What I Saw and Did Not See About the Macroeconomic Situation Eight Years Ago: Hoisted from the Archives
Hoisted from the Archives from June 2008The Macroeconomic Situation, with added commentary:(June 2008):
Looking back, what did I get right or wrong back eight years ago when I was talking about the economy? I said:
- That the best way to think about things was that we were in a 19th-century financial crisis, and so we should look way back to understand things (RIGHT)
- That a recession had started (RIGHT), which would probably be only a short and shallow recession (WRONG!!!!)
- That the Federal Reserve understood (MAYBE) that it has screwed the pooch by failing to prudentially regulate shadow banks, especially in the housing sector (RIGHT), but that it would shortly fix things (MAYBE).
- That the Federal Reserve was still trying to raise interest rates (RIGHT).
- That the Federal Reserve should not be trying to raise interest rates (RIGHT), because the tight coupling between headline inflation today and core inflation tomorrow that it feared and expected had not been seen for 25 years (RIGHT).
- That central bank charters are always drawn up to make financial markets confident that they are tightly bound not to give in to pressure and validate inflation (RIGHT).
- That, nevertheless, when the rubber hit the road and financial crisis came there was ample historical precedent that central banks were not strictly bound by the terms of their charters--that they were guidelines and not rules (RIGHT).
- That the Federal Reserve understood these historical precedents (WRONG) and would, with little hesitation, take actions ultra vires to avoid a major financial and economic collapse (WRONG).
- That there was a long-standing tradition opposed to central banks' taking action to stem financial crisis and depression--a Marx-Hayek-Mellon-Hoover axis, if yo will (RIGHT).
- That this axis thought that business cycle downturns were always generated by real-side imbalances that had to be faced via pain and liquidation--could not be papered over by financial prestidigitation (RIGHT).
- But that this axis was wrong: business cycle downturns, even those to a large degree generated by real-side imbalances, could be papered over by financial prestidigitation (RIGHT).
- That even though the Fed and the Treasury believed that interest rates should still go up a little bit, they were also engaged in unleashing a huge tsunami of financial liquidity upon the economy (RIGHT).
- That this liquidity tsunami was appropriate as an attempt to maintain full employment response to the collapse in construction and to the great increase in financial risk (RIGHT).
- That this liquidity tsunami would do the job, and the recession would be short and shallow (WRONG!!!!!!!!)
- That the runup in oil prices was not a speculative bubble that would be rapidly unwound (RIGHT).
- That the runup in oil prices was a headwind for real growth (RIGHT).
- That the dollar was headed for substantial depreciation (WRONG).
- That the housing price and housing construction shocks to the economy were still ongoing (RIGHT).
- That for those with a long time horizon equities were fairly valued, offering higher returns than other asset classes, if risky returns (RIGHT).
- That asset prices would fluctuate (RIGHT).
But I did not, even in June 2008, understand (a) how bad the derivatives books of the major money-center banks were, and (b) how weak the commitment of central banks to doing whatever was necessary to stabilize the growth path of nominal GDP was.