September 14, 2009

The consequences of economic decisions depend on the incentives of those affected. Unfortunately, this fundamental truth has been overlooked by government reactions to the recent downturn – which is my reason for starting this blog. As an economist I have an interest in economic theory, and am disturbed when officials, cheered on by their economic advisors, disregard or violate economic truths that rest on the best theory and have been confirmed by experience. They raise problems for teachers who would like to be able to consider applications of theory to policy.

The next several (weekly) issues of this blog ask:

How Could So Much Be So Wrong? U.S. Monetary and Fiscal Policies, 2008-09

with Contents, or Menu of Mistakes:

1. The stimulus packages

2. Operation twist again

3. Capital replenishments and requirements

4. Excess reserves again

5. Confusion of liquidity and risk

6. We need more regulation

7. We’ve got to do something

8. Monetary policy as credit controls

The failures of these policies are explained by their inconsistencies with theory (even of logic) and experience. It is hard to comprehend them except as products of the hysterical atmosphere that pervades the centers of power:

We heard from the chairman of the Federal Reserve that unless we act the financial system of this country and perhaps the world will melt down…. There was complete silence for twenty seconds. The oxygen left the room.

Senate Banking Committee Chairman Christopher Dodd on a meeting of legislative leaders leading to the $700 billion Emergency Economic Stabilization Act of 2008.

If we don’t do this [authorize $700 billion] tomorrow, we won’t have an economy on Monday.

Federal Reserve Board Chairman Ben Bernanke.

We were looking at the abyss.

New York Federal Reserve Bank President (later Treasury Secretary) Timothy Geithner.

………………….