June 19, 2005


Time to Toss The Textbook: Greenspan confessed again that he doesn't understand why rates on mortgages and long-term bonds keep falling. This is but one mystery. (Robert J. Samuelson, June 19, 2005, Newsweek)

If economics were a boat, it would be a leaky tub. The pumps would be straining, and the captain would be trying to prevent it from capsizing. Which is to say: our ideas for explaining trends in output, employment and living standards—what we call "macroeconomics"—are in a state of disarray. If you're confused, you're in good company. Only recently Federal Reserve chairman Alan Greenspan confessed again that he doesn't understand why interest rates on long-term bonds and mortgages have dropped, just when the Fed is raising short-term rates. This is but one mystery. [...]

But here's an intriguing irony: the less we understand the economy, the better it does. In the 1960s and 1970s, many economists had confidence. They thought they understood spending patterns, could estimate "full employment" and propose policies to prevent recessions. What we got was high inflation and four recessions (1969-70, 1973-75, 1980 and 1981-82). Since then, we've had lower inflation, only two mild recessions (1990-91 and 2001) and faster productivity growth.

Economists' overconfidence—and the resulting policies—may have weakened the economy. But its improved performance could also have other explanations: lower inflation; the good judgment of two Fed chairmen—Paul Volcker and Greenspan; the economy's self-regulating characteristics, and new technologies. It could be all of the above or just dumb luck. We don't know.

Indeed, neither of those slowdowns ultimately qualifies as a recession. The policies initiated by Volcker and Reagan--deflation, globalization, deunionization, open immigration, and a reversal of tax creep--combined with computerization, pre-tax savings, and the American defiance of the global demographic implosion have put in place the conditions for what is know an economic boom of over twenty years that shows no sign of ending any time soon.

Posted by Orrin Judd at June 19, 2005 3:46 PM
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