In defence of the dismal science - Robert Lucas - 經濟

In defence of the dismal science
Robert E. Lucas

Aug 6th 2009
From The Economist print edition
http://www.economist.com/businessfinance/displayStory.cfm?story_id=14165405

In a guest article, Robert Lucas, the John Dewey Distinguished Service
Professor of Economics at the University of Chicago, rebuts criticisms that
the financial crisis represents a failure of economics

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THERE is widespread disappointment with economists now because we did not
forecast or prevent the financial crisis of 2008. The Economist’s articles
of July 18th on the state of economics were an interesting attempt to take
stock of two fields, macroeconomics and financial economics, but both pieces
were dominated by the views of people who have seized on the crisis as an
opportunity to restate criticisms they had voiced long before 2008.
Macroeconomists in particular were caricatured as a lost generation educated
in the use of valueless, even harmful, mathematical models, an education that
made them incapable of conducting sensible economic policy. I think this
caricature is nonsense and of no value in thinking about the larger
questions: What can the public reasonably expect of specialists in these
areas, and how well has it been served by them in the current crisis?

One thing we are not going to have, now or ever, is a set of models that
forecasts sudden falls in the value of financial assets, like the declines
that followed the failure of Lehman Brothers in September. This is nothing
new. It has been known for more than 40 years and is one of the main
implications of Eugene Fama’s “efficient-market hypothesis” (EMH), which
states that the price of a financial asset reflects all relevant, generally
available information. If an economist had a formula that could reliably
forecast crises a week in advance, say, then that formula would become part
of generally available information and prices would fall a week earlier. (The
term “efficient” as used here means that individuals use information in
their own private interest. It has nothing to do with socially desirable
pricing; people often confuse the two.)

Mr Fama arrived at the EMH through some simple theoretical examples. This
simplicity was criticised in The Economist’s briefing, as though the EMH
applied only to these hypothetical cases. But Mr Fama tested the predictions
of the EMH on the behaviour of actual prices. These tests could have come out
either way, but they came out very favourably. His empirical work was novel
and carefully executed. It has been thoroughly challenged by a flood of
criticism which has served mainly to confirm the accuracy of the hypothesis.
Over the years exceptions and “anomalies” have been discovered (even tiny
departures are interesting if you are managing enough money) but for the
purposes of macroeconomic analysis and forecasting these departures are too
small to matter. The main lesson we should take away from the EMH for
policymaking purposes is the futility of trying to deal with crises and
recessions by finding central bankers and regulators who can identify and
puncture bubbles. If these people exist, we will not be able to afford them.

The Economist’s briefing also cited as an example of macroeconomic failure
the “reassuring” simulations that Frederic Mishkin, then a governor of the
Federal Reserve, presented in the summer of 2007. The charge is that the Fed’
s FRB/US forecasting model failed to predict the events of September 2008.
Yet the simulations were not presented as assurance that no crisis would
occur, but as a forecast of what could be expected conditional on a crisis
not occurring. Until the Lehman failure the recession was pretty typical of
the modest downturns of the post-war period. There was a recession under way,
led by the decline in housing construction. Mr Mishkin’s forecast was a
reasonable estimate of what would have followed if the housing decline had
continued to be the only or the main factor involved in the economic
downturn. After the Lehman bankruptcy, too, models very like the one Mr
Mishkin had used, combined with new information, gave what turned out to be
very accurate estimates of the private-spending reductions that ensued over
the next two quarters. When Ben Bernanke, the chairman of the Fed, warned
Hank Paulson, the then treasury secretary, of the economic danger facing
America immediately after Lehman’s failure, he knew what he was talking
about.

Mr Mishkin recognised the potential for a financial crisis in 2007, of
course. Mr Bernanke certainly did as well. But recommending pre-emptive
monetary policies on the scale of the policies that were applied later on
would have been like turning abruptly off the road because of the potential
for someone suddenly to swerve head-on into your lane. The best and only
realistic thing you can do in this context is to keep your eyes open and hope
for the best.

After Lehman collapsed and the potential for crisis had become a reality,
the situation was completely altered. The interest on Treasury bills was
close to zero, and those who viewed interest-rate reductions as the only
stimulus available to the Fed thought that monetary policy was now exhausted.
But Mr Bernanke immediately switched gears, began pumping cash into the
banking system, and convinced the Treasury to do the same. Commercial-bank
reserves grew from $50 billion at the time of the Lehman failure to something
like $800 billion by the end of the year. The injection of Troubled Asset
Relief Programme funds added more money to the financial system.

There is understandable controversy about many aspects of these actions but
they had the great advantages of speed and reversibility. My own view, as
expressed elsewhere, is that these policies were central to relieving a
fear-driven rush to liquidity and so alleviating (if only partially) the
perceived need for consumers and businesses to reduce spending. The recession
is now under control and no responsible forecasters see anything remotely
like the 1929-33 contraction in America on the horizon. This outcome did not
have to happen, but it did.

Not bad for a Dark Age

Both Mr Bernanke and Mr Mishkin are in the mainstream of what one critic
cited in The Economist’s briefing calls a “Dark Age of macroeconomics”.
They are exponents and creative builders of dynamic models and have taught
these “spectacularly useless” tools, directly and through textbooks that
have become industry standards, to generations of students. Over the past two
years they (and many other accomplished macroeconomists) have been centrally
involved in responding to the most difficult American economic crisis since
the 1930s. They have forecasted what can be forecast and formulated
contingency plans ready for use when unforeseeable shocks occurred. They and
their colleagues have drawn on recently developed theoretical models when
they judged them to have something to contribute. They have drawn on the
ideas and research of Keynes from the 1930s, of Friedman and Schwartz in the
1960s, and of many others. I simply see no connection between the reality of
the macroeconomics that these people represent and the caricature provided by
the critics whose views dominated The Economist’s briefing.


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