Economists have been caught up in their own tale of hubris but have come out barely unscathed
Sometimes life plays out like fiction and such has been the case with economists. The advocates of economics had been riding high at the beginning of the century as everything seemed to be running smoothly. Economists look on a renewed sense of swagger stemming from the (mistaken) belief that fluctuations in the economy had been mastered. But as often happens in a tale of hubris, the world comes crashing down just at the point where the hero starts to get carried away. Such has been the tragedy for economists but it is the rest of us that have paid the price.
Like the rest of us, economists are liable to go too far when things go their way. This is made worse by the way in which economics can be seen as more like a religion than a science as it is difficult to prove that economic ideas are wrong. This means that faith can mean more than fact. But when faith and fact align is when the problems really begin. Such was the case for a couple of decades after economists increasingly took charge of central banks since the 1980s.
Central banks took on the mission of combating the scourge of inflation and their success with this began to build up confidence in their capabilities. Their theories led economists to believe that low and stable inflation was the key to economic wealth and well-being. But this meant that problems were allowed to fester elsewhere in the economy due to this narrow focus on consumer prices. The dot com bubble just over ten years ago should have been a wakeup call. Prices for tech stock had gotten out of hand but central banks preferred to stand back with the plan of letting the boom and bust run its course and then mop up afterwards. The mild recession that followed reaffirmed the notion that central banks could fix any problems.
No so clever after all
Economists made the most of their time in the sun. Thinking that they had all of the answers, economists started applying their ideas to other topics. Economists also increasingly plugged their ideas to the public fuelled by the claim that economics could explain almost everything (see the photo above). Thinking that they knew it all, economists weren’t afraid to let other know about it. As is typical for a Greek tragedy, it is precisely at this point (where the hero thinks that the world has been conquered) that everything comes crashing down.
The turning point in this tale of woe came with the global financial crisis. Economists were not just unfortunate victims of unforeseen circumstance but were the architects of their own downfall. Their conviction in their own ideas prompted economists at central banks to overlook growing distortions in the economy. Interest rates were kept too low for too long which allowed for the levels of debt to get out of hand. The dogma of the almighty central bank also led to complacency at banks that chased after profits without worrying about risks in the economy.
Skipping over the lesson of the tale
It does not take the wisdom of hindsight to see that catastrophe was just around the corner. But it does help with realizing that the success that central banks achieved may have been more due to luck than clever management. The surge in exports from China was always going to keep prices down whatever central banks did. Inflation may not even be a major concern any more considering that prices did not jump despite the surge in lending heading into the global financial crisis or with central banks printing loads of cash as part of quantitative easing.
The saga proved to be something similar to the tale of Icarus. Emboldened economists also flew too close to the sun but it was their ideas that went into eventually went into meltdown. But the main difference is that, while economists have fallen from grace, it was others who got badly burnt. This would be easier to take if economists were busying themselves coming up with better ideas to allow for less turbulence in the economy. But economists are slow learners and policy is still guided by the same old ideas. Change may happen and hopefully it does before we all crash and burn again.