Why Weren’t Alarm Bells Ringing?

1.

Almost nobody predicted the immense economic crisis that overtook the United States and Europe in 2008. If someone claims that he did, ask how many other crises he predicted that didn’t end up happening. Stopped clocks are right twice a day, and chronic doomsayers sometimes find themselves living through doomsday.

Martin Wolf
Martin Wolf; drawing by James Ferguson

But while prediction is hard, especially about the future, this doesn’t let our economic policy elite off the hook. On the eve of crisis in 2007 the officials, analysts, and pundits who shape economic policy were deeply, wrongly complacent. They didn’t see 2008 coming; but what is more important is the fact that they even didn’t believe in the possibility of such a catastrophe. As Martin Wolf says in The Shifts and the Shocks, academics and policymakers displayed “ignorance and arrogance” in the runup to crisis, and “the crisis became so severe largely because so many people thought it impossible.”

Did supposed experts really think that nothing like what did happen could happen? Yes. In his 2003 presidential speech to the American Economic Association, Robert Lucas of the University of Chicago, the most influential macroeconomist of the late twentieth century, asserted that “the central problem of depression prevention has been solved, for all practical purposes, and has in fact been solved for many decades.” What he meant was that modern policymakers wouldn’t repeat the mistakes that, according to the prevailing wisdom, made the Great Depression possible.

In particular, Milton Friedman had convinced many economists that depression prevention is actually a fairly simple task, which can be carried out by technocrats at the central banks that control national money supplies. According to Friedman, the Great Depression occurred only because the Federal Reserve failed to do its job in the 1930s; if it had acted to rescue troubled banks and prevent a fall in the money supply, catastrophe would have been avoided.

At a celebration of Friedman’s ninetieth birthday, Ben Bernanke, an eminent monetary economist and Depression scholar who would become Fed chairman a few years later, accepted this verdict: “You’re right, we did it. We’re very sorry. But thanks to you, we won’t do it again.”

Then crisis struck, and major central banks—the Fed under Bernanke’s leadership, the European Central Bank, the Bank of England—did everything Friedman said they should have done in the 1930s. Troubled banks were rescued; money supplies were sustained. And we got a depression all the same.

True, in the United States we can comfort ourselves slightly with the observation that, bad as our experience has been, it hasn’t been as bad as the 1930s; but in Europe, where a weak recovery stalled in 2011, and growth between 2007 and 2014 was slower than between 1929 and 1936, they can’t even say that.

How could such a thing happen? If you try to follow the economic debate by listening to the talking heads on TV, or even from press…


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