The perverse effects of easy money

Sep 5th 2012, 17:13 by M.C.K. | WASHINGTON

With a few noteworthy exceptions, mainstream academic economists failed to anticipate that the global financial crisis and ensuing collapse of output was even possible. There are several legitimate explanations for this failure, including bad incentives among economists and the absence of a realistic financial system in standard macro models. The most unconvincing excuse, however, is that the crisis was such a freakish event that it was—by definition—impossible to predict. Naturally, this became the academic establishment’s main line of defense.

But there were people who had accurately foreseen what was to come. These were not astrologers who had gotten lucky but serious thinkers who studied the way the economy and financial system interacted with each other. They just had different models and different assumptions that happened to work a lot better—a very awkward fact for academic economists who pride themselves on being “scientists.” As Thomas Kuhn argued in The Structure of Scientific Revolutions, new ideas are rarely accepted by an establishment that did not create them. Thus the mainstream has decided to either ignore or ridicule those who dared to be right. The persecution of Raghuram Rajan for his concerns about post-crisis monetary policy should be understood in this context.

Most recently, we have William White, a brilliant Canadian economist who used to do research at the Bank of England and the BIS before taking over the Economic Development and Review Committee at the OECD. He is not, in other words, a nut who hides in the woods with gold bricks and canned food. Moreover, he presented one of the earliest and most thoughtful warnings of the financial crisis back in 2003. Anyone with a brain ought to take him seriously,especially when he bucks the conventional wisdom. Thus, this correspondent was very excited to find that Mr White has just released a thoughtful new paperon.

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As long as politicians in the world’s big three economies continue to dither, another global recession is possible

Oct 6th 2012 | from the print edition

FOR investors around the world, the recovery seems assured. The MSCI global share index has risen almost 10% since July. The credit for this largely goes to central bankers. In July Mario Draghi, president of the European Central Bank, said he would do whatever it takes to hold the euro together. In early September the ECB pledged to be a lender of last resort to governments, albeit under certain conditions. Soon afterwards the Federal Reserve launched a new round of quantitative easing (printing money to buy bonds) and promised to keep buying assets until American unemployment was “substantially” less awful. Other central banks followed with loosening of their own, in part to stop their currencies from rising. All this activism boosted share prices.

But is it justified? The surge in shares certainly looks odd in light of the recent economic statistics. Over the past few months global growth has slowed to its weakest pace since the 2009 recession, as the world’s big economies have lost steam simultaneously. American output is growing at less than 2%. Growth in China, which until recently was in double digits, appears to have slowed to around 7%. Japan’s economy almost certainly shrank in the third quarter. And the euro zone’s recession shows no sign of easing.

Financial markets, of course, are forward-looking. Investors are betting that sustained monetary loosening will perk up the world economy. Mr Draghi and his peers are certainly doing their bit. However, investors’ optimism ignores the fact that many politicians are being shockingly irresponsible. In different ways, politicians’ actions (or inaction) are the biggest short-term danger facing the American, European and Chinese economies. Judging by politicians’ current behaviour, the world economy could slow a lot further. It could even tip into recession in 2013.

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