Believe it or not, the economy is in the doldrums. Inflation is north-bound: eight percent, right? The cooking gas crossed the Rs.1000/cylinder mark. Fuel breached the Rs.100/liter mark a few weeks ago. Tomato sells at Rs.100/kg in Vijayawada. What’s happening? The Reserve Bank of India has hiked interest rates to taper bank lending. The governmental rebuttal is that it is not India alone that is in the grips of unmanageable inflation, but the entire world. Wah, Wah!
Why is the world experiencing (40 years high of 8% inflation in the United States!) such an incredible inflationary spiral? Were the apex banks not monitoring 24x7 the rising price level? Sure, they did. If so, why did they not succeed in taming the monster? Good question. Throughout the Covid spell, beginning from 2020 until the Russian invasion of Ukraine in February 2022, they kept harping that inflation is “temporary” and it would correct itself soon.
Obviously, their economic modeling and calculations went awry, putting the general public in a tight spot. Without exception, the central bankers finally woke up to admit that they failed miserably in their growth versus inflation management and were compelled to course-correct via interest rate hikes recently. More such monetary tightening measures are around the corner. Brazen up.
The question is, why were the economists unable to predict correctly? Did their econometric models let them down badly? The dismal science disappoints the practitioners. Former Planning Commission Member Arun Maira shines on this aspect of crystal gazing: “A 2008 report by the Commission on Growth and Development led by Nobel laureate Michael Spence recommended solutions for increasing global growth. It admitted, however, that while economists could confidently recommend how GDP can be increased, they did not know yet how to make growth inclusive at the same time. Their models were based on the assumption that macro growth lifts all boats, with accumulating wealth tricking down. However, the trickle-down does not happen automatically.”(1)
According to him, the Covid crisis revealed more starkly the flaws in economic models. Crystal ball gazers were made to eat mud. Their models failed miserably. Otherwise, the rising inequality with the rich getting richer and the poor becoming poorer does not sound logical.
Maira is spot on when he says that large size and scale are not always virtues. The governmental chest-thumping that India is the fast-growing emerging economy globally has to be tempered with a heavy dose of ground reality. Economic models are not sacrosanct. After all, they are the product of the human mind, and the less said about the behavior of the mind, the better.
On the same issue, it is not out of place to shine on the Swedish economist Axel Leijonhufvud who died recently at 88. In the Financial Times weekend magazine (May 14, 2022), Gillian Tett alludes to Leijonhufvud: “while he loved economics, he was disconcerted and baffled by how professional economists tended to behave. They were not only clubby, status-driven, and scornful towards outsiders, he lameented, but also obsessed with abstract, maths-driven models divorced from real life. Worse still, they lacked introspection and, thus, were ubale to see these flaws.” He opined thus half a decade ago in his “Lie among the Econ” essay. (2)
Economists admit that they are clueless: “The old model — where inflation moves up ever so slightly, and then you raised rates a tiny bit and all was well — that’s dead. We are in a new world, and we’re all just experimenting,” tells a former Central banker at Davos, Switzerland recently during the World Economic Forum circus. (3)
India’s former Chief Economic Advisor K V Subramanian recalls his research days at the University of Chicago: “During the Ph.D. program, mathematical modeling of economic phenomena came more easily than empirical analysis with data. Learning to do empirical research after becoming an Assistant Professor was hard work because other empirical researchers picked this during their Ph.D. programs.”
Tett does not spare the dismal science practitioners. “The economists studying the macroeconomic data generally do not investigate the bedrock finance. Siloed thinking continues to proli3erate. The economists at the Fed, who last yere were proclaiming that inflation pressures were “transitory,” generally do not make visits to warehouses or talk to people who are on the ground, involved in the supply chains or “real companies.” If they had, they might never have uttered that misguided “t” word.”
What’s her prescription to economists? “What the professional still struggles with is finding ways to supplement top-down quantitative models with bottom-up qualitative observations.
Will the practitioners of dismal science listen to her” or dismiss her suggestions with a “what does she know” attitude? Keeping fingers crossed.
(1) It’s Society, Stupid! Not a Machine!, The Economic Times, May 16, 2022
(2) Remembering the economist who skewered his tribe, Gillian Tett, Financial Times Weekend Magazine, May 14, 2022
(3) The One Hopeful Sign coming out of Davos, Fareed Zakaria, The Washington Post, May 27, 2022