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Home Publications Blogs Beat the Press Robert Samuelson Wants People to Be Unemployed: The Economics of the Economics of the Great Recession

Robert Samuelson Wants People to Be Unemployed: The Economics of the Economics of the Great Recession

Sunday, 29 June 2014 19:37

The basic story of the Great Recession is about as simple as they come. The economy was being driven by a housing bubble and the bubble burst. The combination of the loss of housing construction, due to the enormous overbuilding of the bubble years, and the loss of the consumption that had been driven by bubble generated housing wealth, created a gap in annual demand of more than $1 trillion. That's all simple and easy.

And what did economists think would fill that gap in demand, manna from heaven? Did they expect another building boom even when vacancy rates were at record highs? Better go study the basics of supply and demand. Did they expect investment to soar at a time of massive excess capacity? That one would not be supported by any studies of the determinants of investment I have seen. Would consumers just ignore the $8 trillion in housing wealth they saw vanish and spend just as though nothing had changed?

None of these sound remotely plausible, so what did economists think would fill a trillion dollar gap in annual spending? Of course the government could do it with more spending and/or tax cuts, but since we have a religious cult in Washington that says it is better to keep millions out of work than to run deficits, this was a political impossibility. (Of course we could have a lower valued dollar to reduce the trade deficit, but economists try to ignore the $500 billion trade deficit. That's another part of the cult.)

Anyhow, we have a simple story as to why we are facing a severe downturn. And of course it was simple to see the bubble. House prices had risen by more than 70 percent in real terms, breaking with a century long trend in which they had just kept pace with inflation. There clearly was nothing in the fundamentals to justify this sudden price surge. Income growth was weak as was population growth. And, there was no shortage of housing as indicated by both record vacancy rates and the fact that there was no increase in real rents.

In short, this is about as easy and simple as it gets and nearly every economist in the country completely blew it. For this the economics profession has enormous grounds for embarrassment. It's sort of like the fire department that rushes to the burning school building and watches in horror as it goes up in flames because they had forgotten to turn on the fire hydrant. No one would want to own up to that mistake. Nor are economists anxious to own up to the horrible economic disaster that happened because they were utterly clueless about basic economics.


So, instead we get the "it's all so complicated story." Robert Samuelson gives us the latest in the "it's all so complicated story," a piece from the Bank of International Settlements [BIS] (amazingly placed outside of the economics mainstream by Samuelson), which tells us the real problem was that central banks sought to counteract business cycles. See, when we got economic downturns (generally brought on by central banks raising interest rates), central banks like the Fed thought it was a good idea to lower interest rates, boosting growth and putting people back to work.

The BIS tells us that this was all wrong. As a result of this countercyclical policy we saw big debt bubbles grow, which eventually crashed and wrecked the economy. We would have been much better off if we just let all those people sit unemployed.

The BIS is of course right about the dangers of bubbles, but was there really no way to have growth without bubbles? Couldn't we, for example, have a lower valued dollar thereby increasing net exports and in that way boost the economy? If not, maybe they could give us a hint why not. Or maybe we could run larger budget deficits, unless the BIS requires its economists to be members of the anti-deficit cult.

And we could take steps to stem bubbles before they grow so dangerous. If there had been intelligent life at the Fed there might have been concern about the NINJA (no asset, no income, no job) loans that were driving the housing market. The National Association of Realtors report that nearly half of first-time homebuyers in 2005 put down zero or less might have also sparked concern. The Fed could have tried to use its regulatory powers to rein in these bad loans. It could have also offered clear warnings (sort of like forward guidance) that house prices would fall. I can't speak for other potential homebuyers, but it would influence my decision on buying a house if I heard the Fed chair say that house prices are over-valued and that it is prepared to take steps to bring them down.

Anyhow, all of this is old hat to BTP readers, but it is important to understand the economics of the economics profession. Economists have enormous incentive to say it's all very complicated and who could have known. It protects their jobs and self-esteem and could even mean increased funding flows so that we know enough to prevent something like this again.

The same incentives apply to economic reporters and columnists. After all, for their sources they relied almost exclusively on the people who completely missed it. They have no incentive to say that they had been too clueless to figure things out for themselves or at least find an economist who had a clue.

So, almost everyone you hear talking about the Great Recession has a huge incentive to say that it's all so complicated. It isn't, they aren't telling the truth. 


Typos corrected, thanks to several readers who called them to my attention.


Comments (20)Add Comment
This magazine of untruth...
written by Sandwichman, June 29, 2014 9:13
Frederic Harrison, 1872: "The complaint one makes against that anti-social jargon, which so easily passes for economic science, is that it is in ludicrous opposition to the common observation of facts. Political economy professes to be a science based on observation. But the bitter pedantry which often usurps that name usually assumes its facts, after it has rounded off dogmas to suit its clients. In practice this magazine of untruth escapes detection for two reasons. One is that the facts relating to labour are invariably seen through the spectacles of capital... The second reason which obscures the truth about industry is, that the facts about capital are almost never honestly disclosed."

Anonymous, 1821: "M. Say seems to think, that to give a new sense to people's words, different from that in which they used them, and then show that, understood in that new sense, they are no longer true, is answering them; or rather is giving 'a demonstration' which 'ruins their assertions.'"

There seems to be a pattern here.
minor correction
written by brian in sacramento, June 29, 2014 10:43
I think in your second paragraph regarding excess capacity and investment you intended to write, "That one wouldn't be supported by any studies of the determinants of investment I have seen."

Also, I'm under the impression that there was an assumption among mortgage lenders that housing prices were always going to be rising so if those who had received NINJA loans couldn't make payments on them at some point in future then they could just sell their homes and wash their hands of the situation. So did our "regulators" assume the same thing?
It's All So Complicated, But At Least We Know Government Caused It
written by Last Mover, June 29, 2014 10:53
The BIS tells us that this was all wrong. As a result of this countercyclical policy we saw big debt bubbles grow, which eventually crashed and wrecked the economy. We would have been much better off if we just let all those people sit unemployed.

This is part of the tortured logic to blame the bubble on the government rather than the private sector, so of course Samuelson buys into it.

The bubble was not part of a countercyclical policy per se. It did replace lost demand from low wages to maintain near full employment but that was not part of the plan by the corrupt deregulated financial sector. Greenspan was certainly not treating the housing sector as if low interest rates were necessary to counter a recession caused by low wages.

Greenspan flatly denied the bubble. He was an inflation hawk. The low interest rates meant he wasn't worried about inflation, not that he was favoring housing to counter some downward cyclical pull on the economy. He believed the economy was about where it should be at mid-cycle and intended to keep it there.

The bubble didn't burst from low interest rates. It burst from extremely high leverage ratios in the shadow banking sector that melted down with falling house prices, something that could have happened at higher interest rates as well.

If Samuelson and BIS want to pin the Great Recession on the government due to "countercyclical policy" they need to understand what a business cycle is with and without an asset bubble, particularly when the latter drives so much demand as Dean Baker has said ten thousand times for the housing bubble.

But it's all so complicated isn't it. If government didn't cause it with countercyclical policy, how did it cause it? By looking the other way and willfully ignoring it, therefore willfully enabling the private sector to cause it, that's how.
Big bankers or Big Joke?
written by Squeezed Turnip, June 29, 2014 11:42
BIS = Buried In Scheisse

Lost in the dreamy opiate fantasies of a return to the gold standard as well, no doubt. This rampant groupthink of the neoliberal financiers is on the verge of converting the American Dream into an American Nightmare. We should continue to pay 0% interest to these bankers spouting macro nonsense.
Please more about the "Economics of the Economics"
written by Dennis, June 30, 2014 3:27
I really like broaching this complicity of journalists and scientists that, as already George Orwell observed, may comparably apply to a variety of topics, including one of Dean's other favorites: "At any given moment there is an orthodoxy, a body of ideas which it is assumed that all right-thinking people will accept without question. [...] Anyone who challenges the prevailing orthodoxy finds himself silenced with surprising effectiveness. [...] Notoriously, certain topics cannot be discussed because of ‘vested interests’. The best-known case is the patent medicine racket..."
written by jonny bakho, June 30, 2014 4:35
Do most economists really don't get this? Or is there a minority of highly visible economists who are paid shills for the wealthy and given a very large megaphone to spread propaganda and misinformation?

The last thing the Malefactors of Great Wealth want are New Deal type programs that transfer wealth from people like our Malefactor to the public. Samuelson is one of the Malefactors well paid useful idiots.
Minsky cycle for the Economy profession?
written by Nichol, June 30, 2014 7:30
Can it be that the economy profession itself follows the Minsky cycle? Only, rather weirdly, economists are available in a wide variety, but the politicians and the media seem able to select those ones for prominence that are a lagging indicator in this cycle?

Is there a meta-Minsky that can describe this meta-economics?
written by skeptonomist, June 30, 2014 9:48
The housing bubble was not a simple price bubble - it was as bad as it was and the ramifications were so extensive because of the "innovative" financial manipulations - if it hadn't been for mortgage bundling and CDS's the results of a housing boom would not have threatened the economy of the world. Economists need to keep an eye out for price bubbles but what will prevent future crashes is identifying and eliminating the things which allow runaway leverage. There is no evidence that authorities can safely deflate leverage-driven bubbles once they get started. The assumption that they can and would do so is one of the things that were claimed to justify deregulation. So to that extent Samuelson may be making sense - leaving everything up to the Fed is certainly a bad idea. No amount of experience seems to get this across to some economists.

Actually economics is complicated. Despite the fact that Dean and some others identified the bubble, it is predictable that many would not - this happens in every bubble. One simple thing that should have been learned is that excessive leverage must be controlled. In fact it is learned periodically and then forgotten. The control of cycles has to be built into the system. The New Deal did this to a considerable extent, but its regulations were partly abandoned, and one reason this was done was because it was thought that monetary manipulations could control cycles.
The Credibility Trap
written by Jesse, June 30, 2014 10:59
The scions of the Establishment (status quo if you will) have to maintain the charade, because otherwise they risk the system that maintains and feeds them in the lofty style to which they have become accustomed.

It is a wide scale criminal enterprise loosely hidden by a fig leaf of bunkum, canards, and intimidation. Economics is a disgraced profession, but it is in company with the media, the accounting profession, the professional politicians, and the other courtiers of the privileged monied interests.

They will thwart reform and the evolution of events until the fabric of society is stretched to the limits.

And in this there is the makings of a tragedy.
Trade, Low-rated comment [Show]
Bubbles which crash the whole economy, can only occur in an environment of a demand shortfall.
written by A Populist, June 30, 2014 12:41
Bubbles in the price of assets, can occur in many different environments.

However, bubbles which result in massive increases in economic activity cannot occur (without causing wage and price inflation), unless there is slack demand.

If we had been at full employment at the start of the housing bubble, then the extra demand would quickly have resulted in labor shortages, and wage increases. TPTB would never allow that to happen, so they would raise interest rates - killing the bubble.

Chronic lack of demand leading up to the bubble, was a critical enabler of the housing bubble growing to such a large size, and having such destabilizing effects on the broader economy. Of course, the willingness to allow the trade deficit to grow (further lowering demand), was another factor enabling bubble demand to grow unchecked.
Housing price trend
written by Yoram Gat, June 30, 2014 1:42
Is the claim really that in real terms houses cost as much in, say, the 1990's as they did in the 1890's? How can that be true? The average income must have gone up several fold in real terms during that period. If so, housing cost in the 1990's should have been a small fraction the average expenditure. But of course it was a substantial (~40%, I believe) of the average household expenditure.

What is the data that you are using for the housing cost trend?
Quality adjusted house prices didn't rise
written by Dean, June 30, 2014 3:15

people have bought better hours through time, but the price of a quality adjusted house did not rise. Shiller is the best source on this. I can't find his series on-line just now, but it's in the second edition of his book "Irrational Exuberance."

eagerly await?
written by Peter K., June 30, 2014 3:44
Samuelson writes with bated breath that people "eagerly await" the BIS's annual report. Why they say the same thing every year.

Avent at the Economist:

"AS MY colleague noted over the weekend, the stopped clock that is the Bank for International Settlements ("the central bank for central banks") is showing the same face to the world that it has for the last few years. In 2011, when unemployment rates in both Europe and America were above 9%, the BIS argued that global growth needed to slow in order to reduce inflationary pressure. In 2012 it warned that central banks shouldn't do any more to boost growth lest they create financial instability and discourage structural reform, even as the crisis in the euro area threatened to tip the rich world back into serious recession. Though the BIS's diagnoses of the global economy's ills have evolved over time its policy recommendations have not. In its latest annual report, it argues that what the world needs now is higher interest rates. One of these days the BIS may just turn out to be right."

See also . . .
written by Doug N, June 30, 2014 5:33
Ryan Avent at The Economist, also weighs in on the BIS.
written by Keating Willcox, July 01, 2014 9:15
India had a rule in 2007, 20% down for all house purchases. no bubble...no huge rise in assets...no bubble burst. The head of the Indian national banks had the balls to hold this policy. It exists as proof that the author of this article is 100% correct.
Move on, now, Establishment on top of things
written by Barkley Rosser, July 01, 2014 1:10
Dean was first out the door identifying the housing bubble, which got picked up on well ahead of the crash by some of us others, mostly heterodox of one sort or another, although Shiller and Rajan are pretty respectable. Now all the hot DSGE models have financial frictions in them, so everything is cool in establishment macroland. No need to pay any more attention. Move on past the car wreck. The central banks will now all get wonderful advice from their DSGEing macroeconomists.
What is the relevant index?
written by Yoram Gat, July 01, 2014 2:15

Thanks for responding. But is "quality adjusted house" really the unit of interest? Shouldn't the relevant index be the fraction of income which is spent on housing?

For example, now that interest rates are low housing prices can be expected to be higher since a larger sum can be borrowed for the same mortgage payment.
written by Globus Pallidus XI, July 01, 2014 5:09
Well said. Indeed, it is simple. Americans are being deliberately driven into poverty, so that wages can fall, and profits can rise. It's not an accident.

I do however disagree that the issue is ENTIRELY financial. There is also America's post-1970 cheap-labor immigration policy. Recently it has come to light that the number of foreign workers imported since 2000 has exactly equalled the number of new jobs created: so 1 million new jobs are created, 1 million new workers are added, the number of unemployed/underemployed stays high. Do the math.

There is also trade policy, as more and more of the remaining manufacturing jobs are shipped overseas (all four presidents carved on Mt. Rushmore were unashamed protectionists, and they took America from a backwards agricultural colony to the greatest industrial power that the world had ever seen. Protectionism does work).

For more on why finance is not everything check out

written by liberal, July 02, 2014 12:22
Barkley Rosser wrote.
Dean was first out the door identifying the housing bubble...

That's probably true, but the clear winner for predicting the bubble was a British Georgist.

Yoram Gat wrote,
Shouldn't the relevant index be the fraction of income which is spent on housing?

Of course. The problem is that Dean (and probably Shiller) doesn't appear to understand land economics. If he did, he'd realize that land rent tends to increase in direct proportion with GDP.

If housing only kept up with inflation, then land rent would asymptote to 0 in the long run, which is absurd.

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About Beat the Press

Dean Baker is co-director of the Center for Economic and Policy Research in Washington, D.C. He is the author of several books, his latest being The End of Loser Liberalism: Making Markets Progressive. Read more about Dean.