If a modern economics journal fell open at your feet, you might be amazed at all the mathematical formulas it contained. Numbers nerds argue that only elaborate mathematical models can illustrate economic truths, while the numerically challenged counter that the math papers over a lack of pragmatic ideas. Either way, neither bashing nor praising Wall Street’s quants, those unloved scapegoats of the current financial crisis, is my purpose here.
Given its mathematical basis, economics can fairly be regarded as a science, but it is surely not a “hard” science like physics or engineering. For one thing, no experiment can really test an economic hypothesis—leaving aside the trials where university students are paid to respond irrationally to microeconomic questions.
History is economics’ only laboratory, the only arena where its empirical results can be judged. And the idea that history repeats itself probably applies more to its lessons than its details. Going by how often the word “unprecedented” has been invoked in connection with the crisis, it follows that history can offer us only limited guidance now.
Legend has it that Thomas Edison made 10,000 duds before managing to produce a working light bulb. Obviously, depending on the complexity of the challenge, mastering something new can be extremely difficult. Thus, as an economist, I am astonished at the public’s faith that the world’s central banks and governments will somehow succeed, in their very first attempt, to steer us clear of depression, deflation or downright disaster, getting us gently back on track, unharmed and inflation-free. I find this optimism naive.
Many parallels have been drawn between the current crisis and the one that followed the stock market crash of 1929. Back then, the Fed and other monetary authorities remained inert and it took the US government four years to start the New Deal. Most economists think that this inaction turned the crash into the Great Depression.
This time around, central banks have been quick to respond, massively increasing their balance sheets and unleashing a flood of fresh money into their economies. Governments have launched large, even “unprecedented,” stimulus packages that will thrust public deficits into the stratosphere.
However, given the universal lack of experience with this kind of rescue operation, especially on such a grand scale, no one can honestly pretend to know how much monetary and fiscal expansion is enough, and even worse, how much of it can safely be withdrawn once the crisis finally passes.
In physics, elasticity is the property of a material to return to its original shape after having been deformed. If too much force is applied, the deformity will be irreversible. The hard question now is whether the economic damage is still reversible or has the deformation been too large? While we can answer this empirically in the hard science of physics, in economics, unfortunately, those who apply the remedies can only guess. History’s verdict awaits us.
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