Monday, May 31, 2010
David Warsh says Obama is making a big mistake pushing ahead with education reform based upon an approach that Republicans "have championed so strongly in the past":
In the Thrall of the Billionaire Boys Club, by David Warsh: It has the potential to become Barack Obama’s Vietnam. Not the Gulf oil spill, serious though that is. Nor Afghanistan. Other people’s mistakes are one thing. The ones that haunt forever are the ones you make yourself. I mean the system of public education.
Remember the recipe for a policy disaster? Start with a handful of policy intellectuals confronting a stubborn problem, in love with a Big Idea. Fold in a bunch of ambitious Ivy League kids who don’t speak the local language. Churn up enthusiasm for the program in the gullible national press – and get ready for a decade of really bad news. Take a look at David Halberstam’s Vietnam classic The Best and the Brightest, if you need to refresh your memory. Or just think back on the run-up to the war in Iraq.
My jaw dropped last week when I picked up The New York Times Magazine and turned to its cover story “The Teachers’ Unions’ Last Stand: How Obama’s Race to the Top could revolutionize Public Education,” by Steven Brill. In 8,000 breathless words, Brill described “a movement spreading across the country to hold public school teachers accountable by compensating, promoting, and even removing them according to the results they produce in class, as measured in part by student test scores.”
That means getting rid of pay and job protection based on seniority, breaking up the teachers’ unions, and starting a lot of new charter schools. True, Brill notes, these are initiatives historically associated with the Republican Party, but Obama “really does seem to be a new kind of Democrat.” By adopting a “Nixon-to-China approach,” the president and his lieutenants can hope to get “some, probably many” Democratic votes, “while winning support from Republicans on an issue they have championed so strongly in the past that taking a flat-out anti-Obama approach would be especially awkward.”
Making it happen, says Brill, “is a network of reformers dedicated to overhauling public education in the United States.” ...
As I read along in the Times Magazine, I wondered what Brill was doing writing about efforts to reform the public schools. A serial entrepreneur, he founded the monthly American Lawyer in 1979, the much less successful Brill’s Content in 1998 (the self-styled media watchdog folded in 2001), and has been involved in a variety of publishing ventures since. Deerfield Academy, Yale College, Yale Law: he has no background in public education. Indeed it was clear from the article that he didn’t know much about the classroom. The key difference between public schools and charter schools – the latter can exclude or fire troublesome kids – goes altogether unmentioned.
Then,... it dawned on me... I realized that Brill goes to parties with the people he was writing about – with Michael Bloomberg, New York City’s billionaire mayor, with Joel Klein, the former antitrust chief at the Justice Department whom Bloomberg appointed to run the city’s schools, and with Mrs. Tisch, the chancellor of the New York State Board of Regents...
Brill’s Times Magazine story is an anomaly, interesting mainly for its cheerleading being so completely over the top. Not since Judith Miller built her case for Saddam Hussein’s weapons of mass destruction has there been anything like it in the Times. (But then the Sunday magazine often seems to operate in a world of its own.) It will be interesting to see if Clark Hoyt, the newspaper’s public editor, takes a look. ...
I’m no expert on public education either, but I know an expert when I see one. Diane Ravitch has been the nation’s preeminent historian of education since her book The Troubled Crusade: American Education 1945-1980 appeared in 1983. She served as assistant secretary of education under George H. W. Bush. For forty years she has pondered each new proposal for restructuring schools as it has come along, often with considerable sympathy: vouchers, charter schools, curriculum reform, standardized testing, punitive teacher accountability.
In her new book, The Death and Life of the Great American School System: How Testing and Choice are Undermining Education, Ravitch describes the evidence that has changed her views of strategies that once seemed promising to her. (Her title’s echo of Jane Jacobs’ great 1961 book on urban life is intentional: she began her career in Manhattan in 1968, at a time when Jacobs was leading her epic battle against highway-planner Robert Moses.) The nostrums that school districts, Congress, and federal officials are pursuing, that mega-rich foundations are supporting, that editorial boards are applauding, are mistaken, she says, fundamentally flawed because they are built on a market metaphor. Schools don’t work like businesses, she says Public education should be preserved “because it is so intimately connected to our concepts of citizenship and democracy and to the promise of American life.” ...Ravitch is especially good on the influence of what she calls the “Billionaire Boy’s Club” – the Bill and Melinda Gates Foundation (the Microsoft fortune), the Walton Family Foundation (Wal-Mart), and the Eli and Edythe Broad Foundation (home-building and finance) – that have eclipsed the older foundations long associated with education policy (Ford, Rockefeller, Carnegie and Annenberg) as the powerful big givers. Sometimes described as “venture philanthropies” or exponents of “philanthrocapitalism,” meaning their methods are borrowed from start-up finance and management, the Gates, Walton and Broad foundations see their grants as investments, designed to produce measurable results. And though they preach accountability to teachers, they receive relatively little scrutiny themselves – or even much dissent, given the power of their interlocking grants to exclude critics. All that money buys a lot of silence, Ravitch says, not to mention admiring friends. The Teach for America program, with its youthful cadre of 24,000 veterans, in one of the fruits of philanthrocapitalism; the Race to the Top is another.
The situation is alarming. Not only is the federal government about to administer a hammer-blow to the basic principles of public education through its competitive grant program; over the next few months, hundreds of thousands of public school teachers are scheduled to be laid off, as well, thanks to state and local budgets that have been stretched to the breaking point by falling tax revenue and rising unemployment claims. Christina Romer, chair of the Council of Economic Advisers, last week estimated that perhaps as many as one out fifteen teachers would receive a pink slip unless Congress extended the emergency aid that so far has saved more than 400,000 teaching positions. No soap, apparently. House leaders, worried about soaring levels of public debt, instead cut back sharply on the extension.
It is not too late for the administration to gradually change its stance on public education. Obama and David Axelrod should take out some old Time and Life magazines, compare them to Brill’s Times Magazine article, and reflect on how the media pranced as Presidents Kennedy and Johnson blundered into Vietnam. They should read and discuss Diane Ravitch’s book. They should think long and hard about whether they are going to let Arne Duncan and his whiz kids put Obama’s presidency in greater peril than the Deepwater Horizon ever could.
Robert Reich says the federal government should take over BP until the oil leak in the gulf is stopped:
Why Obama Should Put BP Under Temporary Receivership, by Robert Reich: It’s time for the federal government to put BP under temporary receivership, which gives the government authority to take over BP’s operations in the Gulf of Mexico until the gusher is stopped. This is the only way the public know what’s going on, be confident enough resources are being put to stopping the gusher, ensure BP’s strategy is correct, know the government has enough clout to force BP to use a different one if necessary, and be sure the President is ultimately in charge.
If the government can take over giant global insurer AIG and the auto giant General Motors and replace their CEOs, in order to keep them financially solvent, it should be able to put BP’s north American operations into temporary receivership in order to stop one of the worst environmental disasters in U.S. history.
The Obama administration keeps saying BP is in charge because BP has the equipment and expertise necessary to do what’s necessary. But under temporary receivership, BP would continue to have the equipment and expertise. The only difference: the firm would unambiguously be working in the public’s interest. As it is now, BP continues to be responsible primarily to its shareholders, not to the American public. ...
Five reasons for taking such action:
1. We are not getting the truth from BP. BP has continuously and dramatically understated size of gusher. ... Government must be clearly in charge of getting all the facts, not waiting for what BP decides to disclose and when.
2. We have no way to be sure BP is devoting enough resources to stopping the gusher. BP is now saying it has no immediate way to stop up the well until August, when a new “relief” well will reach the gushing well bore... August? If government were in direct control of BP’s north American assets, it would be able to devote whatever of those assets are necessary to stopping up the well right away.
3. BP’s new strategy for stopping the gusher is highly risky. It wants to sever the leaking pipe cleanly from atop the failed blowout preventer, and then install a new cap so the escaping oil can be pumped up to a ship on the surface. But scientists say that could result in an even bigger volume of oil – as much as 20 percent more — gushing from the well. At least under government receivership, public officials would be directly accountable for weighing the advantages and disadvantages of such a strategy. ...
4. Right now, the U.S. government has no authority to force BP to adopt a different strategy. ... The President needs legal authority to order BP to protect the United States.
5. The President is not legally in charge. As long as BP is not under the direct control of the government he has no direct line of authority, and responsibility is totally confused. ...
The President should temporarily take over BP’s Gulf operations. We have a national emergency on our hands. No president would allow a nuclear reactor owned by a private for-profit company to melt down in the United States while remaining under the direct control of that company. The meltdown in the Gulf is the environmental equivalent.
I've wondered if BP's attempts to close off the leak also try to preserve the ability to tap the well again in the future. Are there other things that could be tried that might work better, but make it impossible to use the well again (and hence are last resort measures from the company's point of view, but no the public's)? Perhaps that's not the case, I don't have enough technical expertise to assess the options, maybe the public relations fallout, prospects of fines, lawsuits, etc., make the company do all it can to stop the leak in any case. But it's hard not to wonder given the present structure of responsibility for stopping the leak (including limits on financial responsibility). If the government were to takeover until the leak is stopped, this worry would be lessened (as would others).
However, if the administration does take over, then it will also take over responsibility for what happens. If the well continues to leak until August, and if the administration has taken BP into receivership, the administration will take the direct blame. It has that problem now, of course, the blame will be there in any case, but presently BP absorbs some of the fallout from the failed attempts to plug the leak and the administration can at least try to deflect some of the blame in BP's direction. If the administration takes over, it also takes full responsibility from that point forward, and it's not clear they want that, especially given the present prospects for stopping the leak (though, again, do we know the full spectrum of options, no matter how costly they are?).
So, in general, it's unlikely that an administration will want to take over a company when the problems are particularly hard to solve. It will take over when quick victory is assured, but why take the political risk when the problems are really hard? Better to blame the company.
I'm struggling a bit with this one. I am not very comfortable recommending a take over. I don't feel like I've thought it through enough to call for a government take over of BP, such take overs should be last ditch measures to prevent severe damage (which may justify a takeover in this case). They should not become government habits. I'd prefer that the prospects of charges for damages, fines from the EPA, lawsuits from people whose livelihood depends upon the fisheries, and so on give BP an unambiguous incentive to stop the leak as soon as possible, that its life would be just as threatened as the life in the gulf is threatened if the leak is not plugged relatively soon. There would still be a need for strict government oversight, and it would be important that the government have the authority to force or prevent certain actions and to force disclosure of information. But at least I'd be more sure that the company is doing everything it possibly can -- devoting every possible resource (and asking for government help if more resources are needed) -- to getting this fixed as soon as possible. However, it's not at all clear that the company has these incentives, and even if it did, I would still have doubts about its actions.
Again, maybe all that can be done is being done, but I'd be more confident that's the case if the company faced more consequences than it appears that it will, and if the company itself wasn't running the show and determining, at least to some extent, what I do and don't know about its options and actions.
No matter who is technically in control of the company, i.e. receivership or not, the one thing that is needed is for the government to have the authority it needs to force the company to fully disclose all the information it has about the leak, and about how to stop it. It also needs to be able to force the company to take particular actions to stop the leak even if the actions demand so many resources it results in the company going bankrupt. This is where the case for a take over seems to be the most compelling to me. Suppose that two strategies for stopping the leak exist, one that will work with near certainty and costs 1 billion, another that may or may not work that costs 200 million. If the company can adopt the 1 billion dollar strategy only by liquidating its business, but can possibly survive trying the 200 million method, it may waste valuable time trying the riskier strategy first, especially if it doesn't face the full costs of the damage it is causing (because there are externalities, or because there are legal limits on the damages it has to pay). If the potential damages are well in excess of 1 billion, enough to make the 1 billion dollar attempt the only logical choice from society's perspective, then the government should step in and force the company to finance the higher cost method of stopping the leak even if it means the company must liquidate itself. (If, say, the company only has 800 million in assets, then it can't choose the less risky option in any case. Here the government could force liquidation, and then add the extra 200 million needed to ensure the leak is stopped and the greater than 1 billion dollars saving in environmental damage is realized.)
I'm obviously unsettled on this one (and talking without enough thought behind it). Maybe you can help in comments?
I'm surprised to see Greg Mankiw endorsing Robert Samuelson's column about measuring poverty (or at least pointing to it without comment as though he endorses it). Apparently Samuelson is worried that the new measurements might cause us to give more help to the poor. I guess in his view, the poor are getting all the help they need, but that's not how I see it.
Dean Baker responds to Samuelson:
Robert Samuelson's Cellphone Standard of Living, by Dean Baker: Robert Samuelson invokes the cellphone standard of living in his column today which complains about the Obama administration's adoption of a new measure of poverty as an alternative to the official standard. The administration will use both.
Samuelson argues that we have failed to pick up all the gains for the poor over the last four decades noting, among other things, that 48 percent of poor households own cellphones. Needless to say, the reduction in price of many products in recent decades has made them accessible in ways that would not have been possible in the recent past, but it is not clear how much this tells us about living standards.
In China, there are more than 600 million cell phones in use. This means that roughly the same percentage of people in China have cell phones as do poor people in the United States. China's per capita income on a purchasing power parity basis is less than one-sixth as high as per capita income in the United States. By Samuelson's cell phone standard of living the average person in China has the same standard of living as do poor people in the United States.
There are a couple of other points worth noting about Samuleson's diatribe. The Obama administration did not just invent the measure that Samuelson denounces as a "propaganda device." This is a measure developed by the National Academies of Science based on research by many of the country's leading poverty experts. It is fine to criticize the measure, but Samuelson should have at least noted its origins.
Finally, Samuelson reports on research from the American Enterprise Institute (AEI) that shows that spending on the poor from all sources may be as much as double their reported income. It is worth noting that much of this spending involves Medicaid expenditures...
I think it's pretty slimy to act like the new measure is an invention of the Obama administration that will be used to implement a political agenda. Complaints about the existing measure are long-standing, and there was considerable pressure on George Bush to change the measure. But since it might have shown an increase in poverty -- something his administration wanted to avoid -- he refused. If you want an example of political manipulation, that was it. The Bush administration refused to use more accurate statistics because it might reflect poorly (pun intended) on the administration. And he wasn't the only president to make this choice. The problems with the measure have been evident for the last four decades, and this is the first president willing to consider making a new measure official:
Where's the Poverty Line?: ...So why hasn't such an important statistic been updated...? The answer is politics. ... the poverty indicator, unlike many other economic statistics, is not under the jurisdiction of an authoritative statistical agency like the Bureau of Economic Analysis or the Bureau of Labor Statistics. Instead, it resides in perhaps the most political place of all: the office of the president. And during the last four decades, no president of either party has wanted to draw attention to [the] statistic ..., especially if updating it might cause the number of people regarded as living in poverty to increase. ...
Samuelson doesn't tell us that other presidents have refused to update the measure (and why), instead he makes it seem like this is an invention of the current administration. He says:
The new indicator is a "propaganda device" to promote income redistribution by showing that poverty is stubborn or increasing, says the Heritage Foundation's Robert Rector. He has a point.
The propaganda device is Samuelson's column, not the adoption of the new poverty measure. The current administration's willingness to consider updating the measure should bring Samuelson's respect if he had something other than a political agenda as the goal of the column
Here's another reaction:
You can’t be poor if you own a cellphone, by Jamelle Bouie: Robert Samuelson invokes a familiar canard in his column complaining about the Obama administration’s choice to use a new definition of poverty developed by the National Academies of Science:The official poverty measure obscures this by counting only pre-tax cash income and ignoring other sources of support. ... Although many poor live hand-to-mouth, they’ve participated in rising living standards. In 2005, 91 percent had microwaves, 79 percent air conditioning and 48 percent cellphones. [Emphasis mine]
With microwaves, air conditioning and cell phones, it’s clear that poor people aren’t nearly as poor as we think they are! I mean, it’s not as if poverty is concentrated in the nation’s two warmest regions — the South and the West — where air conditioning is a necessity, and it’s not as if cell phones are a cheaper alternative to landlines, and critical to navigating the world of low-wage service jobs. I guess you could call microwaves luxuries, but even that’s ignoring the fact that the are for more likely to consume frozen and prepared foods that need microwaving.
So in Samuelson’s column, what you have is another attempt to minimize the actual poverty of poor people by pointing to items that are actually necessary to surviving in low-wage service economy. Indeed, by the end of the piece, Samuelson is a step away from lamenting that the new poverty measures will force the government to do more to combat poverty, as if what we do now is adequate. Of course, given Samuelson’s routine Hooverism — “deficits are more important than everything else!” — and his disdain for Social Security and Medicare, I guess I shouldn’t be surprised.
Let's move on to more accurate assessments of the new measure. Here's a report from Nancy Folbre, someone who doesn't come to the problem with Samuelson's biases, on the new measure:
A Rich New Poverty Measure, by Nancy Folbre: The Census Bureau recently announced plans to develop a new Supplemental Poverty Measure (S.P.M.), also referred to as a Supplemental Income Poverty Measure (SIPM). ...
Most of us dislike the official poverty lines used to determine who, exactly, qualifies as poor. Most of us can recite at least five reasons why these measures (based on a mid-1960s assessment of the costs of a minimal food budget) are narrow, out of date and downright misleading.
Most of us can also expound on how current methods of measuring poverty make it difficult, if not impossible, to accurately assess the impact of anti-poverty policies.
Food assistance administered through the Supplemental Nutritional Assistance Program (SNAP) has been a mainstay of our safety net during the current recession. But since food stamps are not income, they don’t show up in our income-based poverty measures.
The Earned Income Tax Credit (E.I.T.C.) is our largest cash-assistance program other than unemployment insurance in this recession. Our poverty measures are based on pre-tax, rather than after-tax, income. So, by definition, the E.I.T.C. does not reduce poverty.
It’s hard to find anyone more passionate about these inconsistencies than Professor Timothy Smeeding, current director of the Institute for Research on Poverty at the University of Wisconsin. ... He is thrilled that the new measure will take near-cash benefits and taxes into account to supplement conventional poverty measures.
He emphasizes its other innovations: poverty thresholds will be linked to accurate measures of expenditures on food, shelter, clothing and utilities, rather than just food. It will subtract some work-related costs, such as the child-care expenditures of employed parents, to better capture disposable income.
Professor Smeeding concedes that the measure has some kinks in it that will need to be worked out, including better estimates of out-of-pocket health care expenses and differences in regional costs of living.
I’m worried about other factors that affect family living standards, like the costs and benefits of unpaid care of dependents.
Curious about other criticisms, I reached out to Shawn Fremstad of the Center for Economic and Policy Research, also on his way to the discussion at the Brookings Institution.
In his view, the SIPM sets its thresholds too low, excluding many struggling families from the category of poverty. Mr. Fremstad also warns that adopting the new measure by itself could sideline efforts to develop more complete measures of basic economic security that would include consideration of family wealth as well as income.
I’m not yet sure where I stand. As Professor Smeeding reminded me, the perfect can be the enemy of the good. This new measure, whatever its limitations, represents a rich addition to our statistical infrastructure. ...
Samuelson objects to the use of relative poverty measures. He wants an absolute standard. So long as people aren't starving in the streets and have clothes to wear, no matter how ragged, they are not poor.
It's true people don't literally starve on the streets anymore, but is that our goal as a society? I think a relative standard that says that people who, because of their incomes, cannot participate fully in society are poor. A child getting enough to eat, and with clothes to wear, who cannot afford the toys needed to be part of the group of kids in the neighborhood is socially isolated and socially disadvantaged (we don't want to play at your house because you don't have a TV, you can't come with us because you don't have a bike, you didn't get my text message about baseball practice being moved?, etc., etc., etc.). Giving people, children in particular, what they need to participate in the society around them is an important element of how successful they will be in the future. It helps to determine their ability to give back to society as fully participating adults.
Why do people like Samuelson object to helping the poor (in a relative poverty sense)? I think it's partly because they fail to recognize the social roots of poverty. They assume it is the poor's own fault that they ended up that way. They made bad choices, and that fact that they are barely getting by, the fact that their kids that will remain socially isolated, is the price that must be paid for those bad choices. If we bail them out like a big bank, how will they ever learn life's lessons?
The answer is that they know life's lessons all too well, certainly better than the Samuelsons of the world. Most of the poor are working poor, many working more than one job just to get by. To refuse to help the hardest working among us, those who toil at or near poverty to give the rest of us the products and services we desire at very low prices, is unconscionable.
The budget and inflation hawks are winning the battle to define the "conventional wisdom" over how policymakers should respond now that the economy is just setting out on the long road to recovery. The wisdom may be conventional, but it is not very wise:
The Pain Caucus, by Paul Krugman, Commentary, NY Times: What’s the greatest threat to our still-fragile economic recovery? Dangers abound... But what I currently find most ominous is the spread of a destructive idea: the view that now, less than a year into a weak recovery from the worst slump since World War II, is the time for policy makers to stop helping the jobless and start inflicting pain.
When the financial crisis first struck, most of the world’s policy makers responded appropriately, cutting interest rates and allowing deficits to rise. And by doing the right thing, by applying the lessons learned from the 1930s, they managed to limit the damage: It was terrible, but it wasn’t a second Great Depression.
Now, however, demands that governments switch from supporting their economies to punishing them have been proliferating in op-eds, speeches and reports from international organizations. Indeed, the idea that what depressed economies really need is even more suffering seems to be the new conventional wisdom...
The extent to which inflicting economic pain has become the accepted thing was driven home to me by the ... Organization for Economic Cooperation and Development... The O.E.C.D. is a deeply cautious organization; what it says at any given time virtually defines that moment’s conventional wisdom. And what the O.E.C.D. is saying right now is that policy makers should stop promoting economic recovery and instead begin raising interest rates and slashing spending.
What’s particularly remarkable ... is that ... the O.E.C.D.’s own forecasts show no hint of an inflationary threat. So why raise rates? The answer, as best I can make it out, is that the organization believes that we must worry ... that markets might start expecting inflation, even though they shouldn’t and currently don’t...
A similar argument is used to justify fiscal austerity. Both textbook economics and experience say that slashing spending when you’re still suffering from high unemployment is a really bad idea — not only does it deepen the slump, but it does little to improve the budget outlook, because much of what governments save by spending less they lose as a weaker economy depresses tax receipts. And the O.E.C.D. predicts that high unemployment will persist for years. Nonetheless, the organization demands both that governments cancel any further plans for economic stimulus and that they begin “fiscal consolidation” next year.
Why do this? Again, to give markets something they shouldn’t want and currently don’t. Right now, investors don’t seem at all worried about the solvency of the U.S. government; the interest rates on federal bonds are near historic lows. ...
The best summary I’ve seen of all this comes from Martin Wolf..., who describes the new conventional wisdom as being that “giving the markets what we think they may want in future — even though they show little sign of insisting on it now — should be the ruling idea in policy.”
Put that way, it sounds crazy. And it is. Yet it’s a view that’s spreading. And it’s already having ugly consequences. Last week conservative members of the House, invoking the new deficit fears, scaled back a bill extending aid to the long-term unemployed — and the Senate left town without acting on even the inadequate measures that remained. As a result, many American families are about to lose unemployment benefits, health insurance, or both — and as these families are forced to slash spending, they will endanger the jobs of many more.
And that’s just the beginning. More and more, conventional wisdom says that the responsible thing is to make the unemployed suffer. And while the benefits from inflicting pain are an illusion, the pain itself will be all too real.
Sunday, May 30, 2010
Bloggers (and Jon Stewart) need help:
The Impact of the Irrelevant on Decision-Making, by Robert H. Frank, Commentary, NY Times: Textbook economic models assume that people are well informed about all the options they’re considering. It’s an absurd claim... Even so, when people confront opportunities to improve their position, they’re generally quick to seize them. ... So most economists are content with a slightly weaker assumption: that people respond in approximately rational ways to the information available to them.
But behavioral research now challenges even that more limited claim. For example, even patently false or irrelevant information often affects choices in significant ways. ...
An intriguing example ... comes from a 1974 ... experiment by the psychologists Daniel Kahneman and Amos Tversky. In the experiment, subjects first spun a wheel that supposedly would stop at random on any number between 1 and 100. Then they were asked what percentage of African countries belongs to the United Nations. For one group of subjects, the wheel was rigged to stop on 10; for a second group, on 65. On average, the first group guessed that 25 percent belong to the United Nations, but the second group guessed 45 percent.
All subjects would have insisted, correctly, that the number on the wheel bore no relation to the correct answer to the question. Yet, obviously,... demonstrably false or irrelevant information can influence judgments, which in turn influence decisions. In such cases, Professors Tversky and Kahneman wrote in 1981, “the adoption of a decision frame is an ethically significant act.”
Policy makers have long recognized the potential danger of false statements by advertisers. ... But what about merely irrelevant statements, or only implicitly misleading ones? ... Such ads make no explicitly false claims, but that doesn’t make them less misleading, even for informed consumers. ... [P]oliticians employ patently false statements to shift the terms of important public debates. Of course, politicians of both parties have long taken liberties with the truth. But ... Republicans have lately been far more aggressive in stretching traditional boundaries. ...
Can anything be done? For a variety of practical reasons, legal sanctions promise little protection against blatantly false statements. It is helpful, to be sure, when journalists call out politicians who stray too far from the truth. But merely knowing that a statement is false doesn’t nullify its impact. To be effective, a remedy must ... discourage people from making false statements in the first place.
Economists have long recognized that social sanctions are often an effective alternative to legal and regulatory remedies. ... People who know they’ll be ridiculed for telling untruths are more likely to show restraint. ... In recent years, the most conspicuous public falsehoods have been ridiculed by independent bloggers and Comedy Central’s faux news hosts. But television and Internet audiences are highly segmented. Many of Jon Stewart’s targets may never hear his riffs about them, or may even view them as badges of honor.
That’s why it’s important for the circle of critics to widen — and why we need to remember that framing a discussion appropriately is “an ethically significant act.”
I posted this at Maximum Utility a few days ago:
Growth Policy versus Stabilization Policy, by Mark Thoma (with a few minor edits): In macroeconomics, there are two important policy questions, and our attention to one or the other changes with the economic events of each era. One question concerns stabilization policy -- keeping the economy as close as possible to the long-run growth path -- and the other is growth policy, i.e. policy that attempts to maximize the long-run growth rate. (There is also work on whether stability and growth are related. More stable economies could grow faster due to reduced uncertainty, but government intervention to stabilize the economy could also stifle growth according to some models, so the relationship is not clear a priori. In modern models, these are not strictly separable, but it is still a useful way to think about policy conceptually)
We could go back further than this, but let me pick the story up in the 1970s. A few economists were worried about growth at this time, but the main concern during the tumultuous 1970s and early 1980s was with how to do a better job of stabilizing the economy. The traditional Keynesian policies, which had not taken account of inflation or expectations in a satisfactory way, had failed to produce the desired stabilization. This led to the search for a new economic model that could provide better guidance. The result was the development of the New Classical model, replaced soon after by the New Keynesian model when the New Classical could not explain both the duration and magnitude of actual cycles, and it's implication that only unanticipated money matters appeared to be contradicted by actual data.
The New Keynesian model, and its new advice for stabilization policy concerning the use of interest rate rules, seemed to work and we entered into a period known as "The Great Moderation" (stated compactly, the new policy involved targeting an interest rate with a Taylor rule that responds to output and inflation, where the response to inflation was more than one to one). This period, which began in the early 1980s, saw low and stable inflation rates, and a fall in the variation in GDP of around 50 percent. The result was the emergence of the view that the stabilization problem had been solved. By using the correct monetary policy, policymakers had produced the Great Moderation, and that left other policy tools such as fiscal policy free to pursue the maximum growth objective (and the result was supply-side fiscal policies such as cutting capital gains and dividend taxes justified by arguments about their contribution to growth).
Because of this, the profession moved on to growth theory and policy. Stabilization had been solved with monetary policy, and growth was now the major question to be solved. If the economy was still as jittery as it had been in the past, then stabilization policy would have also been of concern to academic economists, but developing optimal monetary policy rules from the New Keynesian structure seemed to have solved that problem.
Of course, recent events show us in no uncertain terms that the stabilization problem has not been solved, and questions about how to stabilize the economy ought to be coming to the forefront again. And they are, to some extent, but I'd argue that our ability to stabilize the economy has been limited by those who still think growth is the only important consideration for evaluating policy. For example, because of this, the stimulus package that was put into place had to be justified by its ability to stimulate long-run growth when its main concern should have been with how to stabilize the economy. That led us to concentrate on tax cuts (because conservatives believe tax cuts increase economic growth) and infrastructure spending. However, tax cuts of the type that were implemented are mostly saved, and infrastructure spending takes much too long to put into place (and may not generate as much employment per dollar as other types of spending). These are not optimal stabilization policies. Other types of spending, the types that get money into people's hands and puts people to work right away, might have worked faster and had a greater benefit in terms of moving the economy closer to trend, but since these policies were harder to justify in terms of their contribution to long-run growth. Therefore, they could not find the support they needed.
I believe that stability is important to people (i.e. that utility is lower when there is more economic uncertainty), and because of this stabilization policy can be justified on its own terms, there's no reason to insist that stabilization policy maximize growth. The policies that maximize growth are different in some cases from the polices that stabilize the economy, and insistence that all policies can be justified by their contribution to long-run growth causes us to sacrifice economic stability. The policies we put into place should pay attention to both goals, but I believe we have paid far too much attention to growth in formulating recent policy, and not nearly enough to stability.
Hopefully, recent events will begin to shift our thinking away from the "growth above all else" policies we've pursued since the early 1980s, and that we will devote more attention to stabilization policy. We can put people back to work faster than we did this time around, and we can do a better job of increasing aggregate demand early in the recession (thereby reducing the fall in GDP and employment). But to do so we have to realize that stabilization is an important policy goal, and that it does not always lead to the same policies that are needed to maximize growth. People's lives, or at least their livelihoods, depend on it.
Saturday, May 29, 2010
Brad DeLong gives an example of what economic historians and economic history has to contribute to the understanding of and response to financial crises:
A Missing Macroeconomic Playbook?, by Brad DeLong: I am reminded of the extraordinary gulf between economics as I see it and economics as at least some others see it when I read things like Narayana Kocherlakota's opening paragraph:
Modern Macroeconomic Models as Tools for Economic Policy: I believe that during the last financial crisis, macroeconomists (and I include myself among them) failed the country, and indeed the world. In September 2008, central bankers were in desperate need of a playbook that offered a systematic plan of attack to deal with fast-evolving circumstances. Macroeconomics should have been able to provide that playbook. It could not. Of course, from a longer view, macroeconomists let policymakers down much earlier, because they did not provide policymakers with rules to avoid the circumstances that led to the global financial meltdown...
My reaction to this is the old one: "Huh?!"
For "macroeconomics" did and does have a playbook that offered a systematic plan of attack to deal with fast-evolving circumstances. The playbook was first drafted back in 1825, during the bursting of Britain's canal bubble.
Let me briefly set out what the macro playbook is, and how it has been developed by economists and policymakers over the past 185 years. Start with Say's or Walras's Law: the circular flow principle that everybody's expenditure is someone else's income--ands everyone's income is somebody else's expenditure. It has to be that way...
How, then, can you have a depression--a "general glut," a situation in which there is excess supply of not one or a few but all commodity goods and services? How can you have a situation in which workers laid off from shrinking industries where demand is less than was expected and thus less than supply are not rapidly hired into industries where demand is more than was expected and hence more than supply?
Moral philosopher, libertarian, colonial bureaucrat, feminist, public intellectual, and economist John Stuart Mill put his finger on the answer in a piece he published in 1844:
[T]hose who have... affirmed that there was an excess of all commodities, never pretended that money was one of these commodities.... [P]ersons in general, at that particular time, from a general expectation of being called upon to meet sudden demands, liked better to possess money than any other commodity. Money, consequently, was in request, and all other commodities were in comparative disrepute. In extreme cases, money is collected in masses, and hoarded; in the milder cases, people merely defer parting with their money, or coming under any new engagements to part with it. But the result is, that all commodities fall in price, or become unsaleable...
Mill was thus explicitly refuting the older French economist Jean-Baptiste Say. ... In 1821 Say published his Letters to Mr. Malthus, in which he argued that the very idea of a "general glut" was self-contradictory, for the very fact that commodities had been produced meant that there was sufficient demand in aggregate to buy them...
Say was thus the first of a long line of economists to argue that the fact that something that appeared to exist in reality could not really be there because it was inconsistent with his theory.
In a normal microeconomic case of market adjustment--excess supply of one good and excess demand for another--it is clear how adjustment proceeds. Those entrepreneurs making the good in excess supply find themselves selling for less than their costs and so losing money. They cut back on the wages they pay and dismiss workers. But this is not a tragedy, because the profits they have lost have gone into the pockets of entrepreneurs in expanding industries, who are eager to expand production, raise wages, and hire more workers. After a short time the structure of production is better-suited to make what people want, and wages and profits in total are higher than if the structure of production had remained frozen in its old pattern.
But what if there is a general glut of commodities? What if the excess supply is for pretty much all goods and services, and the excess demand is for liquid cash or for safe investments that will not lose their value no matter what? How do you expand labor employed in the liquid cash-creating or in the AAA asset-creating businesses to make more of such assets?
One possibility is to rely on the private sector, saying: risky assets are at a discount and safe assets a premium? Good!
Make the profits from creating safe assets large enough, and Goldman Sachs and company will find a way. ... They will hire people to shuffle the papers. They will finance enterprises, and then slice and dice the cash flows from those enterprises in order to create lots of AAA-rated securities. And when they do, the excess demand for safe assets will be satisfied...
You say nobody trusts Goldman Sachs or Standard and Poor's when they say: "we know we lied last time when we warranted that the assets we were selling were AAA, but this time for sure!!"? Well, how about investing abroad? There are still lots of AAA assets out there in the wider world. Suppose everybody devalues, puts people to work in newly-competitive export industries, and thus runs an export surplus and, in exchange, imports AAA assets from abroad for our savers and investors to hold.
I see. Everybody can't devalue at once. Greece can run an export surplus only if Germany is willing to run an import surplus. The United States can boost its net exports only if China shrinks its own.
Maybe we could ship millions of our citizens to South Africa equipped with picks and shovels and put them to work as gastarbeiteren mining the gold of the Witwatersrand?
I know! Let's cut the price of every good and service by 25%! Then our same stock of nominal AAA assets will meet a 33% larger demand for real AAA assets, and there will be no excess demand for safe assets, and thus no excess supply of goods and services! The problem with this "solution" is that "money" is not just a medium of exchange and a store of value, it is also a unit of account. ... A lot of people have debts denominated in money and were counting on selling their goods and their labor at something like their previous prices to pay off their mortgages, their loans, and their bonds. A whole bunch of assets that were AAA before the decline in the price level are no longer AAA. You haven't fixed the imbalance. Each nominal AAA asset does indeed satisfy a larger slice of demand for real AAA assets as a result of the price-level decline. But the price level decline has shrunk the (nominal) supply of AAA assets just as it has shrunk the (nominal) demand for them. And how have you managed to reduce nominal wages and prices? By years if not decades of idle capacity and high unemployment.
So now--drumroll--it is time to pull the rabbit out of the hat. The solution is... the government! The government has the power to tax! And so the government can make AAA assets when nobody else can!
Or the government can until and unless the assets that it has created for others to hold--which are its debts--rise to the point where people begin to get nervous about whether the government's taxing power will actually be deployed in the end to repay those debts--and we in the United States are still very far from that point (although we in Greece are not).
The first and easiest way for the government to create more safe assets is for the central bank to create them by buying up risky assets for safe ones via open-market operations or lending cash and taking other, riskier assets as its sole security. As Walter Bagehot wrote about the Panic of 1825:
The way in which the panic of 1825 was stopped by advancing money has been described in so broad and graphic a way that the passage has become classical. 'We lent it,' said Mr. Harman... [one of the Directors] of the Bank of England:
by every possible means and in modes we had never adopted before; we took in stock on security, we purchased Exchequer bills, we made advances on Exchequer bills, we not only discounted outright, but we made advances on the deposit of bills of exchange to an immense amount, in short, by every possible means consistent with the safety of the Bank, and we were not on some occasions over-nice. Seeing the dreadful state in which the public were, we rendered every assistance in our power...
Since the fall of 2007 the central banks and the Treasuries of the world have been following this playbook. They have expanded the supply of safe assets via open-market operations... They have topped up bank capital. They have guaranteed private-sector loans. They have swapped in risky private-sector debt in exchange for government bonds. They have--via expansionary fiscal policy--printed up huge honking additional tranches of government bonds and used the money raised to pull forward government spending and push back taxes.
Now it may be that we are creeping up on the point at which government debts are rising to the limits of politically-limited debt capacity. But that does not mean that the playbook comes to an end. Indeed, Ricardo Caballero is writing a new chapter about how even now governments can go on:
expanding the real supply of AAA assets.... [So far] governments in safe-asset-producing countries [have] produce[d] a lot more of them.... [We could also] let the private sector create the AAA assets... [with] governments... absorb[ing]... risk the private sector cannot handle... Currently the focus (implicitly) is [still] on the former strategy. ... However... at some point it will make sense to decouple fiscal deficits from asset production.... The US Treasury... [could] start buying riskier private assets rather than running fiscal deficits as the counterpart for its supply of Treasuries to the market.... [A] sounder medium-term strategy than the purely public approach... [is to use] the securitisation industry... [I]f the government only provides an explicit insurance against systemic events to the micro-AAA assets produced by the private sector, we could have a significant expansion in the supply of safe assets without the corresponding expansion of public debt...
by formalizing and making explicit what Charles Kindleberger always called their commitment to act as lender of last resort when systemic risk came calling.
The playbook is old and well-established, and has been put to effective use.
That Narayana Kocherlakota and company did not know it existed--that he and his circle had never studied Kindleberger and Minsky, let alone Fisher and Bagehot and Mill, and knew Keynes and Hicks only as straw men to be ritually denounced as sources of error rather than smart people to be listened to--will doubtless appear to future generations as an interesting episode in the history of political economy. But nobody should confuse the failure of Kocherlakota's branch of macroeconomics with the failure of macroeconomics in general.
It's interesting that as we add the appropriate tweaks to modern models and then ask them these questions, in most cases the old wisdom emerges as the answer.
I'm not sure that, in general, people were as unaware of this work as Brad implies. In some cases that was true, certainly, particularly given the fading attention to economic history within economics programs. But some programs still emphasize economic history, e.g. Berkeley,, and I'd hope Brad's students have been made aware of this work.
So it wasn't complete ignorance. But those who did know about this work discounted it. They found a way to argue that we had moved on from old models for good reason, that taking such advice from the past would be a step backwards. It was the arrogance that the present had nothing to learn from the past as much as ignorance of what the past had to say that caused policymakers to respond to the crisis with a deer in the headlights, "oh no my models have nothing to say about this," manner. After all, if the proponents of modern macro had thought there was something to be learned from the Kindlebergers and Bagehots of the past, then those who were ignorant of what they had to say would have already read and absorbed this work. The fact that they didn't gives an indication of the value they thought it had. Hopefully that assessment has changed.
Claude Fischer is a sociologist at UC Berkeley:
Angry old white men, by Claude Fischer, Berkeley Blog: The April, 2010, New York Times survey of Tea Party supporters found that they skew toward male, white, and old. Journalists’ reports on Tea Party events suggest that TPA activists skew even more those ways. The reports also suggest that TPA activists hold a wide set of grievances far beyond their objections to taxes and to Obama. They demand to have their “country back.”
Dispossessed in the household
18th-Century America was a society of households each ruled by a property-owning white man. Just about everyone else – wives, children (including older boys awaiting their own households), servants, slaves, apprentices, farm hands, spinsters, widows, orphans of relatives, and the destitute whom the town officers had “bound out” – lived or were supposed to live under the legal, political, and moral authority of a patriarch. ... Occasionally, town officials would remind lax men to rule their households with a tighter fist, if, for example, their servants misbehaved or their wives were too proud.
Over the course of American history, these dependents – perhaps most importantly, the women – became increasingly independent. Generation after generation, the patriarchs lost more and more power over those dependents. (Historian Carole Shammas wrote a particularly nifty, short book on this topic.) Wives, for example, gained some control over their own property and a greater right to divorce; young men – and young women – grasped independence by leaving farms for emerging industrial jobs; journeymen moved out of the masters’ houses to their own homes; and so on.
As with most social changes, the dispossession appeared first among the more affluent and educated classes. In the 19th century, couples in these groups “re-negotiated” the terms of households. Wives took on greater authority in the home by, for example, displacing fathers in the role of premier moral instructor to children. In the latter part of the century, observers applauded a new trend: More middle-class men were going straight home to their families after work, bypassing the bar or men’s club, and there participating in the emerging sentimental, “feminized” family. (Margaret Marsh tells the homecoming story here and here.) Many historians describe this as the era when middle-class men were “domesticated.” We could also say dispossessed.
Such trends spread slowly and for much of working-class, immigrant, and rural America, it took much longer. But by the end of the 20th century, women and youths were independent everywhere. Older men no longer could simply command and be obeyed.
Dispossessed in the community
Roughly in parallel, the power of older, property-holding, white men over the wider community also waned: Propertyless men gained the right to vote, grassroots religious movements (fueled if not led by women) challenged established church leadership, slaves were freed, immigrants flooded into politics, employees organized against their bosses, women voted, courts discovered more and more individual rights – including the rights of children against their parents, an emerging welfare state gave workers new options..., and minorities of all sorts who had once known “their place” stepped out, organized, spoke up, and successfully pressed their claims. Old white guys, especially affluent, Protestant ones, had to give ground. No wonder they’re ticked.
It is a delicious irony that currently the lead spokesperson for angry old white men is a bodacious, young, entrepreneurial woman. But when Sarah Palin energizes claims to “take back” the country, she is pressing to give the country back to the angry old white men.
I've been thinking about the extent to which the tea party movement represents resistance to and resentment over waning power in rural America. Obama is a symbol of a shift toward urban interests. Rural America senses that he represents a major shift in the political landscape, one that will no longer put the white male farmer at the center of the American political landscape. Even though the majority of the population moved to cities long ago, the rural myth persisted in American politics. The "small town values" that politicians pay so much attention to is a reflection of this, and Obama is a signal that the special place rural America holds in American politics is coming to an end.
Friday, May 28, 2010
Making this point once again may be redundant and a bit tedious, but it's an important issue and, unfortunately, the pendulum seems to be swinging the other way, i.e. in favor of the deficit hawks (plus, about to hit the road for a few hours and this is all I have):
Why Deficit Hawks Are Killing the Recovery, by Robert Reich: Consumer spending is 70 percent of the American economy, so if consumers can’t or won’t spend we’re back in the soup. Yet the government just reported that consumer spending stalled in April – the first month consumers didn’t up their spending since last September. Instead, consumers boosted their savings, probably because they’re worried about the slow pace of job growth..., as well as a lackluster “recovery.” They’re also still carrying enormous debt burdens. One in four home owners is still underwater. And median wages are going nowhere.
So what’s Congress doing to stoke the economy as consumers pull back? In a word, nothing. Democratic House leaders yesterday shrank their jobs bill to a droplet. They jettisoned proposed subsidies to help the unemployed buy health insurance, as well as higher matching funds for state-run health programs such as Medicaid. And they trimmed extended unemployment insurance.
“Members who are from low unemployment areas are very concerned about the deficit,” Nancy Pelosi explained. She might have added that so-called Blue Dog Democrats have the same warped view of fiscal policy as most Republicans. They fail to distinguish between short-term deficits (good) and long-term debt (bad).
Deficit-cutting fever has also struck the Senate – except when it comes to the military, of course. Last night the Senate okayed a $60 billion war-funding bill for Afghanistan. So far this year, the Afghan war has cost more than the war in Iraq... But spending on road-building in Afghanistan does little to boost the American economy.
Meanwhile, state and local governments continue to slash and burn. They’re laying off even more teachers, fire fighters, social workers, and police; canceling more programs for the poor and working class; and raising sales taxes. The fiscal drag from all of this will be around $150 billion in 2010.
Without consumers opening their wallets, and without government making up the difference, we’re careening toward a double-dip recession. The long-term deficit (i.e. Medicare as boomers become seniors) needs attention, but right now it’s critical for government to spend. Otherwise we have no hope of getting free of the gravitational pull of this recession.
Paul Krugman is on vacation, so I essentially picked an article randomly (by date) from the PKarchive. This column appeared December 6, 2002. Not much has changed:
Digital Robber Barons?, by Paul Krugman, Commentary, NY Times: Bad metaphors make bad policy. Everyone talks about the "information highway." But in economic terms the telecommunications network resembles not a highway but the railroad industry of the robber-baron era — that is, before it faced effective competition from trucking. And railroads eventually faced tough regulation, for good reason: they had a lot of market power, and often abused it.
Yet the people making choices today about the future of the Internet — above all Michael Powell, chairman of the Federal Communications Commission — seem unaware of this history. They are full of enthusiasm for the wonders of deregulation, dismissive of concerns about market power. And meanwhile tomorrow's robber barons are fortifying their castles.
Until recently, the Internet seemed the very embodiment of the free-market ideal — a place where thousands of service providers competed, where anyone could visit any site. And the tech sector was a fertile breeding ground for libertarian ideology, with many techies asserting that they needed neither help nor regulation from Washington.
But the wide-open, competitive world of the dial-up Internet depended on the very government regulation so many Internet enthusiasts decried. Local phone service is a natural monopoly, and in an unregulated world local phone monopolies would probably insist that you use their dial-up service. The reason you have a choice is that they are required to act as common carriers, allowing independent service providers to use their lines.
A few years ago everyone expected the same story to unfold in broadband. The Telecommunications Act of 1996 was supposed to create a highly competitive broadband industry. But it was a botched job; the promised competition never materialized.
For example, I personally have no choice at all: if I want broadband, the Internet service provided by my local cable company is it. I'm like a 19th-century farmer who had to ship his grain on the Union Pacific, or not at all. If I lived closer to a telephone exchange, or had a clear view of the Southern sky, I might have some alternatives. But there are only a few places in the U.S. where there is effective broadband competition.
And that's probably the way it will stay. The political will to fix the 1996 act, to create in broadband the kind of freewheeling environment that many Internet users still take for granted, has evaporated.
Last March the F.C.C. used linguistic trickery — defining cable Internet access as an "information service" rather than as telecommunications — to exempt cable companies from the requirement to act as common carriers. The commission will probably make a similar ruling on DSL service, which runs over lines owned by your local phone company. The result will be a system in which most families and businesses will have no more choice about how to reach cyberspace than a typical 19th-century farmer had about which railroad would carry his grain.
There were and are alternatives. We could have restored competition by breaking up the broadband industry, restricting local phone and cable companies to the business of selling space on their lines to independent Internet service providers. Or we could have accepted limited competition, and regulated Internet providers the way we used to regulate AT&T. But right now we seem to be heading for a system without either effective competition or regulation.
Worse yet, the F.C.C. has been steadily lifting restrictions on cross-ownership of media and communications companies. The day when a single conglomerate could own your local newspaper, several of your local TV channels, your cable company and your phone company — and offer your only route to the Internet — may not be far off.
The result of all this will probably be exorbitant access charges, but that's the least of it. Broadband providers that face neither effective competition nor regulation may well make it difficult for their customers to get access to sites outside their proprietary domain — ending the Internet as we know it. And there's a political dimension too. What happens when a few media conglomerates control not only what you can watch, but what you can download?
There's still time to rethink; a fair number of Congressmen, from both parties, have misgivings about Mr. Powell's current direction. But time is running out.
One way to induce competition is to follow the model used for phone services and force internet service providers to sell their services at wholesale rates to other providers (e.g., see unbundled network elements). In any case, there's no reason why there should be so little competition in this industry other than political power that these firms have.
Christina Romer makes the case for helping states keep teachers in the classroom:
How to prevent huge teacher layoffs, by Christina D. Romer, Commentary, Washington Post: The emergency spending bill before the House would address the education crisis facing communities across America -- and the jobs of hundreds of thousands of teachers are at stake. Because ... state and local budgets are stressed to the breaking point..., hundreds of thousands of public school teachers are likely to be laid off over the next few months. As many as one out of every 15 teachers could receive a pink slip this summer...
Additional federal aid targeted at preventing these layoffs can play a critical role in combating the crisis. Such aid would be very cost-effective. There are no hiring or setup costs. The teachers are there, eager to stay in their classrooms. ...
Furthermore, by preventing layoffs, we would save on unemployment insurance payments, food stamps and COBRA subsidies for health insurance, and we would maintain tax revenue. Accounting for these savings, the actual cost of the program is likely to be 20 to 40 percent below the sticker price...
Yes, we all understand that our budget deficit is too large. ... But it would be penny-wise and pound-foolish to deal with that issue by failing to allot essential spending on teachers at a time when the unemployment rate is still near 10 percent.
The right way to deal with a budget problem that was years in the making is by formulating a credible plan to reduce the deficit over time and as the economy is able to withstand the necessary fiscal belt-tightening. ...
And here's the response:
Bill on jobless benefits, state financial help scaled back, by Lori Montgomery, Washington Post: Under fire from rank-and-file Democrats worried about the soaring national debt, congressional leaders reached a tentative agreement Wednesday to scale back a package that would have devoted nearly $200 billion to jobless benefits and other economic provisions...
After struggling throughout the day to reach a compromise, House leaders scheduled a Thursday vote on the slimmed-down package in hopes of pushing it through both chambers before the 10-day Memorial Day recess...
But the ultimate fate of the package was unclear as Republicans stepped up efforts to paint it as irresponsible when the recession and its aftermath are driving the nation deeply into debt -- a concern many Democrats share. ...
"This is fiscal recklessness. And that's why even some Democrats are starting to revolt," Senate Minority Leader Mitch McConnell (R-Ky.) said...
Senate Majority Leader Harry M. Reid (D-Nev.) was noncommittal when pressed by reporters about the tax bill's chances in his chamber. ... While expressing confidence that some form of the legislation would pass, Reid said he had yet to secure commitments from any Republicans. At least one GOP senator must defect...
But Reid said the Senate would at the very least approve an unemployment extension before adjourning this weekend. "We can't leave here unless we address that issue," he said.
The deficit hawks generally talk about the fate of our children when making the case to reduce the deficit, but at a time like now when the recession is pressuring school budgets, how are kids helped by reducing their educational opportunities?
More on recent trends in education:
Economic segregation rising in US public schools, by Stacy Teicher Khadaroo, csmonitor.com: ...The portion of schools where at least three-quarters of students are eligible for free or reduced-price meals – a proxy for poverty – climbed from 12 percent in 2000 to 17 percent in 2008.
The federal government released a statistical portrait of these schools Thursday as part of its annual Condition of Education report. When it comes to educational opportunities and achievement, the report shows a stark contrast between students in high-poverty and low-poverty schools (those where 25 percent or less are poor).
Economic segregation is on the rise in American schools, and that “separation of rich and poor is the fountainhead of inequality,” says Richard Kahlenberg, a senior fellow at The Century Foundation... High-poverty schools “get worse teachers ... are more chaotic ... [have] lower levels of parental involvement ... and lower expectations than at middle-class schools – all of which translate into lower levels of achievement.”
Cities aren’t the only places facing this challenge: Forty percent of urban elementary schools have high poverty rates, but 13 percent of suburban and 10 percent of rural elementary schools do as well. In some states – Mississippi, Louisiana, and New Mexico – concentrated poverty affects more than one-third of K-12 schools.
Hispanic and black children make up the majority of students in high-poverty schools – 46 percent and 34 percent, respectively, compared with just 14 percent white and 4 percent Asian/Pacific Islander. ...
“There have been gains in achievement in high-poverty schools over the last decade or so ... but what we don’t see in most cases is a closing of the gap,” says Daria Hall, director of K-12 policy at the Education Trust in Washington...
In graduation rates, there’s actually been a backward slide. In 2008, high-poverty schools reported that 68 percent of seniors graduated the previous year, compared with 86 percent in 2000. For students in low-poverty schools, the rate remained about 91 percent.
Solutions have been hard to come by... While efforts to improve high-poverty schools are valiant, they’ve haven’t worked very well...
Thursday, May 27, 2010
David Andolfatto responds to my recent posts and sets me straight about his beliefs on fiscal policy and other matters. It turns out that I didn’t represent them accurately, something I try to avoid. As he notes below, he is neither for nor against fiscal policy, and remains agnostic about its use. His main point is that different models give different conclusions, some such as Woodford and Eggertsson are quite supportive of fiscal policy while others are not. His objection is about taking the word of one model over another when we really don't have the evidence to know which model is best. That's a fair point. I should also acknowledge, as many people have pointed out, that it’s possible to find shrill, over the top attacks on all sides of the debate on macroeconomic policy:
Taken Out Behind the Woodshed, by David Andolfatto : Been out of commission for a while. (Had Lasik surgery on Monday -- I can actually see now -- which will no doubt please those who accuse me of blindness). And I have just now read the replies to my previous two posts. Not very pretty. I'll have a few things to say about this. Before I begin though, I would like to take a moment to thank all my supporters out there: thanks...you've both been great!
When I originally contemplated the idea of Macromania, I thought it might be a cheap and interesting way to learn a few things. By and large, it has turned out to be a successful experiment (for me personally, at least).
But not everything in the experiment has turned out well. My more thoughtful postings were met with thoughtful replies, followed by fruitful discussion. My more childish personal attacks on people I did not even know were met by counterattacks of a similar nature by people who do not even know me. I am now reminded of a useful Bible lesson: As you sow so shall you reap.
There is nothing wrong, I think, with the harsh criticism of an idea. Having a stupid idea does not make one stupid. But it is another thing altogether when one criticizes a person. And here I confess to having gone too far. There are probably times and places where personal attacks might be justified, but I don't want Macromania to be a venue for that sort of activity. Nothing good comes of it.
So I would like to clear the air. Both Paul Krugman and Brad DeLong deserve far more respect that what I afforded them. (Let me also toss Ron Paul in there, who has at times found himself in my crosshairs). My ego is not so large as to expect that they would welcome an apology from me. But I would like to apologize nevertheless, for the record, if for nothing else.
And while I'm clearing the air, I would like to reply to Mark Thoma's post here. Mark takes some justified jabs at me. But he also misrepresents me along a few dimensions. Again, for the record:
 I am neither for nor against fiscal stimulus in the form of government purchases to combat a peacetime economic crisis (I have repeatedly said that I am an agnostic whose beliefs on the matter vary over time as I am exposed to more evidence). I have, in fact, made arguments elsewhere in favor of fiscal policy as a redistributive mechanism (but sadly, in my view, redistribution is never mentioned in this debate; it's all about the effect of G on Y).
 What I am against is the practice (perhaps it is unintended or simply a product of my imagination) of seducing the public into thinking that our "science is settled" on any given question. Greg Mankiw's more cautious approach as exhibited here teaches us how to persuade without being dogmatic.
 I have never, as far as I can remember, disputed the logic of fiscal stimulus in a NK model with zero nominal interest rates. But the NK model is not the only game in town. There are competing frameworks (for example, the so-called New Monetarist framework) that are no less plausible and may deliver very different answers to the same policy question. We need to keep an open mind and avoid making bold assertions on the basis of a single model.
OK, now let's go do some economics.
Brad DeLong argues the world wants more safe financial assets, and that governments ought to provide them:
The Flight to Quality, by J. Bradford DeLong, Commentary, Project Syndicate: In late May, the yield to maturity of the 30-year United States Treasury bond was 4.07% per year – down a full half a percentage point since the start of the month. That means that a 30-year Treasury bond had jumped in price by more than 15%. ... This signals ... an extraordinary rise in market-wide excess demand for such assets.
Why does this matter? Because, as economist John Stuart Mill wrote in the first half of the nineteenth century, excess demand for cash (or for some broader range of high-quality and liquid assets) is excess supply of everything else. What economists three generations later were to call Walras’s Law is the principle that any market in which people are planning to buy more than is for sale must be counterbalanced by a market or markets in which people are planning to buy less.
We have seen this principle in action since the early fall of 2007, as growing excess demand for safe, liquid, high-quality financial assets has carried with it growing excess supply for the goods and services... And global financial markets are now telling us that this excess demand for safe, liquid, high-quality financial assets has just gotten bigger. ...
But most of the recent shift has come not from an increase in demand for safe, liquid, high-quality financial assets, but from a decrease in supply: six months ago, bonds issued by the governments of southern Europe were regarded as among the high-quality assets in the world economy that one could safely and securely hold; now they are not. ...
When there is excess demand for safe, liquid, high-quality financial assets, the rule for which economic policy to pursue – if, that is, you want to avoid a deeper depression – has been well-established since 1825. If the market wants more safe, high-quality, liquid financial assets, give the market what it wants.
After all,... a market tells us which things are valuable and thus gives us the signal to make more of them. ... So those governments whose credit is still unshaken ... should be creating a lot more of them. ...
How much should they do? As long as there is a clear global excess supply of goods and services – as long as unemployment remains highly elevated and inflation rates are falling – they are not doing enough. And the gap between what they should be doing and what they are doing grew markedly in May.
This isn’t rocket science or capping deep-sea oil blowouts. These are problems that we have long known how to solve.
New post at MoneyWatch:
Tax cuts can be particularly helpful in "balance sheet recessions".
Marshall Auerback takes on the deficit hawks:
Deficit Hawk Hypocrisy, by Marshall Auerback: Harold Meyerson is spot on: “Of all the gaps between elite and mass opinion in America today, perhaps the greatest is this: The elites don’t really believe we’re still in recession. Or maybe, they just don’t care.” What is even more galling is that, having been the greatest beneficiaries of the government’s largesse over the past 2 years, these very same people now decry the government’s “irresponsible” and “unsustainable” fiscal policy.
The collective amnesia and moral turpitude of these elites is truly mind-boggling.
Why do we have a deficit of about 10% of GDP right now when it was less than 2% about 3 years ago? The reasons are: the Obama stimulus, the TARP, and the slower economy (which arose in response to a major financial crisis, not because the government began an irrational and irresponsible spending binge). A slower economy leads to lower revenues ... and higher spending on the social safety net.
Conveniently lost in all of this furor about the deficit are the beneficiaries of this recent government largesse. It’s certainly not the unemployed or the vast majority of people who do not work in the financial services industry.
And let’s stop with the now prevailing meme (regurgitated most recently in John Heilemann’s New Yorker Magazine piece, “Obama is from Mars, Wall Street is from Venus”) that the costs of the financial bailout are minimal thanks to the “successful” measures taken to “save” our financial system (as if it is worth saving in its current incarnation). With the conspicuous exception of Simon Johnson, virtually all analysts fail to factor in the fact that our public debt to GDP ratio has moved from 40% of GDP to 90% in the space of 2 years, directly as a consequence of the crisis of 2008.
Naturally, the deficit terrorists are now out in force about this fact, conveniently forgetting the underlying cause of this increase. So are the journalists who cover it, Meyerson being a conspicuous exception. In a market economy, where most of us have to work to make a material living, the threats posed by the likes of Pete Peterson and the deficit hawk brigade represent a true impingement on our right to work. As my friend Bill Mitchell notes, “the neo-liberals deliberately undermine the right to work of millions and force them into a state of welfare dependence and then start hacking into the welfare system to deny them the pittance that the system delivers.” ...
What will happen to the deficit as and when the economy finally improves? The Obama stimulus and TARP go away in a few years regardless. Tax revenues increase and safety net spending falls. We’re back to “normal” with deficits around 2-4% depending on the state of the economy, which is where we’ve been for the past 30 years aside from 1998-2001. Even CBO agrees, though what happens to the Bush tax cuts will have an effect of about + or - 2% of GDP (depending on whether they are extended or ended, respectively).
In fact, full employment is also the best “financial stability” reform we could implement, because with jobs growth comes higher income growth and a corresponding ability to service debt. That means less write-offs for banks and a correspondingly smaller need to provide government bailouts.
Fiscal austerity, by contrast, won’t cut it. Our elites seem think that you can cut “wasteful government spending” (that is, reduce private demand further) and cut wages and hence private incomes and not expect major multiplier effects to make things significantly worse. Of course, that “wasteful”, “unsustainable” spending never seems to apply to the Department of Defense, where we always seem to be able to appropriate a few billion, whenever necessary. “Affordability” principles never extend to the Pentagon, it appears.
Our policy-making elites also seem to have bought the IMF line that the fiscal multipliers are relatively low and that the automatic stabilizers (working to increase deficits as GDP falls) will not drown out the discretionary cuts in net spending arising from the austerity packages. The overwhelming evidence is that this viewpoint is wrong and implementation of policies based on it cause generational damages in lost output, lost incomes, bankruptcy and lost employment (especially denying new entrants from the schooling system a robust start to their working life).
The real issue is that those who are better off don’t want to have government intervention in economic affairs unless it benefits them. With typical ingratitude, Wall Street is now threatening to cut campaign donations for Obama and the Democrats because of their proposals to impose more regulation on the financial sector. However, when the government intervenes with bailouts, Wall Street stands first in the queue, cap in hand. No one wants to bear the actual discipline of markets if that means losses. Those at the high end of income distribution aren’t against every kind of government intervention, but are frequently against certain types of government intervention that might make the workers stronger, or create competition for private businesses (in the case of a public option in health care reform, for example).
Full employment is the real value that should guide economic policy, not the bogus emphasis on financial ratios that just play into the hands of the financial sector. Somehow, I doubt that this is the underlying principle guiding our “counsel of wise men” who are deliberating the future of Social Security and Medicare behind closed doors as the rest of us debate this issue in the open.
What Economic Policies Should Government Pursue During the Recovery?, Maximum Utility: Now that the economy appears to be turning around, how should the government react? What types of policies are needed for the recovery period?
1. Things look better now. Almost all economic indicators are beginning to point upward, but we don't know yet if the recovery will be strong or weak, or if we might be headed for a double dip. For that reason, don't pull back on monetary and fiscal stimulus too soon. It will be tempting to listen to the deficit and inflation hawks as things start to improve, but it's important that the stimulus not be withdrawn before the economy can stand on its own.
2. If the recovery seems to be very slow or stagnating, don't be afraid to give the economy the additional help it needs. Output is starting to grow, but labor markets are lagging behind. It's not yet clear if the lag will be as large as in the previous two recessions, but it's certainly something to keep an eye on.
3. Similarly, there is a huge jobs backlog -- millions and millions of people have lost jobs during this recession -- and it will take a considerable amount of time to reemploy these workers even under strong labor market conditions. Workers will still need unemployment compensation, help with health care, and other social services until they can find work. They are not lazy or playing the system, it's just that the applicant to jobs ratio will remain high until the backlog is cleared, so don't cut them off too soon.
4. If the government does try to take an active rather than a passive role in the recovery, try to anticipate what the post-recession economy will look like and help with the adjustment. For example, there is lots of structural unemployment due to the scaling down of the housing and financial industries. Where will these workers go and what can the government do to help them get there? Will we need to rely upon exports to a greater degree than before the recession in order to maintain robust growth? If so, what can the government do to help this sector to develop? I don't mean the the government should try to manage the economy with a heavy handed industrial policy approach, but when it's clear that change is coming to a particular sector, then the government should do what it can to help (or at least get out of the way).
5. As the economy recovers, it will be easy to forget about the problems we had and what caused them. Don't let exuberance over the recovery get in the way of making the changes that need to be made to try to prevent this from happening again. All of the promises to do better that are made when things are really bad are easily forgotten once things improve.
6. When the time comes -- but not a moment before that -- policy must be reversed. The fiscal policy measures involving both government spending and tax cuts were sold as "targeted, timely, and temporary." We could have done better at the targeted and timely part, but it's not too late to make it temporary. It will be difficult to cut the stimulus once it's clear that the economy has recovered, there will be an outcry about the jobs that will be lost, the decline in growth, etc., but it's important that we do it. First, there are theoretical reasons to believe that temporary fiscal policy has a much larger effect than permanent changes within modern, New Keynesian structures. Second, we may need fiscal policy again someday. If we don't keep out promises and reverse the spending and tax cuts, the next time fiscal policy is needed nobody will believe that will actually be temporary no matter what is promised, and that will make it much more difficult to pursue the policy that is needed.
Update: 7. State and local governments are still having trouble, and are likely to continue to struggle at least through the next fiscal year. If they don't get more help, this create a big drag on the recovery.
This is surely incomplete. What else should be on the list?
Wednesday, May 26, 2010
Frank Barry at the Irish Economy Blog:
Keynes in Ireland, by Frank Barry, Irish Economy Blog: Keynes’ famous lecture on economic experimentation, delivered at UCD in April 1933, has recently become available online.
If you can't access that copy -- I couldn't -- it turns out it was already online elsewhere. It's an interesting essay:
John Maynard Keynes, "National Self-Sufficiency," The Yale Review, Vol. 22, no. 4 (June 1933), pp. 755-769: I was brought up, like most Englishmen, to respect free trade not only as an economic doctrine which a rational and instructed person could not doubt, but almost as a part of the moral law. I regarded ordinary departures from it as being at the same time an imbecility and an outrage. I thought England's unshakable free trade convictions, maintained for nearly a hundred years, to be both the explanation before man and the justification before Heaven of her economic supremacy. As lately as 1923 I was writing that free trade was based on fundamental "truths" which, stated with their due qualifications, no one can dispute who is capable of understanding the meaning of the words."
Looking again to-day at the statements of these fundamental truths which I then gave, I do not find myself disputing them. Yet the orientation of my mind is changed; and I share this change of mind with many others. Partly, indeed my background of economic theory is modified; I should not charge Mr. Baldwin, as I did then, with being "a victim of the Protectionist fallacy in its crudest form" because he believed that, in the existing conditions, a tariff might do something to diminish British unemployment. But mainly I attribute my change of outlook to something else--to my hopes and fears and preoccupations, along with those of many or most, I believe, of this generation throughout the world, being different from what they were. It is a long business to shuffle out of the mental habits of the prewar nineteenth-century world. It is astonishing what a bundle of obsolete habiliments one's mind drags round even after the center of consciousness has been shifted. But to-day at last, one-third of the way through the twentieth century, we are most of us escaping from the nineteenth; and by the time we reach its mid point, it may be that our habits of mind and what we care about will be as different from nineteenth-century methods and values as each other century's has been from its predecessor's.
It may be useful, therefore, to attempt some sort of a stocktaking, of an analysis, of a diagnosis to discover in what this change of mind essentially consists, and finally to inquire whether, in the confusion of mind which still envelops this new-found enthusiasm of change, we may not be running an unnecessary risk of pouring out with the slops and the swill some pearls of characteristic nineteenth century wisdom.
What did the nineteenth-century free traders, who were among the most idealistic and disinterested of men, believe that they were accomplishing? ...[continue reading]...
With immigration issues coming to the forefront once again, it's a good time to review the evidence on its effects:
The Economics of Immigration Are Not What You Think, by Robert J. Shapiro, NDN [CC]: Waves of new immigrants often spark economic anxiety and cultural discomfort, as well as occasional violence and wide-net crackdowns, on the Arizona model. Even here, a nation comprised almost entirely of immigrants and their descendents, we’ve seen these reactions not only in recent times but also a century ago, when waves of poor immigrants from Europe arrived here. With a hundred years’ distance, however, we can now see that those early waves of immigration were generally associated not with economic dislocation and national decline, but with extraordinary economic boom times and America’s emergence as the world’s leading economy. And for much the same reasons as a century ago, recent evidence indicates that the economic effects of the current waves of immigration are also largely positive.
The New Policy Institute (NPI) asked me to review all of the available data and economic studies of recent U.S. immigration. With my colleague Jiwon Vellucci, we found, to start, that more than one-third of recent immigrants come from Europe and Asia, while less than 57 percent have come from Mexico and other Latin American nations. The popular portrait of recent immigrants is off-point in other respects as well. While more immigrants than native-born Americans lack high school diplomas, equivalent shares of both groups have college or post-college degrees. That finding should make it unsurprising that 28 percent of U.S. immigrants work as managers or professionals, including 38 percent of those who have become naturalized citizens or the same share as native-born Americans.
Many Americans would probably acknowledge that their concerns about immigration lie principally with those who are undocumented. No one likes being reminded that the world’s most powerful nation hasn’t figured out how to effectively police its own borders. But the data also show that these undocumented people, who account for 30 percent of all recent immigrants, embody some traditional values much more than native-born Americans. For example, while undocumented male immigrants are generally low-skilled, they also have the country’s highest labor participation rate: Among working-age men, 94 percent of undocumented immigrants work or actively are seeking work, compared to 83 percent of the native born. One critical reason is that undocumented immigrants are more likely to support traditional families with children: 47 percent of undocumented immigrants today are part of couples with children, compared to just 21 percent of native-born Americans.
The evidence regarding the impact of immigration on wages also turns up some surprising results. First, there’s simply no evidence that the recent waves of immigration have slowed the wage progress of average, native-born American workers. Overall, in fact, the studies show that immigration has increased the average wage of Americans modestly in the short-run, and by more over the long-term as capital investment rises to take account of the larger number of workers. Behind those results, however, lie winners and losers – although in both cases, the effects are modest. Among workers, the winners are generally higher-skilled Americans: For example, when a factory or hotel hires more low-skilled workers, demand also increases for the higher-skilled people who manage those workers or carry out other professional tasks for an enterprise that’s grown larger.
The losers are generally the lower-skilled workers who have to compete for jobs with recent immigrants. But studies also show that immigration reform might well take care of most of those effects. Following the 1986 immigration reforms, for example, previously-undocumented immigrants experienced big pay boosts – as much as 15 or 20 percent – and immigrants who already had legal status saw hefty wage gains, too. But the reforms also led to higher wages for lower-skilled native-born Americans. One reason is that undocumented people who gain legal status can move more freely to places with greater demand for their skills, reducing their competition with native-born people with similar skills. More important, their new legal status confers certain protections such as minimum wage and overtime rules. Today, about one-fourth of low-skilled workers in large American cities are paid less than the minimum wage, including 16 percent of native-born workers, 26 percent of legal immigrants, and 38 percent of undocumented workers. Ending the ability of unscrupulous employers to recruit people to work for less than the minimum wage would not only raise the incomes of those currently paid less than the minimum wage. It also would ease downward pressures on the wages of other lower-skilled Americans, which comes from the below-minimum wage workers. This process is something we have refered to as "closing the 'trap-door' under the minimum wage."
Looking again at immigrants generally, recent research also shows a strong entrepreneurial streak, with immigrants being 30 percent more likely than native-born Americans to start their own businesses. Nor are immigrants the fiscal drain that’s commonly supposed, at least not in the long term. In California and a few other states, immigrants today do entail a net, fiscal burden, principally reflecting the costs of public education for their children. But studies that use dynamic models to take account of the lifetime earnings of immigrants – most of whom arrive here post-school age and without elderly parents to claim Social Security and Medicare – show substantial net fiscal gains at the federal, state, and local levels.
Political disputes are rarely settled by facts. Nevertheless, it’s reassuring to see that the humane and progressive approach to immigration is also a policy likely to produce good economic results for almost everyone.
Paul Collier says opposition to the plunder of natural resources is often based upon romantic environmentalism or self-denying utilitarianism. But these ethical structures do not provide the "simple common ethics of nature" that is needed to motivate collective worldwide action to stop this plunder from occurring. Instead, he says, we should adopt an ethical principle common among most societies, one that says our obligation to the future is "to pass on equivalent value for the natural assets we deplete":
Towards a new ethics of nature, by Paul Collier, Commentary, Financial Times: Natural assets are valuable and they are vulnerable. The current frontier for their exploitation is the quarter of the earth’s land surface home to the bottom billion: hence the new scramble for Africa..., but much of it is weakly governed. Advances in technology will open up those natural assets beneath the oceans and the poles... The governance of these huge areas is even weaker.
Ungoverned natural assets are subject to plunder... Plunder can only be avoided by robust collective action..., ultimately it can only rest on a common understanding by citizens, society by society. ...
In popular debate the high moral ground has been seized by romantic environmentalists who define our ethical obligation as preservation. Even in the west this can never be more than a minority view. Meanwhile, in the more rarefied technocratic debate, the high ground has been occupied by economic models. The models judge choices about the future by an austere utilitarianism in which future people, however remote, count for just as much as we do. ...
[A] more practical common ethics of nature, around which majorities could mobilize, is latent in most societies. ... Economists should be bringing the insight that natural assets matter not because of their intrinsic purity, but because they are valuable. Our obligation to the future is not to preserve purity but to pass on equivalent value for the natural assets we deplete. If, by converting natural assets into more productive assets, a poor society can escape poverty, then it should do so. ... In an impoverished society, the future will prefer to inherit schools and cities rather than to remain in impoverished purity.
This simple ethical test of whether we are infringing the rights of the future is much closer to how we see our obligations than either utilitarianism or romantic environmentalism. Respecting the rights of the future is manifestly more compelling than basing decisions on the esoteric sanctity of the infinite-horizon utilitarian calculus. Recognizing that the future may want us to use nature rather than preserve it distinguishes humane environmentalists from romantics: we are the custodians of value, not the curators of artifacts. ...
Whereas the ethics of romantic environmentalism and self-denying utilitarianism are both eccentric, the idea that natural assets oblige us to be custodians of value is common to widely differing cultures. ... The struggle to prevent the plunder of nature will be fought mainly in the societies of the bottom billion, which control the current frontier, and in the international conference halls that must regulate the future frontier. Neither is a promising venue. Rallying around a simple common ethics of nature would improve the chances.
Rajiv Sethi on macro theory:
An Outsider's View of Modern Macroeconomics, by Rajiv Sethi: Following up on a testy exchange with David Andolfatto, Mark Thoma has written a thoughtful post in which he discusses the state of modern macroeconomic theory, the appropriateness of appeals to professional authority, the shortcomings of some canonical models, and the way forward. I posted a brief comment in response, with a few constructive suggestions for mainstream macroeconomists from the perspective of an outsider. I have made these points on various occasions before, and reproduce them here (slightly edited and expanded with links to earlier posts):
- Rational expectations is not a behavioral hypothesis, it's an equilibrium assumption and therefore much more restrictive than "forward-looking behavior". It might be justified if equilibrium paths were robustly stable under plausible specifications of disequilibrium dynamics, but this needs to be explored explicitly instead of simply being assumed.
- Think about whether a theory of economic fluctuations should be shock-dependent (in the Frisch-Slutsky tradition) or shock-independent (in the Goodwin tradition). Go back and look at Goodwin's 1951 Econometrica paper to appreciate the importance of the distinction.
- Build models in which leverage, collateral, and default play a central role. The work of John Geanakoplos on this is an excellent starting point. He uses equilibrium theory but allows for heterogeneous priors (so differences in beliefs can persist even if they are common knowledge.) More broadly, take a close look at Hyman Minsky's integrated analysis of real and financial activity.
- Do not assume that flexible wages and prices imply labor market clearing. They do in equilibrium (by definition) but wage and price flexibility in disequilibrium can make matters worse. Keynes recognized this, and Tobin explored these mechanisms formally. Arbitrary assumptions of "sticky prices" are not necessary to account for persistent unemployment or under-utilization of capacity.
- Finally, show some humility. There are anonymous bloggers out there, some self-taught in economics, who may know more about the functioning of a modern economy than you do.
The last point is directed at David Andolfatto, whose arrogant appeal to professional authority jolted the normally polite Mark Thoma to respond with (justifiable) belligerence. Andolfatto's entire post was dripping with condescension, but I found the following passage particularly disturbing:DeLong tells us that we can learn a lot of economics from Krugman. You will be forgiven for wondering whether DeLong can even tell whether he is learning economics or not. DeLong is, as far as I can tell, an historian.
As I said on Mark's blog, it could be argued that economic historians (and historians of thought) have had more useful things to say about recent events than the highest of high priests in macroeconomics. Andolfatto seems to be confusing an understanding of modern macroeconomic theory with an understanding of the modern macroeconomy. The two are not the same, and the former is neither necessary nor sufficient for the latter.
Contrast the tone of Andolfatto's post with the following passage from a recent essay by Narayana Kocherlakota, president of the Minneapolis Fed:
I believe that during the last financial crisis, macroeconomists (and I include myself among them) failed the country, and indeed the world. In September 2008, central bankers were in desperate need of a playbook that offered a systematic plan of attack to deal with fast-evolving circumstances. Macroeconomics should have been able to provide that playbook. It could not. Of course, from a longer view, macroeconomists let policymakers down much earlier, because they did not provide policymakers with rules to avoid the circumstances that led to the global financial meltdown.
Because of this failure, macroeconomics and its practitioners have received a great deal of pointed criticism both during and after the crisis. Some of this criticism has come from policymakers and the media, but much has come from other economists. Of course, macroeconomists have responded with considerable vigor, but the overall debate inevitably leads the general public to wonder: What is the value and applicability of macroeconomics as currently practiced?
Kocherlakota goes on to defend the many advances made in macroeconomic research over the past four decades, but openly acknowledges the enormous challenges that remain. He goes on to say:The seventh floor of the Federal Reserve Bank of Minneapolis is one of the most exciting macro research environments in the country. As president, I plan to learn from our staff, consultants, and visitors.
I hope that some of those visitors (real or virtual) will be voices of dissent from beyond the inner circle of research macroeconomics. It is in this spirit of openness that my comments are offered.
Tuesday, May 25, 2010
I have a new post at MoneyWatch:
Growth Policy versus Stabilization Policy: In economics, as in other disciplines, the important questions change over time. In macroeconomics, there are two big questions and our attention to one or the other changes with the economic events of each era. One question concerns stabilization policy -- keeping the economy as close as possible to the long-run growth path -- and the other is growth policy, i.e. policy that attempts to maximize the long-run growth rate. (There is also work on whether stability and growth are related. More stable economies could grow faster due to reduced uncertainty, but government intervention to stabilize the economy could also stifle growth according to some models, so the relationship is not clear a priori.)
We could go back further than this, but let me pick the story up in the 1970s. ...[continue reading]...
The argument is that we have paid too much attention to growth policy, and not enough to stabilization. Even if the growth policies do pay off in the long-run, the over emphasis on growth has caused a slower recovery and it's not at all evident that's a desirable trade off.
Tom Bozzo argues that the case for airline deregulation isn't as clear as many people would have you believe:
The Effects of Airline Deregulation: What’s The Counterfactual?, by Tom Bozzo: Matt Welch at the Reason blog takes credit for airline deregulation on behalf of libertarianism:
The “worldview” of libertarianism suggested, back in the early 1970s, that if you got the government out of the business of setting all airline ticket prices and composing all in-flight menus, then just maybe Americans who were not rich could soon enjoy air travel. At the time, people with much more imagination and pull than Gabriel Winant has now dismissed the idea as unrealistic, out-of-touch fantasia. They were wrong then, they continue to be wrong now about a thousand similar things, and history does not judge them harsh enough.
Mark Kleiman observes that transportation deregulation was more directly the progeny of 1970s Brookings-esque neoliberalism (though I’d grant Welch that libertarians got there first), though Kleiman doesn’t take issue with the basic claim that deregulating prices and service offerings “was, on balance, a good thing.” This argument ultimately rests on the declines in airfares and resulting democratization of air travel that Welch cites; indeed that’s what the Brookings-esque neoliberals I know cite when they’re defending the deregulatory record.
The catch is that all such economic comparisons must be counterfactual: they must show an improvement not with respect to CAB-set fares of the late-1970s, but rather with respect to what reasonably competent regulation could have produced under the other circumstances of the deregulated era. (This, FWIW, is one of Robert W. Fogel’s central insights into what makes economic history economic history.) If the comparison exercise is tough by the (inappropriate) historical yardstick thanks to declines in (average) service quality and the airline industry’s trail of fleeced stakeholders, then the counterfactual comparison is going to be tougher still thanks to a couple of factors that should have produced large declines in airline costs and hence fares even in the absence of deregulation.
The factors of note are a pair of technological advancements — the development of high bypass ratio turbofans suitable for shorter-haul airliners and the demise of the flight engineer’s job thanks to cockpit automation, both of which have origins predating deregulation — and the long secular decline in oil prices through the deregulated era’s zenith prior the crash of the 1990s stock market bubble. Since a regulator could have promoted adoption of the cost-saving technologies and passed the resulting productivity improvements and input cost decreases through to fare-payers using elementary regulatory technologies, deregulation must have produced substantial fare reductions relative to the late CAB era to have a claim to constituting a true improvement.
One of the airline industry’s problems is that it isn’t “revenue adequate” or able to recover its total costs including a normal return to investors. If you thought airlines were incurring costs efficiently, then moving towards revenue adequacy would require more revenues and hence higher average fares. On the face of things, that wouldn’t look good for a regulated alternative providing more secure revenues to the industry. However, there are dynamic efficiency counterbalances to the apparent static inefficiency under regulation: revenue adequacy implies having money for efficiency-improving investments. For instance, U.S. legacy airlines have somewhat notoriously kept relatively aged fleets in the air. Partly, that was a deliberate strategy that blew up when the Goldilocks conditions of the late-90s ended, and partly they don’t have the money to turn over their fleets as fast as they arguably should.
The formerly regulated transportation industries shared, to one extent or another, cost structures under which an efficient carrier would go broke under econ 101 perfect competition with prices driven down to marginal costs. So the question isn’t so much whether carriers will exercise such market power as they have in order to survive, but how. Real firms might or might not do that better than a real regulator. I do think there’s a good case to be made for some degree of pricing and service liberalization with regulatory policing of “excessive” use of market power; that’s a one-sentence version of the Staggers Act’s approach to the (very successful) freight rail industry.
Problems at the ratings agencies contributed to the crisis, and it's important for financial reform legislation to address the problems in this industry. The issues arise from the fact that the ratings agencies are paid by the firms whose assets are being rated. This gives the ratings agencies an incentive to issue pleasing ratings to encourage future business, and with enough money on the line, this can lead to large distortions in the risk assessments.
There are many ways to break the link between the ratings that are given and prospects for future business, e.g. the randomized selection of the agency that rates the assets that Dean Baker has been proposing, and the current proposal from the Senate takes a step in this direction. Lucian Bebchuk describes the Senate legislation, and explains how tying the profits that ratings firms earn to their actual performance breaks the link between issuing tough but accurate ratings and losing future business:
Rating the Raters, by Lucian Bebchuk, Commentary, Project Syndicate: In the new financial order being put in place by regulators around the world, reform of credit rating agencies should be a key element. Credit rating agencies, which play an important role in modern capital markets, completely failed in the years preceding the financial crisis. ...
What should be done? One proposed approach would reduce the significance of the raters’ opinions. In many cases, the importance of ratings comes partly from legal requirements that oblige or encourage institutional investors and investment vehicles to maintain portfolios of assets that have received sufficiently high grades from the recognized agencies.
Disappointment about the raters’ performance, and skepticism about the effectiveness of regulation, has led to calls to eliminate any regulatory reliance on ratings. If ratings are not backed by the force of law, so the argument goes, regulators ... can leave the monitoring of raters to the market.
Even if ratings were no longer required or encouraged by law, however, demand for ratings – and the need to improve their reliability – would remain. Many investors are unable to examine the extent to which a bond fund’s high yield is due to risk-taking, and would thus benefit from a rating of the fund’s holdings. Given past experience, we cannot rely on market reputation to ensure that such ratings will be reliable.
Another approach would be to unleash the liability system. ... But ... judicial scrutiny ... cannot ensure that raters do the right thing... There is thus no substitute for providing raters with incentives to provide as accurate a rating as they can. This can be done by making raters’ profits depend not on satisfying the issuers that select them, but on performing well for investors. ...
The US Senate voted this month to incorporate such a mechanism into the financial reform bill that will now have to be reconciled by the bill passed by the US House of Representatives. Under the Senate’s approach, regulators would create rules under which an independent regulatory board would choose raters. The board would be allowed to base its choices on raters’ past performance.
For such a mechanism to work well, it must link the number of assignments won by raters, and thus their compensation, to appropriate measures of their performance. Such measures should focus on what makes ratings valuable for the investors who use them...
Predictably, the Senate’s bill encountered stiff resistance from the dominant rating agencies. ... Rating agencies have been and should remain an important aspect of modern capital markets. But to make ratings work, the raters need to be rated.
At this point I'm not picky about how the incentive to issue higher than justified ratings is removed, there's more than one way to do this, the main thing is that a strong and effective mechanism along these lines is included in the final bill. [There also needs to be an entry and exit mechanism so that firm's that consistently give misleading risk assessments are driven from the set of authorized ratings agencies and replaced by new entrants to the industry.]
I want to follow up on the post highlighting attempts to attack the messengers -- attempts to discredit Brad DeLong and Paul Krugman on macroeconomic policy in particular -- rather than engage academically with the message they are delivering (Krugman's response). The attacks have served to mislead people as to what macroeconomic theory has to say about monetary and fiscal policy interventions during severe recessions, fiscal policy in particular. So it's a bit mysterious as to why this group thinks that personal attacks on the messengers, attacks that mislead people about modern macroeconomic theory and what it says about policy, somehow advance the cause they purport to be interested in.
One of the objections often raised is that Krugman and DeLong are not, strictly speaking, macroeconomists. But if Krugman, DeLong, and others are expressing the theoretical and empirical results concerning macroeconomic policy accurately, does it really matter if we can strictly classify them as macroeconomists? Why is that important except as an attempt to discredit the message they are delivering? Same with all the nonsense about their not understanding modern theory beyond old style textbook IS-LM, that's nothing but a blatant attempt to discredit them. And it's not even true, both have a thorough understanding of New Keynesian model coupled with that rare ability to see through the mathematical formalities and highlight it's most important elements. In addition, does the advancement of economics that you are so worried about really depend upon whether you find them likable at a personal level? Of course not. Attacking people rather than discussing ideas avoids even engaging on the issues. And when it comes to the ideas -- here I am talking most about fiscal policy -- as I've already noted in the previous post, the types of policies Krugman, DeLong, and others have advocated (and I should include myself as well) can be fully supported using modern macroeconomic models. There's not much of an argument to be had when it comes to the ideas themselves.
One way to try to get around this is to cite empirical evidence from past recessions showing that fiscal policy multipliers are small. Eggertsson deals with this objection in his paper by noting that things are very different at the zero bound. Things don't work the same when the policy rate is already at the zero bound and the Fed cannot push it any lower. Multipliers that are small away from the zero bound can become large, they can even flip sign in some cases. Because of this, evidence gathered from periods when the economy was not at the zero bound tell us almost nothing about the size of multipliers we should expect in episodes like we are experiencing today. The problem is that we have almost no data for episodes such as the Great Depression when the economy was at the zero bound, certainly not enough evidence to say anything specific about the magnitude of fiscal policy multipliers. There are economists who ought to know better who are still acting as though evidence from, say, World War II or some other episode somehow matters, but if we take modern theory seriously that evidence ought to be heavily discounted. To quote Eggertsson (pg. 2):
This illustrates that empirical work on the effect of fiscal policy based on data from the post-WWII period, such as the much cited and important work of Romer and Romer (2008), may not be directly applicable for assessing the effect of fiscal policy on output today. Interest rates are always positive in their sample, as in most other empirical research on this topic. To infer the effects of fiscal policy at zero interest rates, then, we can rely on experience only to a limited extent. Reasonably grounded theory may be a better benchmark with all the obvious weaknesses such inference entails, since the inference will never be any more reliable than the model assumed.
On that note about model reliability, let me address one further criticism highlighted by Robert Waldmann:
Speaking for myself only, I don't care what modern macro models say. I don't think that New Keynesian models add anything much of value to the Keynesian cross. I certainly haven't noticed any great empirical success. Oh also speaking only for myself, I have never bothered to keep up with macro theory. It is entirely possible that people understand new Keynesian DSGE models and think they are worthless.
Since he is clear that he is only speaking for himself, and his point is a bit broader than mine, let me be clear that I am the one making the claim that the view that the standard macroeconomic model is useless is a more generally held sentiment.
I thought about addressing this point in the original post, but since the point I was making there does not depend upon whether modern macro theory is valid or not -- my point was that the policies Krugman, DeLong and others are advocating can, in fact, be justified using modern models contrary to what was being implicitly or explicitly suggested in attacks on them -- so I decided to leave this out and address it later if it came up.
I don't know that I'd go as far as Robert, but I agree that the current macroeconomic models are unsatisfactory. The question is whether they can be fixed, or if it will be necessary to abandon them altogether. I am OK with seeing if they can be fixed before moving on. It's a step that's necessary in any case. People will resist moving on until they know this framework is a dead end, so the sooner we come to a conclusion about that, the better.
As just one example, modern macroeconomic models do not generally connect the real and the financial sectors. That is, in standard versions of the modern model linkages between the disintegration of financial intermediation and the real economy are missing. Since these linkages provide an important transmission mechanism whereby shocks in the financial sector can affect the real economy, and these are absent from models such as Eggertsson and Woodford, how much credence should I give the results? Even the financial accelerator models (which were largely abandoned because they did not appear to be empirically powerful, and hence were not part of the standard model) do not fully link these sectors in a satisfactory way, yet these connections are crucial in understanding why the crash caused such large economic effects, and how policy can be used to offset them.
There are many technical difficulties with connecting the real and the financial sectors. Again, to highlight just one aspect of a much, much larger list of issues that will need to be addressed, modern models assume a representative agent. This assumption overcomes difficult problems associated with aggregating individual agents into macroeconomic aggregates. When this assumption is dropped it becomes very difficult to maintain adequate microeconomic foundations for macroeconomic models (setting aside the debate over the importance of doing this). But representative (single) agent models don't work very well as models of financial markets. Identical agents with identical information and identical outlooks have no motivation to trade financial assets (I sell because I think the price is going down, you buy because you think it's going up; with identical forecasts, the motivation to trade disappears). There needs to be some type of heterogeneity in the model, even if just over information sets, and that causes the technical difficulties associated with aggregation. However, with that said, there have already been important inroads into constructing these models (e.g.). So while I'm pessimistic, it's possible this and other problems will be overcome.
But there's no reason to wait until we know for sure if the current framework can be salvaged before starting the attempt to build a better model within an entirely different framework. Both can go on at the same time. What I hope will happen is that some macroeconomists will show more humility they've they've shown to date. That they will finally accept that the present model has large shortcomings that will need to be overcome before it will be as useful as we'd like. I hope that they will admit that it's not at all clear that we can fix the model's problems, and realize that some people have good reason to investigate alternatives to the standard model. The advancement of economics is best served when alternatives are developed and issued as challenges to the dominant theoretical framework, and there's no reason to deride those who choose to do this important work.
So, in answer to those who objected to my defending modern macro, you are partly right. I do think the tools and techniques macroeconomists use have value, and that the standard macro model in use today represents progress. But I also think the standard macro model used for policy analysis, the New Keynesian model, is unsatisfactory in many ways and I'm not sure it can be fixed. Maybe it can, but that's not at all clear to me. In any case, in my opinion the people who have strong, knee-jerk reactions whenever someone challenges the standard model in use today are the ones standing in the way of progress. It's fine to respond academically, a contest between the old and the new is exactly what we need to have, but the debate needs to be over ideas rather than an attack on the people issuing the challenges.
Monday, May 24, 2010
I don't fully agree with Robert Reich's view expressed below and elsewhere that breaking up the big banks is the key to solving the too big too fail problem. It does mean that the failure of an individual firm would be less worrisome, and hence less likely to get help from the government, but that assumes shocks are idiosyncratic rather than common. However, the shocks we should worry about are common -- systemic to use another term. The shocks that are capable of bringing down large institutions would, if the large banks had been broken up into smaller pieces, bring down all the smaller banks just as easily. Collectively they would still be too big too fail and still require a bailout. And it's certainly true that there are historical episodes where the failure of a large number of small banks was the problem.
But there is another reason to worry about big banks, the economic and political power that comes with size. Even if it's true that breaking banks into smaller pieces doesn't help much, if at all, to make the system safer, all else equal, it does make it much less likely that banks will capture regulators and legislators. And it makes it harder for banks to use their economic power in the marketplace to increase profits at the expense of consumers, or to maintain a financial marketplace where high risk, high reward, taxpayers pay the bill it things go sour strategies are allowed.
So yes, break up the big banks if for no other reason than to curtail economic and political power. And if I'm wrong and this also makes the system substantially safer, so much the better. But what I was really interested in here is the distinction Reich makes between the regulatory and structural approaches, a distinction I think is important:
Obama’s Regulatory Brain, by Robert Reich: The most important thing to know about the 1,500 page financial reform bill passed by the Senate last week — now on he way to being reconciled with the House bill — is that it’s regulatory. If does nothing to change the structure of Wall Street. The bill omits two critical ideas for changing the structure of Wall Street’s biggest banks so they won’t cause more trouble in the future, and leaves a third idea in limbo. The White House doesn’t support any of them.
First, although the Senate bill seeks to avoid the “too big to fail” problem by pushing failing banks into an “orderly” bankruptcy-type process, this regulatory approach isn’t enough. The Senate roundly rejected an amendment that would have broken up the biggest banks... You do not have to be an algorithm-wielding Wall Street whizz-kid to understand that the best way to prevent a bank from becoming too big to fail is preventing it from becoming too big in the first place. ... Because traders and investors know they are too big to fail, these banks have a huge competitive advantage over smaller banks.
Another crucial provision left out of the Senate bill would be to change the structure of banking by resurrecting the Depression-era Glass-Steagall Act and force banks to separate commercial banking ... from investment banking. Here, too, the bill takes a regulatory approach..., it would not erode the giant banks’ monopoly over derivatives trading, adding to their power and inevitable “too big to fail” status.
Which brings us to the third structural idea, advanced by Senator Blanche Lincoln. She would force the banks to do their derivative trades in entities separate from their commercial banking. This measure is still in the bill, but is on life-support after Paul Volcker, Tim Geithner, and Fed chair Ben Bernanke came out against it. Republicans hate it. The biggest banks detest it. ... Almost no one in Washington believes it will survive the upcoming conference committee. But it’s critical. ...
Wall Street’s lobbyists have fought tooth and nail against these three ideas because all would change the structure of America’s biggest banks. The lobbyists won on the first two, and the Street has signaled its willingness to accept the Dodd bill, without Lincoln’s measure. The interesting question is why the president, who says he wants to get “tough” on banks, has also turned his back on changing the structure of American banks — opting for a regulatory approach instead.
It’s almost exactly like health care reform. Ideas for changing the structure of the health-care industry — a single payer, Medicare for all, even a so-called “public option” — were all jettisoned by the White House in favor of a complex set of regulations that left the old system of private for-profit health insurers in place. The final health care act doesn’t even remove the exemption of private insurers from the nation’s antitrust laws.
Regulations don’t work if the underlying structure of an industry — be it banking or health care — got us into trouble in the first place. ... A regulatory rather than structural approach to deep-seated problems in complex industries like banking and health care is also vulnerable to the inevitable erosion that occurs when industry lobbyists insert themselves into the regulatory process. Tiny loopholes get larger. Delays get longer. Legislative words are warped and distorted to mean what industry wants them to mean. ...
Inevitably, top regulators move into the industry they’re putatively trying to regulate, while top guns in the industry move temporarily into regulatory positions. This revolving door of regulation also serves over time to erode all serious attempt at overseeing an industry.
The only way to have a lasting effect on industries as large and intransigent as banking and health care is to alter their structure. That was the approach taken to finance by Franklin D. Roosevelt in the 1930s, and by Lyndon Johnson to health care (Medicare) in the 1960s.
So why has Obama consistently chosen regulation over restructuring? Because restructuring Wall Street or health care would surely elicit firestorms from these industries. Both are politically powerful, and Obama did not want to take them on directly.
A regulatory approach allows for more bargaining, not only in the legislative process but also, over time, in the rule-making process as legislation is put into effect. It’s always possible to placate an industry with a carefully-chosen loophole or vague legislative language that will allow the industry to continue to go on much as before.
And that’s precisely the problem.
The line between structural and regulatory intervention is a bit vague in some cases, but it's still conceptually useful to categorize the types of intervention in this way. As I've said many times, we should try as hard as we can to make the system safe, but we'll never be able to guarantee that the financial system is immune to sudden collapse. Thus, as we think about the structural and regulatory changes that are needed, we should be sure to make changes that minimize the fallout when another collapse occurs, as it eventually will. Much of the change that is needed is structural in nature, but not all, e.g. I'd categorize leverage limits, which I view as critical to minimizing the fallout when problems occur, as regulatory.
However, as noted above structural change is harder than imposing new regulations. The fact that legislators are shying away from the harder to impose types of change out of fear of losing reelection support from the financial industry points to the political power the industry still has, and to the need for structural change to reduce this political (and economic) power. If we cannot muster the political will to make such changes in light of the most devastating financial collapse since the Great Depression, that does not bode well for the future.
It's time for President Obama to earn his "badge of honor":
The Old Enemies, by Paul Krugman, Commentary, NY Times: So here’s how it is: They’re as mad as hell, and they’re not going to take this anymore. Am I talking about the Tea Partiers? No, I’m talking about the corporations.
Much reporting on opposition to the Obama administration portrays it as a sort of populist uprising. Yet the antics of the socialism-and-death-panels crowd are only part of the story of anti-Obamaism, and arguably the less important part. If you really want to know what’s going on, watch the corporations.
How can you do that? Follow the money — donations by corporate political action committees. ... So far this year, according to The Washington Post, 63 percent of spending by banks’ corporate PACs has gone to Republicans, up from 53 percent last year. Securities and investment firms, traditionally Democratic-leaning, are now giving more money to Republicans. And oil and gas companies, always Republican-leaning, have gone all out, bestowing 76 percent of their largesse on the G.O.P.
These are extraordinary numbers given the normal tendency of corporate money to flow to the party in power. Corporate America, however, really, truly hates the current administration. ... What’s going on?
One answer is taxes... The Obama administration plans to raise tax rates on upper brackets back to Clinton-era levels. Furthermore, health reform will in part be paid for with surtaxes on high-income individuals. All this will amount to a significant financial hit to C.E.O.’s, investment bankers and other masters of the universe.
Now, don’t cry for these people: they’ll still be doing extremely well, and by and large they’ll be paying little more as a percentage of their income than they did in the 1990s. Yet the fact that the tax increases they’re facing are reasonable doesn’t stop them from being very, very angry.
Nor are taxes the whole story.
Many Obama supporters have been disappointed by what they see as the administration’s mildness on regulatory issues — its embrace of limited financial reform that doesn’t break up the biggest banks, its support for offshore drilling, and so on. Yet corporate interests are balking at even modest changes from the permissiveness of the Bush era. ...
So what President Obama and his party now face isn’t just, or even mainly, an opposition grounded in right-wing populism. For grass-roots anger is being channeled and exploited by corporate interests, which will be the big winners if the G.O.P. does well in November.
If this sounds familiar, it should: it’s the same formula the right has been using for a generation. Use identity politics to whip up the base; then, when the election is over, give priority to the concerns of your corporate donors. ...
But won’t the grass-roots rebel at being used? Don’t count on it. Last week Rand Paul, the Tea Party darling who is now the Republican nominee for senator from Kentucky, declared that the president’s criticism of BP over the disastrous oil spill in the gulf is “un-American,” that “sometimes accidents happen.” The mood on the right may be populist, but it’s a kind of populism that’s remarkably sympathetic to big corporations.
So where does that leave the president and his party? Mr. Obama wanted to transcend partisanship. Instead, however, he finds himself very much in the position Franklin Roosevelt described in a famous 1936 speech, struggling with “the old enemies of peace — business and financial monopoly, speculation, reckless banking, class antagonism, sectionalism, war profiteering.”
And that’s not necessarily a bad thing. Roosevelt turned corporate opposition into a badge of honor: “I welcome their hatred,” he declared. It’s time for President Obama to find his inner F.D.R., and do the same.
I suppose I should respond to this. After getting home from Beijing, a process that involved a 12 hour flight followed by a 6 hour layover in SF, then a 3 and 1/2 hour delay, a flight cancellation, a last minute flight from SF to Portland, renting a car since there were no more flights to Eugene, then driving to Eugene for 2 hours, finally arriving after 28 hours with only the sleep one grabs here and there on planes, I did manage to catch a few hours sleep. But not enough. I then got up, tired and crabby, read this post, found myself a bit annoyed and did something I don't usually do, I left a comment at another blog.Let me explain. It wasn't the overwhelming evidence of Krugman/DeLong derangement syndrome that got to me in my tired and crabby state. It was this part:
Where is the evidence that Paul Krugman has ever thought deeply about the theoretical foundations of Keynesian theory? (Maybe there is some and I have just missed it). As far as I can tell, his "deep" understanding goes no further than an elementary Keynesian cross (OK, OK, maybe he knows a bit more than this).
So, what do I take away from all this? Well, I conclude that it should be clear enough that this dynamic duo are primarily interested in pushing their own pet political agendas; they have no interest in pushing the frontier of economic theory... Nothing wrong with this... Nothing wrong, that is, except when they label these activities as "fair and balanced" or as "rooted in rigorous theory." That's just plain dishonest.
It's the suggestion that the policy advice Krugman and DeLong have been giving is not "rooted in rigorous theory" that annoyed me the most. The suggestion that Krugman's policy advice was based upon an understanding of the models no deeper than the Keynesian cross contributed as well.
So let's get something absolutely clear. The fiscal policy intervention that Krugman, DeLong, and others have been advocating can be analyzed and supported using the New Keynesian model. See Woodford and Eggertsson's work in particular, or see this work by my colleague George Evans along with his coauthors. For the most part, these models support the types of policies the administration has put into place. (Generally, demand side policies are the solution when the economy is stuck at the zero bound. Supply side polices such as a capital gains tax cut actually make things worse. The reason is that an increase in supply when demand as already insufficient causes prices to fall, and the fall in the price level raises the real interest rate. At the zero bound, the rise in the real interest rate cannot be offset by the Fed. Away from the zero bound, the Fed can stabilize the real rate and the policy has positive effects, but it depends critically on the Fed's ability to offset increases in the real rate and the nature of the reaction).
There has been an attempt to discredit fiscal policy intervention by suggesting it is based upon old fashioned Keynesian cross models. My reaction to the original post was because it read like another contribution to those pushing this idea. If David wants to back away from that, and it seems he does from his latest post (the part where he pats himself on the back for being so open minded), great. Because the attack along these lines is, to echo a term, "plain dishonest." There's no doubt whatsoever in my mind about Krugman and DeLong's knowledge of modern theory, but that's not my main concern. It's the suggestion that the people advocating fiscal policy cannot possibly understand what modern models say, that they must be relying on old-fashioned, out of date theory, that brought the reaction. There's nothing at all inconsistent with advocating fiscal policy when the economy is stuck at the zero bound and what modern macro has to say on the topic. Those who suggest otherwise either explicitly or implicitly are the ones pushing an agenda rather than helping to illuminate what modern models have to say on this topic.
Sunday, May 23, 2010
Jeff Frankel argues that energy security does not mean minimizing imports of oil and maximizing domestic production of energy. Instead, it means insuring ourselves against future variations in supply that might damage the economy or interfere with our national defense needs. When approached in this manner, it's important to have large domestic deposits available under some scenarios that lead to long-term reductions in the available supply of oil. Since the economic and strategic damage could be large if one of these scenarios were to occur, it's also important to give them substantial weight when thinking about insuring ourselves against the risk of long-term reductions in our access to outside sources of energy. What this means is that current thinking on energy security -- termed "Drain America First" below -- is not the optimal energy security policy. It extracts rather than preserves the domestic oil reserves that would be needed if one of the scenarios actually occurred:
Gulfs in our Energy Security, and the Louisiana Oil Blowout, by Jeff Frankel: In the wake of the April oil well blowout off the coast of Louisiana, policy-makers are rethinking the issue of off-shore drilling. Clearly the last decade’s neglect of safety rules by federal regulators needs to come to an end. But what larger implications should we draw for domestic oil drilling? ...
Ever since September 11, 2001, “energy security” has received increased emphasis. ... Usually it is taken as self-evident that the energy security goal argues in the direction of increased exploitation of domestic oil resources: “Drill, Baby, Drill.” But some of us have long thought that a more appropriate slogan for the policy of using domestic reserves as aggressively as possibly would be “Drain America First.” A true understanding of energy security could tip the balance the other way instead, in the direction of conserving American energy resources. Oil wells such as the Deepwater Horizon site, once it is capped, should be saved, their future use to be made conditional on a true national emergency, such as a long-term cut-off of Persian Gulf oil...
Public debate is hampered by the lack of a working definition of energy security. A goal of ending US imports of oil would not be attainable, in the foreseeable future, given the gulf between domestic deposits and our consumption. ... A goal of ending imports from specific geographic regions such as the Mideast would not be relevant, because oil is mostly fungible. ...
What, then, should be the goal of energy security policy? Imagine that at some point in the coming half-century, there is a sudden cut-off in oil exports from the Persian Gulf...
The goal of policy now should be to take steps that would reduce the impact of such a shock in the future, creating non-military response options. The solution is to leave some domestic oil underground, or underwater, for use in such emergencies, and only in such emergencies. Reserves in the Gulf of Mexico are precisely the ones we should save. Think of it like the SPR, but without going to the trouble of bringing the oil above ground only to put it back underground.
The argument doesn’t work as well in the case of oil reserves in the North Slope of Alaska. Experts say it would take more than a decade to start pumping... The continental shelf of the Gulf of Mexico may be the best location for designating certain deposits as reserves...
Even in the case of known oil deposits off Louisiana and Texas, there would be a certain lag between the date of a geopolitical crisis and the date when the oil would start flowing. But this is no reason to dismiss the idea. Oil shocks such as 1979 and 1990 led to immediate sharp increases in the world price of oil — and caused or at least contributed to US recessions – not because the supply of oil physically fell, but rather because everyone was afraid that it might; as a result, rational speculation increased holdings of oil in inventories, bid up the price, and had the same macroeconomic impact as if the supply cut-off had already gone into effect. The point is that, if there were to be a sudden new mideastern oil shock, the knowledge that some replacement supplies would come on-stream domestically within a few years and so the economy would not be left high and dry would help moderate the panic, and so even in the short term would allow lower inventories and lower prices than otherwise.
I am not claiming that my proposal, to conserve offshore Gulf oil deposits for an emergency, would solve all our energy problems. ... But, on the margin, a barrel of Gulf of Mexico oil would be far more valuable under crisis conditions than it is today.
What are the chances that the deficit hawks will come out in favor of this?:
The Challenge of Closing Tax Loopholes For Billionaires, by Robert Reich: Who could be opposed to closing a tax loophole that allows hedge-fund and private equity managers to treat their earnings as capital gains – and pay a rate of only 15 percent rather than the 35 percent applied to ordinary income?
Answer: Some of the nation’s most prominent and wealthiest private asset managers, such as Paul Allen and Henry Kravis, who, along with hordes of lobbyists, are determined to keep the loophole wide open.
The House has already tried three times to close it only to have the Senate cave in because of campaign donations from these and other financiers who benefit from it.
But the measure will be brought up again in the next few weeks, and this time the result could be different. Few senators want to be overtly seen as favoring Wall Street. And tax revenues are needed to help pay for extensions of popular tax cuts, such as the college tax credit that reduces college costs for tens of thousands of poor and middle class families. Closing this particular loophole would net some $20 billion.
It’s not as if these investment fund managers are worth a $20 billion subsidy. Nonetheless they argue that if they have to pay at the normal rate they’ll be discouraged from investing in innovative companies and startups. But if such investments are worthwhile they shouldn’t need to be subsidized. ...
Nor are these fund managers especially deserving, as compared to poor and middle-class families that need a tax break to send their kids to college. ...
Several of these private investment fund managers, by the way, have taken a lead in the national drive to cut the federal budget deficit. The senior chairman and co-founder of the Blackstone Group, one of the largest private equity funds, is Peter G. Peterson... Curiously, I have not heard Peterson advocate closing this tax loophole as one way to further the cause of fiscal responsibility.
Closing tax loopholes for billionaires may seem like a no-brainer... But you can expect a huge fight.
There is also a moral issue here. Call me old fashioned but I just think it’s wrong that a single hedge fund manager earns a billion dollars, when a billion dollars would pay the salaries of about 20,000 teachers.
Saturday, May 22, 2010
Daniel Little looks at the role of theory in the social sciences:
Social theory and the empirical social world, by Daniel Little: How can general, high-level social theory help us to better understand particular historically situated social realities? Is it helpful or insightful to "bring Weber's theory of religion to bear on Islam in Java" or to "apply Marx's theory of capitalism to the U.S. factory system in the 1950s"? Is there any real knowledge to be gained by applying theory to a set of empirical circumstances?
In the natural sciences this intellectual method is certainly a valid and insightful one. We gain knowledge when we apply the theory of fluid dynamics to the situation of air flowing across a wing, or when we apply the principles of evolutionary theory to the problem of understanding butterfly coloration. But do we have the same possibility in the case of the social world?
My general inclination is to think that "applying" general social theories to specific social circumstances is not a valid way of creating new knowledge or understanding. This is because I believe that social ensembles reflect an enormous degree of plasticity and contingency; so general theories only "fit" them in the most impressionistic and non-explanatory way. We may have a pure structural theory of feudalism; but it is only the beginning of a genuinely knowledge-producing analysis of fourteenth-century French politics and economy or the Japanese samurai polity. At best the theory highlights certain issues as being salient -- the conditions of bonded labor, the nature of military dependency between lord and vassal. But the theory of feudalism does not permit us to "derive" particular features or institutions of French or Japanese society. "Feudalism" is an ideal type, a heuristic beginning for social analysis, rather than a general deductive and comprehensive theory of all feudal societies. And we certainly shouldn't expect that a general social theory will provide the template for understanding all of the empirical characteristics of a given instance of that theorized object.
Why is there this strong distinction between physical theory and social theory? Fundamentally, because natural phenomena really are governed by laws of nature, and natural systems are often simple enough that we can aggregate the effects of the relevant component processes into a composite description of the whole. (There are, of course, complex physical systems with non-linear composite processes that cannot be deductively represented.) So theories can be applied to complicated natural systems with real intellectual gain. The theory helps us to predict and explain the behavior of the natural system.
The social world lacks both properties. Component social mechanisms and processes are only loosely similar to each other in different instances; for example, "fealty" works somewhat differently in France, England, and Japan. And there is a very extensive degree of contingency in the ways that processes, mechanisms, agents, and current circumstances interact to produce social outcomes. So there is a great degree of path dependency and variation in social outcomes, even in cases where there are significant similarities in the starting points. So feudalism, capitalism, financial institutions, religions, ethnic conflicts, and revolutions can only be loosely theorized.
That is my starting point. But some social theorists take a radically different approach. A good example of a bad intellectual practice here is the work of Hindess and Hirst in Pre-Capitalist Modes Of Production, in which they attempt to deduce the characteristics of the concrete historical given from its place within the system of concepts involved in the theory of the mode of production.
Is this a legitimate and knowledge-enhancing effort? I don't think that it is. We really don't gain any real insight into this manor, or the Burgundian manor, or European feudalism, by mechanically subsuming it under a powerful and general theory -- whether Marx's, Weber's or Pareto's.
It should be said here that it isn't the categories or hypotheses themselves that are at fault. In fact, I think Marx's analysis and categories are genuinely helpful as we attempt to arrive at a sociology of the factory, and Durkheim's concept of anomie is helpful when we consider various features of modern communities. It is the effort at derivation and subsumption that I find misguided. The reality is larger and more varied than the theory, with greater contingency and surprise.
It is worthwhile looking closely at gifted social scientists who proceed differently. One of these is Michael Burawoy, a prolific and influential sociologist of the American labor process. His book, Manufacturing Consent: Changes in the Labor Process Under Monopoly Capitalism, is a detailed study of the American factory through the lens of his micro-study of a single small machine shop in the 1940s and 1970s, the Allied/Geer factory. Burawoy proceeds very self-consciously and deliberately within the framework of Marx's theory of the capitalist labor process. He lays out the fundamental assumptions of Marx's theory of the labor process -- wage labor, surplus labor, capitalist power relations within the factory -- and he then uses these categories to analyze, investigate, and explain the Allied/Geer phenomena. But he simultaneously examines the actual institutions, practices, and behaviors of this machine shop in great participant-observer detail. He is led to pose specific questions by the Marxist theory of the labor process that he brings with him -- most importantly, what accounts for the "consent" that he observes in the Allied workers? -- but he doesn't bring a prefabricated answer to the question. His interest in control of surplus labor and coercion and consent within the workforce is stimulated by his antecedent Marxist theory; but he is fully prepared to find novelty and surprise as he investigates these issues. His sociological imagination is not a blank slate -- he brings a schematic understanding of some of the main parameters that he expects to arise in the context of the capitalist labor process. But his research assumptions are open to new discovery and surprising inconsistencies between antecedent theory and observed behavior.
And in fact, the parts of Burawoy's book that I find most convincing are the many places where he allows his sociological imagination and his eye for empirical detail to break through the mechanism of the theory. His case study is an interesting and insightful one. And it is strengthened by the fact that Burawoy does not attempt to simply subsume or recast the findings within the theoretical structure of Marx's economics.
(Burawoy addresses some of these issues directly in an important article, "Two Methods in Search of Science" (link). He advocates for treating Marxist ideas as a research program for the social sciences in the sense articulated by Imre Lakatos. )
So my advice goes along these lines: allow Marxism, or Weber or Durkheim or Tilly, to function as a suggestive program of research for empirical investigation. Let it be a source of hypotheses, hunches, and avenues of inquiry. But be prepared as well for the discovery of surprising outcomes, and don't look at the theory as a prescription for the unfolding of the social reality. Most importantly, don't look to theory as a deductive basis for explaining and predicting social phenomena. (Here is an article on the role of Marxism as a method of research rather than a comprehensive theory; link.)
David Warsh paints a somewhat gloomy picture of the "fate that, in varying degrees, awaits almost all retirees in Western Europe and North America in the next twenty years":
No Gold Watch, by David Warsh: Another generation of US workers, at least significant numbers of them, are being forced into retirement sooner than expected and without ceremony, by the Bust. As Catherine Rampell noted in The New York Times last week, millions of people have been dismissed – file clerks, ticket agents, autoworkers and the like – who might otherwise have stopped working in more orderly fashion.
“But because of the recession,” Rampell writes, “winter came early.”
This has happened before, notably in the 1980-82 recession, when the steel and domestic manufacturing industries led the casualty list; and, after 1990, when banks and other financial institutions shed millions of jobs. This time clerical and administrative workers have borne the brunt – 1.7 million of them have lost their jobs since the recession began in the fourth quarter of 2007. These are people for whom there was no gold watch. Is there anything for them besides the informal respect and affection of their peers? ...
Out of curiosity, I took a look at Studs Terkel’s Working: People Talk About What They Do All Day and How They Feel About What They Do. Terkel, a legendary Chicago radio interviewer and author, talked to more than 130 people of various occupations about their jobs, then edited and organized the results to produce a 600-page best-seller sufficiently beloved to have inspired a Broadway musical and a graphic novel. The Chicago Historical Society agreed last week to put nearly 6,000 hours of his interviews online over the next two years.
Working appeared in 1974. Terkel dwells at greater length on the dissatisfactions of work– the boredom and breakdowns and petty humiliations – than on its pleasures. He tends to value blue-collar jobs over office work. He quotes Freud from Civilization and Its Discontents – “his work at least gives him a secure place in a portion of reality, in the human community” – but compares his own role as interviewer to that of a physician lancing a series of mostly painful boils. John Coleman, the Haverford College president who famously spent a leave semester taking a series of menial jobs in 1973, speculates about the pain of losing a job at age fifty. Terkel ruminates about the pain that can come of having one.
Evidence of oligopoly – of the lack of competition – is everywhere in Working. In the 75 pages devoted to the automotive industry, there is no intimation to be found of the flood of competition that will begin to show up in the next few years in the form of better-made cars from Japan. Nor is there much of a hint of the computer revolution that will begin in a few years, displacing tens of millions. Typewriters, cash registers, phonograph records and skilled spot welders are everywhere.
The pace of change accelerated in the early 1980s when China began to enter world markets, followed by Brazil, Russia and India. New competitors entered one industry after another in which the United States had been dominant or insulated altogether from competition by regulatory or technological barriers.
Globalization won’t go on forever. No tree grows to the sky. The fast-growing economies that have joined the global economy since 1980 will top out eventually, at least temporarily, in a generation or two, just as did Japan. In the meantime, firms of all nations will become even more accustomed to competing internationally. Their employees will adjust accordingly. Terkel’s method was brilliant, but attitudes towards social causation and personal responsibly have changed greatly since he wrote. We need a new Working for the twenty-first century.
And the victims of the Bust of 2008-10? They’ll do what the steelworkers and the bankers did as part of the cohorts of 1990-82 and 1980-82: they’ll search extensively for new jobs, retrain, relocate or, if they are over fifty, confront the possibility that they will never work again in their accustomed field, perhaps not work at all. They’ll reduce consumption, explore the social safety net, titrate their savings, move to their second homes or sell them, take part-time jobs on spec, or simply capitulate to a life of leisure sooner and with less income than they expected, and cultivate their interests.
This is an exaggerated version of a fate that, in varying degrees, awaits almost all retirees in Western Europe and North America in the next twenty years, as modest tax increases and benefit cuts become general. We should view with sympathy those who are in the van. A somewhat reduced retirement, sooner or later, will happen to us all.
Friday, May 21, 2010
- Why do women leave science and engineering? - voxeu
- Return of the Nervous Weekend - Mohamed El-Erian
- Peter Wallison: Opinions without Data - Richard Green
- Can’t spot an asset bubble? - Money Supply
- What Does a Euro Depreciation Mean for the US? - Econbrowser
- Bashing BP Is "Un-American"? - EconoSpeak
- The Senate reform bill is too kind to Wall Street - Dan Gross
- It’s the general equilibrium, stupid - voxeu
- Richard Abrams: debunking free marketarianism - Angry Bear
Just a couple of thoughts before I head to the airport for the long flight home. Someone once told me that China is an interesting mix of the very old and the very new -- there's very little in the middle. And that does seem to be true. It is due to the abrupt transition that has been made, most places do not develop so rapidly and hence have middle-aged parts, not just old and new, and the pace of the transition shows. There are inevitable growing pains associated with development that is this rapid.
My casual observation both from all the government presentations on the economy I heard from various government ministers over the last two days and from walking around is that the economic development mirrors this pattern that. There is the new and efficient, and there are the old ways of doing things that are much less modern and much less efficient. There's very little in the middle. As I said on a tweet yesterday while strolling around, although growth of output has been high, it seems to me that there are still many, many people playing "small ball" economically, and hence there is still quite a bit or room for productivity to increase.
Anyway, glad I had the opportunity to come here and see what is happening first hand, particularly the ability to hear from and talk to people from the agencies in charge of economic development (though most of them were involved in one way or another with job creation and development, so I didn't hear all about all the issues they face). I am in the heart of Beijing, fairly close to the Forbidden City -- you don't see many cranes, etc. constructing new buildings since this area is already pretty densely developed -- so I may not have gotten a very good sense of the old-new balance (even so, there is lots of construction in evidence, mostly old buildings being gutted or raised to make room for something else). All in all, it's a pretty interesting place. I saw no signs of anything but full spreed ahead,
Looks like the next conference is Budapest in June. That will be interesting too. If someone had told me that starting a blog would lead to world travel on other people's dimes, I would have laughed. But it has. And all I can say is huh. Cool. Didn't expect that.
I am not looking forward to getting to the airport 2 hours early, my 12 hour flight, 6 hour layover in SF, and then the 1 hour flight to Eugene (and on the way here, one plane was delayed an extra three hours). But clicking my heels together and wishing I was back in Kansas (OK, Oregon) won't get it done, so I guess I don't have much choice. So I'd better get going -- maybe I can connect at the airport. If not, and I'm pretty much out of the international data plan I got before coming, no more internet until SF. I hope I don't get tremors from the withdrawal (I have two posts that I set before I left to publish later tonight).
Apologies for writing so little the last several days. The opportunity cost was giving up the chance to use the few free hours I had to see (a little bit of) Bejing, and I decided MU/P was higher for sight-seeing than for most anything else. But Tim Duy did a pretty good job picking up the slack, so I owe him a thanks.
Remember how people who don't like the New Keynesian model would claim there is no Phillips curve, i.e. that inflation does not depend upon the output gap (e.g., here, or here)? They're looking pretty foolish:
Lost Decade Looming?, by Paul Krugman, Commentary, NY Times: Despite a chorus of voices claiming otherwise, we aren’t Greece. We are, however, looking more and more like Japan.
For the past few months, much commentary on the economy — some of it posing as reporting — has had one central theme: policy makers are doing too much. Governments need to stop spending, we’re told. Greece is held up as a cautionary tale, and every uptick in the interest rate on U.S. government bonds is treated as an indication that markets are turning on America over its deficits. Meanwhile, there are continual warnings that inflation is just around the corner, and that the Fed needs to pull back from its efforts to support the economy and get started on its “exit strategy,” tightening credit by selling off assets and raising interest rates.
And what about near-record unemployment, with long-term unemployment worse than at any time since the 1930s? .... [T]he truth is that policy makers aren’t doing too much; they’re doing too little. Recent data don’t suggest that America is heading for a Greece-style collapse of investor confidence. Instead, they suggest that we may be heading for a Japan-style lost decade,... a prolonged era of high unemployment and slow growth.
Let’s talk first about those interest rates. On several occasions over the past year, we’ve been told, after some modest rise in rates, that ... America had better slash its deficit right away or else. Each time, rates soon slid back down. ... I wish I could say that falling interest rates reflect a surge of optimism about U.S. federal finances. What they actually reflect, however, is a surge of pessimism about the prospects for economic recovery, pessimism that has sent investors fleeing ... into the perceived safety of U.S. government debt.
What’s behind this new pessimism? It partly reflects the troubles in Europe... But there are also warning signs at home, most recently Wednesday’s report on consumer prices, which showed a key measure of inflation falling below 1 percent, bringing it to a 44-year low.
This isn’t really surprising: you expect inflation to fall in the face of mass unemployment and excess capacity. But it is nonetheless really bad news. Low inflation, or worse yet deflation,... encourages people to hoard cash rather than spend, which keeps the economy depressed, which leads to more deflation. That vicious circle isn’t hypothetical: just ask the Japanese, who entered a deflationary trap in the 1990s and, despite occasional episodes of growth, still can’t get out. And it could happen here.
So ... we should really be asking ... what we’re doing to avoid turning Japanese. And the answer is, nothing.
It’s not that nobody understands the risk. I strongly suspect that some officials at the Fed see the Japan parallels all too clearly and wish they could do more... But in practice it’s all they can do to contain the tightening impulses of their colleagues, who (like central bankers in the 1930s) remain desperately afraid of inflation... I also suspect that Obama administration economists would very much like to see another stimulus plan. But they know that such a plan would have no chance of getting through a Congress that has been spooked by the deficit hawks.
In short, fear of imaginary threats has prevented any effective response to the real danger facing our economy.
Will the worst happen? Not necessarily. Maybe the economic measures already taken will end up doing the trick, jump-starting a self-sustaining recovery. Certainly, that’s what we’re all hoping. But hope is not a plan.
More reactions from Tim, this time in response to various comments on his recent post claiming that the European debt crisis might help the US:
More on the European Impact, by Tim Duy: Some clarification and expansion of my recent off-consensus analysis of the implications of the European debt crisis is in order. In short, I noted that lower energy costs and interest rates were generally positive for the US. Responses came from Scott Sumner, Felix Salmon, Ryan Avent, and Paul Krugman.
The context in which I considered my remarks are well described by Michael Pettis, in his rebuttal to claims that China should avoid currency revaluation in light of the Euro's decline. He argues that the Euro's decline makes the a shift in Chinese currency policy all the more critical. In his summary:
5. If Europe’s current account surplus grows, there must be one or both of two automatic consequences. Either the current account surplus of surplus countries like China and Japan must contract by the same amount, or the current account deficits of deficit countries like the US must grow by that amount, or some combination of the two.
6. If the Chinas and Japans of the world lower interest rates, slow credit contraction, and otherwise try to maintain their exports – let alone try to grow them – most of the adjustment burden will be shifted onto countries that do not intervene in trade directly. The most obvious are current account deficit countries like the US.
A collapsing trade surplus in Europe needs to be met with an expanding trade surplus somewhere else, and my view is that the US is the most likely candidate, especially as the trend is already in place - the external sector is a drag on growth, despite all expectations that a sustained rebalancing will occur in the wake of the US financial crisis.
I think that the decline in oil prices and interest rates is one mechanism by which markets essentially offset some the contractionary consequences of the European debt crisis. Like the declining Euro, they are price signals that correspond to propping up demand elsewhere, such as the US, thereby allowing the US to absorb the European contraction via an expansion in the US current account deficit. Thus, the surprising effect of the crisis is that US demand growth is higher than would otherwise be the case, even as global growth in aggregate suffers.
Pettis argues, I think correctly, that this sets the stage for a rather nasty increase in trade tensions:
I don’t really see how the numbers are going to work. Europe, China and Japan are all implicitly demanding that the US trade deficit rise to help them through their domestic employment problems. The US has its own domestic employment problems and is determined to bring the trade deficit down. Both sides cannot win and there doesn’t seem to be much serious attempt at global coordination. In fact the easiest part of any global coordination – that between surplus Europe and deficit Europe – has already degenerated into a nasty round of accusations, counter-accusations and insults.
Note that Pettis is hinting at one of Ryan Advent's criticisms regarding domestic employment problems:
For another, it seems unreasonable to expect personal consumption to power recovery all the way back to full employment, no matter what interest rates or oil prices do. Household balance sheets are simply too stressed. Consumption can act as a bridge from government-driven growth to export- and investment-driven growth, but little more, and export- and investment-driven growth is looking dicier now than it was a month ago.
I agree - it seems ludicrous to expect the US consumer to continue to power forward sufficiently to hold the US economy and the global economy together. Yet, I suspect that it is the course of least resistance, or at least appears to be at the moment. For what it's worth, consumer spending growth has been on something of a tear - a trend that stretches back to the middle of last year. One can argue that this spending is simply propped up by the expansion of government debt rather than private debt, but note that that dynamic becomes more sustainable given lower interest rates. It is almost as if market participants are encouraging the US government to take over where the Greeks, Spanish, etc. let off. Indeed, it seems to be clear evidence that public debt is nowhere near crowding out private spending in the US. Room for more, not less.
Is this economically healthy? No, no, no. Felix points out that an expansion of the US imbalance now only implies higher interest rates later. The adjustment will come, and will only be more difficult in the future. That is a story I have told many times, but I have to add this - going bearish on US debt has been risky. Like Japan, economists keep saying the end is near, but it has not yet happened. Timing is everything.
Sumner argues that declining commodity prices in response to demand shock are rarely a good thing, and the recent episode is another reason to believe that central bankers are failing to support nominal GDP growth. With respect to my earlier argument, I see no reason why a decline in energy prices due to a demand drop in Europe cannot be a net positive for the US. But, nonetheless, I agree with Sumner's broader point regarding the need for more aggressive monetary policy:
It’s true that US exports to Europe are modest, but if the strong dollar is symptomatic of unintentional tightening of monetary policy, despite low rates, then it may not be good news at all.
He reiterates the point here. The European Central Bank, in particular, should be working more aggressively to counter deflationary pressures internally. But, alas, policymakers don't want to be seen as bailing out weaker members for fear of losing credibility. One of the cut of your nose to spite your face situations. Likewise, with the US facing ongoing disinflationary pressures, the Fed arguably should be expanding policy more aggressively. In theory, the two expansions could leave the relative currency prices unchanged, yet sink both against other trading partners.
This, of course, brings us back to the apparently intractable Chinese currency issue. A Dollar and Euro depreciation against the renminbi and other emerging market currencies looks like a nobrainer approach to preventing an intensification of global imbalances. Moreover, it just makes economic sense given relative inflation trends. Consider today's Wall Street Journal:
U.S. inflation slid last month to its lowest level in 44 years, highlighting a potentially troublesome unevenness in the global recovery.
Inflation has sped up in booming economies such as China and Brazil, while in many developed nations like the U.S., prices remain tame, even flirting with deflation in some cases.
The U.S. government reported Wednesday that consumer prices, excluding volatile food and energy, rose a meager 0.9% in April from a year earlier. It is the latest sign that high unemployment and excess production capacity are holding down wages and prices in much of the developed world.
At the same time, emerging economies are taking steps to contain high inflation in their booming markets—moves that some economists worry could dampen demand for exports, which many developed countries are depending on to help fuel their recoveries.
Note that US Treasury Secretary Timothy Geithner said again this week that Chinese currency policy is set for a change:
The Treasury chief also yesterday reiterated his call that China will abandon its exchange-rate peg. The government is moving toward changes in currency policy that would allow market forces to play a greater role, he told reporters after the speech.
Of course, Geithner says things like this a lot. And one gets the expected pushback from China:
Yuan forwards weakened for a second day after Chinese officials said the nation won’t yield to global calls to end a 22-month peg, damping speculation next week’s U.S.-China trade talks would trigger appreciation.
China won’t succumb to external pressure and will modify the currency based on the economic situation, Assistant Finance Minister Zhu Guangyao said in Beijing today. Stability between the world’s major reserve currencies will aid the global economic recovery, he said at a briefing to discuss the May 24- 25 Strategic & Economic Dialogue in Beijing…
“Only the authorities of a sovereign country have the right to decide how to form the exchange rate,” Zhu said. Countries should “work to maintain the stability of exchange rates between currencies so as to create a favorable environment for the global economic recovery,” he said.
Note that Chinese policymakers hold all the cards regarding any policy shifts. They know that Geithner is not going to push for capital controls, nor will he request the Fed to beginning stockpiling renminbi on Treasury's behalf. The latter policy - a tit for tat response to Chinese dollar accumulation - would be interesting to say the least, but no US policymaker wants to be accused of initiating a chain of competitive devaluations that will only end badly.
Sorry if this is rambled; external adjustment stories on a global scale tend to get messy. Which I imagine is why we have yet find a sustainable path to resolving imbalances.
Tim Duy reacts to Federal Reserve Governor Daniel Tarullo's recent testimony on the European debt crisis:
Fed Disconnect, by Tim Duy: Federal Reserve Governor Daniel Tarullo's recent testimony on the European debt crisis illustrates a significant inconsistency with between the Fed's outlook and its policy. Honestly, if Tarullo actually believes with he says, the Fed needs to be pursuing a much more aggressive policy. But the FOMC is actually debating the opposite - when and how to reverse its swelling balance sheet.
Tarullo highlights the two obvious negative channels by which the European crisis will feed into the US economy. The first is financial:
These effects on U.S. markets underscore the high degree of integration of the U.S. and European economies and highlight the risks to the United States of renewed financial stresses in Europe. One avenue through which financial turmoil in Europe might affect the U.S. economy is by weakening the asset quality and capital positions of U.S. financial institutions...
...In addition to imposing direct losses on U.S. institutions, a heightening of financial stresses in Europe could be transmitted to financial markets globally. Increases in uncertainty and risk aversion could lead to higher funding costs and liquidity shortages for some institutions, and forced asset sales and reductions in collateral values that could, in turn, engender further market turmoil. In these conditions, U.S. banks and other institutions might be forced to pull back on their lending, as they did during the period of severe financial market dysfunction that followed the bankruptcy of Lehman Brothers.
The second is via trade linkages:
Another means by which an intensification of financial turmoil in Europe could affect U.S. growth is by reducing trade. Collectively, Europe represents one of our most important trading partners and accounts for about one-quarter of U.S. merchandise exports. Accordingly, a moderate economic slowdown across Europe would cause U.S. export growth to fall, weighing on U.S. economic performance by a discernible, but modest extent. However, a deeper contraction in Europe associated with sharp financial dislocations would have the potential to stall the recovery of the entire global economy, and this scenario would have far more serious consequences for U.S. trade and economic growth. A resultant slowdown in the United States and abroad would likely also feed back into the health of U.S. financial institutions.
Tarullo acknowledges that the European crisis is largely a European problem, while the Fed is reduced to a limited supporting role. What caught my attention was first this section regarding the potential for financial disruption:
The timing of such an event in the current instance would be unfortunate, as banks generally have only recently ceased tightening lending standards, and have yet to unwind from the considerable tightening that has occurred over the past two years. Moreover, aggregate bank lending, particularly to businesses, continues to contract. The result would be another source of risk to the U.S. recovery in an environment of still-fragile balance sheets and considerable slack. Although we view such a development as unlikely, the swoon in global financial markets earlier this month suggests that it is not out of the question.
The fact that aggregate bank lending continues to contract, that the Fed is obviously aware of this, and that, according to Tarullo, the European crisis has the potential to aggravate an already existing problem all clearly point toward a more aggressive quantitative easing program than in place. Actually, what is happening is the Fed is considering a quantitative tightening program:
Meeting participants agreed broadly on key objectives of a longer-run strategy for asset sales and redemptions. The strategy should be consistent with the achievement of the Committee's objectives of maximum employment and price stability. In addition, the strategy should normalize the size and composition of the balance sheet over time. Reducing the size of the balance sheet would decrease the associated reserve balances to amounts consistent with more normal operations of money markets and monetary policy. Returning the portfolio to its historical composition of essentially all Treasury securities would minimize the extent to which the Federal Reserve portfolio might be affecting the allocation of credit among private borrowers and sectors of the economy.
Tarullo also presses for a hawkish fiscal stance:
The United States is in a very different position from that of the European countries whose debt instruments have been under such pressure. But their experience is another reminder, if one were needed, that every country with sustained budget deficits and rising debt--including the United States--needs to act in a timely manner to put in place a credible program for sustainable fiscal policies.
Interestingly, Tarullo seems to suggest that the US response to fiscal problem in Europe should be to tighten US fiscal policy on roughly the same timetable the Fed is looking forward to tightening US monetary policy.
To summarize, the Fed believes we are facing another threat to demand, either via financial or real trade linkages, at a time when lending activity continues to fall, suggesting that monetary policy is too tight to begin with. But the Fed stance is to believe that monetary policy is on the verge of being too loose, and, if anything, planning needs to be made to tighten policy. At the same time, Fed policymakers also believe fiscal policy needs to turn toward tightening as well. Meanwhile, unemployment hovers just below 10%, nor is it expected to decline rapidly, and inflation continues to trend downward.
All of which together suggests that the Fed's policy stance is seriously out of whack with policymaker's interpretation of actual and potential economic developments. And I have trouble explaining the disconnect.
Nick Rowe on the "silent shift in macroeconomic thought":
The orthodox loss of faith, by Nick Rowe: I think we are witnessing the biggest silent shift in macroeconomic thought since the Second World War. For 70 years we have taught, and believed, that we would never again need to suffer a persistent shortage of demand. We promised ourselves the 1930's were behind us. We knew how to increase demand, and would do it if we needed to.
The orthodox have lost faith in that promise; only the heterodox still believe it. And the heterodox have nothing in common, except for keeping the faith.
The orthodox haven't lost hope. They hope that monetary and fiscal policy will be enough to get us out of this recession, and that the limits on monetary and fiscal policy will not be binding this time around. And they are probably right. But they have lost faith that monetary and/or fiscal policy will always be enough - that there are no limits.
And if the Eurozone too turns Japanese, they may start to lose even that hope.
There are two types of macroeconomist.
The first says "What do you mean you can't increase aggregate demand? You run out of paper? Ink? You scared of inflation?"
The second says "But monetary policy won't work at the zero lower bound. And there are limits on fiscal policy, because we daren't let the national debt get too big."
Scott Sumner and Modern Monetary Theorists are examples of the first type of macroeconomist. They have nothing in common, except that one thing. But that one thing is more important than all their differences. And they are heterodox.
Traditional Keynesians and monetarists, the competing schools of the old orthodoxy, belonged to the first type of macroeconomist. They differed only on tactics. They kept the faith. But they have now gone, and only monetary cranks sing the old religion.
The second type of macroeconomist represents the new orthodoxy. Few orthodox macroeconomists today will admit point-blank to having lost the faith, any more than a bishop, no matter how liberal, will admit to being an atheist. But if you believe that monetary policy is ineffective at the zero bound, and that there are limits to how long you can have a big fiscal deficit, it comes to the same thing. You have lost faith that you can always and everywhere increase demand by whatever it takes for as long as is needed.
Losing faith in monetary and fiscal policy, the orthodox turn to financial policy. "If we had better regulation and/or supervision of financial markets and institutions, we wouldn't have gotten into this mess in the first place". That's probably true, but it's also a distraction from the loss of faith. Financial markets and institutions are inherently unstable. They borrow short and lend long; they borrow safe and lend risky; they borrow liquid and lend illiquid; they borrow simple and they lend complex. Finance is magic; you know it can't really be done. Regulation and supervision can never eliminate financial instability. If your faith is contingent on being able to prevent financial crises, you have lost the faith.
Good financial regulation and supervision are important in their own right. A good financial system will better serve the interests of borrowers and lenders. It will create benefits on the supply side. And financial crises will almost certainly cause demand to fall. But just because something causes demand to fall doesn't mean monetary and fiscal policy can't work. The whole point of Keynesian policy was that when (not if) something did cause demand to fall, monetary or fiscal policy could and should be used to increase it back again.
Even suppose the financial system totally collapsed. Why should that prevent monetary and fiscal policy working to increase demand? The biggest flaw of orthodox macroeconomic models is that they have no financial sector. So, if the financial system disappeared, that ought to mean those models would work even better.
This is what I sensed to be the overarching but unspoken theme of a conference at Carleton on the economic and financial crisis. I may do subsequent posts on more specific topics.
Robert Barro and Jong-Wha Lee use a new data set to measure the rate of return to an additional year of schooling on output and find that is "quite high":
Educational attainment in the world, 1950–2010, by Robert Barro and Jong-Wha Lee, Vox EU: It is widely accepted that human capital, particularly attained through education, is crucial to economic progress. An increase in the number of well-educated people implies a higher level of labour productivity and a greater ability to absorb advanced technology from developed countries (Acemoglu 2009). Empirical investigations of the role of human capital require accurate and internationally-comparable measures of human capital across countries and over time.
Our earlier studies (1993, 1996, and 2001) constructed measures of educational attainment of the adult population for a broad group of countries. This column introduces a new data set (available at barrolee.com) providing improved estimates for 146 countries at 5-year intervals from 1950 to 2010. The data are disaggregated by sex and by 5-year age groups among the population aged 15 years and over (see Barro and Lee 2010).
The new data improve on our widely used earlier information by using more observations of censuses, surveys, and enrolment-rate figures and by employing better methodology. We use consistent census and survey data compiled from UNESCO, Eurostat, and other sources to provide benchmarks for school attainment by gender and age group. We use enrolment-rate data to fill in missing observations at 5-year intervals by forward and backward extrapolation from the benchmark statistics. As part of this analysis, we construct new estimates of mortality rates by age and education level. We also use estimates of completion ratios applicable to each country and level of schooling.
In 2010, the world population aged 15 and over had an average 7.8 years of schooling, increasing steadily from 3.2 years in 1950 and 5.3 years in 1980. The rise in average years of schooling from 1950 to 2010 was from 6.2 to 11.0 years in high-income countries and from 2.1 to 7.1 years in low-income countries. Thus in 2010 the gap between rich and poor countries in average years of schooling remained at 4 years, having narrowed by less than 1 year since 1960 (see Figure 1). In 2010 the level and distribution of educational attainment in developing countries are comparable to those of the advanced countries in the late 1960s.
Figure 1. Average years of schooling by education level (population over age 15)
We use the new data to estimate the relationship between education and output based on a production-function approach. Our findings confirm that schooling has a significantly positive effect on output. Our estimates of rates of return for an additional year of schooling range from 5% to 12%. These estimates control for the simultaneous determination of human capital and output by using the 10-year lag of parents‘ education as an instrumental variable for the current level of schooling. These estimates are close to typical Mincerian return estimates found in the labour literature.
Estimates of rates of return to education vary across regions (Figure 2). The estimates for the group of advanced countries, East Asia and the Pacific, and South Asia are the highest at 13.3%. In contrast, the estimated rates of return are only 6.6% in Sub-Saharan Africa and 6.5% in Latin America.
Figure 2. Rates of return to an additional year of schooling, by region
Source: Country fixed-effects instrumental variable (IV) estimation in Table 6 of Barro and Lee (2010).
Results confirm that the rate of return to schooling varies across levels of education. The estimated rate of return is higher at the secondary (10.0%) and tertiary (17.9%) levels than at the primary level, which differs insignificantly from zero. The results imply that, on average, the wage differential between a secondary-school and a primary-school graduate is around 77% and that between a college and a primary-school graduate is around 240%.
Our improved dataset on educational attainment should be helpful for a variety of empirical work. For example, our previous estimates have been used to study the linkages across countries between education and important economic and social variables, such as economic growth, fertility, income inequality, institutions, and political freedom. We anticipate that the new data will help to improve the reliability of these types of analyses.
Disclaimer: The views expressed in this article are those of the authors and do not necessarily reflect the views and policies of the Asian Development Bank or its Board of Governors or the governments they represent.
Acemoglu, Daron (2009), “Modern economic growth”, VoxEU.org, 27 February.
Barro, RJ and JW Lee (1993), “International Comparisons of Educational Attainment”, Journal of Monetary Economics, 32:363-394.
Barro, RJ and JW Lee (1996), “International Measures of Schooling Years and Schooling Quality”, American Economic Review, 86:218-223.
Barro, RJ and JW Lee (2001), “International Data on Educational Attainment: Updates and Implications”, Oxford Economic Papers, 53:541-563.
Barro, RJ and JW Lee (2010), “A New Data Set of Educational Attainment in the World, 1950-2010”, NBER Working Paper 15902, (accompanying data are available at www,barrolee.com).