Why Did It Take Economists so Long to Figure It all Out?

A Time line of Sorts:

If the Fed is wrong, the housing market and economy might collapse and bring America into a new recession. We should know which way the coin flipped by the end of the year.
– Me, 08/11/2004

“It may not happen in that order – and I can’t give a precise time line – but I believe an extremely difficult recession will begin late this year or early next. Please remember, I say this not as an expert, but layman. Then again, the experts predicted the housing market would surge indefinitely.”
– Me, 08/19/2007

“I don’t like the fact that the economy is headed for what I suspect will be the worst recession in our lifetimes. And I don’t like to unnecessarily alarm people.”
– Me, 11/21/2007

“The recent financial turmoil has many causes, but they are tied to a basic fear that some of the economic successes of the last generation may yet turn out to be a mirage.”
– David Leonhardt, New York Times, 01/23/08

“But a recession is now more likely than not. It may well have started already. The Philadelphia Fed reported Tuesday that the economy shrunk in 23 states last month, including Ohio, Missouri and Arizona, and was stagnant in seven others. California and Florida, with their plunging home values, may soon join the recession list.”
– David Leonhardt, New York Times, 01/23/08

Finally, after huge credit bubbles precipitated the ridiculous run up in home prices, Asia finally sent the wake up call that too many  American economists and business leaders failed to hear: something is seriously wrong with the U.S. economy.

Massive losses by U.S. financial institutions and sizable market sell offs in the United States were not enough to convince Federal Reserve Board Chairman Ben Bernanke to take serious action. Ironically, it was President Bush’s attempt to shore up the economy that helped trigger the huge drop in Asian markets that finally persuaded the Fed to cut interest rates by a whopping 75 basis points. Here’s an excerpt from the emergency announcement:

The Committee took this action in view of a weakening of the economic outlook and increasing downside risks to growth.  While strains in short-term funding markets have eased somewhat, broader financial market conditions have continued to deteriorate and credit has tightened further for some businesses and households.  Moreover, incoming information indicates a deepening of the housing contraction as well as some softening in labor markets.

Sadly, it took a confluence of events to force the Fed, into taking this action: Asian markets had fallen 5 percent to 10 percent over two days of brutal selling and up to 30 percent over the last couple months;  U.S. banks continued to report huge losses; while record number of foreclosures were reported in California; and 23 states reported shrinking economies.

The idea behind the rate cut is two-fold: restore temporary confidence in the markets while pumping money into the economy to slow the recession. Will the solution really solve America’s economic problems?

No, but it slowed the bleeding for a few minutes. Traders exhaled. Rates are low enough to excite banks. Even some homeowners may benefit from lower adjustable mortgage rates, though to what degree I am not sure.

On the other hand, cutting rates just shifts the problem. Pumping money into the economy this way generally inflates consumer costs and lowers the dollar’s value against foreign currencies.

Plus, the price still has to be paid for America’s endless spending binge. Writes Leonhardt:

The great moderation now seems to have depended – in part – on a huge speculative bubble, first in stocks and then real estate, that hid the economy’s rough edges. Everyone from first-time home buyers to Wall Street chief executives made bets they did not fully understand, and then spent money as if those bets couldn’t go bad. For the past 16 years, American consumers have increased their overall spending every single quarter, which is almost twice as long as any previous streak.

Now, some worry, comes the payback. Martin Feldstein, the éminence grise of Republican economists, says he is concerned that the economy “could slip into a recession and that the recession could be a long, deep, severe one.” In Monday’s Democratic presidential debate, Barack Obama made the same argument: “We could be sliding into an extraordinary recession,” he said.

I’m glad the experts are finally figuring this all out. Many bloggers “got it” a long time ago and it came to a very simple question: How can someone buy a $600,000 house on $50,000 annual income?

Maybe America’s economists and businessmen should start reading more blogs for a daily dose of the obvious.

Comments

[chip]

how about ideological blindness?

[brettdl]

Well, there's definitely that.