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Analysis | Economists finally have a good excuse to be wrong


Contrary to most economists’ predictions, it is possible that the US will survive this period of disinflation and make the proverbial “soft landing”. This should prompt a more general reconsideration of macroeconomic forecasts.

The lesson is that they have a disturbing tendency to go wrong. It is striking that two years ago Larry Summers was right when he warned of impending inflationary pressures in the US economy, when most of his colleagues were wrong. Still, Summers may be wrong about his current warning about the looming threat of a recession. The point is that both his inflation and recession forecasts stem from the same underlying aggregate demand model.

It is understandable if a model is wrong because of a major and unexpected shock, such as the war in Ukraine. But that’s not the case here. The US could avoid a recession for mysterious reasons inherent in the aggregate demand model. Indeed, the Federal Reserve’s monetary policy has been tighter, and disinflation usually comes at a high economic cost.

It gets even more curious. Maybe Summers will be right about a recession. When a recession arrives, it is often quite sudden. Consulting every possible macroeconomic theory may not help.

Or think of the nineties. President Bill Clinton believed that federal deficits were too high and were crowding out private investment. The Treasury Department worked with a Republican Congress on a fiscal consolidation package. Real interest rates fell and the economy boomed – but that’s just the observed correlation. The true causal story remains obscure.

Two of the economists behind the Clinton package, Summers and Bradford DeLong, later argued against fiscal consolidation, even during the years of full employment under President Donald Trump. The new concern was instead secular stagnation based on insufficient demand, even as the final years of the Trump presidency saw debt and deficits well above Clinton-era levels.

The point here is not to criticize Summers and DeLong as being inconsistent. Rather, it’s to note that maybe they were right both times.

And what about that idea of ​​secular stagnation – the idea that the world is heading into a period of little to no economic growth? The theory was based in part on the assumption that global savings were high relative to investment opportunities. Are all those savings gone? In most places, measured savings increased during the pandemic. But the problem of insufficient demand has disappeared, so secular stagnation theories no longer seem valid.

To be clear, the theory of secular stagnation could have been true before the pandemic. And it may still be a valid concern if inflation and interest rates return to pre-pandemic levels. The simple answer is that no one knows.

Again, it is not just a matter of intervening surprises, which inevitably confuse all attempts to apply science and social sciences. It is that we economists are not sure which model to refer to in the first place. For example, how did Japan move so quickly from a high-growth economy to a bubble economy to a slow-growth economy? I haven’t seen any good answers to this question.

To what extent can the Fed control real interest rates? In the 1990s, economists worked very hard to establish the existence of a modest “liquidity effect” on real interest rates through monetary policy. More recently, the Fed pushed for ZIRP – Zero Interest Rate Policy – and real interest rates on loans have been negative for the US Treasury for years in a row. It’s hard to pinpoint how much Fed policy mattered, but suddenly it felt like a different world, at least until the pandemic relief measures came along.

A practical consequence is that people might not have to pay so much for expensive macroeconomic forecasts from the private sector. Every economist has his or her models, but there’s no way to know when one model stops working and another starts to matter.

On the policy side, beware of any claim that there is “no reason to worry” about an impending crisis – be it monetary, fiscal, financial or whatever. “So far things are going well” is a relevant observation, but it is not reassuring. The macroeconomics doesn’t quite justify the confidence the world is trying to place in it.

More from Bloomberg’s opinion:

• Don’t get disoriented by recession talk about fatigue: Jonathan Levin

• Even the Masters of the Universe are stunned: Robert Burgess

• The labor market struggles to solve the recession puzzle: Kathryn Edwards

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This column does not necessarily reflect the views of the editors or Bloomberg LP and its owners.

Tyler Cowen is a Bloomberg Opinion columnist. He is a professor of economics at George Mason University and writes for the blog Marginal Revolution. He is the co-author of “Talent: How to Identify Energizers, Creatives and Winners Around the World.”

More stories like this are available at bloomberg.com/opinion

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