Grasping Reality on TypePad, by Brad DeLong

Economics 1, 001|Spring 2012|UC Berkeley - Download free content from UC Berkeley on iTunes

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Jonathan Gruber on Public Finance:

Eve Gerber: Let’s turn to Losing Ground by Charles Murray. Please tell us about it.

Jon Gruber: Charles Murray took the economic concept of moral hazard – the concept that if you reward people for bad behaviour then they behave badly – and turned it into prose. Reading the book moved me a notch to the right. It posed a challenge to liberals – to get more rigorous in our analysis. It showed the simple facts didn’t look so good for us and that we needed to address questions like, “Is welfare causing women to become single mothers?” Murray really challenged the way I thought.

It turned out his facts were largely wrong, so it’s really more a book to read for an example of how someone can shift the debate with potent use of clear arguments.

Eve Gerber: When it was written, liberals were very resistant to the idea that social programmes discourage work or have bad side effects. Has this shifted? How much of Losing Ground actually became embodied in reforms or proposals that many liberals would now support?

Jon Gruber: Losing Ground was the intellectual basis of the push to reform welfare in the United States, not in terms of the actual ideas but just in terms of challenging the orthodoxy. And, of course, welfare was reformed in 1996.

Eve Gerber: Next, Free For All? It certainly sounds good. Please tell us about it.

Jon Gruber: Health is the single most important topic in public finance today and this is the single most important book written about health – that’s why I chose it. The book is by Joseph Newhouse, who led the group that designed the RAND Health Insurance Experiment. In the 1970s people tried to figure out how much of the cost of healthcare consumers should bear and how much insurance should pay…. Joe Newhouse and his colleagues put together this incredible social experiment… randomly assigned individuals to plans with a variety of cost-sharing provisions, to determine how health was affected when people paid more for healthcare. This was the premier use of a social experiment of this magnitude and quality.

The results were profound because, not only did the study show that people are price sensitive in their health decisions and if you charge more for healthcare they’ll use less but it also showed that, at least back then, higher deductibles didn’t matter much for health. People in the study used less healthcare but weren’t less healthy…. Subsequent studies, including a number of mine, have generally found similar conclusions, but no study has ever been as good as this one….

Eve Gerber: Have we seen other large-scale economic experiments like this in the United States or around the world? If you could design just one new experiment, what would it be?

Jon Gruber: There haven’t been that many. There’s another famous one called the Negative Income Tax Experiment – it’s also very old [from 1968 to 1979]. In that experiment they changed people’s tax rate and saw how hard they worked. That one has been influential…. There were two things about RAND that made it so influential. The first was it was truly a randomised trial – the kind that’s done in medicine – so it’s very convincing. Second, they got detailed data on individuals – not just how subjects felt but their actual blood pressure and other objective measures of health. I was fortunate enough to be part of the closest thing we’ve seen to RAND – a study we just did in the state of Oregon, with my colleague Amy Finkelstein at MIT and Katherine Baicker and Joe Newhouse at Harvard…. The Oregon study is about what happens when you’re insured vs uninsured…. The first finding, which just came out and got a lot of attention, is that people who won the lottery and got the health insurance were hugely better off. Their utilisation went up but, more importantly, their health went up, their wellbeing improved and their odds of financial distress were reduced. This was a neat initial finding and now we’re gathering data from people in household surveys on objective measures of health like their blood pressure and blood glucose and things like that. This is, in my mind, the biggest study since RAND.

Eve Gerber: You were an architect of Mitt Romney’s Massachusetts health programme and an instrumental adviser in the design of the Obama administration’s health reforms. So please settle the question of the year: How similar are they?

Jon Gruber: They are very, very similar. You can think of the Affordable Care Act as a more ambitious version of the Massachusetts reform. Both reforms have the same core principles: Non-discrimination in insurance markets, health insurance mandates and subsidies so insurance is affordable. In Massachusetts, we stopped there. The national bill – the Affordable Care Act – has two additional features. One is it’s paid for and two, it takes on cost controls. Romney’s reform was paid for with funding from the federal treasury. The Affordable Care Act is paid for through offsets in the federal budget. And the Affordable Care Act tackles the increase in costs in a serious way, which the Massachusetts bill didn’t do. So you can think of the Affordable Care Act as the Massachusetts bill-plus.

Eve Gerber: Where did the idea for a mandate come from?

Jon Gruber: I associate it with Stuart Butler from the Heritage Foundation and Mark Pauly, an academic at Wharton. I first heard about it as the conservative alternative to the Clinton healthcare reform of the early 1990s….

The biggest issue in dollar terms is just how to control healthcare costs. The Affordable Care Act makes a start but more must be done. I like to say there are only two problems we have to worry about in America – healthcare spending and global warming…. How we control healthcare costs is probably the number one problem public finance economists and everyone in the world has to grapple with…

Atrios:

Eschaton: It's Always Been About Birth Control And Sex: I don't expect the eventheliberals who have been denying this for years to ever come around, but it's never really been about abortion, it's always been about women not being properly punished for having unapproved sex.

"The failure of the duly elected [Weimar German] government to build a new Army that would be faithful to its own democratic spirit and subordinate to the cabinet and the Reichstag was a fatal mistake for the Republic, as time would tell. The failure to clean out the judiciary was another. The administrators of the law became one of the centers of the counterrevolution, perverting justice for reactionary political ends.'

--William Shirer, The Rise and Fall of the Third Reich

World War II Day-By-Day: Day 891 February 7, 1942:

Singapore. Japanese shelling is getting heavier. In the evening, 400 Japanese Imperial Guards Division troops land unopposed on the island of Pulau Ubin in the Strait of Johore separating Singapore from Malaya. Pulau Ubin lies Northeast of Singapore and the landings are a feint for the main assault to come at the Western end.

Problem Set 3

• brettkeller Brett Keller Paul Starr's spring course on US health policy reform, looks like a great reading list >> http://goo.gl/DEINi 1 hour ago Retweeted by delong

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• Noahpinion Noah Smith @ @delong @ModeledBehavior Haters gonna hate, as they say. 5 Feb

Of course, it never was highly contested, among fair-minded people who had done their homework.

Paul Krugman:

The Great Anti-Keynesian Flip-Out: Keynesian economists made some pretty clear predictions around 3 years ago – predictions that were very much at odds with what anti-Keynesians were saying. We said that as long as the economy remained deeply depressed, even a huge rise in the monetary base would not be inflationary, and that even huge budget deficits would not send interest rates soaring. And we said that fiscal austerity would be contractionary, not expansionary.

All these predictions have been borne out….

But some anti-Keynesians have tried to save their dignity, or something, by attacking supposed Keynesian propositions that nobody actually, you know, proposed. The usual one is to claim that Keynesians predicted great results from the Obama stimulus (which I very noisily did not). But Tyler Cowen has come up with something truly strange. He seems to believe that any good news anywhere somehow refutes Keynes. Hints of recovery in Ireland (which proved a false dawn)? Keynesianism is wrong! A relatively encouraging month on the jobs front? Keynesianism is wrong!

I’d say that this was attacking a straw man, but that would be an insult to straw men. What is going on in Cowen’s head?

M.S.:

Debating economic policy: Stimulus, austerity and the weltgeist: While independent economists generally agree that [Obama's Recovery Act] stimulus saved or created somewhere in the neighbourhood of 2m jobs, it remains unpopular with the general public; the sense was that there was no point engaging on this issue, regardless of the merits. Now ProPublica's Mike Grabell is out with a book-length investigation of the stimulus, titled "Money Well Spent?"…

Mr Grabell said… money funneled to states to forestall budget cuts saved huge numbers of jobs for teachers, firefighters and other employees, and delayed cutbacks in infrastructure spending. He subscribes to the general wisdom that unemployment probably would have hit 12% in 2009 rather than 10% without it. On the other hand, the administration had to drop an idea that almost certainly would have made sense—building a national electric smart grid—because the jurisdictional and red-tape problems made it impossible to implement fast enough. Instead the administration decided to invest in clean energy; but those investments placed their bets too heavily on individual companies, some of which then went bankrupt. In an excerpt from the book on the electric car and battery industry jump-started by stimulus funding, Mr Grabell says the jury is still out: without a rapid pickup in demand for Leafs and Volts (which in turn depends on a big increase in electric charging stations), America's electric-car industry will probably fail to hit critical mass, and it'll wind up relocating to South Korea or China like every other manufacturing industry has.

So, here's the thing. The debate we had about the stimulus probably should have been a lot like the book Mr Grabell has written: a detailed investigation of what does and doesn't work…. But that wasn't the debate we had. Instead we had a debate about the very concept of whether the government ought to spend money counter-cyclically during a recession in order to keep the economy from collapsing, or whether it should tighten its belt along with consumers and businesses in order to generate confidence in the financial markets and allow markets to clear. We had a debate about whether governments should respond to recessions with deficit spending or austerity.

That was the debate we had. And what's interesting about this particular moment is that while Mr Grabell is writing about what did and didn't work in the stimulus, and Mr Obama is staying away from the topic for political reasons, out there on the barricades what's happening is that the entire argument that governments should engage in austerity appears to be collapsing.

Item 1: Over the past month, Paul Krugman, Brad DeLong, and Simon Wren-Lewis engaged in an interminable duel with Tyler Cowen, Scott Sumner, sort-of Karl Smith (occupying as usual an esoteric position not easily placed on the ideological grid), and probably some other people I'm forgetting—over an old argument by John Cochrane claiming that the multiplier effect of government stimulus spending probably ought to be zero. The argument by Mr Cochrane was a critical document in the stimulus debate, because it was an articulation in more-or-less public discourse by a well-respected economist of a mechanism through which increased government spending could fail to raise GDP or increase employment at all. Essentially every working practical economist and forecaster believed that the stimulus, like any other government spending, would raise aggregate demand, GDP, and employment. Republican politicians were arguing that it would not, and Mr Cochrane backed them up.

Two weeks ago, Mr Cochrane responded to the argument in a fashion that suggested that either he has changed his mind, or he never thought what the expansionary-austerity people claimed he did in the first place.

Let's be clear what the "fiscal stimulus" argument is and is not about. It is not about the proposition that governments should run deficits in recessions. They should, for simple tax-smoothing, consumption-smoothing, and social-insurance reasons, just as governments should finance wars with debt. That doesn't justify all deficits—one can still argue that our government used the recession to radically increase permanent spending. But disliking "stimulus" is not the same thing as calling for an annually balanced budget.Nor is it about debt financing of "infrastructure" or other genuine investments. If the project is valuable, do it. And recessions, with low interest rates and available workers, are good times to do it... Stimulus [is] still an economically interesting proposition, and there is a great deal of uncertainty about whether, when, and how well it might work.

Okay. There's a lot of nuance here. But as Noah Smith pointed out in response, if the basic gist is that governments should run deficits in recessions to smooth consumption, deliver social insurance, and take advantage of low interest rates to invest in infrastructure... then the policies Mr Cochrane is recommending here are to the left of anything Congress is contemplating….

Item 2: Niall Ferguson has spent the last three years arguing, contra Paul Krugman, that America is courting disaster by allowing deficits to balloon its national debt to such high levels, and will have to reign in spending or face a crippling rise in interest rates. Last week, in an interview with Henry Blodget, he admitted defeat.

BLODGET: That is a shockingly optimistic view of the United States from you. Are you conceding to Paul Krugman that over the near-term we shouldn't worry so much?

FERGUSON: I think the issue here got a little confused, because Krugman wanted to portray me as a proponent of instant austerity, which I never was. My argument was that over ten years you have to have some credible plan to get back to fiscal balance because at some point you lose your credibility because on the present path, Congressional Budget Office figures make it clear, with every year the share of Federal tax revenues going to interest payments rises, there is a point after which it's no longer credible. But I didn't think that point was going to be this year or next year. I think the trend of nominal rates in the crisis has been the trend that he forecasted. And you know, I have to concede that.

I could go on...

And some historical documents:

Paul Krugman: Myths of Austerity: July 1, 2010: When I was young and naïve, I believed that important people took positions based on careful consideration of the options. Now I know better. Much of what Serious People believe rests on prejudices, not analysis. And these prejudices are subject to fads and fashions. Which brings me to the subject of today’s column. For the last few months, I and others have watched, with amazement and horror, the emergence of a consensus in policy circles in favor of immediate fiscal austerity. That is, somehow it has become conventional wisdom that now is the time to slash spending, despite the fact that the world’s major economies remain deeply depressed. This conventional wisdom isn’t based on either evidence or careful analysis. Instead, it rests on what we might charitably call sheer speculation, and less charitably call figments of the policy elite’s imagination — specifically, on belief in what I’ve come to think of as the invisible bond vigilante and the confidence fairy….

What’s the evidence for the belief that fiscal contraction is actually expansionary, because it improves confidence? (By the way, this is precisely the doctrine expounded by Herbert Hoover in 1932.) Well, there have been historical cases of spending cuts and tax increases followed by economic growth. But as far as I can tell, every one of those examples proves, on closer examination, to be a case in which the negative effects of austerity were offset by other factors, factors not likely to be relevant today. For example, Ireland’s era of austerity-with-growth in the 1980s depended on a drastic move from trade deficit to trade surplus, which isn’t a strategy everyone can pursue at the same time.

And current examples of austerity are anything but encouraging…

Paul Krugman: Liquidity preference, loanable funds, and Niall Ferguson: May 2, 2009: Joe Nocera writes about Thursday’s New York Revie/PEN event on the economy, but fails to mention what I found the most depressing aspect of the whole thing: further confirmation that we’re living in a Dark Age of macroeconomics, in which hard-won knowledge has simply been forgotten.

What’s the evidence? Niall Ferguson “explaining” that fiscal expansion will actually be contractionary, because it will drive up interest rates. At least that’s what I think he said; there were so many flourishes that it’s hard to tell. But in any case, this is really sad: John Hicks knew far more about this in 1937 than people who think they’re sophisticates know now….

Right now the interest rate that the Fed can choose is essentially zero, but that’s not enough to achieve full employment. As shown above, the interest rate the Fed would like to have is negative. That’s not just what I say, by the way: the FT reports that the Fed’s own economists estimate the desired Fed funds rate at -5 percent…. So what does government borrowing do? It gives some of those excess savings a place to go — and in the process expands overall demand, and hence GDP. It does NOT crowd out private spending, at least not until the excess supply of savings has been sopped up, which is the same thing as saying not until the economy has escaped from the liquidity trap.

Now, there are real problems with large-scale government borrowing — mainly, the effect on the government debt burden. I don’t want to minimize those problems; some countries, such as Ireland, are being forced into fiscal contraction even in the face of severe recession. But the fact remains that our current problem is, in effect, a problem of excess worldwide savings, looking for someplace to go.

Paul Krugman: A history lesson for Alan Meltzer: May 4, 2009: From today’s Times:

Besides, no country facing enormous budget deficits, rapid growth in the money supply and the prospect of a sustained currency devaluation as we are has ever experienced deflation. These factors are harbingers of inflation.

Japan’s lost decade.

Matthew Yglesias:

What Is A Great Gatsby Curve And Why Do I Care?: Council on Economic Advisors Chairman Alan Krueger sparked a lot of debate with a recent speech (PDF) on inequality at the Center for American Progress where he made reference to, among other things, a chart he called "The Great Gatsby Curve" illustrating that countries with more unequal distributions of income have less social mobility. That gave rise to a critique from Scott Winship, a reply to Winship from Miles Corak, and an effort by Tyler Cowen to dismiss the whole thing as meaningless....

Krueger's antagonists should remember the proper context for this debate. Income inequality has increased a lot in the United States over the past thirty years, and American politics is increasingly organized around one coalition that wants to respond to that with higher tax rates on high income earners and another coalition which wants to oppose those efforts. Everything we're talking about here are rhetorical and analytic moves in that game. And the reason mobility is relevant is that one move Team Don't Soak The Rich has made is to argue that income inequality doesn't matter because the United States is a uniquely wonderful classless society with massive social mobility. That means the onus is on Team Don't Soak to demonstrate that this is true and relevant or else to withdraw the claim.

Krueger, like many others on Team Soak, is making an effort to show that it's not true.

Attacks on Krueger that end up attacking the conceptual underpinnings of measuring or caring about social mobility undermine Team Don't Soak's side of the argument. It's important to get that straight. It's Paul Ryan and Mitt Romney who brought social mobility and equal opportunity up as an alleged alternative to welfare-enhancing redistribution of income....

[T]hat puts us back where we started with the fact that the American economy has grown a lot over the past thirty years but a huge share of that growth has gone to a very small slice of the population, and that this is not compensated for in any meaninful way by the existence of boundless upward opportunities.

"When we compare the genomes of Archaea, bacteria, fungi, plants, and animals, we find about 500 genes that exist in all domains of life…"

--Sean B. Carroll, The Making of the Fittest:

60 British bombers attack Nazi battlecruisers Scharnhorst and Gneisenau in port in Brest, Brittany, France.

• delong J. Bradford DeLong Paul Krugman Is Much too Kind: Keynesian and Pseudo-Keynesian Propositions http://bit.ly/Aqho4p 1 hour ago

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Gavyn Davies today:

Assessing the risk of a fiscal crisis | Gavyn Davies: The debate on the correct setting for fiscal policy at a time of recession is probably the oldest debate in macro-economics. One key element in the debate is the trade off between supporting output growth in the short term, versus the need to control the growth of public debt in the long term.

There are some economists who do not recognise that this trade off exists at all, because they claim that an increase in the fiscal deficit cannot impact aggregate demand, even in the short run. But this is not a view which I believe to be supported either by empirical research or by economic theory (except on some very restrictive assumptions about Ricardian Equivalence or Says Law).

I recognise that this last statement is very contentious, but it is not my subject today…

As I have said before: The models say and always have said that a debt-financed expansion of government purchases has no effect on production, income, and employment if:

1. bottlenecks in resource and labor markets are so severe that increases in nominal spending show up entirely as increases in prices and not at all as increases in production; or

2. the central bank has a nominal GDP target and takes steps to hit it, and so offsets any impact of fiscal policy on nominal spending; or

3. what the government buys is exactly the same as what the private sector would have bought; or

4. the government's debt is sufficiently risky that issuing more government debt does not reduce the average riskiness of the pool of outstanding savings vehicles; or

5. perhaps there are a few other edge cases we could think of if we were sufficiently ingenious, but nobody has focused on them.

If you are arguing that fiscal policy has no effect on production, employment, and income, and you are arguing within economics, you are making one of those five arguments. (2) applies to the U.S. in normal times (for example, to the U.S. under the Clinton Administration in 1993-2000). (4) applies to Greece today. (1) can apply to economies with rapidly-rising inflation rates that are in a thorough-going inflationary boom. (5) might apply anywhere--but if you make that argument, you have to specify what it is. (3) has never applied anywhere at anytime.

I think that every fair-minded person admits that (1), (2), (3), and (4) do not apply to the U.S., to Britain, or to Germany today. I think that every fair-minded person admits that the arguments for (5), whatever they might be, have not been made in a way that applies to the U.S., to Britain, or to Germany today.

Yet Gavyn Davies claims that today his view--that neither empirical research nor economic theory supports the proposition an increase in the fiscal deficit cannot impact aggregate demand--is "very contentious".

So I have a question for Gavyn Davies: what fair-minded person contends? Name one fair-minded person who contends that either economic theory or empirical research supports the proposition an increase in the fiscal deficit cannot impact aggregate demand?

Paul Krugman:

Keynesian and Pseudo-Keynesian Propositions: Just a brief further thought on the anti-Keynesian flip-out. Consider three propositions:

1. Deficit spending is expansionary, other things equal.

2. Deficit spending is always expansionary.

3. Only deficit spending is expansionary.

Keynesian economics basically asserts proposition 1. Testing that proposition is tricky, but that’s always the case in economics; you have to look for natural experiments, or be very careful about controls. Christy Romer talks about this in her excellent speech (pdf) on the topic. But when you do it right, the evidence strongly supports proposition #1.

Proposition #2 is, well, stupid. It’s what you see in bad comment threads, where people rant about how if Keynesian economics was right, Greece would be a miracle economy.

Alas! It is not just in bad comment threads. It is--or, at least was back in 2009-the University of Chicago's Myron Scholes Professor of Finance John Cochrane too:

"Private Jets": If you've got magic, why not 2 trillion dollars [of stimulus]? Why not 10 trillion dollars? Why not 100 trillion, and we can all have private jets?…

And Paul continues, focusing on Tyler Cowen's "The new jobs report: The 'big loser' here?: Old Keynesianism…. The big winners, apart from the American public?: real business cycle theory…"

And proposition #3 is worse. Which is why I am boggled to see professional economists apparently believing that this is the proposition to focus on.

I am still looking for a RBC theory that predicts that more than three years after an adverse monetary-financial shock the unemployment rate will still be elevated above trend by 3.5% points. I am still looking for an "Old Keynesian" who would take the fact that the unemployment rate is elevated above trend by only 3.5% points more than three years after an adverse monetary-financial shock as a failure to confirm their view of the worl.

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"A large Japanese fleet has been contacted. They are fifteen miles away and headed in our direction. They are believed to have four battleships, eight cruisers, and a number of destroyers.

"This will be a fight against overwhelming odds from which survival cannot be expected. We will do what damage we can…"

--James D. Hornfischer, The Last Stand of the Tin Can Sailors

In Libya, the Nazi winter offensive comes to an end as the Afrika Korps reaches the British defensive positions on the Gazala Line.

Why oh why can't we have a better press corps? We will see if anybody at the Wall Street Journal is honorable enough to run a retraction and a correction.

There is literally nothing these people can do or say that will lose them their megaphone, is there?

Stephen Moore: Federal workers on balance still receive much better benefits and pay packages than comparable private sector workers, the Congressional Budget Office reports. The report says that on average the compensation paid to federal workers is nearly 50% higher than in the private sector, though even that figure understates the premium paid to federal bureaucrats. CBO found that federal salaries were slightly higher (2%) on average, while benefits -- including health insurance, retirement and paid vacation -- are much more generous (48% higher) than what same-skilled private sector workers get…

AS:

Seven things I learned about the transition from communism: First, in all countries in Eastern Europe and the former Soviet Union, economic activity shrunk at the beginning of transition, in some very sharply.  In many countries, economic decline started earlier, but still continued. In Russia, the steepness and the length of the decline (almost a decade) was a big surprise. Countries with the biggest trade shocks (such as Poland and Czechoslovakia) experienced the mildest declines. To be sure, the true declines were considerably milder than what was officially recorded… but this does not take away from the basic fact that declines occurred and were surprising. These declines contradicted at least the simple economic theory that a move to free prices should immediately improve resource allocation. The main lesson of this experience is for reformers not to count on an immediate return to growth. Economic transformation takes time.

Second, the decline was not permanent. Following these declines, recovery and rapid growth occurred nearly everywhere. Over 20 years, living standards in most transition countries have increased substantially for most people…. [C]apitalism worked and living standards improved enormously…. [But] for a time things looked glum. So lesson learned: have faith – capitalism really does work.

Third, the declines in output nowhere led to populist revolts – as many economists had feared…. Instead of populism, politics in many countries came to be dominated by new economic elites, the so-called oligarchs, who combined wealth with substantial political influence. From the perspective of 1992, this came as a huge surprise…. [T]the lesson is clear: a reformer should fear… capture of politics by the new elites.

Fourth, economists and reformers overstated both their ability to sequence reforms, and the importance of particular tactical choices…. Politics and competence frequently intervened and dictated to a large extent most of the tactical choices. Still, most countries, despite different choices, ended up with largely similar outcomes (notable and sad exceptions are Belarus, Uzbekistan, and Turkmenistan)… privatisation and macroeconomic stabilisation as well as legal and institutional reform…. Lesson learned: do not over-plan the move to markets, but, more importantly, do not delay in the hope of having a tidier reform later.

Fifth, economists have greatly exaggerated the benefits of incentives by themselves, without changes in people…. Winners in the communist system turned out not to be so good in a market economy. Transition to markets is accomplished by new people, not by old people with better incentives….

Sixth, it is important not to overestimate the long-run consequences of macroeconomic crises…. Debt restructurings do not necessarily make permanent scars. This experience bears a profound lesson for reformers, who are always intimidated by the international financial community: do not panic about crises; they blow over fast.

Seventh, it is much easier to forecast economic than political evolution. Although nearly all transition countries have eventually converged to some form of capitalism, there has been a broader range of political experiences, from full democracies, to primitive dictatorships, to just about everything in between… middle-income countries eventually slouch toward democracy, but not nearly in as direct or consistent a way as they move toward capitalism.

John Maynard Keynes (1936):

The General Theory of Employment, Interest and Money, chapter 32: the essence of the situation is to be found, nevertheless, in the collapse in the marginal efficiency of capital, particularly in the case of those types of capital which have been contributing most to the previous phase of heavy new investment. Liquidity-preference, except those manifestations of it which are associated with increasing trade and speculation, does not increase until after the collapse in the marginal efficiency of capital. It is this, indeed, which renders the slump so intractable. Later on, a decline in the rate of interest will be a great aid to recovery and, probably, a necessary condition of it. But, for the moment, the collapse in the marginal efficiency of capital may be so complete that no practicable reduction in the rate of interest will be enough. If a reduction in the rate of interest was capable of proving an effective remedy by itself, it might be possible to achieve a recovery without the elapse of any considerable interval of time and by means more or less directly under the control of the monetary authority. But, in fact, this is not usually the case…. It is the return of confidence, to speak in ordinary language, which is so insusceptible to control in an economy of individualistic capitalism. This is the aspect of the slump which bankers and business men have been right in emphasising, and which the economists who have put their faith in a “purely monetary” remedy have underestimated.

This brings me to my point. The explanation of the time-element… is to be sought in the influences which govern the recovery of the marginal efficiency of capital…. [T]he length of life of durable assets… the carrying-costs of surplus stocks… [explain why] the downward movement… does not fluctuate between, say, one year this time and ten years next time, but… between, let us say, three and five years….

So long as the boom was continuing, much of the new investment showed a not unsatisfactory current yield. The disillusion comes because doubts suddenly arise… because the current yield shows signs of failing off, as the stock of newly produced durable goods steadily increases…. Once doubt begins it spreads rapidly. Thus at the outset of the slump there is probably much capital of which the marginal efficiency has become negligible or even negative. But the interval of time, which will have to elapse before the shortage of capital through use, decay and obsolescence causes a sufficiently obvious scarcity to increase the marginal efficiency, may be a somewhat stable function of the average durability of capital…. The second stable time-factor is due to the carrying-costs of surplus stocks which force their absorption within a certain period…. The sudden cessation of new investment… lead[s] to an accumulation of surplus stocks of unfinished goods…. [T]he process of absorbing the stocks represents negative investment, which is a further deterrent to employment; and, when it is over, a manifest relief will be experienced. Moreover, the reduction in working capital, which is necessarily attendant on the decline in output on the downward phase, represents a further element of disinvestment, which may be large….

Unfortunately a serious fall in the marginal efficiency of capital also tends to affect adversely the propensity to consume. For it involves a severe decline in the market value of Stock Exchange equities….

When once the recovery has been started, the manner in which it feeds on itself and cumulates is obvious. But during the downward phase… the marginal efficiency of capital may fall so low that it can scarcely be corrected, so as to secure a satisfactory rate of new investment, by any practicable reduction in the rate of interest…. In conditions of laissez-faire the avoidance of wide fluctuations in employment may, therefore, prove impossible without a far-reaching change in the psychology of investment markets such as there is no reason to expect. I conclude that the duty of ordering the current volume of investment cannot safely be left in private hands.

The preceding analysis may appear to be in conformity with the view of those who hold that over-investment is the characteristic of the boom, that the avoidance of this over-investment is the only possible remedy for the ensuing slump, and that, whilst for the reasons given above the slump cannot be prevented by a low rate of interest, nevertheless the boom can be avoided by a high rate of interest. There is, indeed, force in the argument that a high rate of interest is much more effective against a boom than a low rate of interest against a slump.

To infer these conclusions from the above would, however, misinterpret my analysis; and would, according to my way of thinking, involve serious error. For the term over-investment is ambiguous. It may refer to investments which are destined to disappoint the expectations which prompted them or for which there is no use in conditions of severe unemployment, or it may indicate a state of affairs where every kind of capital-goods is so abundant that there is no new investment which is expected, even in conditions of full employment, to earn in the course of its life more than its replacement cost. It is only the latter state of affairs which is one of over-investment, strictly speaking, in the sense that any further investment would be a sheer waste of resources…. [I]t is only in the former sense that the boom can be said to be characterised by over-investment. The situation… is not one in which capital is so abundant that the community as a whole has no reasonable use for any more, but where investment is being made in conditions which are unstable and cannot endure, because it is prompted by expectations which are destined to disappointment.

It may, of course, be the case — indeed it is likely to be — that the illusions of the boom cause particular types of capital-assets to be produced in such excessive abundance that some part of the output is, on any criterion, a waste of resources; — which sometimes happens, we may add, even when there is no boom…. But over and above this it is an essential characteristic of the boom that investments which will in fact yield, say, 2 per cent. in conditions of full employment are made in the expectation of a yield of, say, 6 per cent., and are valued accordingly. When the disillusion comes, this expectation is replaced by a contrary “error of pessimism”, with the result that the investments, which would in fact yield 2 per cent. in conditions of full employment, are expected to yield less than nothing; and the resulting collapse of new investment then leads to a state of unemployment in which the investments, which would have yielded 2 per cent. in conditions of full employment, in fact yield less than nothing. We reach a condition where there is a shortage of houses, but where nevertheless no one can afford to live in the houses that there are.

Thus the remedy for the boom is not a higher rate of interest but a lower rate of interest! For that may enable the so-called boom to last. The right remedy for the trade cycle is not to be found in abolishing booms and thus keeping us permanently in a semi-slump; but in abolishing slumps and thus keeping us permanently in a quasi-boom…

Tyler Cowen:

The new jobs report: The “big loser” here?: Old Keynesianism.  You really can get a recovery when the real shocks are moderately positive.  You will note, as we have been told many many times by many many sources, fiscal and monetary policy have not been extremely pro-active in recent times; in fact the stimulus has been trickling to a close. The big winners, apart from the American public?: real business cycle theory.  It is part of any cyclical explanation, whether one likes it or not.

Huh?!

"[I]t was to head off a return of the old demons (unemployment, Fascism, German militarism, war, revolution) that western Europe took the new path with which we are now familiar. Post-national, welfare-state, cooperative, pacific Europe was not born of the optimistic, ambitious, forward-looking project imagined in fond retrospect by today’s Euro-idealists. It was the insecure child of anxiety. Shadowed by history, its leaders implemented social reforms and built new institutions as a prophylactic, to keep the past at bay…"

--Tony Judt, Postwar: A History of Europe Since 1945

Diligent searching have not turned up a copy of Hayek's letter to which this is a reply:

Letter from Margaret Thatcher to Friedrich Hayek: February 17, 1982

Thank you for your letter of 5 February. I was very glad that you able to attend the dinner so thoughtfully organized by Walter Salomon. It was not only a great pleasure for me, it was, as always, instructive and rewarding to hear your views on the great issues of our times.

I was aware of the remarkable success of the Chilean economy in reducing the share of Government expenditure substantially over the decade of the 70s. The progression from Allende's Socialism to the free enterprise capitalist economy of the 1980s is a striking example of economic reform from which we can learn many lessons.

However, I am sure you will agree that, in Britain with our democratic institutions and the need for a high degree of consent, some of the measures adopted in Chile are quite unacceptable. Our reform must be in line with our traditions and our Constitution. At times the process may seem painfully slow. But I am certain we shall achieve our reforms in our own way and in our own time. Then they will endure.

Bureaucratic procedures being what they are, I would have hoped that a copy of Hayek's letter would have survived and surfaced by now…

The Nazis in winter on the Russian Front: an upbeat look:

• BetseyStevenson Betsey Stevenson It's good news! RT @bethmorgan It's that "Betsey's Employment Report" time of the month. Let me get a good bottle of wine and some tissues. 1 hour ago Retweeted by delong

• justinwolfers Justin Wolfers @ @KarenDynan @DLeonhardt @TedGayer: Ah, so you are making the right choice... Please tell @delong to do the same! 1 hour ago Retweeted by delong

• KarenDynan Karen Dynan @ @DLeonhardt @justinwolfers @TedGayer I'd tweet more if Justin didn't have me so busy writing a paper 1 hour ago Retweeted by delong

• Atrios Atrios related remember when McCain gave his convention speech in front of the wrong Walter Reed? that was excellent news for john mccain 3 hours ago Retweeted by delong

• daveweigel daveweigel ACORN. RT @StevenTDennis: Dow +95% from 6574 March '09 low, +70% since Obama signed stimulus, +60% since inauguration day 3 hours ago Retweeted by delong

• daveweigel daveweigel Traveled 800 miles so far, have yet to see any non-Ron Paul candidate signs. Signs don't vote, but still 2 hours ago Retweeted by delong

• radleybalko radleybalko Anonymous says hacked emails show Ron Paul met "regularly" with white supremacist group A3P. pirasec.com 2 hours ago Retweeted by delong

• crampell Catherine Rampell @ MT @BetseyStevenson not a big increase in discouraged workers. What happened, was Census found a bunch of old people we had assumed died. 2 hours ago Retweeted by delong

• BorowitzReport Andy Borowitz Romney: "To those who say I'm out of touch with the average American, I say, 'Au revoir.'" 2 hours ago Retweeted by delong

• netw3rk netw3rk @ @Mobute All he did was knowingly publish racist material in a newsletter bearing his name. Could happen to anyone. 2 hours ago Retweeted by delong

• Mobute Mobutu Sese Seko "Name one thing I've said that's racist." holds up enormous stack of documents "No, I meant said OUT LOUD. Ahahaha, gotcha. Owned, facts." 2 hours ago Retweeted by delong

• delong J. Bradford DeLong How the GOP Is Resegregating the South | The Nation thenation.com/article/165976… 2 hours ago

• delong J. Bradford DeLong @ @Noahpinion Tyler Cowen thinks what?!?! 5 hours ago

• delong J. Bradford DeLong Hooray! First Genuinely Good Employment Report of the Recovery! http://bit.ly/xQPpbG 7 hours ago

• DemocratMachine Viva DemocratMachine Mitt Romney says America is becoming like Greece, Italy or Spain. If only we became more like a Carribean island, Mitt would invest here 23 hours ago Retweeted by delong

• kevinddaly Kevin Daly 'One is a practicing polygamist, and he's not even the Mormon.' - Sandra Day O'Connor's comic assessment of the GOP field. 23 hours ago Retweeted by delong

• NiemanWatchdog NiemanWatchdog Thursday’s #newsq: Just how twisted are Mitt Romney’s tax returns? Steven Rattner takes a hard look. http://bit.ly/yJzW7r 2 Feb Retweeted by delong

• mattyglesias Matt Yglesias Related, the Milk Bar at @CowgirlCreamery is freaking me out. Ultra-violence must lurk around the corner. 2 Feb Retweeted by delong

• rortybomb Mike Konczal Serious question: What is the set of problems that middle-income people have that the poor don't? 2 Feb Retweeted by delong

• DavidCornDC David Corn Romney accepts CBO projection of future unemployment but not its conclusion that the stimulus lifted employment by 3m jobs. #TheTrumpMitt 2 Feb Retweeted by delong

• delong J. Bradford DeLong @ @mattyglesias It's sadism and it's masochism! It's a floor was and a dessert topping! 2 Feb

• delong J. Bradford DeLong Hudson: The Neo-Rentier Economy « Multiplier Effect http://multiplier-effect.org/?p=3476 2 Feb

• dangillmor Dan Gillmor Frozen out of both of my Google accounts; Authenticator is providing incorrect codes. This really really sucks... 2 Feb Retweeted by delong

• TheStalwart Joseph Weisenthal Bernanke: Congress Should Avoid Too Big Fiscal Contraction In 2013 2 Feb Retweeted by delong

• dangillmor Dan Gillmor Google's 2-step authentication is great when it works, but when it doesn't you are hosed. As I am, thoroughly, at the moment.... 2 Feb Retweeted by delong

• delong J. Bradford DeLong On Bloomberg Surveillance This Morning... http://bit.ly/zZoReh 2 Feb

• JessicaValenti Jessica Valenti Komen VP retweeted (then deleted) message saying "pro-abortion" groups should "cry me a river" http://yfrog.com/kkzyuyp via @KatieMStack 1 Feb Retweeted by delong

• BloombergRewind Bloomberg Rewind @delong thank you for joining us on @bloombergrewind w/ @mattmiller1973 last night! 1 Feb Retweeted by delong

• DemocratMachine Viva DemocratMachine ICYMI, Mitt Romney's favorability percentage in Ohio is 28%. No Republican has won without Ohio, ever 1 Feb Retweeted by delong

• justinwolfers Justin Wolfers @ @KarenDynan @DLeonhardt @TedGayer: Ah, so you are making the right choice... Please tell @delong to do the same! 1 hour ago

• nick_bunker Nick Bunker RT @delong: Everything We Know About the Long-Term Unemployed http://bit.ly/z5OIR4 2 hours ago

• Noahpinion Noah Smith @ @delong Obviously a smashing victory for RBC. (shakes head) Silly Keynesians... 2 hours ago

• UnlearningEcon Unlearning Economics @ @delong @Noahpinion marginalrevolution.com/marginalrevolu… < Step 1. news! Step 2. ???? Step 3. Keynesianism sucks! 5 hours ago

• Noahpinion Noah Smith @tylercowen thinks recent numbers = a win for RBC theory. I disagree: @ryanavent @delong @mattyglesias @justinwolfers 7 hours ago

• Hesiod2k11 Hesiod Theogeny @ @ezraklein @tylercowen @delong LMAO! Whatever, Tyler. 9 hours ago

• mattyglesias Matt Yglesias @ @delong The issue is that it's sadism masquerading as masochism. 2 Feb

• jonst0kes Jon Stokes @ @delong "Coronary Capitalism" has a near twin in what @rickperlstein has called "E. Coli Conservatism" 1 Feb

BLS:

Employment Situation Summary: Total nonfarm payroll employment rose by 243,000 in January, and the unemployment rate decreased to 8.3 percent….

The unemployment rate declined by 0.2 percentage point in January to 8.3 percent…. In January, the number of job losers and persons who completed temporary jobs fell to 7.3 million. The number of long-term unemployed (those jobless for 27 weeks or more) was little changed at 5.5 million and accounted for 42.9 percent of the unemployed…. [T]he employment-population ratio (58.5 percent) rose in January, while the civilian labor force participation rate held at 63.7 percent….

In January, 2.8 million persons were marginally attached to the labor force, essentially unchanged from a year earlier. (The data are not seasonally adjusted.) These individuals were not in the labor force, wanted and were available for work, and had looked for a job sometime in the prior 12 months. They were not counted as unemployed because they had not searched for work in the 4 weeks preceding the survey….

Total nonfarm payroll employment rose by 243,000 in January. Private-sector employment grew by 257,000, with the largest employment gains in professional and business services, leisure and hospitality, and manufacturing. Government employment was little changed over the month….

The average workweek for all employees on private nonfarm payrolls was unchanged…. [A]verage hourly earnings for all employees on private nonfarm payrolls rose by 4 cents, or 0.2 percent, to $23.29. Over the past 12 months, average hourly earnings have increased by 1.9 percent….

The change in total nonfarm payroll employment for November was revised from +100,000 to +157,000, and the change for December was revised from +200,000 to +203,000. Monthly revisions result from additional sample reports and the monthly recalculation of seasonal factors…

"He was not a bad fellow, no worse than most and probably better than some, and not a bad ballplayer neither when they give him a chance, when they laid off him long enough.

"From here on in I rag nobody."

--Mark Harris, Bang the Drum Slowly

One of the more surprising things about Mitt Romney was in evidence yesterday.

When the market is broken, it is silly policy to wait for the market to fix itself and then fix a situation.

Yet that is what Romney wants to do, over and over again.

He wanted to do it in late 2008 with the auto industry. He wanted the government to back off, to let private firms come in with debtor-in-possession financing, and let the private sector reorganize the auto sector. The problem that Romney did not see was that the financial crisis meant that there was no private debtor-in-possession financing available. Thus having the government step back and leave the private bankruptcy process to work itself out would have meant not Chapter 11 but Chapter 7, and liquidation--a liquidation of the American auto industry that it is now evident would have involved an enormous destruction of long-run value.

In a similar fashion, Romney yesterday said that the government should get its nose out of the housing-finance business, let the waves of foreclosures roll their way forward, and let the housing market find its bottom.

But private mortgage lending is broken: there are no large pools of private money willing to take on long-term mortgage default risk. Either the government backstops the risk and greases the transactions, or the market freezes.

The somewhat scary thing is that Romney had and has advisers who know this very well, at least as well as anybody in the world. Glenn Hubbard's briefings to Romney today about housing markets must be filled with statistics and anecdotes about housing-finance market failures. Jon Gruber's healthcare briefings to Romney of seven years ago were filled with analyses of health-finance market failure: that is why Romney decided to go with the individual mandate in order to limit the extent and influence of health-finance market failure.

The Romney who ran pain appeared then to be firmly reality-based. Where has that Romney gone?

The hope is that that Romney will reemerge after the election should Romney become president. The hope is that the current Romney is simply a mask donned to pull off a con job on the Republican Party base.

But I have not found anybody who claims to know what is really going on.

David Glasner:

Keynes v. Hayek: Enough Already: Ralph Hawtrey and Gustav Cassel had explained what was happening ten years before the downturn started in the summer of 1929. Both… understood that restoring the gold standard after the demonetization of gold that took place during World War I would have hugely deflationary implications if, when the gold standard was reinstated, the world’s monetary demand for gold would increase back to the pre-World War I level…. That is why both… called for measures to limit the world’s monetary demand for gold (measures agreed upon in the international monetary conference in Genoa in 1922 of which Hawtrey was the guiding spirit). The measures agreed upon at the Genoa Conference prevented the monetary demand for gold from increasing faster than the stock of gold was increasing so that the world price level in terms of gold was roughly stable from about 1922 through 1928.

But in 1928, French demand for gold started to increase rapidly just as the Federal Reserve started to tighten monetary policy in a tragically misguided effort to squelch a supposed stock-price bubble on Wall Street, causing an inflow of gold into the US while the French embarked on a frenzied drive to add to their gold holdings and other countries rejoining the gold standard were increasing their gold holdings as well, though with a less fanatical determination than the French. The Great Depression was therefore entirely the product of monetary causes, a world-wide increase in gold demand causing its value to increase, an increase manifesting itself, under the gold standard, in deflation.

Hayek, along with his mentor Ludwig von Mises, could claim to have predicted the 1929 downturn as well, having criticized the Fed in 1927 for reducing interest rates to 3.5%, by historical standards far from a dangerously expansionary rate…. But it has never been even remotely plausible that a 3.5% discount rate at the Fed for a little over a year was the trigger for the worst economic catastrophe since the Black Death of the 14th century. Nor could Keynes offer a persuasive explanation for why the world suddenly went into a catastrophic downward spiral in late 1929. References to animal spirits and the inherent instability of entrepreneurial expectations are all well and good, but they provide not so much an explanation of the downturn as a way of talking about it or describing it. Beyond that, the Hawtrey-Cassel account of the Great Depression also accounts for the relative severity of the Depression and for the sequence of recovery in different countries, there being an almost exact correlation between the severity of the Depression in a country and the existence and duration of the gold standard in the country. In no country did recovery start until after the gold standard was abandoned, and in no country was there a substantial lag between leaving the gold standard and the start of the recovery.

So not only did Hawtrey and Cassel predict the Great Depression, specifying in advance the conditions that would, and did, bring it about, they identified the unerring prescription – something provided by no other explanation — for a country to start recovering from the Great Depression.

Hayek, on the other hand, along with von Mises, not only advocated precisely the wrong policy, namely, tightening money, in effect increasing the monetary demand for gold, he accepted, if not welcomed, deflation as the necessary price for maintaining the gold standard…. Faced with a conflict between maintaining the gold standard and following his own criterion for neutral money, Hayek along with his friend and colleague Lionel Robbins, in his patently Austrian book The Great Depression, both opted for maintaining the gold standard.)

Not only did Hayek make the wrong call about the gold standard, he actually defended the insane French policy of gold accumulation in his lament for the gold standard after Britain wisely disregarded his advice and left the gold standard in 1931. In his paper “The Fate of the Gold Standard” (originally Das Schicksal der Goldwahrung) reprinted in The Collected Works of F. A. Hayek: Good Money, Part 1, Hayek offered a lament for impending demise of the gold standard after Britain tardily did the right thing. The tone of Hayek’s lament is struck in his opening paragraph (p. 153).

There has been much talk about the breakdown of the gold standard, particularly in Britain where, to the astonishment of every foreign observer, the abandonment of the gold standard was very widely welcomed as a release from an irksome constraint. However, it can scarcely be doubted that the renewed monetary problems of almost the whole world have nothing to do with the tendencies inherent in the gold standard, but on the contrary stem from the persistent and continuous attempts from many sides over a number of years to prevent the gold standard from functioning whenever it began to reveal tendencies which were not desired by the country in question. Hence it was by no means the economically strong countries such as America and France whose measures rendered the gold standard inoperative, as is frequently assumed, but the countries in a relatively weak position, at the head of which was Britain, who eventually paid for their transgression of the “rules of the game” by the breakdown of their gold standard…

I have only three relatively minor quibbles with what Glasner has to say:

1. He seems to want to have it both ways. He says both (a) the decision to return to the gold standard with an inadequate gold cover caused the Depression, and (b) French and American refusals to actually use their (gold) reserves for their proper purpose (shades of the ECB today) caused the Depression. It's hard to make both arguments at once. If the Bank of France and the Federal Reserve acting in a non-insane way could have prevented the Great Depression, you can't say that the gold cover was inadequate. If you say the gold cover was inadequate, then it is hard to see how Bank of France and Federal Reserve spending their gold could have rescued the situation.

2. The experience of the past four years leads me to think that perhaps Glasner should rethink elements of his position. The Federal Reserve and the ECB and the Bank of England have flooded the North Atlantic economy with liquidity over the past four years. Yet it has not been enough to produce a healthy recovery. Cassel and Hawtrey took it for granted that enough monetary ease--buying enough short-term bonds for gold or other forms of rock-solid cash--would do the job. But today it looks as though balance-sheet depressions are more stubborn beasts, that simple liquidity-provision by the government is not enough, and that proper handling may require banking and fiscal policy to provide the market with duration and safety as well.

3. Related to (2), I think that Cassel and Hawtrey are not enough. I think that their exclusive focus on monetary liquidity misses large aspects of the picture. You need to think along Bagehot-Minsky-Kindleberger lines about safety and risk and along Wicksellian lines about the savings-investment balance as well. And, historically, the traditional road from the quantity theory of money to those concerns has been the Keynes-Hicks-Tobin road.

In our defense, I would say that we have five kinds of equilibrium:

• Market day equilibrium, in which quantity supplied cannot change but quantity demanded (and sometimes prices) can.

• Short run equilibrium, in which labor supplied, quantity demanded (and sometimes prices) can change, but capital stocks, technology, and the number of firms cannot.

• Medium run equilibrium, in which labor supplied, quantity demanded, prices, and firm capital stocks can change but technology and the number of firms cannot.

• Long run equilibrium, in which labor supplied, quantity demanded, prices, the number of firms, and firm capital stocks can change but technology cannot.

• Very long run equilibrium, in which everything can change.

So we are not quite a metaphysical as James thinks…

James Wimberly:

In which I challenge famous ghosts: Not sure if anybody will read to the end of this, but here goes.

Brad deLong recently (my italics):

It turns out in economics to be remarkably hard for lots of people to distinguish between:

• behavioral relationships–things that tell you how people will change their behavior to respond to changes in the economic environment and economic policy;
• equilibrium conditions–things that tell you what configurations of the economic environment are consistent and are not rapidly-changing out-of-equilibrium phenomena seen for an eyeblink of time, if that long;
• and accounting identities–things true by the metaphysical necessity of the definitions that are devoid of interesting substantive implications.

Hum. The doctrine of instantaneous equilibrium looks suspiciously like an analytical convenience that has got metaphysical notions above its station. It seems remote from real life. Getting information and taking decisions take time and effort. We run out of time before we optimise and then things change.

Just for fun, let’s build a toy qualitative model that reflects these facts, and see where it takes us…. Walras’ image is of a peaceful Swiss Bronze Age mountain village, a picture postcard without the chocolate. On market day all the farmers and shepherds bring their produce in kind: sacks of grain, baskets of parsnips, jugs of milk, goats and chickens. Each seller wants to go home with a different bundle of goods than he (it’s presumably a patriarchy) arrives with. The relative prices are established by multilateral haggling, in the famous process of tâtonnement – groping. Eventually everybody is Pareto-happy and the prices and quantities are frozen. Bingo, general equilibrium. In the absence of money and money prices, it’s general equilibrium or chaos. Also, it’s unclear whether the individuals are subject to a hard budget constraint in their initial haggling. If they are, how does the tâtonnement get started? But it applies fully at the end.

We’ll fast-forward 3000 years from Walras-la-Vallée to Keyneston, 1935.

Keyneston is an autarkic city-state, with factories run by industrialists, shops, wage-earning workers, a government, bonds, and money. The week is divided into three periods. Monday morning is market time, when contracts are negotiated to fix all the activities carried out in the second period from Monday noon to Saturday. On Sunday everybody reviews how things went in the week, taking account of information about others, and draws up plans for the Monday trading session. These plans are internally consistent, but not as a rule compatible.

Now here’s the crucial tweak. There is imperfect information and high search costs for everything, and a strict time limit to trading. The initial offers of participants are not random but good guesses based on previous experience – what happens is strongly path-dependent. The bell rings at noon, trading stops, and all participants must abide by their last offers, whether to buy or sell. Since there is money, the hard budget constraint on each is the income they expect to receive under the last offer for their labour or goods for sale, plus their holding of money. Money acts as a short-term cushion against trading uncertainty.

In this universe, everybody starts the week with a portfolio of contracts to buy and sell, and an invisible portfolio of regrets about what went wrong….

[H]ere’s the thing, In a world when no individual is ever in subjective equilibrium except by a fluke, still less entire markets or the whole economy, the accounting identities still hold in full as long as there any transactions at all: including Say’s Identity (total supply = total demand), and Keynes’ Lemma (savings = investment).

The impact of a bond-financed government stimulus cannot possibly be inferred from these identities. For this, you have to look at the behavioural responses embedded in the regret portfolios and revised bidding strategies. It’s very plausible, via Keynes’ propensity to consume, that there will be a positive multiplier in succeeding cycles. It’s plausible too that this will be counteracted to some extent by crowding-out of private investment as interest rates rise…

Memo Question for February 8, 2012: Slavery and Serfdom:

Adam Smith in the Wealth of Nations has a theory about unfree labor. It is, he says, economically inefficient. But wherever demand is very high relative to supply masters will resort to slave labor because it yields them powerful psychic income:

The experience of all ages and nations, I believe, demonstrates that the work done by slaves, though it appears to cost only their maintenance, is in the end the dearest of any…. Whatever work he does beyond what is sufficient to purchase his own maintenance, can be squeezed out of him by violence only, and not by any interest of his own. In ancient Italy, how much the cultivation of corn degenerated, how unprofitable it became to the master, when it fell under the management of slaves, is remarked both by Pliny and Columella….

The pride of man makes him love to domineer, and nothing mortifies him so much as to be obliged to condescend to persuade his inferiors. Wherever the law allows it, and the nature of the work can afford it, therefore, he will generally prefer the service of slaves to that of freemen. The planting of sugar and tobacco can afford the expense of slave cultivation. The raising of corn, it seems, in the present times, cannot. In the English colonies, of which the principal produce is corn, the far greater part of the work is done by freemen…. The profits of a sugar plantation in any of our West Indian colonies, are generally much greater than those of any other cultivation that is known either in Europe or America; and the profits of a tobacco plantation, though inferior to those of sugar, are superior to those of corn, as has already been observed. Both can afford the expense of slave cultivation…

Was he right? Was he wrong?

Bloomberg Surveillance Podcast

Goldman School of Public Policy 269.  Public Budgeting. (4):  

Three hours of lecture/discussion per week. Formerly 209. Public sector budgeting is an activity that incorporates many, perhaps most, of the skills of the public manager and analyst. The goal of this course is to develop and hone these skills. Using cases and readings from all levels of American government, the course will allow the student to gain an understanding of the effects and consequences of public sector budgeting, its processes and participants, and the potential impacts of various reforms. Graduate level of Public Policy 179. TTh 3:30-5, GSPP 250

20120202 DeLong Presentation PP 269 Ellwood.pdf

Lecture Audio

J. Edgar Hoover:

February 2, 1942 - Hoover memorandum for Attorney General: With reference to the conference of yesterday held in your office between representatives of the War Department and the Department of Justice concerning the evacuation of Japanese from the West Coast area, I communicated with our several offices upon the Pacific Coast following this conference, and checked with them as to the various aspects of this rather intricate and certainly difficult problem.

The following pertinent items have been advanced for consideration in connection with any mass evacuation of Japanese from the Pacific Coast. Both pro and con items are considered in an effort to present a broad picture of the situation.

The necessity for mass evacuation is based primarily upon public and political pressure rather than on factual data. Public hysteria and in some instances, the comments of the press and radio announcers, have resulted in a tremendous amount of pressure being brought to bear on Governor Olson and Earl Warren, Attorney General of the State, and on the military authorities. It is interesting to observe that little mention has been made of the mass evacuation of enemy aliens.

It is believed by many that the mass evacuation will be a cure-all and will eliminate the danger of Japanese espionage and sabotage. It would, of course, eliminate the possibility of the Japanese physically committing sabotage on the coast. However, experience has taught that the Japanese often rely on Occidentals to obtain physically their information for them. Bureau cases substantiate this.

If only the Japanese aliens are excluded from restricted areas, the problem of enforcement becomes extremely difficult. The necessity for challenging every Japanese observed within these areas is obvious. Then there must follow a close interrogation to establish citizenship. There also remains the fact that a large portion of the aliens have immediate or close relatives who are citizens and who would have access to the restricted areas. It is recognized that the second generation Japanese are, as a whole, more inclined to be loyal to this country than their alien elders. Irrespective of this, aliens and citizens being in the same families would tend to nullify effectiveness of the exclusion of aliens and not citizens from restricted areas. The advisability of excluding aliens and not citizens is therefore highly controversial.

In the event of an attempted invasion, an altogether different problem presents itself. The Japanese as a race, although extremely law-abiding, are very loyal to their native land. This is attributed largely to the close relationship between their religion and their government. The are taught that their emperor has divine rights and power and that their reward in the hereafter depends upon their service to him. Although usually law-abiding while under the control of the Occidental, little doubt remains that they would assist a Japanese army having apparent local successes. No one can say definitely what the local Japanese would do during an invasion as it would be a matter of individual decision.

The possibility of race riots continues to exist. There is a large Filipino population in California that presents a constant threat to widespread violence. Stories of Japanese atrocities in the Philippines, either true or magnified, could quickly bring about a serious condition in the Sacramento Valley where there are large Japanese and Filipino populations. This is presently of major concern in the Hawaiian Islands. The unrest there, as well as in California, has, however, resulted only in individual assaults. If widespread conflicts do occur, the Filipinos will be the aggressors.

Naturalized citizens who were, until recently, Axis nationals present a problem equal to that of the Japanese aliens. Many of the Japanese aliens would have become citizens, if permitted, either because of their appreciation of this country or for selfish or ulterior reasons. The subjects of a great number of our internal security cases involving Axis powers are naturalized citizens. They have, in many instances, considered their American citizenship as a license and a protective cloak instead of a privilege to be appreciated. Thus their American citizenship is being used to protect and to facilitate their un-American activities...

"'Lady.' She looked up from her loom. The sergeant of the guard, the one with red eyes, bowed to her.

"'Sergeant?'

"'Lady, we have the workmen for you. The Children of the Sun you wanted. With all their tools and gear. Himself says come and see.'

"'Thank you, Sergeant.' She rose, smiling. 'Where are they?'

"'Got ‘em in the lower courtyard.' He escorted her down through the corridors. Hideous monsters saluted shyly as she passed them. She stepped out into the courtyard and beheld red men, kneeling in a long row. They were blindfolded, their hands bound before them, and some wept and prayed to their gods. Piled in a heap to one side of them were chests and trays of tools.

"Gard stood to the other side of them, in his full black armor. When he spoke, it was not to her but to the prisoners, in a voice full of rolling thunder. 'Now, Children of the Sun, if you die tomorrow, you will still have seen the fairest sight of your lives, and you’d not see anything fairer if you lived on a thousand years. Free their eyes!' His guards stepped forward and pulled off the blindfolds, one by one.

"One by one the red men blinked, stared around, then gasped as they saw the Saint. Some of them fell prostrate before her, bound hands outstretched. 'Oh, Lady, save us!' 'Have mercy on us!' 'Don’t let him kill us!'

"She looked on them in horror and looked white rage at Gard. 'What have you done?'

"'Brought you workmen, as I promised,' he said in that same theatrical tone, meeting her eyes without flinching. She saw amusement there, and a covert purpose. 'Why, madam, are you displeased? Shall I have them hanged?'

"'No!' she cried. 'You will have them released at once!'

"The red men crowded forward on their knees, weeping, thanking her, imploring her, praising her. 'Then I will spare your lives,' said Gard to the Children of the Sun. 'But you will slave for me nonetheless, to make fair the rooms in which my lady lives.'

"'They will not slave!' said the Saint. 'If they choose to work, you will pay them in gold, and then you’ll let them go!'

"'Lady, is it fine work you want?' said one of the prisoners. 'By all the gods, I swear you’ll have rooms finer than a duchess’s!'

"'Wife, I will defer to your wishes,' said Gard. 'For I am your slave in all things. Should one of them displease you, however, his head shall look down sadly from a pike.'

"'May I speak with you alone a moment?' said the Saint to Gard.

"He bowed her to the door, and she pulled him within the hall after her. 'Now they will do anything you ask them,' said Gard smugly.

"'How dare you!' The Saint looked him full in the eyes with all the force of her anger, and he rocked back a little on his heels but did not look away.

"'Wife, this is the way a Dark Lord accomplishes his affairs. And I had to bring them up here blindfolded, you know, that’s elementary security. They haven’t been hurt. They haven’t been robbed. If they do a good job for you, by all means pay them what you will. They’ll have to be taken down the mountain blindfolded too, but you have my word they’ll be released alive and unharmed. That’s fair, isn’t it?'

"'That isn’t the point! Why couldn’t you have asked them to come?'

"'Because they wouldn’t have. What with me being a Dark Lord and all, as they’d say. But look now: we’ll get your rooms redecorated. They’ll go back home and spread tales about the terrible Master of the Mountain and his beautiful and saintly Lady who saved their lives. It’ll do both our reputations a world of good.'

"'But this is all absurd!'

"'Isn’t it? I lie to survive, because people fear and respect a black mask more than an honest face. Life became much simpler once I understood that.'

"'We have not done with this conversation,' she said."

--Kage Baker, The House of the Stag

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• delong J. Bradford DeLong @ @AndyHarless Are you asking why Obama bonded with Geithner? 31 Jan

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• jbplainblog Jonathan Bernstein RT @coreyrobin: @jbplainblog @daveweigel @delong I think "rootless" is the word you're looking for. 31 Jan

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• pnewall Philip Newall @delong the crazy thing is that George Osborne thinks a 10-year bond yield under 2% is healthy, and no-one questions him. 31 Jan

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• matttbastard Matthew Elliot Self-interest & income equality: Why it doesn't -- & shouldn't -- matter whether one "deserves" to be poor http://is.gd/WVR0rt h/t @delong 30 Jan

Food for thought related to Allen on nitrogen:

Henry Farrell and Cosma Shalizi, "Evolutionary Theory and the Dynamics of Institutional Change"

• Class Slides

Suggested answers for problem set 1

Marshall Islands Raid: 1 February 1942:

On January 2, Nimitz's staff recommended strikes against the Gilberts and Marshall Islands, but Vice Admiral William S. Pye - former commander of the Battle Fleet - raised the possibility of Japan expecting Samoa to be reinforced. Pye suggested, and Nimitz concurred, that a second carrier cover the Marine's arrival in Samoa. Once the Marines were safely ashore, the two carriers would head towards the Gilberts to fend off any Japanese advance, or to strike at bases there should no opposition be met. A third carrier would strike Wake Island, while the fourth (including Yorktown, four U.S. carriers were available in the Pacific) guarded Hawaii. Though Nimitz himself approved of the plan, several members of his staff vocally opposed it: the battleships had already been lost, and they were not about to lose the carriers in a raid the Japanese could be anticipating. Nimitz needed support.

Support arrived the following day, January 7, when Enterprise - flagship of Vice Admiral William F. Halsey - returned to Pearl Harbor from an uneventful patrol. Halsey immediately approved of Pye's plan, and was first astounded and then outraged by the opposition against it. In the words of a biographer, Halsey "cleared the air", going so far as to volunteer to lead the operation. As perhaps no other man in Oahu at the time better appreciated the offensive power of the carrier, Halsey's opinion won the day, not to mention Nimitz's gratitude. On January 9, Nimitz gave Halsey his orders. Halsey, Enterprise, and Task Force 8 would escort the Yorktown group to Samoa. The sister ships would then raid Japanese bases in the Gilberts and Marshalls…. Enterprise provisioned all day and into the night on January 10 - "Are loading for bear" noted one Enterprise Air Group pilot - and stood out of Pearl Harbor at noon, Sunday, January 11…. The first days steaming southwest were marred by mishaps and bad news. Saratoga was torpedoed by an enemy sub the first evening Enterprise was underway, and damaged badly enough to have to return to the West Coast for repair….

Enterprise and Task Force 8 arrived off Samoa on schedule, and took up station 100 miles north of the islands. For five days, she steamed east to west and back again, her planes searching northwest for any sign of the Japanese, and south for Yorktown and the transports, which arrived on January 23. The 5000 Marines were all safely ashore the next day, and on January 25, the two carrier task forces set course to the northwest, toward the Marshall Islands, 1600 miles away….

On January 29, Yorktown, Enterprise, and their respective task forces parted ways, and early the next morning swept across the International Date Line into January 31. With less than 24 hours remaining before their first offensive mission of the war, the men of Enterprise and her Air Group prepared. Fighting Six installed homemade armor - literally made of boilerplate - behind the seat of each Wildcat, a vital if weighty addition their Japanese counterparts would never consider. Halsey ordered each ship rigged for towing and for being towed, not wanting to waste a minute should any ship need help escaping after the raid. Navigators and airmen poured over aged maps, picking out reefs and targets. At 1830, Task Force 8 began its final run-in to the launching point, the ocean waves hissing past hulls at 30 knots, each of Enterprise's four 13-ton propellers revolving 275 times a minute….

The first missions were timed to reach their targets throughout the northern Marshall Islands simultaneously, just before 0700: the same time that Spruance's cruiser force was to commence bombardment of Wotje and Taroa. At 0430, Enterprise turned into the wind. Thirteen minutes later, six F4F Wildcats roared into the black night for Combat Air Patrol, followed immediately 36 Scouting Six and Bombing Six SBDs…. Just after 0500, a second strike of nine TBD Devastators from Torpedo Six, and an SBD delayed by engine trouble…. These 46 planes formed up in the dark - no easy task - and headed for Kwajalein Atoll, 155 miles away. At 0610, still nearly an hour before sunrise, twelve Fighting Six Wildcats were launched for Wotje and Taroa. One Wildcat pilot, ENS David W. Criswell, apparently became disoriented in the dark. His plane stalled shortly after takeoff and plunged into the sea: Criswell was never found. Considering the limited training given pilots in night operations before the war, it's remarkable there weren't further mishaps….

[I]t fell to LT James S. Gray and his flight of five Wildcats to stir up the Marshall's real hotspot: Taroa. Shortly before 0700, Gray and his wingman, LT(jg) Wilmer Rawie, mistakenly bombed the unoccupied island of Tjan, which Gray had misidentified as Taroa. Somewhat chagrined, Gray roared away to the southeast, stringing out the other Wildcats in a long, thin line, as they scrambled to keep up. Fifteen miles from Tjan, they found their target. Expecting to find a lightly-defended seaplane base, as intelligence reports had suggested, Gray and his flight were thrilled and alarmed to behold a fully operational airfield, two new mile-long runways and an ample complement of warplanes. Barely 100 miles southeast of the Big E, Taroa was a genuine threat, and its defenders were wide awake. Streaking in from 8,000 feet, the Wildcats targeted the island's small navy yard and airfield with their remaining 100 lb bombs, then swung back around to deliberately strafe the neat rows of planes parked on the airfield, including an estimated 30-40 twin-engine bombers. With no incendiary shells, the fighters were able to set only one parked plane on fire, but rendered many others inoperable, an accomplishment that would prove of vital importance later in the day….

Taking remarkable risks, the Taroa's ground crews and airmen scrambled six more fighters into the air despite Fighting Six's repeated strafing runs. As these fighters came to grips with Gray's Wildcats, a flaw which had plagued the F4F's guns for months came into play. One by one, the .50-caliber guns jammed: all four of Rawie's guns jammed on his second pass over the airfield, ENS Ralph Rich's failed him as well, and both pilots soon turned for home, along with two other VF-6 airmen in similar straits. Unintentionally, they left LT Gray behind, who soon found himself the center of attention for Taroa's angry fighters. Outmatched by the more maneuverable Japanese planes, Gray struggled to break free, turning into and firing his one operating gun at each Claude as it streaked by. By 0720, Gray was finally in the clear and on his way home, his plane sporting over thirty holes and numerous dents in the seat armor installed just a day earlier.

With Fighting Six's retirement from Wotje and Taroa, Spruance's bombardment force - which had been observing the aerial action over the atolls - went to work….

Aboard Enterprise, Halsey and his staff interrogated the returning pilots, beginning with Rawie who returned at about 0800, and quickly singled out Taroa as deserving of additional strikes. By this time, LCDR Lance Massey was well on his way to Kwajalein with nine torpedo-laden Devastators, to follow up on the earlier attacks on shipping there. With most of VF-6 now needed for Combat Air Patrol, Bombing and Scouting Six were called on to continue the attack.

As she did twenty-one other times during the raid, Enterprise turned into the easterly wind at about 0930 to launch planes….

At 1030, a third strike against the beleaguered atoll rumbled down Enterprise's flight deck. Led by Bombing Six's Richard Best, the SBDs finished the job Hollingsworth's had started, wrecking a radio tower, fuel tanks, and airfield installations. Taroa's fighters lashed out, engaging two of Best's SBDs in sustained aerial combat, and finally cornering the last SBD in formation, flown by ENS John Doherty. The Dauntlesses could claim two Claudes, but Doherty and his gunner AOM 3/c Will Hunt failed to return. Taroa, it was believed, was in ruins.

With the return of Best's strike, and a second strike against Wotje led by Air Group Commander Young, the Big E began retiring from the Marshalls, or, as it was colorfully referred to in some quarters, "hauling ass with Halsey". Having operated for nearly ten hours in a narrow rectangle of ocean in range of several enemy airfields, sometimes even in sight of Wotje itself, Halsey had stretched his luck as far as he dared, which was far indeed. Enterprise left the area much as she had arrived, racing north at 30 knots….

A little past 1330, there was again confusion when a bogey appeared on Enterprise's radar, closing range rapidly. This time, however, the planes were not friendly: from Taroa's battered airfield, five big twin-engined Type 96 "Nell" bombers bore down on the island's tormentor.

Four VF-6 Wildcats made contact with the bombers 15 miles from the Big E, but jammed guns and cloud cover allowed the Nells to elude the CAP. Approaching in a shallow dive, the bombers burst from the clouds 3500 yards off Enterprise's starboard bow, hurtling towards their target at 250 knots. Every five inch gun that could be brought to bear opened fire, but the gunners' inexperience, the stress of battle and the high speed of the approaching planes led to the shells trailing their target, where they were of more danger to the CAP than to the enemy…. Recovering from their dive a scant 1500 feet above the Big E's flight deck, four of the five bombers sped away, but the fifth plane - piloted by the flight leader LT Kazuo Nakai - turned sharply to the left and circled back towards the carrier as if to land. Despite the combined fire of every gun that could bear, the plane kept coming on, clearly intending to crash into the ship. At the last moment, Enterprise veered hard to the right, and the plane - whether due to mechanical damage or an incapacitated pilot - failed to match her turn….

A little scuffed up from the attack, Enterprise and her escorts returned to their course and made away from Taroa at high speed, under the protection of a wary CAP….

Enterprise and Task Force 8 returned to Pearl Harbor on February 5, receiving a far different welcome than they'd been given in the wake of the December 7 attack….

[I]t became evident that the damage inflicted during the raid fell short of initial estimates, not to mention newspaper reports which trumpeted the raid as a Japanese Pearl Harbor. Nonetheless, Enterprise's Air Group packed a punch. At Kwajalein, one transport and two smaller vessels were sunk, and another eight ships damaged, roughly half the number originally reported sunk. Nine planes were destroyed on the ground at Taroa and Roi, and three Claudes shot down over the atolls, at the cost of one VF-6 Wildcat and five SBDs. Numerous installations were destroyed throughout the northern Marshalls.

The real significance of the raid was not found on the balance sheet of damage inflicted and suffered, but in the lessons learned. Halsey's action report repeatedly notes the poor performance of the ship's anti-aircraft batteries, stating:

The inability of the 5" AA battery to knock down the formation of enemy twin-engine bombers ... is a matter of grave concern. ... AA Gunnery Practices [should] be scheduled when opportunity offers, with ship steaming at not less than 25 knots. If adequate safeguards can be introduced, ship should be required to make radical changes of course.

In their first encounter with their Japanese counterparts, the Air Group came away less than impressed, noting the Japanese fighters seemed easily discouraged when faced with two or three SBDs working together defensively. Both the Air Group and the ship's company gained valuable combat experience, making them much better prepared for the carrier-vs-carrier brawls that would mark the late spring and fall of 1942. And though hardly enough to stall the Japanese offensive, the raid served notice to both sides that the striking arm of the U.S. Navy was not lying broken on Pearl Harbor's muddy bottom.

"This self-questioning produced at least one work of unsurpassed brilliance, Marc Bloch’s Étrange Défaite. France’s most distinguished historian, a reserve officer (the oldest in the French army) who volunteered for service in 1939, Bloch recorded his testimony in 1940; it was only published after the war, by which time its author, an active member of the Resistance, had been shot by the Germans. All subsequent commentators on 1940, including Ernest May, the most recent historian of the battle, pay due homage to Bloch’s essay, describing their own efforts as a mere footnote or amendment to his penetrating analysis. They are right to do so, for Bloch sketched out what is still the conventional explanation of the French disaster."

--Tony Judt, Reappraisals: Reflections on the Forgotten Twentieth Century