Dear Leader Dead, Long Live Great Successor

While all had known that Kim Jong Il had long been seriously ill, his death on Saturday of a heart attack in a train has taken many by surprise, with citizens of the DPRK (North Korea) showing the same sort of hysterical grief they did when his father, Kim Il Sung (Dear Leader) died in 1994, which in turn repeated the sort of reaction seen in the Soviet Union on the death of Joseph Stalin.

In contrast with the long delay of reporting Kim Il Sung's death, it has taken only 48 hours for Kim Jong Il's death to be reported, with DPRK media reporting that his third son, Kim Jong Un, is to be called the Great Successor. Kim Jong Un had been reported to have been favored by his father and to have been groomed for acceptance by the family and military elites that rule the nation. Pretty clearly this ruling group has decided that he is to be the front man for continuing their dominance, although it is almost certain that it will be some time before he will be able to asert anything like the dominance his father and grandfather would come to have.

So, in the intermediate term the prospect is for stability, even as the South Korean stock market dropped 5% on the news before rebounding some, along with a drop in the ROK won as well, and various military maneuvers have been reported near the DMZ. Inter-Korean relations have been particularly bad during the past year, since military attacks by the North, thought by many to have been made to impress the DPRK military with Kim Jong Un on his appointment at a four star general.

Even as the near term seems to augur continuation of the system that has produced five straight years of GDP decline and ongoing malnourishment of large parts of the rural population, particularly in the nation's northeast. However, underneath this apparent stasis, many changes seem to be going on. Cell phones have spread widely, as have informal markets in various goods, towards which the government has oscillated in attitude. Chinese pressure to follow their model has steadily increased, and in recent months there have been reports of negotiations with the US. Kim Jong Un studied in Switzerland. So, there may be major changes down the road, if not immediately, particularly as the Great Successor may need to imitate in economic policy what was done in military policy this last year to assert his legitimacy to be officially on top of the nation's system. But this death and succession does mean the further future becomes much less clear.

President Gingrich Would Ignore The Humphrey-Hawkins Full Employment Act

I was scratching my head as to why any Presidential candidate would say Ben Bernanke should be fired until I read this:

"I would, first of all, demand a thorough audit [of the Fed]. Second, publish all the decision documents for 2008, 2009, 2010. Third, I would prepare legislation to eliminate the Humphrey-Hawkins Full Employment Act, which has totally confused the Fed," Gingrich said. The former House speaker went on to say that he would demand the Fed to hold "hard" money

There are lots of reasons why Newt should never be allowed near the White House again but this one has to go to the top of the list.

The Exegesis of Deceit

One of the steadiest hums of our time is liberal indignation at the dishonesty of the Right.  On any given day, you can hear the shock and disbelief: How can they say that?  Don’t they care about getting the facts right?  Don’t they realize they are being inconsistent?  Last week it was the Romney campaign ad that deliberately and even crudely misquoted Obama.  This morning I wake up to Krugman “truly amazed” at the way Paul Ryan would cite commodity prices on the way up and ignore them on the way down.  May I suggest that there is a method to this deceit and that being shocked is not an adequate response?

Obama's Payroll Tax Cut

When the cut was first announced, I wrote that it seemed to pose a threat to Social Security. Now, a few of the Democrats, especially Bernie Sanders, seem to be picking up on the risk to Social Security. What would have stopped Obama from making it a tax rebate in which the treasury would not have to leave the fingerprint on the Social Security system. Besides, it could be targeted to people who made under x millions of dollars a year. Of course, really smart CEOs do not have to pay the tax. They can take a one dollar salary, then cash in stock options instead.

The Brussels Agreement: Why it will Fail

One response would be to point out the irrationality of the agreement itself—the minimal role that fiscal profligacy played in bringing on the fiscal crisis, the lack of any mechanism for rebalancing between surplus and deficit countries, and the unchanged charter of the ECB, which prevents it from behaving like a normal central bank.  Those arguments have been made, are being made and will continue to be made, and will apparently have no effect on the course taken by European politics.

So let’s look at the realpolitik, past and future.

First of all, it is important to bear in mind that this is an agreement of the European right.  The economic collapse of 2008 resulted in an electoral rout of social democrats throughout the continent (and in the UK).  That’s a story that needs more explanation, but for now the point is simply that conservative parties have absolute control over Europe, and the agreement just reached represents their priorities.  It is for hard money, austerity in the face of recession, full guarantees for creditors, and implicitly for reining in the costs of the welfare state, which must happen if the deficit targets are to be met under foreseeable conditions.  This is why politics matters, after all.

Not liking a political program is not the same as predicting its failure, however.  It could happen that the conservatives get their way and a socially regressive stability takes hold.  Under this scenario, the fiscal crisis recedes and Europe enters a long period of slow growth which is favorable for those who acquired wealth during the go-go years: the value of their assets is protected, and labor is mortally weakened.  For those who designed the Brussels agreement, and for those who bankrolled them, this would look like victory.

A clear-eyed view of the situation suggests, for me at least, that this outcome is unlikely.  I believe that the fiscal pledge will buy time—at most a year—for German support for peripheral finances.  It is essentially a quid pro quo: the countries of Europe make a (foolish) promise to bind themselves to a 3% deficit rule, and in return the main creditor country, Germany, softens its stance toward transfers.  How much softer?  From first appearances, it looks like about €250B net, with some financing moved forward from 2013 to 2012.  (This assumes that the €200B directed to the IMF is returned to Europe without leveraging Chinese or other commitments.)  Is that enough?  It depends on whether the market response is favorable.  If interest rates come down in Italy, Spain and the rest, debt can be rolled over until the economy subsides.  This means something like a quarter or two.  If interest rates shoot back up, the money is not sufficient.  In that case, everything depends on the ECB and whether Draghi now has implicit German forbearance to monetize a portion of euro-denominated sovereign debt.

But this about whether the plan can make it through the next few months.  I believe it is simply impossible for it to survive much more than this.  Absent a miracle, Europe is sliding into a recession.  This will affect Germany as much as the weaker countries, even more considering its dependence on Eurozone exports.  (Germany suffered an exceptionally sharp contraction post-Lehman too.)  The result will be a risk of debt deflation in all markets.  The sovereign debtors will again face default as public revenue dries up.  Speculative assets like real estate will resume their decline.  Overleveraged financial institutions—and Europe is the world leader in overleveraged finance—will need to be bailed out.  Of course, a rise in unemployment will trigger automatic stabilizers and increase the pressures for discretionary fiscal deficits as well.  It is likely that there will be a wave of elections in which center-left parties take revenge for their defeats of the past few years—Germany could lead the way, in fact.

When it comes to whether European economies will simply collapse into a deflationary spiral, or whether the Brussels commitments will be abrogated, I’ll put my money on abrogation.  This agreement has a ticking clock, and when the time winds down, it will be history.

The Meme that Refuses to Die: Government Debt Must Be Paid Back

No it doesn’t.  It almost never is.  To pay back government debt, you have to run a budget surplus, and while there may be modest surpluses from time to time, they don’t add up to more than a minuscule fraction of all the accumulated debt.  But don’t take it from me, look at the record.

The story is unmistakable: the US jacked up its public debt to finance WWII and increased it further in almost every year since then.  We are not paying off the debt left by our parents and grandparents, and our children and grandchildren will not pay off ours.

The debt burden depends on the ratio of debt to GDP as well as the interest cost in servicing it.  The way to reduce this burden is to have a combination of real economic growth, inflation and modest interest rates.  If you want to show your solicitude for the well-being of future generations, demand macroeconomic policies that will boost demand and raise inflation a bit, consistent with continued low interest rates.

What to avoid: nonsense like this excerpt from today’s column by Catherine Rampell of the New York Times:

Total debt for the United States — that is, also including corporate and government debt — hit another all-time high because government borrowing is still outpacing the rate at which households shed debt.

 Guess who will ultimately pay back that government debt: American households.

A Theory About Polish Politics

This morning’s New York Times has a piece about Polish PM Tusk’s avid support for Germany’s stance in EU bargaining.  The article plays up Tusk’s pan-Europeanism and leaves out his equally passionate attachment to fiscal orthodoxy à la Merkel/Schäuble.  Putting both together, you have the classical liberal position, one that can still be found in every European country, although seldom with as much backing as in Poland.

I don’t have a detailed understanding of Polish politics, and I welcome comments from readers who can set me right, but here is my tentative explanation:

More on Teaching Intro

Peter started a discussion here. And Nick Rowe at Worthwhile Canadian Initiative, under the title "God and Man at Yale" has another one, with hundreds of comments. I'll add my two cents. This is a comment I sent to WCI actually.

I want an Intro. Course to show students "how to think like an economist," but I also want some time devoted to the limitations of such thinking. I used to teach the course with David Friedman's *Hidden Order* and Robert Frank's *Choosing the Right Pond*, so they could see how the same methodology - rationality plus equilibrium - could give you very different political-economic visions. But the methodology itself -whether wielded in support of libertarian or left-liberal politics - ought not to be accepted uncritically. So I would assign Dickens' *Hard Times*. The students hated the Dickens, so I dropped it and substituted Amartya Sen's "Rational Fools." I wanted them to understand how the phenomenon of "commitment", as Sen uses it, by which he means "counter-preferential choice" is a deep critique of the conception of rationality that economists use. Unlike the behavioral critique, which simply documents all the ways people make mistakes in maximizing, a Senian critique says that human beings are more than utility maximizers. As the late lamented David Foster Wallace puts the point in a discussion of Dostoevsky, "[Dostoevsky’s] concern was always with what it is to be a human being—that is, how to be an actual person, someone whose life is informed by values and principles, instead of just an especially shrewd kind of self-preserving animal." I don't think this deep critique cuts either right or left, but I think we do a disservice to our students by not exposing them to it. The fact is that most of them when they come to us are already "thinking like economists" in important and pernicious respects: they are cynical about the possibility of principled behavior, they are sure that behind every alleged "value" lies a preference, they are nihilistic about normative authority. The have been brought up, after all, in the age of "sophisters, calculators and economists."

At an AEA meeting one year long ago, there was a session on "Teaching the Principles Course" I attended, which was really just advertising for two new texts by the presenters, one of whom was Robert Frank. (The text he was introducing is the one I have used in the Micro split ever since - it's a great book.) Frank talked about how the book encouraged the students to be economic naturalists, and to apply the economic way of thinking to everything they came across. I asked a question: suppose a student comes to your office hours and thanks you for teaching him the EWT. He was in a long-term relationship and felt that he owed his partner loyalty, but that after learning that sunk costs shouldn't play any part in guiding one's choices, he decided - given that the net benefit of the relationship going forward was negative- that he owed his partner nothing, and consequently was dis-loyal. Frank seemed genuinely at a loss for a response and after the session sought me out to talk more about it.

John Taylor Clarifies His Summary

John Taylor is not happy with a critic from Paul Krugman. His most recent summary states:

Krugman says my conference summary suggested that “Bloom, Baker and Davis had showed that fear of Obama was holding the economy down.” No, my summary said or implied no such thing; there is no mention of Obama, Bush, or any politician in my summary. It simply says that these authors “presented their empirical measures of policy uncertainty and showed that they were negatively correlated with economic growth.” … As part of his presentation Bob said that now and going forward we should assume “no chance of conventional fiscal expansion; rather, possible cutbacks motivated by excessive federal debt.”

Contrast this to what Taylor originally wrote:

In sum there was considerable agreement that (1) policy uncertainty was a major problem in the slow recovery, (2) short run stimulus packages were not the answer going forward

Wow – I read (1) as saying a lot more than simply negatively correlated. I also read (2) as asserting fiscal policy was ineffective but now we know that Dr. Taylor meant fiscal stimulus was never tried and will not be tried. I’m so glad he cleared this up!

Climate Change Proposal

If a large number of countries wish to band together to limit climate change, could they impose a tariff on imports from countries that do not limit CO2 production, accusing the non-compliant of taking advantage of an unfair trade practice?

John Taylor May Have One Thing Right

Paul Krugman provides us with the summary of a conference at the Hoover Institute provided by John Taylor. Paul notes that Taylor’s summary misrepresented what Bob Hall said:

Taylor makes it seem as if Bob Hall showed that fiscal expansion is ineffective. Yet if you have actually been following Hall — which I have, carefully — you’d know that he has been producing extensive evidence that fiscal expansion does, indeed, work; he argues that the Obama stimulus made the slump considerably less severe. His complaint is that the stimulus wasn’t big enough — which is the same argument I made from the beginning.

For a more fair and balanced summary – see Noahpinion. But let’s also note the following from Taylor’s summary:

I presented research with John Cogan on fiscal policy showing that it had not been successful in raising government purchases and was ineffective regardless of the size of the multiplier.

In other words – we really did not try fiscal stimulus after all. Isn’t that also been what Paul has been saying for quite a while!

Eurologic

The word has come down from on high in Europe.  Merkozy have decided:

1. Henceforth, after Greece, there will be no more haircuts administered to creditors of sovereign debt.  All obligations will be paid in full, no matter what interest rate has to be paid or how onerous the debt service program has become.

2. Every country will be subjected to hard limits on its budget deficit and must even show progress toward reducing debt-to-GDP to 60% if it is now above that target.

There are problems with each of these taken alone, but has anyone noticed that, under predictable circumstances, they contradict each other?  You can explain this as a quid pro quo for the two main players in the Eurozone, but sometimes political agreements also have to make sense.

A Modest Tactic for Improving Teaching

Yesterday’s lesson plan was fulmination; today’s is incremental improvement.

We—those of us who teach economics and other subjects—use exams and quizzes to evaluate students and assess our own effectiveness at reaching educational goals.  Some questions are narrow and technical, others broad and open-ended.  I want to talk about the narrow ones.

Narrow, close-ended questions are usually written to find out if the student can supply the correct answer.  The information we draw from them is whether the student “gets it” or not.  If not, and if there is enough time for it, we will go back and see if more explanation can facilitate the getting.

I propose the opposite approach: design these questions to see whether students have fallen into certain predictable errors.  If they have, unteach them.  The underlying conception behind this strategy is that the process of learning is not mainly, or at least only, that of gaining mastery over items of skill and knowledge, but also casting off false habits and beliefs.  The mind is not a tabula rasa but a messy blackboard, and if you simply try to overwrite it you will often get more mess at the end.  The critical tool is an eraser.

This is especially a problem in economics.  Students are exposed to a vast amount of information about economic topics outside the classroom, and a lot of it is wrong.  This exposure began long before they had the ability to question it, so false beliefs are often deeply embedded.  Worse, there are powerful interests operating through politics and popular media who benefit from particular misconceptions and feed them incessantly.  (Think, for instance, about why it is that most students entering their first macroeconomics class believe that inflation, by raising prices, reduces consumers’ real income—unaware that wages are also prices.)

If you want to organize assessment and teaching around error reduction, the key step is empirical.  You have to spend a lot of time listening to your students, not to find out whether they are saying what you want them to say, but simply listening to what they are saying.  What are their actual beliefs?  How do they define for themselves the technical terms you are using in the classroom?  How do they read equations, and how do they go about trying to manipulate them?  Look for errors in clusters, common pathways that lead them away from the goal you are trying to reach.  Then build the narrow questions in your exams and quizzes around what you have found, and use the results to guide your teaching in a more fruitful deconstructive direction.

A Republican Who Doubts the Laffer Curve?

Congressman David Schweikert of Arizona suggests that the payroll tax holiday will increase the deficit:

The simple fact is that this sort of temporary tax stimulus has repeatedly shown that without offsets, they only stimulate bigger federal deficits.

OK – but Republicans also want us to believe that tax cuts for well to Americans pay for themselves. The original Laffer curve was a proposition that even in a full employment economy, tax rate cuts so increase economic activity that tax revenues go up. Laffer described this in terms of reducing the wedge between the demand for labor and the supply of labor, which a reduction in the payroll tax would accomplish.

But to be fair to the Congressman – I should mention two points: (1) few labor economists ever bought the assumption that the labor curve was that elastic; and (2) we are not currently in a full employment economy. Point (2) would have us think in terms of the Keynesian marginal propensities to consume for households receiving the tax cut. If the household were very well to do, one would think the marginal propensity to consume would be low, which would lead to the conclusion that “tax stimulus” would “only stimulate bigger federal deficits”. But tax cuts for the working poor – which is what this payroll tax holiday is designed to accomplish – could lead to an increase in economic activity.

Conclusion – by any economic model, the Congressman has this exactly backwards. But what else is new?

Mankiw’s Reply to the Walk-Out

Whatever my disagreements with Greg Mankiw’s op-ed self-defense today, I appreciate that he takes his dissident students seriously and refrains from slinging labels, pulling rank or other repressive tactics.  Protesters don’t always get this treatment.

That said, I think Mankiw fails to see two ways in which his introductory course, and other mainstream econ courses, impose a worldview that makes thinking constructively about economic problems less rather than more likely.