In an appearance on Meet the Press this morning, Vice President Joe Biden insisted that the president’s $787 billion stimulus package has already “saved or created” 150,000 jobs. The show’s moderator, David Gregory, challenged him on this point, noting that, at 9.4%, the unemployment rate has risen well above the 8% maximum predicted by top Obama advisors in January 2009.
Biden’s response: “We took the mainstream model.” And therein lies the problem.
For as near as I can tell, the mainstream models have been successful at just one thing: failure. They predicted that: subprime loans would not default at substantially different rates than prime loans; the riskiness of credit default swaps and other mortgage backed securities could be efficiently judged; deregulated financial markets were capable of self-policing; and so on. And they were wrong.
Even Alan Greenspan lost faith:
The essential problem is that our models – both risk models and econometric models – as complex as they have become, are still too simple to capture the full array of governing variables that drive global economic reality. . . models, as we currently employ them, are structurally deficient.”
The prediction that comes out of any macroeconomic model is, to a very large extent, driven by the assumptions that underlie it. The mainstream models tend to assume things like: efficient markets, rational expectations, infinite planning horizons, and so on. The rosier the assumptions, the rosier the predictions.
President Obama believed his advisors when they told him that the fiscal stimulus would keep the unemployment rate from rising above 8%, but their forecasts were wrong. They were wrong because their underlying assumptions turned out to be too optimistic.
It’s time to abandon the mainstream model and the rose-colored glasses that go with it.