What Economists Still Don’t Get About the 2008 Crisis

1) High powered money supply produced by the central bank 2) Money held in deposits, available to be increased via the fractional reserve multiplier effect 3) The deposit:reserve ratio, which shows the strength of the fractional reserve multiplier effect

The financial crisis seems to have tanked 2 & 3, such that the Federal Reserve would have needed to do much more QE than it did to keep up with demand for money.

They also found that price growth and wage growth are affected by history: a history of slow money growth predicts an increase in money supply will be absorbed by more output. A history of high money growth suggests that more money growth will lead to modest output changes and an increase in inflation.

Scott Sumner echoes your fear about a coming recession, but thinks that appropriate NGDP growth via the right amount of money printing can lead to a soft landing without inflation. Given that this has been his entire career, I think it is very possible that we won't necessarily see renewed high inflation.

Scott Sumner post here: http://www.themoneyillusion.com/the-next-five-years/

That's not an "argument", it's an observation. Almost all of the QE "new money" was never used by the banks to make loans; it just sat in their accounts at the Fed. Why? Because the banks weren't fools: they knew they had way too little reserves for the loans they already had outstanding, so they just used the QE funds to increase their reserves. That equates to "significantly deleverage".

> I guess it may also have to do with how the QE was introduced. If it was money printed to pay civil servants it might have had a different effect than introduced in the bond market.

Or money printed to pay ordinary people whose retirement savings had collapsed through no fault of their own. And yes, that would have caused inflation, because you would have had a greatly increased quantity of money chasing the same quantity of goods and services. It might also have stimulated some economic growth which could have offset that effect, but that's a chancy thing to rely on.

https://www.advisorperspectives.com/commentaries/2018/07/24/...

The global economy left to its own devices would likely have entered a full-blown depression, and deflation usually accompanies this. The decrease in demand across the economy puts a great downward pressure on prices, this puts pressure on decreasing costs, this puts pressure on decreasing wages, and so on. You have a real threat of a deflationary spiral as demand further dries up due to people having less money to spend on goods and services.

So, as a lot of economists argued, there was a significant threat of a deflationary spiral facing the economy, more than any threat of inflation getting out of control, which had already been low to begin with.

Money and credit can both can be used to buy goods/services. Role of credit here is/was underestimated by economists.

In 2008, bunch of credit was destroyed. In response, central banks printed money, bought assets These things generally netted out.

It's going to mean people who were getting 3% on their bonds and are now getting 0% will go looking for 3% in whatever other financial assets they can find - San Francisco property, shares, etc.

> inflation happened but it was all concentrated into financial assets, real estate

... because demand remained static while supply (of yield bearing invesment assets) was restricted.

That was basically the whole point of QA. It bailed out the banks without needing to give them taxpayer cash by bumping up asset values until their loanbooks started to look healthy again.

Inflation doesn't work as simply as you might expect. What people believe is actually a big piece of the puzzle. As proof of this look at the Paul Volcker interest rate hikes, that squashed run-away inflation. While his hikes did eventually work, in the short term they did nothing to combat inflation. Why? Because people didn't believe they would help (in fact many thought it would make the problem worse). You had to get the minds of the the investors and spenders on-board before you actually see results (despite what the math might say).

I think the reason QE hasn't caused much inflation is because people either don't care or don't understand (most likely the latter). I am sure intentionally obscuring "printing shit tons of money" as "Quantitative Easing" also helps with the psychological factor so as to not panic the masses.

Economists often use quite narrow definitions of money, counting things like cash and bank accounts, and maybe CD's, but never other valuable liquid financial assets like stocks and bonds and real estate.

But financial decision makers absolutely do consider their full set of assets in deciding how much purchasing they can afford. How much purchasing power is chasing the available goods is really the relevant statistic for causing inflation.

In quantitative easing, the Fed gave new dollars in exchange for existing financial assets (bonds, mortgage backed securities, etc). The exchanges were roughly at market value, meaning the dollars had the same purchasing power as the assets.

The exchange let the Fed control long term interest rates and increase the supply of safe assets (dollars) in the market, which was needed as banks were forced to increase their holdings of safe assets to deleverage.

Since total purchasing power didn't increase, there was no cause for inflation.

I don't know if this is the correct answer, but a very simple answer would be that we were/are in a massively deflationary environment and (things like QE) have been necessary just to stay in place ...

The most common theory is that this loose equity sloshing around has gone into stocks and bonds.

QE is keeping the stock market up.

In order to inject lots of money into the economy without causing inflation the Fed went to Congress for permission to pay banks interest on the money that they kept on deposit with the Fed beyond the money they were required to keep. Normally banks keep the minimum required reserves with the Fed and lend out the rest but the Fed hoped that paying interest on the reserves would encourage the banks to sit on the money rather than lending it out where it could chase goods and services and cause inflation.

This was all new territory and the Fed's economic models for how IOR would effect the broader economy weren't validated. That's probably part of the reason the Fed's predictions about inflation and recovery were so off as the crisis progressed.

EDIT: You can see the large effect of the policy in the graph of excess reserves over time. The policy is still in effect.

https://en.wikipedia.org/wiki/File:EXCRESNS.png

https://en.wikipedia.org/wiki/Excess_reserves

QE got swallowed up to make the large creditors whole and it ended up being a massive wealth transfer to them, so you see elite real estate, art, etc. being bid up while the rest of the economy flounders around aimlessly

QE money is asset money, it sits on the left hand side of the bank's balances. The money that everybody actually uses is bank deposit - liability money, which sits on the right hand side. Liability money dwarfs asset money in modern economies.

The rest is then a question of what happens when you inject asset money into a banking system, and that depends on the regulatory framework. In the modern banking system capital controls have taken over from asset liability money controls, and that is essentially what has stopped the hyperinflation that some people predicted.

If you look at the deposit money quantities, well the normal rate of expansion for the US is approximately 2x decade, and that continues to be the case.

Real estate prices in Vancouver have spiked since 2008 so sign me up as someone who believes the fincialization of housing and QE is a main component in why Vancouver housing prices suddenly became wildly out of sync with local incomes.

"Monetary policy doesn’t work. What does work are fiscal adjustments" http://antonisoycasals.blogspot.com/2015/10/monetary-policy-...

The truth is that monetary policy does little. QE just swapped out high-interest treasury securities for low-interest reserves on private bank balance sheets. This flood of reserves drove interest rates so far down that the Fed had to start paying interest-on-reserves just to maintain a floor.

It didn't do much else. The idea that banks are reserve constrained is a widely held misconception. They are not. If anything, they are capital constrained. Adding to the supply of reserves then does not increase lending.

Another widely held misconception is that interest rates and inflation are inversely correlated. They are not. Interest is the price of money, and the price of money impacts the prices of everything else. Lowering interest rates decreases inflation, not increases. This is called neo-Fisherism.

Fiscal policy is what does work. Increase government spending enough and you will get inflation. This should be entirely noncontroversial.

The economy was stuck in a rut and needed some kind of kick in the butt. Congress was unwilling to fund another ARRA-like stimulus (the 1st too small), partly because the federal debt was high. Low interest rates were not doing the stimulus job they used to because it appeared the rich decided waiting out the recession and sitting on cash was a better strategy than suddenly investing in business. Near-zero inflation made sitting on cash not feel so bad. Or, invest in Asia: capital-intensive investments no longer paid off in the USA, as manufacturing was shifting to Asia.

The better solution would be to not run up debt so that the Federal Gov't can issue a big stimulus during slumps: classic Keynes, which is basically Grandmother's advice: save up during good times for rainy days.

But there's insufficient incentive for politicians to avoid debt; they are rewarded for short-term improvements in the economy, not long term. We need something akin to a Balanced Budget Amendment that allows Keynesian stimuluses. The law would probably have to kick in gradually so that politicians wouldn't fear a short-term dampening of the economy that could harm their re-election. (Pension problems have a similar short-vs-long-term feedback glitch.)

Because what you call money is just a 0% permanent bearer bond to anybody not in your currency area.

QE is just a swap from interest paying savings to non-interest paying savings. If you're scared, you don't need paying interest to save, and anybody without a good index linked state pension to look forward to is scared.

The IS-LM model has a phenomenon called the "(Hicksian) liquidity trap"

* http://people.ds.cam.ac.uk/mb65/library/boianovsky-2004.pdf

How it applies to quantitative easing (QE):

* https://pro.creditwritedowns.com/2010/10/on-liquidity-traps-...

Basically, as the the rate of interest goes down, the demand for money increases (because it becomes cheap(er) to borrow). This is why when the economy tanks, central banks lower interest rates: cheap money encourages people / business to borrow and spend (thus increasing demand, and stimulating the economy).

However, at a certain point the demand for money becomes perfectly elastic. This is the generally when the interest rate is zero, which is where we were at from 2008 and for some years. The interest rates can't go negative (well, mathematically they can, but practically they generally don't (with some exceptions)).

This is called the zero lower bound, and once you're here, IS-LM says that you can print money without worrying about inflation too much:

* https://en.wikipedia.org/wiki/Zero_lower_bound

Once you do see the economy recovering (through un/employment rates and inflation), you stop printing money and start increasing interest rates.

I know some people on HN like to rag on Krugman, but he was saying all of this over the last ten years, and has generally been correct. All of the above is fairly straight forward IS-LM (which he exposes).

The Great Recession has been pretty good as a "scientific" experiment to see whose predictions were accurate: turns out the demand-side Keynesians were pretty good, and the Chicago-school supply-side folks were not.

You may like "the great wave: price revolutions..." by david hackett fisher for the role of economic conditions on local revolts and global revolution.

He also made a pretty good case for gold's intrinsic value and economic importance being driven by war.

He basically wrote two paragraphs with the most oversimplified and honestly often wrong intellectual history of economics.

> First, because I like his intellectual shit-stirring.

You mean you like it if somebody writes a book criticizing another profession even while he clearly has not studied either modern economics or even the history of intellectual thought in economics. I wish more people would do that, sound like a healthy thing for science.

> Second, because I think he's right about the origin of money. Money evolved from debt. Debt did not evolve from money, as liberal 17/18th century thinkers assumed.

That was one of the nice tricks he pulled. If he actually bothered to read the history of economic thought and not the 2min cliff notes he would have found tons of interesting and complex thought about money and its origins.

He later claims that anthropologists had studied gift giving and debt economy then were the once that studied these things, while economist had done so 50 years earlier and were far more nuanced and with greater integration with economics then the the later anthropologists.

However Graeber is so anti-economics that he literally refused to read that literature to such extend he made the incredible embracing mistake and mis-characterizations that I could not take him seriously.

He didn't know the primary economist who wrote about origins of money and when writing about him he claimed 'he only added math to Smith argument'. That is particularly embracing because Carl Menger was known for not using a lot of math. So where did this notion of 'adding math come from'. Well there is another Carl Menger (the son) who was a mathematician.

So quite simply Graeber is so certain that he is correct and all economist are stupid that he never read the most influential economist on the very topic he claims to criticize economist about.

Graeber himself has admitted that money can arrive both from sustained interaction and trade, as well as from debt systems. So his whole me against the economist argument never even made sense, most economist didn't disagree with his main point.

What he did was trying to make this simple point and the argument that debt is not always good (Britain in Madagascar and so on) and then he hoped people would buy the rest wholesale.

>It is the month of August; a resort town sits next to the shores of a lake. It is raining, and the little town looks totally deserted. It is tough times, everybody is in debt, and everybody lives on credit.

>Suddenly, a rich tourist comes to town. He enters the only hotel, lays a 100 dollar bill on the reception counter, and goes to inspect the rooms upstairs in order to pick one.

>The hotel proprietor takes the 100 dollar bill and runs to pay his debt to the butcher. The Butcher takes the 100 dollar bill and runs to pay his debt to the pig raiser. The pig raiser takes the 100 dollar bill and runs to pay his debt to the supplier of his feed and fuel. The supplier of feed and fuel takes the 100 dollar bill and runs to pay his debt to the town’s prostitute that, in these hard times, gave her “services” on credit. The hooker runs to the hotel, and pays off her debt with the 100 dollar bill to the hotel proprietor to pay for the rooms that she rented when she brought her clients there.

>The hotel proprietor then lays the 100 dollar bill back on the counter so that the rich tourist will not suspect anything. At that moment, the rich tourist comes down after inspecting the rooms, and takes his 100 dollar bill, after saying he did not like any of the rooms, and leaves town.

>No one earned anything. However, the whole town is now without debt, and looks to the future with a lot of optimism.

The problem with the old monetarists was always that they assumed a constant demand of money (or velocity) how they called it. Now they had some empirical reasons for this (see PhD under Friedman) but they missed something that earlier economists had already figured out. Namely that monetary demand can shift for all kinds of reasons and that any good monetary system needs to adjusts to that.

However they were totally correct on interest rate and that interest rate are a terrible guide for monetary policy.

When you actually study New-Keynesian it is perfectly clear that it is not the interest rate that sets monetary policy (or indicts it) but rather interest rate relative to the natural rate. Why New-Keynesian never explain this to anybody when giving interviews or anything like that boggles my mind sometimes.

So in New-Keynesiansim everything hinges on your assumption of the natural rate. 1% interest rate can be contracting or expeditionary depending on the natural rate.

What happened in 2008 is actually quite simple, the Fed had the interest rate fixed and didn't lower it (inflation fears because of oil prices, see FOMC meeting late 2008).

While in the real economy the natural rate was making the Fed policy more and more contractility.

Modern monetarists (Market Monetarists) like Scott Sumner have been point this out since 2009 of course.

Not being familiar with Anna Schwartz, I went googling and came up with these two links... posting here in case anybody else was wondering as well.

https://library.duke.edu/rubenstein/findingaids/schwartzanna...

http://www.nber.org/people/anna_schwartz

First, because economics is the study of exchange, which means the exchange between a human being and another one. Understanding human behavior in its totality is like trying to understand our brains or our own consciousness. It suffers from a halting-problem level dilemma.

Second, because the study of economy tends to be about its application, it will always fail to obtain perfectly predictable results because humans are not perfectly predictable. And humans fight back. It is aking to believing you found the perfect method of making someone fall in love with you: as desirable as it is preposterous to believe you can achieve it.

Whatever model of economics you have, if it has room for 1% of human behavior, rest assured that its enough to take it down.

I still remember the moment I realized this. It was on the first day of my first class in Economics 101, when the professor began by telling us that economics was a science built upon the assumption that people are rational actors. I thought about all the people I'd ever known, and all the deeply irrational things I'd seen them do, and got the sinking feeling that I had committed myself to studying a field of thought that had chosen the wrong rock upon which to build its church.

It sounds like more of the same. It sounds like more "trust us, we won't mess it up this time around." It doesn't sound like a fundamental re-thinking of our economy.

This is one of those pieces where they claim experts don't understand their own field, so they quote experts from that same field to back up that idea.

Have economists actually changed their models, or are they still referring to the 2008 crisis as an unexpected shock?

What are the chances that their "understanding" of the 2008 crisis will prevent them from being surprised by the next one?

Recently in Southern California, listening to the local NPR affiliate, they were covering a candidate race where one candidate accused the other of not hearing his constituents: ~"House prices have fallen, and that's bad for our voters. I hear them, and he doesn't."

I feel like housing in California is unsustainable: pricing, development, etc.

What's strange is that the candidate doing the accusation was a Democrat. I assume he benefits from loose borders (more housing demand), but constituents who can't actually vote and get their voices heard (immigrants wanting affordable housing, not what begins to approach slum-lord style ghettos).

So this oversimplified theory is really just your confirmation bias.

I also think you have contrived an exaggerated view, attributed it to him, and are arguing against that. I'd like to see more quotes to back up your argument because it is difficult to find it persuasive.

Doing a quick search I found an older blog post where he touches on a lot of the same points that you just did, so maybe you agree with him more than you think:

http://noahpinionblog.blogspot.com/2013/04/the-reason-macroe...

It means that people actually doing econ now are rather humble about what they do, and still have to be extremely technical and smart. Indeed, if you bring in a new theory that works, you'll probably be famous very quickly. The bar is pretty high though, your model gotta be inferential and parameters causally identified, while still fitting the data well.

Nevertheless, my macroeconomist buddies got _really_ excited about doing "that machine learning" pretty much years before other fields were even talking about it (until they found out they basically use the same models already), because everyone is looking for the next big idea all the time.

It's exactly the sort of old-style economists who can explain everything with their always-correct theories and basic math and then claim deference by everyone, who don't really have a place anymore - except writing articles for certain business newspapers, that is.

Anyway econ sucks, continue please.

This is not what Keynesian economics is. It's perfectly rational for the government to step up their investment in things like bridges and roads as the private sector weakens for a bit. This restores confidence in markets, and keeps money flowing through the economy.

So long as there are savings during the good times, and the projects are not wasted (even though in some extraordinary cases it would actually make sense to dig holes and fill them) ... it makes sense.

Of course the governments ability to 'save' during the good times and to necessarily spend efficiently is questionable.

"Zero Interest Rate conditions are not normal. Never in this history of humanity have interest rates been held this low for so long."

Central banks as we understand them are a very new phenom. Who's to say 'what's normal' when the very construct of our current version of monetary policy is really only a few decades old?

Maybe this is the actual normal.

Maybe because we are getting older, and working an ever decreasing share of our lives, our net productivity is going down and that's being reflected in rates?

Maybe the amount of debt hanging over every economy is a drag on productivity? (Because debt levels are high and this is new)

Maybe surpluses are being pushed into the real economy and captured by consumers who are getting a good deal, so bonds and stocks just aren't getting the great returns they were before.

Maybe we haven't had a war in a long time, which leads to fixed/stagnated human organizations, and without the opportunity for 'ground up renewal' every once and a while, we can't leap forward.

Maybe the benefits of carbon fuels + industrial revolution have mostly been had, or at least, fully priced into stocks.

Maybe we're just measuring inflation the wrong way.

So many maybes.

This could be very normal.

We probably won't know until another 50 years and then only in hindsight.

A nice article on today’s business schools philosophy: https://www.theguardian.com/news/2018/apr/27/bulldoze-the-bu...

Peter schiff and other like him have been predicting crisis, recession, bear market, and inflation since 2008 to no avail. they were wrong and have no credibility as far as I'm concerned.

You mean like in the "long" history of modern banking? This is a weak statement. The time during which governments have wielded this much influence over the minutia of the economy is surely small compared to all of the "history of humanity."

That led me to the thought that supply-side economics, as the Republicans have been pressing on us for the last 40 years, is essentially Keynesian, or at least shares with it the belief that fiscal policy can be used to heat up the economy at one point in time, with benefits realized at a later point. The difference is that Keynes's recommendation was for fiscal policy to support the economy in recessions, and then cut back on spending (or equivalently, by the above argument, raise taxes) in boom times, while the supply-siders seem to want to cut taxes irrespective of the state of the economy, and never raise them.

I'm not an economist, so I don't know how accurate this is, but I find it striking, given the degree to which Keynesian economics has come under criticism in recent years.

The von Mises Instiute is a very finge even within the Austrian tradition. They are essentially Hard Core Southern Rothbardians. They mis-characterize Mises as the perfect pre-Rothbard.

Peter Schiff in particular is not even an Austrian economist and he widely mis-characterizes the Austria Business Cycle theory.

If you want to learn actual Austrian Economics monetary economics go read Selgin, White, Horowitz. In general the GMU Austrians are far better then anything that comes out of the Mises institute.

The argument that the recession happened because of a fragility of inequality is a highly speculative theory. I have not heard a single economist make that claim.

Also, it fails as an explanation because you are explaining a momentary event with a long term situation.

Hayek when he wrote his version in the 20s deliberately did not go outside of the general equilibrium economics.

Actually his mostly in agreement with modern monetarist interpretations of monetary shock being on of the prime problems.

Read George Selgin, Walter White and Steve Horowitz if you are interested.

Hayek had a concept called secondary deflation they fit the pattern of 2008.

The problem with ABCT is that Hayek and Mises both made the mistake that they assumed to much correlation between the boom and the bust.

While Hayek had the 'secondary deflation' concept, he failed to realize that this was the far more destructive part (if mishandled by the central bank).

So Hayek did not spend enough time on that and it caused him to misunderstand the Great Depression even when his theory was actually capable of explaining it.

Economist do actually quite a bit about studying these shocks, and trying to explain what they are, where the come from and so on and so on.

Take a simple example, tomorrow there is war between Iran and Saudi Arabia and there is no more oil coming from the middle east. That would be a supply shock.

It is true that sometime we can only observe that something change and sometimes its hard to say why that happens, but that is a problem you have in all complex systems.

Your asserting that economists invent 'shocks' when the evidence doesn't fit there models is totally incorrect and leads me to believe that you don't know anything about modern economics.

Have you been living under a rock? We've been in continuous quantitative easing for over a decade. The Fed is just now started to raise rates.

  https://www.imf.org/en/Publications/WP/Issues/2016/12/30/Key-Features-of-Australian-Business-Cycles-15438

People talking like this are a strong indicator for a big blow up coming soon from my experience.

Things like income distribution, freedom of markets and others are value judgements. You first have to agree on these before you can ask an economist.

This is not physics where nature decides what's right or wrong.

Just ask - you will get at least 5 different answers to every question. Those answers will usually exclude each other.

Have you actually done this? Survey results from people who have done this (such as [1]) suggest that economists frequently do come to a majority consensus.

Furthermore, if you ask a group of software engineers how to design or implement complex software. you'll find many conflicting suggestions about which languages, libraries, programming models, databases, etc to use. Does that mean none of them know what they're doing, or does it suggest that complex systems don't have simple, straightforward solutions?

I'd like to gently suggest that you might not know as much about economists and what they know as you think you do.

_______________

1. https://people.uwec.edu/jamelsem/fte/fte/efl/teacher_stuff/a...

Questions such as "What is leaving the EU going to cost the UK economy?" Or "When will we have the next recession and what will cause it?" Are much more nuanced questions. Mostly because markets are predictive, and any new information is immediately incorporated into those predictions. It is like asking "what sort of software failure is going to cause the next major computer breach?" If we knew the answer, we would fix it and our prediction would be immediately invalidated. Computer experts were predicting the rise of cryptolocker variants when Heartbleed & Shellshock happened. Then you had everyone auditing all their OSS stacks, when out of left field we get big news from Intel on Meltdown/Spectre.

That's because you asked a normative rather than a descriptive question.

Admittedly, econ is a field where there can also be a problem with descriptive questions, but blaming the field of economics for the fact that normative questions involve subjective value judgements and every person has a different framework for making those is quite unfair.