We’re Measuring the Economy All Wrong
The idea of overall economic output will always be an important abstract measure of the economy, but it completely ignores most of the ways that economic policy intertwines with politics.<p>I think the biggest danger in how we analyze the economy is that we need to be aware that many of our leaders have an incentive to always report good news about the economy.<p>The core idea behind policies intended to increase employment, credit availability, etc., is that the government should act to help actors in the economy become more leveraged.  Or in other words, that a higher output can be achieved if risk premiums are kept in check through policy action.<p>Why? Because a bunch of unemployed, suffering people will eventually lead to a political revolution, and so political stability is a significant driver for economic stability and long-term planning.<p>Arguably, long-term planning is the bedrock of the financial system.  It allows trading between the present and future, and arbitrage between possible futures.  Political risk&#x2F;instability adds an additional cost to long-term planning.<p>So as a result we have welfare economics, targeted both at individuals and firms.  The political notion of social welfare is used by planners to create a set of meta-strategies that benefit the recipients.<p>The problem is that when you connect politics to economic policy you end up with groups that gain status (and power to influence the policy) as a result of the policy. So the policy changes and groups of beneficiaries compete for rents.<p>Why did the 2008 financial crisis happen?  Because economic policy-makers believed that they understood the safe bounds for certain systemic risks within the system.  They ended up getting those bounds wrong, and so it came to pass that a lot of other &quot;normal&quot; risks were drastically mispriced once the bounds were exceeded, since their prices had been based on the assumption of asset price stability.<p>The rest of the details have to do with the many other mechanisms that suffered a cascade of failures due to the bounds set by regulators being exceeded.<p>Normally, firm insolvency&#x2F;failure can act as a circuit breaker to stop the effects of a price correction from spreading to the rest of the economy... but the key point is that the pricing assumptions were baked into the rules themselves, so securities of mortgage backed securities were allowed to be treated as underwriting capital by financial institutions, etc.<p>Sadly, there is no free lunch.  Growth-oriented policy will always contain some core assumptions about system invariants that are not necessarily <i>actually</i> invariants.  The time horizon for policy mistakes is longer than the typical term in office for those making the rules, so there is no incentive to adopt a more risk-averse view.<p>Of course, what has happened since 2008 is that the financial system has once again figure out ways to use cheap credit to make profits with little apparent risk.  But just as it was the case before 2008 there are still many assumptions about systemic risk baked into the pie.<p>So this article is timely because of Trump&#x27;s economic populism and the apparent rise of left-wing economic populist candidates.  The article calls for more populist economic metrics. But what is not explicitly stated by the article is that the reason for this is simply to reduce the risk of populism-driven economic shocks that might exceed the bounds baked into the core assumptions used by the regulatory regime.<p>In other words, there is a call to reformulate the metrics so that they better reflect populist sentiments, and the corresponding implication that policies ought to shift to make these metrics show &quot;good&quot; numbers.<p>This article comes as part of a series of statements by former Fed and Treasury officials warning that the tools are not adequate to address a future crisis.<p>Since a crisis will come in the form of significant price corrections, and since the interventions post 2008 prevented a lot of price corrections that were probably appropriate, we can infer that a future correction will be larger than the one in 2008.  Combine this with rising tides of economic populism, and it is clear why all of these experts are suddenly calling for a fundamentally different approach.  They must be quite convinced that the next correction could bring massive social and political upheaval that dwarfs what we have seen post 2008 with Brexit and the rise of Trump.<p>Note that a map of the US shows that most counties are &quot;red&quot; and likely find the economic populist message of Trump highly appealing and relevant.  Economic populism is dramatically more widespread now than it was in 2008. But prior to 2008 real estate price appreciation in a lot of historically red states led to feelings of affluence and contentment with the status quo.  I&#x27;ve argued separately that GWB allowed the real estate bubble to grow a few extra years to help sell the war on Terror. The GSEs (primary underwriters of most mortgages) were not held accountable for failing to produce financials for several years in a row during that time.<p>So policymakers are now realizing that none of those tools to make people feel complacent are at the ready when the next correction comes, and they are fearful of the political consequences which are nearly inevitable at this point unless measures are put in place now.