DSGE
VIP Member
- Dec 24, 2011
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They can't predict recessions either.
It's also my impression that most economists are clueless about the effect of valuations on markets. I can't predict where markets will go in the near-term but I can predict with a high degree of accuracy where they will go in the long-term when valuations are distorted. Economics as a profession failed enormously understanding the past two bubbles because they didn't understand the role of valuation on future asset prices and what it would mean for the economy.
What do you mean by this?
I mean why would anybody think that the financial crisis in 2008 has anything at all to do with the current state of the economy?
For a number of reasons. First, you have to work off the excessive bad debt in the banking system before we close the output gap. We haven't done that yet, though we're getting close. Second, it has changed the behavior of corporations, who after not one but two near-death experiences over the past decade, are hoarding cash instead of investing it. Third, you have retail investors who have been spooked even worse than companies, and have pulled hundreds of billions of dollars out of the stock market, and have ratcheted up savings since the crisis instead of spending, though again, that might be changing. Finally, you have a Federal Reserve and its ZIRP, which is affecting risk premia and almost certainly causing distortions in capital markets, which is great for borrowers but sucks for savers. BB bonds are yielding 5%. With inflation at 2% and a default rate of 2%, that means the real rate on junk bonds is 1%. Crazy. Risk is almost certainly being mispriced as the Fed attempts to inflate away the debt. That distorts capital allocation in the economy.
Except that the anatomy of this slump isn't the regular "investment is far below trend" story. When you look at the business cycle accounting, investment isn't the problem at all. Almost all of the slump comes from a huge decline in labour input. The financial crisis story would be nice if this were a typical post-war investment cycle, except the data very clearly show that there is a disruption in labour markets, not in the allocation of credit.