There are days when I think economics is indistinguishable from voodoo. The famous village health-care handbook “Where There Is No Doctor“, written for people who have never been exposed to science, includes a section on distinguishing superstition from medicine. “The more remedies there are for any one illness,” the authors write, “the less likely it is that any of them works.”
And so it is with us, and the many stories about what happened to our economy and how it might be fixed. It’s not that an event like the current financial meltdown is not understandable; it’s just that really understanding what happened and how to make it better requires a lot of training and knowledge that most people lack. Without this background, anything we might be able to say about our economic problems is necessarily a fable, a narrative about one-dimensional heroes and villains with names such as “GDP” and “sup-prime loan.” But if we must have stories, they should be good stories. We want stories that have some relationship to reality, that will expand fractally into the right explanations if we choose to look deeper into any particular point
With that caveat, I present to you the best short explanations I’ve been able to find about the current crisis.
First, how did the economy get this way? Kiplinger’s Personal Finance has a lovely short explanation, which begins
1. It all began with cheap money. To prop up ailing economies early in this decade, central banks in the U.S. and Japan kept interest rates unusually low, which encouraged speculation. In the U.S., the Federal Reserve lowered the federal funds rate — the rate that banks charge each other for overnight loans and a barometer for the cost of borrowing money on a short-term basis — from 6.5% in 2000 to 1% by mid 2003. Cheap money quickly ignited a sharp rise in home values in virtually every corner of the country.
And then, what is the point of the bailout package, and how is it supposed to work? For this I turn to Berkeley economist Brad Delong, who recently wrote an excellent Q&A.
Q: What do you think of this plan? Is it what needs to be done?
A: I think the Paulson-Dodd-Frank plan as it is emerging is much, much less effective than it could be. But it is still much better than doing nothing, which is kind of like being poked in the eye with a sharp stick.
I do not say these are truth. I say only that they are plausible stories, ways into thinking about this mess. These are not really answers, just provocations to the right sorts of questions.