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The Best Science Writing Online 2012
Showcasing more than fifty of the most provocative, original, and significant online essays from 2011, The Best Science Writing Online 2012 will change the way...
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The U.S. political-economic system gives evidence of a phenomenon known as “instrument instability.” Policy makers at the Federal Reserve and the White House are attempting to use highly imperfect monetary and fiscal policies to stabilize the national economy. The result, however, has been ever-more desperate swings in economic policies in the attempt to prevent recessions that cannot be fully eliminated.
President Barack Obama’s economic team is now calling for an unprecedented stimulus of large budget deficits and zero interest rates to counteract the recession. These policies may work in the short term but they threaten to produce still greater crises within a few years. Our recovery will be faster if short-term policies are put within a medium-term framework in which the budget credibly comes back to balance and interest rates come back to moderate sustainable levels.
Looking back to the late 1990s, there is little doubt that unduly large swings in macroeconomic policies have been a major contributor to our current crisis. The lessons of the high inflation of the 1970s had supposedly chastened policy makers against trying to fine-tune the economy. The quest for never-ending full employment had contributed to high inflation in that decade, which required years of economic pain to wring out of the system. Monetary policies thereafter were supposed to be “steady as she goes,” not trying to smooth out every fluctuation and business cycle in the economy.
During the decade from 1995 to 2005, then-Federal Reserve chairman Alan Greenspan over-reacted to several shocks to the economy. When financial turbulence hit in 1997 and 1998—the Asian crisis, the Russian ruble collapse and the failure of Long-Term Capital Management—the Fed increased liquidity and accidentally helped to set off the dot-com bubble. The Fed eased further in 1999 in anticipation of the Y2K computer threat, which of course proved to be a false alarm. When the Fed subsequently tightened credit in 2000 and the dot-com bubble burst, the Fed quickly turned around and lowered interest rates again. The liquidity expansion was greatly amplified following 9/11, when the Fed put interest rates down to 1 percent and thereby helped to set off the housing bubble, which has now collapsed.
We need to avoid reckless short-term swings in policy. Massive deficits and zero interest rates might temporarily perk up spending but at the risk of a collapsing currency, loss of confidence in the government and growing anxieties about the government’s ability to pay its debts. That outcome could frustrate rather than speed the recovery of private consumption and investment. Deficit spending in a recession makes sense, but the deficits should remain limited (less than 5 percent of GNP) and our interest rates should be kept far enough above zero to avoid wild future swings.
We should also avoid further gutting the government’s revenues with more rounds of tax cuts. Tax revenues are already too low to cover the government’s bills, especially when we take into account the unmet and growing needs for outlays on health, education, state and local government, clean energy and infrastructure. We will in fact need a trajectory of rising tax revenues to balance the budget within a few years.
Most important, we should stop panicking. One of the reasons we got into this mess was the Fed’s exaggerated fear in 2002 and 2003 that the U.S. was following Japan into a decade of stagnation caused by deflation (falling prices). To avoid a deflation the Fed created a bubble. Now the bubble has burst, and we’ve ended up with the deflation we feared! Panics end badly, even panics of policy; more moderate policies will be safer in the medium term.
There is little reason to fear a decade of stagnation, much less a depression. The U.S. economy is technologically dynamic and highly flexible. The world economy has tremendous growth potential if we don’t end up in financial and trade conflict, and if the central banks ensure adequate liquidity to avoid panicky runs on banks, businesses and sovereign borrowers. We should understand that the Great Depression itself resulted from a horrendous run on the U.S. banking system in an era without deposit insurance, and when the Fed and Congress did not understand the critical role of a lender of last resort. Moreover, the Gold Standard of the 1930s, which we long ago abandoned, acted like a kind of straightjacket on monetary policies.
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24 Comments
Add CommentThe budget is completely busted unless we can grow very rapidly. We need solid incentives to invest wisely and with a long term focus. The ability of the economy to generate jobs depends upon the abiltiy of business to generate adequate profits. The willingness of investors to part with their capital depends upon a coherent, sensible and fair incentive system, none of which we have put in place as yet. Look at Medicare's pricing scheme for 2010. An increase of 0.5%. No profitabilty no jobs. We are headed for a train wreck. Also look at today's NY Post and the benefits the City are liable for to retirees. We have made too many promises which we can not keep.
Reply | Report Abuse | Link to thisIncreasing instability increases the power of the political class – they determine who succeeds and who fails. It is not in their interest to allow the new innovative businesses to put the old friends and supporters out of business. This means that the excellent advise of this column will fall on deaf ears.
Reply | Report Abuse | Link to thisNote that the productivity is increasing, which means that most of what and who is being dumped are of low productivity. If only the pubic sector could use this "crisis" to pump the bottom 10% of their staff and get a productivity jump.
I truly don't understand how an economist could blame the start of the internet bubble or the start of the housing bubble on Federal Reserve actions.
Reply | Report Abuse | Link to thisThere are some great points in the article and the Federal Reserve isn't always correct. But the entire pargraph on bubble is pure nonsense.
Being that economic articles don't commonly appear in SA is it possible that paragraph was editorily butchered and the meaning changed?
Reply | Report Abuse | Link to thisWhy are you, Mr. Sachs, not on Pres. Obama's economic team? If you were, and your advise was implemented, we all would be in a much better economical condition.
The way I see it, the reason we're in the predicament we're in is because corporations have forgotten which side their bread is buttered. Day one of Economics 101: No profit is realized until a sale has been made. It makes no difference how much (or how little) you pay for materials, shipping and labor if nothing gets sold. Too much focus has been on cutting costs. While this is understandable, it doesn't do you any good if you cause your customers to become unemployed.
Reply | Report Abuse | Link to thisiconoclasm;
Reply | Report Abuse | Link to thisThe one thing that is absolutely required for a bubble to occur is credit. Credit can be supplied by vendors (tulip bubble), or by brokerage firm margin accounts (dot.com bubble), or by mortgage companies (housing bubble). Credit is clearly within the Federal Reserve area of responsibility; the FOMC buys and sells bonds every day in order to manage interest rates, the FED sets reserve requirements for banks, the FED sets margin requirements for brokerage accounts. The Federal Reserve did not create the problems we have today all by themselves, but they bear a significant portion of the blame.
KurtH. Right you are. The job of the FED is to take away the punch bowl and they failed at the critical moment in each bubble. Their problem is the price index they focus on. They purposely avoid the most sensitive indicators like energy and even leave out major items like the price of housing or stocks. The result is that they are always too late because the "stable" items only start to move after inflation or deflation in the real money supply (which includes such things as RE and stock loans) is already well underway.
Reply | Report Abuse | Link to thisYou don't get it, diroha. Look where unsubstantiated growth gets us! Right now the policy should be toward STABILIZATION, not unconstrained growth which is not supported by reality. This is not so much a depression as a correction. When the market is not based on the true value of a company (assets, income, etc.) but rather on that company's value as an INVESTMENT, then these bubbles will develop and burst. The reason that we have the current crisis is fully explained by the commercial for E-trade where the baby buys stock, then barfs. Cramer only makes it worse by making people think they are smart enough to trade with the big boys. People like you need to be taxed at high levels because you are STUPID and GREEDY. Greed is the reason that this happens. And the common people that you despise are the ones that made you rich. By the way, I'm a retired $400/hr. attorney with a big, full safe under my house because I KNOW people like you can't be trusted. Of course you are from New York.
Reply | Report Abuse | Link to thisYes, but it time to ask questions of the greater interest to society and restructure accordingly. Societies are free to make their own choices. They need not live with some religious-like economic ideology that spend most of its times saying what is impossible rather than what is possible and desirable for that matter. Inherited wealth and domination of the super wealthy is not inevitable. But rather it is tolerated, coddled and protected by the system such as it is today. Today those who actually work for a live and produce things of value are taxed at twice the rate of those who live off the gains of unearned income from raw speculation. The policies of the late 70s broke the back of wage inflation only to encourage asset inflation. Since that time real income has been stagnant or worse, but the housing market misbehaved by inflating horribly and the stock market did the same. Does anybody seriously believe that American companies today produce more than 30 years ago - no, the balance of trade says otherwise. But 401Ks have stolen a generations retirement funds to proper up a speculators den. The "value" that the financial "industry" has "created" is by in large purely asset inflation. Ultimately all that fake symbolic wealth has to rest on something real. When wages cannot support absurd prices, those prices ultimately must collapse. When unemployment wipes out wages, there must be a crash. This binge of super wealth has brought down the house on all of use, so to speak. So why do we want to rescue financial speculators? Why not turn the banks into mutual organizations like credit unions? Taxes are way too low where the unreal wealth has been allowed to accumulate. Why do we act like only the wealthy should get medical care at any price, why the rest of us literally suffer? This is a choice and we need imagination to realize the problem runs deeper than returning to business as usual and need to think of new business and social models. The combination by government and central bankers to depress wages and encourage asset inflation was not just risk it inevitably had to end in disaster. Ironically the true class warriors of super wealth have brought chaos to all of us. I believe also that in time WTO will be seen to be as bad a mistake, maybe worse, than Smoot-Hawley, albeit in the opposite way. Both distorted the notion of collective gains between societies that national competitive advantage that should underlie all free trade decisions. Both wreaked havoc on the greater good of the entire world. Time to seek a balance in all things without fear of offending the false gods of discredited economic theory.
Reply | Report Abuse | Link to thisYes, but it time to ask questions of the greater interest to society and restructure accordingly. Societies are free to make their own choices. They need not live with some religious-like economic ideology that spend most of its times saying what is impossible rather than what is possible and desirable for that matter. Inherited wealth and domination of the super wealthy is not inevitable. But rather it is tolerated, coddled and protected by the system such as it is today. Today those who actually work for a live and produce things of value are taxed at twice the rate of those who live off the gains of unearned income from raw speculation. The policies of the late 70s broke the back of wage inflation only to encourage asset inflation. Since that time real income has been stagnant or worse, but the housing market misbehaved by inflating horribly and the stock market did the same. Does anybody seriously believe that American companies today produce more than 30 years ago - no, the balance of trade says otherwise. But 401Ks have stolen a generations retirement funds to proper up a speculators den. The "value" that the financial "industry" has "created" is by in large purely asset inflation. Ultimately all that fake symbolic wealth has to rest on something real. When wages cannot support absurd prices, those prices ultimately must collapse. When unemployment wipes out wages, there must be a crash. This binge of super wealth has brought down the house on all of use, so to speak. So why do we want to rescue financial speculators? Why not turn the banks into mutual organizations like credit unions? Taxes are way too low where the unreal wealth has been allowed to accumulate. Why do we act like only the wealthy should get medical care at any price, why the rest of us literally suffer? This is a choice and we need imagination to realize the problem runs deeper than returning to business as usual and need to think of new business and social models. The combination by government and central bankers to depress wages and encourage asset inflation was not just risk – it inevitably had to end in disaster. Ironically the true class warriors of super wealth have brought chaos to all of us. I believe also that in time WTO will be seen to be as bad a mistake, maybe worse, than Smoot-Hawley, albeit in the opposite way. Both distorted the notion of collective gains between societies that national competitive advantage that should underlie all “free trade” decisions. Both wreaked havoc on the greater good of the entire world. Time to seek a balance in all things without fear of offending the false gods of discredited economic theory.
Reply | Report Abuse | Link to thisPinetree, did we say the same thing? Your eloquence can sometimes disguise your true meaning, or at least make it hard to find and define. I think we agree that GREED is the root of this economic problem. Facing the REALITY of our economy is the only solution. We have outsourced our once dominant manufacturing economy. Did America forget that manufacturing is what won the civil war? Pulled us out of the great depression? Made us the great nation that has been raped and pillaged by the globalization movement? Real Americans buy American (I wrote this in permanent ink on the tailgate of my Chevy pickup and I love making the Toyota drivers squirm). We have made the Chinese economy more stable than ours. And we are suffering for it. AMERICANS...PAY OFF YOUR MORTGAGES, BUY AMERICAN PRODUCTS, SUPPORT BRINGING HOME OUR TROOPS TO PROTECT OUR BORDERS, END FOREIGN AID, FORGET THE WAR ON DRUGS, SAVE RATHER THAN SPEND...don't keep us from the greatness we deserve.
Reply | Report Abuse | Link to thisRight on. Save rather than spend and watch more people get employed to produce what you are not buying.
Reply | Report Abuse | Link to thisif we follow Quran then no body will ever die hungry,
Reply | Report Abuse | Link to thisit is human policies which make poor more and more poor... and the rich; richer.
www.QuranEnglish.com (complete 114 chapter with english translation available)
http://www.harunyahya.com/en.m_video_index.php
check this link if you think evolution is true theory...life is not simple as is thought by human...the human which calls DNA "the code" and still says life is a work of chance...
In the current world financial crisis we have now, I trully wish that there is someone out there who could show the solution is as simple as E=mc2. Yes simple, but tremendously powerfull. Unfortunately, an Einstein equivalent is not available for our world financial woes right now. Instead we are stuck up with a huge crisis we have never heard and met before. Correct me if I am wrong; The whole summary of what President Obama is trying to say is, we are in a situation where more than ever before, fewer people or groups possessed most of the financial instruments and they are not moving. There are so many reasons why they are not moving.
Reply | Report Abuse | Link to thisForemost of them all is that there is no value to chase out there worth investing. They are all risky or suicidal. It is like a thief who could recognize another thief miles away. Meanwhile, while the monies are not moving, common people are losing means to participate in the market. The market is shrinking fast. Decades of widening gap between the rich and poor have contributed heavily to this problem. Free market have run amock with unfettered greed. Artificial or pseudo-market were brought to form so that those on top of pecking order could also create their artificially high market value. And now almost everybody knows that artificial market can not go up forever. After all reality is finite. It is like the infinite fractions between zero and one. zero and one is finite.
The big question now is, how do we solve it? Looks like there is an abundance of sayers out there. Unfortunately, most of those reasonings are flawed and myopic in my opinion. Therefore, the first step to the solution is to select a leader who could see and analyze the situations both globally and in details internally. Few people has that capacity. Reasonable intelligence is required. I sincerely believe President Obama has all this essential qualities and probably more. There is probably a lot of brilliant specialist out there and I hope they would make positive contribution to the solutions. Good luck to all of us!
It is about time they realize we do not need the Federal Reserve, which is a private corporation, trying to run our country. The free markets can determine what interest rates should be set at. Wake up America and abolish the Non tax paying Federal reserve.
Reply | Report Abuse | Link to thisYes and if we follow the Quran we would have to kill all the infidells so more food would be for us.
Reply | Report Abuse | Link to thisJust a clarification: the Y2K issue was only a "false alarm" due to folks like me who worked in IT at the time to correct the issues. The problem was solved before it became a problem, that doesn't eliminate the fact that doing nothing would have lead to the problem. Would it have been as disastrous as some believe? No. But, there would have been world-wide incidents had it been allowed to occur.
Reply | Report Abuse | Link to thisSo what this article says is that the previous group of greed-motivated "capitalists" got us into this mess but the current group of eager-to-help "stimulus" promoters is off to a poor start. All because both groups (political office holders) are thinking only in terms of their favorite (but flawed) "pure ideology."
Reply | Report Abuse | Link to thisWe can only hope that we'll have to suffer a few months before the current administration gets this "stabilizing policies" message and does some helpful, stabilizing course corrections.
Given that few people noticed that our direction over the past 25 years has been toward "popular ideologies" supporting unrealistic (personal) get rich quick schemes, I can only add that we have to find a way to remind each generation of the dangers of such foolishness. We also have to put forth the idea that politics must promote: leadership, stewardship and statesmanship versus peddling rants and name-calling.
As a former purchasing exec, I want to know: whatever happened to consumerism? That's the only "ism" we should be concerned with because it emphasizes the key element of economic trust: giving and getting value for value.
“The need for Stable Policies” (Jeffrey Sachs, March 2009) expressed a belief commonly heard in these times of economic hardship, but not the prevailing opinion of most reputable economists. Much of what Mr. Sachs had to say about this economic crisis regarding the likelihood of a turnaround in "another year or two" without an economic stimulus package and other changes is without meaningful justification, although he did mention that “… the central banks [need to] ensure adequate liquidity...” Even without this statement, he fails to realize the root cause of the problem started in the housing finance industry, that the banks were major contributors to the problem with their lack of professional business standards and desire for unbridled profits, and that until the problem in the housing market is negated, a meaningful recovery, not only in the United States but worldwide, will either not occur or will be significantly delayed. Further, his comments would have been more appropriate, although still substantially wrong, if made last fall rather than here at the first of March 2009.
Reply | Report Abuse | Link to thisIt is disappointing that Scientific American would give voice to an off-center opinion about economics. If I want economic opinion, I’ll look to respected economic journals.
Tom
I think you should all read the Bible, there are many financial principles that would help us out of this mess. It may be too late for that now, but there are serious applications for stable business practices. I am no economist, but I do use google for more than porn!!!
Reply | Report Abuse | Link to thisSingapore has become the powerhouse of the Far East overnight by eliminating the cap gains tax and the corporate tax. The basis of stable business growth and hence a stable economy is to provide incentives for business investment and employment. Thus, the only thing that can save us now is to follow the example of eliminating cap gains and reducing the corporate payroll tax by 50% to 80%. Our government speaks of the need to spend hundreds of billions to rescue the economic mess created by excessive spending but ignores the fact they take billions of dollars from citizens and business every week in the form of payroll tax. The only stable method of stimulating the economy is to let people keep more of their own money and spend it. The only stable method to promote business growth is to reward investment in business. The New Deal did into work. We had double digit unemployment throughout the 30s and our economy was only revitalized by the end of a war that breathed fresh vitality into the national psyche and a world that was ready to buy the products of our industrial machinery ramped up out of the necessity of war.
Reply | Report Abuse | Link to thisThe problem with our government leaders is that they are devoted to a dead Marxist philosophy. As Obama said in the debates; he will not lower taxes even though there is a benefit, because in his paradigm, this is not "fair". But there is nothing fair about driving our economy into the ground!
DEWEAVER wrote:
Reply | Report Abuse | Link to this"If only the pubic sector could use this "crisis" to pump the bottom 10% of their staff..."
Pubic sector? Pump the bottom 10% of their staff? Didn't Clinton try that already?
This is a great synopsis of the downside of overly intrusive government policy. (I am suprised to see it comming from my all-time favorite magazine who's economic policy can usually be summed up as "spend more money on science.")
Reply | Report Abuse | Link to thisHow can the current crisis be a supprise when so many people knew that the fed was propping up the dollar with unrealistic housing prices? Although I have little faith on Wall Street when it comes to honestly reporting conditions this can hardly even be viewed as the product of backroom dealings. All the basic facts were out there for us to see! Were we all drinking our own cool-aide, whatever that means?
Very good job on this summary. The fourth paragraph are words from my own mind. But in the sixth paragraph you say we need to avoid further tax cuts? What wild fantasy world to you see that looming on the horizon of? We have a democratic president elected by wild majority and a democratic congress. Does that sound like a harbinger of small government and lower taxes to you? Oh and throw in trillions of dollars of spending in the first months. Does that make tax cuts more likely? We need to stop talking about governments role in the economy and start talking about economy's role in the government or this value crisis will only deepen.
RE: Prof J Sachs article, The Need for Stable Policies. (Scientific American, March 2009, p 20.)
Reply | Report Abuse | Link to thisWhether or not large swings in macroeconomic policy contributed to the present crisis, the inherent instability of competitive markets played a large role. Prof. Sachs' difficulties arise because economics is not a science. In the essay that defined modern economics as the science of constrained choice, Lord Robbins cemented into place the philosophical position (apriorism) of his predecessors. This claims that, when humans study human behaviour, they automatically have special insights into their material denied to natural scientists. These insights are (supposedly) totally reliable; and on this sure foundation, mathematics and logic can erect a body of generalisations whose substantial accuracy are open to question only by the ignorant or the perverse. Working economists may not be conscious of the reasons behind their practice, but this principle has neither been rescinded nor replaced a recent British economist claimed that economics is a branch of logic (and logic, of course, cannot be wrong). Science thrives on doubt; and ultimately, no theoretical postulate is protected from empirical evidence but not so in economics.
Despite the growing concern within the profession, many economists remain convinced that their simple, static models tell us the essential truth about economic systems. This is why we do not have theory that would guide us through this turbulence. The theory that tells Prof. Sachs that the crisis must have sprung from interference with the market, and that minimal intervention will see us safely through, actually created the crisis. The promise of earthly Nirvana via laissez-faire depends (inter alia) on the assumption that all parties to transactions have full, equal knowledge. However, that certainly did not apply during the initial mis-selling of sub-prime mortgages, and the crisis was triggered by the evaporation of assets from the banking system when those mortgages collapsed. (You cannot blame the US housing bubble or its collapse primarily on government intervention, since both sorts of phenomena readily happen without it.)
Worse yet: Sachs theory says nothing about how new markets buyers, sellers, the right technology and plant capacity are born; how long it would take them to reach that state of equilibrium on which the Nirvana-theorems depend; or how real, unstable prices relate to Nirvana-prices. Nevertheless, economists had to believe that markets could price large volumes of