Ezra Klein writes,

The Kling post goes a bit far. Plenty of respected macroeconomists still use macroeconomic models, which is in itself a refutation of the idea that "the profession has decided that this macroeconometric project was a blind alley." Alan Blinder, for instance, is part of the profession, and so is the president of the Minneapolis Fed, who wrote this paper on macroeconomic modeling.

Scott Sumner writes,

The US can't really use the exchange rate as a policy tool, it is too controversial.

That is not what Sumner says, of course. He says that the Fed can just announce a target for nominal GDP, and the markets will obey.

I find that highly implausible for nominal GDP, but I do find it plausible for the exchange rate. If the Fed announced a policy of "20 percent weaker dollar or bust," and proceeded to buy euros, yen, and other currencies, by golly, I do not think that private speculators would try to get in the way. And if foreign governments tried to get in the way, that would probably lead to some sort of worldwide monetary expansion that I imagine would make Sumner happy.

One point to make here is that this represents another reason to reject the notion of a liquidity trap. If the Fed runs out of T-bills to buy, it can always buy foreign currencies.

However, I cannot leave this issue without referring to the two-regime theory of monetary policy, which would say that this sort of policy risks moving the U.S. into a regime where the inflation rate becomes high and variable. Instead of keeping cash in mattresses, people will try to conserve on cash, and this will raise the velocity of money, even as the Fed is expanding the money supply. There is a risk that we will overshoot the inflation target. If higher inflation solves a lot of our unemployment problem, then, fine, Scott Sumner is a hero. If not, then, well, he is something else.

But it is certainly amusing to see Sumner dismiss a policy option as "too controversial," as if it competes with all sorts of noncontroversial alternatives that are in play.

Why is it "too controversial?" Is it too simple? The status-preservation theory of the Fed is that it wants to maintain an air of mystery and complexity around monetary policy. Buying foreign currency fails to satisfy that.

Alex Tabarrok writes,

The U.S. housing vacancy rate--an unemployment rate for home--is at its highest level since at least 1965 (see figure). Why? Is it sticky prices? Lack of aggregate demand? Structural?

The allocation of land and of housing units is also a by-product of patterns of specialization and trade. Technology affected these patterns. Riverboats, trains, and automobiles altered patterns of land use. The Internet may do so as well.

The Stevenson-Wolfers theory is that since 1970 marriage has been driven more by consumption complementarity than by production complementarity. I think that one can see a similar trend in location. I know of many young women who want to move to New York City because of the way they would like to live, not because of the work opportunities it provides.

Suppose that the choice of housing and location nowadays is based less on the production complementarity of being close to particular work zones (more people can work from home or from satellite offices, thanks to the Internet) and more on the consumption characteristics of the housing unit. In that case:

1. Because people have different consumption preferences (including preferences related to locational amenities), housing will become more specialized. The problem of matching housing characteristics with consumer preferences will be more challenging, just as the problem of matching worker skills with occupational demands has become more challenging.

2. If people care relatively more about consumption complementarity and relatively less about work complementarity in their choice of location, then the correlation between housing vacancies and unemployment may be reduced.

3. People may be less eager to obtain inexpensive housing, because moving to a location far from one's preferred amenities is perceived as a big sacrifice. This may slow the process of adjustment in the housing market.

So, when you overbuild houses in Nevada or condos in Florida, you cannot lure very many people with lower prices. Most unoccupied houses have close to zero marginal value to the vast majority of consumers, just as most unemployed workers have zero marginal product to the vast majority of firms. A long, difficult adjustment process is required before unoccupied houses can be matched with people who want to live in them, just as a long, difficult adjustment process is required before unemployed workers can be matched with firms that can put them to productive use.

How many times have you heard the following argument in the last two years?

Tax cuts/helicopter drops of cash/whatever won't stimulate demand.  People are too nervous to spend.  Whatever you give them, they'll just save it.

The problem with this claim, like the analogous argument about reserves, is that it never considers the savers' motives.  Why are they saving in the first place?  Once again, there are two theories:

Theory #1: People just don't have anything they want to buy.  They're satiated, so no matter how much extra income they get, they'll just sit on it.

Theory #2: People want a buffer.  They aren't comfortable with their current asset cushion, so they're saving in order to return to their comfort zone.

Theory #1 is wholely implausible.  There's tons of stuff that people still covet.  The truth, then, lies in Theory #2: People will start spending again once they feel like they've got enough breathing room.

So what?  Well, if you believe in Theory #2, tax cuts/helicopter drops of cash/whatever do much more to stimulate demand than they appear.  Even if they don't persuade anyone to actually spend more, they move people closer to their financial comfort zone.  And once they reach that zone, they'll start spending again!  Even seemingly ineffective efforts to boost demand reduce the time we'll have to wait before demand begins to rise. 

If your goal is to stimulate demand, then, the right implication to draw from the "They'll just save it" mantra isn't fatalism.  Instead, you should ask yourself, "By how much do their savings need to rise before they will start spending again?" - and ramp up your tax cut/helicopter drop/whatever accordingly.

I'm well-aware that stimulating demand isn't everything, and has its own dangers.  My point is that a plausible account of savers' motives shows that, contrary to many, purely demand-based problems have been and remain easy to solve.

What the Blinder-Zandi paper does is explore the properties of a macroeconometric model. The economics profession abandoned those models thirty years ago, so the tool they are using is like a fossil, frozen in time. Of course, there have been many tweaks over the years, but my guess is that if I had access to the full model I would feel like I was returning to what I first worked on when I worked for Blinder thirty-five years ago.

The model assumes a Keynesian world, in which labor is a variable factor of production that responds to incremental increases in aggregate demand. That might be an excellent assumption for 1910, when 73 percent of the work force was blue-collar. By 2000, 73 percent of the work force was white-collar. See Wyatt and Hecker. In today's Garett Jones economy, labor acts more like a fixed factor. Blinder and Zandi do not know this (they may know it, but I doubt that it is incorporated into the model). So they do not know about jobless recoveries, breakdowns in Okun's Law, the high ratio of permanent job losses to temporary layoffs, etc. Instead, at best they are living in 1970, with some add factors thrown in to get the model to track recent data.

They do not know about lots of new research into labor dynamics, which shows that the rates of job creation and destruction are enormous relative to the net gains or losses in employment. See Davis, Faberman, and Haltiwanger. Again, Blinder and Zandi may know about this research, but I can almost guarantee you that their model does not.

If macroeconometrics were a viable paradigm, we would have seen major efforts to try to bring this sort of model up to date from its 1975 time warp. However, for reasons I have documented, the profession has decided that this macroeconometric project was a blind alley. Nobody bothered to bring these models up to date, because that would be like trying to bring astrology up to date.

While ghost-writing for the Conservative Missionary and the Libertarian Missionary, I found myself reflecting on the principles of good debating.  I realize that debating can just be a sophistical exercise.  But it doesn't have to be.  In fact, it has obvious truth-seeking advantages over the straightforward lecture format.  For starters, debaters usually have a knowledgeable opponent to keep them honest.  Even better, debate gives people a chance to put the other side "on the stand" - to publicly ask them the tough questions people normally evade, then say, "Yes or no, Mr. Such-and-such?"

In any case, here are my candidate principles of good debating.  They're not primarily about winning, but about deserving to win.  But I do think that they are crowd-pleasing as well as truth-seeking.

Principle #1: Strive to address people who don't already agree with you.  Realistically, you'll at best change the minds of the undecided.  But the best way to sway the undecided is to reach out to your most intransigent opponents.

Principle #2: Talk to your opponent like he's your best friend, even if he does the opposite.  Not only are ad hominem arguments invalid, but they send the signal that you lack better arguments.  You'll also think harder and more creatively about your position once you spurn invective.

Principle #3: Split your time between talking to your audience and talking to your opponent.  The optimal balance might not be 50/50 exactly, but you should spend a goodly amount of time both appealing directly to your opponent, and pointing out his blind spots.

Principle #4: If you're uncomfortable publicly defending aspects of your position, reconsider your position.  In extremely oppressive societies, keeping your thoughts to yourself is common sense.  But in modernity's largely open societies, your discomfort says more about the quality of your beliefs than the unfairness of the world.

Any others?

Alan Blinder and Mark Zandi used Zandi's econometric model as the basis for a claim that the stimulus and the TARP worked. Thirty-five years ago, I was Blinder's research assistant, doing these sorts of simulations on the Fed-MIT-Penn model for the Congressional Budget Office. I think they are still done the same way. See lecture 13. Here are some of the things that Blinder had to tell his new research assistant to do.

1. Make sure that there were channels in the model for credit market conditions to affect consumption and investment.

2. Correct the model's past forecast errors, so that it would track the actual behavior of the economy over the past two years exactly. With the appropriate "add factors" or correction factors, the model then produces a "baseline scenario" that matches history and then projects out to the future. For the future, a judgment call has to be made as to how rapidly the add factors should decay. That is mostly a matter of aesthetics.

3. Simulate the model without the fiscal stimulus. This will result in the model's standard multiplier analysis.

4. Make up an alternative path for what you think would have happened in credit markets without TARP and other extraordinary measures. For example, you might assume that mortgage interest rates would have been one percentage point higher than they actually were.

5. Simulate the model with this alternative scenario for credit market conditions.

6. (4) and (5) together create a fictional scenario of how the economy would have performed had the government not taken steps to fight the crisis. According to the model, this fictional scenario would have been horrid, with unemployment around 15 percent.

Some comments:

i) Blinder and Zandi do not spell out the details of step 1 or step 4. Thus, I have no idea how to evaluate their approach to estimating the impact of financial measures.

ii) Other than the add factors, and any ad hoc adjustments that were made in step 1, every result in the paper would have been found by simulating the model three years ago. There is no new evidence being brought to bear. What Blinder and Zandi are reporting is the Keynesian theory that was built into the model.

iii) They report model multipliers to two decimal places, e.g. 1.61 for extending unemployment insurance benefits. They do not provide confidence intervals or any other estimate of reliability.

iv) the paper has not been published in a peer-reviewed journal. The theoretical and statistical properties of the model probably would not be considered acceptable in modern practice. Even if those issues were overlooked, the intensity of the political rhetoric combined with the opacity of the exercise would cause difficulties for most editors of academic journals.

I do not think we will ever know what would have happened to the economy without the fiscal stimulus and the large monetary interventions. My guess is that the overwhelming majority of economists would agree that we will never know the answers to those questions. However, in the competition for public attention, Blinder and Zandi have two advantages. First, they support a narrative in which government experts did the right thing, which is comforting to government experts and all who believe in them. Second, at a tactical level, their use of an esoteric computer model along with those two decimals of precision, they intimidate journalists and other laymen.

I know that they think this is for a good cause. They really believe that the stimulus and TARP were good policies that got a bad rap. But in my view that does not justify this unseemly exercise in propaganda dressed up as research.

I'm going on vacation Thursday morning here. I'll be there until August 15. Sometime tomorrow and for a four-hour layover in Denver on Thursday, I'll pre-program some posts on things I've been thinking about. I'll also go on line from time to time while I'm there, although that's not easy. What that means is that I won't be nearly as active a responder to people who comment on my posts.

I've gone to Minaki for at least some time every summer of my life since 1951, except for about five years in the 1970s, 1980s, and 1990s. My grandfather built the cottage in 1921 or 1922 and the major improvements were electricity (1958) and running water (2000.) It's partly because of that that I appreciate modern technology. After having hauled literally thousands of buckets of water, I love running water.

Paul Romer is always interesting, and especially in this podcast with Paul Kedrosky. In the last quarter of the interview, the discussion turns to badly-performing cities, and Romer speculates that we need a workout procedure that would allow a city government to move into completely different hands. As with troubled banks, one could argue that we need a more effective resolution authority for troubled governments.

Possibly related: Tyler Cowen on privatizing local government.

The above title should have been the title of my previous post. The title I gave it, "Mark Thoma Doesn't Get It," was unnecessarily provocative, as one of my co-bloggers has pointed out. I know the myth of male power, and part of it is that we men are not supposed to have feelings. We do have feelings. I think, based on his reaction in a subsequent post, that I hurt Mark Thoma's feelings. I didn't mean to. It was thoughtless of me to think that with that title, I wouldn't upset him. What I really meant to do is talk about the following:

When people advocate government intervention, they rarely, maybe never, tell us how the incentives will be set up so that government will do the right thing. Think about how asymmetric the argument is. Incentives in the private sector are such that someone will do something in his interest that hurts others in society, but he doesn't take account of that hurt in his decision. Or, someone could take action that would benefit others a great deal but it isn't in his interest to take the action. Notice the use of reasoning about incentives to show why the market fails. Therefore, continues the argument, we should have government intervene.

Did you catch the non sequitur? The argument proceeds at first using standard economic tools. We show that the incentives are such that the private actors make the decision that leads to sub-optimal results. Then we (not really we, but many of us) conclude that government should step in. But there's no analysis of government incentives. Why would government do the right thing? That's the unjoined debate. The late George Stigler once said it's like a judge at a beauty contest seeing just the first contestant and then awarding the prize to the second contestant.

I wasn't naive enough, as Mark Thoma suggests in his response, to think that he has "unqualified support for regulation." Also, he has been critical of specific regulations. One of the things that makes his blog interesting is his eclectism. I was just saying that although I read his blog a fair bit, I've never seen him, when he advocates a regulation or a government program, explain why he thinks the incentives will be set up so that it works. I had hoped to get him to address this. It would still be nice if he would.

Addendum: One of the commenters on my post said the discussion shouldn't proceed without mentioning Coase and Demsetz. I'm a fan of both men, and indeed, it was Demsetz who got me into economics, as I lay out in Chapter Two of my book, The Joy of Freedom: An Economist's Odyssey. Of course, I had Demsetz's nirvana fallacy in mind when I wrote this. But I'll often use ideas without naming the person I got them from.

I mean, nothing says "have a nice day" like an issue brief from the Congressional Budget Office on the prospects for a U.S. sovereign debt crisis. On the potential for inflating away the problem, the brief says,

On balance, the increase in tax revenues resulting from higher inflation would be more than offset by higher payments for benefit programs and higher interest payments as the outstanding debt rolled over and ongoing deficits required the issuance of more debt.

Read the whole issue brief. There is no way that excerpts can do it justice.

Eric Falkenstein offers a theory of financial manias.

Sometimes, the investors (dupes) think a certain set of key characteristics are sufficient statistics of a quality investment because historically they were. Mimic investors seize upon these key characteristics that will allow them to garner funds from the duped investors. The mimic entrepreneurs then have a classic option value, which however low in expected value to the investor, has positive value to the entrepreneur. The mimicry itself may involve conscious fraud, or it may be more benign...The mimicking entrepreneurs are really symptomatic of investing based on insufficient information that is thought sufficient.

Falkenstein's point is that the signaling is endogenous. When a particular signal works well for good intermediaries (ones that make a legitimate profit by choosing investments wisely), there is an incentive for bad intermediaries (who choose investments less wisely) to mimic the signals provided by good intermediaries.

Falkenstein claims that there is no equilibrium in which good intermediaries are well received and bad intermediaries are not. When times are good, the incentives are great for bad intermediaries to develop the ability to mimic good intermediaries. Only when there is a crash do the bad intermediaries get exposed and wiped out. Right after a crash, people distrust all sorts of signals, including those that had been used by good intermediaries. So after a crash, even good intermediaries have difficulty establishing credibility. By the time they come up with credible signals, bad intermediaries are ready to mimic those signals.

Government as Deux Ex Machina

Almost all economists recognize that there are some market failures that must be corrected by government intervention, the disagreement is over their prevalence. Some economists see widespread and costly market failures, and that government can intervene effectively to overcome them.

Notice a category missing? The category includes me. It's economists who do "see widespread and costly market failures" but don't see how "government can intervene effectively to overcome them." The debate between advocates of government intervention like Mark and critics like me is still unjoined--by Mark. What he has not shown us and, more upsetting, what so few advocates of government intervention even try to show us, is how a government regulator will have the right incentive to do the right thing. Will the government regulator be fired if he screws up? Not typically. Will he get a huge bonus if he does something right? Not typically. And how, with a centralized information system, will he get the information needed to make a good decision, something I wrote about in the context of dealing with terrorism? I don't read Thoma as much as Arnold does, but I read him a fair bit and I've never seen him deal with these issues. Have you?

Bruce Charlton writes,

A decade ago people all over the place were saying confidently that the economic effect of the internet would outstrip the effects seen by the invention of railways and telecommunications, and that new synergies from fast and universal communication would generate a society of massive capability...

Yet economic growth since the internet came has been, well - ahem! - very modest...

I think that ultimately the Internet will yield high productivity, but for now it is creating a mix of winners and losers. I am a winner. My cost of living is way down as a result of the Internet. Our household gets along very well, and if it were not for college tuition for our daughters, the past few years I would not even have needed the income of a median worker .

Many people who use the Internet for work have been winners. At the same time, the Internet has introduced new forms of competition, including offshoring of services, and this has created losers.

I suspect that the age of mass production is gradually passing. That is, the proportion of the world's population that can be economically put to work producing mass goods, such as automobiles, is on the decline. That may reduce the standard of living for low-skilled workers.

You might look at the technology of warfare as a leading indicator. In 1939, the world's armies still had a lot of horses. But motorized vehicles soon made horses obsolete.

The idea of sending massed formations of relatively untrained soldiers into war, as countries did in the middle of the 20th century, seems absurd today. Instead, we think in terms of highly professional military personnel using advanced equipment. What if the economy in general is moving in that sort of direction? With highly-skilled professionals using advanced equipment substituting for masses of low-skilled workers?

We are undergoing a major demographic shift, with the ratio of older dependents to younger workers rising. That may slow the increase in the standard of living, at least for the younger workers.

We may end up throwing away much of the productivity increase on ineffective medical services. But I think that we will have a lot to throw away.

Megan McArdle writes,

When an academic starts pushing the tenure model for anywhere outside academia, I will find their defense of its use in academia more convincing.

A while back, I ran into Olivier Blanchard. He and I do not exactly agree on the state of academic macro. He told me that he thought that I was disparaging something that had "met the market test."

Some market. Some test. If Blanchard's generation of macroeconomists have passed a test, it is one that they made up themselves.

In experimental science and engineering, these is enough external validation to keep the process honest. In other disciplines, in-breeding can get out of hand. In my opinion, macroeconomics has suffered from that.

I think that the general problem in the academy is that it is too strongly cartelized. Perhaps the most appalling symptom of that is the disparity between tenured professors and adjuncts. Such a disparity would almost surely not emerge in a free market.

Tenure is one way in which incumbents enforce the cartel. But getting rid of tenure would not be sufficient. I think that the key for fields outside of science and engineering is to create a meaningful role for those outside of a narrow field to influence hiring and compensation within that field.

I said in my previous blog that I would give an unspecified prize to the best proposal for getting rid of a government ban on some peaceful activity. The prize, I said, would likely be simple recognition. I was heartened by the creativity that people showed in responding and disheartened by the extent of government intrusion in our lives. I never made clear by what criterion or criteria I would just the proposals. So let me give the top few and why:

Jacob Kearns: the minimum wage.
Yes, absolutely. I'll do a back-of-the-envelope calculation in a day or two. I predict that even cutting the minimum wage by 20 percent would create somewhere between 500,000 and one million jobs.

Troy Camplin: zoning laws that prevent people from having businesses in their homes.

JKB: Liquor sales prohibitions.

Harold Cockerill: Getting rid of the Fairfax County law that says that getting the second employee for a home office results in an additional fee to be paid to the county of $14,950.

Sisyphus: Get rid of laws against dancing in bars. This is such an attack on our freedom to use our bodies peacefully. I think, though, that it would be like pushing a rock uphill to get rid of this restriction, Sisyphus.

Thanks, all. One of the things I enjoy most about Vegas, by the way, even though I don't do it myself, is that people are allowed to walk the strip carrying a drink of alcohol. One reason I go to Vegas is that I can enjoy one of the trappings of a free society.

The Economist asks about it. Paul Seabright answers:

this recession, more than most, seems likely to have produced a great increase in the mismatch, due to the unsustainable patterns of consumption and investment induced by the credit boom that preceded the financial crisis. It's as though the passengers on the rail network need a whole new pattern of travel to different combinations of destinations, for which the connections are no longer optimised and for which there are too many trains in some directions and too few in others.

Daron Acemoglu suggests that what we are seeing is a speed-up of a trend away from low-skill manufacturing jobs. There is much to chew on in this discussion, and the question of what to do about structural unemployment requires a lot more thought. Thoma's answer strikes me as a bit too vague, although I am sure he could flesh it out.

I just want to mention a question that came up in the comments on my post on recalculation. What is a sustainable pattern of production and trade? A sustainable pattern is where comparative advantage is utilized. So, if we both eat carrots and potatoes, and I live in a region that has better land for growing carrots, then for me to produce lots of carrots and trade them to you for potatoes is a sustainable pattern of production and trade. If I instead grow mostly potatoes, I will not be successful as a farmer. Thus, a sustainable pattern is one in which comparative advantage is realized. An unsustainable pattern is one in which comparative advantage is not realized, presumably because people are deceived for a while about the costs of their enterprises.

Now consider the greatest perceived triumph of Becker's approach: the fact that increasing education - especially women's education - explains much of the decline in fertility.  The facts are clear, but the best way to interpret the facts is not.  Education could affect fertility by making it more expensive to take time off from work.  Yet it could just as easily affect fertility by changing values. 

Teachers and professors often explicitly try to "broaden horizons" - to undermine students' preconceptions, and introduce them to less traditional measures of success.  In a sense, one of educators' goals is to convince students - especially female students - that there's more to life than having kids.  To some degree, educators succeed; they may be uninspiring speakers, but they do have captive audiences. 

Worth noting: Time diaries show that better-educated parents devote more time to childcare. (Changing Rhythms of American Family Life, p.75)  This suggests yet another way for education to reduce family size: Educated parents impose stricter rules on themselves.  Why does female education matter more?  Because women have stronger opinions about upbringing.  Dad usually gives Mom extra say on the family's self-imposed rules, as long as he's not in charge of compliance.  The best-educated moms keep their families small because the rules they choose to impose on themselves are especially tough to live by.

That's not the title of a piece in today's San Francisco Chronicle by my friend and Hoover colleague, Joe McNamara. But it could be. One excerpt:

Who would buy pot on dangerous streets if they could get it at regulated stores without unsafe impurities? Al Capone and his rivals made machine-gun battles a staple of 1920s city street life when they fought to control the illegal alcohol market. No one today shoots up the local neighborhood to compete in the beer market. The federal Drug Enforcement Administration estimates that Mexican cartels derive more than 60 percent of their profits from marijuana. How much did the cartels make last year dealing in Budweiser, Corona or Dos Equis?

The California Police Chiefs Association, of which I have been a member for 34 years, is also in opposition. Personally, I have never even smoked a cigarette, let alone taken a hit from a bong, and while I have great respect for the police chiefs, I wouldn't want to live in a country where it is a crime to behave contrary to the way cops think we should.

I have had a number of requests for this. I will put it below the fold.