The last dozen or so years have not been especially kind to the economics profession. There was the financial crisis that few predicted; the realization that tried-and-true policy measures, both fiscal and monetary, don't seem to work any more; and signs that the consensus belief in the virtues of free trade may be set to unravel.
In truth, it's not all of economics that's having problems. Microeconomics is doing just fine; it's macro that's struggling. While it's not true that "nobody" foresaw the financial crisis, it's true to say that those of us who feared something bad was about to happen back in 2006 or so were relying on gut instinct rather than anything in the textbooks. In the aftermath of the crisis, macroeconomics has taken a welcome and overdue shift towards empirical rather than purely theoretical work, but there's been little progress in devising a robust new intellectual basis for the discipline.
Consider free trade, long a matter of near-universal consensus among economists: the freer international trade is, the better. Thanks to the concept of "comparative advantage", economists have preached that trade makes everyone better off, even if one trading partner is more efficient than the other in producing absolutely everything. This belief has driven the development of GATT, the WTO and the various regional trading blocs, including the EU, NAFTA and, prospectively, the TPP.
Yet free trade has become increasingly unpopular in wealthier countries, and not just because of populists like Donald Trump. It may be true that "everyone" in an aggregate sense is better off under free trade, but there are inevitably going to be winners and losers. The textbooks will tell you that the winners can afford to compensate the losers, but in practice, that rarely happens: the losers -- GM workers in Flint, Michigan, seeing their jobs literally heading south -- are left to fend for themselves.
The fault in the textbook logic seems to be this. Demonstrations of the principle behind comparative advantage tend to look at a simplified case involving two countries and two goods -- just look again at the article linked above. In the real world, however, there's another factor at play: who gets to distribute the benefits. If we think again about the auto workers in Flint, they're clearly the losers when the plant closes, but the gainers are not primarily the workers at the new factory in Alabama or Mexico or wherever it may be. Sure, those workers are better off, but the real winner is the corporation that moved the jobs south, which is now able to produce its product at a much cheaper cost.
In the real world, it's not just about the geography, but about who is driving the process and reaping the benefits. In the very broad aggregate, the world is better off because GM is making cars in Mexico and because free trade has allowed South Korea and others to muscle their way into the market. However, the benefits are so unevenly distributed, and the costs so heavily concentrated, that it's little wonder that free trade is losing its appeal.
Let's move on to monetary policy. Those of us who feared that the Greenspan Fed, with its unnecessarily lax policy approach, was paving the way for a huge crisis were proven right, but the crisis certainly did not take the form that most might have feared. Printing money would inevitably lead to an inflationary spiral, right? Not at all right, it turns out -- and as we approach the tenth anniversary of the crisis, we find central banks everywhere pumping ever larger amounts of money into the system in a desperate attempt to spark inflation and growth.
Milton Friedman's famous saying that "inflation is always and everywhere a monetary phenomenon" now seems about as valid as the phlogiston theory.
There's an explanation for why things didn't turn out as they were supposed to, but it's not necessarily a comforting one as we try to figure out what to do next. The Greenspan Fed, and Greenspan himself in particular, thought that the low inflation rate the US was experiencing in the early years of this century was the result of a rise in US productivity; in truth, it owed a whole lot more to the influx of consumer goods from newly-industrializing countries. The father of the low inflation era wasn't Greenspan, it was Sam Walton. Keeping interest rates low in these circumstances didn't generate inflation at the consumer level; it just led to rising prices for both financial and non-financial assets, ultimately putting the stability of the global financial system at risk.
Here's the scary part. Since we don't fully understand what's changed, we can't find the exit. The treatment for a crisis brought about by excessive liquidity creation has been....even more excessive liquidity creation. You can still find old-guard commentators out there who shake their heads and warn that all this money slopping around the system is bound to create inflation sooner or later. Maybe it will, but it seems more likely that unsustainable asset price growth will lead to another financial crisis long before consumer prices start getting out of hand.
The central banks seem to know this, of course. You can sense that the Fed would like to keep raising interest rates, if only in the hope of having a few shots in its locker when the next crisis hits. Trouble is, events keep getting in the way. We may be well rid of some of the supposed economic certainties of the past, but having no real intellectual anchors any more is not a comforting feeling.
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