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Scott Sumner Says I Was Right Back in 2008...

Scott Sumner:

TheMoneyIllusion » Brad DeLong was right: [Warning, this post will initially seem sarcastic, but I'm dead serious.] In July 2008 Brad DeLong made the  following astute prediction:

The chance that American taxpayers will actually lose any money if Ben Bernanke and Henry Paulson decide that Fannie and Freddie need government support is very low:

  • The interest payments they have coming in are greater than the interest payments they have going out.

  • Their government guarantee is itself a very valuable asset that they have made a lot of money off of in the past and will make more off of in the future.

  • They are not even in liquidity trouble–unless they begin to have problems rolling over their discount notes…

  • As long as it is generally understood that they are too big to fail, they should not even have liquidity problems–absent a depression that bankrupts many currently-solvent homeowners, that is.

I’d guess that 99% of readers would find DeLong’s prediction incorrect.  That’s because most people are excessively impressed by unconditional forecasts.  When dealing with business cycles and financial markets only conditional forecasts matter.  People win the lottery every day.  I’m no more impressed by an economist making an unconditional prediction that turns out correct than I would be if my plumber won the lottery.

DeLong correctly realized that a depression could push a lot of otherwise-solvent homeowners over the edge.  And of course that’s exactly what happened; the biggest drop in NGDP since the 1930s began the very month DeLong made the prediction.

I’ve had a hard time convincing people that much of the financial crisis was caused by falling NGDP.  Or that with better Fed policy the banking crisis would have been far milder.  I don’t know if DeLong agrees with me, but based on the logic of his prediction he ought to.  After all, the very same factor that caused the GSEs to end up much worse off than expected, also damaged the rest of the financial system.  That’s not to say that there weren’t many problem loans that were unrelated to the fall in NGDP, and I won’t deny that some banks (plus Greece) would have failed with even perfect monetary policy.  But the NGDP collapse made the crisis far worse than it should have been.

I’d guess DeLong made the same mistake as I did.  I suspect he assumed that a Fed chairman who has written papers criticizing the BOJ for not showing “Rooseveltian resolve” in fighting against inadequate NGDP growth, would be unwilling to preside over the greatest NGDP collapse since the 1930s.

I blame myself.  As Ball recently showed, the warning signs were there.  Ever since 2003 Bernanke was increasingly absorbed into Fed-think, which doesn’t allow for price level or NGDP commitments that might later embarrass the Fed.

PS.  After I completed this post I ran across Paul Krugman’s Playboy interview:

PLAYBOY: Were crimes committed here, and should people be in jail?

KRUGMAN: It’s hard for me to believe there were no crimes. Given the scale of this, given how many corners were being cut, some people must have violated laws. I think people should be in jail partly because I’m sure crimes were committed and partly because the lack of accountability is a serious problem. Something terrible happened and nobody has been held accountable. The public is angry, and a lot of the anger is being directed at the wrong targets.

I wonder how commenters will react to this quotation.  His answer reminds me of  the film “12 Angry Men.”   And also that if I’m a banker I don’t want Krugman on the jury.  But I do very much identify with the final sentence of that answer.  There are lots of scapegoats out there, and sometimes it’s easier to see the real villains in another culture, where you can be more dispassionate.  Krugman underestimates how much of our recession was caused by the Fed.  But there’s no doubt he knows who’s to blame for the eurozone recession:

PLAYBOY: Greece and Italy are in financial chaos. Are the euro and the European Union dead? Is that a good thing or a bad thing, or should we even care?

KRUGMAN: It’s on the edge. They need drastic action—basically printing a lot of money for the time being—and it looks highly doubtful that they’ll do it.

DeLong is right that much of our debt crisis is due to falling NGDP and Krugman’s right that the eurozone’s big problem is excessively tight money.

Now that both Keynesians and market monetarists agree on the problem, let’s start working on solutions.