Economics claims to be a science, providing a theory and tools to understand the behavior of individuals, firms, and economies.  Of course, it failed badly to forecast the onset of the great recession, the magnitude of the great recession, the persistence of the great recession, or to provide any clear policy advice on how to get the world out of the great recession.

Here we sit, three and a half years after the bankruptcy of Lehman Brothers triggered the greatest economic collapse in eighty years, and the U.S. employment ratio (the fraction of the working age population with jobs) essentially ticks along unchanged from its lows.

Employment-population ratio: Percent employed for those 16 years and over.  US Bureau of Labor Statistics: http://data.bls.gov/timeseries/LNS12300000

Meanwhile, the U.K. and almost all of Europe have returned to recession, while growth is slowing in India, China, and Brazil.

In short, we remain utterly mired in the most unforeseen, catastrophic, and unremedied economic downturn in nearly a century, and to whom do the media and policy makers repeatedly turn to for explanations and advice – economists!

To be sure, some economists did foretell the slump – Robert Schiller warned of a housing bubble; and Ken Rogoff and Carmen Reinhardt warned us in This Time It’s Different that this time would not – and several economists, such as Christina Romer and Paul Krugman, warned that austerity policies would make the recession worse and have been proven right.

Still, it is frustrating that several years ago, most economists believed we were in a “Great Moderation” in which events such as the Great Recession we are living through simply could not and would not occur.  It is equally frustrating that even as the market plummeted in 2008-2009, most economists promised that this time would be different from the great financial slumps of the past, because we had the lessons and theories of modern economics and finance to guide us – so that we would never repeat the disastrous ‘double-dip’ of the Great Depression, nor the ‘lost decade’ (now two decades) suffered by Japan.

Yet despite these promises that we are now in a more enlightened age of economic knowledge, Europe has practiced three years of austerity policies that have been to no avail in reducing debt but have blown youth unemployment up to self-destroying levels of 20-50%, while the U.S. faces a fiscal cliff in December when an economy that has grown less than 2% per year for three consecutive years despite negative real interest rates faces new tax hikes and government spending that will in one blow hack three to four percentage points off of GDP.

Economists will of course say that these problems are ones of politics, and thus not theirs.  To a certain degree they are correct; politicians’ inability to make difficult choices is the ultimate binding constraint on future outcomes.  Yet if the economics profession, as a science, could speak with a clear voice on the causes of the Great Recession and the policies most likely to remedy it, there is a greater chance that politicians would make the difficult choices and would see positive results in time to bring along disgruntled populations.  Instead what we see is politicians enacting policies based on ideology and conviction, those policies failing to produce any positive results, and the disgruntled populations being driven to electoral revolt or rebellion in the streets.

Take the situation of the GIPSIs (the weaker peripheral economies) in Europe.  To a historian, the problem is familiar from the Latin American debt crisis, the Asian financial crisis, and many other episodes of economic crash.  A number of countries enjoyed misleadingly favorable exchange and borrowing rates due to their membership in the Euro.  This led them to spend and borrow too much, loading them up with debts they could never repay.  When the markets recognized this, they deserted those countries (their bonds in this case, rather than their currencies), causing a credit crunch and economic crash.

The ONLY real-world remedy for those countries is to correct the imbalances in exchange and borrowing rates that caused the problem.  The best way to do this is to write off a portion of their debts, and revalue their currency to make their labor and goods and services more globally competitive while shrinking their consumption of imports.

Politicians are now calling for “growth policies” instead of austerity, which is good.  But no growth policies will pay off big enough in anything like the 2-3 year period needed to extract countries from the immediate crisis.  Unfortunately, despite economists’ multiplier models, we do NOT have sure prescriptions that say spending X dollars this year will provide X+n dollars in growth next year.  The more certain long-term government programs to boost growth such as spending on needed infrastructure (electric grid and transport), basic science, and high-risk high-reward technologies (e.g. solar power) will not pay off for a decade or more.

So what is to be done?  The one law of economics that does seem to hold up is the law of supply and demand – there is a price at which the supply called forth at that price balances the demand sought at that price.  If you hold up the price above that level you get excess supply; if you hold the price below that level you get excess demand.  The high value of the Euro in south European countries with lower productivity essentially holds the price of their labor too high (so excess labor, i.e. unemployment, results) and the price of their consumption too low (so excess spending results).    Fixing this problem by a currency revaluation for indebted states will reduce their imports and spending, while boosting growth by increasing their relative competitiveness and reducing the real burden of past debts.  The necessary revaluation is of most European currencies against German/Nordic currencies, so the Euro has to go.

Austerity imposed on part of Europe through starving government and raising taxes while keeping their exchange rates at the same misleading levels that caused the crisis is no solution.  It simply imposes suffering while doing nothing to ease their long-term debt burden nor to improve the competitiveness of their economies.

No doubt losing the Euro will be traumatic.  But it need not destroy the EU.  After all, many EU members have stayed out of the Euro zone (and now look wise for doing so).  The EU is not a single nation, so it should not have a single currency.  What we have learned from this crisis is that until the day the EU does function as a nation, the Euro was premature.  It has been a set of handcuffs in a crisis, rather than a benefit.  It is necessary to remove it.