Has Economic theory failed Bernanke? (Jim Young/REUTERS)
Now that I know the answer to what Juan Williams meant by “Muslim garb,” I can focus on the other question that has been bugging me recently: Why haven’t low-interest rates boosted the economy?
Economists have long believed that lowering interest rates is one of the most forceful cures for a weak economy. Indeed, earlier this year I scolded another blogger for suggesting that low-interest rates were actually hurting the economic recovery, not helping. Yet, nearly two years after interest rates have been near zero, the economy seems stuck in a funk. Decades of economic research should tell us why low-interest rates aren’t doing what they are supposed to, and what should be done next. But that doesn’t seem to be the case. In a week, Bernanke & Co. head to their policy meeting and what the Federal Reserve should do next to boost the economy is a source of headed debate both inside and outside the Fed.
So why don’t economists know the answer? When I have big questions I don’t understand I and those who read this blog used to turn to two of the smartest people I have ever worked with Justin Fox and Barbara Kiviat. And thankfully this week we can. For the rest of this week, Justin and Barbara are guest blogging on Felix Salmon’s blog. This will be their second week of always thought-provoking posts. My favorites so far have been a number crunch from Justin that refutes the notion that spending caused the current budget deficit (the problem is taxes) and Barbara’s very good questioning of why people get so angry about minimum wage laws. But I’m surprised that Barbara has yet to respond to last week’s New York Times article about what’s the Economic X Factor. I’m hoping she soon will. Here’s why:
Like me, the article from the NY Times asks the question why can’t economists agree. The answer the article lands on is that basically the world is a complicated place and the study of economics is really not up to the task. Here’s the best part of the article:
Economics, Mr. Mankiw concludes, won’t tell us, definitively, whether Peter or Paula is paying too much, because an answer inevitably leads to matters of values, which inevitably leads to different answers.
This is not to suggest that economics is a total free-for-all, lacking a broad consensus on any subject. Polls of economists have found near unanimity on topics like tariffs and import quotas (bad), centralized economies (very bad) and flexible, floating exchange rates (very good). Nor is it fair to say that economists have done little to help in the latest crisis. A depression seemed possible two years ago, and thanks to the ideas of economists, that didn’t happen.
But economics will forever have to contend with the biggest X factor of all: people. As Mr. Solow notes, you feed people poison, and they die. But feed them a subsidy and there is no telling what will happen. Some will use it wisely, others perversely and some a mix of both.
Two months ago, Barbara Kiviat when she was still a Curious Capitalist took on basically the same question phrased in a slightly different way, Is Economics Ideological by Nature? Here’s what she concludes:
And when you think about it, it is a little odd that we think economics would be able to do these things. After all, the economy is as much a product of sociology and policy as it is pure-form economics. Yet we’d not expect a sociologist or a political scientist to be able to write a computer model to accurately capture system-wide decision-making. The conclusion I’ve come to: while economists may have an important perspective on whether it’s time for stimulus or austerity, maybe we should stop looking to them as if they are people who are in the ultimate position to know.
Both the New York Times piece and Barbara’s piece land heavily on the idea the economics does a very poor job of predicting the irrational behavior of individuals, and that’s why it fails. But Barbara doesn’t just raise the idea that economics is flawed but that economists themselves are flawed. She doesn’t quite embrace that that later notion, but I think it is a compelling conclusion to why economists so often disagree. Economists see the world through one lens, which is very often colored by their own biases. So the real behavior problem may not be with economics but with economists themselves.