The predictions from economists about the consequences of Brexit were widely ignored. That shouldn’t be surprising. In recent years the public has lost faith the in the economics profession.
One reason for the lack of faith is the failure to predict the Great Recession, but the public’s dismissal of macroeconomists is based upon more than the failure to foresee the dangers the housing bubble posed for the economy. It is also due to false promises about the benefits to the working class from globalization, tax cuts for the wealthy, and trade agreements – promises that were often used to support ideological and political goals or to serve special interests.
In retrospect the evidence for the housing bubble was easy to see and a few people tried to sound the alarm but they were widely dismissed. Even when the warnings were taken seriously the belief was that the consequences from a housing bubble collapse would be relatively minor and confined to the housing sector. Very few people believed there would be a deep and long-lasting recession.
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There is an argument that recessions are not predictable because policymakers will take steps to offset risks that can be foreseen. Perhaps there is something to that argument. But other failures of macroeconomic models and the misuse of the models to promote ideological and political goals are not so easy to set aside. For example, the arguments used to justify austerity policies put forth both by reputable economists and promoted by those with an ideological agenda for smaller government – the idea that reducing government deficits would create a confidence effect and stimulate the economy – turned out to be wrong. Repeated warnings about inflation due to quantitative easing from economists with standing in the profession, warnings that proved false again and again, provided ammunition to those with a vendetta against the Fed.
If we go back a bit further in time, it’s easy to find more examples. Globalization and international trade were supposed to make us all better off. There would be adjustment costs along the way that would hopefully be offset by government policies to help those who paid the cost of the transition, but in the long-run more trade would lift all boats. But that hasn’t happened. Wages for the majority of people have stagnated, there have been large job displacements that government policy has not done much to address, and the gains have gone to those at the top of the income distribution.
Tax cuts for the wealthy were supposed to stimulate growth and make everyone better off. There was dispute about this within the profession, but there were also many economists who provided intellectual support for the claim that tax cuts will create growth and widespread prosperity. The evidence from the Bush and Reagan tax cuts does not support this claim, but it is still made by some economists and this gives those who are serving wealthy interests or who want to force government to shrink by starving it of revenue the cover they need for their arguments.
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Economic models have two uses, as a way to understand how the economy works and as a way to forecast the future. It’s possible to forecast the economy through extrapolation from the past and from fishing for empirical models that that can explain past data. But these models can be unreliable when they encounter circumstances that deviate from past experience. It is much better if the forecasts are derived from flexible theoretical models based upon a solid understanding of the mechanisms that drive the economy.
Unfortunately, we do not yet have the understanding needed to do this. For example, we cannot agree on the answers to the following questions:
- Why has productivity fallen? Will it stay low in the future?
- What has caused the decline in labor force participation?
- How strong is the economy’s self-correction mechanism in recessions, and how does it work?
- Is there a Phillips curve (i.e. a reliable relationship between inflation, inflation expectations, and unemployment)?
- How are expectations formed, and do they converge to rational expectations over time?
- What is more important in the determination of wage and capital shares of income, marginal products or bargaining power and other institutional features of labor markets?
- What frictions should we focus on? Price and wage stickiness? Financial frictions? Both? How do these frictions vary over the business cycle?
- How high can the minimum wage be raised before there are significant employment effects?
- What is the cause of inequality? Is it baked into the capitalist system, or is it the result of political and institutional forces?
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And that’s nowhere near a complete list of the things we don’t fully understand. We don’t even agree about what caused the Great Recession. Was it due to the loss of wealth from the collapse of the housing bubble or the fallout from the financial meltdown? Was it some combination of both? If so, which was more important?
Even if we do have a through understanding of how the economy works, we still may not be able to make accurate forecasts very far into the future. We understand the science of weather fairly well, but the forces involved are so complicated we cannot make reliable forecasts very far ahead. Perhaps the economy is the same. But even if that’s the case, if we understand how the economy works we can still provide useful information about the nature of the risks to the economy, guidance on how to reduce those risks, and the best policy response should those risks materialize.
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I am not suggesting that economists stop giving policy advice or making predictions. There are some areas where there is widespread agreement within the profession backed up by solid empirical evidence. Even when there is disagreement we can often identify policy prescriptions that will work across a wide variety of possible models of the economy. And, much like weather forecasters, we can provide information about the chances of good or bad weather in the near future even if those forecasts are highly uncertain.
But we do need more humility about what we do and do not know, more willingness to change our minds when the evidence disagrees with our favorite theoretical model, and the willingness to acknowledge disagreement within the profession. But most of all we need to take a strong stand against those inside and outside the profession who misuse economic theory and empirical results for political and ideological purposes.