Sun Jul 12th, 2009 at 11:47:25 AM EST
It was interesting to see Dirk Bezemer's recent paper hit the top of the charts at the Seeking Alpha site
John Lounsbury - No-one saw it coming
Dirk is (like me) a member of the Gang 8 "Creditary Economics" Yahoo list.
A research paper, published in June by Dirk J. Bezemer, Groningen University, addresses this question and says the answer is that many saw it coming but those with the power to act did nothing. Bezemer contends that the problem is that economic policy is executed using macro equilibrium models and what is needed to establish economic policy that can anticipate crises, such as we have now, and take actions to head them off, are micro accounting cash-flow models. The entire paper can be read here.
No One saw this coming
First, let me show you a table that Bezemer has prepared listing some of those who saw it coming. Table is in two parts for graphics processing reasons.
Lounsbury's excellent review of Bezemer's paper then summarises Bezemer's key point that the conventional Washington University Macro Model is actually detached from the real world. (my bold)
The "WUMM" is a quarterly econometric system of roughly 600 variables, 410 equations, and 165 exogenous variables. Figure 4 presents a schematic overview. The boxes indicate the variables included in the model. In the present context, the important observation is that all are real-sector variables except the money supply and interest rates, the values of which are in turn fully determined by real-sector variables. In contrast to accounting models, the financial sector is thus absent (not explicitly modelled) in the model.
In other words, the elements in the economy that are at the root cause of the current crisis are absent from the models of economic activity that are used to guide economic policy. The entire financial sector is absent. The very elements that have siphoned the life blood out of the economy have been completely off the radar screen. The FIRE (finance, insurance and real estate) was hidden behind a shield of invisibility, just pumping money into their coffers until the real economy bled out.
Bezemer discusses the result:
Perhaps because of this omission,Macroeconomic Advisers chairman Joel Prakken could tell Reuters as late as September 2007 that the probability of recession was less than 50%, a "slightly higher risk than it was a month ago but not a dominant risk." This was well after Godley and associates in April 2007 had predicted output growth "slowing down almost to zero sometime between now and 2008" and in November 2007 forecast "a significant drop in borrowing and private expenditure in the coming quarters, with severe consequences for growth and unemployment".
(Note: Godley is one of the people Bezemer has singled out as having analyzed and forecast the current crisis correctly.)
Bezemer concludes that the reason this condtion exists is that macro equilibrium theory dominates academia and has become institutionalized in governments. He defines the objective of his paper to encourage the merging of accounting and economic theory. He has some interesting things to say about factors that are missing from the macro equilibium view, factors highlighted by John Maynard Keynes.
Most of the analysts discussed in the Appendix reject rational equilibrium on the basis of arguments related to economic psychology and to the Keynesian notion of `radical uncertainty' (as opposed to calculable risks).
Keen, in a 1995 article titled `Finance and Economic Breakdown' explained that "Keynes argued that uncertainty cannot be reduced to `the same calculable states as that of certainty itself' whereas the kind of uncertainty that matters in investment is that about which "there is no scientific basis on which to form any calculable probability whatever. We simply do not know" (Keynes, 1937:213-24).
Keynes argued that in the midst of this incalculable uncertainty, investors form fragile expectations about the future, which are crystallized in the prices they place upon capital sets, and that these prices are therefore subject to sudden and violent change.
The reference to Keen is to Steve Keen.
Bezemer's paper includes Michael Hudson's diagrammatic representation of the economy.
This has a simplicity and elegance that appeals to a Bear Of Little Economic Brain like me.
In essence, the assembled panoply of neoclassical Nobel prize winners; their camp followers, and MSM cheerleaders did not connect the FIRE area in pink to the rest of the Economy.