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Economists Continue to Favor Failed Doctrine Against Real Facts

Economics / Credit Crisis 2008 Jul 10, 2008 - 02:58 PM GMT

By: Tim_Iacono

Economics

Best Financial Markets Analysis ArticleWhat if what they taught you is wrong? - In this Financial Times commentary , Wolfgang Münchau comes ever so close to asking what must be one of the most difficult of all questions for any practicing economist to ask, "What if what they taught you is wrong?"

[Note: This is similar to what some U.S.-based financial advisers might be asking themselves today, eight years into a secular bear market in stocks where "stocks for the long run" may not make a whole lot of sense for someone whose "long run" is only 15 years or so and happened to begin around 2000.]


In a story appearing elsewhere at the Financial Times under the much more direct title of " The villains are not the bankers, but the economists ", Mr. Munchau questions the very foundation of accepted economic theory and modern central banking.

Munchau As the Bank of International Settlements said in its latest annual report, subprime might have been the trigger for this crisis, but not the cause. We do not have a full understanding yet of what happened but the BIS suggested that fast expansion of money and credit must have played a role. I would go further and say this is not primarily a crisis of financial speculation, but one of economic policy. Its principal villains are therefore not bankers, but economists – not in their role as teachers and researchers, but as policy advisers and policymakers.
...
Several of them have been leading proponents of an economic theory known as New Keynesianism. It is, in fact, probably the most influential macroeconomic theory of our time . At the heart of the New Keynesian doctrine stands the so-called dynamic stochastic general equilibrium model, nowadays the main analytical tool of central banks all over the world. In this model, money and credit play no direct role. Nor does a financial market. The model's technical features ensure that financial markets have no economic consequences in the long run.

This model has significant policy implications. One of them is that central banks can safely ignore monetary aggregates and credit. They should also ignore asset prices and deal only with the economic consequences of an asset price bust. They should also ignore headline inflation.

Wow! Distilled to its essential elements, this New Keynesian doctrine sounds like a real recipe for disaster!

Negative real interest rates, government bailouts, and moral hazard are all apparently part of what passes as "accepted wisdom" amongst modern-day economists.

Does any economist who proudly displays the letters PhD after his/her name have a reasonable explanation why we are now battling problems caused by too much easy money with even more easy money?

Are there still economists out there who believe that easy money was not a principle cause of the current mess?

Mr. Munchau's proposed solutions - let asset prices fall, focus on price stability including asset prices, and let banks fail - sound a lot more like Austrian Economics than the Keynesian variety as if he had channeled Andrew Mellon, Herbert Hoover's Treasury Secretary, describing his solution to the 1929 downturn:

Liquidate labor, liquidate stocks, liquidate the farmers, liquidate real estate... It will purge the rottenness out of the system. High costs of living and high living will come down. People will work harder, live a more moral life. Values will be adjusted, and enterprising people will pick up the wrecks from less competent people.

Should this approach be adopted, the important question will become, "Are there enough enterprising people left?"

By Tim Iacono
Email : mailto:tim@iaconoresearch.com
http://www.iaconoresearch.com
http://themessthatgreenspanmade.blogspot.com/

Tim Iacano is an engineer by profession, with a keen understanding of human nature, his study of economics and financial markets began in earnest in the late 1990s - this is where it has led. he is self taught and self sufficient - analyst, writer, webmaster, marketer, bill-collector, and bill-payer. This is intended to be a long-term operation where the only items that will ever be offered for sale to the public are subscriptions to his service and books that he plans to write in the years ahead.

Copyright © 2008 Iacono Research, LLC - All Rights Reserved

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