Nobody really knows

In today's London Times Gerald Baker describes some of the bad things happening to the US economy. For instance: the US dollar has fallen by 40 percent in the past 5½ years:

If you had asked the average gloomy economist back then what would be the implications of such a steep fall in the dollar, the answer would have included a good deal of pessimistic conventional wisdom. Such a sharp drop in the value of the currency would, it was generally assumed, spell real trouble for the value of US assets. Demand for US Treasury bonds would surely fall sharply. In fact, the decline in the dollar’s value would be both cause and effect of a flight from dollar-denominated assets. Interest rates, which move inversely to bond prices, would, therefore, surge, presumably prompting a serious retrenchment. Foreigners would surely offload many of their US equities, too, and Americans would not be far behind them.

Then there would be an inflationary surge. A 40 per cent decline in the dollar’s value, would, other things being equal, push up import prices by a similar amount and the feed-through to the broader economy would be swift and painful. The Times, 27 November

But what has actually happened? Mr Baker continues:

In the past 5½ years, US Treasury prices actually have soared. In early 2002 the yield on the benchmark ten-year Treasury was about 5.5 per cent. It is now about 4 per cent. Equities, on a broad measure, are up by about 50 per cent in the past five years. Inflation? It has gone up, but hardly enough to notice. In December 2002, the core consumer price index ...was up 1.9 per cent from a year earlier. Last month it was up to 2.2 per cent.

Now there are lots of specific reasons that explain these unexpectedly benign outcomes: foreign central banks still buying US Treasuries; global savings keeping demand strong for all US assets; prices held low by international competition. And it is still true that we face serious challenges. But when you think of all the factors that could have produced disaster in the past five years – not just a dollar collapse but soaring oil prices and an overextended housing market – you have to conclude that something quite fundamental has changed. The US and global economies continue to demonstrate a remarkable structural resilience and flexibility unseen in modern history.

Remarkable, yes, and unforeseen, even by the experts. It reminds me of work done by Eban Goodstein, which shows that not only interest groups, but disinterested commenatators routinely overstate the costs of pollution control. The link doesn't seem to be working right now, but here is one example Goodstein gives:

Asbestos. When the Occupational Safety and Health Administration (OSHA) instituted regulations covering exposure to asbestos in the early 1970s, they hired a consulting firm to estimate the cost of compliance. Two later studies found that the original prediction for the cost of compliance was more than double the actual cost, because of overly static assumptions.

The common factor between the poor performance of experts at prediction is probably complexity rather than self-interest. From the point of view of a Social Policy Bond advocate, the implication is that subordinating policies to outcomes can work: if there are sufficient incentives, then large numbers of motivated people can defy the doomsters. Costs of implementing valuable social and environmental policies cannot be predicted by experts, so why not target desirable outcomes - however seemingly unrealistic or idealistic - and let the market worry about the cost? We may well be pleasantly surprised.