May 5, 2016Lip Service
May 4, 2016The Keynesian Model is not a Big Government or Small Government Model
May 4, 2016The Keynesian model is not a "big government" model
May 3, 2016The End of British Coal
May 3, 2016Lucas on Keynes and "spending flows"
May 3, 2016Exploring the Place Premium
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Bryan Caplan, David Henderson, Alberto Mingardi, and Scott Sumner, with guest blogger Emily Skarbek, blog on issues and insights in economics.
MAY 5, 2016
Individualists such as myself are often accused of being psychologically oblivious. Look around! The vast majority of human beings crave community and belonging. Social thinkers who refuse to account for this obvious fact may be smart and articulate. But they don't know what they're talking about.
I agree that most individualists are psychologically oblivious. But so is almost everyone. The problem is not individualists, but psychology. The replication crisis notwithstanding, psychology is a tough and subtle subject. We can't directly observe anyone's psychology but our own - and our self-descriptions are corrupted by our desire to impress others. Each person's intimate familiarity with his own psychology helps, but also misleads because we're so quick to generalize from our person to all mankind.
Assertions about humans' intense craving for community and belonging are a case in point. The surface problem: The humans who energetically defend these claims tend to be exceptionally communitarian. That's why they're so outspoken on the topic. The fundamental problem, though, is that "community" and "belonging" sound good, leading to rampant lip service.
How can I say that? By noting the stark contrast between how much people say they care about community, and how lackadaisically they try to fulfill their announced desire. I've long been shocked by the fraction of people who call themselves "religious" who can't even bother to attend a weekly ceremony or speak a daily prayer. But religious devotion is fervent compared to secular communitarian devotion. How many self-styled communitarians have the energy to attend a weekly patriotic or ethnic meeting? To spend a few hours a week watching patriotic or ethnically-themed television and movies? To utter a daily toast to their nation or people? Indeed, only a tiny percentage of people who claim to love community find the time for communitarian slacktivism.
You could argue that coordination costs explain the curious shortage of intentional communities. But nothing stops secular communitarians from matching the time commitment of suburban Catholics. Well, nothing but their own apathy.
The lesson: While individualists do tend to neglect mankind's craving for community, they err on the side of truth. Actions really do speak louder than words. And actions reveal that people are far less communitarian than they claim.
MAY 4, 2016
Co-blogger Scott Sumner has written an excellent post this morning pointing out that the Keynesian model per se is not a big government model. He is right, for the reasons he gives.
When the late Ben Rogge came to give a talk at the University of Winnipeg in the winter of 1969, I asked him if there were any non-big-government Keynesians. He named one: David McCord Wright. Isn't it striking that he named one rather than saying, "Oh, yes, there are a lot of them."
Then, when I first learned the Keynesian model later that year in my one undergraduate course at the University of Winnipeg, I came to the same conclusion as Scott: If the government raises taxes during booms and lowers them during busts, or decreases government spending during booms and reduces government spending during busts, there is no built-in growth of government from following the policy implications of the Keynesian model. Nevertheless, even then I noticed that the Keynesians who wrote my textbook--Paul Samuelson and Canadian economist Anthony Scott--seemed to be big-government people. When I started looking around, I noticed that most Keynesians were big-government people.
Why was that? I think it was because they were big-government people anyway and they could use the Keynesian model, quite consistently with no sleight-of-hand, to advocate tax increases during booms and government spending increases during busts. I hasten to add that I'm not accusing them of any kind of dishonesty. They honestly believed in big government and, with that belief, it came naturally to them to advocate as they did.
If you could convince me that it [the Keynesian model] worked in a technical sense, I'd immediately favor tax cuts in recessions and tax increases in booms.
My bottom line would be different from Scott's and it's informed by something Alan Reynolds told me in the mid-1970s:
If you could convince me that it worked in a technical sense, I'd immediately favor tax cuts in recessions and cuts in government spending in booms.
Alan pointed out that that would lead to a small-government bias in Keynesian policy.
CATEGORIES: Fiscal Policy
MAY 4, 2016
[This is a sort of follow-up to my most recent Econlog post.]
Before getting into this post, let me remind you of previous pointless debates, such as whether "Islam" is "really" a this or that sort of religion. I hope my readers can see the pointlessness of those debates. Similarly, I do understand that many Keynesians, and also many anti-Keynesians, think that Keynesianism is a sort of big government ideology, at least when compared to new classical economics, monetarism, Austrianism, etc.
So there is a sense in which the title of this post is wrong. If Keynesians act as if their model has big government implications, then in a sense it does.
So what do I mean by the title of the post? I mean that the technical aspects of the model have no big government implications, and that people who claim otherwise are simply using bad logic. To use the Islam analogy, I'm looking at the Koran. Here's The Economist:
The fundamental reason for Europe's low interest rates and bond yields is the fragility of its economy. Its unemployment rate is stuck at 10%. While the ECB has been doing what it can to press down the accelerator, however, the austerity preached by the likes of the German and Dutch governments has slammed on the brakes. For years, Mr Draghi has been saying that monetary policy alone cannot speed up the economy, and that creditworthy governments must use fiscal policy as well, ideally by raising public investment. If Mr Schäuble wants higher yields for German savers, he should be spending more money. Instead, his government is running a budget surplus.
1. The Keynesian model is wrong, fiscal stimulus is not a good idea. The Economist is flat out wrong when they claim, "the ECB has been doing what it can", that doesn't even pass the laugh test. If they don't know how to do more, then please call me in for an interview and I'll show them.
But in this post I'm not interested in bashing the Keynesian model, and for the rest of the post I'll assume I'm wrong and the Keynesians are right. Fiscal stimulus is needed.
2. Fiscal stimulus does not mean "more spending" as The Economist claims, and as hundreds of other recent news articles claim, it means a bigger budget deficit. I don't think fiscal policy ever makes much sense, but if I were wrong I'd always favor tax rate changes, never spending changes. There are no big government implications from pro-cyclical tax rates.
3. Some claim that spending changes are more powerful, but that's probably wrong, and irrelevant even if it's right. Romer and Romer showed that tax changes had a surprisingly large multiplier effect, which you'd expect due to their supply-side effects. (There's still no agreement as to the relative size of tax and spending multipliers.) Some people oppose tax cuts because they are regressive. But that's also wrong; tax cuts can involve lump sum rebates, as with the 2008 Bush stimulus, or higher EITC, etc. The regressivity or progressivity is totally up to the government.
4. And even if I'm wrong and spending changes have a bigger multiplier effect, you should still never use spending increases. Just make the tax cuts bigger. Spending changes should always reflect classical cost/benefit considerations; they should never be used to boost AD.
5. Some Keynesians argue that government investment is more justified when interest rates are low. I hope by now that everyone sees that as a basic EC101 error, reasoning from a price change. Interest rates are often low precisely because the productivity of new investments is lower than usual.
6. Some Keynesians suggest that more infrastructure can be justified right now on cost/benefit (NPV) considerations. Fine, but don't pretend that that has anything to do with Keynesian stimulus. Even anti-Keynesian economists agree that investments are justified if the
7. And even if everything I said above is totally 100% wrong, I'm still right and the Keynesians and anti-Keynesians are still wrong, Keynesian economics is not inherently a big government model. It doesn't call for bigger government, it calls for more countercyclical government. Thus if under classical assumptions you favored government spending 36% of GDP, with 4% of that infrastructure, a Keynesian who rejected all of my arguments above might favor spending of 34% during booms and 38% during recessions. The infrastructure spending would be 2% of GDP during booms and 6% during recessions. (In practice, other spending is also somewhat countercyclical; I'm just trying to simplify my example.)
So even if everything I said in points 1 through 6 is completely wrong (and they aren't all wrong), the assumption that Keynesianism is a big government model is not based on anything in the model itself, but rather the (false) perception of both Keynesians and anti-Keynesians. What can we infer from this widespread misconception? One possibility is that the model is being misused. Another is that people are confusing battles over the size of government with battles over stimulus. This might explain, for instance, why Paul Krugman favored higher taxes in 2013. He believed that a tax increase would lead, in the long run, to higher spending---which he prefers.
But I would caution readers that there are many more conservative Keynesians than most people assume. When people use the term "Keynesian" they often instinctively think of progressives, but unless I'm mistaken most conservative economists (Mankiw, Feldstein, etc.) also think of macro issues using a Keynesian framework. There is nothing necessarily "big government" about that theoretical framework.
I am a libertarian who dislikes Keynesian economics, but not for "anti-government" reasons. If you could convince me that it worked in a technical sense, I'd immediately favor tax cuts in recessions and tax increases in booms. I'm eager to be converted; I want to be a Keynesian. So show me the evidence.
MAY 3, 2016
I was going through my pile of unread Wall Street Journals over the weekend and found this news story: Scott Patterson, "End of an Era: England Closes Its Last Deep Coal Mine," December 11, 2015.
Here's one key paragraph:
The last deep-pit coal mine in the U.K. plans to shut its doors here next week, heralding the end of a centuries-old industry that helped fuel the industrial revolution and build the British Empire.
The shutdown, targeted for next Friday, represents a victory for advocates of reducing carbon emissions after world leaders gathered in Paris to discuss how to combat global warming, with coal in the cross hairs. It also reflects a glut of energy on world markets, from crude oil to natural gas and coal itself.
As he continues, though, Patterson notes that a large part of the reason, besides the decline in demand for coal, is the availability of cheaper coal imports:
The U.K. already imports most of the coal that fuels its power plants, with imports first surpassing local production in 2001. Russia has been the biggest beneficiary of the U.K.'s increased appetite for imported coal, providing 46% of its thermal coal in 2014, according to the U.K. government. Coal supplies roughly one-third of the energy for electricity generation in the U.K., with natural gas and renewable sources making up the rest.
Students of the history of economic thought will find this interesting because one of the giants in 19th century thinking, one of three contributors to the "Marginal Revolution" of the late 20th century, was Stanley Jevons. Jevons wrote a book called The Coal Question. Here's what I wrote about that book in his bio in The Concise Encyclopedia of Economics:
Jevons put much less thought into the production side of economics. It is ironic, therefore, that he became famous in Britain for his book The Coal Question, in which he wrote that Britain's industrial vitality depended on coal and, therefore, would decline as that resource was exhausted. As coal reserves ran out, he wrote, the price of coal would rise. This would make it feasible for producers to extract coal from poorer or deeper seams. He also argued that America would rise to become an industrial superpower. Although his forecast was right for both Britain and America, and he was right about the incentive to mine more costly seams, he was almost surely wrong that the main factor was the cost of coal. Jevons failed to appreciate the fact that as the price of an energy source rises, entrepreneurs have a strong incentive to invent, develop, and produce alternate sources. In particular, he did not anticipate oil or natural gas. Also, he did not take account of the incentive, as the price of coal rose, to use it more efficiently or to develop technology that brought down the cost of discovering and mining (see natural resources).
Here's what Jevons said in Chapter XIII of The Coal Question, "Of the Export and Import of Coal":
CATEGORIES: Energy, Environment, Resources
MAY 3, 2016
If you rely on bloggers like Paul Krugman and Brad DeLong, you'll end up with a very crude caricature of Robert Lucas's views on macro. The following was from a 2003 Lucas paper (sent to me by Marcus Nunes), which I saw Lucas deliver at Duke University:
The problem is that the new theories, the theories embedded in general equilibrium dynamics of the sort that we know how to use pretty well now--there's a residue of things they don't let us think about. They don't let us think about the U.S. experience in the 1930s or about financial crises and their real consequences in Asia and Latin America. They don't let us think, I don't think, very well about Japan in the 1990s. We may be disillusioned with the Keynesian apparatus for thinking about these things, but it doesn't mean that this replacement apparatus can do it either. It can't. In terms of the theory that researchers are developing as a cumulative body of knowledge--no one has figured out how to take that theory to successful answers to the real effects of monetary instability. Some people just deny that there are real effects of monetary instability, but I think that is just a mistake. I don't think that argument can be sustained. I do think that most of the post-World War II fluctuations of GDP about trend can be accounted for in real terms. I've estimated that would be something on the order of 80 percent. People can argue with that. But that's not because money doesn't matter. That's because monetary policy in the postwar United States has been so good.
Of course "spending flows" are NGDP. I view this as one of the very best summaries of why Keynes was so important. The technical aspects of his model weren't very good, but the overall message was extremely important. Stabilize NGDP.
Unfortunately, the post-WWII Keynesian model didn't do a good job of handling the distinction between NGDP and RGDP. Only now, in the 2010s, are we rediscovering the importance of NGDP---a variable that was mostly ignored for decades, but is actually the key to macroeconomics.
MAY 3, 2016
Clemens, Montenegro, and Pritchett continue to expand the frontiers of human knowledge about migration. Their latest working paper, "Bounding the Price Equivalent of Migration Barriers," mostly measures the total wage effect of globally relocating identical workers. But it closes by weighing the wage effects of immigration restrictions versus all-other-factors-combined.
[I]nformation is available to form reasonable qualitative priors about the fraction of the place premium that arises from policy barriers. To begin with, most people outside the United States are prohibited by default from entering the country and working there unless they acquire a special license from the federal government, a visa. This includes citizens of all 42 countries we study. Such policy barriers have large effects on migration flows... Many U.S. visas are tightly rationed, with waiting periods measured in decades. The United States government spends more on enforcing its immigration restrictions than it spends on all other principal federal law-enforcement agencies combined--including the Federal Bureau of Investigation, the Drug Enforcement Administration, and the Bureau of Alcohol, Tobacco, and Firearms (Meissner et al. 2013, p. 22)... These suggest a reasonable starting prior that the fraction of the wage gap R related to policy is nonzero, even substantial.Not do-able, but:
There do exist territories free of policy barriers that are nevertheless similar in some respects to foreign countries. People from Puerto Rico and Guam hold U.S. citizenship and can live and work at will to any part of the United States. It is illustrative to estimate Rc for these territories.Bottom line: Contrary to friends of immigration restrictions, enforcement is already draconian. Contrary to enemies of immigration restrictions, existing laws "work" in the sense that they drastically reduce migration.
MAY 2, 2016
Yesterday Ilya Somin reminded readers of the Washington Post of his ongoing support for changing May 1st from a celebration of communists, socialists, and labor unions - to a holiday that commemorates the millions who have died because of communist government regimes. Bravo.
Watching from central London, hundreds filled the streets yesterday carrying flags with the hammer and sickle, pictures of Karl Marx, and prints of Che Guevara. Some wore the hats from the Mao Suit. Many chanted "ho, ho, Ho chi minh." These people march in wilful defiance or plain ignorance of the 80 to 100 million dead at the implementation of communism.
If you ask them, they say that the ideas have not been implemented fully, correctly, or that the ideals are important for their own sake. Rubbish.
Peter Boettke has a wonderful saying that sticks with me on this point (he repeats it, I believe, in his discussion on Econtalk about the contributions of Ludwig von Mises): "Humanity did not fall short of the ideals of socialism; socialism fell short of the demands of humanity."
In other words, collective ownership of property cannot live up to the demands of the human species in the extended order of exchange. It's simply not fit for purpose -- if by purpose you mean prosperity and social cooperation under the division of labor. It would be a milestone in social evolution if humanity would learn the appropriate lesson from the terrors and atrocities of past experiments in collectivism.
MAY 2, 2016
But the standard rendition of the B&B [Bootleggers and Baptists] story leaves out something that bootleggers and Baptists need to achieve their goals: emotion. One of the common emotions is anger, and the group whose anger is most important is voters.This is from Dwight R. Lee, "Bootleggers, Baptists, Anger, and Voters," one of two Econlib Feature Articles for May.
In the article, Lee highlights anger as motivation (for voters) and as a tool (for bootleggers and Baptists.)
The B&B metaphor provides a useful way of thinking about how regulations are enacted in response to the political interaction of groups that have different interests and motivations and face different incentives. Smith and Yandle (2014) are to be congratulated for expanding on the insights from Yandle (1983) by creatively applying the B&B logic to a number of recent examples. This article expands those insights further by highlighting the role of voters and adding in anger as an important political motive. All political decision makers are influenced by emotions, but voters are particularly sensitive to emotions, both benevolent and hateful. And as government has increasingly become an arena for negative-sum competition over the distribution of existing wealth, political outrage can be expected to become an even more common influence on government decisions.
MAY 2, 2016
Back on March 11, 2011, Japan was hit by the worst national disaster to strike a developed country in modern times. Last week, Japan was hit by a human made disaster with a comparable effect on the economy (albeit obviously not in terms of human life). I don't expect many people will agree, but consider the following news report from March 2011:
The rash of buying of Japanese stocks came after the country's benchmark Nikkei 225 index, the equivalent to the Dow Jones industrial average, fell 16 percent over two days in panic-driven selling, reaching its lowest level since the 2008 financial crisis. The index bounced back nearly as quickly, jumping 5.6 percent on March 16 and 4.3 percent on March 22. The index is now down 7.8 percent since the earthquake.Japan's stocks fell a bit over 6% on the first trading day after the earthquake. As the severity of the quake became clearer, stocks plunged as much as 16%. Then, when it became clear the worst case of nuclear disaster would not occur, stocks recovered so that by March 22 they were only down around 7.8%. (AFAIK they leveled off around there, someone correct me if I'm wrong.)
During recent years, major Japanese stock indices have been closely correlated with the forex value of the yen. Late last week, Japan was hit by a yen earthquake, a sharp appreciation in the yen:
The next question is what caused the stronger yen late last week. It's pretty clear that the initial surge in the yen was due to the Bank of Japan's unexpected decision not to cut the interest rate on reserves to an even more negative level. I don't know what caused the further appreciation the next day, but suspect it was related to hawkish statements from government officials, or at least a lack of reassuring statements on the need for more monetary stimulus. If any of my Japanese readers have any information, I would greatly appreciate hearing it.
To summarize, a strong yen that was at least partly triggered by bad monetary policy, can be just as destructive as the worst natural disaster to hit a developed country in modern times. And it's all so unnecessary.
PS. On the other hand, if you rely on the financial press, you might assume the decision not to cut IOR further into negative territory was good news for Japan.
CATEGORIES: International Macroeconomics: Exchange Rates, International Debt, etc. , Macroeconomics , Monetary Policy
MAY 2, 2016
Donald Trump has wildly exceeded electoral expectations at every stage of the election. But betting markets still say he has but a 20% chance of winning the presidency. Isn't Trump's record of success after success strong evidence that he's far more popular than normal measures suggest? Most obviously, couldn't there be preference falsification at work on a mass scale?
Maybe, but there's a simpler story. Trump has an enviable track record in the Republican primaries. But hardly anyone votes in those primaries! His victories notwithstanding, most of Trump's victories were backed by less than 10% of registered voters. These results from late March omit the latest primaries, but still show the big picture.
Of course, the same goes for every primary candidate. Hillary too has received few actual votes so far. The key distinction: For well-established candidates, we have prior measures of their national appeal. Not so for Trump. Each of his victories has confirmed his unexpectedly strong appeal to politically active Republicans; it's no fluke. But he's yet to demonstrate appeal to a broader audience, so betting markets remain the smart bet.
Disagree? I'm happy to bet against Trump at even odds with my usual interface.
MAY 1, 2016
In my post on the late Lester Thurow on April 15, I promised to post more from his book The Zero-Sum Society. Here are some further excerpts.
Thurow as Ludwig von Mises
Proposition VII: Regulation Leads to Regulation
I disagree with "have to" and "forced us," but otherwise he's spot on.
On the unfairness of price controls:
But there is also a question of equity involved. Price controls can only stop real income reductions by stopping real income increases for someone else. To hold down the price of natural gas or rents it is necessary to hold down someone's income. Let's suppose that we have decided to cushion the income shocks of market-priced natural gas or rents. This leads to the question of what is the fair way to raise the necessary revenue. Should we all have to pay through general taxation or is it fair to levy a tax on the owners of natural gas or apartments? They may be richer than the average consumer, but there also are many other even richer people who do not own natural gas or apartments. Why should they be excused from paying?
On the postal monopoly:
Since postal rates have been set at a level far above the cost of delivering much of the mail, regulations must be issued and enforced thereby stopping others from going into the first-class mail business. We are all familiar with the news story of the post office suing to stop some child from delivering local mail, but the purpose is to stop real competition. The result is a situation where the post office and postal workers have little or no incentive to cut mail delivery costs. As we have recently witnessed, this is true regardless of whether the post office is organized as a government department or as a profit-making corporation. Utilities, industrial mailing firms, and others would undoubtedly do to first-class rates what United Parcel and others have done to parcel post if given a chance. Undoubtedly there are routes in the United States that could not be competitively serviced with fifteen-cent letters. [DRH note: remember that Thurow was writing in 1979.] But if low-price mail deliveries are a national goal, then we ought to finance this goal nationally and not levy a tax on those who should be getting cheap mail deliveries because they live in places where mail can be delivered cheaply.
APRIL 30, 2016
But isn't SoFi cherry-picking loans? Absolutely. Why can't banks do this? Because if you use depositor money for loans, as all banks do, you fall under the jurisdiction of the Federal Deposit Insurance Corp. and the Community Reinvestment Act, which bans discriminatory credit practices against low-income areas, known as redlining. In exchange, banks use leverage, but that's courting trouble.This is from Andy Kessler, "The Uberization of Banking," Wall Street Journal, April 29, 2016 (the Saturday/Sunday issue of the WSJ for those who get the print version.)
The whole thing is worth reading, as is John Cochrane's "Equity-Financed Banking," which called my attention to the WSJ piece.
Cochrane summarizes succinctly:
Yes, bank "safety" regulations demand that banks purposely lend to people that one can pretty clearly see will not pay it back, and demand that they do not lend money to people that one can pretty clearly see will pay it back.
Back to Kessler:
SoFi doesn't take deposits, so it's FDIC-free. The firm isn't a bank, at least in that sense of the word. Instead, SoFi raises money for its loans, most recently $1 billion from SoftBank and the hedge fund Third Point, in exchange for about a quarter of the company. SoFi uses this expanded balance sheet to make loans and then securitize many of them to sell them off to investors so it can make more loans.
But watch out for the regulators:
Rather than by the FDIC, SoFi is monitored by the Consumer Financial Protection Bureau. The overbearing regulator that was Elizabeth Warren's brainchild thus far hasn't come down on SoFi--the CFPB is perhaps too preoccupied with using "disparate impact" analysis of old-school auto-loan businesses to focus on a relatively exotic, app-based form of banking. But Mr. Cagney should watch his back.
Cochrane points out one huge systemic advantage of this form of banking:
Since it makes no fixed-value promises, this structure is essentially run free and can't cause or contribute to a financial crisis.
In 2012, candidate Mitt Romney said that starting banks in garages was a bad idea. I challenged him on John Stossel's show. SoFi is coming awfully close.
BTW, I can't find the Stossel show on line any more. If someone can find a link, I would be most grateful, to the tune of $40. (First one who comes through with something I can download gets the money.)
APRIL 30, 2016
I have just come across a nice two part documentary on Adam Smith available at Free to Choose TV. The videos give those unfamiliar with Smith's thought a good introduction to his life and work in both the Theory of Moral Sentiments and the Wealth of Nations.
There were several points that I found particularly appealing in this treatment. First, Nicholas Phillipson, author of Adam Smith: An Enlightened Life, points out exchange behavior was at the very core of Smith's reasoning about both morality and the division of labor. It is operative in Smith's mechanism of how moral rules emerge and are shaped in society, the impartial spectator. And, of course, it is central in understanding the division of labor.
This division of labour, from which so many advantages are derived, is not originally the effect of any human wisdom, which foresees and intends that general opulence to which it gives occasion. It is the necessary, though very slow and gradual, consequence of a certain propensity in human nature which has in view no such extensive utility; the propensity to truck, barter, and exchange one thing for another. - WN I.2.1
Similarly, the video emphasizes that economics was embedded in Smith's thinking about moral philosophy, justice, and institutions. This is important, as it helps to correct the mistaken notion that Smith's work on morality in TMS was wholly disconnected from his ideas concerning how free markets generate widespread prosperity in WN. The former concerns the operative principles governing the intimate order, the latter the principles governing the extended order of exchange. For an excellent piece on Smith's ideas concerning the moralizing role of commerce, see this paper by Maria Pia Paganelli published in the History of Political Economy in 2010.
Second, the video makes it clear that a central concern for Smith was improving the conditions of the poor. This is a legacy of Smithian political economy that is all too often shadowed by the crude caricature of Smith's invisible hand. Moreover, the discussion highlights Smith's opposition to government grants of privilege and how he condemned the East India Company for its operation as a government sponsored monopoly.
Finally, what comes across so clearly is just how revolutionary the ideas of the Scottish Enlightenment were at the time and how foundation these ideas are to contemporary liberalism and economics. Eamonn Butler, of the Adam Smith Institute, talks about how Smith's evolutionary view of language, institutions, morality, and the market preceded Darwin by roughly a hundred years. Overall, it is a good resource for introducing people to the life and mind of Adam Smith.
CATEGORIES: Political Economy
APRIL 30, 2016
In my book entitled The Midas Paradox, I argued that FDR's NIRA wage program set back economic recovery by almost 2 years. Prior to the wage increase, industrial production had surged by 57% in 4 months, mostly due to the stimulative effects of dollar devaluation. After July 1933, however, hourly wages surged by over 20% in just 2 months, despite nearly 25% unemployment. As a result, industrial production started falling, and did not reach July 1933 levels for another two years. I also documented four other wage shocks during the New Deal, each of which led to a pause in growth.
Other researchers, such as Gauti Eggertsson and Paul Krugman have argued for a "paradox of toil", where at the zero wage bound an artificial attempt to force wages higher may actually be expansionary. (I emphasize "may"; Eggertsson and Krugman were prudently cautious on this claim.) The idea is that this sort of policy can boost inflation expectations, and hence reduce real interest rates.
In my view inflation doesn't matter, what matters is expected NGDP growth. Artificial attempts to raise wages do not boost expected NGDP growth. Instead, as nominal hourly wages rise (for any given level of NGDP), hours worked fall.
Vaidas Urba sent me a new NBER study, by Jérémie Cohen-Setton, Joshua K. Hausman, and Johannes F. Wieland, which confirms my view of wage shocks:
The effects of supply-side policies in depressed economies are controversial. We shed light on this debate using evidence from France in the 1930s. In 1936, France departed from the gold standard and implemented mandatory wage increases and hours restrictions. Deflation ended but output stagnated. We present time-series and cross-sectional evidence that these supply-side policies, in particular the 40-hour law, contributed to French stagflation. These results are inconsistent both with the standard one-sector new Keynesian model and with a medium scale, multi-sector model calibrated to match our cross-sectional estimates. We conclude that the new Keynesian model is a poor guide to the effects of supply-side shocks in depressed economies.In The Midas Paradox I did mention the French experiment, and speculated that it provided another example of the contractionary effects of artificial attempts to raise wages. However, I did no formal empirical study of that episode.
I've recently argued that the simple AS/AD model is superior to more sophisticated new Keynesian models with upward sloping AD curves. It's good to see another confirmation of the workhorse AS/AD model.
APRIL 29, 2016
The headlines are alarming. The New York Times panicked that Americans are "Running in Debt" and just a few years later warned that Americans were "Borrowing Trouble." Business Week asked, "Is the Country Swamped with Debt?" and U.S. News and World Report worried that "Never Have So Many Owed So Much." Harper's even expressed fear that "Debt Threatens Democracy."
This is from Todd Zywicki, "America's Debt Paranoia," The Freeman, September 23, 2009. The whole article is excellent. Somehow I missed it at the time.
If you ask economists to explain this state of affairs, they are likely to finger credit-card debt as a main culprit. Long before the Great Recession, many say, Americans got themselves into credit trouble. According to an analysis of Federal Reserve and TransUnion data by the personal-finance site ValuePenguin, credit-card debt stood at about $5,700 per household in 2015. Of course, this figure factors in all the households with a balance of zero. About 38 percent of households carried some debt, according to the analysis, and among those, the average was more than $15,000. In recent years, while the number of people holding credit-card debt has been decreasing, the average debt for those households carrying a balance has been on the rise.
Todd takes issue with that. It's true that getting rid of price controls on interest rates (usury laws) made it easier to get into debt. Thank goodness for that court decision. When I was 22 and had just moved from Canada to "the States," I applied to Visa for a $250-limit credit card, I was turned down. I didn't know the reason at the time, but now I do: California's usury ceiling combined with my completely absent credit history. But, as Todd points out, credit cards caused people to alter the form of debt. There was not a huge increase in debt overall. Zywicki writes:
Consumer debt exploded in the 1940s and 1950s during the postwar migration to the suburbs as consumers used credit to buy new cars and to fill their new homes with new furniture and appliances. The ratio of consumer credit to household assets rose from about 1 percent to over 3 percent from 1945 to 1960, where it has hovered ever since.
Russ Roberts interviewed Todd Zywicki about this in 2009 on Econtalk.
APRIL 29, 2016
Like all useful tools, cost-benefit analysis is flawed. After surveying cost-benefit analyses of global warming and warming abatement, Ron Bailey's The End of Doom turns to methodological objections. From his section on "How Much to Insure Against Low Probability Catastrophic Warming?":
How much should we pay to prevent the tiny probability of human civilization collapsing? That is the question at the center of an esoteric debate over the application of cost-benefit analysis to man-mind climate change. Harvard University economist Martin Weitzman raised the issue by putting forth a Dismal Theorem arguing that some consequences, however unlikely, would be so disastrous that cost-benefit analysis should not apply.Deja vu. Bailey's Nordhaus digest continues:
Weitzman's analysis also assumes that humanity will not have the time to learn about any impending catastrophic impacts from global warming. But midcourse corrections are possible with climate change...Bailey closes with a spot-on challenge:
Why has no one ever applied a Dismal Theorem analysis to evaluate the nonzero probability that bad government policy will cause a civilization-wrecking catastrophe?I fear climate activists will dismiss Bailey's challenge as a debating trick. But I see no way around it.
P.S. Anything important Bailey's treatment misses on methodological objection to cost-benefit analysis? If so, please share contrary sources in the comments.
CATEGORIES: Behavioral Economics and Rationality , Cost-benefit Analysis , Economic Methods , Energy, Environment, Resources
APRIL 28, 2016
Earlier this month, I read two articles that were somewhat eye-opening to me about various Americans' views and actions on income, spending, and saving.
One, which got a lot of play, was Neil Gabler's piece in The Atlantic, "The Secret Shame of Middle-Class Americans," about how badly he has done financially despite a relatively healthy income: he never gives the income number and so it's hard to say. The other is a set of interviews by David Walters in Esquire. Walters, in "4 Men with 4 Very Different Incomes Open Up About the Lives They Can Afford," interviews 4 people whose annual incomes, respectively, are $1 million, $250K, $53K, and about $20K. He asks about their incomes, spending, etc.
One surprising thing in the Gabler piece was this:
the study by Lusardi, Tufano, and Schneider found that nearly one-quarter of households making $100,000 to $150,000 a year claim not to be able to raise $2,000 in a month.
Who knows if it's true? But even the reasonable probability that it might be true was surprising.
By the way, if not for the credit line on my house, there would be some months in the year--probably at least 6--in which I could not raise $2,000 quickly. I would have to not pay off one or two credit cards. So you could argue that I'm one of those people who lives paycheck to paycheck.
Although that's literally true, it misses the fact that my wife and I save about $30K or so a year and have done so in most years since about 1995, except when my daughter was in college. (Those years, we saved "only" about $15K.) We do it, though, in 403(b)s, SEP-IRAs, and Roth IRAs. In other words, it's all tax-sheltered. That's why we live paycheck to paycheck.
But that's not Neal Gabler's problem. He really did make bad decision after bad decision. Refreshingly, he's not asking for sympathy or blaming anyone else. I did get the impression, though, that he still doesn't realize just how bad some of his decisions were.
Try this from Gabler:
And then, on top of it all, came the biggest shock, though one not unanticipated: college. Because I made too much money for the girls to get more than meager scholarships, but too little money to afford to pay for their educations in full, and because--another choice--we believed they had earned the right to attend good universities, universities of their choice, we found ourselves in a financial vortex. (I am not saying that universities are extortionists, but ... universities are extortionists. One daughter's college told me that because I could pay my mortgage, I could afford her tuition.) In the end, my parents wound up covering most of the cost of the girls' educations. We couldn't have done it any other way. Although I don't have any regrets about that choice--one daughter went to Stanford, was a Rhodes Scholar, and is now at Harvard Medical School; the other went to Emory, joined WorldTeach and then AmeriCorps, got a master's degree from the University of Texas, and became a licensed clinical social worker specializing in traumatized children--paying that tariff meant there would be no inheritance when my parents passed on. It meant that we had depleted not only our own small savings, but my parents' as well.
The most telling part of that paragraph? The term "earned the right." Really? Just because your daughters were your daughters and, presumably, had done well in high school, they earned the right to go to Stanford and Emory?
Megan McArdle, in an excellent piece on Gabler's piece, responds:
Untold generations of human beings have lived to adulthood without the blessings of a brand-new minivan, a travel soccer trophy or a Harvard education. Modern children raised without them will probably also be fine.
Here's another stunning Gabler decision:
We have no retirement savings, because we emptied a small 401(k) to pay for our younger daughter's wedding.
Now to the Walters interviews. First, I think Walters should have probed a little more. Maybe he did but didn't report it.
But consider this question he asked: "Looking at your current career prospects, how much money do you think you'll be earning in ten years' time?"
Not one of the 4 men interviewed answered it. The guy making $1 million a year stated a net worth goal but didn't answer what he thought his income would be. The guy making $250K a year stated an income goal but didn't say that he thought that's what his income would be. The guy making $20K also stated an income goal, an ambitious one that made me wonder.
At least they stated a goal.
The guy making $53K a year stated a wish.
The overall impression I get from the Gabler piece and parts of the Walters interviews is that many people just aren't willing to think clearly about their financial lives. I'm blessed because I had so little growing up that I learned to appreciate ads on TV for various things for the dreams I could have about them: it didn't even occur to me to buy them. I couldn't. That carried over to my adulthood. I love going to car dealers and looking at the cars. I buy a car once a decade. My motto has been to live below my means and invest in index funds. It has worked.
APRIL 28, 2016
About 2 years ago, I predicted that 3% NGDP growth was the new normal. At the time, the Fed predicted significantly higher trend growth (both RGDP and NGDP.)
The Fed has a big NGDP problem. It's becoming increasingly clear that when the labor market recovers, RGDP growth will be very slow, maybe 1.2%. Add in about 1.8% on the GDP deflator, and 3% NGDP growth looks like the new normal, assuming the Fed intends to stick with 2% PCE inflation targeting. Bill Woolsey wins!!With today's figures, it is now pretty clear that I was right and the Fed was wrong.
(This has been repeatedly true of one issue after another, over the past 8 years. For instance, in December I predicted the Fed would raise interest rates in 2016 fewer than the 4 times they were predicting.)
To estimate the rate of trend growth in real GDP, you need to go back to a period where the labor market was approximately in equilibrium. In the 1st quarter of 2008, the unemployment rate averaged 5.0%. In the first quarter of 2016, the unemployment rate averaged 4.97%, virtually identical to 2008:1. The growth rate in RGDP over that 8 year period was 1.286%/year, just slightly above the 1.2% rate I estimated as the trend rate. And with labor force growth now slowing due to boomer retirements, I expect RGDP growth to slow a bit further, to 1.2% as the new normal.
Why was I able to see something the Fed missed? Because I don't rely on past values of trend growth as being stable. In 2008 and 2009, the Fed erred by assuming that the natural interest rate was higher than it actually was. The performance of the economy was telling us that the Wicksellian equilibrium rate had fallen sharply, but the Fed simply refused to believe it. These low rates were inconsistent with decades of experience. The Fed assumed we'd eventually get back to normal, although now it's becoming increasingly clear that low rates are the new normal.
Conclusion: Listen to the markets.
The same occurred with trend RGDP growth. For well over 100 years, America has averaged roughly 3% per year in trend RGDP growth. Thus the Fed assumed the economy would return to this growth path, after the recession. In fact, we are not doing so---we are in a "Great Stagnation" that (AFAIK) has no precedent in all of American history. Even the 1930s were totally different, as productivity growth was high and RGDP growth bounced back once the unemployment rate fell. But now we have unemployment having fallen all the way to 5%, and growth is still 1.29% over 8 years.
I first saw this coming back in 2011, because I noticed that we had a "job-filled non-recovery" not the jobless recovery postulated in the media. That is, the unemployment rate was falling quickly, but output growth remained well below 3%. Normally, growth is well above trend when unemployment is falling fast. That told me that RGDP trend growth had slowed sharply.
So should the Fed fire all their economists and hire me? Yes. But an even better solution is to fire all their economists and hire someone like Robin Hanson or Justin Wolfers to set up prediction markets for macro variables. Stop relying on government bureaucrats to predict the economy, and instead rely on the wisdom of crowds.
PS. Was the slow growth in Q1 (1.2% annual rate for NGDP) caused by the Fed's decision to tighten policy in late 2015? Probably, at least in part.
APRIL 28, 2016
Mario Vargas Llosa has recently turned 80: his birthday was saluted with a great celebration in Madrid, with a two-days conference organised by the Fundacion Internacional Libertad. Vargas Llosa gave a splendid speech at his birthday dinner, along the lines of this article run by El Pais.
Many of the guests were paying their tribute to Vargas Llosa as an icon of classical liberalism in politics. The story is well known. In 1987, when the President of Peru, Alan García, was aiming at the nationalisation of the financial sector, Vargas Llosa published a forceful manifesto against García's ill-advised policies. He understood well that by controlling banks and insurance the government would have increase it stronghold on the Peruvian economy. It begun as a statement by the country's best known intellectual, but it soon evolved into a political movement, Movimiento Libertad, which got close to have Vargas Llosa elected President. He lost in the second ballot against Alberto Fujimori, whose drift towards authoritarianism Vargas Llosa opposed right from the beginning. Incidentally, the runoff for this year's presidential election in Peru will be held next June 5th, and will see Keiko Fujimori, the daughter of the former president, confronting the liberal technocrat Pedro Pablo Kaczynski.
Mario Vargas Llosa is then a most rare figure: a major character of the literary scene, indeed one of the masters of writing in our time, who also had a political interlude--perhaps unsuccessful, as far as the poll results were concerned, but which inspired many.
I was particularly impressed by the essay of Carlos Rodriguez Braun, who used a splendid novel by Vargas Llosa, "El paraíso en la otra esquina" (The Way to Paradise, 2003) to share his thoughts about populism. The novel is based on the parallel lives of Paul Gaugin and his grandmother, Flora Tristan. Tristan was an "Utopian socialist", Gaugin looked for his own Utopia down under, they both looked for something else than the imperfect and yet perfectible bourgeois society of their times.
Rodriguez Braun sees much in common between utopianism and what we call today "populism." They are both rejection of that free society that, he writes "is founded upon modesty concerning the existence of any historical law, on the community of interest of free women and men, on realism over the nature of politics and on the respect of the individual in a liberal democracy". Cutting to the chase: on the impossibility of building heaven on earth.
The richness and diversity of human experience militates against this tendency to oversimplify social reality, for the sake of selling snake oil. As such, a novelist of the complexity of Mario Vargas Llosa, who has spent his own life telling stories and exploring the hearts of women and men, is the best prescription against populism, precisely by means of his novels.
CATEGORIES: Books: Reviews and Suggested Readings
APRIL 28, 2016
I learned Austrian economics over a year before I started learning regular economics. The Austrians taught me to stonewall all cost-benefit analysis with methodological objections. It took me years to see the emptiness of their approach. Cost-benefit analysis is imperfect, but so is every performance measure. We learn a lot more about policy effectiveness if we carefully measure costs and benefits, then reflect on potentially serious flaws, than if we refuse to play the cost-benefit game.
Partly as a result of this experience, I am deeply suspicious when the proponents of any policy dodge requests for cost-benefit analysis. I know cost-benefit analysis isn't everything. But if I request estimates of net benefits, and you respond with methodological scolding, I hold it against you. Indeed, I summarily reduce my estimate of the net benefits of your policy proposal. After all, if cost-benefit analysis were on your side, you'd probably answer my question instead of questioning my question. Case in point: I asked Yoram Bauman, author of The Cartoon Introduction to Climate Change, to "review the point estimates and confidence intervals" for cost-benefit studies of global warming. Instead of satisfying my curiosity, he alluded to four methodological problems with cost-benefit analysis. This heightened my suspicion that cost-benefit analysis views climate inaction much more favorably than mainstream thinkers allow.
In sharp contrast, Ron Bailey's new The End of Doom: Environmental Renewal in the Twenty-first Century, gave me just what I wanted: A readable summary of cost-benefit estimates. Highlights from the section on "How Much Will Global Warming Cost?":
The IPCC reports offer cost estimates for both adaptation and mitigation. The 2014 Adaptation report reckons, assuming that the world takes no steps to deal with climate change, that "global annual economic losses for additional temperature increases of around 2°C are between 0.2 and 2.0 percent of income." The report adds, "Losses are more likely than not to be greater, rather than smaller, than this range."Followup work:
In his 2013 book The Climate Casino... Nordhaus notes that a survey of studies that try to estimate the aggregated damages that climate change might inflict at 2.5° comes in at an average of about 1.5 percent of global output. The highest climate damage estimate Nordhaus cites is a 5 percent reduction in income. The much criticized 2006 Stern Review: The Economics of Climate Change suggested that the business-as-usual path of economic growth and greenhouse gas emissions could even reduce future incomes by as a much as 20 percent.Is Bailey's literature review accurate? If not, please name an equally responsive but higher-quality review.
CATEGORIES: Austrian Economics , Books: Reviews and Suggested Readings , Cost-benefit Analysis , Energy, Environment, Resources
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