Grasping Reality with Both Hands

Cracking Christiano, Eichenbaum, and Rebelo's Big Multipliers without Coffee...

Greg Mankiw asks a question:

Greg Mankiw's Blog: Modern macro even Paul Krugman will love: Lately, Paul Krugman has been dissing modern macroeconomics, mainly because many macroeconomists do not agree with his conclusions about fiscal policy. This new paper by Marty Eichenbaum, Larry Christiano, and Sergio Rebelo should, however, make Paul happy. They report large fiscal policy multipliers in a new Keynesian DSGE model when the economy is at the zero interest lower bound.

An open question: How can the results in this paper be reconciled with results by John Cogan, Tobias Cwik, John Taylor, and Volker Wieland, who seem to perform a similar policy simulation in a similar model but reach a very different conclusion? Are there subtle differences in the models? Or subtle differences in the policy experiments? Or did one team simply make a mistake of some sort?

Figuring out why these two prominent teams of researchers come to opposite conclusions about fiscal policy multipliers, and which conclusion is more applicable to actual policy, would be a good paper topic for an ambitious grad student.

As I understand it, the big problem with Cogan, Cwik, Taylor, and Wieland is that there is nothing special going on at the zero nominal interest rate bound. In their model, a fiscal expansion (a) raises expected future inflation, which (b) creates expectations of future interest rate rises by the Federal Reserve to cool off that inflation, which (c) damps present spending, and so (d) shrinks the multiplier. Their model is a model of a small multiplier in an economy away from the zero nominal interest rate bound when central banks are targeting inflation.

Christiano, Eichenbaum, and Rebelo, by contrast, have a model in which:

a shock increases desired savings.... When the shock is small enough, the real interest rate falls and there is a modest decline in output. However, when the shock is large enough, the zero bound becomes binding.... The only force that can induce the fall in saving required to re-establish equilibrium is a large transitory fall in output. The fall in output must be very large because hitting the zero bound creates an economic meltdown. A fall in output lowers marginal cost and generates expected deflation which leads to a rise in the real interest rate. This increase in the real interest rate leads to a rise in desired savings which partially undoes the effect of the fall in output. As a consequence, the total fall in output required to reduce savings to zero is very large. This scenario captures the paradox of thrift originally emphasized by Keynes (1936).... The government spending multiplier is large when the zero bound is binding because an increase in government spending lowers desired national savings and shortcuts the meltdown created by the paradox of thrift...

That said, I think that the CER multipliers are much too large to be applicable to our world today. If I understand CER completely (which I may not: the coffee has not yet hit the brain this morning), their Calvo pricing assumption creates a direct link between output Y and inflation π. Recall the flow -of-funds balance equation:

S(Y, 0-π) = D + I(0-π)

Savings S as an increasing function of income Y and of the real interest rate, which is the nominal interest rate 0 (we are at the lower bound) minus the inflation rate π, is equal to the government deficit D plus investment I which is a decreasing function of the real interest rate, which is the nominal interest rate 0 minus the inflation rate π.

An increase in the deficit thus (a) directly increases saving S necessary to finance the deficit which requires a direct increase in Y. But this direct increase in Y then increases inflation π--there is less deflation. And less deflation means both less savings and more investment. So the direct effect increase in Y does not generate enough savings to close the gap in the flow-of-funds market: savings must increase by more--which requires that Y increase by even more. The government deficit thus genuinely "primes the pump" and the multiplier is very large.

This channel is, I think, the channel pointed to by those who think that the New Deal had an enormous impact, as Roosevelt's deficits in combination with the increase in price rigidity produced by the NIRA and the breaking of deflationary expectations created by the abandonment of the gold standard diminished desired S.

But I don't think we have big expectations of deflation right now. And I don't think fiscal policy moves right now are having a great deal of effect in reducing expected deflation. So I don't think the interaction of output gaps and deflation is playing a big role in boosting the multiplier right now...

I may well, however, assign CER next March when I hit the Great Depression week in Econ 210a as an argument for why Cary Brown's estimates of the fiscal policy effect of the New Deal are too low...

And it is nice to see a model in which J. Bradford DeLong and Lawrence H. Summers (1986), "In Increased Price Flexibility Destabilizing?" American Economic Review makes a reappearence...

"The Short and Simple Annals of the Poor..."

Thomas Gray, 1750:

Elegy Written in a Country Church-Yard":
Oft did the harvest to their sickle yield,
Their furrow oft the stubborn glebe has broke;
How jocund did they drive their team afield!
How bow'd the woods beneath their sturdy stroke!

Let not Ambition mock their useful toil,
Their homely joys, and destiny obscure;
Nor Grandeur hear with a disdainful smile
The short and simple annals of the Poor...

The first four or so times I read:

Robert C. Allen: The year 1762 witnessed two momentous changes in cropping [in Spelsbury in Oxfordshire]. First, turnip cultivation was shifted from the sainfoin [grass] enclosure to the open fields themselves.... Secondly, clover was introduced...

the word "momentous" did not strike me as at all out of place or inappropriate or funny...

Should I be alarmed? Or distressed? Or just accept that the particular road I have walked has made me a somewhat strange person?

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St. Giles Church, Stoke Poges, Buckinghamshire, next door (well, only by California standards: an hour ro so by the M40 via Oxford and High Wycomb) to Spelsbury.

(Site of Gray's "Elegy," and also IIRC of the game of Centrifugal Bumble-Puppy in Brave New World, of scenes in the fims Bridget Jones's Diary and Goldfinger, and something to do with Bertie Wooster...)

The Pivot of Global History: The Handoff from the First to the Second Industrial Revolution

Bob Allen of Oxford writes the smartest thing I have read in at least a year. The conclusion of Robert Allen (2009), The British Industrial Revolution in Global Perspective (Cambridge: Cambridge University Press: 9780521687850), p. 272 ff.:

I have argued that the famous inventions of the British Industrial Revolution were responses to Britain's unique economic environment and would not have been developed anywhere else.... Buy why did those inventions matter?.... Weren't there alternative paths to the twentieth century? These questions are closely related to another... asked by Mokyr: why didn't the Industrial Revolution peter out after 1815?... [O]ne-shot rise[s] in productivity [before] did not translate into sustained economic growth. The nineteenth century was different--the First Industrial Revolution turned into Modern Economic Growth. Why? Mokyr's answer... that scientific knowledge increased enough to allow continuous invention [is incomplete]....

Britain's pre-1815 inventions were particularly transformative.... Cotton was the wonder industry.... [T]he great achievement of the British Industrial Revolution was... the creation of the first large engineering industry that could mass-produce productivity-raising machinery. Machinery production was the basis of three developments that were the immeiate explanations of the continuation of economic growth until the First World War... (1) the general mechanization of industry; (2) the railroad; and (3) steam-powered iron ships. The first raised productivity... the second and third created the global economy and the international division of labor... (O'Rourke and Williamson, 1999). Steam... accounted for close to half of the growth in labor productivity in Britain in the second half of the nineteenth century (Crafts 2004). The nineteenth-century engineering industry was a spin-off from the coal industry. All three of the developments... depended on two things: the steam engine and cheap iron....

Cotton played a supporting role in the growth of the engineering industry.... The first is that it grew to immense size.... Mechanization in other activities did not have the same potential... global industry with.. price-responsive demand... cotton... sustained the engineering industry by providing it with a large and growing market for equipment....

There was a great paradox... the macro-inventions of the eighteenth century... increased the demand for capital and energy relative to labour. Since capital and energy were relatively cheap in Britain, it was worth developing the macro-inventions there and worth using them in their early, primitave forms. These forms were not cost-effective elsewhere.... However, British engineers improved this technology.... This local learning often saved the input that was used excessively in the early years of the invention's life and which restricted its use to Britain. As the coal consumption of rotary steam power declined from 35 pounds per horsepower-hour to 5 pounds, it paid to apply steam power to more and more uses.... Old fashioned, thermally inefficient steam engines were not "appropriate" technology for countries where coal was expensive. These countries did not have to invent an "appropriate" technology for their conditions, however. The irony is that the British did it for them....

[T]he British inventions of the eighteenth century--cheap iron and the steam engine, in particular--were so transformative... the technologies invented in France--in paper production, glass, and knitting--were not, The French innovations did not lead to general mechanization or globalization.... The British were not more rational or prescient than the French... simply luckier in their geology. the knock-on effect was large, however: there is no reason to believe that French technology would have led to the engineering industry, the general mechanization of industrial processes, the railway, the steamship, or the global economy.... [T]here was only one route to the twentieth century--and it traversed northern Britain.

What Bob Allen said.

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N.F.R. Crafts (2004), "Steam as a General Purpose Technology: A Growth Accounting Perspective," Economic Journal 114:495, pp. 338-51.

Kevin O'Rourke and Jeffrey Williamson (1999), Globalization and History: The Evolution of a Nineteenth-Century Atlantic Economy (Cambridge: MIT Press).

Arthur Burns in the 1970s...

Sounding a little bit like the fish in The Cat in the Hat: "'This is not a good game!' said the fish to the cat...":

Each temporary surge in inflation was quickly followed by--or in the case of the mid-1970s oil shock inflation cycle roughly coincident with--an increase in unemployment. Each cycle in the late 1960s and 1970s was larger than the one before: unemployment peaked at around 6 percent in 1971, at about 8.5 percent in 1975, and at nearly 10 percent in 1982-83. Congress attempted to legislate full employment. Federal Reserve chair Arthur Burns pushed back: “[The] Humphrey-Hawkins [proposal]... continues the old game of setting a target for the unemployment rate. You set one figure. I set another figure. If your figure is low, you are a friend of mankind; if mine is high, I am a servant of Wall Street.... I think that is not a profitable game...” (Wells (1994))

DRAFT Lecture Notes for September 1 & 3, 2009: Econ 115: Twentieth Century Economic History

The state of the world's economy in 1870, back at the start of the "long" twentieth century.

(DRAFTS only--without reference notes yet, and saying a number of things I think are wrong...)

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The Lessons of 1937

Christie Romer is live at the Economist:

Economics focus: The lessons of 1937.

And myComment for the Economist on Christina Romer (2009), "The Lessons of 1937"? For now it is now not yet live...

http://www.economist.com/blogs/freeexchange/romer_roundtable/

Comment for the Economist on Christina Romer (2009), "The Lessons of 1937"

Five Lessons from 1937 and Otherwhen

J. Bradford DeLong
U.C. Berkeley and NBER
delong@econ.berkeley.edu

June 17, 2009

Comment on Christina Romer (2009), "The Lessons of 1937":

Let me make five points to eliminate or refute or at least to fight against or lay down a marker that there is--well, call it "confusion" about what the right state of American macroeconomy should be.

Last December’s Unemployment-Rate Forecast and Outcome to Date

Source: Romer and Bernstein (2009).

My first point is that over the past six months the economy has been a severe disappointment. Output and employment have fallen much faster than people were projecting last December. Romer and Bernstein (2009) projected at the very start of this year that unemployment in the U.S. would reach a peak of 7.9% in the summer of 2009. But unemployment now in mid-June is about 9.7%, with 10% baked in the cake and the possibility existing that it might go much higher. The signs that the cliff-dive of employment has come to an end are very few. The level of new unemployment claims is still consistent with a rapidly-collapsing labor market nationwide.

New Weekly Unemployment Claims (Red, Right Scale, Four-Week Average) and Monthly Fall in Payroll Employment (Blue, Left Scale, Thousands)

Source: Paul Krugman.

Six months ago a net federal fiscal stimulus of about $1 trillion--$400 billion each year for about 2.5 years--seemed appropriate: that seemed to balance the benefits of filling-in the hole in aggregate demand without running too great a risk of triggering worrisome inflationary fever further down the road. Now the hole in aggregate demand is greater than was thought likely last December--about twice as great--and the likelihood of heightened future inflation is less. Thus if it was appropriate to set a $1 trillion federal fiscal stimulus in motion last December given what we knew then, if we had known then what we know now it would have been appropriate to set a roughly $2.4 trillion fiscal stimulus--$800 billion for 3 years--in motion back then.

My first point is thus that the Obama administration's federal fiscal stimulus programs are on the low side of what is appropriate by a substantial margin: this is the largest economic downturn since the Great Depression and the standard tools of expansionary monetary policy are tapped out and broken right now.

My second--related--point is that the need for federal-level fiscal expansion is reinforced by what state governments are doing right now. The federal government's discretionary actions are expanding aggregate demand by about $400 billion over fiscal year 2010, but state governments are right now cutting their spending and raising their taxes in order to offset this federal fiscal expansion more or less completely. On net, the government sector will be on autopilot as far as discretionary policy moves to stimulate the economy are concerned: federal-level expansion is offset and neutralized by state-level fiscal contraction. This is not an appropriate macroeconomic policy stance: this is the largest economic downturn since the Great Depression.

My third--unrelated--point is that the policy innovations of the past year have created a potentially dangerous weakness in the Federal Reserve system. The Federal Reserve's balance sheet has more than doubled over the past year, as it has acquired an enormous and bizarre menagerie of assets. On the liability side, it has funded this acquisition by expanding the monetary base, and has increased private-sector willingness to hold this monetary base by paying interest on reserves. This has added a fourth motive--profit--to the three traditional motives for holding reserve deposits at the Fed: the transactions demand, the emergency liquidity demand, and the speculative demand.

As long as the dollar remains the safest currency in the world, as long as the dollar remains the linchpin of the global financial system, there is no problem in the Federal Reserve's funding by what is essentially overnight borrowing the expansion of its balance sheet and the purchase of private securities that will vary up or down in market price with an eye toward holding them to maturity.

However, at some future time the dollar will cease to be the linchpin of the world financial system, in which case the Federal Reserve's financing its balance sheet via overnight borrowing will leave it vulnerable to the mother of all bank runs. It would be very good to fix this now: to give the Federal Reserve now the option to borrow not in what are essentially demand but rather in time deposits--to grant the Federal Reserve the power to issue its own bonds. This diminishes the chance of a great financial crisis in 2050 or so, with no downside that I can see.

My fourth point is the obvious one that health care is the only thing tht matters for the long run budget. The other points that the Hon. Dr Christina Romer raises, are--as is almost always the case--accurate and important. America's long-run fiscal problems are caused by health care, and will not be appreciably made worse by this half-decade's federal fiscal stimulus. If restructuring the health care system can bend the curve on the rise in overall (and hence public as well as private) health care costs, then America has ample debt capacity to borrow whatever we wish in this crisis--and to borrow it at extraordinarily favorable rates as well. If the curve of rising health-care costs is not bent, then the government's long-term finances are in trouble and so is the growth of private-sector non-health living standards: health care costs that rise as fast as CBO is projecting in the baseline cause lots of long-run economic problems, of which government fiscal bankruptcy is not the worst. Health care reform to bend the long-run curve of costs is now just what it was back in 1993: the most important issue for the American political system to deal with.

Fifth, I have the sense that the Obama administration's economic policymakers have forgotten one of the most basic lessons taught by Robert Rubin during his stewardship of economic policy during the 1990s. The lesson is to think probabilistically: to project yourself forward into the possible futures, to ask in each one what would be the actions that you would then wish you hd undertaken today, and then to actually take the appropriate action today. Looking forward into the future, (a) I see a 10% chance that something happens to create renewed cliff diving--a recession that bottoms out not with an unemployment rate in the 10-12% range that we currently anticipate but an unemployment rate that blows through 12% and keeps on rising. (b) I see a 30% chance of a rapid recovery as confidence and asset prices recover, and firms take advantage of high unemployment to hire new workers in droves at wage levels that make increasing production very profitable. But (c) I see a 60% chance of the end of the current cliff-dive in employment being followed by what happened in Japan in the 1990s, in the U.S. after 1991, in the U.S. after 2001, and to some extent in the U.S. after 1933--a recovery that does not see the market exert sufficient upward pressure on employment to return the unemployment rate to normal levels in two or three years, but that instead sees a jobless or low-job recovery during which the unemployment rate continues to drift upward for years, or falls only then to rise again.

The Obama administration's policies appear to me to be the ones that would be adopted if we believed that there was a 75% chance of scenario (b) and a 25% chance of scenario (a). But I don't think those are the probabilities. And I wonder what the Hon. Dr. Christina Romer thinks the probabilities are. For she is the one who warns of how:

[t]he 1937 episode provides a cautionary tale. The urge to declare victory and get back to normal policy following an economic crisis is strong. That urge needs to be resisted until the economy is again approaching full employment. Financial crises, in particular, tend to leave scars that make financial institutions, households and firms behave differently [than in normal times]. If the government withdraws support too early, a return to economic decline or even panic could follow...

The blunt fact is that the economic recoveries that have been rapid and seen fast growth in employment are those that ended when a Federal Reserve following strongly restrictionary policies to fight inflation eased off and significantly lowered interest rates. No such lowering of interest rates is possible this time--interest rates are already as low as they can possibly go at the short end. So I can see no reason to anticipate a rapid recovery and employment when the cliff-diving stops. And I do not understand why the Obama administration is following policies that presume such a rapid recovery--a V rather than an L for the shape of the recession--is not just possible but probable.

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Posted via email from http://braddelong.posterous.com/comment-for-the-economist-on-christina-romer at Brad DeLong's Scrapbook

The Duties and Privileges of an Academic Speaker

Eszter Hargittai writes:

Clueless? Rude? Neither? Both?: [A]n incident I experienced years ago. I was surprised economists didn’t get more of a mention in the thread following John H’s post earlier given what I’ve seen in their colloquia. I have close-to no experiences in philosophy exchanges... but I’ve attended quite a few talks among economists so I’m used to their style of Q&A.... [I]t often starts a few slides in – or in some famous cases the speaker doesn’t get to proceed past the title slide for most of the time allotted – and being rather aggressive seems standard. If that’s the local norm, they are likely used to it and it doesn’t raise any eyebrows. However, what if you put such an economist in a room full of sociologists? Is it okay for him to import his style or should he take a moment to familiarize himself with the local norms?

What struck me as rather curious was the way an economist behaved during a job talk I attended in a sociology department.... The economist engaged in the usual norms for his own department’s culture: interrupting at pretty much every slide. He didn’t take any cues from the rest of the group.... [S]ociologists don’t tend to interrupt a speaker, certainly not a slide or two in, and certainly not for questions that are more than mere points of clarification.... [T]his was a job talk, which in... this particular department meant that people would... more courteous [than] usual. (Do not confuse courteous with lack of very serious and difficult questions, of course.) The audience was listening intently and the room was quiet for the most part except for the economist’s questions.... [I]t is a bit surprising that he did not pick up on the fact that his approach was not in line with local norms. Perhaps he did, but just didn’t care. I was clearly not the only one bothered by the economist’s style. The uneasiness in the room was palpable. In the end, a senior sociologist stepped in. She turned to the economist and explicitly stated that this is simply not how we do things and asked that he hold his questions until the speaker had finished his talk. You could tell that everyone (presumably other than the economist) in the room was quite relieved to have had her do this...

Eszter seems to me to be getting three things wrong:

1. Economists are used to situations in which you are supposed to be quiet until the paper-giver has finished speaking, only those are not "workshops" but rather "conference presentations." A conference presentation would, typically, have the presenter speak for 30 minutes, an assigned discussant speak for 10, the presenter respond for 5, and then 15 minutes for questions from the floor and answers by the presenter. It's not a discipline-wide norm that economists follow in workshops, but rather one specific to the format of the "workshop."

2. The difference between interrupting and non-interrupting cultures is not a simple and arbitrary choice of social norm, but instead reflects a judgment about whose words are likely to be most valuable to hear. In an "interrupting culture" the presumption is that everyone has read and thought about the paper beforehand, and that to spend half or more of the available time with the presenter simply summarizing the paper (or, worse, reading large chunks of it) is a waste of everybody's time. Much better to have people raise and argue the points that puzzled them or that they think need to be expanded at their appropriate place in the argument. Moreover, when questions are asked in non-interrupting cultures at the end of the seminar, they don't lead to any discussion: questions come in response to things the presenter said 15, 30, or 45 minutes ago, and lead to formulaic thrust-and-parry-and-end rather than any more complex discussion. Now in a conference, where the presenter and the discussant are up at front for a reason, and where many in the audience have indeed not read the paper, the noninterrupting culture format makes a certain amount of sense. But in a workshop it does not.

3. The noninterrupting culture format is, in the last analysis, one that does even the presenter no favors. It greatly diminishes the fraction of the audience that will read the paper beforehand--for everyone knows that the presenter is going to eat up the lion's share of the time going over it with everyone else sitting around like bumps on a log. A good presenter is more interested in what an intelligent and thoughtful audience thinks of his or her argument than in listening to himself or herself summarize the paper one more time. And if for some reason the presenter gets off on the wrong foot and does not make contact with the audience, then an interrupting culture gives the presenter clues that may allow him or her to adjust on the fly and reconnect. In a non-interrupting culture--no chance of that.

This last was brought home to me when I heard about a job talk in another discipline than mine at... let me call it Potlatch State University...

The young presenter was, the story goes, making an argument that the British classical economists in fact had as much of the milk of human kindness and as much of a desire to build a better world as any group--but just found themselves by their observations and by the logic of their discipline led to conclude that lots of policies that you might think of as good were in fact counterproductive. And he went through example after example, while the audience sat silently. And then he got to the end of his presentation with ten minutes left, because he had gone over. And, the story goes, one of the most senior people asked the first question, which was:

It is said that Benjamin Jowett, Master of Balliol College, was seated at High Table next to British classical economist Nassau Senior during the Irish Potato Famine. And that Jowett asked Senior how many people would die in the famine. And Senior replied: "About one million--and that is not nearly enough..."

Now if there is a better anecdote to back the claim that the British classical economists were Enemies of Humanity--shills for the ruling classes, social darwinists before Darwin, who sought to exalt the wealthy while gleefully grinding the bones of the poor into meal in the Dark Satanic Mills of the Industrial Revolution--I don't know what it is.

If this question had been raised at the start or even in the middle of the seminar, the speaker could have scrambled to recover--qnd would have had a chance of fitting that story into his broad argument. He would have said that Nassau Senior:

• believed that Irish land was good enough to support 4 million people at a reasonable standard of living, but that at the start of the Potato Famine it had 8 million.

• thought that at a population of 4 million average labor productivity in agriculture would be high enough that children could be released from farmwork to go to school, where they would learn self-respect and the fear of God, that as a result the people of Ireland would be prudent and chaste and marry relatively late, and the population would be stable and the island prosperous.

• thought, on the other hand, that at a population of 7 million average labor productivity in agriculture would be so low that children too would have to work digging potatoes and would grow up illiterate and unchurched, that not fearing God they would have sex as often and as young as possible, and that the population would then grow back to its pre-Potato Famine level of 8 million--at which Ireland was starving even when the potato harvest was good, and at which population was kept from growing further only because babies were so malnourished that their immune systems were compromised and women so thin that they stopped ovulating.

Senior believed that Ireland was trapped in a bad poverty-stricken Malthusian subsistence equilibrium at a population of 8 million, and that while a fall in population to 4 million would knock it out of that bad equilibrium and put it on the road to a better one, that a fall in population to 7 million would not and thus, as Jowett later quoted Senior, "would scarcely be enough to do much good." This was, Jowett said, why he had "always felt a certain horror of political economists."

Now Senior was wrong: Ireland in the mid-1840s was no longer hopelessly trapped in a bad Malthusian equilibrium. And Senior's policy advice was wrong because his analysis of Ireland was wrong. You can judge Senior harshly: he ought to have figured out that the Age of Malthus was over. But Nassau Senior did not think that with each Irish famine death an angel got its wings.

That was the argument that the presenter could have made had he been embedded in an interrupting culture and figured out that the most senior people he was talking to were starting from Jowett's High Table at Victorian Balliol. But in a noninterrupting culture in which you have two minutes to respond to each question at the end because there are ten other senior faculty members who want to ask their questions that they have been nursing since minute 20? In a noninterrupting culture you are dead if your audience is starting at a different place than you think they are starting.

A Sokratic Dialogue: Liquidity Preference, Loanable Funds, and European Hedge Funds that Fear the Collapse of U.S. Treasury Bond Prices

Meno: I haven't seen you since spring classes ended.

Adeimantos: I have been away: Paris. London. Frankfurt.

Meno: Oh. Pleasant? Interesting?

Adeimantos: Not really interesting--too jet-lagged, so I sit in my hotel room in my underwear, read the Economist and Financial Times,, and reflect on how if in my 20s I had been in a fancy hotel in central Paris with someone else paying I would have thought I was in heaven, but that now I am just tired. Thus not too pleasant either.

Meno: Middle age is a shipwreck?

Kephalos: It gets worse...

Adeimantos: However, it was somewhat lucrative: talking to European hedge funds.

Meno: And what do European hedge funds think?

Adeimantos: They look at things like this:

Then they demand that I tell them why U.S. Treasury bond prices have not already collapsed (and Treasury interest rates risen) in anticipation of this forthcoming tsunami of bond issues. Given that Treasury bonds have not yet collapsed they are very very bearish about U.S. Treasury bond prices and interest rates. Supply and demand. The supply of U.S. Treasury bonds is about to become huge, and when supply goes up price should go down.

Sokrates: But if that argument is correct, then rational profit-seeking traders should already have sold U.S. Treasury bonds and already have pushed their prices down in anticipation of the sudden increase in supply...

Meno: Are you Sokrates or Milton Friedman?

Kephalos: There are two supply-and-demand arguments that can be made here. The first is that the supply of U.S. Treasury bonds is about to jump enormously--and so by supply-and-demand the price will be low once the extra bond issues hit the market, and should be low now in anticipation of this low-price Treasury bond market equilibrium. The second is that the inverse of the price of U.S. Treasury bonds--the Treasury nominal interest rate--is the price of liquidity: the amount of interest income you forego by keeping your wealth in cash rather than in securities. According to this second argument, the supply-and-demand is the supply and demand for cash: when the supply of cash is high, the price of liquidity is low, and since the price of liquidity is the short-term Treasury interest rate the short-term Treasury interest rate should be very low.

Adeimantos: Which it is...

Kephalos: And the long-term Treasury interest rate is the average of expected short-term future Treasury interest rates. Since the Federal Reserve has flooded the economy with cash and will keep flooding it with cash for the foreseeable, Treasury interest rates should be low which means Treasury bond prices should be very high--which they are--and stay high.

Adeimantos: Loanable funds vs. liquidity preference.

Sokrates: So, Kephalos, with your impeccable logic and deep wisdom derived from a long career financing expeditions to the shores of the Black Sea, you have presented us with two different supply-and-demand arguments, one saying that Treasury bond prices should be low and hence are about to collapse, and the other saying that Treasury bond prices should be high and are likely to stay more-or-less where they are for some time to come.

Meno: Which argument is right? Is the price of bonds the price that balances the supply and demand for bonds in the bond market? Or is the price of bonds the inverse of the interest rate which balances the supply and demand for cash in the money market? Both cannot be true, can they?

Adeimantos: Ah. But both arguments are true...

Meno: Why do I get the feeling that I am being cast as the dumb straight man in this dialogue?

Sokrates: Because you are a sophist and we are philosophers. We write the dialogues, and we write them to make ourselves look good so that everyone thinks that philosophers are the roxxor and sophists are lame...

Meno: What have I ever done to you?

Glaukon: Tried to take our students and their fees, perhaps?

Sokrates: And we have won. There are now departments of philosophy everywhere. But when was the last time you saw a department of sophistry?

Meno: OK. I will take up my role: Kephalos: Can you explain to me how two perfectly-coherent supply-and-demand arguments lead to opposite conclusions? And if both arguments are coherent, why do European hedge funds all believe the first?

Kephalos: I can answer the second question but not the first: European hedge funds live in the bond market and they see the supply and demand of bonds all day, so that is the market they believe is most important...

Adeimantos: That is true about European hedge funds. But, Meno, the way you have posed the issue is somewhat misleading. It is not which supply-and-demand argument is correct--for both are: the price/interest rate on Treasury bonds clears both the bond and the money market, both loanable funds and liquidity preference. It is how does the economy adjust in order to make the Treasury bond price/interest rate clear both these markets.

Meno: And I have the feeling that you are about to tell me...

Adeimantos: Let's start with an economy in equilibrium--where Treasury bond prices are such as to satisfy both loanable funds and liquidity preference, so that everyone is happy to hold the bonds given their current price and everyone is happy to hold the economy's cash supply given the current interest rate. Now suppose the Treasury issues a huge honking tranche of bonds (and Obama spends the money hiring the unemployed to give people cholesterol screenings on the street and hand out statins). Now the supply of bonds is greater than demand at current bond prices. So what happens?

Kephalos: The prices of Treasury bonds fall--interest rates rise...

Adeimantos: And what happens in the money market as interest rates rise?

Kephalos: People are no longer happy holding the economy's cash--it's too expensive; it's burning a hole in their pocket. So they start spending it faster...

Adeimantos: And as they start spending it faster?

Kephalos: This puts upward pressure on prices and employment, as businesses find that they can charge more and make hire profits and so hire more people...

Adeimantos: Incomes rise, and as incomes rise savings rise because people don't spend all of their increased incomes, do they?

Sokrates: Very true, Adeimantos.

Adeimantos: And what happens as savings rise?

Kephalos: People want to park those savings somewhere. They want to park those savings in Treasury bonds. And so demand for Treasury bonds rises...

Adeimantos: And the economy settles back at its new equilibrium, with (a) somewhat higher interest rates and (b) higher spending and income so that (c) people are happy holding the economy's cash at the current interest rates and rate of spending, and (d) people are happy holding the bonds at the current bond prices and level of income.

Kephalos: So both supply-and-demand arguments are true...

Meno: And the way that they can both be true is that there isn't just one quantity--the bond price--that adjusts to match supply and demand in the bond and the money markets...

Sokrates: But there are two quantities that adjust: the bond price and the level of spending...

Adeimantos: Yes. You have just derived things that were well-known 72 years ago. See John Hicks (1937), "Mr. Keynes and the 'Classics': A Suggested Interpretation."

Sokrates: But which adjusts more?

Adeimantos: Once again back to Hicks (1937). When the unemployment rate is high and the nominal interest rate on Treasury bonds is very very slow, adjustment comes in the form mostly of changes in spending and only slightly in changes in interest rates--the world is then "Keynesian." But when the unemployment rate is normal or low and the nominal interest rate on Treasury bonds is near its normal levels, adjustment comes in the form mostly of changes in interest rates and only slightly in changes in spending--the world is than "Classical." That's why the title of the article is "Mr. Keynes and the 'Classics'."

Meno: So when European hedge funds predict the collapse of U.S. Treasury bond prices as the new issues hit the market and ask where is the extra demand to hold all these new bonds come from, the answer is...?

Adeimantos: That even as the government issues the bonds it is also spending the money, and as the money it spends is parked in the bank accounts of the businesses the government is buying things from, the banks in which the money is parked take it and use it to buy Treasury bonds.

Meno: That sounds like sophistry...

Sokrates: You should talk...

Glaukon: Actually, it's just general equilibrium...

Meno: But is this doctrine--that the government's issuance of a fortune in bonds and spending of a fortune in money will show up primarily not as a collapse in bond prices and a spike in interest rates but as an expansion of spending--true?

Sokrates: We will see. Keynesian--or maybe I should say Hicksian--economists would say that bond prices/interest rates and spending/income levels are the two quantities that together adjust to jointly clear the bond and the money markets, to satisfy both loanable funds and liquidity preference equilibrium; that sometimes the principal movement is in interest rates; that sometimes the principal movement is in spending levels; and that right now it is likely that spending will adjust by much more than interest rates.

Adeimantos: And there is a little bit of empirical evidence that the Hicksian economists are right. Tim Fernholz http://www.prospect.org/csnc/blogs/tapped_archive?month=06&year=2009&base_name=compare_and_contrast_economic sends us to Nelson Schwartz, who writes:

Europe Lags as U.S. Economy Shows Signs of Recovery - NYTimes.com: There was more evidence Thursday that the United States economy might be stabilizing, if not rebounding, even as economic reports in Europe remained gloomy. The American news — showing slight growth in retail sales and a dip in first-time jobless claims, as well as rising stocks — was not enough to end the disagreement between bulls and bears over how soon the economy would improve. But the apparent divergence of fortunes between America and Europe highlighted the different approaches to solving the financial crisis, and why some economists say the more aggressive American strategy may be working better, at least for now. It is a debate that is likely to be one of the issues dominating discussions when finance ministers from the eight largest economies meet in Italy this weekend.

Some private economists are even predicting that the American economy will resume growth in the fourth quarter, while Europe’s economy is expected to remain in recession well into 2010, after contracting an estimated 4.2 percent this year compared with an expected 2.8 percent decline in the United States. “The shock originated in the U.S., but Europe is paying a higher price,” said Jean Pisani-Ferry, a former top financial adviser to the French government who is now director of Bruegel, a research center in Brussels. Almost from the beginning of the crisis, the United States and Europe chose largely different paths to aiding their economies. The most stark was Washington’s willingness to commit hundreds of billions of dollars to stimulus spending — in addition to moving aggressively to shore up banks and keep credit flowing — versus Europe’s worry that similar spending would increase inflation in the future. Just as the policies pursued during the Great Depression have been dissected ever since by economists, the fate of the United States and Europe as the two regions emerge from the global crisis will be analyzed for decades to come.....

One crucial concern about America’s increased deficit spending — that it would lead investors to demand higher interest rates on United States debt, making it far more expensive to borrow and slowing the economy — has been allayed, for now. An auction on Thursday of $11 billion in 30-year Treasury bonds found enthusiastic buyers, helping to push the Standard & Poor’s 500-stock index to a seven-month high...

Meno: And the Chicago School economists who say that government borrow-and-spend logically cannot increase overall spending? The Robert Lucases who say: "[W]ould a fiscal stimulus somehow get us out of this bind...? I just don't see this at all. If the government builds a bridge... by taking tax money away from somebody else, and using that to pay the bridge builder... then it's just a wash.... [T]here's nothing to apply a multiplier to. (Laughs.)... [And] taxing them later isn't going to help, we know that..."? And the John Cochranes who said: "[W]hile Tobin made contributions to investing theory, the idea that spending can spur the economy was discredited decades ago. 'It’s not part of what anybody has taught graduate students since the 1960s. They are fairy tales that have been proved false. It is very comforting in times of stress to go back to the fairy tales we heard as children but it doesn’t make them less false.'" To borrow money to pay for the spending, the government will issue bonds, which means investors will be buying U.S. Treasuries instead of investing in equities or products, negating the stimulative effect, Cochrane said. It also will do nothing to unlock frozen credit..."?

Sokrates: I, at least, find myself unable to understand them. They say they believe in the quantity theory of money--that spending is equal to the economy's cash times its velocity. And they say that they believe that velocity is interest elastic--that people respond to incentives and spend the cash in their pockets more rapidly when nominal interest rates are high. They say that they believe that bond prices/interest rates are such as to balance saving and investment and make people willing to hold the stock of bonds. That's all you need to be a Hicksian. Yet they also claim that Hicks is wrong, somehow--without giving arguments. I can trip up and make foolish anybody who makes an argument, but if they don't make an argument I cannot make them look any more foolish...

The Debt and the Deficit in Historical Perspective...

Debt-to-GDP Graphs:

Note: Debt held by the public, excluding debt held by the Federal Reserve.

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Change in Truly-Public-Held Federal Debt, Divided by GDP

Note: Not the change in the debt-to-GDP ratio; rather, the change in debt, then scaled by GDP.

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http://tinyurl.com/de20090611b

Living Standards at the End of the Nineteenth Century: Literary Evidence from Emile Zola

Erich Auerbach (1946), Mimesis (trans. Willard Trask; Princeton University Press) on Emile Zola (1888), Germinal:

We have chosen a passage from Germinal (1888), the novel which describes life in a coal-mining region of northern France. It is the end of the second chapter of part 3. It is kermess time, a Sunday night in July. The workmen of the place have spent the afternoon going from one bar to another, drinking, bowling, looking at all sorts of shows. The day ends climactically with a ball, the bal du Bon-Joyeux, at the estaminet of the fat, fiftyish, but still usty widow Desir. The ball has been going on for several hours; even the older women are coming to it now, bringing their small children.

Jusqu'a dix heures, on resta....

(It was ten o'clock before anybody left. Women kept arriving to find and take away their men; bands of children followed at their heels; and the mohters no longer troubled about appearances took out long blond breasts like bags of oats, smeared their fat-cheeked babies with milk; while the children who could already walk, gorged with beer and on all fours under the tables, relieved themselves without shame. It was a rising sea of beer, Widow Desir's casks broached, beer swelling out bellies, flowing from all sides, from noses, from eyes, and from everywhere. People swelled up so, in the press, that everyone had a shoulder of a knee digging into this neighbor; all were made cheerful, at ease, by feeling one another's elbows in this way. A continuous laugh kept mouths open, gaping to the ears. It was as hot as an oven, everyone was roasting, all made themselves comfortable, their flesh exposed, gilded in the thick smoke of the pipes; and the only difficulty was to move, a girl got up from time to time, went to the back, near the pump, tucked up her skirts, then returend. Under the garlands of colored paper the dancers no longer saw each other, they were sweating so--which encouraged the pit-boys to knock over the haulage-girls by promiscuous thrusts of their haunches. But when a strapping girl fell with a man on top of her, the cornet covered their fall with its furious sounds, the swing of feet rolled them, as if the dance had collapsed on them.

Someone passing by told Pierron that his daughter Lydie was sleeping at the door, across the sidewalk. She had swallowed her share of the stolen bottle, she was drunk, and he had to carry her home in his arms, while Jeanlin and Bebert, more resistant, followed him at a distance, finding it very funny. This was the signal for departure, the families left the Bon-Joyeux, the Maheus and the Levaques decided to returtn to the mining village. At that moment, Pere Bonnemort an old Mouque also left Montsou, both with the same sleep-walking gait, stubbornly maintaining the silence of their memories. And they all went home together, for the last time they passed through the carniaval, the solidifying pans of fried stuff, the bars from which the last mugs were pouring in streams, even to the middle of the road. There ws still a storm threatening, laughter rose as soon as they had left the lighted houses to lose themselves in the dark countryside. A hot breath poured from the ripe wheat, many children must have been conceived that night. When they reached the village, they felt let down. Neither the Levaques nor the Maheus supped with appetite, an the latter fell asleep finishing their morning boiled beef.

Etienne had taken Chaval to drink somre more at Rasseneurs's.

"I'm on!" said Chaval, when his comrade had explained the matter of the reserve fun to him. "Shake! You're all right!"

A touch of drunkenness made Etienne's eyes flame. He cried, "Yes, lets be together... As for me, I tell you, for justice I would give everything, drink, and women. There's only one thing that warms my heart, it's the idea that we are going to get rid of the bosses"...)

The passage is one of those which when Zola's work first appeared... aroused disgust and horror, but also... admiration. A reader... could believe for a moment that he had before him a literary form of the coarse realism whih is so well known from the Flemish and especially the Dutch painting of the seventeenth century... a lower-class orgy of dancing and drinking... found or imagined in Rubens or Jordaens, in Brouwer or Ostade. To be sure, these are not peasants... but factory workers; and there is also a difference in the effect produced, in that the especially brutal details impress us... as more disagreeable and painful than they would as elements in a painting.... The flowing beer the haze of sweat, the grinning and wide-open mouths likewise become visul impressions; acoustic and other sensory effects are also produced....

But... [a]mong [Zola's] enemies... were doubtless many who accepted the grotesque or comic realism of earlier epochs... with equanimity or even delight. What excited them was... that Zola by no means put forward his art... as comic. Almost every line he wrote showed that all this was meant... seriously and morally... the true picture of contemporary society as he--Zola--saw it....

The first line--Jusqu'a dix heures, on resta--would be inconceivable in a [comic] grotesque mob orgy. Why are we told of the end of the orgy at the start? For a purely amusing or grotesque purpose, that would be much too sobering. And why such an early hour? What sort of an orgy is it which reaches its end so early? The coal miners have to be out of bed early on Monday morning, some of them at four o'clock.... And once we have paused, there are many other things that strike us. An orgy, even among the lower classes, calls for plenty. And plenty there is, but it is poor and frugal--nothing but beer. The whole thing shows how desolate and miserable the joys of these people are.

The real purport of the passage.... Lydie is a girl of twelve who has spent the evening running aorund with... Jeanlin and Bebert. The three of them already work as haulers in the mine. They are prematurely depraved.... [T]wo old, worn-out pitmen, Bonnemort anf Moque... hardly sicty years old but already the last of their generation--used up and apathetic....

Crude and miserable pleasures; early depravity and rapid wearing out of human material; a dissolute sex life; and a birth rate too high for such living conditions since intercourse is the only amusement that costs nothing; behind all this, at least among the most energetic and intelligent, revolutionary hatred is on the verge of breaking out--these are the motifs of our text. They are unreservedly translated into sensory terms....

If Zola exaggerated, he did so in the direction which mattered; and if he had a predilection for the ugly, he used it most fruitfully. Even today, after half a century the last decades of which have brought us experiences such as Zola never dreamed of, Germinal is a terrifying book. And even today it has lost none of its significance and indeed none of its timeliness. There are passages in it which deserve to become classic... because they depict, with exemplary clarity and simplicity, the situation and the awakening of the fourth estate...

And, of course, the coal miners of northeast France had it relatively good: these were towns that were growing, not shrinking, in the late-nineteenth century and as a result jobs for which bosses had to pay enough to attract young workers from outside.

Berkeley Political Economy 101: Reference Document SECOND DRAFT

Title:

Modern Theories of Political Economy

Prerequisites:

Completion of PE 100 and IAS 45 are required before students can register for the course.

Sequence:

Students intending to become Political Economy majors will ideally complete PE 101 by the end of their sophomore year.

Objectives:

PE 101 examines modern approaches to the interaction between economics and politics--what in an earlier age would have been called "moral philosophy." Building on the knowledge of world history covered in IAS 45 and the thinkers of the classical political economy tradition covered in PE 100, it focuses on the usefulness of alternative theories of political economy, both the classical theories covered in PE 100 and the modern theories of the 20th and 21st centuries in the their historical context. The course is explicitly interdisciplinary: theories of political economy cannot do their job if they are constrained by discipinary boundaries. It is a thoeretical course: empirical and historical facts are used as aids to theoretical comprehension and yardsticks to assess the usefulness of alternative theoretical perspectives.

The first two-thirds or so of the course will introduce students to general theoretical works and current intellectual debates in political economy. The last third or so of the course will specialize. Political Economy majors here at Berkeley tend to concentrate in one of six areas:

• the political economy of post-industrial societies,
• economic late develpment and political democratization,
• international relations and globalization,
• comparative political and economic systems,
• historical issues of the Great Transformation,
• modern China.

The last third or so of each course should focus on those aspects of political economy theory that will be most useful to students concentrating in one (or at a pinch two) of these areas.

Topics:

Political economy and war, market and non-market systems, distributive justice, libertarianism and communitarianism, liberal democracy and regulated capitalism, social democracy and mixed economy, international economic orders and American hegemony, globalization, public choice, late development successes, late development failures, worlds of welfare capitalism, neoliberalism and its discontents, market reforms in post-industrial economies, transitions from communism, political economy and the digital age.

Authors:

Tentatively and provisionally, the teaching staff believe that all versions of the course taught should cover the thoughts and approaches of John Maynard Keynes, Karl Polanyi, Friedrich Hayek, Charles Lindblom, Anthony Downs, James Buchanan, Mancur Olson, Carl Schmitt, Georg Lukacs, Juergen Habermas, Antonio Gramsci, and Dani Rodrik--not necessarily through intensive reading of the works of the social scientists and moral philosophers themselves, but at least through readings that apply their theories and approaches to issues in 20th and 21st century political economy.

Authors whose works and approaches have been assigned recently in PE 101 include: George Akerlof, Benedict Anderson, Norman Angell, Hannah Arendt, Benjamin Barber, Robert Bates, Simone de Beauvoir, Isaiah Berlin, James Buchanan, Nancy Chodorow, Ronald Coase, Milovan Djilas, Anthony Downs, Barry Eichengreen, James Fallows, James Ferguson, Betty Friedan, Michel Foucault, Robert Frank, Milton Friedman, Francis Fukuyama, Alexander Gerschenkron, Peter Gourevich, Antonio Gramsci, Juergen Habermas, Peter Hall, Friedrich Hayek, Robert Heilbroner, Albert Hirschman, John Hobson, Stephen Holmes, Tony Judt, Terry Karl, John Maynard Keynes, Charles Kindleberger, Jeane Kirkpatrick, Janos Kornai, Paul Krugman, Timur Kuran, Vladimir Lenin, Arthur Lewis, Charles Lindblom, Georg Lukacs, Charles Maier, Hyman Minsky, Mancur Olson, George Orwell, William Pfaff, Karl Polanyi, John Rawls, Robert Reich, Dani Rodrik, Elaine Scarry, Carl Schmitt, Joseph Schumpeter, James Scott, Amartya Sen, Robert Shiller, Judith Shklar, Jessica Stern, Joseph Stiglitz, Gordon Tullock, Michael Walzer, Eugen Weber, Fareed Zakaria. Instructors are certainly not expected to cover all of the topics or assign all the authors listed, but they should discuss enough topics and assign enough authors to span the space of political economy.

Course Boundaries vis-a-vis PE 100:

This course covers the twentieth century world since the Great Depression, which is where PE 100 ends. At most a week should be spent on pre-Depression theorists and events in this course, allowing students to see the ways in which the project of classical political economy set the stage for new kinds of theory to be discussed in PEIS 101. John Maynard Keynes and Karl Polanyi are social scientists/moral philosophers whose thoughts straddle the boundary of the courses.

Assessments and Assignments:

The material lends itself to in-class exams, take-home exams, and research papers. Each instructor cam generate those kind of assignments that work best with that instructor’s teaching. At least three written assignments/exams should be required over the course of the semester, in order to observe student improvement. Provide studente with as many opportunities as possible to reflect upon tbe course content: it will be new and strange to many.

Course Instructional Support:

Since the last budget crisis this course is without GSI-led section support, but with readers/graders. The hope is that capping PE 101 sections at 50 will allow for meaningful interaction to take place in the lecture itself.

Sunday Victorian Industrial Monument Blogging

My father defends the Ames Monument:

UGLY!??! I'll have you know that the Ames Monument contains within itself most of 19th Century American history -- the railroad! crony capitalists! Manifest Destiny! New England duty! government extortion! congressional cynicism and betrayal! the industrial revolution! Victorian taste (it was designed by noted architect H.H. Richardson)! [Not to mention bas-reliefs by St. Gaudens]; irony (the UP moved the tracks and it now sits by itself in the middle of the lone prairie).

Next will be a pix of the Ames Shovel Museum:

By the 1870s Ames was the largest shovel manufacturer in the world, making three-fifths of the world’s shovels, although even as early as the 1830s and 1840s they struggled to meet the demand for their highly prized products. Ames shovels were the tool of choice in both the California and Australian gold rushes as well as in most major American building projects including the Erie and Panama Canals and most American railroad construction. Ames shovels literally built America.

http://maisonbisson.com/blog/post/11302/stonehill-industrial-history-center-aka-the-shovel-museum/

But my favorite is still the Allegheny Portage Railroad:

Allegheny Portage Railroad: Developing Transportation Technology: Imagine riding on horseback or hiking through the Allegheny Mountains of western Pennsylvania in the summer of 1835. A dusty road climbs through an ever narrowing ravine. You are surrounded by steep hillsides covered with towering hemlocks, many reaching over 100 feet high. A small stream, barely four feet across, tumbles down its shallow and rocky course alongside the road. Here, high in the mountains, the air is cool, despite the season, and a feeling of wilderness pervades. As you round a bend in the road you notice the sound of heavy machinery--wheels turning, engines cranking, ropes straining. You see a cloud of dark smoke belching from an unseen smokestack somewhere on the hillside to your right. Then, through a break in the trees, you glimpse the front section of a boat slowly moving up the steep slope of the mountain! There cannot possibly be a river or canal in such a location. What is more, the boat appears to be moving up a steep grade under its own power. Clearly, an unusual event in America’s transportation history is under way...

Allegheny Portage Railroad--Visual 1: The railroad portage over the Allegheny Mountains was crucial to the Pennsylvania Main Line. It joined the system's two great canals into an efficient artery between eastern and western Pennsylvania. Passengers leaving Philadelphia in 1840 could reach Pittsburgh in 4 days instead of 23. The engineering was simple in principle. In the canal basin at Hollidaysburg, the packet boat sections in which passengers had travelled from Philadelphia were floated onto railroad cars for the portage. They were hauled from the water by stationary engines, then pulled by locomotives at about 15 mph over the long grade to the first incline. In a small shed at the foot of the incline, workers hitched three cars at a time, each averaging 7,000 pounds, to the continuous cable that moved over rollers between the rails. This cable was pulled at about 4 mph by a stationary steam engine beneath a large shed at the top of the incline. When possible, the operators used cars descending on the other track to counterbalance those assending, lessening the strain on the engines. On the near-level grades between inclines, the cars were drawn by horses or locomotives. The process was reversed on the other side of the summit...

Allegheny Portage Railroad--Reading 3:

[The United States] now numbers among its many wonderful artificial lines of communication, a mountain railway, which, in boldness of design, and difficulty of execution, I can compare to no modern work I have ever seen, excepting perhaps the passes of Simplon, and Mount Cenis, in Sardinia; but even these remarkable passes, viewed as engineering works, did not strike me as being more wonderful than the Allegheny Railway in the United States.

--David Stevenson, 1838

Occasionally the rails are laid upon the extreme verge of the giddy precipice and looking down from the carriage window, the traveller gazes sheer down without a stone or scrap of fence between into the mountain depths below. The journey is very carefully made however, only two carriages travelling together and while proper precautions are taken, it is not to be dreaded for its dangers.

--Charles Dickens, 1843

The trip of a boat over the mountain is now no novel sight.... Since this road was constructed such improvements have been made in the construction of locomotives, that a project has been suggested for relocating the whole road.

--Sherman Day, 1843

At this place the western division of the Pennsylvania Canal commences, and the miserable Portage Railroad, with its short splintery rails and curvatures, its stationary steam engines and abominable inclined planes, terminates. The traveller, who has crossed the mountain over it, will not regret to leave it, but will thank the stars that a better road will soon supersede it.

--Eli Bowen, 1853

DeLong: Slow Income Growth and Absolute Poverty in the North Atlantic Region, 1800-1870 (DRAFT of Chapter 6 of Slouching Towards Utopia?: The Economic History of the World in the Long Twentieth Century 1870-2010)

Download now or preview on posterous

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Posted via email from http://braddelong.posterous.com/slow-income-growth-and-absolute-poverty-in-th at Brad DeLong's Scrapbook

Hoisted from Archives and Comments: Robert Gordon Reviews Tooze's "Wages of Destruction"

Robert Gordon:

Grasping Reality with Both Hands: "Death of the Wehrmachtl": I am currently writing a book review of the impressive Tooze book "Wages of Destruction". Contra Brad's description, this is not military history but rather economic history. My initial criterion to assess the value of the book is to ask "what is new" as compared to the Abelshauser chapter in the Mark Harrison edited (1998) volume on the Economics of World War II.

I learned two big new ideas from the Tooze book as contrasted to the huge existing literature on Nazi society and economy 1933-45. First, the push to rearmament 1933-39 was consistently forced to face a severe foreign exchange constraint. An oddity of the Nazi economy was its refusal to devalue its currency. Instead, it placed extreme constraints on imports of consumer goods. This was in addition to what everyone already knew, that the Nazi economy held down wages in order to boost profits and stimulate production and hiring.

The second big new idea in the Tooze book, which maybe everyone already knew about but has gotten lost in the focus on the Holocaust, was General Plan Ost. This was a mind-boggling plan to deport (to some unknown destination, mainly death) most of the inhabitants of non-Jewish Poland, Belorussia, and the Ukraine in order to provide "lebensraum" for German settlers. Tooze documents plans to deport as many as 40 million inhabitants. Fortunately, the reverses suffered by the German army starting with the Moscow campaign in Nov-Dec 41 postponed the General Plan Ost. According to Tooze, they tried it out on a part of Poland, and the inhabitants ran away into the forests rather than being subjected to deportation.

Brad talked about his top three WWII military histories of the last half-decade. One of the best new books is Ian Kershaw's (2007) "Fateful Choices" about strategic choices in the major capitals (London, Berlin, Moscow, Tokyo, Washington) in 1940 and 1941. This is deep and wonderful writing about the big issues of WWII -- why didn't the British negotiate with Hitler, why did Hitler decide so early (July 1940) to invade Russia, what was Roosevelt thinking in 1940-41, and the biggest puzzle of all, why did the Japanese decide to attack Pearl Harbor. A related book on strategic planning, but mainly about the U.S., is Michael Beschloss (2002) "The Conquerors" about FDR and Truman. This book's major figure is Morgenthau, and many will be interested in M's efforts to get FDR to take the ongoing holocaust seriously.

Posted by: Robert J. Gordon | February 28, 2008 at 10:59 PM

Brink Lindsey on Paul Krugman: Nostalgianomics: Liberal economists pine for days no liberal should want to revisi

Brink Lindsey shoots! He scores! The crowd goes wild!

Fun with Issuu...

http://issuu.com/delong/docs/20090601_issuu_slouching.vi

Open publication

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Origins of the Present (Financial) Crisis

Mark Thoma sends us to Paul Krugman, who argues that American financial regulation went off on the wrong track with Reagan-Garn-St. Germain:

Economist's View: Paul Krugman: Reagan Did It: Reagan... essentially ended New Deal restrictions on mortgage lending... that, in particular, limited the ability of families to buy homes without putting a significant amount of money down. These restrictions were put in place in the 1930s by political leaders who had just experienced a terrible financial crisis, and were trying to prevent another. But by 1980 the memory of the Depression had faded. Government, declared Reagan, is the problem, not the solution; the magic of the marketplace must be set free. And so the precautionary rules were scrapped.... We weren’t always a nation of big debts and low savings: in the 1970s Americans saved almost 10 percent of their income...

It was only after the Reagan deregulation that thrift gradually disappeared..., culminating in the near-zero savings rate ... on the eve of the great crisis.... All this, we were assured, was a good thing: sure, Americans were piling up debt... but their finances looked fine once you took into account the rising values of their houses and their stock portfolios. Oops. Now, the proximate causes of today’s economic crisis lie in events that took place long after Reagan... — in the global savings glut... and in the giant housing bubble that savings glut helped inflate. But it was the explosion of debt over the previous quarter-century that made the U.S. economy so vulnerable. Overstretched borrowers were bound to start defaulting in large numbers once the housing bubble burst and unemployment began to rise.

These defaults in turn wreaked havoc with a financial system that — also mainly thanks to Reagan-era deregulation — took on too much risk with too little capital. There’s plenty of blame to go around... But the prime villains behind the mess we’re in were Reagan and his circle of advisers — men who forgot the lessons of America’s last great financial crisis, and condemned the rest of us to repeat it...

The "Treasury View" and Fiscal Policy

'I can call spirits from the Vasty Deep!" "Why, so can I, and so can any man. But do they come when you call them?" Felix Salmon calls Alan Beattie of the FT and Justin Fox of Time:

What use economic history? : How relevant is economic history at times like this? I asked. Can studying history prevent us from repeating past mistakes, or does it just end up forcing us into committing new ones? And how much of a good thing is it that an economic historian is chairman of the board of governors of the Federal Reserve?

Successfully:

Beattie replied first:

yes, I think it definitely helps when looking at such once-in-a-century events to have a discipline which focuses on specific similar episodes in the past, not least because the sample size is so small. And that does seem to be having some effect on the policy response now. Despite the best efforts of some, I don’t think the Montagu Norman/Andrew Mellon liquidationist instinct or the 1930s “Treasury view” on deficit spending are getting much serious traction in the US or UK, for example. (Irrelevant trivia: I am very distantly related by marriage to Andrew Mellon - something like a third cousin three times removed. She divorced him in a spectacular case involving all sorts of legal shenanigans and managed to walk off with a sizeable chunk of the Mellon loot, though not a nickel has trickled down to me.)

but of course you need to learn the right lessons and pick the right comparator. the current German reluctance to increase fiscal stimulus, for example, seems to be assuming that this is a 1920s/1970s inflationary situation, not a 1930s deflationary one.

it is good that an economist who is also an economic historian is Fed chairman. Not sure you’d want someone who was reading entirely out of the previous playbooks without also being able to recognise that the monetary transmission mechanism has changed out of all recognition. The General Theory is a bit light on what to do about credit default swaps, for example.

Then Justin weighed in:

My book is basically the story of a bunch of guys who decided to ignore financial market history (the dodgy parts, at least) in order to create more elegant models of financial markets’ future. That didn’t work out so well, so yeah, knowing economic history would seem to be useful. But Alan’s right that there are lots of different lessons that can be drawn from the past, and sometimes people draw the wrong ones. I too am related to a liquidationist, by the way—George Washington Norris, the hard-line president of the Philly Fed in the early 1930s, was my great great uncle.

On Bernanke, I’d certainly rather have somebody with his background in that job than an ahistorical rational expectations type who believes bubbles and panics don’t happen...

And then Felix summons me:

I’d be interested in what Brad DeLong — one of the foremost economic historians of our own time — thinks about whether the “Treasury view” is getting much serious traction — I suspect he might have killed it before it had a chance to spread widely, and it certainly doesn’t seem to have been mentioned much since January 20. And in general I think that economic historians are having something of a day in the sun right now, with lots of people looking back to previous economic crises around the world, and fewer people finding modern theory-based economics particularly helpful from a policymaking perspective. Maybe economic history is a classic countercyclical asset.

I am here:

(I) With respect to the “Treasury View” that Obama's fiscal policy will be ineffective--well, I think it is very common. In the past two months across my desk I have seen it advocated by Robert Barro; Eugene Fama; John Cochrane; Luigi Zingales; Michele Boldrin; Niall Ferguson; Nobel Prize winners Gary Becker, Edward Prescott, and Robert Lucas; John Cogan; John Taylor; and Peter Klenow. Of these, only John Taylor and John Cogan on the one hand and Pete Klenow on the other had even a slightly-coherent argument based on a slightly-recognizable model. And I'm stretching it to call Taylor and Cogan's argument slightly coherent. It was that: (a) Jared Bernstein and Christie Romer say that fiscal expansion is likely to be powerful, (b) they assume a certain reaction by the Federal Reserve to fiscal expansion, (c) a reaction that makes fiscal policy so powerful that we cannot calculate its effects--our model explodes--(d) so we assume a different reaction by the Federal Reserve that makes fiscal policy much less powerful, and so (e) we find that fiscal policy is not very powerful. To which my reaction is: Huh!? Assuming that fiscal policy is not powerful is a reason to think that it is not powerful. That simply will not do.

Klenow said that (a) the Federal Reserve is not powerless to affect spending right now, (b) the Federal Reserve is happy with the projected growth path of spending, so (c) policy moves by Obama that raise the projected path of spending in the future will be offset by the Federal Reserve's raising interest rates to keep the projected growth path of spending the same. This seems to me to be false as a description of what the Federal Reserve is doing. But at least it is coherent--you can at least have a response to it other than "Huh?!"

The assumption of some version of the quantity theory of money plus the recognition that money demand is usually interest elastic create a presumption that fiscal policy is effective. There are then four coherent ways to argue to try to rebut that presumption and arrive at the "Treasury View":

1. Klenow's--that the central bank is happy with the projected growth path of spending and both can and will take action to make sure that fiscal policy is ineffective by offsetting its effects.

2. The goods-crowding out argument: that we are at full employment so workers have so much bargaining power at the moment fiscal policies that increase spending will go 100% into increasing wages and prices and 0% into increasing production and employment. This seems to me to be false.

3. The the interest-crowding out argument: that when the government sells a bond interest rates will rise and induce a private-sector firm not to sell a bond, and thus investment spending falls by as much as government spending increases. This requires that in this particular case the increase in interest rates resulting from a higher government budget deficit have no effect on the velocity of money, which could happen as a limiting case but I see no reason to think that it would happen now.

4. Increases in government spending now lead private individuals to cut back on their spending out of fear of future tax increases by so much that total spending is unchanged. This seems to me to fundamentally misunderstand the permanent income hypothesis.

The interesting thing from my perspective is that Barro, Fama, Cochrane, Zingales, Boldrin, Ferguson, Becker, Prescott, and Lucas don't appear to be making any one or any combination of the four coherent arguments for the "Treasury View." They do believe in the quantity theory of money. But either they don't believe that households and businesses respond to incentives in their money-holdings or they have not tought about the issue. And so they don't recognize that they have to make one or more of the four valid argumentative moves if they are to be coherent.

(II) Nevertheless analytical incoherence seems to be no barrier to influence. Last January I thought that the numbers from the fourth and forecast for the first quarter told us that we should (a) immediately do $1.2T of effective fiscal stimulus, and (b) stand ready--preferably by putting the money into the Budget Resolution--to do another $1.2T of effective fiscal stimulus in October with the Reconciliation Bill if things turned out to be worse than expected. We did about $0.6T of effective fiscal stimulus, nothing got into the Budget Resolution, and there is no legislative prospect for additional fiscal stimulus this year. By my count that is at least a 2/3 victory for the "Treasury View"--we are doing less than we should be doing, and certainly much less than it would be prudent to be doing, and we are doing less than we should be doing because the "Treasury View" advocates have muddied the analytical waters.

(III) As to history--well, yes, of course. Economics does not have solid foundations. We pick episodes from history that seem interesting and informative, and we crystalize these historical episodes into economic theory. But then theorists teach this crystalized history as if it were handed down from Mount Olympus. And so we wind up with a lot of young and many old economists who can manipulate theories but who do not understand what they are good for or where they come from.

Fun with Long-Run Data Series!

There is something wrong with the numbers between 1265 and 1340...

And I am unhappy with the implication that Britain today is only 11 times as rich as it was in 1800...

But this is complaining that Officer and Williamson's free ice cream doesn't have enough toppings...

Measuring Worth - Graphs of Various Historical Economic Series: Lawrence H. Officer and Samuel H. Williamson, "Graphing Various Historical Economic Series" MeasuringWorth.Com, January 2008. Please read our Note on Data Revisions.

Copyright Notice: Copyright © 2009 MeasuringWorth. All rights reserved. This work may be copied for non-profit educational uses if proper credit is given. For other permission, please contact admin@measuringworth.org.

Jacob Viner at His Most Arch

Bull, meet red flag:

Jacob Viner (1937), ["Mr. Keynes on the Causes of Unemployment"(http://www.jstor.org/stable/pdfplus/1882505.pdf): Written tho it is by a stylist of the first order, [Keynes's General Theory] is not easy to read, to master, or to appraise. An extremely wide range of problems, none of them simple ones, are dealt with in an unnecessarily small number of pages. Had the book been made longer, the time required for reading it with a fair degree of understanding would have been shorter, for the argument often proceeds at breakneck speed and repeated rereadings are necessary before it can be grasped. The book, moreover, breaks with traditional modes of approach to its problems at a number of points--at the greatest possible number of points, one suspects--and no old term for an old concept is used when a new one can be coined, and if old terms are used new meanings are generally assigned to them...

Jacob Viner (1933), "Balanced Deflation, Inflation, or More Depression"

Perhaps the most important single document with respect to how much the Chicago School of Economics has forgotten over the past seventy-five years--how much less they know now than Irving Fisher or Knut Wicksell did.

As I understand things, Jacob Viner's estate has rights to this document until 2040, and there is at present no way for me to get permission to legally distribute it. So I think it is time to hoist the jolly roger...

Download now or preview on posterous: 20090527_viner_lecture.pdf

Jacob Viner (1933), "Balanced Deflation, Inflation, or More Depression" (Minneapolis: University of Minnesota).

---

Posted via email from http://braddelong.posterous.com/viner-balanced-deflation-inflation-or-more-de at Brad DeLong's Scrapbook

The Chicago School on Dealing with Depression in 1933 II

Click here to download:

Davis (1968),

J. Ronnie Davis (1968), "Chicago Economists, Deficit Budgets, and the Early 1930s," American Economic Review 58:3,1 (June), pp. 476-481.

---

Posted via email from http://braddelong.posterous.com/the-chicago-school-on-dealing-with-depression at Brad DeLong's Scrapbook

The Chicago School on Dealing with Depression in 1933 I

Milton Friedman in "A Comment on the Critics" approvingly quotes Jacob Viner's (1933) "Balanced Deflation, Inflation, or More Depression":

Even more pertinent is a talk Viner delivered in Minneapolis of February 20, 1933, on "Balanced Deflation, Inflation, or More Depression"....

[I]t woul dhve been sound policy on the part of the federal government deliberately to permit a deficit to accumulate during depression years, to be liquidated in prosperity years.... The outstanding though unintentional achievement of the Hoover Administration in counteracting the depression has in fact been its deficits of the last two years....

[...]

I will use the term 'inflation' to mean an inrease in the total amount of spendable funds.... It is often said that the federal government and the Federal Reserve system have practiced inflation during this depression and that no beneficial effects resulted from it. What in fact happened was that they made mild motions in the direction of inflation.... At no time... since the beginning of the depression has there been for so long as four months a net increase in the total volume of bank credit....

Assjming for the moment that a deliberate policy of inflation should be adopted, the simplest and least objectionable procedure would be for the federal government to increase its expenditures or decrease its taxes, and to finance the resultant excess of expenditures over tax revenues either by the issue of legal tender greenbacks or by borrowing from the banks...

---

From J. Rennie Davis (1968), "Chicago Economists, Deficit Budgets, and the Early 1930s," American Economic Review 58:3,1 (June), pp. 476-481:

Frank H. Knight to Senator Robert F. Wagner (May 8, 1932): As far as I know, economists are completely agreed that the Government should spend as much and tax as little as possible at a time such as this--using the expenditure in ways to do the most good in itself and also to point toward relieving the depression...

Jacob Viner (1931): [T]he public works or other useful services so financed [by deficit spending] during a period of economic depression are from the national economic point of view almost costless...

Time to Think About Next Semester's Teaching...

Econ 115: The Economic History of the Twentieth Century:

Initial Take on Lecture Topics: Econ 115: Twentieth Century Economic History: Fall 2009: U.C. Berkeley

Economics 115: Fall 2009: TTh 12:30-2, F295 Haas

Th Aug 27: I: Overview (II: Growth; III; Fluctuations; IV: Distribution; V: Systems and Politics)

T Sep 1: VI: Slow Income Growth and the Absolute Poverty of the North Atlantic, 1800-1870

Th Sep 3: VII: No Income Growth and the Dire Absolute Poverty of the Globe, 1800-1870

T Sep 8: VIII: The Invention of Invention: Modern Economic Growth Comes to the North Atlantic, 1870-1914

Th Sep 10: IX: The Iron-Hulled Ocean-Going Steamship: One Economic World, Indivisible, 1870-1914

T Sep 15: X: Democracy, 1870-1914

Th Sep 17: XI: Empire, 1870-1914

T Sep 22: FIRST EXAM (pre-WWI/police the reading/instructor reality check)

Th Sep 24: XII: The Knot of War: 1914-1920 and After

T Sep 29: XIII: Trying to Keep Believing in Progress, 1920-1929

Th Oct 1: XIV: The Business Cycle and the Great Depression, 1825-1940

T Oct 6: XV: Nazis, Bolsheviks, Fascists, Socialists, and Social Democrats, 1870-1933

Th Oct 8: XVI: Dealing with the Imperial West, 1914-1950

T Oct 13: XVII: Total War and Cold Peace, 1933-1955

Th Oct 15: XVIII: Social Democracy in One (North Atlantic) Region, 1920-1975

T Oct 20: SECOND EXAM (1914-1950)

Th Oct 22: XIX: From Colonialism to Neocolonialism: Import Substitution, State Building, and Divergence, 1940-1980

T Oct 27: XX: Stalin, Mao, and Their Heirs 1926-1990

Th Oct 29: XXI: Japan and the Stubborn Boundaries of the "First World", 1870-1990

T Nov 3: XXII: 1980: At the Peak of the Great Divergence: One World Unequal and Very Divisible

Th Nov 5: XXIII: Social Democracy Exhausted: 1970-1995

T Nov 10: XXIV: Neocolonialism and Neoliberalism Triumphant, 1980-2000

Th Nov 12: XXV: Decommunization, 1975-2010

T Nov 17: XXVI: China (and India) Stand Up, 1975-2010

Th Nov 19: XXVII: True Wealth Is Informational and Biological, 1940-2020

T Nov 24: XXVIII: The First True Global Division of Labor, 1970-2010

Th Nov 26: NO CLASS

T Dec 1: XXIX: Things Falling Apart? 2000-2010

Th Dec 3: XXX: The Return of Malthus, 1970-2200

T Dec 8: THIRD EXAM (1950-2010)

F Dec 18: FINAL EXAM 12:30-3:30pm

As If an Invisible Hand Had Played a Losing Card...

Gavin Kennedy sets out all the things that Adam Smith did not mean by "invisible hand," and the historical process of misreading by which the phrase acquired the meaning we give it.

What did Smith mean? These:

• That the love of power and authority by the rich induces them to trade real resources to the poor in return for deference, which has an enormous levelling effect on the true distribution of income.
• That the fear of merchants of the strange and foreign leads them to concentrate their investments at home to the benefit of domestic workers.

Smith focused--quite rightly--on what Kenneday aptly terms "emergent order." "Invisible hand" is a metaphor we use for "emergent order." But Smith did not use it so.

But Daniel Klein comments on Gavin Kennedy, and strikes out. It is not even clear that Klein knows what home plate is, and that he is supposed to swing the bat over it:

We will never know whether Smith intended the phrase invisible hand to serve as a tag for the comparative merit of freedom. It certainly is not outlandish to think that he did. As Minowitz (2004, 407) puts it, Smith all but “evicts God” from WN, making the invisible hand all the more striking.... Gavin notes that the phrase appears only infrequently in Smith’s work.... But... [t]hat the phrase appears close to the center, and but once, in TMS and in WN might be taken as evidence that Smith did intend for us to take up the phrase.

It is fun... to speculate that... Smith had the notion of invisible hand occurring but once in each of his masterworks, and in each case near the center. The invisible hand passage in WN is just about dead center. As for TMS, Hamish Riley-Smith... has kindly informed me that the invisible hand passage occurs at page 273, while the whole is 436 pages plus 10 unnumbered pages including title and contents.... In the 6th edition, however, the passage comes closer to the center. Moreover, the 3rd, 4th, 5th, and 6th editions were published with Smith’s essay on language following the text of TMS, and hence in those editions the passage may have been quite close to the center of the combined pages.... But it does not much matter whether Smith intended the phrase to serve as a tag for the comparative merit of freedom. The phrase is as worthy a tag as any for that worthy idea...

Berkeley Political Economy 100: Reference Document DRAFT

Title:

Classical Theories of Political Economy

Prerequisites:

NONE

Sequence:

Ideally students intending to major in Political Economy should complete PE 100 by the middle of their sophomore year.

Objectives:

Students must apply critical thinking skills to engage classical theories of political economy as they were originally written in primary sources. These primary sources may be bolstered, should the instructor choose, with some additional reading material explicating salient points of each text. The course should generally be chronological. Students should engage the writers and their ideas, and confront the ideas of one theorist with those of another, so that they can see hoq ideas grow out of other ideas in their particular historical contexts.

Students should learn the basic historical thinking skills, among them analysis; argumentation; chronological reasoning; interpretation; contextualization; comparison; and synthesis. Students should also be given practice at other critical thinking skills, such as Inquiry, as the instructor sees fit.

Topics:

The principal aim of the course is to engage the students with the central question of political economy: the evolving relationship between the state and the economy as analyzed in the “classical” texts which discuss (1) connections between people and their rulers; (2) the nature and purpose of the state; and (3) linkages between states and their economies. The inevitable focus of the course is the rise of liberalism and the various responses to it

Subjects that ought to be covered in each iteration of PE 100 include but are not limited to: mercantilism, capitalism, industrialization, liberalism, Marxism, socialism, imperialism, nationalism, and internationalization. Students should be constantly considering the applicability of the "classical" theories to the present day. Instructors follow their own judgment in assigning relative weight to these subjects and the degree of engagement of the course with current headlines.

Authors:

Thomas Hobbes, Leviathan; John Locke, Two Treatises on Government; Adam Smith, Wealth of Nations; Jean-Jacques Rousseau, Discourse on Inequality and/or On Social Contract; Mary Wollstonecraft, Vindication of the Rights of Women; Thomas Malthus, Essay on Population; David Ricardo, Principles of Political Economy; Friedrich List, National System of Political Economy; Karl Marx, Das Kapital; Karl Polanyi, The Great Transformation; Max Weber, “On Bureaucracy” and/or The Protestant Ethic and the Spirit of Capitalism; V.I. Lenin, “Imperialism: the Highest Stage of Capitalism”; Joseph Schumpeter, Imperialism. In addition, students should be familiar with the work of J.M. Keynes

Course Boundaries vis-a-vis PE 101:

This course covers the early modern world (but may go back to antiquity or the middle ages) and the modern world ending with the Great Depression, which is where PE 101 will begin. At most a week should be spent on Keynesian political economy in this course, allowing students to see the ways in which he synthesized the classical theorists and set the stage for new kinds of theory to be discussed in PEIS 101.

Assessments and Assignments:

The material lends itself to in-class exams, take-home exams, and research papers. Each instructor cam generate those kind of assignments that work best with that instructor’s teaching. At least three written assignments/exams should be required over the course of the semester, in order to observe student improvement. Provide studente with as many opportunities as possible to reflect upon tbe course content: it will be new and strange to many

Course Instructional Support

This course has--until the next budget crisis--weekly GSI-led sections. Students find the material difficult, and having a regular weekly discussion section is usually the best way for them both to practice their critical thinking skills and internalize content.

---

Appendix: The Larger Barrington Moore Problematic:

Thomas Hobbes, Leviathan

John Locke, Second Treatise of Government, Letter on Toleration

Jean-Jacques Rousseau, Discourse on the Origin of Inequality, The Social Contract

David Hume, Of Commerce, Of the Balance of Trade, Of the Original Contract, Idea of a Perfect Commonwealth

Bernard de Mandeville, Fable of the Bees

Albert Hirschman, The Passions and the Interests

Adam Smith, Theory of the Moral Sentiments, Inquiry into the Nature and Causes of the Wealth of Nations

Thomas Paine, Common Sense

James Madison, Alexander Hamilton, and John Jay, The Federalist

Mary Wollstonecraft, A Vindication of the Rights of Women

William Godwin, An Enquiry Considering Political Justice

Edmund Burke, Reflections on the Revoution in France, Letters on a Regicide Peace

Joseph de Maistre, Essay on the Generative Principle of Political Constitutions

Thomas Malthus, Essay on Population

David Ricardo, Principles of Political Economy

Friedrich List, The National System of Political Economy

Alexis de Tocqueville, The Old Regime and the French Revolution, Democracy in America, Recollections

Karl Marx, Introduction to the Critique of Hegel's Philosophy of Justice, Communist Manifesto, Wage Labor and Capital, Class Struggles in France, Preface to A Contribution to the Critique of Political Economy, Capital, Critique of the Gotha Program

Thomas Carlyle, Occasional Discourse on the Nigger Question

John Stuart Mill, Essay on Bentham, Essay on Coleridge, On Liberty, The Subjection of Women, Principles of Political Economy

Max Weber, Politics as a Vocation, Science as a Vocation, The Chinese Literati, The Protestant Ethic and the Spirit of Capitalism, The City, Class, Status, Party, Bureaucracy

Thorstein Veblen, The Theory of the Leisure Class

Emile Durkheim, Elementary Forms of the Religious Life

Vladimir Lenin, Imperialism: the Highest Stage of Capitalism

Joseph Schumpeter, Imperialism

Sigmund Freud, Group Psychology and the Analysis of the Ego, Civilization and Its Discontents

John Maynard Keynes, The Economic Consequences of the Peace, Essays in Persuasion

Karl Polanyi, The Great Transformation

Barrington Moore, Social Origins of Dictatorship and Democracy

How Much Intellectual Steam Did the Conservative Movement Ever Have?

Richard Posner writes that the American conservative movement is losing intellectual steam:

Is the Conservative Movement Losing Steam? Posner: Until the late 1960s (when I was in my late twenties), I was barely conscious of the existence of a conservative movement. It was obscure and marginal... Barry Goldwater... Ayn Rand, Russell Kirk, and William Buckley--figures who had no appeal for me. More powerful conservative thinkers... Milton Friedman... Friedrich Hayek... George Stigler, were on the scene, but were not well known outside the economics profession.

The domestic disorder of the late 1960s, the excesses of Johnson's "Great Society," significant advances in the economics of antitrust and regulation, the "stagflation" of the 1970s, and the belief (which turned out to be mistaken) that the Soviet Union was winning the Cold War--all these developments stimulated the growth of a varied and vibrant conservative movement... free-market economics... "neoconservatism" in the sense of a strong military and a rejection of liberal internationalism... cultural conservatism, involving respect for traditional values, resistance to feminism and affirmative action, and a tough line on crime.

The end of the Cold War, the collapse of the Soviet Union, the surge of prosperity worldwide that marked the global triumph of capitalism, the essentially conservative policies, especially in economics, of the Clinton administration, and finally the election and early years of the Bush Administration, marked the apogee of the conservative movement.... By the end of the Clinton administration, I was content to celebrate the triumph of conservatism as I understood it, and had no desire for other than incremental changes.... I saw no need for the estate tax to be abolished, marginal personal-income tax rates further reduced, the government shrunk, pragmatism in constitutional law jettisoned in favor of "originalism," the rights of gun owners enlarged, our military posture strengthened, the rise of homosexual rights resisted, or the role of religion in the public sphere expanded. All these became causes embraced by the new conservatism that crested with the reelection of Bush in 2004....

[T]he policies of the new conservatism are powered largely by emotion and religion and have for the most part weak intellectual groundings... weak in conception... failed in execution... political flops.... The major blows to conservatism... have been fourfold: the failure of military force to achieve U.S. foreign policy objectives; the inanity of trying to substitute will for intellect as in the denial of global warming, the use of religious criteria in the selection of public officials, the neglect of management and expertise in government; a continued preoccupation with abortion; and fiscal incontinence in the form of massive budget deficits, the Medicare drug plan, excessive foreign borrowing, and asset-price inflation.

By the fall of 2008, the face of the Republican Party had become Sarah Palin and Joe the Plumber. Conservative intellectuals had no party.

And then came the financial crash last September and the ensuing depression. These unanticipated and shocking events have exposed significant analytical weaknesses in core beliefs of conservative economists concerning the business cycle and the macroeconomy generally. Friedmanite monetarism and the efficient-market theory of finance have taken some sharp hits, and there is renewed respect for the macroeconomic thought of John Maynard Kenyes, a conservatives' bête noire...

At least Posner knows (unlike his co-blogger Gary Becker) what "conservatism" means.

But is he arguing that conservatism has lost steam or that it never had much steam in the first place?

Richard Posner sees things wrong with Bush era conservatism:

• fiscal incontinence
• the inanity of trying to substitute will for intellect
• cultural-conservative issues ("continued preoccupation with abortion" "religious criteria in the selection of public officials")
• the failure of military force as a first resort in attempting to achieve U.S. foreign-policy objectives

But weren't these also the key components of the Reagan administration. Ronald Reagan was the original fiscal incontinence. And the substitution of will for intellect--was it ever any greater than in the rush to cut taxes to raise revenues, or in Alexander Haig's belief that U.S. national security would be enhanced if the IDF gave the Syrian army a thrashing in Lebanon? We had to rely on the alliance of Nancy Reagan and her astrologer to get a sane policy toward Gorbachev, for God's sake. And cultural conservatives--if I understand Posner, his complaint is that Reagan paid them only lip service and they patiently sat in the back of the bus and were quiet, while Bush, Palin, and Joe the Plumber take them seriously.

And, of course, the piece of Reagan-era conservatism of which Posner was most proud--deregulation and the trimming-back of government--has either turned out to be (a) destructive, or (b) accomplished by Carter and Clinton.

How much intellectual steam did hte conservative movement ever have?

Progress in Macroeconomics?

A decade ago, Olivier Blanchard, now IMF chief economist, wrote that there had been a lot of progress in macroeconomics since 1920:

What Do We Know that Fisher and Wicksell Did Not?: The answer to the question... is: A lot.... Pre 1940. A period of exploration.... From 1949 to 1980. A period of consolidation... an integrated framework was developed--starting with the IS-LM, all the way to dynamic general equilibrium models--and used to clarify the role of shocks and propagation mechanisms.... since 1980. A new period of exploration, focused on the role of imperfections... nominal price setting... incompleteness of markets... asymmetric information... search and bargaining in decentralized markets....

[...]

The right [picture] is one of a steady accumulation of knowledge.... [R]evolutionaries make the news... [their ideas are] discarded... bastardized, then integrated. The insights become part of the core....

[...]

Relative to Wicksell and Fisher, macroeconomics today is solidly grounded in a general equilibrium structure. Modrn models characterize the economy as being in temporary equilibrium, given the implications of the past, and the anticipations of th efuture. They provide an interpretation of shocks working their way through propagation mechanisms...

[...]

One way to end is to ask: Of how much use was macroeconomic research in understanding... the Asian crisis?... Macroeconomists did not predict either the time, place, or scope of the crisis.... [W]hen the crisis started, macroeconomic mistakes... were made. But fairly quickly the nature of the crisis was better understood, and the mistakes correcxted. And most of the tools needed were there.... since then, a large amount of further research has taken place, leading to a better understanding of the role of financial intermediaries in exchange-rate crisis...

Even then Paul Krugman snarked:

Paul Krugman recently wondered how many macroeconomists still believe in the IS-LM model. The answer is probably that most do, but many of them probably do not know it well enough to tell..

Today things look considerably different on the progress-in-macroeconomics front. John Quiggin:

Refuted/obsolete economic doctrines #7: New Keynesian macroeconomics at John Quiggin: [Here is] a new entry for my list of refuted economic doctrines... the target... has... [been] rendered obsolete by events... New Keynesianism an approach to macroeconomics, to which Akerlof and Shiller have made some of the biggest contributions, but which they have now... repudiated.... [T]he research task was seen as one of identifying minimal deviations from the standard [rational foresight, self-interest, and competiative markets] microeconomic assumptions which yield Keynesian macroeconomic conclusions.... Akerlof’s ‘menu costs’ arguments... are an ideal example of this kind of work. New Keynesian macroeconomics has been tested by the current global financial and macroeconomic crisis and has, broadly speaking, been found wanting. The analysis of those Keynesians who warned of impending crisis combined an ‘old Keynesian’ analysis of mounting economic imbalances with a Minskyan focus on financial instability.... [T]he policy response... has been informed mainly by old-fashioned ‘hydraulic’ Keynesianism... massive economic stimulus... large-scale intervention in the financial system. The opponents of Keynesianism have retreated even further into the past, reviving the anti-Keynesian arguments of the 1930s and arguing at length over policy responses to the Great Depression.

There is of course, still a need to explain why wages do not adjust rapidly to clear labour markets in the face of an external financial shock. But in an environment where the workings of sophisticated financial markets display collective irrationality on a massive scale, there is much less reason to be concerned about the fact that such an explanation must involve deviations from rationality, and seeking to minimise those deviations....

New Keynesianism... was a defensive adjustment to the dominance of free market ideas.... New Keynesians sought a theoretical framework that would justify medium-term macroeconomic management based on manipulation of interest rates by central banks, and a fiscal policy that allowed automatic stabilisers to work, against advocates of fixed monetary rules and annual balanced budgets. But now that both... the efficient markets hypothesis and the policy framework that brought us the Great Moderation have collapsed, there is no need for such a defensive stance...

George Akerlof and Robert Shiller agree with Quiggin rather than Blanchard:

Akerlof and Shiller, Animal Spirits: The economics of the textbooks seeks to minimise as much as possible departures from pure economic motivation and from rationality.... [E]ach of us has spent a good portion of his life writing in this tradition. The [self-interest and rational foresight-based] economics of Adam Smith is well understood. Explanations in terms of small deviations from Smith’s ideal system are thus clear because they are posed within a framework that is already very well understood. But that does not mean that these small deviations from Smith’s system describe how the economy actually works.... In our view, economic theory should be derived not from the minimal deviations from the system of Adam Smith but rather from the deviations [from competitive markets, self-interested motivation, and rational foresight] that actually do occur...

So does Greg Clark: his rant from his seat as chair of the U.C. Davis Economics Department:

Dismal scientists: how the crash is reshaping economics - The Atlantic Business Channel: In the long post WWII boom, as free market ideology triumphed, economists have won for themselves a privileged place inside academia.... [C]ash.... Not much by the pornographic standards of finance, but a fat paycheck compared to your average English or Physics professor. It is not just the stars.  Journeyman assistant professors in economics routinely come in at $100,000 or more... fresh from their PhDs, without a publication to their name and without years of low pay as post-docs. The high salaries have been accompanied by dramatic declines in the teaching burden....

Why did academic economics generate so much prestige?... [W]hat drove demand was the unquenchable thirst for economists by banks, government agencies, and business schools - the Feds, the Treasury, the IMF, the World Bank, the ECB.  Economics had powerful insights to offer the world, insights worth a lot of treasure.  Economics was powerful voodoo....

The current recession has revealed... as useless the mathematical contortions of academic economics. There is no totemic power.... (1) Almost no-one predicted the world wide downtown.  Academic economists were confident that episodes like the Great Depression had been confined to the dust bins of history. There was indeed much recent debate about the sources of "The Great Moderation" in modern economies, the declining significance of business cycles.... [M]acroeconomists had turned their considerable talents to a bizarre variety of rococo academic elaborations.  With nothing of importance to explain, why not turn to the mysteries of online dating, for example.... (2) The debate about the bank bailout, and the stimulus package, has all revolved around issues that are entirely at the level of Econ 1.  What is the multiplier from government spending?  Does government spending crowd out private spending?  How quickly can you increase government spending? If you got a A in college in Econ 1 you are an expert in this debate: fully an equal of Summers and Geithner. The bailout debate has also been conducted in terms that would be quite familiar to economists in the 1920s and 1930s.  There has essentially been no advance in our knowledge in 80 years....

Bizarrely, suddenly everyone is interested in economics, but most academic economists are ill-equipped to address these issues. Recently a group of economists affiliated with the Cato Institute ran an ad in the New York Times opposing the Obama's stimulus plan.  As chair of my department I tried to arrange a public debate between one of the signatories and a proponent of fiscal stimulus -- thinking that would be a timely and lively session.  But the signatory, a fully accredited university macroeconomist, declined the opportunity for public defense of his position on the grounds that "all I know on this issue I got from Greg Mankiw's blog -- I really am not equipped to debate this with anyone." Academic economics will no doubt survive this shock to its prestige.... [But] the days of the $500,000 economics professor may have passed.... [W]ill the focus of academic economics change?... I would rate the chances of Chrysler producing once again a competitive US automobile at least as high as the chances of academic economics learning any lesson from this downturn...

Watching the scrum over the past six months, I have to call this one for Krugman, Clark, Akerlof, Shiller, and Quiggin and against Blanchard's vision of growing knowledge and analytical convergence. Economists have been worrying about the industrial business cycle and the proper role of the government in trying to tame it since 1825. Yet there are an extraordinary number of people out there calling themselves macroeconomists who do not have the slightest clue as to what the issues have been over the past two hundred years.

Notes for Econ 210a: May 6, 2009: The Great Divergence

Start with Marx:

Karl Marx (1853),"The Future Results of British Rule in India," New York Daily Tribune (August 8): The political unity... imposed by the British sword, will now be strengthened and perpetuated by the electric telegraph. The native army, organized and trained by the British.... The free press.... From the Indian natives... educated at Calcutta under English superintendence, a fresh class is springing up, endowed with the requirements for government and imbued with European science. Steam has brought India into regular and rapid communication with Europe.... The day is not far distant when... the distance between England and India, measured by time, will be shortened to eight days, and when that once fabulous country will thus be actually annexed to the Western world....

[N]ow the ... millocracy have discovered that the transformation of India into a reproductive country has become of vital importance... [and] it is necessary... to gift her with means of irrigation and of internal communication. They intend now drawing a net of railroads over India....

I know that the English millocracy intend to endow India with railways with the exclusive view of extracting at diminished expenses the cotton and other raw materials.... But... [y]ou cannot maintain a net of railways... without introducing all those industrial processes necessary to meet the immediate and current wants of railway locomotion, and out of which there must grow the application of machinery to those branches of industry not immediately connected with railways. The railway-system will therefore become, in India, truly the forerunner of modern industry... the capacities and expertness of the native engineers in the Calcutta mint... the natives attached to the several steam engines in the Burdwan coal districts.... Mr. Campbell himself... is obliged to avow “that the great mass of the Indian people possesses a great industrial energy, is well fitted to accumulate capital, and remarkable for a mathematical clearness of head and talent for figures and exact sciences.” “Their intellects,” he says, “are excellent.”

Modern industry, resulting from the railway system, will dissolve the hereditary divisions of labor, upon which rest the Indian castes.... All the English bourgeoisie may be forced to do will neither emancipate nor materially mend the social condition of the mass of the people.... But what they will not fail to do is to lay down the material premises for both. Has the bourgeoisie ever done more? Has it ever effected a progress without dragging individuals and people through blood and dirt, through misery and degradation?...

The bourgeois period of history has to create the material basis of the new world... universal intercourse... the transformation of material production into a scientific domination of natural agencies. Bourgeois industry and commerce create these material conditions.... When a great social revolution shall have mastered the results of the bourgeois epoch, the market of the world and the modern powers of production, and subjected them to the common control of the most advanced peoples, then only will human progress cease to resemble that hideous, pagan idol, who would not drink the nectar but from the skulls of the slain...

What went wrong?

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Lant Pritchett, "Divergence, Big Time":

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Lewis: The Evolution of the International Economic Order:

"How did the world come to be divided into industrial countries and agricultural countries?"

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rodrik: Getting Interventions Right: How Korea and Taiwan Grew Rich:

Neocolonial origins of economic development:

Role of the Cold War in Asia?

Cryptic Note to Self: I Will Never Understand Chicago Today...

"But monetary policy can still be very effective: you just have to buy things other than Treasury bonds in your open-market operations..."

So you grow the money stock: what does that do? Unless your expansionary monetary policy raises short-term interest rates--in which case it is not what I at least think of as expansionary monetary policy--it moves you by the little red line--and it creates a huge excess demand-inflation problem whenever interest rates return to their normal (black) levels as shown by the big black arrow.

By contrast, fiscal policy--or perhaps flow-of-funds policy: fiscal and banking policy--that sops up the flow of savings and raises short-term safe nominal interest rates gets you quickly to the blue arrow--with no long-run monetary-overhang problem to produce a big burst of inflation later.

More to follow...

A Present for Me

Friedrich A. Hayek (2009), Contra Keynes and Cambridge: Essays, Correspondence, Bruce Campbell Caldwell, ed. (Liberty Fund).

Hoisted from Archives: DeLong and Eichengreen: Post-WWII Europe in the Argentine Mirror

Grasping Reality with Both Hands: DeLong and Eichengreen: Post-WWII Europe in the Argentine Mirror: What Barry Eichengtreen and I wrote back in 1991:

The 1930’s in Europe had seen not chronic bottlenecks but chronic deficiencies of aggregate demand. Production had fallen far below normal for the entire decade; market forces had failed to restore demand to normal levels. Circumstances during the Great Depression had been exceptional, but circumstances in the aftermath of World War II were exceptional as well. Many feared the return of the Depression.

In fact (aside from the possibility that fear of a renewed Great Depression would act as a self-fulfilling prophecy) the return of the Great Depression was a less likely possibility in the 1940’s than was generally feared. The memory of the Depression, and the greater strength and incorporation of social democratic political movements in government kept right-wing governments from adopting policies of out-and-out national deflation. The availability of the large United States market to European exports--especially with the coming of the Korean War Boom and NATO in the early 1950’s--prevented any large world aggregate demand shortfall as in the Great Depression. With the American locomotive under full steam, Western European economies were unlikely to suffer from prolonged Keynesian demand-shortfall depressions.

Nevertheless, a live possibility in the absence of the Marshall Plan was that governments would not stand aside and allow the market system to do its job. In the wake of the Great Depression, many still recalled the disastrous outcome of the laissez-faire policies then in effect. Politicians were predisposed toward intervention and regulation: no matter how damaging “government failure” might be to the economy, it had to be better than the “market failure” of the Depression. Had European political economy taken a different turn, post-World War II European recovery might have been stagnant. Governments might have been slow to dismantle wartime allocation controls, and so have severely constrained the market mechanism. In fact the Marshall Plan era saw a rapid dismantling of controls over product and factor markets in Western Europe, and the restoration of price and exchange rate stability. An alternative scenario would have seen the maintenance and expansion of wartime controls in order to guard against substantial shifts in income distribution. The late 1940’s and early 1950’s might have seen the creation in Western Europe of allocative bureaucracies to ration scarce foreign exchange, and the imposition of price controls on exportables in order to protect the living standards of urban working classes.

The likely consequences of such alternative policies for post-World war II Europe can be seen in the Argentine mirror. In response to the social and economic upheavals of the Depression, Argentina adopted demand stimulation and income redistribution. These policies were coupled with a distrust of foreign trade and capital, and an attraction to the use of controls instead of prices as allocative mechanisms. Argentina’s growth performance in the post-World War II period was very poor. Even in the 1950’s, and even relative relative to Britain, Argentine growth was slow.

Díaz Alejandro (1970) provides a standard analysis of Argentina’s post-World War II economic stagnation. According to his interpretation, the collapse of world trade in the Great Depression was a disaster of the first magnitude for an Argentina tightly integrated into the world division of labor. While Argentina continued to service its foreign debt, its trade partners took unilateral steps to shut it out of markets. The experience of the Depression justifiably undermined the nation’s commitment to free trade.

In this environment Juan Domingo Perón gained mass political support. Taxes were increased, agricultural marketing boards created, unions supported, urban real wages boosted, international trade regulated. Perón sought to generate rapid growth and to twist terms of trade against rural agriculture and redistribute wealth to urban workers who did not receive their fair share. The redistribution to urban workers and to firms that had to pay their newly increased wages required a redistribution away from exporters, agricultural oligarchs, foreigners, and entrepreneurs.

The Perónist program was not prima facie unreasonable given the memory of the Great Depression, and it produced almost half a decade of very rapid growth. Then exports fell sharply as a result of the international business cycle as the consequences of the enforced reduction in real prices of rural exportables made themselves felt. Agricultural production fell because of low prices offered by government marketing agencies. Domestic consumption rose. The rural sector found itself short of fertilizer and tractors. Squeezed between declining production and rising domestic consumption, Argentinian exports fell. By the first half of the 1950’s the real value of Argentine exports was only 60 percent of the depressed levels of the late 1930’s, and only 40 percent of 1920’s levels. Due to the twisting of terms of trade against agriculture and exportables, when the network of world trade was put back together, Argentina was by and large excluded.

The consequent foreign exchange shortage presented Perón with unattractive options. First, he could attempt to balance foreign payments by devaluing to bring imports and exports back into balance in the long run and in the short run by borrowing from abroad.29 But effective devaluation would have entailed raising the real price of imported goods and therefore cutting living standards of the urban workers who made up his political base. Foreign borrowing would have meant a betrayal of his strong nationalist position. Second, he could contract the economy, raising unemployment and reducing consumption, and expand incentives to produce for export by decontrolling agricultural prices.30 But once again this would have required a reversal of the distributional shifts that had been the central aim of his administration.

The remaining option was one of controlling and rationing imports. Not surprisingly, Perón and his advisors chose the second alternative, believing that a dash for growth and a reduction in dependence on the world economy was good for Argentina. Díaz Alejandro writes:

First priority was given to raw materials and intermediate goods imports needed to maintain existing capacity in operation. Machinery and equipment for new capacity could neither be imported nor produced domestically. A sharp decrease in the rate of real capital formation in new machinery and equipment followed. Hostility toward foreign capital, which could have provided a way out of this difficulty, aggravated the crisis...

Subsequent governments did not fully reverse these policies, for the political forces that Perón had mobilized still had to be appeased. Thus post-World War II Argentina saw foreign exchange allocated by the central government in order to, first, keep existing factories running and, second, keep home consumption high. Third and last priority under the controlled exchange régime went to imports of capital goods for investment and capacity expansion.

As a result, the early 1950’s saw a huge rise in the price of capital goods. Each percentage point of total product saved led to less than half a percentage point’s worth of investment. Díaz Alejandro found “[r]emarkably, the capital... in electricity and communications increased by a larger percentage during the depression years 1929-39 than… 1945- 55,” although the 1945–55 government boasted of encouraging industrialization. Given low and fixed agriculture prices, hence low exports, it was very expensive to sacrifice materials imports needed to keep industry running in order to import capital goods. Unable to invest, the Argentine economy stagnated.

In 1929 Argentina had appeared as rich as any large country in continental Europe. It was still as rich in 1950, when Western Europe had for the most part reattained pre-World War II levels of national product. But by 1960 Argentina was poorer than Italy and had less than two-thirds of the GDP per capita of France or West Germany. One way to think about post-World War II Argentina is that its mixed economy was poorly oriented: the government allocated goods, especially imports, among alternative uses; the controlled market redistributed income. Thus neither the private nor the public sector was used to its comparative advantage: in Western Europe market forces allocated resources--even, to a large extent, for nationalized industries--the government redistributed income, and the outcome was much more favorable.

In the absence of the Marshall Plan, might have Western Europe followed a similar trajectory? In Díaz Alejandro's estimation, four factors set the stage for Argentina’s relative decline: a politically-active and militant urban industrial working class, economic nationalism, sharp divisions between traditional elites and poorer strata, and a government used to exercising control over goods allocation that viewed the price system as a tool for redistributing wealth rather than for determining the pattern of economic activity.

From the perspective of 1947, the political economy of Western Europe would lead one to think that it was at least as vulnerable as Argentina to economic stagnation induced by populist overregulation. The war had given Europe more experience than Argentina with economic planning and rationing. Militant urban working classes calling for wealth redistribution voted in such numbers as to make Communists plausibly part of a permanent ruling political coalition in France and Italy. Economic nationalism had been nurtured by a decade and a half of Depression, autarky and war. European political parties had been divided substantially along economic class lines for a generation.

Yet post-World War II western Europe avoided this trap. After World War II Western Europe’s mixed economies built substantial redistributional systems, but they were built on top of and not as replacements for market allocations of goods and factors. Just as post-World War II Western Europe saw the avoidance of the political-economic “wars of attrition” that had put a brake on post-World War I European recovery, so post-World War II Western Europe avoided the tight web of controls that kept post-World War II Argentina from being able to adjust and grow...

The Effects of Fiscal Policy in 2009 and Beyond: A Discussion of Cogan-Cwik-Taylor-Wieland

STANFORD INSTITUTE FOR ECONOMIC POLICY RESEARCH ANNUAL POLICY FORUM 2009

The Effects of Fiscal Policy in 2009 and Beyond:

A Discussion of Cogan-Cwik-Taylor-Wieland

J. Bradford DeLong

University of California at Berkeley and NBER

brad.delong@gmail.com; http://delong.typepad.com/; +1 925 708 0467

May 1, 2009

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Last March I got a note from Ward Hanson asking me to come down today and talk about:

the impact of the Stimulus Bill on jobs creation… the contrast between the Romer/Bernstein estimates of the benefits of the stimulus plan versus… Cogan, Taylor et. al. that estimate/argue that there will be very little benefit…. I've got agreement from the "Taylor group" to present, as well as Martin Giles of the Economist Magazine to serve as a moderator…

So I said yes. And Tuesday afternoon I sat down to reread Romer and Bernstein (2009), which I had read before, and Cogan, Cwik, Taylor, and Wieland (2009), which I had not, and I ran into a problem.

On page 2 Cogan et al. write that their Figure 1 shows how Romer and Bernstein think government spending affects the economy alongside:

exactly the same policy change… in another study… by one of us [John Taylor]… the results are vastly different…. [T]he Romer-Bernstein estimates apparently fail a simple robustness test, being far different from existing published results of another model…

Source: Cogan et al. (2009).

This surprised me. I had talked to Christy. I had talked to Jared. I knew that their intention had been to pull standard models off the shelf and use them--not to push the envelope in economic modeling in any way.

So I dug--and found that Cogan et al.’s claim of “exactly the same policy change” was simply wrong. Romer-Bernstein model an increase in government spending with the Federal Reserve expanding and keeping on expanding the money supply in order to keep the short-term Treasury Bill interest rate the same. Taylor (1993) models an increase in government spending with the Federal Reserve contracting the real money supply to push the short-term Treasury Bill interest rate up over time as unemployment falls and inflation creeps up. There is no “robustness” problem with Romer-Bernstein at all: the results are different because the policy changes are different. Expanding the money supply on the one hand, contracting it on the other.

“Geez,” my first thought was, “this is embarrassing—none of four coauthors of Cogan actually read Romer-Bernstein. Sloppy.” Then I got to page 5 of Cogan: “Romer and Bernstein assume that the Federal Reserve pegs the interest rate—the federal funds rate—at the current level of zero…” Cogan et al. know perfectly well that the policy changes are not “exactly the same.” They just say they are.

I am sorry. In Europe, that gets you four red cards. In America, that gets you sent to the showers. The first intellectual responsibility of critique is to accurately present what you are critiquing. When Cogan et al. learn that they can come back into the game. But not until then.

Cogan is simply not what it is being sold as--a critique of the argument of Romer-Bernstein. It should not be taken as such.

I could stop here.

But I have extra time.

I think the best way for me to spend the rest of my time is to lay out why right now at this moment someone like Christy Romer--fundamentally a monetarist, a believer in monetary policy, author of papers on how it was monetary expansion that substantially alleviated the Great Depression in the late 1930s--is now a believer in, a designer of, and an advocate for Barack Obama’s plan to give the U.S. economy a fiscal boost to try to cushion the current fall in employment.

The analysis I am going to give is essentially that carried out nearly eighty years ago by one of Milton Friedman’s teachers, Jacob Viner, in his analysis of the Great Depression when he called for “large and continuous deficit budgets to combat the mass unemployment and deflation of the times.” Friedman applauded Viner’s analysis and saw it as superior to those of others like John Maynard Keynes: “so far as policy was concerned,” Friedman wrote in the early 1970s, “Keynes had nothing to offer those of us who had sat at the feet of [Henry] Simons, [Lloyd] Mints, [Frank] Knight, and [Jacob] Viner…”

Start with Robert Lucas’s observation that in a modern economy you cannot deflate--you cannot have the total nominal volume of spending fall--without having production, sales, and employment falls as well.

And also start with the quantity theory of money:

PY = MV

The total flow of spending in the economy--the amount produced and sold Y times the prices at which goods and services are sold P--is equal to the stock of money in the economy M--bank reserves, cash, checking-account balances, other liquid assets--times the velocity of money V. If PY threatens to fall--threatening a fall in production and sales and a rise in unemployment—then the standard policy Jacob Viner, Milton Friedman, and Christy Romer would recommend would be to boost M. Provided that V does not move in the opposite direction to offset the increase in M, nominal spending will stabilize and deflation and depression and high unemployment will be averted.

The loose end is V--how fast households and businesses spend their cash balances. Milton Friedman in Studies in the Quantity Theory of Money maintained that the key determinant of velocity is the (nominal) interest rate: the higher are nominal interest rates, the higher is velocity because the faster you want to spend your money. Holding purchasing power in cash rather than in bonds is expensive when interest rates are high: you would rather either spend it and buy something or move it back into bonds that pay interest rather than keep it around idle. The velocity of money of money is low when interest rates are low because delaying purchases while you comparison shop is not costly: you lose little in foregone interest that you could have been earning.

This dependence of velocity on the interest rate puts a limit on the effectiveness of monetary expansion. When you expand the money stock you increase the ratio of money to bonds. By simple supply and demand raise the price of bonds in terms of money—and the price of bonds in terms of money is the inverse of the interest rate. So when you raise the money stock, you lower velocity.

This matters when interest rates on assets like Treasury Bills get very low, like zero, like they are now. If you hold your money in a six-month Treasury Bill you get essentially no interest--0.3% per year Monday afternoon--and you run the small risk that interest rates might rise over the next month and your Bill might lose a little value. If you hold your money in cash you get exactly no interest and it is safe--FDIC insured. Thus there is no economic incentive pushing you to spend your cash when interest rates are very low. And so there is no economic reason for the velocity of money to be any particular value. When the central bank tries to boost nominal spending through standard monetary expansion it might prove ineffective: interest rates will drop even closer to zero as the ratio of money to bonds rises, and the velocity of money might well drop to offset the boost to the money stock.

Guess where we are now? The Federal Reserve is boosting the money supply with extraordinary force, and the velocity of money is dropping like a stone.

In order to ensure that monetary expansion is effective, you need to do something to boost interest rates. What can you? Here is where “large and continuous deficit budgets” comes in. When the government runs a deficit it floods the market with bonds. Once again by simple supply and demand more bonds means a lower price of bonds which is the same thing as higher interest rates. The government cannot hold on to the money it gets from selling bonds for that would reduce the money stock, and the whole point of the exercise is to make the increase in the money stock effective. It has to return the money to the private sector by spending it. And it can spend it in four ways:

• By buying up assets like mortgage-backed securities.
• By buying up companies like Fannie Mae, Freddie Mac, AIG, GM, Citigroup, and more to come.
• By refunding the money to taxpayers by cutting taxes.
• By spending the money directly--boosting government purchases.

Which of these ways would be most effective at keeping the velocity of money from falling further to offset expansionary monetary policy? The answer is that we really do not know which of the ways would be most effective--and that is the reason that we are trying them all right now, with Tim Geithner buying GM and mortgage-backed securities with the government’s money and Peter Orszag directing the flow of spending and tax cuts that is the American Recovery and Reinvestment Plan.

Will it work? It is hard to see how it could not work. Nobody disputes that in normal times monetary expansion boosts spending, demand, production, and employment. But the worry is that these times right now appear to be not-normal. Nobody disputes that in not-normal times when interest rates are very low--as they are now--there are no strong incentives to spend cash working to keep monetary velocity from falling to offset increases in the money supply. Purchasing insurance against this eventuality--which appears to be a reality outside the building--seems a reasonable thing to do.

Is this a good use of the government’s money? It does, after all, saddle us with additional government debt. If we did not spend money on the stimulus program now, we could use that debt capacity for some other, different purpose in the future. But as of 4 PM EDT on Monday, the U.S. government could borrow for seven years at a real interest rate I estimate at –0.5% per year. Government expenditures on national security, on Medicare, on the Center for Disease Control, on the Interstate Highway System, on research and development into green energy technologies would have to be extraordinarily and uniquely inefficient right now for them not to be worth doing right now when they come with the extra bonus of making monetary policy effective in the current situation.

Will it be big enough, or will in two years we wish we had done more? I think the odds are one-in-three that in two years we wish we would have done more, and that the odds are close to zero that in two years we wish we would have done less.

Thus my analysis of the stimulus program is quite positive. And this analysis, remember, is not mine alone. It is modeled on the analysis of Milton Friedman’s teachers at the University of Chicago in the 1930s--men of whom he highly approved as having left him nothing to learn at the feet of John Maynard Keynes, men who called for a two-handed approach to the Great Depression:

• “the Federal Reserve banks systematically pursue open-market operations with the double aim of facilitating necessary government financing and increasing the liquidity of the banking structure…”
• “the use of large and continuous deficit budgets to combat the mass unemployment and deflation of the times…”

That two-handed strategy is the approach we are pursuing now, in a situation that in its level of short-term interest rates has considerable similarities to the Great Depression.

It seems a wise and prudent bet.

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References

John Cogan, Tobias Cwik, John Taylor, and Volker Wieland (2009), “Old Keynesian versus New Keynesian Government Spending Multipliers” < http://www.volkerwieland.com/docs/CCTW%20Mar%202.pdf>.

Milton Friedman (1972), “Comment on the Critics of ‘Milton Friedman’s Monetary Framework’,” Journal of Political Economy.

Milton Friedman, ed. (1956), Studies in the Quantity Theory of Money.

Christina Romer and Jared Bernstein (2009), “The Job Impact of the American Recovery and Reinvestment Plan” http://otrans.3cdn.net/45593e8ecbd339d074_l3m6bt1te.pdf.

John Taylor (1993), Macroeconomic Policy in a World Economy: From Econometric Design to Practical Operation.

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Download now or preview on posterous

Notes for April 29 Econ 210a Class: "Thirty Glorious Years"

John Maynard Keynes (1926), "The End of Laissez Faire" http://tinyurl.com/dl20090112ad

Paul Krugman, "Introduction" to John Maynard Keynes, The General Theory of Employment, Interest and Money http://tinyurl.com/dl20090112z

Barry Eichengreen (1996), "Institutions and Economic Growth: Europe Since 1945," in Nicholas Crafts and Gianni Toniolo (eds), Economic Growth in Europe Since 1945 (Cambridge University Press), pp. 38-72 http://tinyurl.com/dl20090112x

Mancur Olson (1996), "The Varieties of Eurosclerosis: The Rise and Decline of Nations Since 1982," in Nicholas Crafts and Gianni Toniolo (eds), Economic Growth in Europe Since 1945, (Cambridge, Cambridge University Press), pp.73-94 http://tinyurl.com/dl20090112x

J. Bradford DeLong (1995), "America’s Only Peacetime Inflation: The 1970s," in Christina Romer and David Romer, eds., Reducing Inflation: Motivation and Strategy (University of Chicago Press), pp.-, http://tinyurl.com/dl20090112v

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The End of the Presumption of Laissez-Faire

John Maynard Keynes (1926), "The End of Laissez Faire" http://tinyurl.com/dl20090112ad

The idea of a divine harmony between private advantage and the public good is already apparent in Paley. But it was the economists who gave the notion a good scientific basis. Suppose that by the working of natural laws individuals pursuing their own interests with enlightenment in condition of freedom always tend to promote the general interest at the same time! Our philosophical difficulties are resolved-at least for the practical man, who can then concentrate his efforts on securing the necessary conditions of freedom. To the philosophical doctrine that the government has no right to interfere, and the divine that it has no need to interfere, there is added a scientific proof that its interference is inexpedient. This is the third current of thought, just discoverable in Adam Smith, who was ready in the main to allow the public good to rest on 'the natural effort of every individual to better his own condition', but not fully and self-consciously developed until the nineteenth century begins. The principle of laissez-faire had arrived to harmonise individualism and socialism, and to make at one Hume's egoism with the greatest good of the greatest number. The political philosopher could retire in favour of the business man - for the latter could attain the philosopher's summum bonum by just pursuing his own private profit. Yet some other ingredients were needed to complete the pudding. First the corruption and incompetence of eighteenth-century government, many legacies of which survived into the nineteenth. The individualism of the political philosophers pointed to laissez-faire. The divine or scientific harmony (as the case might be) between private interest and public advantage pointed to laissez-faire. But above all, the ineptitude of public administrators strongly prejudiced the practical man in favour of laissez-faire - a sentiment which has by no means disappeared. Almost everything which the State did in the eighteenth century in excess of its minimum functions was, or seemed, injurious or unsuccessful. On the other hand, material progress between 1750 and 1850 came from individual initiative, and owed almost nothing to the directive influence of organised society as a whole. Thus practical experience reinforced a priori reasonings. The philosophers and the economists told us that for sundry deep reasons unfettered private enterprise would promote the greatest good of the whole. What could suit the business man better? And could a practical observer, looking about him, deny that the blessings of improvement which distinguished the age he lived in were traceable to the activities of individuals ‘on the make’? Thus the ground was fertile for a doctrine that, whether on divine, natural, or scientific grounds, state action should be narrowly confined and economic life left, unregulated so far as may be, to the skill and good sense of individual citizens actuated by the admirable motive of trying to get on in the world...

Let us clear from the ground the metaphysical or general principles upon which, from time to time, laissez-faire has been founded. It is not true that individuals possess a prescriptive ‘natural liberty’ in their economic activities. There is no ‘compact’ conferring perpetual rights on those who Have or on those who Acquire. The world is not so governed from above that private and social interest always coincide. It is not so managed here below that in practice they coincide. It is not a correct deduction from the principles of economics that enlightened self-interest always operates in the public interest. Nor is it true that self-interest generally is enlightened; more often individuals acting separately to promote their own ends are too ignorant or too weak to attain even these. Experience does not show that individuals, when they make up a social unit, are always less clear-sighted than when they act separately. We cannot therefore settle on abstract grounds, but must handle on its merits in detail what Burke termed “one of the finest problems in legislation, namely, to determine what the State ought to take upon itself to direct by the public wisdom, and what it ought to leave, with as little interference as possible, to individual exertion.”...

I will illustrate what I have in mind by two examples. (1) I believe that in many cases the ideal size for the unit of control and organisation lies somewhere between the individual and the modern State.... (2).... The important thing for government is not to do things which individuals are doing already, and to do them a little better or a little worse; but to do those things which at present are not done at all.... Many of the greatest economic evils of our time are the fruits of risk, uncertainty, and ignorance. It is because particular individuals, fortunate in situation or in abilities, are able to take advantage of uncertainty and ignorance, and also because for the same reason big business is often a lottery, that great inequalities of wealth come about; and these same factors are also the cause of the unemployment of labour, or the disappointment of reasonable business expectations, and of the impairment of efficiency and production. Yet the cure lies outside the operations of individuals; it may even be to the interest of individuals to aggravate the disease. I believe that the cure for these things is partly to be sought in the deliberate control of the currency and of credit by a central institution, and partly in the collection and dissemination on a great scale of data relating to the business situation, including the full publicity, by law if necessary, of all business facts which it is useful to know...

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Paul Krugman, "Introduction" to John Maynard Keynes, The General Theory of Employment, Interest and Money http://tinyurl.com/dl20090112z

In the spring of 2005 a panel of “conservative scholars and policy leaders” was asked to identify the most dangerous books of the 19th and 20th centuries. You can get a sense of the panel’s leanings by the fact that both Charles Darwin and Betty Friedan ranked high on the list. But The General Theory of Employment, Interest, and Money did very well, too. In fact, John Maynard Keynes beat out V.I. Lenin and Frantz Fanon. Keynes, who declared in the book’s oft-quoted conclusion that “soon or late, it is ideas, not vested interests, which are dangerous for good or evil,” [384] would probably have been pleased.... Stripped down, the conclusions of The General Theory might be expressed as four bullet points: (1) Economies can and often do suffer from an overall lack of demand, which leads to involuntary unemployment. (2) The economy’s automatic tendency to correct shortfalls in demand, if it exists at all, operates slowly and painfully. (3) Government policies to increase demand, by contrast, can reduce unemployment quickly. (4) Sometimes increasing the money supply won’t be enough to persuade the private sector to spend more, and government spending must step into the breach. To a modern practitioner of economic policy, none of this – except, possibly, the last point – sounds startling or even especially controversial. But these ideas weren’t just radical when Keynes proposed them; they were very nearly unthinkable. And the great achievement of The General Theory was precisely to make them thinkable...

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Barry Eichengreen (1996), "Institutions and Economic Growth: Europe Since 1945," in Nicholas Crafts and Gianni Toniolo (eds), Economic Growth in Europe Since 1945 (Cambridge University Press), pp. 38-72 http://tinyurl.com/dl20090112x

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Mancur Olson (1996), "The Varieties of Eurosclerosis: The Rise and Decline of Nations Since 1982," in Nicholas Crafts and Gianni Toniolo (eds), Economic Growth in Europe Since 1945, (Cambridge, Cambridge University Press), pp.73-94 http://tinyurl.com/dl20090112x

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J. Bradford DeLong (1995), "America’s Only Peacetime Inflation: The 1970s," in Christina Romer and David Romer, eds., Reducing Inflation: Motivation and Strategy (University of Chicago Press), pp.-, http://tinyurl.com/dl20090112v

Is Anything Karl Marx Wrote After He Turned Thirty Worthwhile?

Circling around again to Chris Bertram's whine about how lousy my "evaluating Karl Marx as an economist" lecture is, and how he would do something else:

Explaining Marx to newbies: Suppose I were lecturing about Karl Marx: I’d do the same thing. I’d probably start by discussing some of the ideas in the Manifesto about the revolutionary nature of the bourgeoisie, about their transformation of technology, social relations, and their creation of a global economy. Then I’d say something about Marx’s belief that, despite the appearance of freedom and equality, we live in a society where some people end up living off the toil of other people. How some people have little choice but to spend their whole lives working for the benefit of others, and how this compulsion stops them from living truly truly human lives. And then I’d talk about Marx’s belief that a capitalist society would eventually be replaced by a classless society run by all for the benefit of all. Naturally, I’d say something about the difficulties of that idea. I don’t think I’d go on about Pol Pot or Stalin, I don’t think I’d recycle the odd bon mot by Paul Samuelson, I don’t think I’d dismiss Hegel out of hand, and I don’t think I’d contrast modes of production with Weberian modes of domination...

Something occurs to me: Bertram thinks that the lecture should be exclusively about the Communist Manifesto and before. Karl Marx wrote the Communist Manifesto when he was 29, drawing substantially on what Engels had written about the condition of British textile workers in Manchester in his Condition of the Working Class in England when he was 23. Chris Bertram doesn't think that what either of them wrote about for the rest of their lives is worth wrestling with.

That is, I think, a much harsher judgment of Karl Marx-as-economist than I would deliver...

John Kay Weighs in, Calling for a Practical Macroeconomics

Me? I think that we ought to be turning out a lot of macroeconomic historians and historians of economic thought, and that only they should be allowed to serve in government or comment on public affairs at least as far as the business cycle is concerned.

John Kay at the FT:

John Kay: How economics lost sight of real world: The past two years have not enhanced the reputation of economists.... Although more economic research has been done in the past 25 years than ever before, the economists whose names are most frequently referenced today, such as Hyman Minsky and John Maynard Keynes, are from earlier generations. Since the 1970s economists have been engaged in a grand project. The project’s objective is that macroeconomics should have microeconomic foundations. In everyday language, that means that what we say about big policy issues – growth and inflation, boom and bust – should be grounded in the study of individual behaviour.... Most economists would claim that the project has been a success... the criteria are the self-referential criteria of modern academic life....

But policymakers and the public at large are, rightly, not interested in whether models are rigorous. They are interested in whether the models are useful and illuminating – and these "rigorous" models do not score well here.... That people respond rationally to incentives, and that market prices incorporate information about the world, are not terrible assumptions. But they are not universal truths either. Much of what creates profit opportunities and causes instability in the global economy results from the failure of these assumptions. Herd behaviour, asset mispricing and grossly imperfect information have led us to where we are today.

There is not, and never will be, an economic theory of everything....

Keynes... explain[ed] that economic understanding required an amalgam of logic and intuition and a wide knowledge of facts, most of which are not precise: “a requirement overwhelmingly difficult for those whose gift mainly consists in the power to imagine and pursue to their furthest points the implications and prior conditions of comparatively simple facts which are known with a high degree of precision”. On this, as on much else, Keynes was right.

DeLong Smackdown Watch: Marx on India

Apropos of DeLong: Understanding Marx Lecture for April 20, 2009, Michael Perelman--whose knowledge of the history of economic thought far exceeds mine--takes exception to my classifying Marx's writings on the British in India as Marx in his "prophetic mode"

Michael Perelman: I have done some work on the subject. It was not Marx the prophet. The articles [on India] were directed toward Henry Carey, who was undermining Marx's position on the New York Tribune. The story is very interesting, including others, including Frederick Law Olmstead.

Marx says that Carey sent him at least one book. I have tried to locate Marx's correspondence with Carey, but have been unsuccessful.

I am not sure. When I read Marx's:

All the English bourgeoisie may be forced to do will neither emancipate nor materially mend the social condition of the mass of the people, depending not only on the development of the productive powers, but on their appropriation by the people. But what they will not fail to do is to lay down the material premises.... Has the bourgeoisie ever done more? Has it ever effected a progress without dragging individuals and people through blood and dirt, through misery and degradation?... The bourgeois period of history has to create the material basis of the new world... universal intercourse founded upon the mutual dependency of mankind... the development of the productive powers of man.... When a great social revolution shall have mastered the results of the bourgeois epoch... and subjected them to the common control of the most advanced peoples, then only will human progress cease to resemble that hideous, pagan idol, who would not drink the nectar but from the skulls of the slain...

I definitely hear the voice of Daniel and see the Great Social Revolution coming on clouds of glory...

DeLong: Econ 202b April 21, 2009 Lecture: Notes on Bubbles

Let us begin with a very long quote from Chrles Kindleberger, who in turn begins with Hyman Minsky....

[Kindleberger] is, I think, right. And here I have a problem. For it is pretty clear to me that the conventional model of bubbles is not terribly illuminating as a model of this process. The conventional model of bubbles starts with the assumption of a constant required rate of return r. It continues with a one-period equilibrium condition for the price of an asset paying a dividend dt. If there is even one rational, utility-maximizing agent in the economy, than for that agent...

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Attempted DeLong Smackdown Watch: Uncle Joe He-Who-Must-Not-Be-Named Edition

Chris Bertram has not yet learned that a lecture about Marx that does not mention Pol Pot or Joe Stalin shouts their names out more loudly than would otherwise be possible:

Explaining Marx to newbies: Suppose I were lecturing about Karl Marx.... I’d probably start by discussing some of the ideas in the Manifesto about the revolutionary nature of the bourgeoisie, about their transformation of technology, social relations, and their creation of a global economy. Then I’d say something about Marx’s belief that, despite the appearance of freedom and equality, we live in a society where some people end up living off the toil of other people. How some people have little choice but to spend their whole lives working for the benefit of others, and how this compulsion stops them from living truly truly human lives. And then I’d talk about Marx’s belief that a capitalist society would eventually be replaced by a classless society run by all for the benefit of all. Naturally, I’d say something about the difficulties of that idea. I don’t think I’d go on about Pol Pot or Stalin...

DeLong: Understanding Marx Lecture for April 20, 2009

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Understanding Karl Marx
J. Bradford DeLong
University of California at Berkeley and NBER
brad.delong@gmail.com

http://delong.typepad.com/>
+1 925 708 0467
April 20, 2009

In the beginning was Karl Marx, with his vision of how the Industrial Revolution would transform everything and be followed by a Great Communist Social Revolution—greater than the political French Revolution—that would wash us up on the shores of Utopia.

The mature Marx saw the economy as the key to history: every forecast and historical interpretation must be based on the economy's logic of development. This project as carried forward by others ran dry. Sometimes--as in, say, Eric Hobsbawm's books on the history of the nineteenth century--this works relatively well. But sometimes it led nowhere. The writing of western European history as the rise, fall, and succession of ancient, feudal, and bourgeois modes of production is a fascinating project. But the only person to try it seriously soon throws the Marxist apparatus over the side, where it splashes and sinks to the bottom of the sea. Perry Anderson's Passages from Antiquity to Feudalism and Lineages of the Absolutist State are great and fascinating books, but they are not Marxist. They are Weberian. The key processes in Anderson's books concern not “modes of production” but rather “modes of domination.” And when Marx and Engels's writings became sacred texts for the world religion called Communism, things passed beyond the absurd into tragedy and beyond tragedy into horror: the belief that the logic of development of the economy was the most important thing about society became entangled in the belief that Joe Stalin or Mao Zedong or Pol Pot or Kim Il Sung or Fidel Castro was our benevolent master and ever-wise guide.

But let us go back to a time before Marxism lost its innocence. Let us go back and look at the thinker, Karl Marx, and what he actually wrote and thought.

Karl Marx had a three part intellectual trajectory. He started out as a German philosopher; became a French-style political activist, political analyst, and political historian; and ended up trying to become a British- style economist and economic historian. At the start of his career he believed that all we had to due to attain true human emancipation was to think correctly about freedom and necessity. Later on he recognized that thought was not enough: that we had to organize, politically. And then in the final stage he thought that the political organization had to be with and not against the grain of the truly decisive factor, the extraordinary economic changes that the coming of the industrial revolution was bringing to the world.

At each stage Marx had the enthusiasm of the true-believing convert: it was never the case that philosophy alone could bring utopia, it was never the case that after the revolution all problems will be resolved, and it was never the case that the underlying economic mode of production was the base and that its evolution drove the shape of the superstructure. Karl Marx never completed the intellectual trajectory he set himself on. He tried as hard as he could to become a British-style classical economist- -a "minor post-Ricardian theorist" as Paul Samuelson once joked--but he did not make it: the late, mature Marx is mostly an economist and economic historian, but he is also part political activist--and also part prophet.

Marx the prophet, here is a sample: Marx on India:

The ruling classes of Great Britain.... The aristocracy wanted to conquer [India], the moneyocracy to plunder it, and the millocracy to undersell it. But now the... millocracy have discovered that the transformation of India into a reproductive country has become of vital importance.... They intend now drawing a net of railroads over India... exclusive view of extracting at diminished expenses the cotton and other raw materials for their manufactures....

You cannot maintain a net of railways over an immense country without introducing all those industrial processes necessary to meet the immediate and current wants of railway locomotion, and out of which there must grow the application of machinery to those branches of industry not immediately connected with railways. The railway-system will therefore become, in India, truly the forerunner of modern industry.... All the English bourgeoisie may be forced to do will neither emancipate nor materially mend the social condition of the mass of the people, depending not only on the development of the productive powers, but on their appropriation by the people. But what they will not fail to do is to lay down the material premises.... Has the bourgeoisie ever done more? Has it ever effected a progress without dragging individuals and people through blood and dirt, through misery and degradation?...

The bourgeois period of history has to create the material basis of the new world... universal intercourse founded upon the mutual dependency of mankind... the development of the productive powers of man.... When a great social revolution shall have mastered the results of the bourgeois epoch... and subjected them to the common control of the most advanced peoples, then only will human progress cease to resemble that hideous, pagan idol, who would not drink the nectar but from the skulls of the slain...

Large-scale prophecy of a glorious utopian future is bound to be false when applied to this world. The New Jerusalem does not descend from the clouds "prepared as a Bride adorned for her Husband." And a Great Voice does not declare: "I shall wipe away all tears from their eyes; and there shall be no more death, neither sorrow, nor crying, neither shall there be any more pain: for the former things are passed away..." But Marx clearly thought at some level that it would: he never got to the island of Patmos on which John the Divine lived, but there is a sense that he got too much into the magic mushrooms.

Marx the political activist. As I see it, he had three big ideas:

1. that while previous systems of hierarchy and domination maintained control by hypnotizing the poor into believing that the rich in some sense “deserved” their high seats in the temple of civilization, capitalism would–replace masked exploitation by naked exploitation. Then the scales would fall from people's eyes, for without its masking ideological legitimations unequal class society could not survive. This idea seems to me to be completely wrong. Cf. Antonio Gramsci, passim, on legitimation and hegemony. See also Fox News.

2. that even though the ruling class could appease the working class by using the state to redistribute and share the fruits of economic growth it would never do so. They would be trapped by their own ideological legitimations--they really do believe that it is in some sense “unjust” for a factor of production to earn more than its marginal product. Hence social democracy would inevitably collapse before an ideologically-based right-wing assault, income inequality would rise, and the system would collapse or be overthrown. The Wall Street Journal editorial page works day and night 365 days a year to make Marx’s prediction come true. But I think this, too, is wrong.

3. that factory work was the wave of the future, and factory work-- lots of people living in cities living alongside each other working alongside each other--would lead people to develop a sense of their common interest. Hence people would organize, revolt, and establish a free and just society in a way that they could not back in the old days when the peasants of this village were suspicious of the peasants of that one, and peasants formed not a class for themselves but, rather, a sack of potatoes which can attain no organization but simply remains a sack of potatoes. Here I think Marx mistook a passing phase for an enduring trend. Active working-class consciousness as a primary source of loyalty and political allegiance was never that strong. Nation and ethnos trump class, never more so that when the socialists of Germany told their emperor in 1914 that they were Germans first and Marxists second.

Add to these the fact that Marx's idea of the "dictatorship of the proletariat" was clearly not the brightest light on humanity's tree of ideas, and I see very little in Marx the political activist that is worthwhile today.

Marx the economist--well, Marx the economist had six big things to say, some of which are very valuable even today across more than a century and a half, and some of which are not. I would call them the three goods and the three bads:

1. Marx the economist was among the very first to recognize that the fever-fits of financial crisis and depression that afflict modern market economies were not a passing phase or something that could be easily cured, but rather a deep disability of the system--as we are being reminded once again right now, this time with Ben Bernanke, Tim Geithner, and Larry Summers in the Hot Seats. Marx pointed the spotlight in the right direction here. However, I don't think that his theory of business cycles and financial crises holds up. Marx thought that business cycles and financial crises were evidence of the long-term unsustainability of the system. We modern neoliberal economists view it not as a fatal lymphoma but rather like malaria: Keynesianism--or monetarism, if you prefer--gives us the tools to transform the business cycle from a life- threatening economic yellow fever of the society into the occasional night sweats and fevers: that with economic policy quinine we can manage if not banish the disease.

2. Marx the economist was among the very first to get the industrial revolution right: to understand what it meant for human possibilities and the human destiny in a sense that people like Adam Smith did not. In his Politics Aristotle observed that it was not possible to run a household in a way that permitted its head enough leisure and freedom to, say, become a lover of wisdom unless the household owned slaves, and that this would be true unless and until we had instruments like "the statues of Daedalus, or the tripods of Hephaestus, which, says the poet, 'of their own accord entered the assembly of the Gods;' if, in like manner, the shuttle would weave and the plectrum touch the lyre without a hand to guide them, chief workmen would not want servants, nor masters slaves..." Karl Marx was among the very first to see that the industrial revolution was giving us the statues of Daedalus, the tripods of Hephaestus, looms that weave and lyres that play by themselves--and thus opens the possibility of a society in which we people can be lovers of wisdom without being supported by the labor of a mass of illiterate, brutalized, half-starved, and overworked slaves.

3. Marx the economist got a lot about the economic history of the development of modern capitalism in England right--not everything, but he is still very much worth grappling with as an economic historian of 1500-1850. Most important, I think, are his observations that the benefits of industrialization do take a long time--generations--to kick in, while the costs of redistributions and power grabs in the interest of market efficiency and the politically- powerful rising mercantile classes kick in immediately. You have to take seriously the idea that the industrial revolution did not make most or even many people better off right away. Reflect also that, as Tyler Cowen observes, capitalist systems can produce less autonomy than small scale production. Standards of living do rise from industrialization--which can undercut the cultures and networks of suppliers that make the choice of a petit bourgeois lifestyle sustainable.

Now on to the three bads:

1. Marx believed that capital is not a complement to but a substitute for labor. Thus technological progress and capital accumulation that raise average labor productivity also lower the working-class wage. Hence the market system simply could not deliver a good or half-good society but only a combination of obscene luxury and mass poverty. This is an empirical question. Marx's belief seems to me to be simply wrong.

2. Marx the economist did not like the society of the cash nexus. He believed that a system that reduced people to some form of prostitution--working for wages and wages alone--was bad. He saw a society growing in which worked for money, and their real life began only when the five o’clock whistle blows--and saw such an economy as an insult, delivering low utility, and also sociologically and psychologically unsustainable in the long run. Instead, he thought, people should view their jobs as expressions of their species-being: ways to gain honor or professions that they were born or designed to do or as ways to serve their fellow- human. Here, I think, Marx mistook the effects of capitalism for the effects of poverty. The demand for a world in which people do things for each other purely out of beneficence rather than out of interest and incentives leads you down a very dangerous road, for societies that try to abolish the cash nexus in favor of public- spirited benevolence do not wind up in their happy place. We neoliberal economists shrug our shoulders and say that we are in favor of a market economy but not of a market society, and that there is no reason why people cannot find jobs they like or insist on differentials that compensate them for jobs they don’t.

3. Marx believed that the capitalist market economy was incapable of delivering an acceptable distribution of income for anything but the briefest of historical intervals. As best as I can see, he was pushed to that position by watching the French Second Republic of 1848-1851, where the ruling class comes to prefer a charismatic mountebank for a dictator--"Napoleon III"--over a democracy because dictatorship promises to safeguard their property in a way that democracy will not. Hence Marx saw political democracy as only surviving for as long as the rulers could pull the wool over the workers' eyes, and then collapsing. I think that Western Europe over the past fifty years serves as a significant counterexample. It may be difficult to maintain a democratic capitalist market system with an acceptable distribution of income. But "incapable" is surely too strong. Beveridgism or Myrdalism--social democracy, progressive income taxes, a very large and well-established safety net, public education to a high standard, channels for upward mobility, and all the panoply of the twentieth-century social- democratic mixed-economy democratic state can banish all Marx’s fears that capitalist prosperity must be accompanied by great inequality and great misery.

The good things that Marx was able to think must, I believe, be credited to his own account--to his thoughtfulness, his industry, his intelligence, and his desperate desire to try to get things right. The bad things have, I believe, two of his intellectual origins: Marx's beginnings in German philosophy, and the fact that he hooked up in the 1840s with Friedrich Engels whose family owned textile factories in Manchester. German philosophy, or perhaps rather Hegel. I remember reading Capital for the first time. The first three sections of chapter 1 seemed (a) boring, and (b) tautological. For example:

When, at the beginning of this chapter, we said in common parlance that a commodity is both a use value and an exchange value, we were, accurately speaking, wrong. A commodity is a use value or object of utility and a value. It manifests itself as this twofold thing that it is as soon as its value assumes an independent form – viz., the form of exchange value. It never assumes this form when isolated but only when placed in a value or exchange relation with another commodity of a different kind. When once we know this such a mode of expression does no harm...

And then I hit section 4: "The Fetishism of Commodities and the Secret Thereof":

A commodity is… a mysterious thing… in it the social character of men’s labour appears to them as an objective character stamped upon the product… the relation of the producers to the sum total of their own labour is presented… as a social relation… not between themselves but between the products…. In the same way the light from an object is perceived by us not as the subjective excitation of our optic nerve but as the objective form of something outside the eye…. But in the act of seeing there is at all events an actual passage of light from one thing to another, from the external object to the eye. There is a physical relation between physical things. But it is different with commodities. There the existence of the things quâ commodities and the value relation between the products of labour which stamps them as commodities have absolutely no connection with their physical properties… [I]t is a definite social relation between men that assumes in their eyes the fantastic form of a relation between things… we must have recourse to the mist-enveloped regions of the religious world… the productions of the human brain appear as independent beings endowed with life and entering into relations both with one another and the human race. So it is in the world of commodities with the products of men’s hands. This I call the Fetishism which attaches itself to the products of labour so soon as they are produced as commodities…. This Fetishism of commodities has its origin, as the foregoing analysis has already shown, in the peculiar social character of the labour that produces them...

Marx describes this as coquett[ing] with the modes of expression peculiar to [Hegel].

Put me on record as saying that this “coquetting” is profoundly unhelpful.

What is going on here? What I think is going on inside Marx's head is something strange. To say that "the value relation[s] between the products of labour... have absolutely no connection with their physical properties" is simply wrong: if the coffee beans are rotten--or if their caffeine level is low--they have no value at all, for nobody will buy them. Marx says that the value of a good is something inscribed within it and attached to it--the socially-necessary labor time for its production—that then bosses people around. And it is the values--not the prices at which things are actually bought and sold--that are the elements of the real important reality. And those values: "appear as independent beings endowed with life and entering into relation both with one another and the human race." Now I have never found anybody who thinks this way.

Nobody I talk to believes that "values" are objective quantities inherent in goods by virtue of the time it took to produce them.

Everybody I talk to believes that things are both (a) useful to me and (b) useful to other people, and moreover (c) we live in a society where we exchange stuff--where we, in Adam Smith's words, truck, barter, and exchange. If the combination of my wealth and its usefulness to me makes me value it the most, then I use it--it is to me what Marx calls a use value. If there is somebody else out there whose combination of their wealth and its usefulness to them makes them value it more than I do, then I trade it away to them directly or indirectly for stuff that I value more--they consume it, and it is to me what Marx calls an exchange value. But what Marx calls exchange values are really use values to others: a combination of (a) bargaining power--wealth--and (b) utility to actual concrete breathing humans. Things have value not because of the abstraction that socially-necessary labor time is needed to produce them but because of the concretion that somebody somewhere wants to use it and has something ese that others find useful to trade in turn. What Marx calls the mysterious and bizarre dual character of commodities is nothing mysterious or bizarre: it is simply the fact that I am not the only person in the world, and that things very useful to me may be less useful to others, and vice versa.

Moreover, capitalist production has nothing to do with what Marx describes as this mysterious dual character of commodities. The distinction between use-value and exchange-value is not something invented by or peculiar to the capitalist mode of production: it is found in all human societies, no matter how large or small, no matter what the glue that holds them together. The cattle slaughtered and cooked by the thralls of Hrothgar, King of the Geats, have use-value to Hrothgar: He and his family can eat (some of) them. The cattle have exchange-value to Hrothgar as well: He feeds them to his warriors at their nightly banquets in his great hall of Heorot. In exchange for livery and maintenance, the warriors fight Hrothgar's wars. Success in war gains Hrothgar more thralls, more cattle, and a bigger and better reputation as a great drighten worth following--until Grendel comes along and makes eating Hrothgar's cattle in exchange for following him into battle too hazardous to life and limb.

In my view, Marx has trapped himself. He has been primed to expect a deeper layer of real reality underneath mere appearances. And he has chosen the wrong model of the underlying real reality--the labor theory of value, which is simply not a very good model of the averages around which prices fluctuate. Socially-necessary labor power usually serves as an upper bound to value--if something sells for more, then a lot of people are going to start making more of them, and the prices at which it trades are going to fall. But lots of things sell for much less than the prices corresponding to their socially-necessary labor power lots of the time. And so Marx vanishes into the swamp which is the attempt to reconcile the labor theory of value with economic reality, and never comes out.

This matters because one conclusion Marx reaches is that markets and their prices are a source of oppression--that they aren't sources of opportunity (to trade your stuff or the stuff you make to people who value it more) but rather of domination by others and unfreedom: the system forces you to sell your labor-power for its value which is less than the value of the goods you make. And it is that conclusion that human freedom is totally incompatible with wage-labor or market exchange that leads the political movements that Marx founded down very strange and very destructive roads.

I've done Hegel. Now let me do Manchester.

The British interests of the German partnership of Ermen and Engels were not in London or in Birmingham but instead in Manchester. Engels's 1845 Condition of the Working Class in England, cribbed for section 1 of the Manifesto, was about the condition of the working class in Manchester. Yet as Asa Briggs (1963) stressed most strongly, Manchester was not typical of England. Briggs quotes Tocqueville's descriptions of Manchester as a city with "a few great capitalists, thousands of poor workmen and little middle class" compared to Birmingham with "few large industries, many small industrialists... workers work in their own houses or in little workshops in company with the master himself... the working people of Birmingham seem more healthy, better off, more orderly and more moral than those of Manchester..." Briggs speculated that Engels's book would have been very different indeed had Ermen and Engels's interests been elsewhere than Manchester: "his conception of ‘class’ and his theories of the role of class in history might have been very different.... Marx might have been not a communist but a currency reformer..."

Back in 1998, we got George Boyer of Cornell to take a look at the historical circumstances of the composition of the Manifesto:

[A]verage age of death of "mechanics, labourers, and their families" in Manchester was 17, as compared to 38 in rural Rutlandshire... despite the fact that laborers’ wages were at least twice as high in Manchester... 57 percent of children born in Manchester to working class parents died before their fifth birthday.... Engels arrived in Manchester in the late fall of 1842, Britain was just beginning to recover from the deep depression of 1841-42... "crowds of unemployed working men at every street corner, and many mills were still standing idle" (Engels, 1845 [1987], pp. 121 – 22).... The Economist reported that in the first six months of 1848 [as the Manifesto was being written], 18.6 percent of the workforce in Manchester’s cotton mills was unemployed, and another 9.5 percent was on short time (Boyer, 1990, p. 235)....

John Stuart Mill (1848 [1909], p. 751)... concluded that "hitherto it is questionable if all the mechanical inventions yet made have lightened the day’s toil of any human being. They have enabled a greater population to live the same life of drudgery and imprisonment, and an increased number of manufacturers and others to make fortunes."... Marx and Engels… were not alone in asserting that the standard of living... was quite poor, and perhaps declining... during the "hungry ’40s."... [A]rmy recruits born around 1850 were shorter than those born around 1820...

It looks as though Marx and Engels wrote the Manifesto--and made their permanent intellectual commitments--in 1848, at the nadir of living standards as far as British Lancashire textile workers were considered. Their assertion that wages declined as capitalism progressed looks good up until 1848 if you take Manchester as your guide. Thereafter it proved wrong. By 1880 manual workers were earning 40% more than in 1850. Parliament began to regulate conditions of employment in the 1840s. Parliament began to regulate public health in the 1850s. Parliament doubled the urban electorate in 1867, just as volume 1 of Capital was published. Parliament gave unions official sanction to bargain collectively in the 1870s.

Marx appears to have responded to this not by rethinking his opposition to markets as social allocation mechanisms or by reworking his analyses of the dynamics of economic growth, capital accumulation, and the real wage level, but by blaming British workers for not acting according to his model in response to predictions by Marx of continued impoverishment and ever- larger business cycles that had not come to pass. Boyer quotes Marx writing in 1878 about how British workers "had got to the point when [the British working class] was nothing more than the tail of the Great Liberal Party, i.e., of the oppressors, the capitalists." And Boyer quotes Engels writing in 1894 of how "one is indeed driven to despair by these English workers... bourgeois ideas... viewpoints... narrow-mindedness..."

In the late 1870s--after the failure of the British working class to become more militant, the failure of the Paris Commune and the founding of the French Third Republic, and Bismarck's creation of a unified Prussified German Empire--Marx and Engels started to turn their attention toward Russia.

4500 words

Samuel Brittan Worries About Secular Stagnation

He writes:

A long cool look at budget deficits: it would have been much better if the UK could have entered the [current] recession with much lower initial deficit and borrowing ratios – if only because the financial markets do not understand the very good arguments for fiscal deficits in depressed times.... What fundamentally is wrong with a budget deficit? The basic argument is that if borrowing is too high the government can get into a debt trap, having to borrow more and more simply to pay the interest on past borrowings.... Keynes in his General Theory maintained, however, that the propensity to save was much greater than the private propensity to invest, not just at the bottom of a recession but more or less permanently – a state known as secular stagnation.... We could easily have a good few years in which secular stagnation might seem to prevail again, if only because of the near destruction of the world financial system. If we are in such a state then an attempt to adhere rigidly to a fiscal rule could lead to a permanent and unnecessary loss of output outweighing any welfare loss from the debt trap risk itself.

I have sympathy with those economists who favour a mainly monetary approach to sustaining demand. But I fear that the present dangers are great enough to require a belt and braces – monetary and fiscal – approach. I go back to an early suggestion of Milton Friedman... tax rates should be set to balance government spending at a hypothetical level of national income corresponding to “reasonably full employment at a pre-determined price level”... the beauty of the suggestion is that, should the economy go back to a recognisable trend growth rate, then the budget would automatically achieve the target balance. Yet should there really be secular stagnation then deficits would run on as long as necessary...

Silvio Gesell and Stamped Money: Another Thing Fisher and Wicksell Knew that Modern Economists Have Forgotten

Greg Mankiw in 2009, in the New York Times:

It May Be Time for the Fed to Go Negative : The problem with negative interest rates... is... it would be better to stick the cash in your mattress. Because holding money promises a return of exactly zero, lenders cannot offer less. Unless, that is, we figure out a way to make holding money less attractive.

At one of my recent Harvard seminars, a graduate student proposed a clever scheme to do exactly that.... Imagine that the Fed were to announce that, a year from today, it would pick a digit from zero to 9 out of a hat. All currency with a serial number ending in that digit would no longer be legal tender.... That move would free the Fed to cut interest rates below zero. People would be delighted to lend money at negative 3 percent, since losing 3 percent is better than losing 10....

The idea of making money earn a negative return is not entirely new. In the late 19th century, the German economist Silvio Gesell argued for a tax on holding money. He was concerned that during times of financial stress, people hoard money rather than lend it. John Maynard Keynes approvingly cited the idea...

Ummm... Greg... You make it sound as though Keynes noted it in an obscure footnote somewhere. But Silvio Gesell is the topic of part VI of chapter 23 of Keynes's flagship work, The General Theory of Employment, Interest and Money. And it's not just Keynes in his flagship work. There are 55,000 google hits for "Silvio Gesell." Patinkin (1993) reports that Irving Fisher advocated Gesell-based "velocity control" in his 1932 Booms and Depressions. Nobel prize-winning Maurice Allais was an advocate as well. Gerardo della Paolera and Alan Taylor are Gesell's biggest boosters today in their book Straining at the Anchor: The Argentine Currency Board and the Search for Macroeconomic Stability, 1880-1935, a University of Chicago Press book that is part of the NBER's series on "long term factors in economic development." Willem H. Buiter and Nikolaos Panigirtzoglou writing in the Economic Journal in 2003: "Overcoming the Zero Bound on Nominal Interest Rates with Negative Interest on Currency: Gesell's Solution."

This is, I think, yet another example of how much economics has lost by cutting itself off from its moral philosophical and historical roots. Something that Keynes and Fisher and the other founders of monetary economics seriously wrestled with is today seen as something unknown and new to be thought of by clever graduate students. Once again the answer to Olivier Blanchard's question "What Do We Know that Fisher and Wicksell Did Not?" is that Olivier is asking the wrong question: what did they know that we have forgotten?

Here is John Maynard Keynes writing in 1936, summarizing Silvio Gesell writing in 1916:

J.M. Keynes, General Theory of Employment, Interest and Money, chapter 23: It is convenient to mention at this point the strange, unduly neglected prophet Silvio Gesell (1862-1930), whose work contains flashes of deep insight.... [T]he English version (translated by Mr Philip Pye) being called "The Natural Economic Order". In April 1919 Gesell joined the short-lived Soviet cabinet of Bavaria as their Minister of Finance, being subsequently tried by court-martial.... Professor Irving Fisher, alone amongst academic economists, has recognised its significance. In spite of the prophetic trappings with which his devotees have decorated him, Gesell's main book is written in cool, scientific language; though it is suffused throughout by a more passionate, a more emotional devotion to social justice than some think decent in a scientist.... I believe that the future will learn more from the spirit of Gesell than from that of Marx.... Gesell's specific contribution to the theory of money and interest is... that the peculiarity of money, from which flows the significance of the money rate of interest, lies in the fact that its ownership as a means of storing wealth involves the holder in negligible carrying charges.... [H]e had carried his theory far enough to lead him to a practical recommendation, which may carry with it the essence of what is needed... the prime necessity is to reduce the money-rate of interest, and this, he pointed out, can be effected by causing money to incur carrying-costs just like other stocks of barren goods. This led him to the famous prescription of 'stamped' money, with which his name is chiefly associated and which has received the blessing of Professor Irving Fisher.... [C]urrency...would only retain their value by being stamped each month, like an insurance card, with stamps purchased at a post office. The cost of the stamps... should be roughly equal to the excess of the money-rate of interest (apart from the stamps) over the marginal efficiency of capital corresponding to a rate of new investment compatible with full employment. The actual charge suggested by Gesell was 1 per mil. per week, equivalent to 5.2 per cent per annum.... The idea behind stamped money is sound...

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UPDATE: Ah. Here's the original draft of Greg's New York Times column http://gregmankiw.blogspot.com/2009/03/reloading-weapons-of-monetary-policy.html, with Alan Taylor weighing in. And here is Bruce Champ of the Cleveland Fed writing about this a year ago http://www.clevelandfed.org/Research/commentary/2008/0408.cfm.

The Panic of 1825: We Are Live at The Week

The Panic of 1825 - THE WEEK: If you’re not satisfied with Paul Krugman or Nouriel Roubini as your guide to the current turmoil, you can always rely on E.M. Forster. It was Forster who grasped the essential drawback of the Internet long before anyone else, depicting, in his 1909 story "The Machine Stops" a world in which individuals communicate in isolation via machine. It turns out he’s pretty good on 21st-century financial crises, too, mostly because the underlying processes remain so similar to those of a financial crisis he studied. Only the scale has changed.

Forster’s great-aunt Marianne Thornton helped raise him after his father's death, leaving him 8,000 pounds upon her death, when Forster was 8. That legacy gave him the financial cushion to become a writer. So he wrote Marianne Thornton: A Domestic Biography 1797-1887, stringing her voluminous letters together with scene-setting prose. As it happens, the fortunes of the Thornton family turn on history’s first episode of successful central banking: the Bank of England's intervention in the 1825 financial crisis.

Marianne’s younger brother, Henry Thornton, was 25 in 1825. Though the Thornton ancestors had built a successful bank, it had passed out of family control a decade earlier. But in the middle of 1825 young Henry was invited to join it as the most junior of six partners. Marianne writes of profits of 40,000 pounds a year, which is quite a lot when you reflect that Jane Austen's creation, Fitzwilliam Darcy, the richest commoner in early 19th-century England—other than Nathan Meyer Rothschild—receives (I refuse to write "earns") only 20,000 pounds a year from his estate of Pemberly. Forty thousand pounds a year in income corresponds to a market capital value of 1 million pounds, which bears the same proportion to the size of the British economy then as $10 billion would bear today.

The bank—renamed Pole, Thornton upon Henry's joining—was not small change. To join it as one of the profit-splitting partners was one hell of a 25th birthday present. But, then, these were the kind of people whose house had not an address but a name: "Battersea Rise."

And now let me turn the microphone over to 28-year-old Marianne Thornton. Writing in December 1825 to her friend Hannah More, she said: "There is just now a great pressure in the mercantile world, in the consequence of the breaking of so many of these scheming stock company bubbles."

Sound familiar? These were not bubbles in high-tech stocks or in mortgage lending and house prices, however, but bubbles in shipping lines, canals, and textile-spinning factories. And, of course, the bank of which young Henry had been a partner for only four months had gotten itself badly undercapitalized. The managing partner "had been inexcusably imprudent in not keeping more cash in the House, but relying on [the bank's] credit ... which would enable them to borrow whenever they pleased."

Except, of course, that in 1825 just as in 2009, no bank can borrow cash on the one day it really needs to, for every other bank really needs it on that same day. Which is why there came a “dreadful Saturday I shall never forget,” when a run on the bank was made, with “one old steady customer” withdrawing, without warning, his entire 30,000 pounds, leaving the bank vault “literally empty."

According to Marianne, the other bank partners fell apart: The managing partner "insisted on proclaiming themselves bankrupts at once, and raved and self-accused himself." Senior partner Scott "cried like a child of 5 years old." Partner Pole was away at his country estate. Another was on a business trip. It fell to 25-year-old Henry to deal with the fact that in the last business hour of Saturday, "they would have to pay 33,000 [pounds], and they should receive only 12,000 [pounds]. This was certain destruction."

Henry Thornton frantically searched the City of London looking to borrow money. He found banker John Smith, who always has been “particularly kind to Henry." He told Smith he could hardly expect him to lend the bank funds, but asked if Smith could at least tide them over until the 5 p.m. closing time. Smith asked if the bank was solvent and Henry gave his word. Well, then, Smith said, Pole, Thornton would have all he could spare.

“Never, [Henry] says, shall he forget watching the clock to see when 5 would strike, and end their immediate terror. ... The clock did strike ... as Henry heard the door locked, and the shutters put up, he felt [Pole, Thornton] would not open again but would be forcibly liquidated Monday morning."

There were, however, other characters in motion. Robert Banks Jenkinson, Second Earl of Liverpool, first lord of the Treasury and prime minister of His Majesty George IV, had been having whispered conversations with Bank of England Gov. Cornelius Buller and his deputy John Baker Richards. Liverpool said that it was of vital importance that the banking system of London not collapse under the weight of speculation and the popping of all those stock company bubbles.

Liverpool claimed he could not get Parliament to appopriate money to save the banks or to prop up asset prices: Parliament was populated by tax-paying landlords who did not especially trust the stock-jobbing financiers of London. Liverpool had spent much of the past year warning bankers that if their "overtrading" were followed by "revulsion" and "discredit," that he would not spend Treasury money to rescue them.

However, Liverpool told Buller, the Bank of England might. The Bank of England had a peculiar semi-private status with enormous autonomy. And everyone knew it was too big to fail—it was, after all, the bank for the entire British Empire, and the empire would stand behind it. So the Bank of England could save the situation even if the government could not. Moreover, it seems Lord Liverpool said to Buller, if it becomes necessary I want you to print up banknotes in excess of the legal limit, and to lend out your gold reserves even though the bank’s charter requires you to keep them in your vaults.

Banker John Smith had gotten wind of these conversations between Liverpool and Buller. And that Saturday evening, after the banks had closed, John Smith told Henry Thornton that if Henry truly believed that Pole, Thornton was solvent he, John Smith, would undertake to get it cash from the Bank of England. This was a shock. "[T]he Bank [of England]," Marianne Thornton wrote, "had never been known to do such a thing in the annals of banking," and so "Henry had little hope from this."

Nevertheless, the following morning, Sunday, at 8 o'clock, Bank of England Gov. Buller and Deputy Gov. John Baker Richards, along with every member of the Court of the Bank of England who was in London, were assembled to meet John Smith and Henry Thornton.

Marianne Thornton picks up the story: "John Smith began by saying that the failure of [Pole, Thornton] would occasion so much ruin that he should really regard it as a national misfortune," and he also praised Henry Thornton beyond all reason, saying "what he had seen of the conduct of one of the partners ... had convinced him that could [the bank] be saved for the moment," the crisis would pass. Smith "then turned to Henry and said, 'I think you give your word the House is solvent?' Henry said he could ... [and] had brought the books.

“'Well then', said the governor and the deputy governor of the Bank, 'you shall have 400,000 pounds by 8 tomorrow morning, which will I think float you'. Henry said he could scarcely believe what he had heard.”

I can scarcely believe it myself, even now. Blowing that number up to account for the difference between the British economy then and the British economy now, that's a $4 billion commitment secured on the word of a 25-year-old. Amazing—although there was a joke making the rounds last April that JPMorgan Chase CEO Jamie Dimond could have borrowed an extra $2 billion from the Federal Reserve if he had been willing to pledge his dog as collateral.

Monday morning, in the pre-dawn dark, Henry Thornton was at the Bank of England with Gov. Buller and Deputy Gov. Richards. For security reasons, they were alone. Buller and Richards counted out 400,000 pounds in bank notes. "I hope this won't overset you, my young man," Marianne Thornton claims one of the two said to Henry, “to see the governor and deputy governor of the Bank [of England] acting as your two clerks."

Henry Thornton arrived at his own bank before opening with 400,000 pounds in cash. The run on bank funds then recommenced. But "rumors that the Bank of England had taken them under its wing soon spread, and people brought back money [on Monday] as fast as they had taken it out on Saturday."

This was the birth of central banking as we know it.

The Bank of England had accepted the role of maintaining orderly markets and financial stability in a crisis. Why? Because the prices of financial assets are too important to be left to the market when it is panicked and when letting prices reach market levels will mean unemployment for hundreds of thousands in 1825, or tens of millions today.

Ben Bernanke's Public Private Investment Partnerships—the vehicles for purchasing banks’ toxic assets—are a natural development, even a Burkean development, of policy that has been pursued for 184 years now.

When politicians wash their hands of a financial system in crisis and fail to intervene on a large scale, things do not turn out well. The most notable example was 1929–1933, when, at least according to Herbert Hoover, Treasury Secretary Andrew Mellon persuaded Hoover that "even a panic is not altogether a bad thing” because "it will purge the rottenness out of the system.”

Did 1825 turn out better? We think so. George IV was not executed on Tower Green. Lord Liverpool's head was not carried about London on a pike. The spinning of cotton into thread in Britain in 1826 was 11 percent lower than in 1825—the first serious industrial recession—but it bounced back and grew 30 percent from 1826 to 1827.

And the bank of Pole, Thornton? Alas, Henry Thornton was irrationally exuberant when he swore that the bank was solvent. The bank was eventually closed. The partners lost their capital shares. The Bank of England had to wait years before getting its emergency loan back. (They did not care much; they were too big to fail, and Lord Liverpool thought they had done well.) Henry’s career prospered thereafter. Even though the financial ship that he had seized command of as a junior partner foundered, the consensus was that he had displayed great energy, good judgment, a cool head, and a facility with figures that made him worth backing in the future.

Mr. Keynes and the 'Classics'

When John Hicks wrote down his IS-LM model in 1937, he meant it as a halfway house between Keynes and what Keynes called "classical economics." And, indeed, it is. You can think of it in any of three ways:

1. That the LM curve (plus the inflation rate and the risk premium) tells you more-or-less what the real interest rate is, and then the Keynesian income-expenditure function does the real work of determining output, employment, and the shape of the business cycle.

2. That the IS curve (in its flow-of-funds through financial markets form) tells you more-or-less what the nominal interest rate is and thus what the velocity of money is, and then the quantity theory does the real work of determining output, employment, and the shape of the business cycle.

3. That the two sets of factors are symmetric, and that whether it is more like a Keynesian or more like a classical theory depends where on the LM curve you are--and on what the local slope of the LM curve is.

Hicks clearly thought of it as (3), Alex Tabarrok and Tyler Cowen think of it as (2), and it seems as though everybody else thinks of it as (1).

Why?

DeLong: April 9 202b Lecture Part 1: 1825: The Coming of the Industrial-Financial Business Cycle

DeLong: April 9 202b Lecture Part 2: 1825: The Coming of the Industrial-Financial Business Cycle

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The Coming of the Industrial-Financial Business Cycle: Economics 202b: April 9, 2009 Lecture

Download now or preview on posterous

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Lecture Audio:

• Part 1
• Part 2

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Posted via email from http://braddelong.posterous.com/delong-the-coming-of-the-industrial-financial at Brad DeLong's Scrapbook

Captain Swing

1830:

Sir,

Your name is down amongst the Black hearts in the Black Book and this is to advise you and the like of you, who are Parson Justasses, to make your wills. Ye have been the Blackguard Enemies of the People on all occasions, Ye have not yet done as ye ought,

Swing

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Sir,

This is to acquaint you that if your thrashing machines are not destroyed by you directly we shall commence our labours.

Signed on behalf of the whole,

Swing