Speaking in London, Federal Reserve chair Janet Yellen predicted recently that the “the system is much safer and much sounder” and explained that the Federal Reserve is prepared to deal with numerous enormous shocks to the economy.
In her conversation with Lord Nicholas Stern, Yellen also went on to list the reasons that, thanks to central bank intervention, there is unlikely to be another financial crisis “in our lifetimes.”
For those who have lived through more than one business cycle, however, alarm bells tend to go off every time an economist, central banker or high-ranking government official declares that there’s little to no danger of economic turmoil in the near future.
There is a long history of spectacularly bad predictions being made shortly before economic crises. Famously, shortly before the Crash of 1929—one of the earlier crises that occurred on the Federal Reserve’s watch—Herbert Hoover proclaimed that “We in America today are nearer to the final triumph over poverty than ever before in the history of any land.”
But, we certainly don’t have to go back that far.
Indeed, in the late 1990s, it became nearly routine to hear economists announce that “the Internet changes everything” and “the business cycle is dead.”
Economist Rudi Dornbusch—a close associate of current Fed vice chair Stanley Fischer—even wrote a July 1998 column in the Wall Street Journal titled “Growth Forever.” Dornbusch concluded that the possibility of an imminent recession “is remote” and the country “will not see a recession for years to come.” So sure of the benefits of the “new economy” was Dornbusch, in fact, that he declared, “This expansion will run forever.”
Then came the dot-com bust of 2001. After that came a short expansion from 2002 to 2007. After that came the Great Recession.
Meanwhile, from 2000 to 2015, according to the federal government’s data, real median household income was flat. Only over the past two years have we seen any of that expansion that many were venturing to say was permanent back in the late 1990s.
Economists and policymakers were no more insightful when examining the possibility of a new crisis post-2007.
In 2005, for example, Milton Friedman could have been paraphrasing Yellen’s recent comments when he concluded that “the stability of the economy is greater than it has ever been in our history. We really are in remarkable shape.” Friedman went on to give Alan Greenspan credit for the expansion.
In early 2007, Ben Bernanke predicted, “We’ll see some strengthening in the economy sometime during the middle of the new year.”
As late of mid-2007, Bernanke was downplaying any problems associated with the sub-prime housing market, allaying any fears of a bubble or bust and claiming, “I don’t know whether prices are exactly where they should be, but I think it’s fair to say that much of what’s happened [i.e, enormous home price growth during the housing bubble] is supported by the strength of the economy.”
If housing bubbles do prove to be a problem, Bernanke concluded, it’s “mostly a localized problem and not something that’s going to affect the national economy.”
The US would officially begin to contract in December 2007, followed by a financial crisis the following autumn.
Even on the eve of the crisis — in September 2008 — John McCain announced that “the fundamentals of our economy are strong.”
A year later, the unemployment rate would reach 10 percent, foreclosure rates would surge, and total employment would collapse from 116 million to 107 million. Employment would not return to pre-crisis levels until late 2013.
Millions of workers would need to change careers, be retrained, scratch for other forms of income to avoid foreclosure or eviction, and put off retirement indefinitely. The economy was so weak for so long, in fact, that the Fed felt it necessary to keep the key target interest rate near zero for seven years to add “stimulus.”
Of course, just because Janet Yellen says the economy won’t experience a crisis anytime soon doesn’t mean a crisis is imminent. A truly strong economy isn’t going to be “jinxed” by a declaration that things are fine. On the other hand, given the record of eminent economists and Fed board members in the past, Yellen’s predictions are hardly anything that should inspire confidence.