In Defense of Two-Handed Economists

My latest Bloomberg View column with Betsey Stevenson is now online:

Here’s something you don’t often hear an economist admit: We have very little idea where the economy will be next year.

Truth be told, our best guesses just aren’t very good. Government forecasts regularly go awry. Private-sector economists and cutting-edge macroeconomic models do even worse.

Our objective isn’t to beat up economists. Rather, we want to make the point that when we recognize our shortcomings, we’re forced to confront the enormous uncertainty that lies ahead.  And appropriate humility about the economy changes how we think about policy.

Like a meteorologist who warns you to pack an umbrella because there’s some chance of rain, economists can assess the risks that lie ahead in a way that helps policy-makers prepare for the future.

While the consensus among economists (including us!) is that the economy is recovering nicely and that unemployment will fall to about 7.5 percent by the end of next year, we think it’s more helpful to emphasize what we don’t know: 

[T]he consensus forecast is highly likely to be wrong. Unemployment could fall to 6.5 percent, or rise to 8.5 percent. Each of these possibilities needs to be considered, and weighed according to its potential benefit or harm.

If unemployment falls to 6.5 percent, there’s no overwhelming reason for concern. Historical experience suggests that inflationary pressures are unlikely to build unless the jobless rate falls to 5 or 6 percent. Even if inflation does accelerate, the Fed has ample power to reverse course by raising interest rates to slow growth.

By contrast, the longer-run consequences could be dreadful if we find ourselves with 8.5 percent unemployment fully six years after the recession began. Europe’s experience in the 1970s and 1980s demonstrated that persistently high unemployment can become entrenched, leading to further unemployment in the future — a process economists call hysteresis. Skills atrophy, hope fades and people lose contact with the networks that can help them find work. If this occurs with the millions of U.S. workers who have been without jobs for more than a year, it will be costly and very difficult to undo. 

The point:

In other words, the cost of too little growth far outweighs the cost of too much. If we readily bear the burden of carrying an umbrella when there’s a reasonable chance of getting wet, we should certainly be willing to stimulate the economy when there’s a reasonable risk that doing nothing could yield a jobless generation.

You can click through here to read our full column.

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  1. JBP says:

    Maybe we are such poor predictors because we tend to use falsified theories of economics. If we are doing science, then the quality of a hypothesis is based upon whether its predictions hold true. Resorting to arguments about what is the proper counter factual to measure the hypothesis is not science. If the predictions do not hold true, the hypothesis must be abandoned.

    The Keynesian cross predicts that inflation will increase when employment increases and inflation will decrease when employment decreases. In a recession, we should have deflation; they move in tandem. During the 1970s, employment decreased fairly dramatically and inflation increased fairly dramatically. Ergo, the hypothesis is falsified.

    This is true only if we are doing science. If we are doing philosophy or theology, we can continue to believe the hypothesis. But if we are doing science, then we have to accept the observable facts.

    I am not against the government stimulating the economy. I am against the government using a failed hypothesis to fail to stimulate the economy. We will not be able to actually move on and try other ideas until we abandon ideas that don’t work.

    Look, I have a lot of respect for Keynes. Much like Aristotle, he moved science forward a great deal. But like Aristotle’s earth centric universe, he was wrong about some things.

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