Here Comes Trouble: Stories from My Life

"Outstanding…Moore Triumphs! Publishers Weekly

Mike & Friends Blog

Dean Baker

Dean Baker is co-director of the Center for Economic and Policy Research

April 13th, 2011 6:20 AM

Some Market Discipline for Economists

The IMF lashes itself for failing to foresee the crisis, but the only remedy would be the hazard of unemployment for its economists

Last month, the International Monetary Fund's independent evaluation office issued a remarkable report. The report quite clearly blamed the IMF for failing to recognise the factors leading up to the worst economic crisis since the Great Depression and to provide warning to its members so that preventive actions could be taken:

"It [the report] finds that the IMF provided few clear warnings about the risks and vulnerabilities associated with the impending crisis before its outbreak. […] The IMF's ability to correctly identify the mounting risks was hindered by a high degree of groupthink, intellectual capture, a general mindset that a major financial crisis in large advanced economies was unlikely, and inadequate analytical approaches."

The report noted that several prominent economists had clearly warned of the dangers facing the world economy prior to the collapse that began in 2007. One of these economists was Raghuram Rajan, who was actually the chief economist at the IMF when he gave a clear warning of growing financial fragility back in 2005. Yet these warnings were, for all practical purposes, ignored when it came to the IMF's official reports and recommendations to member countries.

The IMF deserves credit for allowing an independent evaluation of its performance in the years leading up to the crisis. It would be great if the Fed, the Treasury, the Securities and Exchange Commission and other regulatory bodies allowed for similarly independent evaluations of their own failings.

Nonetheless, readers can be very confident that nothing at the IMF will fundamentally change because of this report. The first reason for confidence in the enduring power of the status quo is that the report never clearly lays out what the basis of the crisis was. This is important because the basic facts show the incredible level of incompetence of the IMF in failing to recognise the dynamics of the crisis.

The housing bubbles that were driving growth in the United States, United Kingdom, Spain, Ireland and several other countries in this period were front and centre in the crisis. These bubbles created sharp divergences in house prices both from historic trends and also from rents. There was no plausible story whereby these prices could be sustained; the only question was when the bubbles would burst.

Furthermore, there was no plausible story whereby the bubbles could burst without leading to a serious falloff in demand and a sharp jump in unemployment. In the case of the United States, the bubbles in the residential and non-residential real estate had raised construction spending by close to 4 percentage points of GDP and consumption spending by an even larger amount.

The overbuilding from the bubble virtually guaranteed that construction would fall below its trend level following the collapse of the bubble. This means that the collapse of the bubble would leave a gap of 8-10 percentage points of GDP. In the United States, this gap in annual demand is between $1.2tn and $1.5tn.

What mechanisms did the IMF's economists think existed to fill such a gap? The facts here are really simple, so it would have been helpful if they had been spelled out more clearly – in order that readers could appreciate the incredible incompetence of the IMF's staff in this instance.

It is worth noting that the financial crisis was a sidebar to the main story. It is difficult to see how anything would be different, at least in the United States, if the financial crisis had not occurred. At this point, large firms can directly borrow on capital markets at extraordinarily low interest rates. Surveys of smaller firms show that lack of demand is their biggest complaint. Very few mention the availability of capital.

Featuring the financial crisis so prominently in the story makes it more complex than necessary. Credit default swaps (CDSs) and collaterised debt obligations (CDOs) are complicated. Bubbles are simple.

One of the problems highlighted in the report was the problem of groupthink. This is when people say what they expect their bosses and their peers want them to say, rather than independently evaluating the situation:

"Several senior staff members felt that expressing strong contrarian views could 'ruin one's career'. Thus, views tended to 'gravitate toward the middle' and 'our advice becomes procyclical.' Staff saw that conforming assessments were not penalised, even if proven faulty. A lack of accountability was frequently highlighted as a serious obstacle to getting the incentives right."

The report does some serious handwringing over the issue and comes up with a set of proposals that are virtually guaranteed to have no effect.

Remarkably, these economists never suggested the remedy that economists usually propose for bad performance: dismissal. There is a vast economics literature on the need for firing as a mechanism to properly motivate workers to perform. This report provides great evidence of the need for such a mechanism.

The proposals to combat groupthink (pdf) are all very nice, but the bottom line is that the economists at the IMF all know that they will never jeopardise their careers by repeating what their bosses say. If we want economists at the IMF and other institutions who actually think for themselves, they have to know that they will endanger their jobs and their careers if they do mindlessly follow their boss.

Whenever I have raised this point in conversations with economists, they invariably think that I am joking. When I convince them that I am serious, they think the idea of holding economists responsible for the quality of their work to the point of actually jeopardising their careers is outrageously cruel and unfair.

The reality is that tens of millions of people across the globe have seen their lives wrecked because these economists did not know what they were doing – or worse, had doubts but chose the safer route of groupthink. It is outrageous that ordinary workers who were doing their jobs can end up employed, while the economists whose mistakes led to their unemployment can count on job security.

You must log in to comment.

You must be logged in to leave a comment. Log in | Register

George W. Bush Debuts New Paintings Of Dogs, Friends, Ghost Of Iraqi Child That Follows Him... www.theonion.com President Bush has a new hobby -- painting! --...

Apr 17th
7:28 PM
Read More

Big new story from David Sirota and Pando on top Christie adviser and appearance of corruption at New Jersey's pension fund: REVEALED: Gov....

Apr 17th
12:41 PM
Read More

FBI Uncovers Al-Qaeda Plot To Just Sit Back And Enjoy Collapse Of United States www.theonion.com WASHINGTON—The FBI announced today that it has uncovered a...

Apr 15th
3:28 PM
Read More

Revealed: Rahm Emanuel's top donor bought stock in Marriott just before it was awarded huge contract pando.com As schools are closed and pensions cut,...

Apr 9th
2:00 PM
Read More

I'll be at First Time Fest today in New York City at the screening of my first film, Roger & Me. Loews Village 7 at 12:30 pm. Come see it on the big...

Apr 5th
9:48 AM
Read More

Revealed: Rahm Emanuel cuts public pensions, diverts money to benefit campaign donors pando.com If you've read the financial news out of Chicago the last...

Apr 4th
2:19 PM
Read More

Please take a moment today to think of Casey Austin Sheehan, son of Cindy and Patrick, who was murdered by U.S. foreign policy in Sadr City, Baghdad ten years...

Apr 4th
2:00 PM
Read More

ICYMI - I've joined this "thunderclap" to support the Connecticut legislators who voted yes on last year's Act Concerning Gun Violence...

Apr 3rd
7:38 PM
Read More

I've joined this "thunderclap" to support the Connecticut legislators who voted yes on last year's Act Concerning Gun Violence Prevention...

Apr 2nd
8:27 PM
Read More

I am opposed to the death penalty, but to every rule there is usually an exception, and in this case I hope the criminals at General Motors will be arrested...

Apr 1st
3:55 PM
Read More

How Long Some in the US Will Survive Under New Health Law ...by Donna Smith www.michaelmoore.com Those who must access care to live and can afford it are not...

Mar 31st
10:13 PM
Read More

Last night, The Good Wife on the East Coast started 40 minutes late due to the overrun of the NCAA basketball game. If you had your DVR set for the show, you...

Mar 24th
5:41 PM
Read More

Watching films today, looking for the ones I'm going to pick for my film festival this summer. I (and a whole bunch of others!) have this thing we put on...

Mar 23rd
4:48 PM
Read More

When the U.S. Health Care System Keeps Killing, Who Cares Enough to Fight? ...by Donna Smith www.michaelmoore.com We have largely forgotten that people are at...

Mar 21st
5:56 PM
Read More

Tell the White House not to give up on Dr. Vivek Murthy's nomination as Surgeon General despite the ferocious opposition from the NRA: Don't give...

Mar 21st
5:38 PM
Read More

This criminal would never see a jail cell, nor would his cronies. In fact, they'd later be rewarded with re-election: Presidential Address on War with...

Mar 19th
9:40 PM
Read More

The crime of the century -- our invasion & slaughter in Iraq -- started 11 years ago tonite in this 7pm (ET) hour, March 19th, 2003: CNN Coverage of...

Mar 19th
9:08 PM
Read More

Washington’s Back-to-the-Future Military Policies in Africa ...by Nick Turse www.michaelmoore.com Nick Turse is an award-winning journalist, historian,...

Mar 17th
4:59 PM
Read More

"I think democracy is the most revolutionary thing in the world." -- Tony Benn, 1925-2014 Tony Benn in 'Sicko'

Mar 14th
10:07 AM
Read More

RIP Tony Benn, one of the UK's greatest leaders: Tony Benn, veteran Labour politician, dies aged 88 www.theguardian.com Former cabinet minister died at...

Mar 14th
9:53 AM
Read More

Please read this important story from K. Ford K.: Am I the Face of the New American Middle Class? www.huffingtonpost.com I began to feel I had slipped so low...

Mar 13th
2:24 PM
Read More

Yesterday Dianne Feinstein revealed that the CIA has been spying on the Senate Intelligence Committee. This is all about the report the committee has produced...

Mar 12th
6:48 PM
Read More

Health Care for All Colorado has brought Mercy Killers, a show written and performed by Michael Milligan about our murderous for-profit healthcare system, to...

Mar 10th
1:08 PM
Read More

Health Care Dramas that Sting and Why We Have to Watch ...by Donna Smith www.michaelmoore.com The realities Milligan has written into the show cut deep into...

Mar 10th
1:02 PM
Read More

Did you know the Lehrer Newshour on PBS has been produced for 20 years by a company owned by conservative cable billionaire John Malone? Me neither. After...

Mar 7th
8:39 PM
Read More

Mr. Obama, if int’l law is so damn crucial . . . | RootsAction.org act.rootsaction.org The Russian intervention deserves criticism. But let’s be clear. The...

Mar 6th
1:21 PM
Read More

Enron billionaire John Arnold thinks everyone should believe him when he says we've got to cut pensions because he's so incredibly rich: John...

Mar 5th
4:20 PM
Read More

More in David Sirota's continuing series on the billionaire takeover of PBS: More PBS conflict woes as activists move to eject David Koch from board of...

Mar 3rd
12:35 PM
Read More

Ukraine: One ‘Regime Change’ Too Many? ...by Ray McGovern www.michaelmoore.com Is “regime change” in Ukraine the bridge too far for the neoconservative...

Mar 2nd
9:25 PM
Read More

Subscribe to Mike's Blog RSS

Click here to suggest an article

Mike's Blog

See More Blogs

Vew the archives

View older articles