Economist's View

'The Role of Money in New-Keynesian Models'

Should New Keynesian models include a specific role for money (over and above specifying the interest rate as the policy variable)? This is a highly wonkish, but mostly accessible explanation from Bennett McCallum:

The Role of Money in New-Keynesian Models, by Bennett T. McCallum, Carnegie Mellon University, National Bureau of Economic Research, N° 2012-019 Serie de Documentos de Trabajo Working Paper series Octubre 2012

Here's the bottom line:

...we drew several conclusions supportive of the idea that a central bank that ignores money and banking will seriously misjudge the proper interest rate policy action to stabilize inflation in response to a productivity shock in the production function for output. Unfortunately, some readers discovered an error; we made a mistake in linearization that, when corrected, greatly diminished the magnitude of some of the effects of including the banking sector. There seems now to be some interest in developing improved models of this type. Marvin Goodfriend (MG) is working with a PhD student in this topic. At this point I have not been able to give a convincing argument that one needs to include M. ...

There is one respect in which it is nevertheless the case that a rule for the monetary base is superior to a rule for the interbank interest rate. In this context we are clearly discussing the choice of a controllable instrument variable—not one of the "target rules" favored by Svensson and Woodford, which are more correctly called "targets." Suppose that the central bank desires for its rule to be verifiable by the public. Then it will arguably need to be a non-activist rule, one that normally keeps the instrument setting unchanged over long spans of time. In that case we know that in the context of a standard NK model, an interest rate instrument will not be viable. That is, the rule will not satisfy the Taylor Principle, which is necessary for "determinacy." The latter condition is not, I argue, what is crucial for well-designed monetary policy, but LS learnability is, and it is not present when the TP is not satisfied. This is well known from, e.g., Evans and Honkapohja (2001), Bullard and Mitra (2002), McCallum (2003, 2009). ...

'Economic Effects of Hurricane Sandy'

Jim Hamilton on the economic damage from hurricane Sandy:

... One parallel to consider is the devastation from Hurricane Katrina in 2005. In addition to the short-run dislocations, this ended up causing lasting damage to offshore oil-producing infrastructure. An optimist might have thought this would create all kinds of new jobs trying to rebuild. The actual experience was not so cheerful.

Seasonally adjusted nonfarm employment in Louisiana, 2004:M1 - 2007:M12, in thousands of workers. Vertical line marks Hurricane Katrina in August 2005. Data source: BLS.

The Wall Street Journal reports that IHS estimates that Hurricane Sandy could reduce the 2012:Q4 U.S. real GDP growth rate by 0.6 percentage points at an annual rate. I'm not sure how one comes up with that kind of number. But I am persuaded this was not a good thing for the U.S. economy.

No Fear of a Pinocchio Nose: Romney's Welfare Lie

Romney continues to disrespect the mainstream press -- he appears to have no fear that they can expose blatant falsehoods in a way that might cost him votes:

The ignominious return of the welfare lie, by Steve Benen: For much of August, Mitt Romney proudly embraced as obvious a lie as has ever been heard in presidential politics. The Republican insisted -- in speeches, interviews, and ads -- that President Obama had "gutted the work requirement" in welfare law. He was blatantly lying, but didn't care.

Over the last month or so, Romney moved on to different lies, most notably about the auto industry, but in the campaign's closing days, the racially-charged welfare lie has made a comeback. ...

This unannounced attack ad, running in several key states,... argues at the outset that Obama "gutted the work requirement for welfare." This isn't just another lie; it's presidential politics at its most disgusting.

What's more, Romney isn't relying on misleading technicalities, or hiding in some ambiguous gray area between fact and fiction. This is just a demonstrable, racially-inflammatory lie -- and the candidate knows it. ... And yet, Romney keeps repeating it. ...

With this ad, Romney is once again carefully extending his middle finger in reality's face. He doesn't care about getting caught -- his campaign has already said, "[W]e're not going to let our campaign be dictated by fact checkers" -- he just cares about what he can get away with as part of his quest for power.

This is the national political scandal of 2012, whether the political world wants to admit it or not.

The Science of New Monetarist Economics

It's been interesting to watch people like Steven Williamson turn on Narayana Kocherlakota because he no longer agrees with their views on monetary policy. The "economics should be a science" people like Williamson resort to the oh so scientific technique of name-calling, e.g. "goofy," "flimsy-excuse guy," e.g. see Williamson's latest (interesting that he chose to emphasize the name-calling rather than the economics in his title for the post). But to me the most notable thing about this is not Kocherlakota's change of heart. As Yglesias notes today, that's how science should proceed -- if the evidence is against you, change your views. No, the most interesting thing to me begins with statements such as this from Williamson two years ago:

the fact is that reserves are leaving banks in the form of currency as we can see in this chart. ... Note in particular that reserves have recently been leaving banks at a more rapid rate. It's possible that we would get more inflation even without QE2.

Or, around the same time:

I think it is quite possible that we will look back on QE2 as a severe error. In spite of the talk from some quarters about the intervention being too small, this is a very large-scale asset purchase for the Fed, on top of a previous very large purchase of mortgage-backed securities and agency securities. One possibility is that economic growth picks up, of its own accord, reserves become less attractive for the banks, and inflation builds up a head of steam. The Fed may find this difficult to control, or may be unwilling to do so. Even worse is the case where growth remains sluggish, but inflation well in excess of 2% starts to rear its ugly head anyway. Bernanke is telling us that he "has the tools to unwind these policies," but if the inflation rate is at 6% and the unemployment rate is still close to 10%, he will not have the stomach to fight the inflation.

My concern here is that, given the specifics of the QE2 policy that was announced, the FOMC will be reluctant to cut back or stop the asset purchases, even if things start looking bad on the inflation front. Once inflation gets going, we know it is painful to stop it, and we don't need another problem to deal with.

He was worried that economic growth would pick up soon (it didn't -- his model misled him, or he didn't use a model in which case I have to wonder about his "science") and inflation would become a problem. He supported this with charts, etc., and he also said inflation could be aproblem even if economic growth didn't pick up.

Well, it didn't happen. We didn't get the economic growth his model had him worried about, and we didn't get the inflation his model predicted. His argument may be that it just hasn't happened yet, but that was two years ago (Nov. 6, 2010), and whatever model was being used to worry about growth and inflation was wrong. Very wrong. If we listen to Williamson, we forego two years of more aggressive policy based upon a fear of inflation that doesn't materialize. Now, he says more aggressive policy has no real effects so it's useless anyway (so why risk the inflation), but theory and evidence disagree on this point. Most current work shows it did, indeed, have modest effects (another failed prediction of his model).

And this is just funny:

So the Kocherlakota of 2 1/2 years ago had some worries about the potential for inflation. Maybe he changed his mind for good reason? I don't think so. ...

Yes, all that inflation we've had should have validated his fears. Williamson's complaint appears to be that Kocherlakota predicted something two and a half years ago, it didn't happen, and he has the gall to use the fact that his prediction failed to change his mind? He changed his mind based upon evidence? He looked at evidence and did science??? How goofy is that? Doesn't he know -- as Williamson apparently knew years ago -- that inflation is just around the corner (according to his wonderfully scientific model)?

Williamson was wrong then, but right now because higher growth does look likely in the near future, is that the argument? Why should we believe his model of inflation and growth now now if it was wrong before? Or will inflation happen even without higher growth like he said could happen two years ago? What should we believe his model now if it was wrong before?

Look, I'm all for science, but that has to include changing your mind when your model is wrong. After two years of running around telling everyone the sky is about to fall, perhaps Williamson will understand why people are more likely to listen to the evidence based views of Narayana and others than to him.

'The Insurer Of Last Resort'

Paul Krugman:

Disasters and Politics: ...let me just take a moment to flag an issue others have been writing about: the weird Republican obsession with killing FEMA. Kevin Drum has the goods: they just keep doing it. George Bush the elder turned the agency into a dumping ground for hacks, with bad results; Clinton revived the agency; Bush the younger ruined it again; Obama revived it again; and Romney — with everyone still remembering Brownie and Katrina! — said that he wants to block-grant and privatize it. (And as far as I can tell, even TV news isn’t letting him Etch-A-Sketch the comment away).

There’s something pathological here. It’s really hard to think of a public service less likely to be suitable for privatization, and given the massive inequality of impacts by state, it really really isn’t block-grantable. Does the right somehow imagine that only Those People need disaster relief? Is the whole idea of helping people as opposed to hurting them just anathema?

It’s a bit of a mystery, calling more for psychological inquiry than policy analysis. But something is going on here.

Some history from Tod Kelly (via):

One of the hard lessons one learns in risk management is that no one funds for catastrophic losses unless they are required by an outside agency to do so. In many cases this is because it is not feasible to do so; but even in those cases where it is feasible, no one does.

Were FEMA to be dismantled, for example, there would be no financial resources from which to quickly rebuild from disasters like Hurricane Sandy. Conservatives might argue that private insurers could provide such protection, and this is certainly correct – on paper. However, one of the axioms from my industry is that there is no such thing as an uninsurable risk, there are just risks people aren’t willing to pay enough premium for.

This is absolutely true for natural disasters. If your insurance provider offered you or your business coverage that would protect you from disasters like Sandy, you would not be willing to pay the premium required. You might disagree with that statement, but history shows that it is true. In fact, it is almost universally true. Governmental disaster insurance schemes didn’t appear magically in a vacuum; they were created because prior no one was willing to pay enough money in premiums to allow insurance companies to properly fund for them, and as a result the inevitable losses were uncovered.

That's true of government social insurance sprograms as well. They appeared for a reason, and generally the reason is the inability of the private market to provide adequate protection due to market failures or other causes. Pretending that those problems no longer exist -- that privatization would somehow be different this time -- is wishful thinking.

Climate Change and Hurricane Sandy

Is there a link between climate change and hurricane Sandy?:

Did Climate Change Cause Hurricane Sandy?, by Mark Fischetti, Scientific American: If you’ve followed the U.S. news and weather in the past 24 hours you have no doubt run across a journalist or blogger explaining why it’s difficult to say that climate change could be causing big storms like Sandy. Well, no doubt here: it is.

The hedge expressed by journalists is that many variables go into creating a big storm, so the size of Hurricane Sandy, or any specific storm, cannot be attributed to climate change. That’s true, and it’s based on good science. However, that statement does not mean that we cannot say that climate change is making storms bigger. It is doing just that—a statement also based on good science, and one that the insurance industry is embracing, by the way. (Huh? More on that in a moment.)

Scientists have long taken a similarly cautious stance, but more are starting to drop the caveat and link climate change directly to intense storms and other extreme weather events, such as the warm 2012 winter in the eastern U.S. and the frigid one in Europe at the same time. They are emboldened because researchers have gotten very good in the past decade at determining what affects the variables that create big storms. Hurricane Sandy got large because it wandered north along the U.S. coast, where ocean water is still warm this time of year, pumping energy into the swirling system. But it got even larger when a cold Jet Stream made a sharp dip southward from Canada down into the eastern U.S. The cold air, positioned against warm Atlantic air, added energy to the atmosphere and therefore to Sandy, just as it moved into that region, expanding the storm even further.

Here’s where climate change comes in. ... [more] ...

Links for 10-31-2012

• Mitt Romney’s voodoo spending cuts - Ezra Klein
• More on climate change and budget deficits - mainly macro
• Romney would be a backward step - Martin Wolf
• The Real Barrier to Tax Reform - Bruce Bartlett
• Some Properties of Non-linear Least Squares - Dave Giles
• Medium of Account vs Medium of Exchange - Nick Rowe
• A Letter from a Disgusted teacher - Diane Ravitch
• How Retirement Age Tracks Social Security's Rules - Tim Taylor
• Social Media and the 2012 Campaign (Amy Thoma) - KTXL
• Narayana Kocherlakota Speech - Federal Reserve Bank of Minneapolis
• Fed’s Kocherlakota: Fed May Not Be Providing Enough Stimulus - WSJ
• The Price Mechanism - Cheap Talk
• Insider Knowledge - Crooked Timber
• Scoop Dupes - Paul Krugman
• Manufacturing - IGM Forum

'The Philosophy of Economics'

Dan Little is a philosopher of social science:

The philosophy of economics, by Dan Little: The philosophy of economics intersects with several different areas of philosophy, including the philosophy of science, ethics, and social philosophy. (Dan Hausman is the leading expert in the philosophy of economics. His The Inexact and Separate Science of Economics is a recent contribution.) The field is concerned with methodology, values, and substance.

The primary focus of the field is on issues of methodology and epistemology—the methods, concepts, and theories of economists. What kind of knowledge is provided by the discipline of economics? How is economic knowledge justified or confirmed? How does it relate to other social sciences and the bodies of knowledge contained in those disciplines?

Second, philosophy of economics is concerned with values—the values of human welfare, social justice, and the tradeoffs among priorities that economic choices require. Economic reasoning has implications for justice and human welfare; more importantly, economic reasoning often makes inexplicit but significant ethical assumptions that philosophers of economics have found it worthwhile to scrutinize.

Finally, the philosophy of economics is concerned with substance—what might be called the ontology and theoretical space of economics. Here philosophers have expressed interest in the institutions and structures through which economic activity and change take place, and have turned a critical eye to the assumptions economists often make about institutions and social processes. Are there alternative institutions through which modern economic activity can proceed? What are some of the institutional variants that exist within the general framework of a market economy? What are some of the roles that the state can play within economic development so as to promote efficiency, equity, productivity, and growth?

In thinking about the philosophy of economics it is worthwhile dwelling briefly on the intellectual role played by philosophy of economics. Philosophers are not empirical researchers; and on the whole they are not formal theory-builders. So what constructive role does philosophy have to play in economics? There are several. First, philosophers are well prepared to examine the logical and rational features of an empirical discipline. How do theoretical claims in the discipline relate to empirical evidence? How do pragmatic features of theories such as simplicity, ease of computation, and the like, play a role in the rational appraisal of a theory? How do presuppositions and traditions of research work to structure the forward development of the theories and hypotheses of the discipline? Further, philosophers are well equipped to consider topics having to do with the concepts and theories that economists employ—for example, rationality, Nash equilibrium, perfect competition, transaction costs, or asymmetric information. Philosophers can offer helpful analysis of the strengths and weaknesses of such concepts and theories—thereby helping practicing economists to further refine the theoretical foundations of their discipline. In this role the philosopher serves as a conceptual clarifier for the discipline, working in partnership with the practitioners to bring about more successful economic theories and explanations.

In this aspect philosophers can serve as intelligent critics of the coherence and empirical and theoretical credibility of the theories and approaches that economists put forward. In order to accomplish this goal, the philosopher of economics has a responsibility that is parallel to that of the philosopher of biology or philosopher of physics: he or she must attain a professional and rigorous understanding of the discipline as it currently exists. The most valuable work in the philosophy of any science proceeds from the basis of significant expertise on the part of the philosopher about the “best practice,” contemporary debates, and future challenges of the discipline.

So far we have described the position of the philosopher as the “underlaborer” of the economist. But in fact, the line between criticism and theory formation is not a sharp one. Economists such as Amartya Sen and philosophers such as Daniel Hausman have demonstrated that there is a very constructive crossing of the frontier that is possible between philosophy and economics; and that philosophical expertise can result in significant substantive progress with regard to important theoretical or empirical problems within the discipline of economics. The cumulative contents of the journal Economics and Philosophy provide clear evidence of the productive engagements that are possible when philosophy meets economics.

One issue stands out for special philosophical attention -- the role of values in economics. Economists often portray their science as “value-free”—as a technical analysis of the demands of rationality in the allocation of resources rather than a specific set of value or policy commitments. On this interpretation, the economist wishes to be understood as analogous to the civil engineer rather than the transportation policy maker: he or she can tell us how to build a stable bridge, but not where, when, or why to do so. It is for citizens and policy makers to make the judgments about the public good that are needed in order to decide whether a given road or bridge is socially desirable; it is for the technical specialist to provide design and estimate of costs. But philosophers doubt that economics is in fact value-free, or that it should aspire to being so. Here is an earlier post that considers recent thinking about this issue.

'Romney Expands False Jeep-to-China Ad Campaign'

Contra Romney's claims:

Marchionne Weighs In on Jeep Flap, Washington Wire: Fiat/Chrysler Group Chief Executive Sergio Marchionne told company employees in an email that production of Jeep sport utility vehicles will not be moved from the U.S. to China, in his first formal response to a controversy ignited last week when Republican presidential candidate Mitt Romney told a rally in Ohio that Chrysler was contemplating such a move. ...

The Romney campaign has been told this is false. The response:

Romney expands false Jeep-to-China ad campaign, by Greg Sargent: Mitt Romney’s new television ad suggesting that the auto bailout will result in American jeep jobs getting shipped to China has been widely pilloried by news organizations, both nationally and in Ohio. The Romney campaign’s response: It is expanding the ad campaign.

A Dem source familiar with ad buy info tells me that the Romney campaign has now put a version of the spot on the radio in Toledo, Ohio — the site of a Jeep plant. The buy is roughly $100,000, the source says.

The move seems to confirm that the Romney campaign is making the Jeep-to-China falsehood central to its final push to turn things around in the state. The Romney campaign has explicitly said in the past that it will not let fact checking constrain its messaging, so perhaps it’s not surprising that it appears to be expanding an ad campaign based on a claim that has been widely pilloried by fact checkers. ...

As Steve Benen put it, this episode demonstrates more clearly than any other yet that Romney “believes we’ve entered a post-truth era and the disincentive has disappeared — he can repeat falsehoods with impunity without fear of consequences.”

This falsehood is particularly pernicious — it plays on people’s fears for their livelihoods. As I noted earlier today, the president of a United Auto Workers local that oversees workers at the Jeep plant says that after Romney first claimed Jeep was moving production to China, the union received a bunch of calls from workers worried about their jobs.

Ultimately, this may be Romney’s only recourse. ...

The mainstream media is getting dissed big time by the Romney campaign. Romney and company do not appear to have any fear that the media will be able to counter their false assertions (and this is far from the only example). I worry that the media is not up to the task, but nevertheless I hope this one bites back.

Romney's Regressive Plan for Social Security

Via email:

The Best Political Case Against Romney (Which Obama Hasn't Made): Probably the election's biggest shocker is the Obama campaign's virtual silence on what is Democrats' single best issue and, as this Bloomberg piece explains, the clearest proof that Romney's agenda puts the wealthy over the middle class.

Bloomberg explains that Romney's Social Security plan puts 10 times the burden on the middle class than it does on the rich. While all the focus has been on explicit tax bills, Romney's Social Security plan is like a $1,000 tax hike for a $45k/year worker, or 2.3% of wages. That's 10 times the implicit 0.23% tax hike for a $1 million earner.

This goes a long way to explaining why Romney is leading on the economy; Obama has been so focused on the invisible parts of Romney's agenda, he has never pointed out the smoking guns that would have -- and still can -- destroy Romney's credibility as an advocate for the middle class.

Without the wealthy paying their fare share of a Social Security fix, it would be quite forceful to hit Romney's plan to raise the retirement age to nearly 70, which is OK for Mitt's banker friends, but not so much for police officers, miners and those who do physical work.

The kicker is that Ryan said at the VP debate the Romney's Social Security cuts hit the "wealthy" and Romney says they target higher income workers. This is simply false. The attached Bloomberg piece linked to above shows that the cuts would almost certainly hit the top 70% of earners -- as low as $30k/yr. Ryan made the same "wealthy" claim about his 2010 plan -- here at the 1:15 mark.

Romney's Social Security plan provides the substantive evidence that makes the rest of his agenda look suspect. Romney's carried interest loophole does the same thing in a way that is quite powerful: Instead of analyzing his plans, we can see his actions since he started running for president.

You may recall that when Romney started running in 2007, Democrats began trying to close this loophole that lets investment managers pay less than half the regular income tax rate on a big part of their compensation.

Keep in mind that Romney's top economist Greg Mankiw wrote back in 2007 that preferential tax treatment of carried interest was unjustified. Further, even 3 out 4 on Wall Street say it is welfare for millionaires (Investment pros see Romney's tax break as welfare for the Mitt ).

So we know that Romney has netted millions from this loophole since he started running for president, while his rich donors have netted billions and it has cost the government about $15 bil.

Bottom line: Romney calls this deficit a "moral issue" yet he's been receiving millions in welfare for millionaires while calling for healthcare cuts for the poor and uninsured and calling for retirement age hikes for Social Security and Medicare. Though he is personally generous, it is mind-boggling that his moral compass has been pointing at everyone but himself and his donors.

Next, Romney must be the first presidential candidate in history running on plan to increase the number of uninsured -- by 45 million, according to a Commonwealth study. Getting rid of ObamaCare's backstop and hiking Medicare's retirement age will leave a gaping hole in the safety net that millions in the middle class will fall through.

When you add this all up and consider that Romney has been running for president for 6 years but won't reveal details of his tax, deficit, healthcare & immigration plans, it is clear that his assurances don't count for much.

[Let me add this from pgl at Econospeak: Social Security: Romney Rehashes Robert Bennett’s Regressive Plan.]

Links for 10-30-2012

• Cliff Confusions - Paul Krugman
• Credit Access Following a Mortgage Default - FRBSF
• Higher Taxes Hurt Job Creators? That's Malarkey - Robert Reich
• What the Federal Government Does - Baseline Scenario
• PCE Inflation Update, September 2012 - Dallas Fed
• Housing Bubble and Fraud - Luigi Zingales
• Central Limit Theorems - Dave Giles
• Time Watching Television - Tim Taylor
• The End of Men, Revisited - Nancy Folbre
• How Jonathan Gruber became ‘Mr. Mandate’ - MIT News
• Reinventing Unions for the 21st Century - Modeled Behavior
• The Monetary Theories of Ricardo and Thornton - Uneasy Money

Romney/Ryan on FEMA and NOAA

Menzie Chinn at Econbrowser:

Romney/Ryan on FEMA and NOAA

But mostly just wanted to say that if you are in the storm's path, I sincerely hope that all is well.

What’s the Use of Economics?

Alan Kirman on how macroeconomics needs to change (I'm still thinking about his idea that the economy should be modeled as "a system which self organizes, experiencing sudden and large changes from time to time"):

What’s the use of economics?, by Alan Kirman, Vox EU: The simple question that was raised during a recent conference organized by Diane Coyle at the Bank of England was to what extent has - or should - the teaching of economics be modified in the light of the current economic crisis? The simple answer is that the economics profession is unlikely to change. Why would economists be willing to give up much of their human capital, painstakingly nurtured for over two centuries? For macroeconomists in particular, the reaction has been to suggest that modifications of existing models to take account of ‘frictions’ or ‘imperfections’ will be enough to account for the current evolution of the world economy. The idea is that once students have understood the basics, they can be introduced to these modifications.

A turning point in economics

However, other economists such as myself feel that we have finally reached the turning point in economics where we have to radically change the way we conceive of and model the economy. The crisis is an opportune occasion to carefully investigate new approaches. Paul Seabright hit the nail on the head; economists tend to inaccurately portray their work as a steady and relentless improvement of their models whereas, actually, economists tend to chase an empirical reality that is changing just as fast as their modeling. I would go further; rather than making steady progress towards explaining economic phenomena professional economists have been locked into a narrow vision of the economy. We constantly make more and more sophisticated models within that vision until, as Bob Solow put it, “the uninitiated peasant is left wondering what planet he or she is on” (Solow 2006).

In this column, I will briefly outline some of the problems the discipline of economics faces; problems that have been shown up in stark relief during the current crisis. Then I will come back to what we should try to teach students of economics.

Entrenched views on theory and reality

The typical attitude of economists is epitomized by Mario Draghi, President of the European Central Bank. Regarding the Eurozone crisis, he said:

“The first thing that came to mind was something that people said many years ago and then stopped saying it: The euro is like a bumblebee. This is a mystery of nature because it shouldn’t fly but instead it does. So the euro was a bumblebee that flew very well for several years. And now – and I think people ask ‘how come?’ – probably there was something in the atmosphere, in the air, that made the bumblebee fly. Now something must have changed in the air, and we know what after the financial crisis. The bumblebee would have to graduate to a real bee. And that’s what it’s doing” (Draghi 2012)

What Draghi is saying is that, according to our economic models, the Eurozone should not have flown. Entomologists (those who study insects) of old with more simple models came to the conclusion that bumble bees should not be able to fly. Their reaction was to later rethink their models in light of irrefutable evidence. Yet, the economist’s instinct is to attempt to modify reality in order to fit a model that has been built on longstanding theory. Unfortunately, that very theory is itself based on shaky foundations.

Economic theory can mislead

Every student in economics is faced with the model of the isolated optimizing individual who makes his choices within the constraints imposed by the market. Somehow, the axioms of rationality imposed on this individual are not very convincing, particularly to first time students. But the student is told that the aim of the exercise is to show that there is an equilibrium, there can be prices that will clear all markets simultaneously. And, furthermore, the student is taught that such an equilibrium has desirable welfare properties. Importantly, the student is told that since the 1970s it has been known that whilst such a system of equilibrium prices may exist, we cannot show that the economy would ever reach an equilibrium nor that such an equilibrium is unique.

The student then moves on to macroeconomics and is told that the aggregate economy or market behaves just like the average individual she has just studied. She is not told that these general models in fact poorly reflect reality. For the macroeconomist, this is a boon since he can now analyze the aggregate allocations in an economy as though they were the result of the rational choices made by one individual. The student may find this even more difficult to swallow when she is aware that peoples’ preferences, choices and forecasts are often influenced by those of the other participants in the economy. Students take a long time to accept the idea that the economy’s choices can be assimilated to those of one individual.

A troubling choice for macroeconomists

Macroeconomists are faced with a stark choice: either move away from the idea that we can pursue our macroeconomic analysis whilst only making assumptions about isolated individuals, ignoring interaction; or avoid all the fundamental problems by assuming that the economy is always in equilibrium, forgetting about how it ever got there.

Exogenous shocks? Or a self-organizing system?

Macroeconomists therefore worry about something that seems, to the uninformed outsider, paradoxical. How does the economy experience fluctuations or cycles whilst remaining in equilibrium? The basic macroeconomic idea is, of course, that the economy is in a steady state and that it is hit from time to time by exogenous shocks. Yet, this is entirely at variance with the idea that economists may be dealing with a system which self organizes, experiencing sudden and large changes from time to time.

There are two reasons as to why the latter explanation is better than the former. First, it is very difficult to find significant events that we can point to in order to explain major turning points in the evolution of economies. Second, the idea that the economy is sailing on an equilibrium path but is from time to time buffeted by unexpected storms just does not pass what Bob Solow has called the ‘smell test’. To quote Willem Buiter (2009),

“Those of us who worry about endogenous uncertainty arising from the interactions of boundedly rational market participants cannot but scratch our heads at the insistence of the mainline models that all uncertainty is exogenous and additive”

Some teaching suggestions

New thinking is imperative:

• We should spend more time insisting on the importance of coordination as the main problem of modern economies rather than efficiency. Our insistence on the latter has diverted attention from the former.
• We should cease to insist on the idea that the aggregation of the choices and actions of individuals who directly interact with each other can be captured by the idea of the aggregate acting as only one of these many individuals. The gap between micro- and macrobehavior is worrying.
• We should recognize that some of the characteristics of aggregates are caused by aggregation itself. The continuous reaction of the aggregate may be the result of individuals making simple, binary discontinuous choices. For many phenomena, it is much more realistic to think of individuals as having thresholds - which cause them to react - rather than reacting in a smooth, gradual fashion to changes in their environment. Cournot had this idea, it is a pity that we have lost sight of it. Indeed, the aggregate itself may also have thresholds which cause it to react. When enough individuals make a particular choice, the whole of society may then move. When the number of individuals is smaller, there is no such movement. One has only to think of the results of voting.
• All students should be obliged to collect their own data about some economic phenomenon at least once in their career. They will then get a feeling for the importance of institutions and of the interaction between agents and its consequences. Perhaps, best of all, this will restore their enthusiasm for economics!

Some use for traditional theory

Does this mean that we should cease to teach ‘standard’ economic theory to our students? Surely not. If we did so, these students would not be able to follow the current economic debates. As Max Planck has said, “Physics is not about discovering the natural laws that govern the universe, it is what physicists do”. For the moment, standard economics is what economists do. But we owe it to our students to point out difficulties with the structure and assumptions of our theory. Although we are still far from a paradigm shift, in the longer run the paradigm will inevitably change. We would all do well to remember that current economic thought will one day be taught as history of economic thought.

References

Buiter, W (2009), “The unfortunate uselessness of most ‘state of the art’ academic monetary economics”, Financial Times online, 3 March.
Coyle, D (2012) “What’s the use of economics? Introduction to the Vox debate”, VoxEu.org, 19 September.
Davies, H (2012), “Economics in Denial”, ProjectSyndicate.org, 22 August.
Solow, R (2006), “Reflections on the Survey” in Colander, D., The Making of an Economist. Princeton, Princeton University Press.

Paul Krugman: Medicaid on the Ballot

Medicaid faces large cuts if Romney is elected:

Medicaid on the Ballot, by Paul Krugman, Commentary, NY Times: There’s a lot we don’t know about what Mitt Romney would do if he won...; his economic “plan” is an empty shell.

But one thing is clear: If he wins, Medicaid ... will face savage cuts. Estimates suggest that a Romney victory would deny health insurance to about 45 million people who would have coverage if he lost, with two-thirds of that difference due to the assault on Medicaid.

So this election is, to an important degree, really about Medicaid. And this, in turn, means that you need to know something more about the program. ...

Medicaid is generally viewed as health care for the nonelderly poor... For those who get coverage through the program, Medicaid is a much-needed form of financial aid. It is also, quite literally, a lifesaver. Mr. Romney has said that a lack of health insurance doesn’t kill people in America; oh yes, it does, and states that expand Medicaid coverage show striking drops in mortality.

So Medicaid does a vast amount of good. But at what cost? There’s a widespread perception, gleefully fed by right-wing politicians and propagandists, that Medicaid has “runaway” costs. But the truth is just the opposite. ... Medicaid is significantly better at controlling costs than the rest of our health care system. ...

Is Medicaid perfect? Of course not. Most notably, the hard bargain it drives with health providers means that quite a few doctors are reluctant to see Medicaid patients. Yet given the problems facing American health care — sharply rising costs and declining private-sector coverage — Medicaid has to be regarded as a highly successful program. It provides good if not great coverage to tens of millions of people who would otherwise be left out in the cold, and as I said, it does much right to keep costs down.

By any reasonable standard, this is a program that should be expanded, not slashed — and a major expansion of Medicaid is part of the Affordable Care Act.

Why, then, are Republicans so determined to do the reverse, and kill this success story? You know the answers. Partly it’s their general hostility to anything that helps the 47 percent — those Americans whom they consider moochers who need to be taught self-reliance. Partly it’s the fact that Medicaid’s success is a reproach to their antigovernment ideology.

The question — and it’s a question the American people will answer very soon — is whether they’ll get to indulge these prejudices at the expense of tens of millions of their fellow citizens.

Fed Watch: On Coordinated Monetary and Fiscal Policy

Tim Duy:

On Coordinated Monetary and Fiscal Policy, by Tim Duy: Note: This began as an effort to tie together various themes in my writing. Unfortunately, short and succinct did not work. So I apologize in advance for the length of this post.

There are certainly trends in my writing. One is that the Federal Reserve spent much of this year behind the curve by failing to adapt their large scale asset purchase program or their communication strategy to the reality of a persistently weak economy. The Federal Reserve effectively dealt with that issue at the last FOMC meeting.

To be sure, I can quibble with some of the specifics, such as a lack of more explicit economic targets and a clear commitment to near term-irresponsibility by allowing inflation to rise above 2 percent when (or if) the economy gathers steam. On the first issue, I am coming around to the thinking that while explicit targets (other than inflation or nominal GDP) might sound good in theory, in practice trying to tie policy to a constellation of price and output targets risks becoming a communications nightmare. The Fed needs to tread very carefully on this point; it may be best for them to fall back on that old adage about pornography. We will know a "sufficient and sustainable" recovery when we see it.

The second issue, a promise to be irresponsible on inflation, remains unlikely as long as the Fed continues to stress it will take actions "in the context of price stability." I don't view a temporary increase in inflation as necessarily undermining neither the Fed's long-term inflation targets nor a nominal GDP target. And I think that the failure to make such a promise could very well disrupt a reversion of the economy to pre-recession trends. This I will discuss further later.

Another trend in my writing is that there needs to be some coordination between fiscal and monetary policy. Putting aside what I believe will be an aberration in the third quarter, authorities are already engaged in some degree of fiscal austerity:

and have effectively promised to do more. Should it even be reached, a compromise to the fiscal cliff will likely still be further austerity. I think that we should be wary about underestimating the impact of such austerity, especially as it is increasingly evident that multipliers are larger than expected at the zero bound. Fiscal austerity would likely be a key factor in maintaining the relatively tepid pace of the recovery into 2013. Moreover, fiscal austerity wastes the opportunity provided by a low interest rate environment. The Federal Reserve has already promised to buy a steady stream of assets from the financial markets. All Congress needs to do is sell debt into that stream. No explicit coordination necessary.

Another issue that I can't run away from is the potentially negative impacts of a sustained zero interest rate environment. It would be a mistake to believe that monetary policy does not have distributional impacts. Low interest rates obviously hurt savers:

Moreover, we should be concerned about distortions to the capital allocation process. Encouraging excessive risk taking now will come back to haunt us later. That said, it is necessary to balance such negative impacts against the positive impacts. Nor is it clear that the Federal Reserve is driving this train; the absence of an aggressive monetary policy might very well weaken the economy such that interest rates fall further. In any event, I am challenged to see how a different monetary policy would be effective; tightening policy at this juncture would likely be disastrous for the economy.

Finally, another issue to which I have already alluded is a belief that the US economy is on a suboptimal path:

This is obviously controversial. For example, St. Louis Federal Reserve President James Bullard has repeatedly said there is only one path, and we are on it. The appropriate monetary and fiscal reaction functions are obviously different in a such a world. In such a world monetary policy leads only to potentially greater inflation with little impact on growth.

Jumbled as it might seem due to the nature of blogging, somewhere in the background I have a framework that ties this altogether. And I was reminded by a colleague that I had seen that framework presented by another colleague, George Evans. The associated paper, "The Stagnation Regime of the New Keynesian Model and Recent US Policy" is here.

Evans begins with a New Keynesian in which expectations are formed by adaptive learning. An outcome of the model is that a sufficiently large negative shock can push the economy into a deflationary trap. Interestingly, agents learn their way into the trap by forming pessimistic expectations of future economic outcomes. My interpretation is that agents learn to live in what is often called the "new normal" and as a consequence make decisions that ensure the the new normal is a stable equilibrium.

The model is subsequently modified to account for nominal wage rigidities such that the low equilibrium trap, the stagnation regime, has an inflation floor. Another characteristic of the regime is low levels of output and consumption in which welfare is potentially much lower than the preferred equilibrium.

How can we break out of the stagnation regime? A temporary increase in government spending that is sufficiently large to allow a self-sustaining process to take over. The economy reaches an escape velocity such that agents learn there way allow a dynamic path to the preferred locally stable, higher equilibrium. At such a point, government spending can revert to normal without threatening a recession.

Monetary policy can also come into play, but Evans is less optimistic that the Federal Reserve is capable of breaking the US economy out of the trap. He notes that even promises of low rates forever may not be enough if the economy has suffered a sufficiently large negative shock. Evans adds that quantitative easing can support the economy via lowering long-term rates and stimulating demand, but also warns:

An additional problem, however, is that there are some distributional consequences that are not benign. Households that are savers, with a portfolio consisting primarily in safe assets like short maturity government bonds, have already been adversely affected by a monetary policy in which the nominal returns on these assets has been pushed down to near zero. A policy commitment at this juncture, which pairs an extended period of continued near zero interest rates with a commitment to use quantitative easing aggressively in order to increase inflation, has a downside of adversely affecting the wealth position of households who are savers aiming for a low risk portfolio.

There is a lot to digest in a short paper, but I encourage making the effort.

Thinking in terms of this model, it is immediately clear that one should be very concerned with impending fiscal austerity unless you believed the economy had already reached escape velocity (I don't). Moreover, you should be concerned about austerity even in context of the evolution of monetary policy into QE3 as it is not clear that the Fed can by itself push the economy to escape velocity. The Fed is literally stuck between a rock and a hard place, with the stimulative force of lower rates for borrowers traded off against lower income for savers, a point that Ed Harrison often makes. And the more we lean on monetary policy, the tighter that space gets. Yet we have little choice with a political environment that favors austerity over stimulus.

In addition, one should be concerned about the fragility of any recovery based upon a Fed-induced effort to achieve escape velocity. This is especially the case if the Fed has not promised (and whether such a promise is credible is another question) to be irresponsible in the transition to the higher equilibrium. Consider that the CBO projection for GDP growth is 4.8% in 2015. This, I suspect, is the kind of number needed to achieve escape velocity. But consider the Fed's reaction function in the face of such growth in the context of 1.) price stability and 2.) internal concerns about the ability to unwind quantitative easing. I think under those circumstance policymakers would error on the of tighter, faster rather than allowing a temporary acceleration of inflation.

The last paragraph brings up an interesting question. Even if the Fed promised to allow inflation to accelerate and did so, eventually they would tighten policy just the same. Which means the same recession, just a year later. 2015 or 2016. 2017 at the latest.

The problem is that the recovery is pretty much held together by debt refinancing, cheap mortgages and higher asset prices; by such measures, monetary policy has been successful! To be sure, there has been some debt reduction on the part of households:

But it is limited in comparison of the ability of households to utilize lower interest rates to reduce the cost of financing that debt:

I think in the near-term those who believe the monetary authority is the only answer will appear correct as the recovery progresses. Indeed, Annie Lowrey at the New York Times reports that household debt is now increasing for the first time since the Great Recession began. From a broad macroeconomic perspective, this is a near-term positive, and creates reason to believe that monetary policy will cushion the impacts of whatever flavor of the fiscal cliff we experience.

But I don't think this will be a stable long-term result. Obviously, I could be wrong, but it seems to me that we are using the same trick we have been using since the mid-1980's - lowering debt financing costs, thus allowing for a greater debt burden. This trick will continue to work as long as there is room to push interest rates further down. Now that we are at the zero bound in short-term rates and the Fed has been forced to move quite far out the yield curve to implement monetary policy, it is likely this is the last time that trick will work. There will not be much room to refinance our way out of trouble the next time around. Hence why I concerned about still being at the zero bound when the next recession hits.

Moreover, I would find it unlikely that we pass through another two or more years of zero interest rates without seeing capital mis-allocations, assets bubbles, and excessive risk taking. In such an environment, I don't think the Fed is going to be particularly successful in moving the economy off the zero bound without triggering a fresh recession.

Now, it would be easy to take this as criticism of the Federal Reserve. It isn't. The Fed should have moved to open-ended QE long ago to end the problem of arbitrary end dates to policy and needed to clean up its communication strategy to make clear the economic outcomes would define when QE would end. And, probably most importantly, the Fed is compensating for a dysfunctional US political process. I know there is one view (see Raghuram Rajan) that the Fed is simply enabling that process. Perhaps Congress would do the "right" thing if push comes to shove. But what is the "right" thing? If Congress were left to its own devices, would it take us down the road of fiscal stimulus sufficient to spring the economy from the stagnation trap? Or would they continue down the road of additional fiscal stimulus, driving the economy deeper into the trap? My sense is that Congress would find additional austerity to be the path of least resistance. Pete Peterson has won. The Congressional deck is stacked against the economy. And I think Federal Reserve Chairman Ben Bernanke knows this.

Putting all the piece together, I tend to think that neither fiscal nor monetary policy by itself will support a sustained recovery in which the interest rate environment normalizes and fiscal stimulus can be eliminated without fear of renewed recession. The two need to work hand in hand; the Federal Reserve has provided the monetary environment conducive to additional fiscal stimulus. Congress and the Administration now need to take advantage of the environment. Or, alternatively, if the fiscal authorities are not issuing sufficient new financial assets such that there is upward pressure on interest rates, they need to be issuing more.

In conclusion, the above framework both praises the direction of monetary policy without discounting concerns about the dangers of the permanent zero bound policy. A framework that allows for both accepting near-term growth on the back of monetary policy but also concern about the sustainability of that policy. A framework that decisively rejects additional austerity on a simple basis that it will not help normalize the interest rate environment. If nominal rates were 8% then yes, fiscal austerity would help normalize the interest rate environment. But that simply isn't the current situation. Perhaps, if we are lucky, it will be a problem in the future.

I realize that it would probably be easier if I could find myself either advocating the primacy of monetary policy in determining the level of output or deriding the Federal Reserve for the evils of the quantitative easing. Or if I could fully embrace fiscal stimulus as the only solution or austerity as the only solution. Picking one of those quadrant and defending it absolutely would probably make me more friends that straddling all four quadrants at once. But absolute devotion to one quadrant is probably not the right answer. I tend to believe that the right answer is a more complicated mix of monetary and fiscal policy than is currently employed. And don't think we can get to that right mix if we lock ourselves into an ideological box. Hence why I try to avoid such boxes.

Again, sorry for the long post.

Links for 10-29-2012

• Building blocks for America’s recovery - Larry Summers
• The War on Objectivity - Paul Krugman
• Yet another discouraging GDP report - Econbrowser
• The /Real/ Club of Rome Turns Forty, in Vienna - Economic Principals
• Our banks are too big. We need to cap their assets. - Simon Johnson
• Flexibility for Employers Means Less Flexibility for Workers - Dean Baker
• I’m a Mac. You’re a PC. There really are two types of people - Digitopoly
• Financial Shocks, Risk Premiums, and Monetary Policy - David Beckworth
• Economic recovery and policy uncertainty in the US - vox
• More Financial Crisis Denialism - Paul Krugman

Technorati Top 100 Blog?

This can't be right --  I don't trust the ranking -- but I can't help but be amused at being ranked ahead of CNN's Political Ticker (and just behind The Caucus at the NYT). According to the Technorati Top 100:

'White House Quells Talk of New Tax Cuts'

Given how slow the recovery has been, we should at least try to maintain the fiscal stimulus we have. And if we can help middle class households a bit at the same time, so much the better. Unfortunately:

White House quells talk of new tax cuts, by James Politi, FT: The White House has sought to damp speculation it is considering new tax cuts for the middle class, as it comes under pressure from fellow Democrats to limit the economic damage from the expiration of the payroll tax cut at the end of the year.

The expected increase in payroll tax would be one element of the “fiscal cliff” ... that would shrink the disposable income of middle-class American workers. One option for Barack Obama would be to propose new temporary tax breaks for the middle class, which would go a long way towards easing those concerns.

However, such a move would probably face resistance from Republicans...

I guess that settles it. There's no way to use the fact that Republicans are proposing tax cuts for the wealthy while resisting a tax cut that helps the middle class to any political advantage. Republicans would resist, so why bother?

DeLong: Inequality: Living in the Second Gilded Age

Brad DeLong:

Inequality: Living in the Second Gilded Age, by Brad DeLong: A third of a century ago, all of us economists confidently predicted that America would remain and even become more of a middle-class society. The high income and wealth inequality of the 1870-1929 Gilded Age, we would have said, was a peculiar result of the first age of industrialization. Transformations in technology, public investments in education, a progressive tax system, a safety net, and the continued decline in discrimination on the basis of race and sex had made late-20th century America a much more equal place than early 20th century America, and would make early 21st century America even more equal — even more of a middle-class society — still.

We were wrong.

America today is at least as unequal as, and may be more unequal than, it was back at the start of the 20th century when Republicans, such as President Theodore Roosevelt of New York condemned the power wielded by “malefactors of great wealth,” and Democrats such as perennial losing presidential candidate William Jennings Bryant of Nebraska denounced shadowy conspiracies that had somehow manipulated the financial system to rob the typical family of its proper share in America’s prosperity.

Four major and a host of minor factors have driven rising inequality over the past third of a century: ...[continue reading]...

One complaint: It's more than just economics. In my view, Brad doesn't put enough emphasis on the changing political tide over the last few decades, and how that has altered public policy towards institutions such as unions that were able to help workers get a fair share of the output they produce (unions aren't even mentioned in the article). The explanation for rising inequality makes it appear that economics -- factors such as winner-take-all markets in an increasingly globalized world and skill based technical change -- can fully account for the problem. I don't see it that way. Economics surely contributed to the inequality problem, but the idea that those at the top haven't received a penny more than they earned, that their incomes can be explained by economics alone, is hard to defend. Workers incomes have not kept up with productivity -- they did not get a fair share of the output they produced over the last few decades -- and that means some other group got more than it deserves. Given the stagnant incomes at lower levels and widening inequality from growth at the top, it's not hard to think of who that group might be, and it is not the least bit surprising that this just happens to be the group with the largest amount of political influence.

I don't have any problem with the statements made in the article about taxes on the wealthy and educational opportunity for working class households -- we need more of both -- but we also need to reform our institutions so that they work for all of us, not just the (ahem) job creators at the top.

(To be fair, Brad acknowledges that there has been a misallocation of resources with too much going to finance and health care administration, and not enough elsewhere, and he also notes that the political power of the wealthy make it hard to change the tax code. But for the most part his argument about rising inequality relies upon economics, and the political and institutional arguments are not emphasized. Again, I am not quarreling with the economics, I just think the political and institutional factors deserve more weight.)

But this is an old debate with Brad DeLong and others on one side, and Krugman. et. al. on the other, e.g. see here:

To a good neoclassical economist, the statement that the relative price of a factor of production--like the labor of the elite top 1% of America's wage and salary distribution--has risen is the same thing as the statement that the relative productivity of that factor of production has risen. But we need to distinguish between these statements in order to make sense of the ongoing argument between Andrew Samwick on the one hand and Paul Krugman and Mark Thoma on the other.

In a nutshell: Is the statement that there is a higher return to education today merely an assertion that the rich today earn more in relative terms than their counterparts in the past? Or is it also a statement that the rich today are more productive in relative terms than their counterparts in the past?

Andrew Samwick takes the first definition, and concludes that rising inequality is the result of a higher return to education. By his lights, he is clearly correct.

Paul Krugman and Mark Thoma take the second definition and conclude that that rising inequality is not primarily the result of a higher return to education but instead primarily the result of socio-political factors that have raised the relative price of what the rich and well-educated do. And they too have a strong case. Piketty and Saez's latest numbers estimate that top 13,000 American households have multiplied their relative real incomes nearly fivefold since the 1970s. Then they received some 0.6% of national income. Now they receive nearly 2.8% of national income--an average of $25 million each, compared to roughly $5 million each had the relative income distribution remained at its 1970s levels. What are the CEOs, CFOs, COOs, elite Hollywood entertainers, investment bankers, and the very highest levels of professionals doing differently now in their work lives that makes them, in relative terms, worth five times as much as their predecessors of a generation and a half ago?...

Links for 10-28-2012

• Denial of Economics - Paul Krugman
• Who Gets Credit for the Economy’s Recovery? - NYTimes.com
• The UK and Austerity: some facts - mainly macro
• Federal Reserve Policy vs. Fiscal Cliffs - NYTimes.com
• How Rich Political Donors Are Hurting Themselves - NYTimes.com
• The New Physiocrats - Paul Krugman
• The renminbi bloc is here - vox
• Viren Srivastava - Dave Giles

Climate Change and 'Free Drivers'

Gernot Wagner and Martin Weitzman on the "allure of geoengineering" as a solution to global warming, and the temptation for individual countries to act on their own:

Playing God: ... All it takes is a single actor willing to focus on the purported benefits to his country or her region to pull the geoengineering trigger. The task with geoengineering is to coordinate international inaction while the international community considers what steps should be taken. The fate of the planet cannot be left in the hands of one leader, one nation, one billionaire.

Fortunately, we are still many years off from the full "free driver" effect taking hold. There's some time to engage in a serious global governance debate and careful research: building coalitions, guiding countries and perhaps even individuals lest they take global matters into their own hands. In fact, that is where the discussion stands at the moment, with a governance initiative convened by the British Royal Society, the Academy of Sciences for the Developing World, and the Environmental Defense Fund, among other deliberations guiding how geoengineering research should be pursued.

With time come the "free drivers"

The clock, however, is ticking. A single dramatic climate-related event anywhere in the world - think Hurricane Katrina on steroids - could trigger the "free driver" effect. That event need not be global and it need not even be conclusively linked to global warming. A nervous leader of a frightened nation might well race past the point of debate to deployment. The "free driver" effect will all but guarantee that we will face this choice at some point.

"Free riding" and "free driving" occupy opposite poles of the spectrum of climate action: One ensures that individuals won't supply enough of a public good. The other creates an incentive to engage in potentially reckless geoengineering and supply a global bad. It's tough to say which one is more dangerous. Together, these powerful forces could push the globe to the brink.

Inequality of Income and Consumption

Via an email from Lane Kenworthy, here's more research contradicting the claim made by Kevin Hassett and Aparna Mathur in the WSJ that consumption inequality has not increased (here's my response summarizing additional work contradicting their claim, a claim that is really an attempt to blunt the call to use taxation to address the growing inequality problem):

Inequality of Income and Consumption: Measuring the Trends in Inequality from 1985-2010 for the Same Individuals, by Jonathan Fisher, David S. Johnson, and Timothy M. Smeeding: I. Introduction: Income and Consumption The 2012 Economic Report of the President stated: “The confluence of rising inequality and low economic mobility over the past three decades poses a real threat to the United States as a land of opportunity.” This view was also repeated in a speech by Council of Economics Advisors Chairman, Alan Krueger (2012). President Obama suggested that inequality was “…the defining issue of our time...” As suggested by Isabel Sawhill (2012), 2011 was the year of inequality.

While there has been an increased interest in inequality, and especially the differences in trends for the top 1 percent vs. the other 99 percent, this increase in inequality is not a new issue. Twenty years ago, Sylvia Nasar (1992) highlighted similar differences in referring to a report by the Congressional Budget Office (CBO) and Paul Krugman introduced the “staircase vs. picket fence” analogy (see Krugman (1992)). He showed that the change in income gains between 1973 and 1993 followed a staircase pattern with income growth rates increasing with income quintiles, a pattern that has been highlighted by many recent studies, including the latest CBO (2011) report. He also showed that the income growth rates were similar for all quintiles from 1947-1973, creating a picket fence pattern across the quintiles.

Recent research shows that income inequality has increased over the past three decades (Burkhauser, et al. (2012), Smeeding and Thompson (2011), CBO (2011), Atkinson, Piketty and Saez (2011)). And most research suggests that this increase is mainly due to the larger increase in income at the very top of the distribution (see CBO (2011) and Saez (2012)). Researchers, however, dispute the extent of the increase. The extent of the increase depends on the resource measure used (income or consumption), the definition of the resource measure (e.g., market income or after-tax income), and the population of interest.

This paper examines the distribution of income and consumption in the US using data that obtains measures of both income and consumption from the same set of individuals and this paper develops a set of inequality measures that show the increase in inequality during the past 25 years using the 1984-2010 Consumer Expenditure (CE) Survey.

The dispute over whether income or consumption should be preferred as a measure of economic well-being is discussed in the National Academy of Sciences (NAS) report on poverty measurement (Citro and Michael (1995), p. 36). The NAS report argues:

Conceptually, an income definition is more appropriate to the view that what matters is a family’s ability to attain a living standard above the poverty level by means of its own resources…. In contrast to an income definition, an expenditure (or consumption) definition is more appropriate to the view that what matters is someone’s actual standard of living, regardless of how it is attained. In practice the availability of high-quality data is often a prime determinant of whether an incomeor expenditure-based family resource definition is used.

We agree with this statement and we would extend it to inequality measurement.[1] In cases where both measures are available, both income and consumption are important indicators for the level of and trend in economic well-being. As argued by Attanasio, Battistin, and Padula (2010) “...the joint consideration of income and consumption can be particularly informative.” Both resource measures provide useful information by themselves and in combination with one another. When measures of inequality and economic well-being show the same levels and trends using both income and consumption, then the conclusions on inequality are clear. When the levels and/or trends are different, the conclusions are less clear, but useful information and an avenue for future research can be provided.

We examine the trend in the distribution of these measures from 1985 to 2010. We show that while the level of and changes in inequality differ for each measure, inequality increases for all measures over this period and, as expected, consumption inequality is lower than income inequality. Differing from other recent research, we find that the trends in income and consumption inequality are similar between 1985 and 2006, and diverge during the first few years of the Great Recession (between 2006 and 2010). For the entire 25 year period we find that consumption inequality increases about two-thirds as much as income inequality. We show that the quality of the CE survey data is sufficient to examine both income and consumption inequality. Nevertheless, given the differences in the trends in inequality, using measures of both income and consumption provides useful information. In addition, we present the level of and trends in inequality of both the maximum and the minimum of income and consumption. The maximum and minimum are useful to adjust for life-cycle effects of income and consumption and for potential measurement error in income or consumption. The trends in the maximum and minimum are also useful when consumption and income alone provide different results concerning the measurement of economic well-being. ...

Links for 10-27-2012

• Can charitable donations offset despicable behavior? - Felix Salmon
• Paintballs may deflect an incoming asteroid - MIT News
• On the Bretton Woods transcripts - Crooked Timber
• Cheese Smuggling in Canada - Conference Board
• German Hypocrisy on “Strengthening Europe” - EconoSpeak
• A Kind Word for Austrian Business Cycle Theory - Uneasy Money
• The Effects of Golden Parachutes - Baseline Scenario
• Robert Samuelson's wrong about government jobs - Josh Bivens
• News10 political analysts (Amy Thoma) discuss VP debate - news10
• Would Inflation Help Cut Government Debt? - Tim Taylor
• Comments on Q3 GDP and Investment - Calculated Risk
• Real GDP increased 2.0% annual rate in Q3 - Calculated Risk

NBER Economic Fluctuations & Growth Research Meeting

I was supposed to be here today, but a long flight delay made that impossible. (I know better than to route through San Francisco in the fall -- it is often fogged in all morning -- but I took a chance and lost the bet.):

National Bureau of Economic Research
Economics Fluctuations & Growth Research Meeting
Paul Beaudry and John Leahy, Organizers
October 26, 2012 Federal Reserve Bank of New York
10th Floor Benjamin Strong Room
33 Liberty Street New York, NY

Program

Thursday, October 25:

6:30 pm Reception and Dinner Federal Reserve Bank of New York (enter at 44 Maiden Lane) 1st Floor Dining Room

Friday, October 26:

8:30 am Continental Breakfast

9:00 am Chang-Tai Hsieh, University of Chicago and NBER Erik Hurst, University of Chicago and NBER Charles Jones, Stanford University and NBER Peter Klenow, Stanford University and NBER The Allocation of Talent and U.S. Economic Growth Discussant:  Raquel Fernandez, New York University and NBER

10:00 am Break

10:30 am Fatih Guvenen, University of Minnesota and NBER Serdar Ozkan, Federal Reserve Board Jae Song, Social Security Administration The Nature of Countercyclical Income Risk Discussant:  Jonathan Heathcote, Federal Reserve Bank of Minneapolis

11:30 am Loukas Karabarbounis, University of Chicago and NBER Brent Neiman, University of Chicago and NBER Declining Labor Shares and the Global Rise of Corporate Savings Discussant:  Robert Hall, Stanford University and NBER

12:30 pm Lunch

1:30 pm Stephanie Schmitt-Grohe, Columbia University and NBER Martin Uribe, Columbia University and NBER Prudential Policy for Peggers Discussant:  Gianluca Benigno, London School of Economics

2:30 pm Break

3:00 pm Eric Swanson, Federal Reserve Bank of San Francisco John Williams, Federal Reserve Bank of San Francisco Measuring the Effect of the Zero Lower Bound on Medium- and Longer-Term Interest Rates Discussant:  James Hamilton, University of California at San Diego and NBER

4:00 pm Alisdair McKay, Boston University Ricardo Reis, Columbia University and NBER The Role of Automatic Stabilizers in the U.S. Business Cycle Discussant:  Yuriy Gorodnichenko, University of California at Berkeley and NBER

5:00 pm Adjourn

Paul Krugman: Pointing Toward Prosperity?

Obama's economic plan is nothing to get overly excited about, but it's still a lot better than Romney's:

Pointing Toward Prosperity?, by Paul Krugman, Commentary, NY Times: Mitt Romney has been barnstorming the country, telling voters that he has a five-point plan to restore prosperity. And some voters, alas, seem to believe what he’s saying. So President Obama has now responded with his own plan, a little blue booklet containing 27 policy proposals. How do these two plans stack up?

Well, as I’ve said before, Mr. Romney’s “plan” is a sham. It’s a list of things he claims will happen, with no description of the policies he would follow to make those things happen. “We will cut the deficit and put America on track to a balanced budget,” he declares, but he refuses to specify which tax loopholes he would close to offset his $5 trillion in tax cuts.

Actually, if describing what you want to see happen without providing any specific policies to get us there constitutes a “plan,” I can easily come up with a one-point plan that trumps Mr. Romney any day. Here it is: Every American will have a good job with good wages. Also, a blissfully happy marriage. And a pony.

So Mr. Romney is faking it. ... But what about the man he wants to kick out of the White House?

Well, Mr. Obama’s booklet comes a lot closer to being an actual plan. ... So, is Mr. Obama offering an inspiring vision for economic recovery? No... His economic agenda is relatively small-bore...

But a slow job is better than a snow job. Mr. Obama may not be as bold as we’d like, but he isn’t actively misleading voters the way Mr. Romney is. Furthermore, if we ask what Mr. Romney would probably do in practice, including sharp cuts in programs that aid the less well-off and the imposition of hard-money orthodoxy on the Federal Reserve, it looks like a program that might well derail the recovery and send us back into recession.

And you should never forget the broader policy context. Mr. Obama may not have an exciting economic plan, but, if he is re-elected, he will get to implement a health reform that is the biggest improvement in America’s safety net since Medicare. Mr. Romney doesn’t have an economic plan at all, but he is determined not just to repeal Obamacare but to impose savage cuts in Medicaid. So never mind all those bullet points. Think instead about the 45 million Americans who either will or won’t receive essential health care, depending on who wins on Nov. 6.

'Support the undeserving poor'

Chris Dillow says he's surprised a libertarian would even ask this question

Murrary Rothbard asks:

Why won't the left acknowledge the difference between deserving poor and undeserving poor. Why support the feckless, lazy & irresponsible?

I'd answer thusly ...

Links for 10-26-2012

• “Misunderstanding Financial Crises”, Q&A with Gary Gorton - FT Alphaville
• A political economy argument for economic policy delegation - mainly macro
• Triumph of the (Electoral) Nerds? - Paul Krugman
• Banking’s ‘golden age’ is a myth - FT.com
• West should pay attention to India’s woes - FT.com
• Why Romney’s Threat on the Chinese Currency Matters - Econbrowser
• Social Security: Romney Rehashes Robert Bennett’s Regressive Plan - pgl
• Transcript of ’44 Bretton Woods Meeting Found at Treasury - NYTimes.com
• FOMC Behavior and the Dual Mandate - Stephen Williamson
• How should macroeconomics be taught to undergraduates - vox
• The Future of Computer Based Trading - Magic, maths and money
• The Dark Side of Bipartisanship - Simon Johnson

DeLong: Our Debt to Stalingrad

Travel day for me today -- one more quick post before heading to the airport:

Our Debt to Stalingrad, by Brad DeLong, Commentary, Project Syndicate: We are not newly created, innocent, rational, and reasonable beings. We are not created fresh in an unmarked Eden under a new sun. We are, instead, the products of hundreds of millions of years of myopic evolution, and thousands of years of unwritten and then recorded history. Our past has built up layer upon layer of instincts, propensities, habits of thought, patterns of interaction, and material resources.

On top of this historical foundation, we build our civilization. Were it not for our history, our labor would not just be in vain; it would be impossible.

And there are the crimes of human history. The horrible crimes. The unbelievable crimes. Our history grips us like a nightmare, for the crimes of the past scar the present and induce yet more crimes in the future.

And there are also the efforts to stop and undo the effects of past crimes.

So it is appropriate this month to write not about economics, but about something else. Seventy-nine years ago, Germany went mad. ...

Does Taxing the Wealthy Hurt Growth?

This is by Ethan Kaplan of the University of Maryland (via email):

Does Taxing the Wealthy Hurt Growth?, by Ethan Kaplan: What is the impact of taxation on growth? In theory, a country without taxation will have difficulty providing basic public goods such as roads and research that are fundamental for economic growth. However, many politicians and some economists argue that once basic public goods are provided for, increases in taxation have a negative impact on growth. According to this argument, this is especially true for taxes on the very wealthy, who are likely to save their income and channel that savings into entrepreneurship or other investment. Much of the argument over tax policy in the United States is focused on whether the rich should be taxed at a higher or lower rate than they are today. The argument in favor of higher rates is that income inequality is at extremely high levels and the government should focus more on redistribution and also that the rising national debt is also potentially harmful to growth. The argument against higher rates is that raising taxes on wealthy would disincentivize the people most likely to create economic growth and thus jobs. In a climate where jobs are scarce, the argument goes, this is a particularly bad economic idea.

This debate, however, is largely based on ideology rather than evidence. Unfortunately, it is quite difficult to figure out the impact of taxation on growth. Changes to the tax codes usually pass Congress when other things are happening to the economy. For example, the 1982 tax cuts, which dropped the top marginal tax rate from 69% to 50%, were passed towards the end of a large recession. Moreover, the impact of taxes on growth can change over time as the economy changes.

Nevertheless, looking at the raw correlation between top marginal tax rates and growth can be helpful for getting a rough sense of the likely impacts of higher taxation on growth. One recent paper by Pikkety, Saez, and Stantcheva looks at the correlation between top marginal tax rates and growth and finds the growth is higher when top marginal tax rates are higher. I restrict myself to the historical experience of the United States and go back to 1930. In particular, I took real chained per capita GDP growth from 1930 to the present from the Bureau of Economic Analysis' (BEA) website. The correlation over this period between the top marginal tax rate and output growth is strong and positive as can be seen below:

A rise in the top marginal tax rate from 0 to 100 percent is correlated with a rise in per capita growth of 5.85 percentage points per year. One reason that this simple correlation might overstate the impact of the marginal tax rate on growth is that the top growth years were in the early 40s when the government was spending heavily and when the country was finally recovering from the Great Depression. If we look only at the post war period (after 1946), a rise from 0 to 100 percent in the top marginal tax rate is associated with an increase of only 2.69 percentage points of growth. Moreover, the statistical significance of the relationship becomes marginal, as the p-value rises from 0.017 to 0.122. On the other hand, if we look at the time period encompassing 1960 to the present, a rise in the top rate from 0 to 100 percent is correlated with a rise in per capita growth of 3.03 percentage points of growth per year, and the relationship becomes more statistically significant (with a p-value of 0.064 percent). Finally, if we look only at the years since 1980, a rise from 0 to 100 percent in the top marginal tax rate is associated with an increase in growth of 3.87 percentage points. In this case, the relationship is statistically insignificant (with a p-value of 0.392 percent), in part because the sample size is small.

While we cannot say that there is a robust significant positive relationship between tax rates and growth, it is still interesting that regardless of when we start the sample, higher top marginal tax rates are associated with higher not lower growth. Moreover, a narrative reading of postwar US economic history leads to the same conclusion. The period of highest growth in the United States was in the post-war era when top marginal tax rates were 94% (under President Truman) and 91% (through 1963). As top marginal rates dropped, so did growth. Moreover, except for 1984, a recovery year, the highest per capita growth rates since 1980 were all in the late 1990s, after the top marginal tax rate had been increased from 28% under President Reagan to 31% under the first President Bush and then 39.6% under President Clinton. One possible reaction to this finding is that what matters more than the top marginal tax rate on income is the capital gains tax rate but growth has also been higher when the capital gains tax rate has been higher.

So, what does this tell us? Of course, it would be silly to make the argument that increasing top marginal rates from 0 to 100 percent increased per capita growth by almost 6 percentage points per year. No doubt there are other factors that could confound the relationship between tax rates and growth. However, the changes in top marginal tax rates over the period are quite large so it seems likely that if raising top marginal rates did have a large negative impact on growth, we should be able to see it in the correlations. Thus, it also seems silly to argue that higher taxes on the rich have a large negative impact on growth, given that historically growth is, if anything, positively correlated with the top marginal rate.

What does this mean for public policy? Given the large rise in inequality in the United States over the past 40 years, if the historical evidence tells us that it is unlikely that taxing the wealthy has a large negative impact on growth (and it might even have a positive impact), shouldn't we increase rates on the wealthy from their current top rates of 35%?

p.s. the data used to analyze the time series is available on my website: econweb.econ.umd.edu/~kaplan

Fed Watch: Still The Scariest Data

Tim Duy:

Still The Scariest Data, by Tim Duy: I tend to view the data as being modestly optimistic in that it has generally surprised on the upside of late, enough to drive away fears that the slow patch this summer would evolve into a recession in the near future. Still, the data has not been sufficiently optimistic to sway me from my general view that underlying growth continues to be slow and steady.

For example, I would like to see initial unemployment claims make another push lower to cement a stronger outlook:

That said, I remain unsettled by the core manufacturing data, which I would say is clearly in recession territory:

I think this is the scariest near-term indicator at the moment. Of course, one piece of data in no way makes a recession. I attribute the decline to three factors. First, expiring tax credits pulled some investment into 2011. Second, the drag from international weakness. Third, uncertainty about the extent of fiscal tightening in 2013. At least the second, and probably the third, of these three factors is weighing on earnings growth, which in turn has brought the bull market in equities to at least a pause. From Neil Irwin at the Washington Post:

The CEO mindset on the fiscal cliff has been evident in a spate of third-quarter earnings announcements in the past two weeks. Almost uniformly, company executives discuss the looming threat to the economy, usually offering only vague comments that it has been a drag on their confidence and that they don’t know exactly what a resolution would look like....

...Some of the gloomiest assessments of economic conditions have come from companies that do extensive business overseas. By many accounts, as troubled as the U.S. economy has been in recent months, it looks better than many of its counterparts.

Yes, sad as it seems, across the globe the US is a bright spot at the moment.

Bottom Line: The core manufacturing data stands out as an aberration. While arguably a recessionary indicator, it also comes at a time of an improving housing market. It would be unusual, to say the least, to experience a recession when housing is trending up. Moreover, I remain skeptical that trade channels are sufficient to trip the economy into recession. Still, I can't discount the recession threat entirely; to do so would be ludicrous in the face of the looming fiscal cliff. On average, Congress and the Administration have tended to limp things along, and hence the median bet should be that they will continue to do so. But all bets wear thin after awhile. Assuming monetary policy remains on hold (which it will), the degree of fiscal austerity in 2013 remains my chief concern.

'Higher Education and Theory of the Second Best'

John Holbo:

... My basic thought ... is that the paradigm college experience is just plain going to cost a lot. Four years being a full-time student at a residential college, say. That’s not going to come cheap. We shouldn’t beat our brains out about how we can do this thing inexpensively... There isn’t some conspiracy to artificially inflate the cost of college. We could do different things. That might cost less. ... But there isn’t any reason to think we can do substantially the same things we already are, just at much lower cost. This is clearly a source of sincere disagreement... Some people think that the rate at which college costs have gone up means that there must be some way to pop the cost bubble and dramatically lower costs back down without sacrificing quality. There’s some conspiracy of incompetence or venality by the administrators/teachers. We need to break the back of that, whatever it is, then things would get better. I don’t really think that’s plausible, but if you think it’s plausible, go ahead and work out your own solution to the problem along those lines.

College is a premium product. A costly good. But a valuable one we want people to have. If the state isn’t going to subsidize its provision, making it available to all, then how will it go?

Option 1: everyone who isn’t rich goes into serious debt to pay for this costly but valuable good.

Option 2: we devise a less premium product. It won’t be as good, but it will cost less.

I distrust Option 1. In fact, I’m paranoid about it, for reasons outlined in this article. I don’t quite drink the full jug of kool-aid. For example, I don’t buy that tuition has skyrocketed ‘because it can’. That is, there’s just a speculative bubble, in effect. I don’t think the growth in administration is quite as sinister as they suggest. It’s largely a function of universities wanting to do so much for students – so many programs and options and choices – which is a good thing. But it creates overhead costs.

I do agree that private for-profit outfits like University of Phoenix are, in effect, trying to get their noses into the huge trough of student loan money. That’s worrisome. The old are eating their young, leaving them holding the debt bag [pardon my mixed metaphor]. I am less worried by things like Western Governors University, which seems genuinely committed to trying to find a way to Option 2. Which makes me sad, but at least it isn’t some private sector trick to saddle students with debt. At least it’s an attempt to keep the democratic ideal of higher education for all alive, even if the dream looks pretty shabby.

Western Governors gives up the dream of a well-rounded liberal arts education. It gives up all the stuff that you can only do hands-on, in person. It gives up college as a formative social experience. It gives up a lot. But what it provides is worth something, and it’s not clear they are charging more than it is worth. It just makes me depressed to look at it, is all. But I can’t really argue with the logic of it, if the alternative is Option 1..., it might be the way of the future. ...

Links for 10-25-2012

• Romney’s Social Security Plan Hides a Tax Hike - Bloomberg
• Tax Policy Center in Spotlight for Its Romney Study - NYTimes.com
• Higher Education and Theory of the Second Best - Crooked Timber
• For Whom Golden Parachutes Shine - Lucian Bebchuk
• Bernanke complicates Wall Street’s view of Romney - MacroScope
• Shapley Nobel Resurrects Von Neumann Versus Nash - Barkley Rosser
• The Economic Consequences of Mr. Osborne - Paul Krugman
• Press Release: FOMC statement - FRB
• From Master Plan To No Plan - Rortybomb
• Is Fiat Money a Bubble? - EconLog
• Too Big To Handle - Simon Johnson
• Character and history - Daniel Little
• Ethics and Finance: The Role of Mathematics - Magic, maths and money
• Professor questioned over hundreds of false job applications - Korea Times
• The Lost Generations - Jeffrey D. Sachs
• China and Protectionism: It's Not So Simple - Dean Baker
• Better Ways to Deal With China - NYTimes.com
• If It Tastes Good It Has To Be Bad For You - Cheap Talk

The Myth that Growing Consumption Inequality is a Myth

Kevin Hassett and Aparna Mathur argue that consumption inequality has not increased along with income inequality. That's not what recent research says, but before getting to that, here's their argument:

Consumption and the Myths of Inequality, by Kevin Hassett and Aparna Mathur, Commentary, WSJ: In multiple campaign speeches over the past week, President Obama has emphasized a theme central to Democratic campaigns across the country this year: inequality. ... To be sure, there are studies of income inequality—most prominently by Thomas Piketty of the Paris School of Economics and Emmanuel Saez of the University of California at Berkeley—that report that the share of income of the wealthiest Americans has grown over the past few decades while the share of income at the bottom has not. The studies have problems. Some omit worker compensation in the form of benefits. And economist Alan Reynolds has noted that changes to U.S. tax rules cause more income to be reported at the top and less at the bottom. But even if the studies are accepted at face value, as a read on the evolution of inequality, they leave out too much.

Let me break in here. Here's what Piketty and Saez say about Reynold's work:

In his December 14 article, “The Top 1% … of What?”, Alan Reynolds casts doubts on the interpretation of our results showing that the share of income going to the top 1% families has doubled from 8% in 1980 to 16% in 2004. In this response, we want to outline why his critiques do not invalidate our findings and contain serious misunderstandings on our academic work. ...

Back to Hassett and Mathur

Another way to look at people's standard of living over time is by their consumption. Consumption is an even more relevant metric of overall welfare than pre-tax cash income, and it will be set by consumers with an eye on their lifetime incomes. Economists, including Dirk Krueger and Fabrizio Perri of the University of Pennsylvania, have begun to explore consumption patterns, which show a different picture than research on income.

Let me break in again and deal with the Krueger and Perri Krueger and Perri (2006) paper, which followed the related work by Slesnick (2001):

Has Consumption Inequality Mirrored Income Inequality?: This paper by Mark Aguiar and Mark Bils finds that "consumption inequality has closely tracked income inequality over the period 1980-2007":

Has Consumption Inequality Mirrored Income Inequality?, by Mark A. Aguiar and Mark Bils, NBER Working Paper No. 16807, February 2011: Abstract We revisit to what extent the increase in income inequality over the last 30 years has been mirrored by consumption inequality. We do so by constructing two alternative measures of consumption expenditure, using data from the Consumer Expenditure Survey (CE). We first use reports of active savings and after tax income to construct the measure of consumption implied by the budget constraint. We find that the consumption inequality implied by savings behavior largely tracks income inequality between 1980 and 2007. Second, we use a demand system to correct for systematic measurement error in the CE's expenditure data. ...This second exercise indicates that consumption inequality has closely tracked income inequality over the period 1980-2007. Both of our measures show a significantly greater increase in consumption inequality than what is obtained from the CE's total household expenditure data directly.

Why is this important? (see also "Is Consumption the Grail for Inequality Skeptics?"):

An influential paper by Krueger and Perri (2006), building on related work by Slesnick (2001), uses the CE to argue that consumption inequality has not kept pace with income inequality.

And these results have been used by some -- e.g. those who fear corrective action such as an increase in the progressivity of taxes -- to argue that the inequality problem is not as large as figures on income inequality alone suggest. But the bottom line of this paper is that:

The ... increase in consumption inequality has been large and of a similar magnitude as the observed change in income inequality.

So they are citing what is now dated work. They either don't know about the more recent work, or simply chose to ignore it because it doesn't say what they need it to say.

Okay, back to Hassett and Mathur once again. They go on to cite their own work -- more on that below. One thing to note, however, is that the recent research in this area says the data they use must be corrected for measurement error or you are likely to find the (erroneous) results they find. As far as I can tell, the data are not corrected:

Our recent study, "A New Measure of Consumption Inequality," found that the consumption gap across income groups has remained remarkably stable over time. ...

While this stability is something to applaud, surely more important are the real gains in consumption by income groups over the past decade. From 2000 to 2010, consumption has climbed 14% for individuals in the bottom fifth of households, 6% for individuals in the middle fifth, and 14.3% for individuals in the top fifth when we account for changes in U.S. population and the size of households. This despite the dire economy at the end of the decade.

Should we trust this research? First of all this is Kevin Hassett. How much do you trust the work once you know that? Second, it's on the WSJ editorial page. How much does that reduce your trust? I'd hope the answer is "quite a bit." Third, big red flags when researchers cherry pick start and/or end dates. Fourth, as already noted, recent research shows that the no growth in consumption inequality result is due to measurement error in the CES data. When the data are corrected, consumption inequality mirrors income inequality. They don't say a word about correcting the data.

Next, we get the "but they have cell phones!" argument:

Yet the access of low-income Americans—those earning less than $20,000 in real 2009 dollars—to devices that are part of the "good life" has increased. The percentage of low-income households with a computer rose... Appliances? The percentage of low-income homes with air-conditioning equipment..., dishwashers..., a washing machine..., a clothes dryer..., [and] microwave ovens... grew... Fully 75.5% of low-income Americans now have a cell phone, and over a quarter of those have access to the Internet through their phones.

Before turning to their conclusion, let me note more new research in this area from a post earlier this year, But They Have TVs and Cell Phones!, emphasizing the measurement error problem:

Consumption Inequality Has Risen About As Fast As Income Inequality, by Matthew Yglesias: Going back a few years one thing you used to hear about America's high and rising level of income inequality is that it wasn't so bad because there wasn't nearly as much inequality of consumption. This story started to fall apart when it turned out that ever-higher levels of private indebtedness were unsustainable (nobody could have predicted...) but Orazio Attanasio, Erik Hurst, and Luigi Pistaferri report in a new NBER working paper "The Evolution of Income, Consumption, and Leisure Inequality in The US, 1980-2010" that the apparently modest increase in consumption inequality is actually a statistical error.

They say that the Consumer Expenditure Survey data from which the old-school finding is drawn is plagued by non-classical measurement error and adopt four different approaches to measuring consumption inequality that shouldn't be hit by the same problem. All four alternatives point in the same direction: "consumption inequality within the U.S. between 1980 and 2010 has increased by nearly the same amount as income inequality."

Here's Hassett and Mathur's ending:

It is true that the growth of the safety net has contributed to massive government deficits—and a larger government that likely undermines economic growth and job creation. It is an open question whether the nation will be able to reshape the net in order to sustain it, but reshape it we must. ...

After arguing (wrongly) that consumption has kept pace with income, they say it's only because of the deficit -- but it's not sustainable. So suck it up middle class America, consumption inequality has increased despite the claims of denialists like Hassett, and if they get their way and reduce the social safety net, it will only get worse.

Hassett and company denied that income inequality was growing for years (notice their attempt to do just that in the first paragraph by citing discredited research from Alan Reynolds), then when the evidence made it absolutely clear they were wrong (surprise!), they switched to consumption inequality. Recent evidence says they're wrong about that too.

Video: Krugman and Stiglitz

[Note: The video starts at the 16:15 mark, and the Krugman and Stiglitz discussion begins at 25:30]

Attempted Price Manipulation at Intrade? Probably Not.

Rajiv Sethi argues that the abrupt change in the price of presidential contracts on Intrade was probably due to something other than attempted manipulation of the market to make Romney look better:

Algorithms, Arbitrage, and Overreaction on Intrade, by Rajiv Sethi: There were some startling price movements in the presidential contracts on Intrade yesterday. ...

What caused this unusual price behavior? There's been some talk of attempted price manipulation, but I have my doubts because the trader who was buying aggressively over this period was extremely naive. ... Throughout the buying frenzy, the Obama contract never fell below 57 and there was a substantial block of bids at or above this price. The trader who was buying Romney at 48 could have made the same bet for 43 by simply selling the Obama contract at 57. In fact, he would have obtained a slightly superior contract, which would pay off if any person other than Obama were to win, including but not limited to Romney.

This fact also explains the oscillations in the Romney price, and the decline to 57 under selling pressure of the Obama price. Any individual who had posted ask prices in the 43-48 range in the Romney market had these orders met by the crazed buyer, and could then sell Obama above 57 for an immediate arbitrage profit. As it happens, there are algorithms active on Intrade that do precisely this. ...

If this was not an instance of attempted manipulation, then what was it? I suspect that it was an overzealous response to reports of a major announcement concerning the presidential race, promised by Donald Trump. Further frenzied activity in the presidential and state level markets took place in the evening, as speculation about the nature of the announcement started to spread.

This whole bizarre episode tells us very little about the presidential race, but does shed some light on how these markets work. Changes in one market spill over instantaneously to changes in linked markets via arbitrage, some of it executed algorithmically. And algorithms that work very effectively when rare can end up with disastrous results if copied. For instance, if two algorithms were to follow the strategy outlined above, it is possible that only one of them may be able to complete the second sale since the first mover would have snapped up the existing bids. This kind of game is currently being played in the world of high frequency trading, but with much higher stakes and considerably more serious economic consequences.

Whoever it was lost money, which seems an appropriate outcome for putting one's faith in Donald Trump's crazy ramblings.

'Four Magic Tricks for Fiscal Conservatives'

Jeffrey Frankel:

Four Magic Tricks for Fiscal Conservatives, by Jeffrey Frankel, Commentary, NY Times: ...Aspiring fiscal conservatives ... might be interested in learning four tricks that American politicians commonly use when promising to cut taxes while simultaneously reducing budget deficits. ...

The first ... was coined by Reagan’s budget director, David Stockman..., because the numbers in the 1981 budget plan did not add up. “We invented the ‘magic asterisk,’” ... Ever since, the magic asterisk has become a familiar American device. ...

[Second,]... the conjurer ... resorts to the rosy scenario: since he cannot find enough tax loopholes to eliminate, he must claim that ... stronger economic growth will bring in the additional revenue. ..

Right on cue, it is time for the famous Laffer hypothesis – the proposition ... that reductions in tax rates ... so stimulate economic growth that total tax revenue ... goes up... One might think that the Romney campaign would not resurrect so discredited a trick. ...

The final trick, “starve the beast,” typically comes later, if and when the president has enacted his tax cuts and discovers ... tax revenues have not grown... The audience is now told that losing tax revenue and widening the budget deficit was the plan all along. The performer explains that the deficit is all the fault of congress for not cutting spending and that ... “Congress can’t spend money it doesn’t have.” This trick never works...

By the time the crowd realizes that it has been conned, the magician has already pulled off the greatest trick of all: yet another audience that came to see the deficit shrink leaves the theater with the deficit bigger than before.

Links for 10-24-2012

• The Myth of the Exploding Safety Net - CBPP
• Rejection Improves Your Papers? - Cheap Talk
• Governments Aren’t Like Businesses - Jodi Beggs
• Theory and the Thirties - Paul Krugman
• No more bubble talk (please!) - MacroMania
• Mitt Romney's Question-Mark Economy - Robert Reich
• Liquidity, bubbles/ponzis/chain letters, and money - Nick Rowe
• How “Different” is the Recovery from the Financial Crisis? - Econbrowser
• Housing Was a Huge Headwind; Now a Small Tailwind - Jared Bernstein
• What's Good for General Motors ... - Tim Taylor
• The Cost of Higher Education - Crooked Timber

The 'Old News' on Inequality and Growth

A professor of sociology at Berkeley, Claude Fischer, says all the recent talk about inequality causing a reducing in growth is "old news":

A cost of inequality: growth, by Claude Fischer: A recent story in The New York Times, back in its business section, had important news about inequality: “Income Inequality May Take Toll on Growth.” A couple of economists at the IMF reported research (here) showing that, across many countries, periods of greater income inequality tend to be followed by slow-downs in economic growth.  ...

This is, actually, old news. About twenty years ago the research literature already showed that inequality probably damped the economy (see pp. 126ff here). But this remains important to repeat – not just because reporting the baleful effects of inequality now has the imprimatur of the IMF, but also because so many people still resist the news; they insist instead on believing the opposite, that inequality stimulates the economy, to the benefit of everyone. And, of course, this insistence has political implications right now. ...

To the extent that facts matter in such a politicized debate, it is becoming increasingly clear that equality rather than inequality is a better policy for economic growth. ...

'The Health Mandate Romney Still Supports'

Eliminate boredom at meetings blogging -- quick one -- Bruce Bartlett on Mitt Romney's (silly) claim that the individual mandate for health insurance is unnecessary because people can get the care they need at emergency rooms:

The Health Mandate Romney Still Supports, by Bruce Bartlett, Commentary, NY Times: Republicans ... are adamantly opposed to government paying for health care or a mandate requiring people to buy health insurance. At the same time, they recognize that they cannot say ... that if a dying person shows up at an emergency room without insurance, that person will be left to die in the street. Thus they support a little-known mandate requiring hospitals to treat the uninsured, the Emergency Medical Treatment and Active Labor Act.

Often referred to as Emtala, the bill ... was signed into law by Ronald Reagan... It was enacted because, previously, people had in fact been left to die in the street... Since then, Republicans have routinely cited Emtala as a key reason that the United States already has de facto national health insurance...

In fact, the Emergency Medical Treatment and Active Labor Act isn’t even remotely a substitute for health insurance... It does not demand that all hospitals care for whoever walks in, only those who require urgent care to avoid serious injury or life-threatening consequences. Only hospitals that both participate in Medicare and have emergency rooms are covered by the law...

A new report ... found that hospitals continue to engage in a practice known as “patient dumping” – turning away uninsured patients from emergency rooms despite the law. One reason they are able to do so is because in 2003 the George W. Bush administration eased the rules regarding Emtala. ...

The ... mandate on hospitals ... is a very inadequate and inefficient substitute for health insurance – something Mr. Romney used to acknowledge – and every bit as much a violation of Republican principles, which oppose unfunded mandates, as the individual mandate that they abhor.

Inflation and Unemployment

I have a bunch of meetings this morning -- you know how those go. That will give me a chance to think about these graphs:

This is a graph of PCE core year-over-year inflation versus unemployment since 2007 (the scatterplot with headline rather than core PCE is a noisier version of this, but the basic pattern remains):

The same graph since 2008 eliminates many of the observations in the upper left part of the graph:

And, since 2009:

We Should Stop Blaming China For Our Economic Problems

Here's my contribution to the debate over China bashing:

We Should Stop Blaming China for our Economic Problems: The second presidential debate featured Mitt Romney and Barack Obama going nose to nose over who would be tougher on China and other countries over their unfair trade practices. But by adopting a narrative that places the blame for our problems on other countries, President Obama is playing into the hands of those who’d like to make significant cuts to social insurance programs that protect working class households. ...

Here's the bottom line:

Blaming our troubles on external causes and implying that all will be well once these causes are eliminated allows the wealthy winners from globalization to escape the taxes that are needed to provide the social protections workers need in the global economy, and to ensure that the gains from globalization are shared equitably. President Obama needs to make it clear that helping the working class will take a lot more than just forcing China to change its ways... [It] will require us to look inward at our own character as a nation instead of blaming others.

Pointing fingers at other countries and demanding change may be politically effective, but the real change begins at home.

[Read more]

Links for 10-23-2012

• Things That Aren't Bubbles - Paul Krugman
• Money and Bubbles - Stephen Williamson
• Whole Lot of Bubbling Going On - Uneasy Money
• The Money Bubble - Karl Smith
• Revolving Doors Matter - Baseline Scenario
• An Issue Whose Time Has Passed - Paul Krugman
• Toward a Serious Discussion of the Trade Deficit - Dean Baker
• The multiplier: Lessons from history - Eichengreen and O'Rourke
• If the confidence fairy ever existed... - Jonathan Portes
• Are electon probabilities meaningful? - Andrew Gelman
• What Did the Debates Tell Us? - Jeff Frankel
• The "Uncertainty" Scam - Paul Krugman
• Enter the Asterisk - Econbrowser
• Your Fees, Their Bank - Nancy Folbre
• U.S. Birth Rates - Tim Taylor
• Which market failure? - Chris Dillow
• Why and How to Help Lagging Regions Catch Up - Otaviano Canuto
• A Post-Debate Interview with Hubbard on Housing Policy - Rortybomb
• The Uncomfortable Truth About American Wages - NYTimes.com
• US public and ARRA reconciled - Angry Bear

Reinhart and Rogoff: This Time is Different, Again?

Reinhart and Rogoff take on the claim by "famous economists associated with the Romney campaign" that the economy is recovering slower than we should expect. In fact, when the data are examined honestly, " the economy’s performance is better than expected." Here's the introductory summary and a link to the article explaining this in detail:

This time is different, again? The US five years after the onset of subprime, by Carmen M Reinhart, Kenneth Rogoff: The strength of the US recovery has become a political issue in the presidential election. The US is doing better than other advanced economies, but famous economists associated with the Romney campaign claim this is not good enough. The US, they argue, is different. Here, the masters of the 'this time is different' research genre – Carmen Reinhart and Ken Rogoff – argue that US historical performance is not different when it is properly measured, so the economy’s performance is better than expected.

Paul Krugman: The Secret of Our Non-Success

One of these recessions is not like the others:

The Secret of Our Non-Success, by Paul Krugman, Commentary, NY Times: The U.S. economy finally seems to be recovering in earnest... But the news is good, not great — it will still take years to restore full employment...

Why is recovery from a financial crisis slow? Financial crises are preceded by credit bubbles; when those bubbles burst, many families and/or companies are left with high levels of debt, which force them to slash their spending. This slashed spending, in turn, depresses the economy...

And the usual response to recession, cutting interest rates to encourage spending, isn’t adequate. Many families simply can’t spend more, and interest rates can be cut only so far — namely, to zero but not below.

Does this mean that nothing can be done to avoid a protracted slump after a financial crisis? No, it just means that you have to do more than just cut interest rates. In particular, what the economy really needs ... is a temporary increase in government spending, to sustain employment while the private sector repairs its balance sheet. And the Obama administration did some of that, blunting the severity of the financial crisis. Unfortunately, the stimulus was both too small and too short-lived, partly because of administration errors but mainly because of scorched-earth Republican obstruction.

Which brings us to the politics.

Over the past few months advisers to the Romney campaign have mounted a furious assault on the notion that financial-crisis recessions are different. For example,... former Senator Phil Gramm and Columbia’s R. Glenn Hubbard published an op-ed article claiming that we should be having a recovery comparable to the bounceback from the 1981-2 recession, while a white paper from Romney advisers argues that the only thing preventing a rip-roaring boom is the uncertainty created by President Obama.

Obviously, Republicans like claiming that it’s all Mr. Obama’s fault... But ... the Romney team is willfully, nakedly, distorting the record, leading Ms. Reinhart and Mr. Rogoff — who aren’t affiliated with either campaign — to protest against “gross misinterpretations of the facts.” And this should worry you.

Look, economics isn’t as much of a science as we’d like. But when there’s overwhelming evidence for an economic proposition ... we have the right to expect politicians and their advisers to respect that evidence. Otherwise, they’ll end up making policy based on fantasies rather than grappling with reality.

And once politicians start refusing to acknowledge inconvenient facts, where does it stop? Why, the next thing you know Republicans will start rejecting the overwhelming evidence for man-made climate change. Oh, wait.

Links for 10-22-2012

• Austerity, debt burdens and hypocrisy - mainly macro
• Money is just little green pieces of paper! - Noah Smith
• A Snowball Flung on the Uppermost Slopes - David Warsh
• Beware of Romneycare - James Surowiecki
• How to think about work - UnderstandingSociety
• China’s currency rises in the US backyard - FT.com
• Fun with Numbers - Jared Bernstein
• High fiscal multipliers undermine austerity - Gavyn Davies
• Reinhart, Rogoff, and Latvia - Paul Krugman

Stavins: Cap-and-Trade, Carbon Taxes, and My Neighbor’s Lovely Lawn

Speaking of externalities associated with energy use, Robert Stavins throws cold water on "current enthusiasm about carbon taxes in the academic and broader policy-wonk community":

Cap-and-Trade, Carbon Taxes, and My Neighbor’s Lovely Lawn, by Robert Stavins: ...my conclusion in 1998 strongly favored a market-based carbon policy, but was somewhat neutral between carbon taxes and cap-and-trade. Indeed, at that time and for the subsequent eight years or so, I remained agnostic regarding what I viewed as the trade-offs between cap-and-trade and carbon taxes. What happened to change that? Three words: The Hamilton Project.

...In 2007, the Project’s leadership asked me to write a paper proposing a U.S. CO₂ cap-and-trade system. ... The Hamilton Project leaders said ... they wanted me to make the best case I could for cap-and-trade, not a balanced investigation of the two policy instruments. Someone else would be commissioned to write a proposal for a carbon tax. (That turned out to be Professor Gilbert Metcalf of Tufts University ... who did a splendid job!) Thus, I was made into an advocate for cap-and-trade. It’s as simple as that. ...

In principle, both carbon taxes and cap-and-trade can achieve cost-effective reductions, and – depending upon design — the distributional consequences of the two approaches can be the same. But the key difference is that political pressures on a carbon tax system will most likely lead to exemptions of sectors and firms, which reduces environmental effectiveness and drives up costs, as some low-cost emission reduction opportunities are left off the table. But political pressures on a cap-and-trade system lead to different allocations of the free allowances, which affect distribution, but not environmental effectiveness, and not cost-effectiveness.

I concluded that proponents of carbon taxes worried about the propensity of political processes under a cap-and-trade system to compensate sectors through free allowance allocations, but a carbon tax would be sensitive to the same political pressures, and should be expected to succumb in ways that are ultimately more harmful: reducing environmental achievement and driving up costs.

Of course, such positive political economy arguments look much less compelling in the wake of the defeat of cap-and-trade legislation in the U.S. Congress and its successful demonization by conservatives as “cap-and-tax.”

A Political Opening for Carbon Taxes?

Does the defeat of cap-and-trade in the U.S. Congress, the obvious unwillingness of the Obama White House to utter the phrase in public, and the outspoken opposition to cap-and-trade by Republican Presidential candidate Mitt Romney indicate that there is a new opening for serious consideration of a carbon-tax approach to meaningful CO₂ emissions reductions?

First of all, there surely is such an opening in the policy wonk world. Economists and others in academia, including important Republican economists such as Harvard’s Greg Mankiw and Columbia’s Glenn Hubbard, remain enthusiastic supporters of a national carbon tax. And a much-publicized meeting in July at the American Enterprise Institute in Washington, D.C. brought together a broad spectrum of Washington groups – ranging from Public Citizen to the R Street Institute – to talk about alternative paths forward for national climate policy. Reportedly, much of the discussion focused on carbon taxes.

Clearly, this “opening” is being embraced with enthusiasm in the policy wonk world. But what about in the real political world? The good news is that a carbon tax is not “cap-and-trade.” ... But if conservatives were able to tarnish cap-and-trade as “cap-and-tax,” it surely will be considerably easier to label a tax – as a tax! Also, note that Romney’s stated opposition and Obama’s silence extend beyond disdain for cap-and-trade per se. Rather, they cover all carbon-pricing regimes.

So as a possible new front in the climate policy wars, I remain very skeptical that an explicit carbon tax proposal will gain favor in Washington, no matter what the outcome of the election. ...

I would personally be delighted if a carbon tax were politically feasible in the United States, or were to become politically feasible in the future. But I’m forced to conclude that much of the current enthusiasm about carbon taxes in the academic and broader policy-wonk community in the wake of the defeat of cap-and-trade is – for the time being, at least – largely a manifestation of the grass looking greener across the street.

'Reducing Oil Imports'

Jim Hamilton:

Reducing oil imports, by Jim Hamilton: ...In 2011, the U.S. imported $462 billion of petroleum and petroleum products, or more than a billion dollars every day (see BEA Table 4.2.5). The fact that we import goods from other countries is not a problem per se. Standard economic theory teaches that if the U.S. imports some goods and exports others, the country overall will be richer than in the absence of trade, because the value of what we gain in imports is higher to us than the value of what we sell as exports. But in the current U.S. situation, our oil imports aren't balanced by other exports. Last year the U.S. spent $568 billion more on imported goods and services than we sold to other countries, with petroleum imports accounting for more than 80% of the total current account deficit

When we import more than we export, we have to pay for the difference either by selling off some of our assets or by borrowing more from foreigners. Notwithstanding, running a current account deficit could still be a way to make the country richer. If we use the imported goods and borrowed funds to invest in productive capital and useful infrastructure, we should have plenty of future resources to pay back all that we borrowed, with more left over for ourselves. In such a case, a big current account deficit could still be a win-win situation.

But what if we're not investing, and are just using the imports and foreign borrowing to enjoy a temporarily higher standard of living, leaving it to the future to pay the bills? That, too, could be economically optimal if what we most value as a nation is having more consumption spending right now.

But I'm not convinced that's the future that most Americans want. ...

I agree with the position taken by both President Obama and Governor Romney that presidential decisions need to encourage more oil production in the United States.

However, I would add that policies that discourage U.S. consumption of petroleum would also achieve the same goal. For example, trying to make more use of our natural gas resources for transportation is an idea that should appeal to Americans on both sides of the political spectrum. ...

I retain the hope that, whoever wins the election, they might seize the opportunity to move the country in a more positive direction by focusing on some goals and strategies on which both political parties should be able to agree.

Increasing U.S. oil production and decreasing U.S. oil consumption should be two such goals.

I see more difference between the candidates on the drill versus conserve continuum, and I'd guess I tilt more toward the conservation/find new energy sources end of the spectrum than he does. In addition, I wish the externalities associated with energy use and the need to use some form of regulation to reduce them (e.g. carbon tax, cap and trade, etc.) -- regulation that should discourage consumption -- had been mentioned (a point where the two parties clearly differ -- it matters who is elected).

Links for 10-21-2012

• Different approaches to austerity - mainly macro
• A Rant on Refereeing - Normal Deviate
• Bubble, Bubble, Conceptual Trouble - Paul Krugman
• Romney the Detail Man? - Robert Reich
• Big Companies Use ‘Plain English’ To Rob You - David Cay Johnston
• The Financial Industry and Financial Crises - Paul Krugman
• Oil And Defense Spending - EconoSpeak

Romer: The Fiscal Stimulus, Flawed but Valuable

Christina Romer:

The Fiscal Stimulus, Flawed but Valuable, by Christina Romer, Commentary, NY Times: As a former member of President Obama's economic team, I have a soft spot for the fiscal stimulus legislation... But I'm also an empirical economist who's spent a career trying to estimate the effects of monetary and fiscal policy. So let me put on my empiricist's hat and evaluate what we know about the legislation's effects. ...

After going through the considerable historical and empirical evidence that the fiscal stimulus worked, she concludes:

Though the Recovery Act appears to have had many benefits, it could have been more effective. Most obviously, it was too small. When we were designing it, most forecasters estimated that the United States would lose around six million jobs... Compared with this baseline, creating three million jobs would have filled roughly half of the employment hole. As it turned out,... the correct no-stimulus baseline was a total employment fall of nearly 12 million. With a loss that big, creating three million jobs was helpful, but not nearly enough.

A different mix of spending increases and tax cuts might also have been desirable. ... And I desperately wish we'd been able to design a public employment program that could have directly hired many unemployed workers, especially young people.

Finally, there's little question that policy makers — myself included — should have worked harder to earn the public's support... One frustrating anomaly is that many of its individual components routinely received favorable reactions in polls, while the overall act was viewed negatively. ...

Recovery measures work better when they raise confidence — as Franklin D. Roosevelt understood. ... Recent research suggests that New Deal programs may actually have had their primary impact on the economy by influencing consumer and business expectations of future growth and inflation.

Partly because of fierce political opposition, and partly because of ineffective communication and imperfect design, the Recovery Act generated little such rebound in confidence. As a result, it didn't have that extra, Rooseveltian kick. ...

I believe that as more research occurs and the political rancor fades, the fiscal stimulus will be viewed as an important step at a bleak moment in our history. Not the knockout punch the administration had hoped for, but a valuable effort that improved the lives of many.

That seems to come dangerously close to saying that a "Mr. Awesome" as president might have made the recovery much better. But not quite, at least not if one has Romney's claims about himself in mind. As Paul Krugman noted in his last column, Mr. Romney "doesn’t have a plan. ... Mr. Romney himself asserted that he would give a big boost to the economy simply by being elected, 'without actually doing anything'..., the true Romney plan is to create an economic boom through the sheer power of Mr. Romney’s personal awesomeness."

To put it another way, Romney would cure the economy by relying upon a placebo effect, an effect that somehow works through the powers of his personality. The Obama cure provided too little medicine, and there was not enough communication with the patient -- both could have been improved -- but the medicine it did provide was real, not a placebo, and it did have positive effects.

Robber Barons

The entry below this one reminded me of this old post featuring Brad DeLong on the Robber Barons (he wrote this in 1998, the actual essay is much, much longer):

Robber Barons, by J. Bradford DeLong, 1998: I. Introduction "Robber Barons": that was what U.S. political and economic commentator Matthew Josephson (1934) called the economic princes of his own day. Today we call them "billionaires." Our capitalist economy--any capitalist economy--throws up such enormous concentrations of wealth: those lucky enough to be in the right place at the right time, driven and smart enough to see particular economic opportunities and seize them, foresighted enough to have gathered a large share of the equity of a highly-profitable enterprise into their hands, and well-connected enough to fend off political attempts to curb their wealth (or well-connected enough to make political favors the foundation of their wealth).

Matthew Josephson called them "Robber Barons". He wanted readers to think back to their European history classes, back to thugs with spears on horses who did nothing save fight each other and loot merchant caravans that passed under the walls of their castles. He judged that their wealth was in no sense of their own creation, but was like a tax levied upon the productive workers and craftsmen of the American economy. Many others agreed: President Theodore Roosevelt--the Republican Roosevelt, president in the first decade of this century--spoke of the "malefactors of great wealth" and embraced a public, political role for the government in "anti-trust": controlling, curbing, and breaking up large private concentrations of economic power.

Their defenders--many bought and paid for, a few not--painted a different picture: the billionaires were examples of how America was a society of untrammeled opportunity, where people could rise to great heights of wealth and achievement on their industry and skill alone; they were public benefactors who built up their profitable enterprises out of a sense of obligation to the consumer; they were well-loved philanthropists; they were "industrial statesmen."

Over the past century and a half the American economy has been at times relatively open to, and at times closed to the ascension of "billionaires." Becoming a "billionaire" has never been "easy." But it was next to impossible before 1870, or between 1929 and 1980. And at other times--between 1870 and 1929, or since 1980--there has been something about the American economy that opened roads to the accumulation of great wealth that were at other times closed.

Does it matter whether an economy is open to the accumulation of extraordinary amounts of private wealth? When the economy is more friendly to the creation of billionaires, is economic growth faster? Or slower? And what role does politics play? Are political forces generally hostile to great fortunes, or are they generally in partnership? And when the political system turns out to be corrupt--to serve as a committee for extracting wealth from the people and putting it into the pockets of the politically well-connected super-rich--what is to be done about it? What can be done to curb explicit and implicit corruption without also reducing the pressure in the engine of capital accumulation and economic growth?

These are big questions. This essay makes only a start at answering them.

Here's an interesting note:

And this is the third thing ... about the turn of the century robber barons: even though the base of their fortunes was the railroad industry, they were for the most part more manipulators of finance than builders of new track. Fortune came from the ability to acquire ownership of a profitable railroad and then to capitalize those profits by selling securities to the public. Fortune came from profiting from a shift--either upward or downward--in investors' perceptions of the railroad's future profits. It was the tight integration of industry with finance that made the turn of the twentieth century fortunes possible. ...

The jump in wealth of the founders of these lines of business was intimately tied up with the creation of a thick, well-functioning market for industrial securities. And that would turn out to be a source of weakness when Wall Street came under fire during the Great Depression. ...

And:

Progressives did not believe that the billionaires were just the helpless puppets of market forces. In 1896 Democratic presidential candidate William Jennings Bryan called for the end to the crucifixion of the farmer by a gold standard working in the interests of Morgan and his fellow plutocrats. Fifteen years later Louis Brandeis warned Morgan partner Thomas Lamont--after whom Harvard University's main undergraduate library is named-that it was in fact in Morgan's interest to support the Progressive reform program. If Morgan's partners did not do so, Brandeis warned, the Progressives would recede. Their successors on the left wing of American politics would be real anarchists and real socialists (DeLong, 1991).

Louis Brandeis and company did not much care whether the billionaires of what they called the "money trust" were in any sense economically efficient. In Brandeis's mind, they're evil because their interests were large..., size alone made a billionaire's fortune "dangerous, highly dangerous." ...

Populists from the American midwest found this set of issues a reliable one, and their senators took turns calling for political and economic changes to reduce the power exercised by the super-rich. ...

The political debate was resolved only by the Great Depression. The presumed link between the stock market crash and the Depression left the securities industry without political defenders. The old guard of Progressives won during the 1930s what they had not been able to win in the three earlier decades.

Ironically, it was Republican president Herbert Hoover who triggered the process. Hoover thought that Wall Street speculators were prolonging the Depression and refusing to take steps to restore prosperity. He threatened investigations to persuade New York financiers to turn the corner around which he was sure prosperity waited. Thus, as Franklin D. Roosevelt put it, "the money changers were cast down from their high place in the temple of our civilization." The Depression's financial market reforms act broke the links between board membership, investment banking, and commercial banking-based management of asset portfolios that had marked American finance before 1930. Investment bankers could no longer be commercial bankers. Depositors' money could not be directly used to support the prices of newly-issued securities. Directorates could not be interlocked: that bankers could not be on the boards of directors of firms that were their clients.

D. The Drying-Up of the Flow of Billionaires

Whatever else Depression-era financial reforms did (and there are those who think it crippled the ability of Wall Street to channel finance to new corporations) and whatever else the New Deal did (and it did a lot to bring social democracy to the United States and to level the income distribution), one important--and intended--consequence was that thereafter it was next to impossible to become a billionaire.

Not that it was ever easy to become a billionaire, mind you, but the channels through which lucky, skilled, dedicated, and ruthless entrepreneurs had ascended were largely closed off. ...

The hostility of Roosevelt's New Deal to massive private concentrations of economic power was effective: the flow of new billionaires dried up, as the links between finance and industry that they had used to climb to the heights of fortune were cut.

This is the important question:

Did the hostility of America's political and economic environment to billionaires between 1930 and 1980 harm the American economy? Did it slow the rate of economic growth by discouraging entrepreneurship? As an economist--someone who believes that there are always tradeoffs--I would think "yes." I would think that there must have been a price paid by the closing off of the channels of financing for entrepreneurship through which E.H. Harriman, James J. Hill, George F. Baker, Louis Swift, George Eastman, and others had made their fortunes.

But if so, there are no signs of it in aggregate growth data. ...

V. Tentative Conclusions

So what can Americans expect from their current crop of billionaires? Or rather what can they expect from the processes that have allowed their creation?

They should be extremely dubious about billionaires' social utility. Their relative absence from the 1930s to the 1970s did not seem to harm economic growth in the United States. Their predecessors' claim to much of their wealth is, to see the least, dubious. And their large-scale presence was associated with the serious corruption of American politics.

Perhaps those who are going to be industrial statesmen have as reasonable a chance of truly being industrial statesmen in an environment hostile to billionaires, as in an environment friendly to their creation: at that level of operations, after all, money is just how people keep the score in their competitions against nature and against each other. ...

On the other hand, their personal consumption is only an infinitesimal proportion of their total wealth. Much less of Andrew Carnegie's fortune from his steel mills went to his own personal consumption than has gone to his attempts to promote international peace, or to build libraries to increase literacy.

The child who in mid-nineteenth century Scotland painfully learned to read from the handful of books he had access to in his family's two-room cottage as they fell closer and closer to the edge of starvation--that child is visible in the Carnegie libraries that still stand in several hundred cities and towns in the United States, and is visible around us now. ...

So if there is a lesson, it is roughly as follows: Politics can put curbs on the accumulation of extraordinary amounts of wealth. And there is a very strong sense in which an unequal society is an ugly society. I like the distribution of wealth in the United States as it stood in 1975 much more than I like the relative contribution of wealth today. But would breaking up Microsoft five years ago have increased the pace of technological development in software? Probably not. And diminishing subsidies for railroad construction would not have given the United States a nation-spanning railroad network more quickly.

So there are still a lot of questions and few answers. At what level does corruption become intolerable and undermine the legitimacy of democracy? How large are the entrepreneurial benefits from the finance-industrial development nexus through which the truly astonishing fortunes are developed? To what extent are the Jay Goulds and Leland Stanfords embarrassing but tolerable side-effects of successful and broad economic development?

I know what the issues are. But I do not yet--not even for the late nineteenth- and early twentieth-century United States--feel like I have even a firm belief on what the answers will turn out to be.

He's a bit reluctant to take a strong position against the robber barons, they are, perhaps, "tolerable side-effects of successful and broad economic development." I see more costs and fewer benefits than Brad, so I wouldn't give as much ground here as he does. But this was written before the Great Recession, and I'd be curious to hear if his view of "the entrepreneurial benefits from the finance-industrial development," and the necessity of tolerating these "side-effects" has changed in light of recent events.