Perhaps the fundamental problem with economics is that the numbers only get you so far.  There comes a point where empirical testing cannot prove or disprove economic claims.  Instead, ideology acts as the final piece of the macroeconomic puzzle – the point where the various schools part ways.  When it comes to depressions, economic liberals see them as demonstrative of capitalism’s inherent flaws, while conservative economists see them as the product of unnecessary governmental intrusion into the market.  This leaves both Washington and the public without any real confidence in their understanding of how the economy works, since almost any economic explanation or claim can be rebutted by an opposing school of thought.  All of this has contributed to the public’s confidence in the trade dwindling to a historic low.  In the words of the Economist, “an arrogant profession has been humbled.”

Yet, as is often the case in depressions, there may be a silver lining.  The current condition has already encouraged some of the most loyal free market economists to begin to think outside of the box.  For example, Ben Bernanke supports the economic stimulus – a program that is straight out of the Keynesian playbook.  He seems to have come to terms with the fact that monetary policy alone is not enough to bring a country out of depression.  In light of the government’s action during both the Great Depression and the current crisis, one must conclude that a more active role for the government in filling the void left by falling demand during severe economic downturns is essential, and seems to suddenly emerge as a unifying notion between the historically warring economic sects.

The danger, of course, is the replacement of one evil with another.  If Keynes blindly becomes the heart of American economic policy, then another economic calamity may well await us once we dust ourselves off from the current mess.  The trouble with societal shocks as significant as the one we are in is that it has the potential to shift the pendulum too far in the opposite direction.  Nobody wants to be too close to a source of distaste.  And the speed of the economic profession’s shift from free market principles to Keynes might prove that the intellectual underpinnings of the profession are unstable.  If they are unstable, then they’re capable of being pushed and pulled by changing tides.  Both the public and Washington must dispassionately come to terms with economics.  We cannot substitute the exaggerated virtues of free market economics with a blindness to its benefits.

Unified action during severe economic downturns is only one piece of “Milton Keynes.”  The true test of lessons learned may not come for decades – when the next asset bubble begins expanding.  Will future administrations ride the next bubble in the hopes of maximizing the political advantage that comes with economic prosperity?  Or will they have the foresight necessary to sacrifice immediate prosperity for long-term stability?  The idea behind Milton Keynes is the decreased reliance upon outdated ideologies and the rediscovery of economics as a non-partisan tool of decision-making, the principles of which appeal equally to all parties.  After all, no party has an interest in seeing its policies create economic instability.  And the entire country has an interest in Washington relying less on ideologies and partisan interests and more on the science of economics as evidenced by the past.

Ideology is a common thread that runs through almost all policy judgments. It is difficult, if not impossible, to analyze or articulate policy without the application of some broader framework that acts as a preconceived paradigm for how the world works. The ongoing economic crisis is a significant example of just how blind ideology can lead a country astray.

The twentieth century witnessed free market, capitalist principles emerge as the bedrock of American values. The private sphere, fueled by its self-interested, profit driven, rational actors became the great driver of the capitalist economy.  Real successes derived from deregulation and privatization helped nurture this American ideology, as did the collapse of the Soviet Union and the negative impacts of constrained economic freedoms in the Third World.

And as Posner writes, this mentality was not unique to any party.  True, the champions of the free market are generally thought to be the American Right.  But its principles are engrained in the policies of various administrations and thus virtually confine American policy within its parameters. It is the Clinton Administration that, in one of its final acts, legalized credit default swaps after they had been prohibited for nearly a century.  This collective commitment to the infallibility of the market blinded government officials to the potential of market failure and hindered the development of contemporary solutions to an unprecedented economic challenge. Ideology acted almost as intellectual shackles, constraining decision-makers in a realm of thought where the discovery of appropriate solutions was impossible.

Ideology has its uses.  But applying general principles to the particulars of novel problems leaves you inherently short of solving those problems. Good policy formulation needs to be tailored to the specific circumstances that may exist. This does not mean that ideology cannot coexist as a general value from which the particulars of individual policies may depart. We can have a strong collective faith in the free market – in the ability of self-interested players to make rational decisions through profit motive that spur growth and benefit the economy and in the overall power of the individual – and at the same time regulate that free market in order to guard against potential, even if unlikely, catastrophic side-effects. To believe in general, underlying economic principles is not to strictly adhere to them at every conceivable turn at the expense of economic stability.

From what I understand, the underlying causes of the current financial crisis are 1) very risky mortgages, 2) very risky financial products backed by and/or based on these very risky mortgages with no historical parallel but with enormous profit potential for various players 3) years of low interest rates, or “cheap credit,” which encouraged banks to over-leverage, 4) the bursting of the housing bubble, 5) a subsequent credit freeze after homeowners defaulted on the mortgages because banks, fearing potential insolvency, were too scared to lend, 6) a lack of personal savings by most Americans that would have enabled them to continue to consume once this credit market froze, 7) the resulting decrease in consumption, leading to a decrease in production and an increase in unemployment, and 8 ) an inadequate regulatory framework that enabled all of the above to transpire.

People love to cast blame in situations like this, and for good reason.  But blaming these events on things like “greed” serves no useful purpose.  Richard Posner writes in his recent book A Failure of Capitalism (which he continues to update from his blog) that rational decisions, in an industry where risk is rewarded, converged with an inadequate regulatory regime to create the downward spiral we’re currently in: banks stopped lending due to the existential threat of insolvency; Americans stopped consuming because they were unable to borrow and had little or no savings in which to dip; less demand for goods and services led to layoffs and rising unemployment; and a general lack of confidence infected the stock markets, causing stock prices to plummet.

But these decisions were entirely rational.  And because rational actors made rational decisions in a regulatory environment that allowed such decisions, the self-interest of individual players in the crisis should not take the brunt of the blame.  Rather, the lack of regulation that permitted such behavior should be the focus of the criticism.  Undesirable conduct should be either illegalized or disincentivized.  Criticizing rational human conduct in an environment in which such conduct is permitted is like criticizing gravity.

• Money spent on this airport over the last 10 years: 150 million dollars
• Average number of people per day who actually used this airport last year:  20
• Number of locations you can get to from this airport: 1, Washington D.C.
• Number of flights per day: 3
• Amount of “stimulus” money given to the airport, so that they can repave one of the alternate runways: $800,000

The belief that spending 800K on paving one alternate runway of this useless airport is going to help stimulate the economy is a great example of Keynes and bottles in the coal mines from my last post.  In the future, perhaps people will laugh when they consider that we believed in this crazy idea – the same way we now laugh at doctors from three hundred years ago, who thought bloodletting would solve common medical ailments.

Here is the video:

In response to criticism over the huge amounts of spending, Obama noted that economists on both the left and right agree that spending is imperative when a country is in a recession.  Since people themselves are reluctant to spend in hard times, businesses suffer and jobs are lost.  Spending, he argued, is thus necessary to fill the void left by a lack of confidence in the economy.

Obama also addressed the common cry of “where’s my bailout?”  While noting that this line of thinking makes sense morally, since saving those responsible for the economic mess does not seem right, the President noted that bailing out individuals will not go as far in stimulating the economy as bailing out banks.  Money given to banks, according to Obama, will lead to exponential growth in lending and thus stimulate the frozen credit market more so than bailing out the people themselves.

The speech is still ongoing as I write this.  But I think that, so far, this has been a really good speech.  There has been virtually none of that campaign rhetoric that I voiced some frustration with a few weeks back and he seems to be discussing the nuts and bolts of his economic policy with Americans.

UPDATE: Ron Paul was just on CNN responding to the speech.  Addressing the first point above, he noted that individuals are correct to cut back on spending in such economic conditions.  However, he thinks that governments should not be any different.  More spending, according to him, will prolong the crisis.

I love how Obama and Paul both cite to history’s lessons in justifying their opposing positions.  Sometimes it seems that if history has taught us anything, it is that we all invent our own.