocks lowers the equity of a unit, even as it increases liabilities and the prior commitment of future incomes. A unit that Ponzi finances lowers the margin of safety that it offers the holders of its debts.
It can be shown that if hedge financing dominates, then the economy may well be an equilibrium-seeking and containing system. In contrast, the greater the weight of speculative and Ponzi finance, the greater the likelihood that the economy is a deviation-amplifying system. The first theorem of the financial instability hypothesis is that the economy has financing regimes under which it is stable, and financing regimes in which it is unstable. The second theorem of the financial instability hypothesis is that over periods of prolonged prosperity, the economy transits from financial relations that make for a stable system to financial relations that make for an unstable system.
In particular, over a protracted period of good times, capitalist economies tend to move to a financial structure in which there is a large weight to units engaged in speculative and Ponzi finance. Furthermore, if an economy is in an inflationary state, and the authorities attempt to exorcise inflation by monetary constraint, then speculative units will become Ponzi units and the net worth of previously Ponzi units will quickly evaporate. Consequently, units with cash flow shortfalls will be forced to try to make positions by selling out positions. This is likely to lead to a collapse of asset values.
Edited by happy?

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Guest happy?
Mainstream economists are dangerous.

The should be locked up, or made to wear red noses and silly hats, so they can be seen as the clowns

that they are.

The models they use are badly flawed, and have done big damage, and they are slow to admit how little

they know. The once-arrogant Efficient Marketeers are the worst. I had may debates with them, and they

would mention their models and theorists, and think they won the debate. Clearly, they have lost, and

instead of paying the price. by losing their jobs and many of their assets, we have all had to pay for them.

The Keynesians are not much better, and soon we will be made to pay for their mistakes too.

Only the Austrians have the correct understanding of what is happening.

Nah, the biggest cult of the lot.

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Mainstream economists are dangerous.

The should be locked up, or made to wear red noses and silly hats, so they can be seen as the clowns

that they are.

The models they use are badly flawed, and have done big damage, and they are slow to admit how little

they know. The once-arrogant Efficient Marketeers are the worst. I had may debates with them, and they

would mention their models and theorists, and think they won the debate. Clearly, they have lost, and

instead of paying the price. by losing their jobs and many of their assets, we have all had to pay for them.

The Keynesians are not much better, and soon we will be made to pay for their mistakes too.

Only the Austrians have the correct understanding of what is happening.

In my experience not towing the political line gets you the sack pretty sharpish. Hence no remaining dissenting voices.

The only alternative is to shut up and stick to your equations.

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In my experience not towing the political line gets you the sack pretty sharpish. Hence no remaining dissenting voices.

The only alternative is to shut up and stick to your equations.

Which is the problem. Mediocrity has won. If your mediocre your never going to promote anyone who is better than you for the fear of exposing your own mediocrity, so the clear choice is to promote other mediocre people and ensure that they are even below your own mediocrity thus ensuring you don't get exposed.

Academia has become a bedrock for mediocrity.

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Not an Austrian:
Three distinct income-debt relations for economic units, which are labeled as hedge, speculative, and Ponzi finance, can be identified.
Hedge financing units are those which can fulfill all of their contractual payment obligations by their cash flows: the greater the weight of equity financing in the liability structure, the greater the likelihood that the unit is a hedge financing unit. Speculative finance units are units that can meet their payment commitments on 'income account' on their liabilities, even as they cannot repay the principal out of income cash flows. Such units need to 'roll over' their liabilities: (e.g. issue new debt to meet commitments on maturing debt). Governments with floating debts, corporations with floating debts of commercial paper, and banks are typically hedge units
For Ponzi units, the cash flows from operations are not sufficient to fill either the repayment of principal or the interest on outstanding debts by their cash flows from operations. Such units can sell assets or borrow. Borrowing to pay interest or selling assets to pay interest (and even dividends) on common stocks lowers the equity of a unit, even as it increases liabilities and the prior commitment of future incomes. A unit that Ponzi finances lowers the margin of safety that it offers the holders of its debts.
It can be shown that if hedge financing dominates, then the economy may well be an equilibrium-seeking and containing system. In contrast, the greater the weight of speculative and Ponzi finance, the greater the likelihood that the economy is a deviation-amplifying system. The first theorem of the financial instability hypothesis is that the economy has financing regimes under which it is stable, and financing regimes in which it is unstable. The second theorem of the financial instability hypothesis is that over periods of prolonged prosperity, the economy transits from financial relations that make for a stable system to financial relations that make for an unstable system.
In particular, over a protracted period of good times, capitalist economies tend to move to a financial structure in which there is a large weight to units engaged in speculative and Ponzi finance. Furthermore, if an economy is in an inflationary state, and the authorities attempt to exorcise inflation by monetary constraint, then speculative units will become Ponzi units and the net worth of previously Ponzi units will quickly evaporate. Consequently, units with cash flow shortfalls will be forced to try to make positions by selling out positions. This is likely to lead to a collapse of asset values.

this is Austrian but with different words.

so you have two kinds of entities: ones where customers pay for the upkeep and are rewarded with services after paying a price. the entity provides the services within the price.

the other kind, ponzi: ones where customers pay for the upkeep and are rewarded with services after payin a price, the entity provides the services outside the price. to survive, only new finance or new customers can keep existing ones served.

so, the recession comes and the obvious Ponzis fail quickly because new customers cant be found. if the recession gets much worse, then customers are lost to the others and in order to maintain the status quo, the service capacity is cut. failure to do so turns them into a ponzi too.

Sounds totally Austrian to me.

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Guest UK Debt Slave
The Austrian theory of economics has one significant problem - it does not allow governments to create bubbles for political purposes without it being absurdly clear who is responsible. It will never catch on because they would not be able to spend your money without you knowing it.

100% correct and guaranteed

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Guest UK Debt Slave
Mainstream economists are dangerous.

The should be locked up, or made to wear red noses and silly hats, so they can be seen as the clowns

that they are.

The models they use are badly flawed, and have done big damage, and they are slow to admit how little

they know. The once-arrogant Efficient Marketeers are the worst. I had may debates with them, and they

would mention their models and theorists, and think they won the debate. Clearly, they have lost, and

instead of paying the price. by losing their jobs and many of their assets, we have all had to pay for them.

The Keynesians are not much better, and soon we will be made to pay for their mistakes too.

Only the Austrians have the correct understanding of what is happening.

The Austrians advocate gold backed currency

There will NEVER be a gold backed currency system in the UK or America.

There's no gold. It was looted years ago

My advice to gold bugs is GET OVER IT.

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Isn't it alll working perfectly? Job cuts, public service cuts, privitisation of remaining public entitities, asset sell off?

Not sure who will ever really benefit from this now, as there will be few places left on the planet to enjoy your wealth.

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The Austrians advocate gold backed currency

There will NEVER be a gold backed currency system in the UK or America.

There's no gold. It was looted years ago

My advice to gold bugs is GET OVER IT.

when state collapse happens because people eventually wake up to governments printing more money to pay their debts

you aint gonna be using paper to barter with

not that im a gold bug but there are times when gold is undervalued and times when overlvalued - at the moment its under valued compared to lots of things - but not Silver

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When I studied Economics (quite a few years ago). I thought it was mostly rubbish.

After the 2 (mad)Nobel Economic Scientists (Scholes and Merton) blew up the LTCM laboratory in 1998, I KNEW it was rubbish. :)

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I reckon much of the reason for the overall complacency and smugness was that, whilst the 'going was good', most of them just made hay. And they either knew it couldn't keep going, or they "persuaded" themselves [and others] that it could. That simple.

A 14 year old doing his first years of GCSE Maths could have predicted it.

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And in the real world, economists believed they had things under control:

Why did they get it so wrong? Due to a deeply seated moral flaw in human nature, that of the lust for power.... closely associated with the lust for knowledge.

An earlier age called these "libido dominandi" and "libido scientia". When you think about it, the singular achievement of modernity is to combine these two in the human sciences and thereby influence the way people think and the institutions they create.

Virtues such a sense of humour and an enlightened skepticism do much to puncture the pretensions of science.

Edited by roman holiday

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