11 Dec 2008

Mario Rizzo Reminds Macroeconomists About Economics

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My dissertation chairman, Mario Rizzo, was invited to comment in the Social Science Research Council’s forum on “What Do We Know About Bailouts?” There are some big guns who contributed, and they all say basically variations of the stuff we’ve been hearing from the talking heads over the last few months.

Then Rizzo steps to the plate and shatters the box into which all the macro guys had painted themselves:

I am not a macroeconomist. I am not even a financial economist. So much of my reaction to the current financial and economic problem may seem a bit out-of-step with what most commentators are saying. Yet I think it is important.

The macro-economic frame of mind is quite peculiar, it seems to me. In the name of the emergency, the macroeconomic way of thinking dismisses most concerns about the efficient allocation of resources and throws almost total emphasis on maintaining levels of expenditure and employment….Thus the solution lies is returning to the status-quo ante. Restore the condition of the financial institutions perhaps by buying toxic assets or perhaps by infusing capital into them. Restore the conditions of the housing market by getting the Fed and/or Treasury to buy Fannie and Freddie mortgage securities, thus sending capital into housing and lowering mortgage rates. Restore the condition of industries with large numbers of employees and others indirectly dependent on them….Once economic agents believe all of this will take place, confidence will be restored.

I believe that the above analysis is an intellectual disaster that threatens not only the intermediate-term economic condition of the United States but its long-term reliance on market institution and the liberty they undergird.

The conventional macroeconomic diagnosis and proposed cures ignore many important factors, including the following:

The “irrationality” is not primarily in the system’s response to the initial financial impulse but in the unsustainable expansion of the housing and other capital markets in the first place….Too many resources went into the housing market due to the low interest-rate policy the Fed followed for too long….

Recessions are not simply crises of confidence or of insufficient demand (due to increases in the demand to hold money). They also have their allocational – or microeconomic – aspects….

I do not think that these hastily devised macroeconomic schemes will succeed in promoting recovery because they ignore the microeconomic fundamentals. I do fear, however, that will succeed in fundamentally transforming our economic system for the worse.

Go Mario! I think the only time I was ever more pleased by his words was when he said, “Congratulations Dr. Murphy!” (after my doctoral defense).

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