Have Economists Got It Wrong About The U.S.? (Part 2) | WPN World People News

Here are some experts on why economists got it wrong, and whether there are reasons for optimism — or pessimism — today.

Why did Bernanke get it wrong five years ago?

Answer: The Fed had no experience with the kind of recession that unfolded in 2007, the root cause of which was massive private borrowing.

"I think they got it wrong because they thought of it as a recession instead of what it was — a financial crisis," says Jeffrey Keefe, a professor at Rutgers University's School of Management and Labor Relations.

When the housing market went bust, he says, the credit markets ground to a halt because the economy was shot through with leverage based on the sector's continued growth.

Joseph Gagnon, an economist who was at the Federal Reserve when Bernanke was making his less-than-clairvoyant forecasts in 2007, says he and many of his colleagues did foresee a housing crisis, but they thought it would be a small one.

"What we thought would happen when it popped was a similar mild recession to the one we had in 2001 when the stock market bubble burst," says Gagnon, now a senior fellow at the Peterson Institute for International Economics.

"We were surprised by how serious the recession ended up being," he concedes.

The cause of the Great Recession almost guaranteed a slow and difficult recovery. In the past, the Fed had always lowered interest rates to spur the economy, but with this recession, that tool lost much of its effectiveness, Gagnon says.

"It wasn't just that you could lower interest rates and that people would suddenly spend again," he says. Individuals and institutions "had to repair their balance sheets and that was going to take some time. Lowering interest rates does help, but it doesn't help as quickly as it would in a normal recession."

Are financial experts missing signs of a major upswing?

Answer: It depends on whom you talk to. Even the most optimistic economists are unwilling to break out the champagne — even with an unemployment report as good, relatively speaking, as this one released Friday.

You can count Brian Wesbury, chief economist at First Trust in Wheaton, Ill., as one of those on the cautiously optimistic list.

Everything about the latest employment report, he says, "shows that the economy is strengthening and should continue to get stronger in 2012." Retail, manufacturing, construction, mining — it's all looking better.

But even Wesbury, who expects the unemployment rate to be about 7.8 percent by Election Day, acknowledges that it's "very difficult right now for people to feel optimistic about the economy."

Keefe of Rutgers University worries about the situation in Europe. He says it's muddling through for now but could take a turn for the worse and throw the world back into a serious crisis.

And the U.S. residential housing market is still in pretty miserable shape, he says.

"There's enormous inventory," Keefe says. "I am pretty confident we're not going to have a real recovery until that real estate piece is straightened out."

Which U.S. sectors are likely to see strong growth and which might lag?

Answer: Friday's jobs report showed gains in nearly all sectors.

"The most impressive thing is that it's really hard to find any weak figures in this report," says Stephen Bronars, senior economist with Welch Consulting in Washington, D.C.

Keefe sees a brighter horizon for some sectors: "Financial services, I suspect, will recover fully. Health care continues to grow, retail continues to grow and business services will continue to grow."

Even though there was growth in construction, housing remains in the doldrums.

Gagnon is more optimistic about the housing sector than some of his fellow economists. He thinks we've been building too few houses lately and that "demographic trends that are going on regardless of the recession will lead to pent-up demand."

He's also willing to make what he describes as a risky prediction.

"I think exports might be a surprising help to the economy," Gagnon says. "But that depends a lot on the policies of other countries. It depends on how the Europeans react to their crisis, because our exports will be hurt if they have a serious crash there. I am not expecting that. But it is a risk."

What have we learned from this recession?

Answer: "I learned the importance of leverage, but I can't speak for all my colleagues," says Gagnon. "The importance of that caught me by surprise."

He says individuals and institutions will be more on guard against financial fraud and unsustainable borrowing.

But Keefe thinks we've missed opportunities to revisit the Glass-Steagall Act, the Depression-era law aimed at keeping banks from engaging in risky financial practices. Many economists believe that its repeal in 1999 contributed to the financial crisis.

"We also completely missed the boat on 'too big to fail,' " says Keefe, referring to a congressional push to try to put limits on massive banks and financial institutions.

"Instead, they are bigger than ever," he says.

Source: NPR