A week ago, a Portuguese journalist asked me a few questions about current debates in macroeconomic policy: fiscal stimulus and monetary expansion versus deficit and inflation hawkery. I used the opportunity to organize some of the arguments I've presented in previous posts.
1. With near-zero percent interest rates (negative in real terms) and $2.3 trillion balance sheet, and no clear results translated in growth, employment and credit to the real economy, which feasible options has the Federal Reserve? Is the FED playing a dangerous gamble as Kansas City FED’s chairman just said?
These are really two questions: (a) What arrows does the Fed still have in its quiver? (b) Is the Fed’s current set of policies elevating the risk of future inflation?
a) As many, including Ben Bernanke’s former self, have pointed out, the Fed can engage in almost unlimited balance sheet expansion through purchases of private sector debt. Thus, rather than exchanging MBS and similar items as they mature with long-term government debt–the current “hold steady” policy–the Fed could acquire even more. This option is predicated on the assumption that the economy can absorb much more liquidity, that the true risk is deflation rather than inflation. My own view is that a bit of additional quantitative easing can help at the margin, but that fiscal policy would more effectively offset the effects of private sector deleveraging on effective demand. Moreover, the level of private sector debt acquisition necessary to fully absorb this deleveraging would expose the Fed, and US taxpayers, to significant credit risk.
Another proposal is that the Fed should raise its announced inflation target. This originates with Krugman and is receiving a lot of support. To see why this may not work, note that it rests on two premises: first, that agents will adopt the target as their new basis for calculating real interests rates (making real rates more negative at the zero nominal lower bound), and that this recalculation will induce them to resume borrowing. The first is rather a leap under current conditions; why should agents believe that the announced target will be realized within their planning horizons? The second overlooks the fact that (1) many sectors of the US economy really are overleveraged and need to reduce their debt burdens, and (2) investment is stymied by a lack of anticipated demand, not the real cost of credit. But I don’t think raising the target will cause any harm, so why not? It would then be more consistent with the emerging view of (some) macroeconomists that the optimal inflation band in normal times may have an upper bound of 3-4%.
I should add that the weight now being placed on the Fed’s shoulders is unfair. Everyone is looking to them to forestall a second dip and put the US (and world) economy on a growth track, but that’s because we have given up on Obama’s willingness/ability to push significant policy through Congress. The Fed just can’t do it alone; it needs lots of help. The political paralysis in the US is an extremely important contextual factor. If the global economy does take a second plunge or simply remains mired for a prolonged period, future historians will surely place much more of the blame on Obama and Congress than Bernanke and the Fed. But they will also have harsh words for the failure of global policy coordination, with no leader willing to rise above short-term domestic political motives.
b) In the short run it is obvious that inflation is not a problem. First, it would require monetary expansion of Zimbabwean proportions to induce serious inflation at current levels of unemployment and productive slack. Second, a bit more inflation would be a good thing. The real question is, if the Fed continues to bulk up its balance sheet and private sector credit starts flowing again, can the Fed get out in time so that there isn’t an explosion in the money supply? Most economists, myself included, think that easing of credit conditions will be gradual and visible, so that the Fed can exit as the private sector reabsorbs its debt. From a political point of view, to allow a given stock of debt to shift back from public to private hands is neutral with respect to macropolicy, so there is no reason to expect that the Fed will fail to do this. Having said this, however, I think the risk of a future inflationary surge as a result of current policies is not zero. Deleveraging could be reversed at a speed the Fed can’t keep up with. Or the specific markets that would be impacted by a Fed asset sale might not be sufficiently liquid: the Fed holds asset A and the public wants asset B. Or some other problem, currently unforseen, could interfere with the Fed’s withdrawal from private markets. On balance, though, the near-term risk of deflation exceeds the highly speculative longer-term risk of inflation.
2. Has federal Treasury political support to new Keynesian interventions preventing the risk of a double-dip, or the debt-to-GDP, the fiscal deficit-to-GDP and slightly changes from Chinese Central Bank policy gives no fiscal space for those options?
Rewording, I see the question, do either the trajectory of US fiscal deficits/debt to GDP ratio or the prospects for reduced Chinese demand for this debt limit the ability of the US government to implement a second round of stimulus? Again there are two questions.
a) I think the attempt to impose a mechanical rule for fiscal debt/GDP are misguided and have no basis in the historical evidence. The reason is that fiscal deficits are endogenous: they are jointly determined by private sector debt growth, the external balance, terms of trade, and other factors that influence both the numerator and the denominator. (And politics, of course.) Economics has a lot to say about the exact ways these factors interact, but in any given situation you have to evaluate policy on the basis of the full set of variables. For instance, to make an obvious point, on the one hand the US has for some time had a structural trade deficit of substantial proportions, and the economy has organized itself around chronically high private and public deficits. (We are biased toward the production of goods financed by these deficits: housing, military goods, etc.) On the other, the dollar remains the world’s primary reserve currency, and this fact permits the US to borrow much more than others might–the “exorbitant privilege”, in Eichengreen’s term. (Portugal too could borrow much more if the ECB were willing to underwrite all your debt, which they aren’t. We don’t have this problem with the Fed in the US.) In a nutshell, I don’t think the US faces an immediate constraint on its ability to market its public debt, and the deeper problem is the current account imbalance that necessitates this debt.
b) There are many aspects, some rather complex, in the China-US financial relationship, but the broad outlines are simple. China, along with the other surplus countries, finances US net borrowing, and the reason this net borrowing needs to be financed is that these countries have surpluses vis-a-vis the US. In principle, the solution is rebalancing, which would mean less financing and less debt, simultaneously and equally. In real life, of course, there are potential potholes in this road. The main risk is that there could be a sudden stop if confidence in dollar assets drops unexpectedly. This risk is ever-present and is proportional, more or less, to the scale of dollar recycling. Therefore a gradual Chinese retrenchment, if it means reduced trade surpluses, directly or indirectly, with the US, would be very positive for the world economy.
But it’s not only China. The US runs deficits with the EU, the oil exporters and just about everyone else. We need rebalancing on every front. This would remove much of the need for Keynesian stimulus in the US. It should be obvious: a country with a roughly balanced current account finances episodes of fiscal stimulus domestically. A deficit country is likely to require more stimulus more often and must finance to some extent externally. This second condition is less sustainable. You would think we wouldn’t have to argue about this.
3. America and Europe is living a deficit hysteria regarding the hot topic of “debt-to-growth”, or a deficit threshold is a real problem for future growth?
Hysteria.
4. You refer, in your critic of Rogoff and Reinhart debt-to-GDP threshold that the most important is to identify the processes, the mechanisms governing the expansion and contraction of fiscal space. Can you argue more extensively about that?
I think I did this above, up to a point. Perhaps I should emphasize the particular importance of looking at public debt in the context of private debt. The US ran fiscal surpluses under Clinton, but this was possible (especially in a deficit country) only to the extent that private debt exploded. Private deficits fell in the aftermath of the dot.com bubble, and (again in the context of external deficits) the US faced the choice between much higher fiscal deficits or punishing shortfalls in aggregate demand. We went with the fiscal deficits in the 00's, especially since we didn’t face a borrowing constraint. Spain, by contrast, was a model of fiscal rectitude in the 00's, but their external deficits were monumental and financed by private leverage. The collapse of the housing bubble puts Spain in a position like the US in 2002, except (1) Spain’s current account deficit is even larger, and (2) they face a severe borrowing constraint. The moral of the story is that anyone who looked at the US in the 90's or Spain in the 00's and said, “No problem, the public budget is under control” would be making a big mistake. (And to dig back in history, the US emerged from WWII with a gargantuan public debt, far beyond the R&R threshold, but with little private debt in the wake of Depression-era writedowns, and the prospect of large, continuing structural trade surpluses.)
I used the R-R thesis as an opportunity to make a more general point about economics, what it can do well and what it can’t. Economists try to be like physicists, formulating the “laws of nature”. The Reinhart/Rogoff 90% rule is a rough version of this approach, aspiring to provide something like a gravitational constant. But the subject matter of economics is too complex for this approach; it is more like geology or ecology. A geologist does not have a formula that explains the location and height of every mountain range on earth, or even the “mean mountain”, but detailed knowledge of the forces (plate tectonics, erosion, isostatic uplift, etc.) that constitute the menu of possibilities. Then he or she goes to a particular region, provides a deep description of the local factors at work, and applies the knowledge of geological processes.
It is revealing that R&R have very little to say about processes–exactly how public debt/GDP ratios affect further growth. Their comments in this respect are casual, not the product of careful research. Instead, they search for a single, simple pattern in growth/debt ratio space. It is ineffective physics, rather than the geology we actually need.
Friday, August 20, 2010
Thursday, August 19, 2010
New Video Stream Now on Youtube
Sorry about the confusion. I redid the talk on Youtube, which got rushed as I neared my 15 minute limit.
http://www.youtube.com/watch?v=2hNt_qc-RvMRedoing Last Night's Video
My apologies. For some reason, my video did not record after 19 seconds. I'm sorry for the inconvenience for those of you who sat through the Budweiser commercial only to find nothing more than 19 seconds. I'll try to redo my talk this afternoon.
Wednesday, August 18, 2010
My Video Stream This Week
I will be posting a new talk this evening. I intend to explain how the combination of competition and new technological economies of scale overaccumulation, which led to both deindustrialization and financialization, which, in turn, led to the current crisis. I will start at 6:00 and will finish before 6:30.
http://www.ustream.tv/channel/unsettling-economics
How Big is the Federal Deficit?
Kevin G. Hall and Robert A. Rankin want us to be very worried about the Federal deficit:
OK, the nominal deficit for this year will be about 6 times the nominal deficit in 1986 but might we also point out that nominal GDP is about 3 times what it was almost 25 years ago?
The national debt is rising to levels that have never been seen in the United States during peacetime … This year's federal budget deficit alone is expected to close the fiscal year Sept. 30 in a range between a staggering $1.3 trillion and $1.42 trillion. That's about six times President Ronald Reagan's biggest deficit, and he was blasted as a dangerous budget-buster.
OK, the nominal deficit for this year will be about 6 times the nominal deficit in 1986 but might we also point out that nominal GDP is about 3 times what it was almost 25 years ago?
Tuesday, August 17, 2010
In Memoriam
One of the tallest trees in the forest of jazz has fallen: Abbey Lincoln passed away on Saturday. If you've never heard her, you must: you can see a magnificent performance of "First Song" (music, Charlie Haden; words, Abbey) on YouTube.
There are many recordings to choose from, but my own favorite is The World is Falling Down from 1990. Listen to her utterly distinctive version of "How High The Moon," from that album: you will never hear any other version again without comparing it unfavorably to this one. (Jackie McClean, whose sound on the alto sax seems to be what the word "keening" was invented to describe, is a brilliant accompanist here.) A close second is from early in her career, the album That's Him, featuring the saxophone colossus Sonny Rollins and Max Roach, Abbey's husband-to-be, on drums.
RIP, Abbey.
There are many recordings to choose from, but my own favorite is The World is Falling Down from 1990. Listen to her utterly distinctive version of "How High The Moon," from that album: you will never hear any other version again without comparing it unfavorably to this one. (Jackie McClean, whose sound on the alto sax seems to be what the word "keening" was invented to describe, is a brilliant accompanist here.) A close second is from early in her career, the album That's Him, featuring the saxophone colossus Sonny Rollins and Max Roach, Abbey's husband-to-be, on drums.
RIP, Abbey.
Why are some pharmaceuticals so expensive?
Brian Palmer tries to answer his question without ever writing the term patent protection. I find this amazing and I can’t wait for Dean Baker to address this piece. Mr. Palmer uses as an example the drug Avastin which costs $8000 for a month’s supply and writes:
The cost of manufacturing pharmaceuticals is often a small percentage of sales which is why they can be so profitable for their makers even though an extensive amount of money is often spent on promoting patented drugs. Mr. Palmer also dredges out this excuse:
Credit, however, goes to Mr. Palmer for at least emphasizing the lack of competition for certain drugs. It is true that this sector incurs substantial R&D expenses and the risk that the R&D may generate several dry holes. But do we really need a patent system in order to discover new treatments?
Manufacturing costs play a role in pricing decisions, although a small one. Avastin belongs to a category of drugs called biologics, which are large molecules that usually have to be manufactured by DNA manipulation. Biologics cost more to make than traditional drugs, which usually are generated through cheaper chemical reactions. Still, manufacturing costs normally don't exceed a few percentage points of sales revenue.
The cost of manufacturing pharmaceuticals is often a small percentage of sales which is why they can be so profitable for their makers even though an extensive amount of money is often spent on promoting patented drugs. Mr. Palmer also dredges out this excuse:
You hear a lot about how expensive it is to bring a drug to market.
Credit, however, goes to Mr. Palmer for at least emphasizing the lack of competition for certain drugs. It is true that this sector incurs substantial R&D expenses and the risk that the R&D may generate several dry holes. But do we really need a patent system in order to discover new treatments?
Harvey Friedman's Proposal For Public Refereeing Of Papers
An odd spinoff of the ongoing debate over at http://rjlipton.wordpress.com is a proposal that the genius logician Harvey Friedman (first taught as a prof at Stanford in philosophy at age 18, a world record for youthful professoring) has put forward in the middle of it for refereeing papers at journals, obviously inspired by the ongoing, now many hundreds of entries long, debate over the proposed proof by Vinay Deolalikar that P does not equal NP in computational complexity theory (current consensus: current proof flawed, but argument might still be right, or more likely, proof strategy may be very productive for lesser results).
So, the proposal is that an author is offered the option of public refereeing rather than the standard secretive double-blind type usually done. This public refereeing involves the journal putting the paper up on a website where anybody can publicly critique it. The author can respond and put up new revised versions (and can criticize the editorial board of the journal as well). When the author is satisfied with what has transpired out of the process, s/he can propose that the ed board consider it for publication. They then decide either to publish or not to publish. If it is not published, the last version can either remain up "hanging" on the website or be taken down.
So, the proposal is that an author is offered the option of public refereeing rather than the standard secretive double-blind type usually done. This public refereeing involves the journal putting the paper up on a website where anybody can publicly critique it. The author can respond and put up new revised versions (and can criticize the editorial board of the journal as well). When the author is satisfied with what has transpired out of the process, s/he can propose that the ed board consider it for publication. They then decide either to publish or not to publish. If it is not published, the last version can either remain up "hanging" on the website or be taken down.
Monday, August 16, 2010
Screwing Bondholders: Ending Bondage
The biased legal system lets bondholders make extortionate demands against workers, poor countries, .... President-elect Clinton learned how bond markets can even intimidate the government from exercising reasonable policies. So, with a bit of schadenfreude, I am glad to learn that Blackstone has the right to screw bondolders. Why should Blackstone have more rights than ordinary people? Why can't we organize to put some limits on the untrammeled power of financial markets, including that of Blackstone?
Here is the story:
Denning, Liam. 2010. "Blackstone Might Rewire Dynegy's Balance Sheet." Wall Street Journal (16 August).
http://online.wsj.com/article/SB10001424052748704868604575433722961359484.html?mod=WSJ_Markets_section_Heard
"It isn't often a 62% premium offers reason for grumbling. Blackstone Group's takeover offer for Dynegy effectively gives it two-thirds of the company's generation capacity plus cash for no money down. That is because NRG Energy has simultaneously agreed to buy about a third of Dynegy's megawatts for $1.36 billion, or about $800 million more than the price tag for Dynegy's equity."
"Why didn't Dynegy sell the assets to NRG and keep the money itself? Probably because it did this a year ago for no discernible gain. In August 2009, Dynegy sold about a quarter of its capacity to LS Power to boost liquidity. That didn't stop the stock dropping from about $10 then to less than $3 before Blackstone showed up.
If shareholders are miffed, it is Dynegy's bondholders that have real reason to worry. Should Blackstone decide to dividend the entire proceeds of the NRG deal back to itself, Dynegy will be left carrying its existing debt load on a smaller stream of profits. That would raise the company's already high credit risk. But then Blackstone, sitting on a potential $800 million instant profit and with no other shareholders to protect, need not worry too much about that."
"Alternatively, Blackstone could use some of that profit to buy in some of those bonds. Doing so would reduce Dynegy's debt burden and, possibly, its cash interest costs, potentially boosting Blackstone's return when it sells the company down the road. This likely would only make sense, however, if Blackstone bought the bonds below even today's market values of between 60 and 80 cents on the dollar. Shareholders might wish they got a higher premium. Bondholders may end up scrambling to limit their losses."
Here is the story:
Denning, Liam. 2010. "Blackstone Might Rewire Dynegy's Balance Sheet." Wall Street Journal (16 August).
http://online.wsj.com/article/SB10001424052748704868604575433722961359484.html?mod=WSJ_Markets_section_Heard
"It isn't often a 62% premium offers reason for grumbling. Blackstone Group's takeover offer for Dynegy effectively gives it two-thirds of the company's generation capacity plus cash for no money down. That is because NRG Energy has simultaneously agreed to buy about a third of Dynegy's megawatts for $1.36 billion, or about $800 million more than the price tag for Dynegy's equity."
"Why didn't Dynegy sell the assets to NRG and keep the money itself? Probably because it did this a year ago for no discernible gain. In August 2009, Dynegy sold about a quarter of its capacity to LS Power to boost liquidity. That didn't stop the stock dropping from about $10 then to less than $3 before Blackstone showed up.
If shareholders are miffed, it is Dynegy's bondholders that have real reason to worry. Should Blackstone decide to dividend the entire proceeds of the NRG deal back to itself, Dynegy will be left carrying its existing debt load on a smaller stream of profits. That would raise the company's already high credit risk. But then Blackstone, sitting on a potential $800 million instant profit and with no other shareholders to protect, need not worry too much about that."
"Alternatively, Blackstone could use some of that profit to buy in some of those bonds. Doing so would reduce Dynegy's debt burden and, possibly, its cash interest costs, potentially boosting Blackstone's return when it sells the company down the road. This likely would only make sense, however, if Blackstone bought the bonds below even today's market values of between 60 and 80 cents on the dollar. Shareholders might wish they got a higher premium. Bondholders may end up scrambling to limit their losses."
Social Security's 75th Anniversary
Mark Thoma at http://economistsview.typepad.com links to Paul Krugman's latest defense of social security on its 75th anniversary, and Dean Baker has been beating the drums too. I have nothing really original to add to this, but as defending social security against misrepresenting critics has been a core activity of this blog and its predecessor, Maxspeak, from early on, I feel the duty to add to the beating of the drum. "Bipartisan" deficit commission after bipartisan deficit commission seems to find their agreement on doing stuff to social security in the name of deficit reduction, even though social security is the part of the federal budget in better shape than pretty much any other. I think it is the thing that brings together these Washington "experts," who, even if they are not being directly paid by the Wall Street firms that are drooling for the billions from a privatization, they are under the influence of those who have been for so long that those who should know better seem to either forget it or ignore it.
As it is, for this go-around they are pushing for a 70-year retirement age, which Krugman accurately points out seriously hits the poorer groups in the US whose life expectancy is not rising (and, indeed, is falling for some groups, particularly poorer women). The bottom line argument continues to be "cut future benefits now, because, eeek!, if we don't future benefits now, we may need to be cut them in the future,eeek!" meh, feh, gah!
What needs cutting or slowing is the rate of increase of medical costs. Ezra Klein pointed out over the weekend in WaPo that the Repubs are now fighting against the cost control board (IPAB) set up by the Obama health reform, even as they support its spending subsidies, no cuts in defense spending, and the continuation of tax cuts for the rich, all the while playing to the anti-deficit tea partiers, although they do seem to be shying away from Paul Ryan's plan to voucherize social security. And people are whining that the Congressional Dems have nothing to run on this fall?
As it is, for this go-around they are pushing for a 70-year retirement age, which Krugman accurately points out seriously hits the poorer groups in the US whose life expectancy is not rising (and, indeed, is falling for some groups, particularly poorer women). The bottom line argument continues to be "cut future benefits now, because, eeek!, if we don't future benefits now, we may need to be cut them in the future,eeek!" meh, feh, gah!
What needs cutting or slowing is the rate of increase of medical costs. Ezra Klein pointed out over the weekend in WaPo that the Repubs are now fighting against the cost control board (IPAB) set up by the Obama health reform, even as they support its spending subsidies, no cuts in defense spending, and the continuation of tax cuts for the rich, all the while playing to the anti-deficit tea partiers, although they do seem to be shying away from Paul Ryan's plan to voucherize social security. And people are whining that the Congressional Dems have nothing to run on this fall?
Saturday, August 14, 2010
Burying X-Efficiency: Chicago Economics vs. the World
I am asking for some help. I am ready to send my article for publication. I have already followed instructions to tone way down my critique of Chicago. Anything that can make the story stronger would be appreciated.
http://michaelperelman.files.wordpress.com/2010/08/x2-new.pdf
http://michaelperelman.files.wordpress.com/2010/08/x2-new.pdf
Friday, August 13, 2010
Clawbacks from economists?
This review is not particularly in itself. It is worth skimming to get the flavor. Once you feel comfortable with what you have read, search for the word "ugly." The idea is that these mostly neoliberal economists claim to have created enormous value for the economy. I assume that the essays were composed before the crash, but the editor claims that our profession deserves extra funding for all the value it created. Could the public demand a clawback to penalize these economists for the harm they have done?
Better Living through Economics
Author:
Siegfried, John J.
Reviewer:
Vedder, Richard
Published by EH.NET (August 2010)
John J. Siegfried, editor, Better Living through Economics. Cambridge, MA: Harvard University Press, 2010. viii + 315 pp. $45 (hardcover), ISBN: 978-0-674-03618-5.
Reviewed for EH.Net by Richard Vedder, Department of Economics, Ohio University.
This volume of essays advances the proposition that economic theory and economic research can and has been harnessed to promote human welfare in many different ways, materially improving the quality of our lives and arguably our incomes. Not unusual for compilations of essays, this book contains the good, the bad, and, unfortunately, the ugly. Fortunately, “the good” dominates, and I would say two-thirds of the volume successfully achieves its mission.
John Siegfried, Vanderbilt professor and Secretary-Treasurer of the American Economic Association, seems to be the prime mover on getting this volume published. As Richard Caves states in a cover blurb, many of the “essays are concise, clear and consistently written at a level within the reach of undergraduate economics students.” Good examples include Thomas Tietenberg’s excellent treatment of the evolution of emissions trading to more efficiently deal with restricting environmentally undesirable practices, Elizabeth Bailey’s nice narrative about the benefits of transportation deregulation beginning in the late 1970s, Robert Moffitt’s clear and well balanced discussion of the evolution of the Earned Income Tax Credit, Michael Boskin’s discussion of improvements in measuring inflation, Lawrence White’s analysis of changing views on anti-trust regulation over time, and the Asch, Miller and Warner’s discussion of how the military draft was ended and subsequent issues arising from that. Each of these authors shows that basic propositions taught in any good principles of economics course can be harnessed to make the world work better and more efficiently. Generally speaking, the discipline and self-correcting properties of markets are stronger and more effective in allocating resources than rules-based command decisions made through the political process. Also, aligning incentives with socially desirable objectives pays.
Anne Krueger’s essay stands out in several respects. First, she very convincingly demonstrates that the move away from protectionist/import substitution policies in the 1950s and 1960s harnessed the spirit of enterprise and brought about enormous improvements in the standard of living for literally billions of people. And she appropriately notes that the underlying theory was not discovered by an National Science Foundation grant revealing huge insights, but essentially by the work of Adam Smith and David Ricardo a couple of centuries ago.
This gets to a problem. Economists sometimes get overwhelmed with their own self importance and claim more than they should. John Taylor writes a generally solid essay arguing that reductions in macroeconomic stability in modern times reflects in large part a move to a more intelligent understanding on the role of monetary variables in the economy. Taylor believes the evolution of new economic modeling in recent decades that combine rational expectations with some allowance for price stickiness has brought about enormous policy improvements. Maybe, but I side with commenter Laurence H. Meyer (himself a former Federal Reserve Governor) whose views are “the shifts in monetary policy ... are due more to the rediscovery of classical monetary theory than to advances of modern macroeconomic theory. ... classical monetary theorists had the story basically right” (p. 165). The work of Milton Friedman outlined a half century ago -- itself informed by still earlier work of quantity theorists and neglected practitioners like Clark Warburton -- was far more important than modern-day theoretical refinements.
The less good essays stray a good deal from the stated mission of offering clear, concise explanations of using economics to deal with problems in a language an undergraduate student can understand. Alvin Roth’s paper on deferred-acceptance algorithms is filled with jargon, is exceedingly hard to follow, and deals, frankly, with a far less dramatic advancement in modern economics than improving price indices, promoting the power of comparative advantage, or the gains from transport deregulation. Modest Roth is not -- he cites nearly thirty papers he authored or coauthored in the bibliography. The McAfee, McMillan and Wilkie piece on auctioning spectrum licenses deals with a moderately more important topic, but again gets into too many details of alternative bidding possibilities to be of interest to all but the most gung ho specialists.
Alas, I must come to the “ugly” part of this book. This appears to be not simply a volume of essays to promote the practical dimensions of modern advances in economics, but more an effort to increase the income and prestige of economists relative to other scholars. On page one John Siegfried assets, without a scintilla of supporting evidence, that “the value of the improved policies documented in this volume is likely hundreds of billions of dollars.” His agenda becomes clearer very shortly: “Interestingly ... only a few of the contributions outlined here have been financed or promoted through the private sector” (p. 3). In other words, NSF economics grants have a huge payoff. Charles Plott even goes further: “the social value of the contributions of economics compares well with the contributions of basic research in any field of science.” (p. 6). This, of course, is a normative judgment without a scintilla of rigorous proof, measuring, for example, the rate of return on research in physics or biological sciences with that in economics or psychology (a point that even the NSF’s Daniel Newlon gently takes him to task on).
All and all, this reinforces my own feelings about our profession. For many, Physics Envy is a big cross to bear -- the unwillingness to accept that economics is not considered as respectable as many of the so-called hard sciences. This volume promotes the good economists have done, ignoring the policy disasters that economists have contributed to, for example, the stagflation of the 1970s, or, arguably, even the financial crisis of 2008 -- where were economists in warning about subprime lending, excessive use of untried to financial instruments, etc? Where are we today in opposing stimulus packages that historical experience and economic theory alike say do not work?
But above all, the volume is all about rent-seeking -- a plea to get more economics funding for the NSF and related agencies. It is amazing how much Adam Smith, David Ricardo, A.C. Pigou, Irving Fisher and Milton Friedman contributed to the advancement of human welfare without NSF funds. As Austen Goolsbee notes in a recent NBER working paper, more government grant funding inevitably increases economic rents because of the inherent short-term limits on the supply of good talent. If the authors had stuck to presenting the evidence without its obvious and overplayed commercial message, this would have been a far better volume.
Better Living through Economics
Author:
Siegfried, John J.
Reviewer:
Vedder, Richard
Published by EH.NET (August 2010)
John J. Siegfried, editor, Better Living through Economics. Cambridge, MA: Harvard University Press, 2010. viii + 315 pp. $45 (hardcover), ISBN: 978-0-674-03618-5.
Reviewed for EH.Net by Richard Vedder, Department of Economics, Ohio University.
This volume of essays advances the proposition that economic theory and economic research can and has been harnessed to promote human welfare in many different ways, materially improving the quality of our lives and arguably our incomes. Not unusual for compilations of essays, this book contains the good, the bad, and, unfortunately, the ugly. Fortunately, “the good” dominates, and I would say two-thirds of the volume successfully achieves its mission.
John Siegfried, Vanderbilt professor and Secretary-Treasurer of the American Economic Association, seems to be the prime mover on getting this volume published. As Richard Caves states in a cover blurb, many of the “essays are concise, clear and consistently written at a level within the reach of undergraduate economics students.” Good examples include Thomas Tietenberg’s excellent treatment of the evolution of emissions trading to more efficiently deal with restricting environmentally undesirable practices, Elizabeth Bailey’s nice narrative about the benefits of transportation deregulation beginning in the late 1970s, Robert Moffitt’s clear and well balanced discussion of the evolution of the Earned Income Tax Credit, Michael Boskin’s discussion of improvements in measuring inflation, Lawrence White’s analysis of changing views on anti-trust regulation over time, and the Asch, Miller and Warner’s discussion of how the military draft was ended and subsequent issues arising from that. Each of these authors shows that basic propositions taught in any good principles of economics course can be harnessed to make the world work better and more efficiently. Generally speaking, the discipline and self-correcting properties of markets are stronger and more effective in allocating resources than rules-based command decisions made through the political process. Also, aligning incentives with socially desirable objectives pays.
Anne Krueger’s essay stands out in several respects. First, she very convincingly demonstrates that the move away from protectionist/import substitution policies in the 1950s and 1960s harnessed the spirit of enterprise and brought about enormous improvements in the standard of living for literally billions of people. And she appropriately notes that the underlying theory was not discovered by an National Science Foundation grant revealing huge insights, but essentially by the work of Adam Smith and David Ricardo a couple of centuries ago.
This gets to a problem. Economists sometimes get overwhelmed with their own self importance and claim more than they should. John Taylor writes a generally solid essay arguing that reductions in macroeconomic stability in modern times reflects in large part a move to a more intelligent understanding on the role of monetary variables in the economy. Taylor believes the evolution of new economic modeling in recent decades that combine rational expectations with some allowance for price stickiness has brought about enormous policy improvements. Maybe, but I side with commenter Laurence H. Meyer (himself a former Federal Reserve Governor) whose views are “the shifts in monetary policy ... are due more to the rediscovery of classical monetary theory than to advances of modern macroeconomic theory. ... classical monetary theorists had the story basically right” (p. 165). The work of Milton Friedman outlined a half century ago -- itself informed by still earlier work of quantity theorists and neglected practitioners like Clark Warburton -- was far more important than modern-day theoretical refinements.
The less good essays stray a good deal from the stated mission of offering clear, concise explanations of using economics to deal with problems in a language an undergraduate student can understand. Alvin Roth’s paper on deferred-acceptance algorithms is filled with jargon, is exceedingly hard to follow, and deals, frankly, with a far less dramatic advancement in modern economics than improving price indices, promoting the power of comparative advantage, or the gains from transport deregulation. Modest Roth is not -- he cites nearly thirty papers he authored or coauthored in the bibliography. The McAfee, McMillan and Wilkie piece on auctioning spectrum licenses deals with a moderately more important topic, but again gets into too many details of alternative bidding possibilities to be of interest to all but the most gung ho specialists.
Alas, I must come to the “ugly” part of this book. This appears to be not simply a volume of essays to promote the practical dimensions of modern advances in economics, but more an effort to increase the income and prestige of economists relative to other scholars. On page one John Siegfried assets, without a scintilla of supporting evidence, that “the value of the improved policies documented in this volume is likely hundreds of billions of dollars.” His agenda becomes clearer very shortly: “Interestingly ... only a few of the contributions outlined here have been financed or promoted through the private sector” (p. 3). In other words, NSF economics grants have a huge payoff. Charles Plott even goes further: “the social value of the contributions of economics compares well with the contributions of basic research in any field of science.” (p. 6). This, of course, is a normative judgment without a scintilla of rigorous proof, measuring, for example, the rate of return on research in physics or biological sciences with that in economics or psychology (a point that even the NSF’s Daniel Newlon gently takes him to task on).
All and all, this reinforces my own feelings about our profession. For many, Physics Envy is a big cross to bear -- the unwillingness to accept that economics is not considered as respectable as many of the so-called hard sciences. This volume promotes the good economists have done, ignoring the policy disasters that economists have contributed to, for example, the stagflation of the 1970s, or, arguably, even the financial crisis of 2008 -- where were economists in warning about subprime lending, excessive use of untried to financial instruments, etc? Where are we today in opposing stimulus packages that historical experience and economic theory alike say do not work?
But above all, the volume is all about rent-seeking -- a plea to get more economics funding for the NSF and related agencies. It is amazing how much Adam Smith, David Ricardo, A.C. Pigou, Irving Fisher and Milton Friedman contributed to the advancement of human welfare without NSF funds. As Austen Goolsbee notes in a recent NBER working paper, more government grant funding inevitably increases economic rents because of the inherent short-term limits on the supply of good talent. If the authors had stuck to presenting the evidence without its obvious and overplayed commercial message, this would have been a far better volume.
Thursday, August 12, 2010
Arnold Zellner, RIP
The leading Bayesian econometrician in the world died last night, Arnold Zellner. A very feisty and provocative individual, he will be missed. I knew him and always found him to be lots of fun and very interesting to talk to. He was one of the first of the econometricians to be hired at the University of Wisconsin around 1960, to be followed shortly by Arthur Goldberger, moving that department from being a near zero in that area to the top ranks, although Zellner did not stay around all that long, moving on to the University of Chicago. However, he was originally attracted to Wisconsin by Bayesians and good time series people in the Statistics Department, such as George Box, who in turn had been attracted by the strong biometricians in the genetics department, the most prominent of whom was the late Sewall Wright, one of the three founders of the neo-Darwinian synthesis in the 1930s, and who invented path coefficients in the teens while co-discovering the identification problem with his economist father in the 1920s while studying corn-hog cycles and other agricultural economics questions.
Anyway, Zellner was a great econometrician and a great guy, and I think that in the long run, we will all become Bayesians, or at least a lot of us.
Anyway, Zellner was a great econometrician and a great guy, and I think that in the long run, we will all become Bayesians, or at least a lot of us.
Reinhart and Rogoff: There’s No There There
Here’s the core problem with Reinhart and Rogoff’s claim that public debt levels above 90% of GDP cause reduced growth: it’s all correlation and no mechanism. It epitomizes the worst aspects of empirical economics, searching tirelessly for statistical regularities, but not the mechanisms that might underlie them. Because economic contexts are highly diverse, often singular, it’s the processes at work, not generalizations about outcomes, that economics has the power to elucidate.
Sorry to be so abstract.
The R&R dataset, as the authors proudly explain, encompasses 44 countries over two centuries. We’ve got Finland, Spain, Japan and the US, Thailand, Mexico and Colombia. We’ve got the aftermath of the American Revolution against England and WWII, banking crises under the gold standard, the third world debt crisis of 1982. It’s all there in one hopper, ready to be crunched. I would convert to Rosicrucianism before I would embrace the belief that a single statistical relationship captures all these places and times.
Paul Krugman has highlighted two cases in particular, the US demobilization following WWII and the Japanese lost decades (still lost). Yes, he says, there is a correlation between public debt and slow growth, but in the US episode it’s spurious (war gave us the debt, demobilization the slow growth), and in Japan the causation runs from slow growth to high debt.
Just scanning the R&R list, I see lots of countries that have battled external deficits, a condition that weakens growth and puts governments in the position of running deficits in order to delay adjustment. And what about price shocks that cripple countries with a narrow export base or particular import dependencies? The R&R list is thick with these cases too. Given these interrelationships, it is revealing that, under “Debt and growth causality”, R&R consider only “Growth-to-debt” and “Debt-to-growth”, without the vast third category of “joint causation by other factors”.
Which gets us back to mechanisms. What are the forces, economic, political or otherwise, that cause runups of public debt? Under what circumstances does debt feed back to these other factors? What mechanisms govern the expansion and contraction of fiscal space? These are the kinds of things we need to know.
R&R have it backwards: they are looking for broad generalizations that might be identified over large samples but have uncertain application to any particular case. A better kind of economics would be one that identified processes that, while they generate diverse outcomes with no discernible central tendency over large samples, can be applied precisely to individual cases.
Like, for instance, ours.
Sorry to be so abstract.
The R&R dataset, as the authors proudly explain, encompasses 44 countries over two centuries. We’ve got Finland, Spain, Japan and the US, Thailand, Mexico and Colombia. We’ve got the aftermath of the American Revolution against England and WWII, banking crises under the gold standard, the third world debt crisis of 1982. It’s all there in one hopper, ready to be crunched. I would convert to Rosicrucianism before I would embrace the belief that a single statistical relationship captures all these places and times.
Paul Krugman has highlighted two cases in particular, the US demobilization following WWII and the Japanese lost decades (still lost). Yes, he says, there is a correlation between public debt and slow growth, but in the US episode it’s spurious (war gave us the debt, demobilization the slow growth), and in Japan the causation runs from slow growth to high debt.
Just scanning the R&R list, I see lots of countries that have battled external deficits, a condition that weakens growth and puts governments in the position of running deficits in order to delay adjustment. And what about price shocks that cripple countries with a narrow export base or particular import dependencies? The R&R list is thick with these cases too. Given these interrelationships, it is revealing that, under “Debt and growth causality”, R&R consider only “Growth-to-debt” and “Debt-to-growth”, without the vast third category of “joint causation by other factors”.
Which gets us back to mechanisms. What are the forces, economic, political or otherwise, that cause runups of public debt? Under what circumstances does debt feed back to these other factors? What mechanisms govern the expansion and contraction of fiscal space? These are the kinds of things we need to know.
R&R have it backwards: they are looking for broad generalizations that might be identified over large samples but have uncertain application to any particular case. A better kind of economics would be one that identified processes that, while they generate diverse outcomes with no discernible central tendency over large samples, can be applied precisely to individual cases.
Like, for instance, ours.
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