Economists, as a group, have been criticized for not predicting the collapse of the economy in 2007 and 2008, even though there were a few lonely voices. We need to learn to listen to the ones who sometimes tell us what we don’t want to hear.
Critics argue that the fundamentals were deteriorating in plain sight, and that the market (and economists) simply ignored it. But hindsight distorts analysis. We cannot point to a lonely Cassandra like Robert Shiller of Yale University, who regularly argued that house prices were unsustainable, as proof that the truth was ignored. There are always naysayers, and they are often wrong.
Rajan seems to be saying that, in contrast to Shiller’s analysis of the the housing bubble and his prediction of its collapse, too few reputable economists were predicting the global collapse of financial markets. He gives three reasons:
I would argue that three factors largely explain our collective failure: specialization, the difficulty of forecasting, and the disengagement of much of the profession from the real world.
Rajan was not one of the guilty. His 2005 paper, delivered at the retirement celebration of Alan Greenspan, outlined the coming liquidity crisis and the lack of structural controls that could have limited its damage.
The problems weren’t just the lack of messages and the timidity and remoteness of the messengers, but the inability of market players and central bankers and regulators to make course corrections to avert disaster.
In the Ozarks, at the end of the line, we have to deal with whatever Congress, the Fed, the banking and securities regulators and the EU come up with, as well as market forces. The lesson for protecting ourselves is that we need to become more literate about economics and more skeptical about what seems to be good for us in the short run.
If you think housing is coming back, you might want to listen to Shiller:
IT will take a while for the housing market to recover fully. Still, many people continue to think of housing as an investment, and so it does seem that we are in danger of encountering another whopper bubble someday. Even so, both the history of land bubbles and the slowness of shifts in public opinion suggest that such bubbles will be fairly rare.
Add the new policy restraints and the excess supply in most parts of the housing market, and a new national housing bubble looks even less likely anytime soon.