When Economists Get It Wrong

Source: Google

By Naveed Qazi | Editor, Globe Up Front

Economic theories applied wrongly can have devastating consequences. Bad policymakers affect people’s mindset and the businesses at large because they no longer trust their government anymore.

Macroeconomics is a deeply divided subject. US Federal Reserve Chairman, Alan Greenspan, had dismissed the idea regarding housing bubble spilling over elsewhere for many years (during 2002- 2005). It was not that other economists hadn’t predicted some pessimism about the housing industry, but they were just overshadowed by economists of greater importance in authority. This lead to disastrous consequences in the following years.

The IMF, concerned about fiscal deficits and high debt levels of Germany, US, and Japan, urged countries for austerity much before their matured economic recovery during 2010-2011. In 2012, IMF finally understood that they had underestimated that ‘big budget cuts could hurt growth’ and recommended a slower pace for austerity.

In earlier times, macroeconomists spoke less of unstable markets. They had no answers to sudden economic collapses.  We already have an example of the 2007-2008 GFC and the European debt crises that came later in our recent memory. The other notable crises actually go back to the Great Depression, the ASEAN crises and the Argentinian crises of 2002.

According to Paul Krugman, in a New York Times op-ed, “How Did Economists Get It So Wrong?” wrote: “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.

After these events, people questioned about the intellectual capacity of the elite US graduate school based ‘Fresh Water Economists’, and ‘Salt Water Economists’. Historically, it had been a fact that many in our world believed capitalism to be a perfect or a near perfect system. They believed any form of regulation to be a crime. Despite the blatant critique of Marxists, who followed their own economic school of thought ( e.g the theory of class struggle) and believed about capitalism being replaced by something better.

Economic theories have led policymakers to different paths and that’s where the problems arise. Neoclassical economists have put such a blind faith in the market system. Some economists like Joseph Schumpeter even believed in the bizarre notion of something irregular or abnormal happening in the market as normal. They were apologists for a recession and didn’t approve of fighting economic slumps, hinting that it may lead to something even worse. Keynesians, on the other hand, have believed in monetary policy interventions, the role of government spending when consumer spending and private spending of businesses slow down – in order to keep the economy growing. Monetarist thinking of Milton Friedman believes in a government role to be minimal, with certain things beyond their control especially the ups and downs of the economy, shown in the business cycle. The rifts between these schools are largely known and it thus has further complicated the faculty of right policymaking.

Coming back to time, the IMF, an entity monitoring worldwide capital flows, gave a misleading analysis about the ongoing Australian house prices issue especially during 2014. They called the problem of a housing price rise as a bubble. In fact, it had ignored  ‘a measure of housing affordability’ in one of their examining indexes. Although facing little risks in Sydney and Melbourne, the country is likely not in a housing price bubble, as proclaimed in the press, even at the present moment.

Australia’s house price to income ratio is largely been 30% above the world average. Infact, Australians, during 2014, made highest household savings level for 25 years. And during the same year, Australians were not piling up high household debts. So the analysis of IMF economists had been misleading to a greater extent.

Contrarily, according to HSBC Chief Economist, Paul Bloxham, a lack of land supply, foreign investment, strong domestic demand due to factors like local and international migration etc. had caused a rise in housing market prices and they don’t call it a bubble at all (which stems up due to other reasons). Even if the housing debt is rising in Australia right now, the world had been given a misleading analysis in the past years.

Very few economic policymakers have defended the side of workers who suffer from low wages and job losses in the age of globalisation. They expect them to move and work elsewhere (because of foreign competition) as cheap imports affect their industry. Thus, the good and bad rationale of free trade has not been talked about genuinely.

When Brexit happened, the London press noted that 72% of economists were wrong about their prediction of Britain going into a recession in 2016. The UK, infact, had a better than expected economic performance last year. Dr. Andrew Lilico, director of policy group Europe Economics, cited that a good consumer spending indicated an economic performance last year that had not been recognised. He had blamed the long term forecasting of the economists.


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