D-squared Digest -- FOR bigger pies and shorter hours and AGAINST more or less everything else: The "ist" of science and the "ist" of ideology: Bits and pieces of talk around the way about "is economics a science and if so why to economists disagree so much and so loudly?".
This confusion disappears if you make sure to remember that the "ist" at the end of the word "economist" should be taken not as analogous to "scientist", but rather to "Trotskyist". Robert Conquest was an expert on socialism, but not a socialist; seemingly someone like Tim Worstall (who has no economics degree and, frankly, no realistic prospect of getting one from any university of better-than-sickening quality) is perfectly right to call himself an "economist", while someone like me (who has two economics degrees and makes a living doing a form of economics) probably isn't.
Update: Worstall writes in, in comments, to say that he does have a degree in economics, from the LSE! Well I'll be a monkey's uncle. While this doesn't actually change my view of his knowledge of economics (how could it, he posts the evidence every day on his blog), I am clearly in the wrong here and apologise. Tim also says that he has never claimed to be an economist, although my whole point here is that he should do. The term "economist" has lost all meaning in terms of technical ability these days and simply refers to a party affiliation. Words drift and this one doesn't mean the same thing it used to. Tim, Megan McArdle and Richard Posner are all economists. I'm not one. Paul Krugman isn't any more. Brad DeLong is only just one.
J. Bradford DeLong
Picking up from last time. Let me run through what these schools are, why people believe in them, and why you should not:
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Zero Marginal Product Workers
The first wrong model is the idea that we have high unemployment now because our educational system has failed. We in America have produced 12 million workers who effectively have no useful and productive skills that make it worth anybody's while to pay them to do anything. These 12 million people have a zero marginal product--or at least a marginal product that is less than the minimum wage. Representative thinkers who advocate or have advocated a version of this model include Niall Ferguson and Tyler Cowen.
Tyler Cowen of George Mason, especially, likes to talk about "unemployment" among horses in the early twentieth century. Back in the late 19th Century America had roughly one horse per person. Horses were extremely useful: you could ride them, they could pull things, you could put them on a treadmill and make them power things--with steam engines and windmills as the only other non-human-muscle power sources, we had an awful lot of horses.
Then we developed alternative technologies: diesel engines, gasoline engines, electrical engines linked to power plants via high-voltage transmission lines--and all of a sudden the marginal economic product of most of the horses who had existed in 1900 was zero. Horses became unemployed. Horse-breeding operations shut down.
Why can’t we conclude that the same isn’t true of the 12 million excess American workers who are now unemployed? The coming of computers and the decline in manufacturing today have brought the same reduction in the marginal economic product of low-skilled human workers that the coming of electrical, gasoline, and diesel engines brought to the marginal economic product of horses a century ago.
The first rebuttal is: Although these extra 12 million surplus workers are unemployed now, they were employed back in 2007. Are we supposed to believe that changes in technology have proceeded so rapidly that the marginal economic product of all these 12 million workers crashed in two short years?
The counter is that their marginal economic products had been zero for a long time--but that we had not realized it. Because of irrational exuberance, we thought that they could be productively employed in housing construction because we all overestimated the long-run value of the houses that they were building. Now, however, we have discovered that houses are not terribly valuable things--especially not houses in the swamps of Florida and in the desert between Los Angeles and Albuquerque. We used to think they had a high marginal product working in construction. Now we recognize that they do not, and that they never had. And given that the only industry in which they might have been productive enough to earn their keep was construction, now we recognize that the American economy has a 12 million oversupply of excess zero marginal product workers . The big empirical problem with this theory is that employment on construction payrolls in the United States has only fallen by 2 million since 2006. And of this 2 million decline in payrolls perhaps 500,000 are people who have gone back to Mexico. Of the 12 million excess unemployed currently here in the United States, only something like 1.5 million can be attributed to the decline in construction employment.
Where did the other 10 1/2 million come from?
Even if we do have 1 1/2 million permanently-unemployed zero-marginal-product workers as a result of the decline in the construction sector, why have they carried an extra 10 1/2 million other workers into unemployment as well when the other 10 1/2 million seemed to have perfectly good non-construction skills doing what they were doing in 2007? Why has each construction job that has vanished relative to trend carried another seven jobs along with it? The zero-marginal-product workers story has absolutely no answers to these questions.
This is the decisive argument against the idea that we now have high unemployment because we have 12 million workers who do not have the skills and the mental attitude and the willingness to show up that make it worth anyone’s while to pay them to do anything.
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The Structural-Unemployment Labor-Shortage Economy
A second wrong model is that of Minneapolis Federal Reserve Bank President Narayana Kocherlakota, who argues not that we have 12 million permanently unemployable excess workers but rather that we have 12 million excess unemployed whom it will take a long time to retrain and find other jobs. The idea is that because of structural shifts in the economy we have workers who had the skills for declining industries but do not have the skills for the currently-expanding industries, and that it will take a long time for them to acquire the skills that they need to fit the labor requirements of the new economy.
The decisive rebuttal to this is that if the problem is indeed on the supply side rather than the demand side--if the problem is a lack of workers with the right skills for expanding industries rather than a lack of demand and so a lack of expanding industries in the first place--we should see signs of expanding industries and labor shortages in the data. We should see a lot of vacancies in the economy, as the expanding industries that want to hire workers but can’t find any who are qualified search for workers to fill the holes in their staffing patterns. We should see substantial wage increases--even if not in the economy as a whole, we should see them in the expanding industries as firms in industries that are short of labor try to take qualified workers away from one another by promising higher wages. We should see these things, but where are they?
Job openings are a good 600,000 above their absolute minimum mid 2009 trough. But job openings are still far below their normal non-recession levels. If the structural unemployment theory is correct, they should be above normal non-recession levels. And you simply cannot say that there is upward pressure on the peoples’ wages: four years ago your average wage increased by 4% in dollar terms in a year; now nominal wages are rising at a rate of 2% per year in dollar terms and economy-wide wage increases are kissing zero in real terms.
This is not a labor shortage economy.
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Overaccumulation of Capital
The third wrong model is a perennial: that our problem is the overaccumulation of capital.
This is the oldest alternative theory of all. This was a favorite of Chicago economist Frederick Hayek. It was the theory on which Andrew Mellon and Herbert Hoover ran the U.S. economy during Hoover's presidential term at the start of the Great Depression. This theory dates all the way back to Karl Marx--who talked about how economists like James John Stuart Mill and the politicians they advised like Robert Peel thought that you could deal with a financial crisis and a depression by simple strategic interventions in financial markets. This was, Marx said, an attempt to play a game of economic three-card-monte with the economy--to make the economy live beyond its means on its wits. And, Marx said--and Mellon, Hoover, Hayek, and their present-day epigones fellow them--this cannot work. Increasing the quantity of liquid or safe or savings-vehicle assets in the economy cannot permanently repair aggregate demand because, Marx and company said, the real problem is not a shortage of aggregate demand but rather a surplus of aggregate supply: the economy has made too much capital for the market system to absorb, and needs a "prolonged liquidation" of high unemployment, bankruptcies, and scrapped factories before the process of capitalist economic growth can resume.
I confess it is not clear to me why the Marx-Hayek-Mellon-Hoover axis is so certain that there is no financial sector cure to the problem of high unemployment. But let me try to outline Marx's version of the argument, because it is the one that seems to me to make the most sense--or, at least, the least nonsense.
Capitalists, Marx said, own the capital and hire the workers to produce output which they then sell. Output comes in two forms--consumption goods which they sell to workers, and capital goods which they sell to capitalists. Capitalist economies expand over time: each year the previous year's production of capital goods is added to the economy's capital stock and production becomes more capital-intensive and, hence, larger.
Demand for consumption goods, Marx said, grows only slowly: workers are poorly paid, as the economy's capital stock grows capital is substituted for labor and that puts downward pressure on wages, and so forth. Workers cannot increase the amount of money they spend on consumption goods because they don't have the money and are not earning much more money over time. So as production grows a greater proportion of production must be sold to the capitalists--who buy it because they expect to be able to make bigger profits next year by producing on an even larger scale than they produced this year.
Say that we are in Britain in 1860, with nominal net domestic product at £600 million a year and a capital stock of £1.5 billlion, with £500 million of consumption goods produced and £100 billion of net capital goods produced to add to the capital stock. And let's say that the production function and technological progress are such that production is always 40% of the capital stock, Then next year, in 1851, you will have a capital stock of £1.6 billion, production of £640 million, and of that £500 million will be consumption goods and £140 million will be capital goods--which capitalists must buy because they expect to be able to use it all to make further profits in subsequent years.
Extend this economy's trajectory out a decade, to 1860...
You see that by 1855 the economy's productive capacity will have grown significantly--instead of £600 million of net domestic product we will have £1.04 billion. But with consumption still at £500 million, net purchases of capital goods by capitalist must be not the £100 million they were in 1850 but rather £540 million: capitalists must be willing to purchase not £100 million in the expectation that if they add this amount to their capital stock they will be able to sell all the extra output they can produce but they must be willing to purchase £540 million and plan to sell all the production. By 1860 the level of output will be not £500 million but £3.39 billion--and capitalists must be so exuberant that they expect to sell not £100 million to their fellows but rather £2.89 billion.
Now this, Marx says, is unsustainable. Capitalists may well be willing to add 7% to their capital stocks each year to service expanding markets. But will they be willing to spend their money expanding their capital stocks by 34% in a year in the expectation that there will be demand for the full output of their factories next year because next year capital stocks will grow by 36%? No. Sooner or later capitalists will recognize that full demand for factories next year is a chancy thing. So they will cut back on their plans for expansion this year--and when they do so everybody will find that it is this year and not next year that demand falls short of supply.
The workers are unable to buy the "surplus" output because they have no extra money. The capitalists are unable to buy the "surplus" output because there is no point in expanding their capital stocks when they cannot even find markets for all they can produce this year. The result is crisis: overproduction, mass unemployment, and bankruptcy. The weakest firms fail. Their capital is scrapped. Other factories stand idle. Their capital rusts away. The depression continues until the waste and scrapping of capital has proceeded so far that capitalists once again start to believe that it is time to invest in building up capacity once again--and when they do so decide, they find that there is not a surplus but a shortage of capacity and so the cycle of expansion, exuberance, investment, irrational exuberance, overproduction, crisis, and bankruptcy and unemployment starts all over again.
The root problem, Marx thought, is that a market economy can only run at full employment if the surplus value received by employers is then ploughed back into investing to increase their capital stock. But if the surplus value is invested in increasing the capital stock--well, then, who are you going to sell the next round of increased production to because there will be even more surplus value in the future?
Lowering interest rates via financial manipulation, Marx thought, would not help because artificially propping up capitalist demand for investment goods for a year or two simply magnifies the overproduction of capital and magnifies the eventual crash.
Public works financed by taxes on the rich, Marx thought, would not help because the public works would have to be paid for and taxes raised from the capitalists would diminish their confidence and their willingness to invest in further expansion.
Public works financed by taxes on the poor, Marx thought, would not help because the public works would have to be paid for and you can't get blood from a stone.
The only way out is through universal bankruptcy: "prolonged liquidation." That is the only way out, Marx thought--unless you resort to socialism: the abolition of the capitalist class, the overthrow of the market economy and the wages system, public ownership of the means of production, and the creation of a free and democratic society of associated producers.
Mellon, Hoover, Hayek and their epigones have not been so keen on the "socialism", the "abolition of the capitalist class", and the "free society of associated producers" parts of Marx's argument, but otherwise they buy it: irrational exuberance leads to overaccumulation which has to be cured by a "prolonged liquidation" requiring persistent high unemployment. Mellon, Hayek, and Hoover tended to say that this is an unfortunate drawback of what is otherwise a pretty good economic system.
There always seemed to me to be two big questions here.
The first is Paul Krugman’s question. Capitalists don't have to spend all their money buying capital goods. They are, historical experience teaches us, perfectly happy buying consumption goods as well. The only underlying point that is even potentially valid point is not that full employment requires an unsustainable explosion of capital good production but rather that sometimes the economy gets itself wedged into a configuration in which capital goods production is too high for the level of total demand. The result would be unemployment among workers in capital goods industries--and when they get unemployed they lose their jobs and when they lose their jobs their incomes fall and you get a recession.
Krugman's question is this: Sometimes the economy does indeed get too much capital for the sustainable level of demand. But equally there are times when the economy has too much consumption goods for the sustainable level of demand as well--some times there is not an overaccumulation of capital but instead an overproduction of consumption goods. When that happens the people who make consumption goods do lose their jobs and have to go find jobs someplace else. But that process does not produce a recession: it produces a boom. No period of high unemployment is generated by the redeployment of workers from consumption goods to capital goods industries. High unemployment arises only when workers are switching out of capital goods and into consumption goods industries.
This is a decisive argument against the "overaccumulation of capital" theory in its Hoover-Hayek-Marx form. The logic of the argument requires that overproduction of capital and overproduction of consumption goods have similar effects on unemployment if the argument is true, and they do not.
Second, and more important, where is the overaccumulation of capital right now? Look at private construction spending in the United States. It grows smoothly throughout the 1980s and the 1990s, We get this housing bubble in the 2000s. And since 2007 housing and other construction has been depressed below its trend level.
No matter how you draw the housing-bubble triangle and the housing-depression trapezoid, the trapezoid is larger than the triangle. The housing market has spent more years depressed by more than it’s been elevated back during the boom. We don’t have a surplus of houses relative to trend right now. What we have is a shortage.
Admittedly, we do not have houses we would really want. What we would really want to have would be more two-bedroom condos in Venice Beach rather than five bedroom houses with swimming pools beyond San Bernardino. But the fact that a bunch of our houses are in the wrong place means that we should be more eager to build houses right now, not less willing.
The idea that we have an overaccumulation of capital right now is simply wrong.
What we do have is we have a high housing vacancy rate because a lot of people have lost their jobs and so are doubling up in their apartments with their relatives.
So at the empirical level the "overaccumulation of capital" theory simply does not fly. You might--I doubt it but you might--have been able to use it to justify a recession in 2008 and 2009, but it will not explain high unemployment today and even less high unemployment next year.
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The fourth wrong model--I don't hear this from economists as much as from Republican politicians, and maybe from a very few economists who want jobs in the next Republican administration too much, and from Alan Greenspan--is that there been an enormous increase in uncertainties since the election of Obama. This enormous increase in uncertainty is due to government deficits and overregulation. It has led businesses cut back on their spending. We cannot get spending up again until we do something to make businesses less uncertain about the future.
Here I would say that there are five considerations:
The first is that this is a version of the correct, aggregate demand argument--only instead of placing the deficient demand for goods and services and the excess demand for financial assets on the shock caused by the collapse of the subprime bubble it places it on the shock caused by Obama's election. Thus the cure is the same as in my standard story, for the cure does not depend on and is the same no matter what the cause of the flight to quality: rebalance financial markets to leave investors satisfied with their holdings of safe and liquid assets and they will invest in businesses that want to expand. Restoring business confidence is one way to rebalance financial markets by diminishing the demand for safe and liquid assets, but it is not the only way: rebalancing financial markets by expanding the supply works as well.
Second, this theory should never even get out of the gate. The timing is simply wrong. It was not Obama's election or expectations of Obama's election that caused the flight to quality. The flight to quality was caused by the collapse of the subprime bubble.
Third, if businesses are uncertain and are worried about overregulation and overtaxation, shouldn’t they be saying that that is what worries them? Ask businesses what they are worried about right now, and they will tell you that they are unusually worried about poor sales and not about Obama-generated uncertainty. This theory says that it is worries about future government policies that have hit the minds of business entrepreneurs that are the cause of the recession. If it is true, that is what business entrepreneurs should say that they are worried about when you ask them. And they are not.
Fourth, if businesses are genuinely worried about inflation due to government deficits, shouldn’t we see this in financial markets?
Shouldn’t the price in financial markets for insuring yourself against inflation over the next 10 years be high right now? Right now it is a break-even trade at an inflation rate of less than 3% per year. There are no signs that businesses are worried about inflation and are taking steps to insure themselves against it. And as to high interest rates in general because of a fear that government deficits will starve private businesses of capital--Treasury interest rates continue at their extraordinarily low levels. This, too, simply fails to meet the plausibility test: if people were uncertain, and if that was causing the recession, we wouldsee signs of uncertainty in financial markets and surveys. We do not.
It is entirely possible that uncertainty about future policy can generate a recession.
But uncertainty is not generating this one.
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Inflation Around the Corner
Fifth, closely linked to the argument that "uncertainty" is the cause of the recession is the argument that we definitely do not need stimulative policies right now--an argument I hear most these days from John Cochrane of the University of Chicago. Further stimulative policies will set off a burst of inflation that will harm the economy in the long run and it’s causing that further stimulative policies will raise interest rates and crowd out private investment and slow long term government growth. On the internet this morning, once again, who was it, somebody had a rant about how worries that Japan, Japanese construction after the earthquake, about how that will push up interest rates and so diminish private investment and harm the global economy as the Japanese government borrows and spends a whole bunch of money to deal with the crisis caused by the earthquake and the tsunami. A rant about how that just doesn’t apply because what we saw in the aftermath of the tsunami and the earthquake was not an increase but a decrease in the interest rates on Japanese and American government bonds, that people are more willing to buy them, not less. That we’re not crowding out government investment that we’re crowding it in.
If there were a genuine need to control inflation well you’ll expect to see wages increase or you’d expect to see the inflation rate implicit in government bond prices, this red line rising rapidly and no, we’d expect to see this blue line which is the real interest rate rising rapidly and it’s not. That we see a situation in which an economy is approaching an inflation danger looks like and once again it doesn’t look like this.
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Banking and Fiscal Policy Unnecessary
The sixth wrong model is advocated by those who believe that we do not need to even think about fiscal and banking policy because Milton Friedman was right all along: simply stimulative monetary policy through normal open market operations can do the job. Here we have Nobel Prize winner Robert Lucas, who simply claims to not see the point of either banking policy to lower risk premia when the short-term safe nominal interest rate is already at zero and cannot go any lower or the point of expansionary fiscal policy. Lucas annoys me because he has spent some time trashing Berkeley’s own Christina Romer in an unfair, ignorant, and incoherent way. So I want to stress that when you actually listen to what Lucas is saying--as, for example, at the March 2009 conference of the Council on Foreign Relations--the immediate first impression is that he simply has not thought any of the issues through. Take Robert Lucas back to 1829, put him in a room with John Stuart Mill and Jean-Baptiste Say, have Lucas give his argument for why it was that increased government purchases or that bank rescues would not help an economy in financial crisis--if we were to do that I think that both Mill and Say would classify him as an unarmed man in a battle of wits--they would ask: "this is supposed to be a macroeconomist?"
Back in 1829 economists had got it straight what the relationship was between the soundness of the banking sector and the level of overall employment. How come Bob Lucas in 2009 has not?
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The seventh wrong model is a line of reasoning that you see from finance economists--a set of claims that a whole bunch of policies have no effect on anything.
For example, consider Eugene Fama of Chicago, and his claim that fiscal policy has to be ineffective because whenever government spends it has to borrow, and whenever it borrows it has to take money away from a single private individual who is also spending. Thus whatever the government does to plan to spend money has by definition to be offset by an equal and opposite decrease on what the private sector plans to spend on goods and services.
That is simply wrong. When planned government spending goes up, planned private sector spending does not have to go down. When private sector income and wealth goes down, it does not have to plan to cut its spending if it is willing to hold fewer financial assets. And one way that increased government spending boosts the economy is that government debt issue boosts the supply of safe and liquid financial assets--and so makes people more comfortable holding the financial assets that they have and less anxious to cut back on their current spending on goods and services.
Consider Myron Scholes of Stanford, who criticizes Federal Reserve Chair Ben Bernanke for believing that the Federal Reserve can buy long-term bonds for cash and so affect long-term interest rates. Scholes's argument appears to be that when the Federal Reserve buys risky bonds there is a chance that the Federal Reserve will go bankrupt and then that taxpayers will be taxed in order to pay for the losses on those risky bonds, and so you actually have no removed any risk from investors via the Federal Reserve's purchases. That is simply wrong. Taxpayers are a very different group of people from investors. Investors are rich and old. Taxpayers are middle class and much younger.
When we shift risk off of investors who fear that they are already bearing too much risk and on to taxpayers is a very plausible way to change the economy-wide price of risk and thus to affect interest rates.
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The Seven Sects of Macroeconomic Error
All seven of these lines of argument I have outlined seem to me to be completely, obviously, and trivially fallacious. There are simply not enough unemployed construction workers to account for the recession. There are no signs of the high vacancies you would have in a high-structural-unemployment economy. The overaccumulation of capital simply is not there because the overbuilding triangle is smaller than the post-crisis under-building trapezoid. If the recession were due to uncertainty over overregulation and high future taxes then people would be worried about overregulation and high future taxes rather than being worried about poor sales and slack demand. The need to control inflation in order to avoid a double dip as people get scared of inflation requires that people be actually scared of inflation--which means that asset market signals should show that inflation is expected to rise. Conventional monetary policy is not the only appropriate policy tool because--as the classical economists knew back in 1829--banks are special, and liquidity, confidence, and the solvency of the banking sector are closely linked. If you don't understand things about the centrality of the financial sector that other economists have known for 180 years, why are you on the stage talking rather than in the audience listening? If you have not figured out that planned economy-wide spending goes up when people plan to dump and down when people plan to accumulate financial assets and thus that plans for the government to raise do not immediately entail plans for the private sector to equally cut spending, why are you in the room at all? And if you have not noticed that investors are a different group than tax payers and that shifting the burden of risk off of overburdened investors on the taxpayers may well affect the risk premium--well, you simply have not thought about the issues at all.
And that’s where I want to conclude our depression economics section.
I want you to hold tight to the idea that we could push our current unemployment rate down relatively rapidly if only we had the political will to undertake the stimulative fiscal and monetary policies to do so.
Of course, that might generate inflation. And next lecture we will start on inflation economics: where inflation comes from, how in proceeds, and how to control it.
Karen Dynan emails:
We are now making the entire journal --- which includes the current conference papers as well as the full 40+ years of archived articles -- available online for free. The link is here: http://www.brookings.edu/economics/bpea.aspx. Justin Wolfers (who is co-editor of BPEA) is doing his part to promote this news today on the Freakonomics blog...
For example, here is one of the best: Rudiger Dornbusch and Alejandro Werner (1994), "Mexico: Stabilization, Reform, and No Growth" http://www.brookings.edu/~/media/Files/Programs/ES/BPEA/1994_1_bpea_papers/1994a_bpea_dornbusch_werner_calvo_fischer.pdf:
IN THE SECOND HALF of the 1980s... Mexico was coming to be viewed as a showcase of successful stabilization and economic reform, institutional stability, and financial predictability. Mexico was becoming what Chile already had become and what all of Latin America hoped to be.... By April 1994, the sharp upturn in interest rates, arising from speculative attacks on the peso, suggested that a far too optimistic view may have been taken of Mexico's future.The Mexican economy had come to a virtual standstill. Per capita income is now far below what it was in 1980.... [A]ny positive growth that may occur in 1994 will have been fueled by fiscal expansion not by strength in the real economy.
This paper argues that Mexico suffers from a failure to accompany the stabilization of inflation... and... economic reforms with not only true political reform but also true economic progress. The stabilization strategy has led to an overvaluation of the exchange rate, a precarious financial situation, and a lack of growth....
Less sanguine observers argue that the financial flows may be fragile, however. The flows are financing not only investment but also a high level of consumption and intermediate goods imports, with the large external deficit dampening demand for domestic goods. For full employment to occur, then, crowding-in is required (through an increase in the demand for domestic production). According to this argument, trade liberalization, which was an important part of recent reform, should have been accompanied by real depreciation not appreciation. To a large extent, we agree real depreciation is needed to improve the long-term economic prospects of Mexico and secure the benefits of economic reform...
President Carlos Salinas de Gortari is rightly acknowledged for the sweeping reforms in Mexico, but he left two loose ends. The first was postponing real democracy in favor of another six years of technocratic rule. The other was overvaluing the currency. For Salinas, inflation was the primary issue, just as it had been in Chile in the late 1970s. In his own words,
We must bring inflation down to a one-digit level this year. Some say, why don't you relax your inflation goals a bit so we can have better growth rates? And I respond: There is no trade-off between inflation and growth.
The evidence of the past few years contradicts his statement. Disinflation with overvaluation is a temporary device that ultimately causes great damage. In Mexico, that sad ending lies ahead unless the currency is devalued.
J. Bradford DeLong
The Right Explanation for Our Great Recession
Let me briefly review the right explanation for our Great Recession: the explanation that I been pushing in the past several weeks of the course, since we finished the "economic growth" section of the course. The right explanation of our Great Recession is that the downturn had three sources. First comes irrational exuberance in housing markets. Irrational exuberance in housing markets led to a substantial number of mortgage loans being made that should not have been made. These loans would not have been a problem if you had had capital market arrangements like we had in the late 1990s during the dot-com boom. The dot-com boom also saw irrational exuberance, much more irrational exuberance, in fact, than we saw in the subprime mortgage bubble.
But irrational exuberance in the dot-com boom was not accompanied by overleverage. The venture capital firms that created and issued the securities of the dot-com boom sold them off to unleveraged primary investors, rather than leveraging up and holding on to them by financing their positions with borrowed money. When the dot-com crash came, high-net-worth individuals lost their wealth. But there were no large money-center banks whose solvency was thrown into doubt by the crash.
Things were different with the subprime crash. The large money-center investment and commercial banks found, after the crash, that the losses on their subprime mortgage holdings were of the same order of magnitude as and might exceed their capital cushion. Their other liabilities were thus no longer beyond question--perhaps the money-center banks were not good to pay back all their creditors and make good on all of the deposits they had accepted. This was, in large part, the result of the third factor: misregulation--the government had failed to impose and maintain proper capital adequacy standards of those banks that were indeed "too big to fail"; the government had failed to use its regulatory hammer to check whether the large money-center banks possessed the proper risk controls. It turned out that they did not: that the top managements of the money center banks had no idea of the risks that their subordinates were running on their shareholders' behalf.
The consequence was panic and flight to quality. A huge tranche of financial assets that had been generally classified as safe turned out not to be so. These tranches had been places to put your money where you could sleep easy, confident it would still be there when you came back for it. That was the whole reason for you to invest in a AAA mortgage-backed security rather than in something riskier that offered a higher return.
So what happened when it became clear that the supply of high-quality financial assets was a lot lower than people had thought? What happened when it became clear that a larger value of assets labeled AAA were not so? What happened when all of those debts that were thought to be of high quality because those owing the debts owned AAA assets turned out to be not such high quality at all because the assets backing those debts were not AAA? And what happened when it became clear that the ability of financial professionals to properly understand their risks had been greatly oversold? A collapse in the supply of high-quality financial assets accompanied by a surge in demand.
This fall in the supply and rise in the demand for high-quality assets created an enormous financial market imbalance. The counterpart to this large excess demand for high quality assets was deficient demand for currently-produced goods and services and labor--a "general glut." People who felt that their portfolios were short of high-quality assets cut back on their spending to try to build up their high-quality asset stocks. But when they and everyone else cut back in spending, all they managed to do was to cut back on sales, employment, and income. They found that their cut back on spending was matched by a fall in their incomes so that they did not manage in fact to build up their stocks of high-quality assets. And as total spending fell short of the amount needed to provide full employment the economy headed into recession.
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The Right Cure for Our Great Recession
That was the cause. What is the proper cure for our current macroeconomic distress, for our Great Recession? The cure, I said, had three parts.
The first was regulatory reform. Beef up the regulatory and supervisory structure so that this won't happen again, or at least so that this will be less likely to happen again. Repair the defects of regulation that allowed banks to get themselves into this absurd position. Repair current overleverage. Attempt to ensure that in the future bankers will notice when they get overleveraged. And be sure that they fear that if they get overleveraged and a crash comes then they are going to suffer both in their personal pocketbooks and in the bankruptcy of the institutions they head. If there were a plausible regulatory reform that would successfully curb irrational exuberance on the part of savers and investors we would undertake that as well. That, however, is a much harder task: we economists have not advanced very far. Regulatory reform is this the first prong of the cure.
The second prong is that, while we are waiting for regulatory reforms to take effect--if they are going to take effect--we want to repair the shortage of aggregate demand and return the economy to full employment. The second prong is to use government spending to restore full employment. Have the government stand up its spending when private sector stands down its spending. This is expansionary fiscal policy. There is, because of the excess demand for high-quality financial assets, not enough demand for currently-produced stuff? Then the government can go buy more stuff.
The third prong is the other way that policy can affect the level of aggregate demand in the short run. Have the government carry out strategic interventions in financial markets to rebalance them. Excess demand for financial assets is driving deficient demand for currently-produced goods, services, and labor? By Walras' Law, eliminate the excess demand for financial assets and you will have rebalanced the goods markets as well. The government can provide the private sector with the financial assets that it wants and and cannot find. When the private sector has the financial assets that it wants, then asset prices will go back to normal. There will no longer be this elevated long real risky interest rate which has put so much downward pressure on investment spending.
These strategic interventions in financial markets can be carried out through any of a large number of possible mechanisms. Milton Friedman was certain that the only mechanism you needed was standard open-market operations--purchases and sales of short-term Treasury bonds for cash--and that the right policy to follow was one that kept the economy-wide money stock on a smooth growth path. We are not no certain.
One strategic intervention is to create more savings vehicles, either by creating more government bond directly via additional deficit spending or through inducing the creation of more private bonds. Deficit spending by government--and subsidization policies like investment tax credits to encourage private investment by businesses, or even jawboning to create expectations of a little more inflation in order to boost private bond issues--create more savings vehicles, more places for people to park their money if they want to move it from the present into the future. To the extent that the excess demand in financial markets is an excess demand for duration, the creation of more such savings vehicles is exactly the right thing to do.
A second strategic intervention is that the Federal Reserve can buy back bonds from the private sector for cash, and so increase the amount of liquid cash money in the economy. If the excess demand in financial markets is an excess demand for liquid cash money, this is exactly the right thing to do.
A third set of strategic interventions is more mushy and diffuse. The Federal Reserve and bank regulators together can guarantee bank debt. They can take risk onto their own books by a whole host of what we now call "quantitative easing" measures--the purchase not just of short-term safe nominal assets but risky assets. They can boost not the supply of savings vehicles or the supply of liquidity but rather act to reduce the demand for and increase the supply of safety in financial markets. And since the principal origin of our problem was in the flight to quality and the resulting excess demand for safety, it would be appropriate to take this as the principal focus of policy right now.
In any event, when there is no excess demand at full employment for financial assets, there won’t be any downward pressure on production and employment. That stopped the downturn. To generate a recovery we need to do a little bit more: create an excess supply of financial assets in order to generate an excess demand for currently-produced goods, services, and labor. But we have not advanced far along that road yet.
& & &
Excess Demand for Financial Assets and the Income Expenditure Framework
We formalize all of these considerations in the investment-savings version, the IS version, of our income-expenditure framework. It tells us what the level of real GDP in the economy will be as a function of:
We write the key equation of the investment-savings version of the income expenditure model as:
Y = μ[A0 + G + (Ir+Xεεr)r]
μ = 1/[1 - (1-t)cy + imy] being the multiplier, depending on the tax rate, the marginal propensity to consume, and the marginal propensity to import
A0 being baseline autonomous spending, depending on foreign incomes, foreign interest rates, and the confidence of consumers, business investment planning committees, and foreign exchange speculators
G being government purchases--fiscal policy
Ir being the interest sensitivity of investment
Xεεr being the interest sensitivity of exports--the product of the exchange-rate sensitivity of exports and the interest sensitivity of the exchange rate
r being the long-term, real, risky interest rate.
It is true that the root problem was a derangement in the subprime mortgage market resulting from irrational exuberance which then triggered a derangement in financial markets more generally due to overleverage and misregulation.
But we could fix mass unemployment without tackling the fundamental roots of the downturn. We just have to pull the fiscal, monetary, and banking policy levers in such a way as to get aggregate demand back to where it should be. We can then clean up the financial mess later on. Job number one, after all, is to cure mass unemployment rather than to fix the fundamentals of the financial system.
This is the right model for the cause and cure of the Great Recession.
& & &
Am I Right?
But if you go outside of this classroom out there into the great political-economical debate, into the scrum, you will find that this position that I have been pushing in this course--while it is certainly the dominant position, the plurality position, the position held by the overwhelming majority of most qualified experts--it is by no means the only position out there. I say that our problem is that misregulation, excess of leverage and irrational exuberance produced the financial crisis which then led to an aggregate demand shortfall that we should repair as fast as possible by properly-stimulative fiscal, monetary, and banking policies. But there are others whom you will find saying at least seven different things.
So in the rest of this lecture section, let me run through the wrong models of the current downturn and what we should be doing about it--and let me explain why all of these alternative positions are wrong.
Let me note that I find this to be a very awkward position to be in. There is my karass of economists--sensible, reality-based, empirically-oriented, understanding reality. And there are seven other factions and schools of economists out there saying very different things--things very different from what I am saying and from what all the other economists who I believe are carrying out sensible analyses are saying.
I firmly believe that I am right.
I firmly believe that I am right almost as firmly as I believe that the sun will rise in the east tomorrow.
Of course, there was the day...
I was flying back from Europe during northern hemisphere winter. We came out of the earth's shadow into the sun somewhere north of Manitoba at local noon--so the sun was due south of the plane as we flew into daylight. From the plane, on that day the sun rose in front of us directly to the south.
Thus it is not certain that the sun is always going to rise in the east. In fact, I have seen it do otherwise. Admittedly, I have seen it only in very special circumstances: 30,000 feet up, flying due south out of the earth's shadow during northern hemisphere winter, and at local noon.
That is an important lesson: no matter how certain you are that you are right, you could be wrong.
Nevertheless, I will proceed...
& & &
Why the Seven Sects of Error? The Role of Milton Friedman
The first question I want to address is: why are so many people--smart people--holding on to these wrong models? And here I blame the late Milton Friedman, longtime professor at the University of Chicago, head of the Chicago School of Economics before he developed some sense and moved to San Francisco. I blame Milton Friedman because he made things much much too simple.
Milton Friedman thought that it was sufficient simply to keep the money stock on a stable growth path--that that was the only set of strategic interventions in financial markets necessary to ensure constant full employment. Why did he think this? I believe that there are two reasons. The first was that if you look from say 1980 or so back into the past, the times when the money stock is unstable are the times when there are depressions. The times when the money stock is stable are times when there are no depressions. You could argue whether instability in the money stock was cause or effect of depressions. Milton Friedman thought that instability in the money stock was cause. Others thought it was the effect. They argued back and both. It was not clear. Of course, it is clear now: because the Federal Reserve tried successfully to prevent a decline in the money stock in 2008, it is now clear to us that much of past money-demand correlations arose because when demand fell the banking system came under pressure to shrink the money stock.
If there were good arguments on both sides, what made Friedman so certain that instability that the money stock was the cause and not the effect? I think the answer is that he was a committed libertarian. He was not just an economic libertarian--not just a believer that the government shouldn’t be interfering in the marketplace in prices and quantities and property rights. He was a social libertarian. He was a believer that the government should not be sticking its nose into people’s bedrooms, or into their ideas about how to pursue better living through chemistry. He wanted to say that that government is best that governs least: establish property rights, set up some courts to decide things if people dispute, otherwise just get out of the way--don't interfere with market prices or market quantities or property rights or social mores, but get out of the way in order to maximize individual liberty.
The problem is that this does not fit with macroeconomics. We have this circular-flow income-expenditure system in which there are always these excess demands for and excess supplies of financial assets emerging. They carry with them either high unemployment or inflation. And so the government is always having to intervene to rebalance financial markets to avoid mass unemployment or inflation.
Now that is not a terribly terribly comfortable position for a libertarian to be in. The government is constantly intervening in the money market: buying and selling bonds and cash in order to soak up whatever excess demand or excess supply exists in financial markets. How is this a hands-off, libertarian, laissez-faire policy?
At this point Friedman could have done either of two things. He could have said: libertarianism is true always and everywhere except for monetary economics, where the rules are different. He could have found a way to make his preferred government monetary policy sound like laissez faire.
He chose the second. He said that the right monetary policy is for the government to keep its hands off of the money stock--for the government to follow a non-interventionist policy of letting the money stock grow at a constant rate and not intervene in financial markets to push the money stock up or down. It is a bright-line rule. It should be easy to follow. I would say that it is not "non-interventionist": whenever something happens to the banking system to make banks want to diminish their ratio of deposits to reserves, the Friedman rule requires that the Federal Reserve not keep its hands off the economy but rather that it go into the market and buy a huge amount of bonds. Why is a constant money growth rate rule a "laissez faire" "non-interventionist" policy? It isn't--any more than a constant kwh growth rate rule or a constant steel production growth rate rule is a "laissez-faire" "non-interventionist" policy. But these are not questions Milton Friedman wanted to answer, or even wanted to hear asked.
Instead, Friedman said: keeping the money stock growing at a constant rate is a neutral, non-interventionist, laissez-faire policy. Forget about what all the Keynesians over there are saying about more complicated strategic interventions. Constant M growth is the rule.
And so Milton Friedman acquired a lot of followers behind this constant money stock growth rule. But starting in the 1980 it becomes apparent that it’s simply not true. Central bankers tried to follow Milton Friedman prescriptions. And they found themselves getting into trouble. And lo and behold in 2008 they got into big trouble, when extraordinary increases in the monetary base did not keep unemployment from rising and kissing 10%.
Here Friedman's followers and their intellectual descendants found themselves trapped by the rhetorical strategy Friedman had adopted in the 1950s and 1960s and 1970s. Friedman believed that macroeconomic stabilization required that the central bank be always in the market, buying and selling government bonds in order to match the supply of liquid cash money to the demand, and so make Say's Law true in practice even though it was false in theory. And Friedman tried to maximize the rhetorical distance between his position--which was merely the "neutral," passive policy of maintaining the money stock growth rate at a constant--and the position of other macroeconomists, which was an "activist," interventionist policy of having the government disturb the natural workings of the free market. Something went wrong, Friedman claimed, only when a government stepped away from the "neutral" monetary policy of the constant growth rate rule and did something else.
It was, I think, that description of optimal monetary policy--not "the central bank has to be constantly intervening in order to offset shocks to cash demand by households and businesses, shocks to desired reserves on the part of banks, and shocks to the financial depth of the banking system" but "the central bank needs to keep its nose out of the economy, sit on its hands, and do nothing but maintain a constant growth rate for the money stock"--that set the stage for what was to follow, and for what we see now among the seven sects of macroeconomic error that I am taking an unconscionably long time in getting to.
Friedman's rhetorical doctrine was successful in eliminating the perception of cognitive dissonance between normal laissez-faire policies and optimal macro policy: both were "neutral" in the sense of the government "not interfering" with the natural equilibrium of the market. But it did so at the cost of eliminating all interesting macroeconomic questions: if the government followed the proper "neutral" policy, then there could be no macroeconomic problems. And it left his intellectual descendants with no way to think about these issues: generations of Chicago that had been weaned on this diet turned out to know nothing about macro and monetary issues when they became important again.
It is in this sense, I think, that I blame Milton Friedman: he sold the Chicago School an interventionist, technocratic, managerial optimal monetary policy under the pretense that it was something--laissez-faire--that it was not.
And then it turned out at the end of 2008 that it simply did not work.
Now at this point the seven sects of macroeconomic error could have done either of two things. They could have chosen wisely. They could have said: "Oops we’ve been followers of Milton Friedman for 50 years and we were wrong, his intellectual opponents were right. We have to go back and listen to them and learn what they had to say and change our minds. We need to sit at the feet of Bagehot and Wicksell and Minsky and Keynes and Hicks and Tobin for a while and think through the issues of the determinants of aggregate demand.
They chose not wisely. They chose to say: "Milton Friedman taught us that the Keynesian version of the income-expenditure approach was wrong. There is something wrong with Friedman's theory. But we need to develop it and add something new rather than return to something old and discredited."
It turned out an awful lot of economists decided to follow the second road--that of becoming Ptolemaic astronomers, of trying to add epicycle after epicycle, adding eqants and deferents, and so forth to try to save the phenomena. And they did so even though the standard story of demand shortfall-driven recessions that dated back to 1829 and that in fact underpinned Friedman's version of monetarism was still in good shape, and still perfectly adequate.
That story leaves me highly confident that all seven of the alternative models are wrong. I understand how it is that people--smart people, even if not wise people--arrived at them. And I also understand why they are wrong.
But the explanation of why they are wrong must wait until next time...
Arizona Senate President Russell Pearce:
ThinkProgress: U.S. history, most of us weren’t around when the Constitution was written. But you remember we kind of existed before Congress, the states. We created the Congress, we created the federal government, by compact. Do you know what existed before the Congress, the states? Do you know, you’re not a citizen of the United States. You’re a citizen of a sovereign state. The fifty sovereign states makes up United States of America, we’re citizens of those sovereign states. It is not a delegated authority. It’s an inherent authority that states have over the federal government. [applause] It’s about time somebody gets it right!
Fourteenth Amendment to the Constitution of the United States:
All persons born or naturalized in the United States, and subject to the jurisdiction thereof, are citizens of the United States and of the State wherein they reside...
Indeed, even Roger B. Taney believed back before the Civil War that some of us, at least, were citizens of the United States:
Since the adoption of the Constitution of the United States, no State can by any subsequent law make a foreigner or any other description of persons citizens of the United States, nor entitle them to the rights and privileges secured to citizens by that instrument....A State... may put a foreigner or any other description of persons upon a footing with its own citizens as to all the rights and privileges enjoyed by them within its dominion and by its laws. But that will not make him a citizen of the United States...
Between 1950 and 1990--back in the old days of Federal Reserve inflation-fighting recessions--the unemployment rate in the United States would on average close 32.4% of the gap between its initial value and its natural rate over the course of a year. If the United States unemployment rate had started to follow such a path after its fall 2009 peak, we would now have an unemployment rate of 8.3% instead of 8.9%.
But there is the unfortunate fact that none of the United States net reduction in the unemployment rate over the past year comes from increases in the employment-to-population ratio, and all of it comes from decreases in labor force participation. Perhaps we should not be pleased that the United States unemployment rate has fallen from 10.1% to 8.9% over the course of the past year and a half while the employment-to-population ratio has remained stuck at 58.4%. Perhaps we would rather have people who could and who at full employment would have jobs in the labor force, unemployed, and actively looking for work rather than out of the labor force completely.
If we take that view, we note that between 1950 and 1990--back in the old days of Federal Reserve inflation-fighting recessions--the employment to population rate in the United States would on average rise an extra 0.227 in a year for each year that the unemployment rate was above its natural rate. If the United States employment-to-population ratio had started to follow such a path after its fall 2009 peak, we would now have an employment-to-population ratio of 59.7% instead of 58.4%. It would indeed be morning in America, instead of the current economic state.
This is, I think, the best metric to use to quantify the decidedly sub-par pace of the jobless recovery in the United States. It is not out of line with other American yardsticks: since the output trough real GDP has grown at an average rate of 2.86%/year, barely above the rate of growth of the productive potential of the U.S. economy. It is not out of line with the experience of other rich economies, whether in Europe or Japan. It is in sharp contrast, in fact, only to the experience of developing Asia, where the rate of real GDP growth and of unemployment rate decline shows a solid, well-entrenched, and rapid recovery and where inflation will soon become a more significant macroeconomic problem than unemployment.
The obvious hypothesis for why this current recovery--and the last two recoveries--in the United States have proceeded at a sub-par pace is that the speed of recovery is linked to the causes of the downturn. A pre-1990 recession was triggered by a Federal Reserve decision that it was time to switch policy from business-as-usual to inflation-fighting. The Federal Reserve would then cause a liquidity squeeze and so distort the constellation of asset prices to make much construction, sizable amounts of other investment, and some consumption goods unaffordable to demand and hence unprofitable to produce. The resulting excess supply of goods, services, and labor would lead inflation to fall.
After the Federal Reserve had achieved its inflation-fighting goal, however, it would end the liquidity squeeze. Asset prices and incomes would return to normal. And all the lines of business that had been profitable before the downturn would be profitable once again. From an entrepreneurial standpoint, therefore, the problems of recovery were straightforward: simply pick up where you left off and do what you had used to do.
After the most recent downturn, however--and to a lesser extent after its two predecessors--things have been different. The downturn was not caused by a liquidity squeeze. The Federal Reserve cannot wave is wand and return asset prices to their pre-downturn configuration. The entrepreneurial problems of recovery are much more complex: not to recall what it used to be profitable to produce but rather to figure out what new things it will be profitable to produce in the future.
As Dan Kuehn likes to say, a recession is like somebody knocking your jigsaw puzzle, disturbing the pieces and turning some of them over. When the Federal Reserve ends a liquidity squeeze it turns the pieces right-side-up--and so it is easy to reassemble the puzzle. But right now there is nobody to turn the pieces right-side-up--and so things are much harder.
Pursuing this analogy further, I claim that things are even worse. As long as aggregate demand remains low, we cannot even tell when pieces are right-side-up. New investments, lines of business, and worker-firm matches that would be highly productive and profitable if capacity utilization and unemployment were at their normal levels are unprofitable now. We do need not just demand recovery but structural adjustment. But the market cannot do demand recovery rapidly by itself. And it cannot do structural adjustment at all until demand recovery is well under way.
Come Back To The Blogosphere?: When she quit blogging Hilzoy wrote the following:
The main reason I started blogging, besides the fact that I thought it would be fun, was that starting sometime in 2002, I thought that my country had gone insane. It wasn’t just the insane policies, although that was part of it. It was the sheer level of invective: the way that people who held what seemed to me to be perfectly reasonable views, e.g. that invading Iraq might not be such a smart move, were routinely being described as al Qaeda sympathizers who hated America and all it stood for and wanted us all to die.
I thought: we’ve gone mad. And I have to do something — not because I thought that I personally could have any appreciable effect on this, but because it felt like what Katherine called an all hands on deck moment…
That said, it seems to me that the madness is over. There are lots of people I disagree with, and lots of things I really care about, and even some people who seem to me to have misplaced their sanity, but the country as a whole does not seem to me to be crazy any more.
I submit that the madness is not over.
There is the unfortunate fact that none of our net reduction in the unemployment rate over the past year comes from increases in the employment-to-population ratio and all of it comes from decreases in labor force participation.
Leaving that to one side--assuming (which is surely not the case) that the unemployment rate is a sufficient statistic for the health of the labor market and that all those dropping out of the labor force are not of special concern--how are we doing, recovery-wise?
Between 1950 and 1990--back in the old days of Federal Reserve inflation-fighting recessions--the unemployment rate would on average return 32.4% of the way back to its natural rate over the course of a year.
If the unemployment rate had started to follow such a path after its fall 2009 peak, we would now have an unemployment rate of 8.3% instead of 8.9%.
Between 1950 and 1990--back in the old days of Federal Reserve inflation-fighting recessions--the employment to population rate would on average rise an extra 0.227 in a year for each year that the unemployment rate was above its natural rate by one percentage point.
If the employment-to-population ratio had started to follow such a path after its fall 2009 peak, we would now have an employment-to-population ratio of 59.7% instead of 58.4%.
We all have our guesses as to the mechanism--as to where the labor-market equilibrium-restoring forces in the economy and in the political economy have gone.
But what pieces of evidence would be convincing and help us tell which of the theories of slow labor-market recovery are correct? And where to look for them?
For a long time I have wondered whether the true purpose of the Committee for a Responsible Federal Budget is to attempt to get a responsible long-term federal budget or to provide a safe harbor for politicians--primarily Republicans--who want to burnish their reputations as deficit hawks without actually doing anything to balance the long-term federal budget.
Now Stan Collender and Paul Krugman appear to have decided that it is the second.
Attention Committee for a Responsible Federal Budget: This Letter is Anything But Thrilling: The Committee for a Responsible Federal Budget said in a press release last week that this letter to the president from 64 U.S. senators calling for comprehensive deficit reduction is significant. I say that the letter is so meaningless that it makes you wonder whether the committee is desperately searching for any tiny morsel that indicates it's still relevant. First, some disclosure. Over the years I have worked with and (in a consulting capacity) for the committee. I know and think very highly of CRFB's president, Maya MacGuineas. I have attended many CRFB-sponsored events over the years as their guest. And I know and hold in great esteem many of the people who have been and still are on CRFB's board.
CRFB's press release says that it is "thrilled" by the letter. But the letter says nothing more than that the 64 senators urge the president "to engage in a broader discussion about a comprehensive deficit reduction package" and that they "hope that the discussion will include discretionary spending cuts, entitlement changes and tax reform." Does that really qualify as thrilling?... [T]he letter is more a reflection of the current politics of the budget and current polling than it is a shift in today's deficit reduction landscape. As Bruce and I have posted repeatedly and this column in The Hill by pollster extraordinaire Mark Mellman once again confirms, a broad majority of Americans want the deficit reduced; they just aren't in favor of any of the things that would actually reduce it. That's all the letter from the 64 senators actually says.... So why exactly is anyone "thrilled" by this?
Peacocks on Parade: it’s become more and more clear that the committee’s real purpose isn’t to balance the budget, it’s to provide additional plumage for deficit peacocks. First there was the award to Paul Ryan, whose contribution to reducing the deficit is that he, well, talks a lot about the need to reduce the deficit; never mind that his actual proposals are a mixture of magic asterisks and concrete actions that would actually make the deficit bigger. Now there’s the fervent praise for the letter by 64 Senators whose plan to reduce the deficit is to … call on President Obama to come up with a plan. If you believe that this letter means that Republicans will actually support any plan that involves the slightest tax increase, I’ve got several bridges you might want to buy.
It was remarkable the number of people last fall whom I had thought were smart who were out there arguing that Obama-created "uncertainty" about regulation was at the root of our economic problems--in spite of charts like the one to the right.
I had thought that they had all gone away after the election--after all, if you want to raise uncertainty would there be a better way than to demand immediate and total repeal of the Affordable Care Act as your #1 issue?
Kevin Drum points out that Greenspan's intervention seems as if tuned to keep this talking point alive:
Defending the Ridiculous | Mother Jones: One of the most impressive accomplishments of the modern right is its ability to generate plausible technical papers to justify conservative tropes that are basically ridiculous. For example, during last year's campaign it was popular to claim that our economy was weak because of regulatory uncertainty. This made no real sense at all. Our economy is weak because of economic uncertainty: businesses don't have enough customers to make it worth investing in new capacity or hiring new workers, and they aren't sure when or if new customers will appear in the future. Unfortunately, that didn't make for very good campaign trail bashing. Republicans wanted to convince people that the economy was weak because President Obama and congressional Democrats kept passing onerous new regulations that had businesses scared to death, so that's the story they kept repeating ad nauseum.
It never really caught on outside of campaign stump speeches, though, because — well, because it was ridiculous. What to do? Answer: find someone to write a technical paper demonstrating that regulatory uncertainty really is holding back the economy. But who could they get for this job?
Paul Krugman provides the answer: none other than Alan Greenspan.... Brad DeLong does the dreary work of taking down Greenspan in detail here. Past posts on this site about the uncertainty meme are here, here, and here. Conservative economists piling on the uncertainty bandwagon here....
[A]ll that aside — which is to say, aside from the actual truth of the uncertainty meme — it's impressive, as usual, that the conservative movement managed to find such a big name to put his name to defending the indefensible. After all, news reporters almost have to take the uncertainty meme seriously now, and that's really all that matter. Mission accomplished!
Pieces of economics are certainly a science.
But if you look at the current state of the Chicago School, it seems to me that, among that group of economists at least, it is definitely not a science.
Moreover, it is not even a discipline. There were a lot of things that economists like Frederic Bastiat, Jean-Baptiste Say, and John Stuart Mill knew in 1830 about the origins of aggregate demand shortfalls and the usefulness of expansionary fiscal policy in a downturn that modern Chicago never bothered to read, never bothered to learn, or have long forgotten.
For example, consider Luigi Zingales of the University of Chicago--smart guy.
In my debate with him over at the Economist I found myself flummoxed when he would say things like:
Keynesianism has conquered the hearts and minds of politicians and ordinary people alike because it provides a theoretical justification for irresponsible behaviour. Medical science has established that one or two glasses of wine per day are good for your long-term health, but no doctor would recommend a recovering alcoholic to follow this prescription. Unfortunately, Keynesian economists do exactly this. They tell politicians, who are addicted to spending our money, that government expenditures are good. And they tell consumers, who are affected by severe spending problems, that consuming is good, while saving is bad. In medicine, such behaviour would get you expelled from the medical profession; in economics, it gives you a job in Washington...
Among the 37 Economics Nobel prize winners in the last 20 years, four received the prize for their contributions to macroeconomics. None of these could be considered Keynesian. In fact, it is hard to find academic papers supporting the idea of a fiscal stimulus...
The current crisis is not a demand crisis, it is a trust crisis. Bad corporate governance coupled with bad government policies has destroyed the financial sector, scaring investors and freezing lending. It is as if a nuclear bomb had destroyed all roads in America and we claimed that to alleviate the economic impact of such an event we should invest in banks. It is possible that eventually the effect will trickle down. But if the problem is the roads, you want to rebuild roads, not subsidise the financial sector. And if the problem is the financial sector, you want to fix this and not build roads...
Let me pick on Zingales.
Bad corporate governance coupled with bad government policies certainly produced a trust crisis--a collapse in the perceived supply of safe, liquid, high-quality assets for investors to hold. As a consequence, all across the economy agents cut back on their expenditures on currently-produced goods and services in order to try to build up their stocks of safe, liquid, high-quality assets to desired levels. But they could not do so: the stocks simply were not there. So the consequence of the cutback in planned spending was a fall in demand, production, employment, and income.
When people cannot get high-quality assets by lending to banks, that is a problem. One way to fix it is to fix the banks so that people are once again confident that their loans to banks are high-quality assets. But that is not all you can do. The government is a supplier of high-quality assets. As an alternative to lending to banks which then lend to businesses which then spends by investing in physical capital and so boost demand back to normal levels, we can lend to the government which then spends and so boosts demand back to normal levels.
That is expansionary fiscal policy.
Zingales's claim--that because the current crisis is a trust crisis that has left the economy short of safe high-quality liquid assets we cannot restore employment by having the government build roads and finance road construction by issuing trusted safe high-quality liquid assets--that claim is so incoherent as to reveal nothing more than a failure on Zingales's part to think any of the issues through for more than a weekend. Zingales is a smart guy. But he is also pig-ignorant about what economists have thought and said in the past. And because he is pig-ignorant, he has mentally disarmed himself.
The hallmark of a discipline--let alone a science--is that you are working in an intellectual tradition and know and build on the work of your predecessors.
Had Zingales a clue as to what economists were writing even as early as the first half of the nineteenth-century, he would be familiar with cogent and true arguments like:
Frederic Bastiat, "What Is Seen and Not Seen," on the benefits of fiscal expansion and government employment of the unemployed in a recession:
There is an article in the Constitution which states: "Society assists and encourages the development of labor.... through the establishment by the state, the departments, and the municipalities, of appropriate public works to employ idle hands." As a temporary measure in a time of crisis, during a severe winter, this intervention on the part of the taxpayer could have good effects... as insurance. It... takes labor and wages from ordinary times and doles them out, at a loss it is true, in difficult times...
Jean-Baptiste Say, "Treatise on Political Economy," on the benefits of fiscal expansion and government employment of the unemployed in a recession::
[A] benevolent administration can appropriately make provision for the employment of supplanted or inactive labor in the construction of works of public utility at public expense, as in construction of canals, roads, churches, or the like...
Jean-Baptiste Say, "Complete Course of Political Economy," on how the key problem created by a trust crisis is not the harm it does to aggregate supply--not the disruption of the division of labor--but rather the lack of aggregate demand:
The Bank [of England]... forced the return of its banknotes... cease[d] to discount commercial bills. Provincial banks were... obliged to follow... commerce found itself deprived at a stroke of the advances on which it had counted, be it to create new businesses, or to give a lease of life to the old. As the bills that businessmen had discounted came to maturity, they were obliged to meet them, and finding no more advances from the bankers, each was forced to use up all the resources at his disposal. They sold goods for half what they had cost. Business assets could not be sold at any price. As every type of merchandise had sunk below its costs of production, a multitude of workers were without work. Many bankruptcies were declared among merchants and among bankers...
John Stuart Mill, "Essays on Some Unsettled Questions in Political Economy," on how at the root of high unemployment after a financial crisis is an excess demand for financial assets:
There can never, it is said, be a want of buyers for all commodities; because whoever offers a commodity for sale, desires to obtain a commodity in exchange for it, and is therefore a buyer by the mere fact of his being a seller. The sellers and the buyers, for all commodities taken together, must, by the metaphysical necessity of the case, be an exact equipoise to each other; and if there be more sellers than buyers of one thing, there must be more buyers than sellers for another.... If... we suppose that money is used, these propositions cease to be exactly true.... Although he who sells, really sells only to buy, he needs not buy at the same moment when he sells; and he does not therefore necessarily add to the immediate demand for one commodity when he adds to the supply of another....
In order to render the argument for the impossibility of an excess of all commodities applicable to the case in which a circulating medium is employed, money must itself be considered as a commodity.... [T]hose who have... affirmed that there was an excess of all commodities, never pretended that money was one of these commodities; they held that there was not an excess, but a deficiency of the circulating medium.... [P]ersons... from a general expectation of being called upon to meet sudden demands, liked better to possess money than any other commodity. Money, consequently, was in request, and all other commodities were in comparative disrepute.... [T]he result is that all [other] commodities fall in price or become unsaleable...
Had Zingales known all of this, he would have recognized that expansionary fiscal policy was a perfectly respectable policy response to the shortage of safe, liquid assets created by the trust crisis.
But he didn't. So he didn't.
And he is not alone. Consider how much more Bastiat, Say, Mill, and company knew back in 1830 than all of these Chicago School "thought leaders" whom I wrote about a year and a half ago:
David K. Levine of Washington University in St. Louis:
It is a daunting task to bring you [Paul Krugman] up to date on the developments in economics in the last quarter century. I know that John Cochrane has tried to educate you about what we've learned about fiscal stimulae [sic] in that period...
But the stimulus plan? How can you be arguing for more? Since we are recovering before most of the stimulus money has entered the economy--isn't that evidence it isn't needed? How can you write as if you are proven right in supporting it?...
John Cochrane of the University of Chicago:
[That spending can spur the economy] is not part of what anybody has taught graduate students since the 1960s. They are fairy tales that have been proved false. It is very comforting in times of stress to go back to the fairy tales we heard as children but it doesn’t make them less false...
Paul [Krugman's]’s Keynesian economics requires that people make logically inconsistent plans to consume more, invest more, and pay more taxes with the same income...
Robert Lucas of the University of Chicago:
Christina Romer--here's what I think happened. It's her first day on the job and somebody says, you've got to come up with a solution to this--in defense of this fiscal stimulus, which no one told her what it was going to be, and have it by Monday morning.... [I]t's a very naked rationalization for policies that were already, you know, decided on for other reasons...
If we do build the bridge by taking tax money away from somebody else, and using that to pay the bridge builder--the guys who work on the bridge -- then it's just a wash... there's nothing to apply a multiplier to. (Laughs.) You apply a multiplier to the bridge builders, then you've got to apply the same multiplier with a minus sign to the people you taxed to build the bridge. And then taxing them later isn't going to help, we know that...
Edward Prescott of Arizona State University:
I don't know why Obama said all economists agree on [the need for a stimulus bill]. They don't. If you go down to the third-tier schools, yes, but they're not the people advancing the science...
[T]he period of the '20s was one of healthy growth, until Hoover's anti-market, anti-globalization, anti-immigration, pro- cartelization policies were instituted, brought this expansion to an end, and created a great depression...
Eugene Fama of the University of Chicago:
Sorry, but I’m not familiar with [Hyman] Minsky’s work
Haven't seen it [Paul Krugman's article]. I pay no attention to him...
Government bailouts and stimulus plans seem attractive when there are idle resources - unemployment. Unfortunately, bailouts and stimulus plans are not a cure. The problem is simple: bailouts and stimulus plans are funded by issuing more government debt. (The money must come from somewhere!) The added debt absorbs savings that would otherwise go to private investment. In the end, despite the existence of idle resources, bailouts and stimulus plans do not add to current resources in use. They just move resources from one use to another...
Michele Boldrin of Washington University in St. Louis:
It is a fantasy that the economic profession at large finds the "stimulus" and the "bank bailout" plans sensible and adequate. Most economists we know oppose them.... Outside the administration, the convinced supporters of the plans are a small minority among academic economists working in those fields. Both plans contradict four decades of research and are designed to please special interest groups...
Is there a case for borrowing now to finance a stimulus package? People are worried about the future and are sensibly reducing their spending. Does this imply the government should step in and do the spending for them? Put that way, the idea seems like a non-starter...
And I haven't even mentioned Richard Posner's bizarre and false claims that:
No one has the faintest idea what effect the stimulus has had.... Disentangling the various factors... has not, to my knowledge, been attempted.... This raises the question of the ethical responsibility of academic economists, such as Romer (and Krugman, and Lawrence Summers, and many others), who write for the media or join the government, either to adhere to academic standards in their nonacademic work or to make clear to the public that they are on holiday from those standards...
As I say, before you ask whether economics as an intellectual discipline rises to the standards of a science, you first have to ask whether it rises to the standards of an intellectual discipline at all.
Guns and butter: About that deficit: MARK THOMA has an appropriately succint post up today which reads in its entirety (and I hope he'll forgive my quoting the whole thing):
We have enough money to pay for military action in Libya, but not for job creation?
It's hard not to be cynical about government policymaking.... [B]oth Republicans and Democrats are committed to cutting the government's budget in the current fiscal year... threaten programmes with positive economic returns.... [F]ew party leaders are seriously discussing new spending on programmes with positive economic returns. America has substantial infrastructure needs—current spending is inadequate to simply maintain critical infrastructure at its current state of repair—and yet the odds of passing a new transportation law to replace the one that was scheduled to expire in 2009 but which has since been extended repeatedly, well, they're close to zero. Why? No one can agree on a way to fund new infrastructure spending.
Libya poses no threat to America. It's far from clear that American intervention will yield positive outcomes for Libyans. And yet here America goes, launching massively expensive sorties....
[M]uch of official Washington—Democratic and Republican leaders, along with policy intellectuals and op-ed pages—has acted as though an immediate fiscal crunch loomed. This was never true. American debt levels may be an issue by the end of the decade, but they aren't now, and deficits are forecast to fall sharply for the next few years. Bond yields have rarely been lower. The fiscal problem is long-term, not short-term. And yet dire fiscal scenarios have been used to sell painful short-term cuts, some of which were necessary but could have been accomplished later, many of which weren't necessary at all. Americans have been told, by the president of the United States and his chief Republican antagonists, that in hard times the government, like households, must tighten its belt. And then along comes Libya to put the lie to all of these assertions.
The really, really troubling thing about this is that Washington will almost certainly ignore the inconsistency. I doubt any pundits will take the opportunity to observe that Washington leaders apparently don't actually believe that America faces immediate fiscal constraints (as it does not)...
He is, of course, completely correct.
Ph'nglui mglw'nafh Ryan Avent R'lyeh wgah'nagl fhtagn!!
Rantings of an Ex-Maestro: Some people have asked me for reactions to this piece by Alan Greenspan (pdf) on how Obama’s activism is preventing economic recovery. I could go through the weak reasoning, the shoddy econometrics that ignores a large literature on business investment and ignores simultaneity problems, etc., etc.. But never mind; just consider the tone. Greenspan writes in characteristic form: other people may have their models, but he’s the wise oracle.... Sorry, but he doesn’t get to do that any more. 2011 is not 2006. Greenspan is an ex-Maestro... who saw no evil, heard no evil, refused to do anything about subprime, insisted that derivatives made the financial system more stable, denied not only that there was a national housing bubble but that such a bubble was even possible.
If he wants to redeem himself through hard and serious reflection about how he got it so wrong, fine — and I’d be interested in listening. If he thinks he can still lecture us from his pedestal of wisdom, he’s wasting our time.
So let me take up the task.
What is most notable [about today]... is the unusually low level of corporate illiquid long-term fixed asset investment.... This contrasts starkly with the robust recovery in the markets for liquid corporate securities.... What, then, accounts for this exceptionally elevated level of illiquidity aversion?... I infer that... the effect can be explained by the shock of vastly greater uncertainties embedded in the competitive, regulatory, and financial environments faced by businesses... deriving from the surge in government activism...
I don't see how this hangs together in any coherent fashion at all.
If businesses are unwilling to invest in illiquid capital out of the fear that government action will impair the value of their investments, businesses must also fear that government action will impair the value of their existing illiquid investments. What is the value of their existing illiquid investments? The value of their existing illiquid investments is nothing more than the stock market value of their companies--liquid stock market value is, in the last analysis, nothing more than the cash flows proceeding from the illiquid investments that companies have made that generate the profits.
A much better and more sensible explanation for the relatively high value that the stock market places on existing illiquid corporate assets and the relatively low value that companies place on illiquid investments to expand their fixed capital is precisely that capacity utilization is low--so why spend more money now building factories when doing so would be more expensive and only add to your idle capacity?
And, indeed, if you ask people running businesses what is their single most important problem, they say that it is not (as they sometimes say it is) taxes; they say that it is not (as they said it was at the start of 2000) the cost and quality of labor; it is not (as they said it was in 2004) the availability and cost of insurance; it is not (as they briefly said it was at the start of 1993) government requirements. What do they say their biggest problem is? Poor sales.
Private investment is low because aggregate demand is low and so capacity utilization is low--and is not expected to get better anytime soon. Full stop. That is an explanation that is coherent and fits the facts in the way that Greenspan's Randite claim that it must somehow be the fault of the gummint does not.
Charlie Stross writes:
An observation: [W]hen the definitive history of the Fukushima Daiichi accident is written, there will be a tally of casualties and fatalities.... I firmly believe that the fatalities will be dominated by iodine poisoning, self-administered by people in countries not exposed to emissions from the plant.
How to cut the deficit by doing nothing: There are two major takeaways from the Congressional Budget Office’s analysis of the president’s proposed 2012 budget. The first is that the CBO doesn’t believe it will save as much money as the White House says it will. The second is that doing nothing — yes, nothing — would do more to cut the deficit than anything that the Obama White House proposed or than the GOP is likely to propose....
The difference appears to be that the CBO is more pessimistic about the economic outlook over the next decade — a pessimism that matters enormously for deficit projections. Who’s right? Well, predictions are hard. As Jon Chait details, there was a similar dispute in the 1990s where the Clinton White House was using more optimistic projections than the CBO — and the Clinton White House not only proved closer than the CBO, but even their relatively optimistic projection proved overly pessimistic. This time, of course, things might not turn out as rosy. But that’s a guessing game. What’s not a guessing game is that the Obama budget increases the deficit versus a policy of doing nothing....
[O]ver the next 10 years, both the Republican and Democratic budgets will be worse for the deficit than inaction...
Robert's Stochastic thoughts: I agree that a shortage of safe assets caused the current recession...
But, he says:
I don't think that this is the reason unemployment remains high. As far as I know, quality premia are back to normal, banks are flush with cash and [safe] real interest rates are microscopic...
(Not true for risky interest rates, by the way...)
Waldmann goes on:
I assume that it is better to have a job in manufacturing or in construction than in services and better to have a job in equipment manufacturing than in consumer goods manufacturing. I assume this because it is obviously true and everyone knows it. Could employment in construction declinei in a barter economy? Well obviously yes if there can be irrational housing bubbles.... How about manufacturing? Sure if perceived wealth declines due to the end of irrational exuberance or due to irrational pessimism then demand for durables consumption goods falls more than demand for non durables and service but less than demand for capital goods.... So... I can easily get investment (including investment in structures that is construction) and durable goods consumption to bounce around.
So why don't the construction and manufacturing workers get jobs cutting hair or manicuring nails?... [S]hifting to services would be costly. For one thing it would require leaving Las Vegas.... Then the worker would get a much lower wage. Oh and lose contact with his or her friends in construction or manufacturing so when population growth and depreciation and such caused new demand for construction or equipment manufacturing or durable goods manufacturing, he or she wouldn't get the jobs.... [T]o get people to move from good jobs with good wages to bad jobs at bad wages requires enormous unemployment. So much so that the economy recovers before there is much of a shift...
This is, I think, largely wrong: It is true that as long as aggregate demand is depressed there is little incentive for the unemployed to leave Las Vegas and start working at Supercuts. But what would happen were aggregate demand to recover? Well, there would be large profits to be made by employing workers in expanding sectors... and if the unemployed really did not have the skills to work in expanding sectors we would see large wage increases in expanding sectors, and economy-wide inflation would start to rise.
It might happen. I don't think so, but it might. The point, however, is that right now it is not happening: the shortage relative to full-employment equilibrium values of safe assets is no longer putting downward pressure on demand and employment, but it is not putting upward pressure on demand and employment either. For that upward pressure to happen right now we would need a surplus of safe liquid assets...
Paul Krugman says that they are not his children, but his great-grandchildren:
Roots of Macroeconomic Ignorance - NYTimes.com: have some quibbles: Brad, I think, telescopes the process. Today’s freshwater economists don’t believe in Friedman-type monetarism; they’re two intellectual generations of intellectual retrogression beyond that...
Nick Rowe says that they are nothing like his children--that they are Friedman's opposites:
Worthwhile Canadian Initiative: Do Keynesians understand their own models?: If we lived in a world of barter exchange, or in a world where people could use barter exchange at minimal cost, Keynesian macroeconomics would make no sense whatsoever.... [D]o Keynesians understand this? Milton Friedman understood this. Monetarism, rather obviously, would make no sense whatsoever in a non-monetary economy. As Milton Friedman (almost) said, recessions are always and everywhere a monetary phenomenon. He (and Anna Schwartz) wrote a very large book arguing that the Depression was a monetary phenomenon.
If you drew a line, and put Real Business Cycle theory at one end of the spectrum, who would be a natural candidate to put at the other end of the spectrum? I can't think of a better candidate than Milton Friedman. At one end of the line you have people who say that money plays no role in the business cycle. And at the other end you have Milton Friedman. Keynesians are somewhere in between.
So it seems counter-intuitive for Brad DeLong to blame Milton Friedman for the rise of Real Business Cycle theory. The two are polar opposites.
You could argue that the research program called RBC theory, or Classical Macroeconomics (a strange name for something that only started in the 1980's), is an example of the Ricardian Vice. RBC theory is what happens when you insist on modelling everything formally. But who should we blame for the Ricardian Vice? Ricardo, obviously. But if we are looking for more recent culprits, you could argue that, say, James Tobin, an excellent Keynesian economist, is at least as guilty as Milton Friedman.... It makes about as much sense to blame Friedman for the consequences of the Ricardian Vice as it does to blame Keynes. Both gave the model-builders something to model, but they themselves were more talkers. Personally, I blame Tobin for Lucas, and everything that followed. Well, maybe that's a bit unfair...
I think that you can blame Friedman for the current crop of ignorance much more sensibly that you can blame Tobin.
In the 1950s and 1960s and 1970s Milton Friedman faced a rhetorical problem. He was a laissez-faire libertarian. But he also believed that macroeconomic stabilization required that the central bank be always in the market, buying and selling government bonds in order to match the supply of liquid cash money to the demand, and so make Say's Law true in practice even though it was false in theory.
Such a policy of constant government intervention to continually rebalance aggregate demand is hardly a laissez-faire hands-off libertarian policy, is it?
Friedman, however, set about trying to maximize the rhetorical distance between his position--which was merely the "neutral," passive policy of maintaining the money stock growth rate at a constant--and the position of other macroeconomists, which was an "activist," interventionist policy of having the government disturb the natural workings of the free market. Something went wrong, Friedman claimed, only when a government stepped away from the "neutral" monetary policy of the constant growth rate rule and did something else.
It was, I think, that description of optimal monetary policy--not "the central bank has to be constantly intervening in order to offset shocks to cash demand by households and businesses, shocks to desired reserves on the part of banks, and shocks to the financial depth of the banking system" but "the central bank needs to keep its nose out of the economy, sit on its hands, and do nothing but maintain a constant growth rate for the money stock"--that set the stage for what was to follow in Chicago.
First, Friedman's rhetorical doctrine eliminated the cognitive dissonance between normal laissez-faire policies and optimal macro policy: both were "neutral" in the sense of the government "not interfering" with the natural equilibrium of the market. Second, Friedman's rhetorical doctrine eliminated all interesting macroeconomic questions: if the government followed the proper "neutral" policy, then there could be no macroeconomic problems. Third, generations of Chicago that had been weaned on this diet turned out to know nothing about macro and monetary issues when they became important again.
It is in this sense, I think, that I blame Milton Friedman: he sold the Chicago School an interventionist, technocratic, managerial optimal monetary policy under the pretense that it was something--laissez-faire--that it was not.
New York Times paywall: wishful thinking or just crazy? - Boing Boing: lots of people are going to greet the NYT paywall with eye-rolling and frustration: You stupid piece of technology, what do you mean I've seen 20 stories this month? This is exactly the wrong frame of mind to be in when confronted with a signup page (the correct frame of mind to be in on that page is, Huh, wow, I got tons of value from the Times this month. Of course I'm going to sign up!)
Which means that lots of people will take countermeasures to beat the #nytpaywall. The easiest of these, of course, will be to turn off cookies so that the Times's site has no way to know how many pages you've seen this month
Of course, the NYT might respond by planting secret permacookies, using Flash cookies, browser detection, third-party beacons, or secret ex-Soviet vat-grown remote-sensing psychics. At the very minimum, the FTC will probably be unamused to learn that the Grey Lady is actively exploiting browser vulnerabilities (or, as the federal Computer Fraud and Abuse statute puts it, "exceeding authorized access" on a remote system -- which carries a 20 year prison sentence, incidentally)
Even if some miracle of regulatory capture and courtroom ninjarey puts them beyond legal repercussions for this, the major browser vendors will eventually patch these vulnerabilities
And even if that doesn't work, someone clever will release one or more of: a browser redirection service that pipes links to nytimes.com through auto-generated tweets, creating valid Twitter referrers to Times stories that aren't blocked by the paywall; or write a browser extension that sets "referer=twitter.com/$VALID_TWEET_GUID", or some other clever measure that has probably already been posted to the comments below...
If I were the New York Times, I would put up a tip jar rather than a firewall--I would have spent my $40 million talking to psychologists about how to phrase the tipjar...
Why I’m not fleeing Japan: To get some perspective on the earthquake that struck the country to which I moved last year, I hiked a mile and a half Wednesday morning from our house to the Great Buddha of Kamakura, the most famous attraction of this town on the southwest outskirts of Tokyo. Serenity washes over me every time I gaze at the 44-foot, 13th-century bronze statue. I’m not spiritual, much less a Buddhist. But I went to confirm, with my own eyes, that the Buddha looks the same as usual — that he wasn’t, say, glowing because of deadly rays emitting from the crippled nuclear plants 200 miles to the north.
Silly? Of course. Not much sillier, though, than many of the reactions I’ve seen or read about in the past couple of days: the hordes of expats shelling out thousands for flights out of the country; authorities in China, South Korea, Singapore and elsewhere screening Japanese food imports for radioactivity; folks in the States clamoring for potassium iodide pills to protect them against atomic particles wafting across the Pacific. I’ve been deluged with messages from loved ones, wondering whether we’re planning to evacuate. Yet while the concern has been touching, we’re staying put.
Particularly because we don’t live in the immediate vicinity of the nuclear plants, we’re confident that we’re as safe here as always — which is to say, extremely safe, the kind of safe that makes us comfortable sending our fourth-grader on a long train and bus commute to school, a fairly common routine here even for much younger children. Aftershocks, power outages, panic food-buying, long gasoline lines — this, too, will pass, and it’s hard to pity ourselves much given the misery that people along Japan’s northeast coast have endured since March 11.
If there is anything to worry about, it is that the perception of Japan as an unsafe country will inflict all kinds of economic and psychological damage. That would compound the tragedy it is enduring, hamper its ability to recover and elevate the challenges it faces just when it is most in need of support....
I admit that when news broke about the power plants I wondered whether dangerous particulates might drift to our home. But when I read past the headlines, I learned that the risks were negligible for virtually all 125 million residents of the Japanese archipelago (except, of course, the heroic plant workers). I read, for example, that after the Chernobyl disaster, most deaths resulted from children in the surrounding area drinking milk from cows that had grazed on contaminated grass — a blunder the Japanese aren’t going to repeat. I came to realize that even a “core meltdown” — something that I had always assumed spelled doom for millions — didn’t necessarily mean much adverse effects on human health, certainly not for people living distant enough for the particulates to disperse. Radiation, I learned, is a rather weak carcinogen. Even among the hibakusha, as survivors of the atomic attacks on Hiroshima and Nagasaki are known, cancer rates were not a lot higher than among the general population.
The extent of the troubles at the nuclear plants is still uncertain. But it hardly seems sensible for people like us to pack up and leave. Nor does it seem sensible or fair for people here or abroad to act as if Japan is a hotbed of fissile material. All those heartfelt expressions of sympathy for quake victims aren’t going to mean much if overreaction to the nuclear mess worsens Japan’s plight....
If foreigners recoil at Japanese vacations, job postings, products or people because of irrational fears about radiation, they will deepen and prolong the trauma that nature has inflicted. In a few months, Japan should be its recognizable self, maybe even brimming with vitality stemming from a renewed sense of national purpose. The trains will once again be astonishingly punctual; the food will be delectable and plentiful. Once that happens, foreigners will hopefully recognize that Japan — with its Great Buddha and so many other wonders — remains an extraordinarily safe place.
It burns, it burns!
What the New York Times' John Tierney gets wrong about bias and women scientists: John Tierney suggested that a "taboo on discussing sex differences" has prevented frank discourse about the real reason why the ratio of male to female scientists is so skewed. He went on to cite a new paper by Stephen Ceci and Wendy Williams... that, he claimed, contradicts the "assumption that female scientists [face] discrimination and various forms of unconscious bias." But, in fact, the paper's authors make a narrower argument, and some of the evidence they present suggests that female scientists almost certainly do face discrimination and various forms of unconscious bias.
Here's what Ceci and Williams show: That women with the same resources as men are just as likely to get their papers, grants, and job applications accepted. While this might appear to mean that women scientists don't face discrimination, in fact, it's quite compatible with the strong experimental evidence that there is bias against women....
[A]s every first year statistics course will tell you, is that correlation does not imply causation. Nicotine-stained fingers are correlated with lung cancer—people with yellow fingers are more likely to have cancer—but yellow fingers don't actually cause cancer. Also, just because you don't find a correlation between two factors, you can't conclude that there is no causal relation between them—it's possible that two causal factors cancel each other out. For example, you might fail to find a correlation between cholesterol and atherosclerosis because you lumped together two different kinds of cholesterol, LDL, which increases the problem, and HDL which decreases it.... [S]uppose you discover that there is a correlation between poverty and ill health, but this correlation disappears when you factor in health care and nutrition. The few poor people with high-quality health care and nutrition are as healthy as rich people—it's just that hardly any poor people have these advantages. It would be wrong to conclude from this that poverty has no causal influence on health. The right conclusion would be that poverty causes bad health care and poor nutrition, which cause ill health.
Ceci and Williams did not show, or claim to show, that there was no discrimination or unconscious bias against women scientists.... They found that when you factor in women's circumstances—for example, what kinds of teaching loads they have, whether they are at research universities, whether they have young children, and so on—then the correlation between sex and success goes away. Overall, female scientists have fewer resources than male scientists, just as poor people have less access to health care.... Ceci and Williams put it this way in their discussion of the number of journal articles women published:
The primary factor affecting women's productivity was structural position. When type of institution, teaching load, funding, and research assistance were factored in, the productivity gap completely disappeared (which is not to say discrimination has not influenced these factors in the real world).
Concluding from this that gender doesn't influence scientific success, however, would be like concluding that poverty doesn't influence health.... It's much more likely that gender causes the unequal resources, which causes the different outcomes....
Why does gender lead to unequal resources? Ceci and Williams accurately paint the big picture. Women drop out in ever greater numbers as they advance along the academic pipeline.... Ceci and Williams cite several studies showing that the conflict between female fertility and the typical tenure process is one important factor in women's access to resources. You could say that universities don't discriminate against women, they just discriminate against people whose fertility declines rapidly after 35.
But as Ceci and Williams admit, the unquestionable fact of unconscious bias, as revealed in the experimental résumé studies, is another possible reason women make choices that lead them to end up with fewer resources. Those studies show that women are subject to bias from the very start of their careers. Is it any wonder that many of them, keenly aware that their efforts are being downgraded compared to those of men, would withdraw from a competition that is systematically unfair?...
Science reporters are supposed to understand these complexities and explain them to their readers—not claim, in spite of the evidence, that sex discrimination is a figment of the biased liberal imagination.
"And the Lord said unto [Ananias], 'Arise, and go into the street which is called Straight, and inquire in the house of Judas for one called Saul, of Tarsus: for, behold, he prayeth, And hath seen in a vision a man named Ananias coming in, and putting his hand on him, that he might receive his sight'.... And Ananias went his way, and entered into the house; and putting his hands on [Saul].... And immediately there fell from his eyes as it had been scales: and he received sight forthwith..."
Paul Krugman recounts the lessons he drew from the 1997-8 financial crisis:
Mind-Changing Events: One question that comes up occasionally in comments is, what would make me change my mind about how the economy works? Associated with this is the question of whether I have ever changed my views drastically.... Let me answer the latter question first. I had a major change of views in the late 1990s, driven by events in Asia.
Until then I had pretty much accepted the “elegant, and conceptually simple” framework described recently by Olivier Blanchard. Basically, I thought that conventional monetary policy could do the job of stabilizing the economy. The Asian crisis, however, led me to rethink that orthodox view. It showed, first of all, that a market economy can suffer huge financial shocks that can’t be offset just by using monetary policy; in particular, I found myself seeing a real role for capital controls to deal with the effect of currency crises in countries with large foreign-currency-denominated debt. And the reality of Japan’s liquidity trap showed that monetary policy can lose traction even without those kinds of currency and debt-denomination issues.
You could say that the Asian crisis made me more Keynesian — because it showed that 1930s-type problems could happen in the modern world, and that you could not, in fact, count on Uncle Alan or Uncle Ben to solve everything. So I came into the 2008 crisis with a framework based on my interpretation of what happened in Asia in the 1990s — a framework that has worked pretty well at making sense of events so far. Meanwhile, a lot of economists who had not taken the events of the 1990s on board were caught flat-footed.
What would it take for me to decide that I needed another major rethink? A major surge in domestically-driven inflation — in particular, a surge in wages — would do it. And there has been an uptick in core inflation measures that is a bit of a surprise; but at this point it doesn’t remotely count as the kind of discordance with theory that would require a major shift.
Let me say that I was not nearly as smart as Paul. My view of the Asian crisis was that capital controls were as likely to hurt as help a country with large hard-currency foreign debts--their imposition could stop capital flight in its tracks, but fear that they might be imposed in a country could start capital flight in the first place. My view was that the Asian crisis showed the limits of monetary policy in countries with large foreign hard-currency debts and shaky currencies--and those limits were that stimulative policies could not be undertaken by domestic central banks or governments but needed to be undertaken by an organization whose credibility was unimpaired, like the IMF or the U.S. Treasury. It did not seem to me to suggest that Uncle Alan or Uncle Ben would be handed problems beyond their strength.
And for Japan? It seemed to me clear that Japan's big problems were all the result of zombie banks--that normal stimulative policies had no traction because everybody believed that all of Japan's banks were insolvent. Proper marking-to-market of Japanese bank assets and proper recapitalization of the banks would, I thought, cure most of Japan's macroeconomic difficulties in short order.
As to what would cause me to substantially rethink my current positions? An upward expectational wage-price spiral with unemployment remaining above 7.5% or, given current policies, a recovery as fast as the one we saw after the Volcker disinflation would certainly do the trick.
Tim Harfurd reminds us of Piper Alpha:
Piper Alpha - Wikipedia, the free encyclopedia: Timeline of the incident
A new gas pipeline was built in the weeks before the 6 July explosion, and while this work disrupted the normal routine, the platform was operating as normal. The discovery of a small gas leak was not unusual and no cause for concern. Because the platform was completely destroyed, and many of those involved died, analysis of events can only suggest a possible chain of events based on known facts. Some witnesses to the events question the official timeline.
12:00 p.m. Two condensate pumps, designated A and B, displaced the platform's condensate for transport to the coast. On the morning of July 6, Pump A's pressure safety valve (PSV #504) was removed for routine maintenance. The pump's fortnightly overhaul was planned but had not started. The open condensate pipe was temporarily sealed with a blind flange (flat metal disc). Because the work could not be completed by 6:00 p.m., the blind flange remained in place. The on-duty engineer filled out a permit which stated that Pump A was not ready and must not be switched on under any circumstances.
6:00 p.m. The day shift ended, and the night shift started with 62 men running Piper Alpha. As he found the on-duty custodian busy, the engineer neglected to inform him of the condition of Pump A. Instead he placed the permit in the control centre and left. This permit disappeared and was not found. Coincidentally there was another permit issued for the general overhaul of Pump A that had not yet begun.
7:00 p.m. Like many other offshore platforms, Piper Alpha had an automatic fire-fighting system, driven by both diesel and electric pumps (the latter were disabled by the initial explosions). The diesel pumps were designed to suck in large amounts of sea water for fire fighting; the pumps had an automatic control to start them in case of fire. However, the fire-fighting system was under manual control on the evening of July 6: Piper Alpha procedures required manual control of the pumps whenever divers were in the water (as they were for approximately 12 hours a day during summer) regardless of their location, to prevent divers from being sucked in with the sea water (fire pumps on other platforms were switched to manual control only if the divers were close to the inlet).
9:45 p.m. Condensate (natural gas liquids NGL) Pump B stopped suddenly and could not be restarted. As the entire power supply of the offshore construction work depended on this pump, the manager had only a few minutes to bring the pump back online, otherwise the power supply would fail completely. A search was made through the documents to determine whether Condensate Pump A could be started.
9:52 p.m. The permit for the overhaul was found, but not the other permit stating that the pump must not be started under any circumstances due to the missing safety valve. The valve was in a different location from the pump and therefore the permits were stored in different boxes, as they were sorted by location. None of those present was aware that a vital part of the machine had been removed. The manager assumed from the existing documents that it would be safe to start Pump A. The missing valve was not noticed by anyone, particularly as the metal disc replacing the safety valve was several metres above ground level and obscured by machinery.
9:55 p.m. Condensate Pump A was switched on. Gas flowed into the pump, and because of the missing safety valve, produced an overpressure which the loosely fitted metal disc did not withstand. Gas audibly leaked out at high pressure, drawing the attention of several men and triggering six gas alarms including the high level gas alarm, but before anyone could act, the gas ignited and exploded, blowing through the firewall made up of 2.5 x 1.5 metre panels bolted together, which were not designed to withstand explosions. The custodian pressed the emergency stop button, closing huge valves in the sea lines and ceasing all oil and gas production. Theoretically, the platform would then have been isolated from the flow of oil and gas and the fire contained. However, because the platform was originally built for oil, the firewalls were designed to resist fire rather than withstand explosions. The first explosion broke the firewall and dislodged panels around Module (B). One of the flying panels ruptured a small condensate pipe, creating another fire.
10:04 p.m. The control room was abandoned. Piper Alpha's design made no allowances for the destruction of the control room, and the platform's organisation disintegrated. No attempt was made to use loudspeakers or to order an evacuation. Emergency procedures instructed personnel to make their way to lifeboat stations, but the fire prevented them from doing so. Instead the men moved to the fireproofed accommodation block beneath the helicopter deck to await further instructions. Wind, fire and smoke prevented helicopter landings and no further instructions were given, with smoke beginning to penetrate the personnel block. As the crisis mounted, two men donned protective gear in an attempt to reach the diesel pumping machinery below decks and activate the firefighting system. They were never seen again. The fire would have burnt out were it not being fed with oil from both Tartan and the Claymore platforms, the resulting back pressure forcing fresh fuel out of ruptured pipework on Piper, directly into the heart of the fire. The Claymore continued pumping until the second explosion because the manager had no permission from the Occidental control centre to shut down. Also, the connecting pipeline to Tartan continued to pump, as its manager had been directed by his superior. The reason for this procedure was the exorbitant cost of such a shut down. It would have taken several days to restart production after a stop, with substantial financial consequences.
Gas lines of 140 to 146 cm in diameter ran to Piper Alpha. Two years earlier Occidental management ordered a study, the results of which warned of the dangers of these gas lines. Due to their length and diameter it would have taken several hours to reduce their pressure, so that it would not have been possible to fight a fire fuelled by them. Although the management admitted how devastating a gas explosion would be, Claymore and Tartan were not switched off with the first emergency call.
10:20 p.m. Tartan's gas line (pressurised to 120 Atmospheres) melted and burst, releasing 15-30 tonnes of gas every second, which immediately ignited. A massive fireball 150 metres in diameter engulfed Piper Alpha, killing two crewmen on a fast rescue boat launched from the standby vessel Sandhaven and the six Piper Alpha crewmen they had rescued from the water. From that moment on, the platform's destruction was assured.
10:30 p.m. The Tharos, a large semi-submersible fire fighting, rescue and accommodation vessel, drew alongside Piper Alpha. The Tharos used its water cannons where it could, but it was restricted because the cannons were so powerful they would injure or kill anyone hit by the water.
10:50 p.m. The second gas line ruptured, spilling millions of litres of gas into the conflagration. Huge flames shot over 300 ft (90 m) in the air. The Tharos was driven off by the fearsome heat, which began to melt the surrounding machinery and steelwork. It was only after this second explosion that the Claymore stopped pumping oil. Personnel still left alive were either desperately sheltering in the scorched, smoke-filled accommodation block or leaping from the deck some 200 ft (60 m) into the North Sea.
11:20 p.m. The pipeline connecting Piper Alpha to the Claymore Platform burst.
11:50 p.m. The generation and utilities Module (D), which included the fireproofed accommodation block, slipped into the sea. The largest part of the platform followed it.
12:45 a.m., July 7 The entire platform had gone. Module (A) was all that remained of Piper Alpha. At the time of the disaster 224 people were on the platform; 165 died and 59 survived. Two men from the Standby Vessel Sandhaven were also killed.
BURTON K. WHEELER, U. S. Senator from Montana: H. R. 1776—a bill granting the President the right to give billions of American tax dollars to finance foreign wars for any country on any continent in the world "and for other purposes" is now the law of the land. The bill was debated fully. A majority of both houses voted for it. The President signed it. It must and should be respected by all our people regardless of their previous opposition to it. The opponents branded the bill a measure authorizing the President to wage an undeclared war. Its friends in Congress declared it a peace bill—a bill to keep this Nation out of war. Whether the opponents or the proponents were correct will depend almost entirely upon the future actions of one man—President Roosevelt himself. It is for him to determine by his future course whether or not his spokesman in Congress misled the people. Vast powers are vested in him and all right-thinking Americans will pray that those powers will be used wisely and in the interest of 130 million people here in the United States of America.
To many of us, the President's recent speech carried dark forebodings for the future of the Republic. To you, Americans who waged a valiant fight against the lend-lease bill, I say—continue the fight—not against the bill—now a law—but against war and against every step which gives dictatorial powers to the President. I am opposed to Nazism, Fascism, Communism or one-man Government in any country under whatever name it may be designated. I think it is fair to say that nearly all—if not all—proponents of the bill in Congress are agreed:
1. That the President is not authorized to use convoys under the present law.
2. That the law does not authorize the sending of sailors, airplane pilots, or soldiers into combat areas.
3. That the President of the United States has no right—though he may have the power—to authorize or direct our armed forces to wage offensive war.
4. That nothing forbids citizens from continuing to petition their Senators and their President to fulfill campaign pledges to keep the United States out of a foreign war.
5. That Congress may still—if it will—refuse to give billions of your tax dollars to Great Britain without first obtaining Mr. Churchill's war aims—without knowing if the objectives are the extermination of Hitler or the annihilation of 80,000,000 German people.
6. That Americans should still insist that Congress carefully scrutinize all appropriations to the end that no tax dollars are squandered.
Before going further I want to give full credit to the British propagandists and the Committee to Defend America by Aiding the Allies upon the deadly effectiveness of their propaganda. They have nearly attained their objective-active American participation in a foreign war. They have accomplished it adroitly. Their work has avoided detection by the Nation as a whole—and this notwithstanding the fact that they followed the identical methods of 25 years ago. Someone has said, "Fool me once, shame on you—fool me twice, shame on me." In 1812 the British invaded the United States. With men and arms they ravaged our Capitol. We fought force with force. It was army against army. Today in March 1941—just as before the last World War—the British have again invaded Washington—not with redcoats—but with some 2,000 agents and employees. In New York City they have an official propaganda agency for the United States. It is called the British Library of Information. It is a vast network for dissemination of war propaganda.
We can see and recognize armed forces. We can and would conquer a foreign army—but insidious and vicious foreign propaganda can be recognized only by those armed with a knowledge of the facts. Clever propaganda can be combated only with reason and sanity—and even these are ineffective weapons during periods of hysteria. To illustrate some methods of war propagandizing, I want to read a letter received a few months ago from a responsible former publisher of a daily paper—Mr. A. P. Whiteside, of Foristell, Mo.—I quote:
He (the American professor acting as a British agent) told me that he had recommended my paper for free newsprint and that his recommendation has been approved. All I had to do was to file my application with J. P. Morgan & Co. of New York and print paper in carload lots would be shipped to me.
Is history now repeating itself? It is not difficult to secure a congressional investigation of German propagandists, of Russian propagandists, of Italian propagandists, or of the activities of peace organizations or labor unions in the United States. But a proposal to investigate all foreign propaganda—which would include the British—dies slowly but surely in congressional committees. A real investigation of British and American war propaganda would have revealed much. It would have exposed the propaganda efforts in the United States of all foreign governments. How much money they spent and to whom it was paid. It would have shown the parts played by Mr. Bullitt and other American ambassadors prior to the outbreak of war. It would have shown the promises that were made to foreign governments by American ambassadors—roving or stationary. It would have taken the American people behind the scenes in this great game of war.
A congressional investigation would have shown the people of America, that pronouncements by the Committee to Defend America by Aiding the Allies foretell the next administration move toward war. This week that war committee advocated the convoy of ships to Britain, American defense of Singapore and the Dutch Indies, and permission for the British to recruit soldiers in the United States for the British Army. William Allen White, then chairman of the Committee to Aid the Allies, unequivocally stated on December 28, 1940, that American convoys meant war. And what does recruiting American soldiers for the British Army mean? Winston Churchill could best answer that. In his book, the World Crisis, Churchill states: "Nothing will bring America in on our side quicker than some blood spilled in Europe." American youth killed at Singapore, American youth slaughtered on land and sea-war—that is what the Committee to Aid the Allies advocates today. And this committee, aided and abetted by war makers, have led the American people to believe their only choice today is war or slavery under Hitler. They have been and are creating a war psychology by making it appear that war is inevitable because peace means slavery. Nothing could be more fantastic. But many honest and sincere people believe that to oppose war, to oppose the delegation of dictatorial powers to the President, is no longer patriotic, is no longer pro-American. Propaganda has made honest though deluded Americans actually believe opposition to war and dictatorship in the United States is pro-Nazi....
The American people have a right to know how many of our warships, airplanes, tanks, and anti-aircraft guns are necessary to aid England? Obviously, the most competent authority on British needs would be Mr. Winston Churchill. Will it be he who determines to what extent our defenses are stripped? Will it be the British Prime Minister who decides how much of the taxpayers' money is to be given away? China's needs are known best to Chiang Kai-Shek, the military dictator of China. Will the generalissimo be given a blank check on our war and naval supplies? Will he determine whether or not we send troops to keep open the Burma road? If you approve all-out aid to these countries—who knows best what these countries need—the President, Mr. Willkie, or Mr. Churchill? Is this what the American people want? Do you want our foreign policy, directly or indirectly, dictated by a European imperialist or an oriental military dictator?... A billion for America is rank idiocy; seven billion for the British is sheer genius....
Where are the "money changers" and the "economic royalists" now? They have been reinstated in the temples of Government. They have been lured from Wall Street to Washington with White House invitations. They are no longer called economic royalists; they are the dollar-a-year men who dispense billions upon billions of dollars in defense contracts. It is they who sit in the seats of the mighty. It is they who direct the policies of this Government. It is these fugitives from Wall Street, accompanied and guided by royal refugees and British propagandists, who insist the present war is a crusade against fascism. They told us that Britain entered the present war to crusade against and to crush fascism. Forgotten except to history is official British recognition of Italian conquests of Albania and Ethiopia. Forgotten except to history are British approval of Italian aggression and their own conquests of people and nations. Who believes that Mussolini's Italy with which England sought to avoid war last June was less Fascist than the Italy Britain fights today?
Before the present war the leader of this so-called crusade against dictatorship entertained some startling views on Italian fascism. Mr. Winston Churchill said, "If I were an Italian, I would be a Fascist." These words from the lips of the British Prime Minister are reported in the Sheet Metal Workers Journal of March 1927. Think of it—Mr, Churchill saying, "If I were an Italian, I would be a Fascist." The same Mr. Churchill who would take your sons to fight Mussolini and Hitler; the same Mr. Churchill to whom you are giving seven billions of your tax dollars. Britain is today righting Adolf Hitler—the aggressor—not Adolf Hitler, the Nazi. Britain is realistic, not idealistic. So long as the British lion's tail was not twisted, Britain had no quarrel with Nazi Germany. It is difficult to recall that many Britons—including the late Ambassador Lothian—were great respecters of Nazi Germany prior to 1939? The present British Ambassador, Lord Halifax, went to Nazi Germany to visit and go shooting with Goering, and was known to be persona grata to the Nazis—and they apparently were so to him....
Those of us anxious to preserve civil liberties and peace have been subjected to a smear campaign. Never once has fact been answered with fact, or reason with reason. Instead, cries of "pro-Nazi, Hitler agent, anti-Semite" are shouted at the opposition. This is bigotry in its vilest form. This is a return to the monarchial concept that the king can do no wrong. I have said—and I repeat—that there are men in the world who are far more concerned with the restoration or the preservation of their economic and social status than with the welfare of the masses of the people. I am not interested in the race or creed of these men. I am concerned—and always have been—with the welfare of the great mass of humanity, with the underprivileged, with the economic and social status of those who are ill-fed, ill-clothed, and ill-housed...
He has a point:
Worthwhile Canadian Initiative: Do Keynesians understand their own models?: Do Keynesians really understand their own models? Do they understand the central role of money and monetary exchange in generating recessions? If so, why the emphasis on fiscal policy?
Take a Keynesian model. Any Keynesian model. Start in long run equilibrium. Now hit it with the sort of shock that would cause a recession. Aggregate Demand falls, which causes output and employment to fall. Unemployment increases. OK, what's really going on here? The unemployed hairdresser wants her nails done. The unemployed manicurist wants a massage. The unemployed masseuse wants a haircut.... [B]arter is not easy.... The unemployed hairdresser is more than willing to give up her labour in exchange for a manicure, at the set prices, but is not willing to give up her money in exchange for a manicure. Same for the other two unemployed women. That's why they are unemployed. They won't spend their money. Keynesian unemployment makes sense in a monetary exchange economy.... It makes no sense whatsoever in a barter economy, or where money is inessential.
Keynesian unemployment is an excess demand for the medium of exchange. It's a coordination failure.... We buy newly-produced goods with money. A Keynesian recession is an excess supply of newly-produced goods, and a deficiency of Aggregate Demand. In a monetary exchange economy, a deficiency of Aggregate Demand, and an excess supply of goods, is an excess demand for money.... What's fiscal policy got to do with it?...
There is a legitimate Keynesian defence. If a doctor can't fix a broken leg, he might recommend a wheelchair as a second best fix until the leg heals itself. He might argue that it will help the leg heal quicklier. OK. But he should admit that it's a second best, and be looking for a first best, and encouraging others to seek a first best. He shouldn't be selling wheelchairs.
The trouble with Keynesians is that they aren't radical enough. They need to look at their own models and see the root of the problem, and recommend policies to get at the root of the problem. The root of all Keynesian recessions is monetary.
Just like Milton Friedman said.
I would say that the right way to think about the current situation is to move from a two-commodity model--money and goods--to a three-commodity model: goods, money, and "high-quality interest bearing assets." When there is an excess demand for high-quality interest bearing assets the interest rate goes to zero, in which case money becomes a perfectly good high-quality interest bearing asset. Then money gets swapped out of the "transactions" balance account into the "speculative" (or "insurance") balance account, and all of a sudden you have an excess demand for transactions-balance account money and so by Walras's Law a deficient demand for currently-produced goods and services.
I'm happy to call that a "monetary phenomenon" if it will make Nick Rowe happy.
But might it not be more illuminating to call it a financial phenomenon? A Minkyite or Kindlebergian or Bagehotian phenomenon?
Get ready: Government shutdown is coming: Set your government shutdown clock ahead three weeks — and know that this time, the odds are very high that it's going to happen. As it turned out, after all but six Republicans voted for the previous two-week budget extension, about 50 more voted against the current three-week deal, while about 20 Democrats flipped against it. So, by a 271-158 margin, the government gets to stay open for three more weeks, at least assuming the Senate concurs.
Where does that leave us?
First of all, numerous members on both sides said this would be the last short-term extension. Of course, that doesn't mean they would vote against another one if it meant shutdown...but perhaps they would.
Second, House Speaker John Boehner did a solid job, again, of holding things together....
Third, where do we go from here? I don't know. A slim majority of Democrats thought that this bill cut spending too much.... 54 Republicans opposed it....
I’m not convinced there is any middle ground, at this point, that could win 218 votes in the House and 51 — let alone 60 — in the Senate. The problem isn’t the 54 House Republicans who voted against this extension; it’s another hundred or so who voted for funding two more weeks of implementing the Affordable Care Act, environmental regulations, and money for Planned Parenthood only because it was temporary....
If you believe, as I do, that House Republicans have a weak hand going forward, then their best bet is going to be to eventually declare victory (after all, they’ve already enacted $10 billion in spending cuts) and move on. That’s the only winning move available to them. Can Boehner convince them to do that? I’d be very impressed if he can, especially without at least a short shutdown, first. But I don’t see it happening. I think we’re in for at least a short shutdown, and more likely a repeat of the 1995-1996 disaster — with Republicans re-learning the hard way the lesson that the unpopularity of the specific cuts they want to make is far more important politically than the popularity of general, unspecified cuts...
If there was one thing that I would have said in 2007 was certain to be true, it would have been that in a country with as weak a social safety net as the United States that 9% would be a three-alarm political emergency.
Yet it isn't.
Paul Krugman muses on why:
The Forgotten Millions: Washington has lost interest in the unemployed. Jobs do get mentioned now and then — and a few political figures, notably Nancy Pelosi, the Democratic leader in the House, are still trying to get some kind of action. But no jobs bills have been introduced in Congress, no job-creation plans have been advanced by the White House and all the policy focus seems to be on spending cuts. So one-sixth of America’s workers — all those who can’t find any job or are stuck with part-time work when they want a full-time job — have, in effect, been abandoned.
It might not be so bad if the jobless could expect to find new employment fairly soon. But unemployment has become a trap, one that’s very difficult to escape. There are almost five times as many unemployed workers as there are job openings; the average unemployed worker has been jobless for 37 weeks, a post-World War II record.
In short, we’re well on the way to creating a permanent underclass of the jobless. Why doesn’t Washington care?...
[T]hose who still have jobs are feeling more secure than they did a couple of years ago.... [T]he U.S. economy is suffering from low hiring, not high firing, so things don’t look so bad — as long as you’re willing to write off the unemployed. Yet polls indicate that voters still care much more about jobs than they do about the budget deficit. So it’s quite remarkable that inside the Beltway, it’s just the opposite....
[W]e’ve been warned, over and over again, that “bond vigilantes” will turn on the U.S. government unless we slash spending immediately. Yet interest rates remain low... lower now than they were in the spring of 2009.... [W]e’ve been assured that spending cuts would do wonders for business confidence. But that hasn’t happened in any of the countries currently pursuing harsh austerity programs... the Cameron government in Britain... received fawning praise from U.S. deficit hawks. But British business confidence plunged, and it has not recovered....
I still don’t know why the Obama administration was so quick to accept defeat in the war of ideas, but the fact is that it surrendered very early in the game. In early 2009, John Boehner, now the speaker of the House, was widely and rightly mocked for declaring that since families were suffering, the government should tighten its own belt. That’s Herbert Hoover economics, and it’s as wrong now as it was in the 1930s. But, in the 2010 State of the Union address, President Obama adopted exactly the same metaphor and began using it incessantly.
And earlier this week, the White House budget director declared: “There is an agreement that we should be reducing spending,” suggesting that his only quarrel with Republicans is over whether we should be cutting taxes, too. No wonder, then, that according to a new Pew Research Center poll, a majority of Americans see “not much difference” between Mr. Obama’s approach to the deficit and that of Republicans.
So who pays the price for this unfortunate bipartisanship? The increasingly hopeless unemployed, of course. And the worst hit will be young workers — a point made in 2009 by Peter Orszag, then the White House budget director.... [T]he next time you hear some Republican declaring that he’s concerned about deficits because he cares about his children — or, for that matter, the next time you hear Mr. Obama talk about winning the future — you should remember that the clear and present danger to the prospects of young Americans isn’t the deficit. It’s the absence of jobs.
But, as I said, these days Washington doesn’t seem to care about any of that...
If monetary policy is not distortionary--if it simply has an influence on the level of aggregate demand but no other real consequences--but fiscal policy is distortionary because it has the government buying things that are worth their cost only because of the aggregate demand externality, then of course fiscal policy should be set on classical principles and monetary policy used to stabilize the macroeconomy. That is what we should be doing in normal times.
But right now times are not normal. The dynamic consistency and credibility problems involved in getting monetary policy right in a liquidity trap are substantial.
Credibility and Monetary Policy in a Liquidity Trap (Wonkish): Via Mark Thoma, Mankiw and Weinzierl... argue... that fiscal expansion shouldn’t be the tool of choice even at the zero lower bound... if you can credibly make commitments about future monetary policy.... [This] isn’t a new insight; it was at the heart of my original analysis, and it’s a central theme in Eggertsson and Woodford. But how credible is the idea of credible future monetary commitments, of the type needed to make this work? Bear in mind that the central bank needs to “credibly promise to be irresponsible”, as I originally put it — that is, to commit to creating or allowing higher inflation....
[I]n order to make a commitment to inflation work, central bankers not only have to stand up to the pressure of inflation hawks — which is much harder when you’re having to testify to Congress than it is if you’re a Harvard professor — but, even harder, they need to convince investors that they’ll stand up to that pressure, not just for a year or two, but for an extended period.
Now, the thing about fiscal expansion is that people don’t have to believe in it: if the government goes out and builds a lot of bridges, that puts people to work whether they trust the government’s commitment to continue the process or not. In fact, to the extent that there’s some Ricardian effect out there, fiscal policy works better, not worse, if people don’t believe it will continue.
On a personal note: I supported fiscal expansion in 2008-2009 precisely because I didn’t believe that the kind of commitment-based unorthodox monetary policy that works in the models could, in fact, be implemented in practice. Nothing I’ve seen since has changed my views on that subject.
‘The Cab Driver’s Homespun Wisdom Is Borne Out By Geopolitical Developments’: Your former Wonkette editor Juli Weiner is helping with this painful transition by offering many completely free endings of New York Times articles, so you can glance at the headline and picture on the front page, and then pick a likely ending, and then you’re done!
- The cab driver’s homespun wisdom is borne out by geopolitical developments.
- Despite record college selectivity, admission was not as unattainable as these teens thought.
- Maureen Dowd disapproves.
This way, you can save your “free 20 Times’ stories” for the really important stuff, like this “think piece” by NYT pop writer Jon Pareles, about how some pop songs lately have a vulgar word in them, but he can’t write what the word is, because that’s not allowed in the NYT. Because you really want to read all of that one.
Mark Thoma tells us that Greg Mankiw calls for the Federal Reserve Board to be staffed by smart reality-based people like Peter Diamond who understand the importance of the Federal Reserve's committing to active lender-of-last resort policies prolonged monetary expansion and higher inflation in order to rebalance the macroeconomy to get it out of a liquidity trap:
Economist's View: Mankiw and Weinzierl: An Exploration of Optimal Stabilization Policy: We... examine the complications that arise because nominal interest rates cannot be set below zero.... [T]he optimal policy is for the central bank to commit to future monetary policy actions in order to increase current aggregate demand. Fiscal policy continues to be set on classical principles....
And yet Greg Mankiw also tells us that Senator Shelby has a definite point when he blocks Peter Diamond's appointment to the Federal Reserve because Peter Diamond is a big-spending Keynesian and TARP supporter who understands the importance of the Federal Reserve's committing to active lender-of-last resort policies prolonged monetary expansion and higher inflation in order to rebalance the macroeconomy to get it out of a liquidity trap.
May I say that this makes no sense?
To write articles that call for certain Federal Reserve policies as optimal entails that you should not also defend politicians who block the appointment of technocrats who would carry out such optimal policies.
Matthew 6:24 is relevant here: You can either argue that the New Keynesian framework is a useful technocratic one and derive and recommend optimal policies, or you can support ignorant right-wing politicians. You cannot do both.
Is economics a science?: if economics weren’t a science, then would previous paradigms so have been done in by empirical outcomes? The old Keynesian Phillips Curve held that there was a tradeoff between inflation and unemployment. When that relationship broke down during the stagflation of the 70s, the Phillips Curve was invalidated, and this helped shift macro away from old Keynesianism and towards the new classical paradigm. Real Business Cycle models of the 80s were also invalidated by reality: it was clear that money mattered, and in the real world it was hard to find technology shocks to explain actual recessions. The point here is that in the long-run economic paradigms and methodologies are judged by their ability to explain the real world.
Economics as a Science: A Bad Example: Um, there’s a problem here. Yes, the old Keynesian Phillips curve was abandoned in the face of evidence. But while real business cycle theory has indeed been “invalidated by reality”, as far as I can tell it’s still going strong in freshwater departments. The point is that while economics certainly did have some of the characteristics of a science three decades ago, you can make a good case that significant parts of the field have lost those characteristics since then.
Robert's Stochastic thoughts: [L]ots of economists working with micro data and either performing experiments or finding natural experiments are acting as scientists.... The claim is that economic theories have bowed to facts. The one example presented by Ozimek in which this actually happened is the abandonment of the Phillips curve.... The example of the Phillips curve is always presented. I think this is because it is unique.... The conjecture was that it was likely to be a useful relationship for the US and UK assuming things stayed about the same. This just isn't the sort of thing whose rejection is the sign of a science....
[T]he reaction of economic schools of thought to rejection of their current model is twofold. First "models are false by definition" and second "OK here is a new model with the same policy implications." This holds in Cambridge MA too. It didn't take long for new Keynesians to get the conclusions they wanted out of models with rational expectations. Scientists do not always reach the same conclusions no matter how many hypotheses are rejected by the data.
And Robert Waldmann:
"Chapter 21. The Theory of Prices.... That the wage-unit may tend to rise before full employment has been reached, requires little comment or explanation. Since each group of workers will gain, cet. par., by a rise in its own wages, there is naturally for all groups a pressure in this direction, which entrepreneurs will be more ready to meet when they are doing better business. For this reason a proportion of any increase in effective demand is likely to be absorbed in satisfying the upward tendency of the wage-unit. Thus... we have a succession of... points at which an increasing effective demand tends to raise money-wages.... In actual experience the wage-unit does not change continuously in terms of money in response to every small change in effective demand; but discontinuously... determined by the psychology of the workers and by the policies of employers and trade unions.... These points, where a further increase in effective demand in terms of money is liable to cause a discontinuous rise in the wage-unit... have... a good deal of historical importance. But they do not readily lend themselves to theoretical generalisations.
That is, the response of wages to aggregate demand in the real world is not smooth, simple or amenable to mathematical formalization. In other words, don't put a Phillips curve into your models.... As Mike Kimel recalled, Keynes also noted that the Phillips curve becomes vertical during a hyperinflation. Unfortunately he makes this point in... the first section of "Chapter 20. The Employment Function" whose one redeeming feature is footnote 1. "Those who (rightly) dislike algebra will lose little by omitting the first section of this chapter." The second half of chapter 20 isn't all that much better, although it does include a presentation of the Lucas supply function...
Assuming the reactors were successfully scrammed at the earthquake, decay has by now proceeded so far that we are now down to 0.2% of normal fission power.
In comments, he defends his claim that both Republicans and Democrats, both Congressman King and "liberals," are comparably wrong--that there is "a witch-hunt on one side, denial on the other, as the threat of home-grown terrorism rises":
Peter David: On the one hand Peter King is a hypocrite who is wrong to accuse American Muslims in general of failing to report terrorist plots. On the other, al-Qaeda is recruiting among American Muslims and this is a legitimate concern of the Homeland Security Committee of the House of Representatives. What's so very hard for you to understand?
The Economist used to be a lot better than this. It could be a lot better than this. It ought to be a lot better than this. You should not accuse people of being in "denial" when you quote from columns in which they expressly note what you claim they deny.
Let's rewind the videotape.
Peter David wrote a plague-on-both-your-houses column, with the houses being Congressman Peter King, Chairman of the House Homeland Security Committee, on the one hand; and "liberals" Richard Cohen, Bob Herbert, and Eugene Robinson on the other. The first was undertaking a "witch-hunt." The second were engaged in "denial":
Lexington: Muslims and McCarthyism: A witch-hunt on one side, denial on the other, as the threat of home-grown terrorism rises: IS A new Joe McCarthy strutting his stuff up on Capitol Hill? You might think so, to judge by the abuse that has thundered down on the head of Peter King, chairman of the House Homeland Security Committee, following his decision to start hearings on “The Extent of Radicalisation in the American Muslim Community and that Community’s Response”. Even before the first one took place this week, the very idea of the hearings came under withering fire from liberal America. They were “fuel for the bigots”, said Richard Cohen, a columnist at the Washington Post. “To focus an investigative spotlight on an entire religious or ethnic community is a violation of everything America is supposed to stand for,” echoed Bob Herbert in the New York Times. “Security hearings that focus exclusively on Muslim Americans serve only to amplify the rumblings of Islamophobia that seem to become louder and crazier by the day,” concurred Eugene Robinson, another of the Post’s columnists...
What's wrong with Cohen's claim that King's hearing was "fuel for the bigots," with Herbert's claim that focusing the "investigative spotlight on an entire religious or ethnic community is a violation of everything America is supposed to stand for," with Robinson's claim that King's hearing will "serve only to amplify the rumblings of Islamophobia that seem to become louder and crazier by the day"?
It is not clear. Indeed, at the end of his column David agrees with Robinson, Cohen, and Herbert that King's hearing:
risks feeding the sense of beleaguerment and outrage many American Muslims have come to feel in the face of the recent scaremongering over the so-called “ground zero” mosque in New York and the Republican Party’s paranoid fantasy about Islamic sharia law taking over America by stealth.... King was in the forefront of the trumped-up objections to the Manhattan mosque. What folly to let such a man chair the Homeland Security Committee of the House of Representatives.
So what's Peter David's complaint with Cohen, Herbert, and Robinson? It is this:
[T]he liberal side has a defect of its own.... [It] let[s] political correctness obscure a troubling development.... Islamist terrorism is the clear and present danger.... [A]l-Qaeda has lately shown an unexpected ability both to recruit American Muslims and to move its battle back to American soil.... Anwar al-Awlaki... grew up in New Mexico. Adnan Shukrijumah... is a Saudi-American who grew up in Brooklyn and Florida. David Headley... scouted targets for the attack on Mumbai.... Nidal Malik Hasan, a Palestinian-American... Faisal Shahzad, a Pakistani-American...
Has Richard Cohen let political correctness obscure a troubling development? Richard Cohen writes, in the column cited by Peter David:
Richard Cohen: Fuel for bigots: [L]ast month... Charles Kurzman reported a drop in attempted or actual terrorist activity by American Muslims -- 47 perpetrators and suspects in 2009, 20 in 2010. This does not mean that there is no threat, but, when measured against ordinary violent crime, it is slight. In fact, the threat from non-Muslims is much greater, encompassing not only your run-of-the-mill murderers but about 20 domestic terrorist plots, including one where a plane was flown into an IRS building in Austin, Texas.... [I]n exposing alleged terrorist plots, "the largest single source of initial information (48 of 120 cases) involved tips from the Muslim American community." Not only does this contradict King's implicit charge that the American Muslim community is one vast terrorism enabler, but it suggests that an outcome of his hearings will be the further alienation of this community -- and less cooperation with the authorities. King is setting a dangerous precedent. The government has no business examining any peaceful religious group because a handful of adherents have broken the law...
Looks to me like Richard Cohen is not letting political correctness obscure a troubling development but is instead taking a balanced and reality-based view of the issue.
Has Eugene Robinson let political correctness obscure a troubling development? Eugene Robinson writes, in the column cited by Peter David:
Stoking Irrational Fears: King further alleges that Muslim Americans have failed to demonstrate "sufficient cooperation" with law enforcement in uncovering potential terrorist plots. With this libel, King casts doubt on the loyalties of millions of Americans solely because of their faith. This is religious persecution -- and it's un-American and wrong.... [T]he 9/11 atrocities were indeed committed by men who espouse a version of Islam -- one that the vast majority of the world's 1.2 billion Muslims reject as warped and blasphemous.... [A]l-Qaeda and its affiliates continue to mount attacks against the United States and the West, and that jihadist ideology is a deadly weapon.... The narrative that al-Qaeda uses to recruit suicide bombers is that the United States and the West are not fighting terrorism but trying to destroy Islam. Peter King, with his little hearings, is about to make it harder to refute the jihadists' big lie.
Looks to me like Eugene Robinson is not letting political correctness obscure a troubling development but is instead taking a balanced and reality-based view of the issue.
Has Bob Herbert let political correctness obscure a troubling development? Bob Herbert writes, in the column cited by Peter David:
Flailing After Muslims: “There is a real threat to the country from the Muslim community,” [Representative King] said, “and the only way to get to the bottom of it is to investigate what is happening.” That kind of sweeping statement from a major government official about a religious minority — soon to be backed up by the intimidating aura of Congressional hearings — can only serve to further demonize a group of Americans already being pummeled by bigotry and vicious stereotyping.... To focus an investigative spotlight on an entire religious or ethnic community is a violation of everything America is supposed to stand for. But that does not seem to concern Mr. King. “The threat is coming from the Muslim community,” he told The Times. “The radicalization attempts are directed at the Muslim community. Why should I investigate other communities?”... There is nothing wrong with the relentless investigation of terrorism. That’s essential. But that is not the same as singling out, stereotyping and harassing an entire community.... Mr. King’s contention that Muslims are not cooperating with law enforcement is just wrong.... What are we doing? Do we want to demonize innocent people and trample on America’s precious freedom of religion? Or do we want to stop terrorism?...
Looks to me like Bob Herbert is not letting political correctness obscure a troubling development but is instead taking a balanced and reality-based view of the issue.
The Economist used to be a lot better than this. It could be a lot better than this. It ought to be a lot better than this.
Econ 210a: Memo Question for March 30:
What were the "rules of the gold standard game?" To what extent were they obeyed or, to the contrary, violated? If they were violated, how then did the gold-standard system survive?
Underbelly: Felix is Bewildered: Felix Salmon is too polite to put it quite that way, but he really can't imagine what kind of lunatic designed the new pricing policy at the New York Times. Me neither...
The NYT paywall arrives: The NYT paywall has arrived: it’s going up in Canada today, and then worldwide on March 28.... This paywall is anything but simple, with dozens of different variables for consumers to try to understand. Start with the price: the website is free, so long as you read fewer than 20 items per month, and so are the apps, so long as you confine yourself to the “Top News” section. You can also read articles for free by going in through a side door.... $15 per four-week period gives you access to the website and also its smartphone app, while $20 gives you access to the website also its iPad app. But if you want to read the NYT on both your smartphone and your iPad, you’ll need to buy both digital subscriptions separately, and pay an eye-popping $35 every four weeks.... The message being sent here is weird: that access to the website is worth nothing. Mathematically, if A+B=$15, A+C=$20, and A+B+C=$35, then A=$0.
Meanwhile, at least where I live in New York, a print subscription which gets you the newspaper only on Sundays costs $19.60 every four weeks — and it comes with free access to the web and tablet versions of the newspaper. Which creates the slightly odd proposition that if you want to use the NYT’s iPad app, you’re marginally better off subscribing to the print newspaper on Sundays and throwing it away unread than you are just subscribing to the app on its own. The pricing structure is also a strong disincentive to use the iPad app at all.... If the NYT wanted to kill any incentive to read and develop its iPad app, it’s going about it the right way.
What does all this mean for the New York Times Company?... [A] lot of regular readers will not subscribe.... [N]ot only will traffic from these readers decline, but so will all their referral traffic, too. The NYT makes more than $300 million a year in digital ad revenue, so even a modest decline in pageviews, relative to what the site could have generated sans paywall, can mean many millions of dollars foregone. On top of that, the paywall itself cost somewhere over $40 million to develop. Against all that, how much revenue will the paywall bring in?...
Emily Bell reckons that the number of people who’ll even hit the paywall in the first place is only... 1.6 million people — compare the 1.3 million people who already subscribe to the paper on Sundays. The former is not a perfect superset of the latter, of course, but there’s a big overlap; let’s say that realistically the NYT is going after a universe of no more than 800,000 people that it’s going to ask to subscribe. And let’s be generous and say that 15% of them do so, paying an average of $200 per year apiece. That’s extra revenues of $24 million per year....
As Ken Doctor notes, the Times Select fiasco, which was unceremoniously killed in 2007 to no one’s regret, was bringing in a good $10 million per year. This new paywall is much more elaborate and expensive, and it’s being introduced into a website which is currently something of a cash cow as regards ad revenues.... I just can’t see how this move makes any kind of financial sense for the NYT. The upside is limited; the downside is that it ceases to be the paper of record for the world. Who would take that bet?
Sleeping under the wagon: More spoilers for Patrick Rothfuss’s The Wise Man’s Fear: Because of the frame story we know certain things. We know that we are about two-thirds of the way through. We know that in the events Kvothe will relate on the third day he will be expelled from the university, kill a king, acquire Bast, lose his magic, exchange his Adem sword, fake his own death and retire to the inn. We also know the world will not end but that it will go to hell—the world we see, full of war and fae monster attacks isn’t the world he’s talking about. We can be pretty sure that this is Kvothe’s fault.
We also know, or think we know, that it’s a tragedy—that tree is on the cover!—but as tragedy is so rare in fantasy, as there’s the conversation about inevitability and free will, and as there is so much humour in these stories, I wouldn’t be at all surprised if Rothfuss manages to pull off eucatastrophe in the frame after all. Kvothe believes it’s a tragedy, and his story so far must be, but I suspect, Chtaeh or not, the first and last chapter or the third book will not be the same. It could honestly go either way. And for me to say that two-thirds of the way through a story is a real treat—and even more for a fantasy story.
In any case, we now know for sure that the story is connected—that Denna and the Chandrian are central to the whole narrative. And we know that the story goes on from what we have and fits into the space between what we have and the frame, that it all connects up. Knowing these things means that when we speculate, we are speculating into a defined space. We are like people doing a jigsaw who have all the edge pieces in place and are trying to fill in the middle...
Outsourced to Jonathan Chait:
Never Anger A Man Named Erskine: Erskine Bowles has harsh words for the left:
Mr. Bowles's tone on the call was grim.... Mr. Bowles had harsh words for fellow Democrats. He dismissed the idea that raising taxes alone might help erase the deficit, saying "raising taxes doesn't do a dern thing" to address health care costs that are projected to be a big driver of future fiscal problems....
Bowles is conflating a couple different issues here.... In the short term, we're in a liquidity trap, with high unemployment and rock-bottom interest rates. We need to be running higher, not lower, deficits.
In the medium term, once the economy recovers, we have high structural deficits inherited from the Bush administration, which could indeed spark a sharp, sudden spike in interest rates. That has to come down. But that's also a problem that could be solved through tax hikes. Letting the Bush tax hikes expire, and returning to Clinton-era rates, would pretty much take care of the medium-term issue:
Finally, there's the long-term deficit issue. As you can see, that will begin to soar in a couple decades. Bowles is correct that this largely reflects rising health care costs. But does his plan do much about that? Its main approach is to set a cap on federal health care costs:
The plan’s call to limit the growth of total federal health program expenditures to the growth of GDP plus one percentage point is likely to prove an impossibly stringent standard. Unlike the Medicare spending target in the ACA — which is based on the growth in spending per beneficiary — the health spending target that the co-chairs have proposed makes no allowance for circumstances where the number of beneficiaries grows more rapidly than the overall population. Yet that is precisely what is expected to occur in Medicare and Medicaid.... The proposal also neglects to make any adjustment for changes in the composition of the beneficiary population. Health care costs much more for elderly Medicaid beneficiaries than for child beneficiaries and working-age adults.... Moreover, the co-chairs’ tax reform proposals may themselves push up the cost of the tax credits in the health insurance exchanges; reducing or eliminating the tax preference for employer-sponsored insurance, as the plan proposes, will likely cause fewer employers to offer coverage and more workers therefore to qualify for subsidies in the exchanges.
The Affordable Care Act has a wide-ranging series of reforms to transform the incentive structure of insurers, hospitals and physicians, so as to control the long-term rise in costs. Bowles-Simpson just says, we're only going to pay so much and no more, without doing anything to ensure that the cost of the care actually stays within those bounds.... [S]etting a cap in perpetuity isn't a terribly effective way to bind future policymakers. You can say they can only spend so much, but if the caps are hard to meet, they'll go around them. You need mechanisms to make the caps effective, but Bowles-Simpson has little of that.
The one step that actually would reduce the deficit substantially and in the correct time frame is letting the Bush tax cuts expire. I can't think of a good fiscal rationale for Bowles to dismiss that...
Economics as a Science: A Bad Example: Adam Ozimek weighs in on the debate over economics as a science, and argues in favor thusly:
Another question is, if economics weren’t a science, then would previous paradigms so have been done in by empirical outcomes? The old Keynesian Phillips Curve held that there was a tradeoff between inflation and unemployment. When that relationship broke down during the stagflation of the 70s, the Phillips Curve was invalidated, and this helped shift macro away from old Keynesianism and towards the new classical paradigm. Real Business Cycle models of the 80s were also invalidated by reality: it was clear that money mattered, and in the real world it was hard to find technology shocks to explain actual recessions.
Um, there’s a problem here. Yes, the old Keynesian Phillips curve was abandoned in the face of evidence. But while real business cycle theory has indeed been “invalidated by reality”, as far as I can tell it’s still going strong in freshwater departments.
The point is that while economics certainly did have some of the characteristics of a science three decades ago, you can make a good case that significant parts of the field have lost those characteristics since then.
Canada 2020 Speakers Series: Brad DeLong & David Dodge | Canada 2020: Ottawa, 9 March 2011 — Canada 2020 welcomed Brad DeLong, University of California at Berkeley professor of economics and former senior Clinton Treasury official, who delivered a keynote on where the US economy is headed. David Dodge responded with what this means for Canada. Don Newman, Chairman, Canada 2020 Advisory Board, moderated the event.
CPAC will be broadcasting the event.
This free event (host bar) is presented in cooperation with iPolitics.ca and the Canadian Brewers Association and is made possible thanks to the kind support of Amgen Canada, AstraZeneca, Bluesky Strategy Group, Inc., Canadian Wireless Telecommunications Association, CIBC, Nexen, Pickworth Investments LP, Plutonic Power Corporation, Scotiabank, Suncor, TELUS, and individual members of the Canada 2020 Founders’ Circle.
Tyler Cowen writes:
A wee bit more on spending, borrowing, and earthquakes: Regarding Brad’s response post. I view our disagreement as such. In my view, a low rate of interest on Treasury securities indicates a high chance that the investors will be paid back. That is all it means. It is not a market signal that the government output should be produced. Investment is a normal good and post-earthquake the world is poorer, and riskier, so optimal investment can either go up or down. The interest rate on debt is not a sufficient statistic summing up all of the conflicting “investment should go up” vs. “investment should go down” forces in our thought experiment. It is not summing up real consumption risk or output valuations, only whether the government will pay back investors (None of this, by the way, need deny that there might be other, non-earthquake reasons for expanding government spending).
If the price of something--in this case, government production--goes down, as it has in the aftermath of the earthquake-and-tsunami as U.S. Treasury interest rates have dropped by 10 basis points, shouldn't you buy more of it? Yes.
It is true that the world is poorer as a result of the earthquake--poorer by perhaps $100 billion as a result of all the destruction. And a poorer world should buy less of everything. But the U.S. is not poorer: we should not buy less of anything.
So it is very clear to me that the U.S. government should spend more.
How about the Japanese government? The world is still short of high-quality assets and the Japanese government can provide them on much the same terms and thus finance its spending on the same terms. Japan is poorer and should buy less of everything. But the return to rebuilding earthquake-and-tsunami damaged infrastructure is very high. The Japanese government should buy more as well.
Arnold Kling genuinely does not know the difference between nominal and real interest rates.