Later On

A blog written for those whose interests more or less match mine.

Bad economics in the current crisis

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Dean Baker in the Guardian:

It is often said that the there are few forces as destructive as the power of bad economics. Rarely has this been more clearly demonstrated than in the current crisis.

While the bankers’ greed fed the housing bubble, the incompetence and corruption of the economics profession allowed the world’s largest financial bubble to grow unchecked, until its inevitable collapse wrecked the economy. Remarkably, the economists who got everything wrong as the bubble was expanding, are still being given the opportunity to get everything wrong as we try to dig out from the wreckage.

Even though most of the "best" economists in the world did not see it, the story of the bubble and its collapse was in fact extremely simple. The recovery from the stock market crash in 2001 was driven by the growth of the housing bubble.

In the United States, the unprecedented run-up in house prices fueled the economy by causing a construction boom, and even more importantly, a consumption boom, as the saving rate fell to zero. While many prominent economists lectured the country on the need to save and to end spendthrift ways, those who knew economics pointed to the well-known housing wealth effect.

Households spend in part based on their housing wealth. The predictable result of the creation of $8tn in housing bubble wealth ($110,000 per homeowner) was a massive consumption boom on the order of $400bn to $600bn a year. The problem was not people’s spendthrift ways; the problem was that economic policymakers allowed a huge bubble to develop. People treated this bubble wealth as real wealth, and responded exactly as economic theory would predict: they spent like crazy.

With house prices falling rapidly back to earth, the housing construction boom is now a bust and saving rates are returning to normal…

Continue reading.

Written by Leisureguy

21 April 2009 at 12:52 pm

Posted in Business, Daily life

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