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Bernanke’s Garbage Conomic Models Mistook Housing Bust for Dot-Com Bubble

by Peter Orszag

“In a speech last month about the financial crisis, Federal Reserve Chairman Ben S. Bernanke trenchantly noted that the initial losses from the dot-com bust were about the same size as those from the housing meltdown — yet the two episodes had very different economic consequences.

What Bernanke didn’t say was that the reason the Fed, along with every other official forecaster, underestimated the depth of the latest downturn so badly is that its models effectively treated the housing collapse as if it were merely dot-com bust 2.0. And only modest progress has been made toward avoiding that same mistake in the future….

The problem is that the macroeconometric models used by the Fed — like those used by the Congressional Budget Office, the White House and others — had at best a very rudimentary financial sector built into them. As a result, they took into account the macroeconomic impact from the housing bust — but for the most part didn’t reflect the concentrated loss of wealth and degree of leverage in the financial industry.

In other words, the official models effectively ignored the very distinction that Bernanke highlighted as being crucial to distinguishing the housing collapse from the tech bust.”

via Bad Models Mistook Housing Bust for Dot-Com Bubble – Bloomberg.

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