Roger E. A. Farmer is a Professor and Department Chair of the UCLA Department of Economics. He is a Research Associate for the National Bureau of Economic Research and the Centre for Economic Policy Research and the co-editor of the International Journal of Economic Theory. He is the author of Expectations, Employment and Prices which brings Keynesian economics into the 21st century by providing a new paradigm that explains how high unemployment could potentially persist forever without a little help from the government. He is also the author of How the Economy Works: Confidence, Crashes and Self-Fulfilling Prophecies which is a jargon-free exploration of the current crisis, offering a powerful argument for how economics must change to get us out of it. In the interview below, which first appeared in UCLA Today, Meg Sullivan asks the author some probing questions.
UCLA economist Roger Farmer was in England at a conference on “The Great Moderation” — based on the premise that the economy had become much more stable since 1980 — when the bottom started to fall out of the market.
Mervyn King, the governor of the Bank of England was supposed to be the host of the event, but he never turned up, and Rachel Lomax, the bank’s deputy governor, disappeared many times throughout the evening. The next day Farmer, who has served as the chair of UCLA’s Department of Economics since July of 2009, learned that the Bank of England was negotiating with Northern Rock, the first financial institution to collapse in the current economic crisis.
In a new book, Farmer attempts to help investors make sense of the bewildering series of events that followed. Designed for the average reader, How the Economy Works: Confidence, Crashes and Self-Fulfilling Prophecies serves partly as a lesson in the history of economics. Writer Meg Sullivan talked to Farmer about how society can avoid similar crises in the future.
Meg Sullivan: What caused the current recession?
Roger Farmer: Stock market wealth accounts for roughly three-fifths of all tangible wealth in the United States. The other two-fifths is in houses. In the fall of 2008, people lost confidence in the value of both those assets at the same time. They stopped spending, firms laid off workers and the drop in wealth was self-fulfilling.
SullivanL How is this crisis similar to the Great Depression?
Farmer: There have been 10 recessions since World War II, including the current one. In every previous recession, the Fed immediately cut interest rates to stimulate demand. But now the Federal Funds Rate — the interest rate on overnight loans — has fallen to zero. The Fed has run out of ammunition; it can’t lower the rate any further. The same thing happened in the 1930s.
Sullivan: Do you think the Fed was right to bail out the banks?
Farmer: Yes, I do. I understand that always bailing out banks provides incentives that encourage risky behavior but the consequences of not bailing them out would’ve been much worse.
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