“Don’t project beyond the range of the known observations” is a rule followed by careful economists. In plain English this means, for example, that we know how American consumers behave when gas prices move between $1 and $4 per gallon, “the range of the known observations”. But we haven’t much of an idea what they would do if prices rose to $5. No experience, no data to inform our forecasts. Which is why we have to be very careful–humble, really–when predicting the effect of the various policies that are being adopted to fight the current credit crisis and recession. We simply have no good experience with this combination of events, and the magnitudes of the changes. So we have reason to worry about the galaxy of stars Barack Obama has assembled to help him right the American economy. They are so bright, so self-confident, so accustomed to being the smartest guy or girl in the room, that doubt is not one of the emotions with which they are familiar, as was true of the bright young “quants” (mathematical economists) who designed the models used to manage the risk taken on by Lehman Brothers and AIG. Something about hubris and nemesis comes to mind.
Consider this. Treasury Secretary Hank Paulson persuaded congress to give him a $700 billion pot of money with which to buy the rotten IOUs on banks’ balance sheets. The theory was straight-forward: relieved of this burden, the banks would resume their role of lenders to potential homeowners, businesses, and consumers. Sounded like a good idea. But almost immediately it occurred to Paulson that British Prime Minister Gordon Brown had a better idea–recapitalize the banks by buying shares so that they could begin lending again. That, too, was confidently touted as a good idea. But we have moved beyond the range of what we know about credit crunches. All we know is that the results so far have not matched the predictions of the proponents of these policies. Which is one reason why Paulson decided not to use the second half of his $700 billion, and to leave it to the next congress and the incoming president to decide whether it might not be better to pass the remaining $350 billion directly to home owners falling behind in their mortgage payments. Surely that would reduce foreclosures and repossessions, thereby easing the glut of unsold homes, raising prices, and helping to bring the recession to an end. Surely? Better, perhaps.
