Brad DeLong

Quote of the Day: April 15, 2012

"Deprived of the old government, deprived in a manner of all government, France, fallen as a monarchy, to common speculators might have appeared more likely to be an object of pity or insult, according to the disposition of the circumjacent powers, than to be the scourge and terror of them all…"

--Edmund Burke, Reflections on the Revolution in France

This Time It Is Not Different: Walter Bagehot and the Persistent Concerns of Financial Macroeconomics

http://delong.typepad.com/20120411-russell-sage-delong-paper.pdf

http://www.russellsage.org/rethinking-finance

J. Bradford DeLong: U. C. Berkeley and NBER

April 2012: DRAFT 2.4: 11905 words

ABSTRACT: When the Financial Times's Martin Wolf asked former U.S. Treasury Secretary Lawrence Summers what in economics had proved useful in understanding the financial crisis and the recession, Summers answered: “There is a lot about the recent financial crisis in Bagehot...”. “Bagehot” here is Walter Bagehot’s 1873 book, Lombard Street.

How is it that a book written 150 years ago is still close to state-of-the-art in economists’ analysis of episodes like the one that we hope is just about to end? There are three reasons. The first is that modern academic economics has long possessed drives toward analyzing empirical issues that can be successfully treated statistically and theoretical issues that can be successfully modeled on the foundation of individual rationality. But those drives are disabilities in analyzing episodes like major financial crises that come too rarely for statistical tools to have much bite, and for which a major ex post question asked of wealth holders and their portfolios is: “just what were they thinking?”. The second is that even though the causes of financial collapses like the one we saw in 2007-9 are diverse, the transmission mechanism in the form of the flight to liquidity and/or safety in asset holdings and the consequences for the real economy in the freezing-up of the spending flow and its implications have always been very similar since at least the first proper industrial business cycle in 1825. Thus a nineteenth-century author like Walter Bagehot is in no wise at a disadvantage in analyzing the downward financial spiral. The third is that the proposed cures for current financial crises still bear a remarkable family resemblance to those proposed by Walter Bagehot. And so he is remarkably close to the best we can do, even today.

• Introduction
• Say's Law
• The British Downturn of 1825-6
• Market Failure
• "Inside Money" and "Outside Money"
• E.M. Forster's Great-Aunt Marianne
• Robert Peel and Moral Hazard
• Robert Peel's Successors and "Suspension Letters"
• Bagehot's Rules
• The Great Depression
• Conclusion: From 1873-2009

This Time It Is Not Different: Walter Bagehot and the Persistent Concerns of Financial Macroeconomics: Introduction

I. Introduction

At the spring 2011 INET Conference in Bretton Woods, New Hampshire, Financial Times correspondent and columnist Martin Wolf asked:

[Doesn’t] what has happened in the past few years simply suggest that [academic] economists did not understand what was going on?...

Former U.S. Treasury Secretary Lawrence Summers, in the course of his long answer, said:

There is a lot in [Walter] Bagehot that is about the crisis we just went through. There is more in [Hyman] Minsky, and perhaps more still in [Charles] Kindleberger...

This Time It Is Not Different: Walter Bagehot and the Persistent Concerns of Financial Macroeconomics: Aggregate Demand and Aggregate Supply: Say's Law

At the beginning of economics, back at the very start of the nineteenth century, Jean-Baptiste Say (1803) wrote that the idea of a “general glut”—of economy-wide “overproduction” and consequent mass unemployment—was incoherent. Nobody, Say argued, would ever produce anything beyond what they expected to use themselves unless they planned to sell it, and nobody would sell anything unless they expected to use the money they earned in order to buy something else.

This Time It Is Not Different: Walter Bagehot and the Persistent Concerns of Financial Macroeconomics: Aggregate Demand and Aggregate Supply: The British Downturn of 1825-6

It is unfair to expect Jean-Baptiste Say to have seen this back in 1803. He did not live in an industrial economy. He had not seen a deflationary financial panic or elevated cyclical unemployment. John Stuart Mill had the advantage of having seen the first industrial business cycle in Britain in the form of the 1825-6 downturn, a downturn generated by the 1825 financial crisis, which was in its turn produced by the collapse of the early-1820s canal boom.

This Time It Is Not Different: Walter Bagehot and the Persistent Concerns of Financial Macroeconomics: Origins of Central Banking: The Market Failure

Thus by late 1825 in Britain the revaluation of assets that was the collapse of the canal boom had created a situation in which “money” was “in request”: safe, liquid stores of value were scarce relative to demand both because the financial crisis had led banks and businesses to seek to hold a greater share of their wealth in safe, liquid form and because the financial crisis meant a substantial proportion of safe and liquid “inside” assets—the debts of bankers, merchants, and industrialists presumed to be well-capitalized—were not so.

This Time It Is Not Different: Walter Bagehot and the Persistent Concerns of Financial Macroeconomics: Origins of Central Banking: "Inside Money" and "Outside Money"

The natural way to repair this market failure is for the government to temporarily supplement the “inside money” that the financial system can no longer create with its own “outside money”. It is then the task of the government to create the safe and liquid financial assets that the private market desires. The central bank should then act as the financial system’s lender-of-last-resort.

This Time It Is Not Different: Walter Bagehot and the Persistent Concerns of Financial Macroeconomics: Origins of Central Banking: E.M. Forster's Great Aunt Marianne

Our best single window into the origin of central banking in 1825 comes from English novelist E.M. Forster, whose great-aunt Marianne Thornton had helped raise him after his father's death and left him a legacy of £8,000 pounds, and who as a consequence wrote Marianne Thornton: A Domestic Biography 1797-1887,14 stringing her letters together with scene-setting prose. In the middle of 1825 Marianne Thornton’s younger brother, the 25-year-old Henry Thornton, was invited to join what had in earlier generations been the Thornton family bank as the most junior of its six partners. Marianne writes of profits of £40,000 pounds a year to be split among six partners.

This Time It Is Not Different: Walter Bagehot and the Persistent Concerns of Financial Macroeconomics: The Development of Central Banking Practice in the Mid-Nineteenth Century: Robert Peel and “Moral Hazard”

In 1844 the British Parliament took a look at the system of central-bank support for the economy in a financial crisis that the Bank of England’s intervention in 1825 had left it. It held a debate on the terms on which the charter of the Bank of England should be renewed. In the end, the conclusion of the 1844 Bank Recharter debate was twofold:

1. The Bank of England should not have the power to print unlimited amounts of money to support the banking system in a financial crisis—in fact, it should be illegal for the Bank of England to print extra banknotes in a crisis. The important principle was that bankers should be on notice that they should not expect a bailout—for that would create too great a risk of substantial losses from moral hazard.

2. In the event of a real emergency coming--which, Prime Minister Robert Peel claimed, should not happen--then the government could and would request that the Bank of England print as many banknotes as needed to fix the financial crisis.

This Time It Is Not Different: Walter Bagehot and the Persistent Concerns of Financial Macroeconomics: The Development of Central Banking Practice in the Mid-Nineteenth Century: Robert Peel’s Successors and “Suspension Letters”

But that the 1844 Bank of England Recharter Act made lender-of-last-resort operations illegal did not mean that they were not thereafter undertaken.

This Time It Is Not Different: Walter Bagehot and the Persistent Concerns of Financial Macroeconomics: From Practice Back to Theory: Walter Bagehot’s Lombard Street: Bagehot’s Rules

Thus when Walter Bagehot settled down to write his Lombard Street, he had at his back not only the analytical apparatus of British classical political economy but also half a century’s worth of policymakers’ experience at dealing with financial crises, and policymakers’ memoirs in which they reflected upon their experience. He thus had several rich veins of material to draw upon as he attempted to systematize what was known about how central banking worked in a financial crisis. The mid-nineteenth century practice of central banking he took it upon himself to rationalize and explaican be summed up simply: when, in a financial crisis, private savers want desperately to hold more safe, liquid savings vehicles, give them what they want.

From Practice Back to Theory: Walter Bagehot’s Lombard Street: The Great Depression

How effective are these rules? How necessary are these rules? They are a systematization of nineteenth-century British central-banking practice. They do have theoretical banking in John Stuart Mill’s observation that deficient aggregate demand—planned total economy-wide spending less than expected income—is the flip side of excess demand for financial assets or for some subset thereof. They do, at least in Peel’s formulation, attempt the sleight of hand and tricks with mirrors, the “ambiguity, verging on duplicity... promis[ing] not to rescue banks and merchant houses... to force them to take responsibility for their behavior, and then rescu[ing] them... for otherwise trouble might spread...” that Kindleberger calls for in the hope of minimizing ex ante moral hazard. But are there alternative public-policy strategies that would do as well?

This Time It Is Not Different: Walter Bagehot and the Persistent Concerns of Financial Macroeconomics: Conclusion: From 1873 to 2009

It is traditional for economic historians and historians of economic thought to lament productive research programs of the past that were then only little further developed, with many threads left dangling for decades if not longer. And it is indeed a fact that the number of economists whose work makes it into the graduate curriculum who build on Bagehot is relatively small: Minsky (1982, 1986) is present to a small degree. Kindleberger (1978, 1984) is present to a somewhat larger one. Eichengreen (1992, 2008) is present in economic history courses. Otherwise, Bagehot (1873) remains remarkably good preparation for reading modern works that attempt to pick up the same or similar threads like Richard Koo (2003, 2009) or Carmen Reinhart and Kenneth Rogoff (2008).

Quote of the Day: April 10, 2012

"The bourgeoisie cannot exist without constantly revolutionising the instruments of production, and thereby the relations of production, and with them the whole relations of society."

--Karl Marx and Friedrich Engels, The Communist Manifesto

Quotation of the Day: April 3, 2012

"Here’s the power of the machine: that having broken arithmetic down into tiny idiot steps, it can then execute those steps at inhuman speed, forever. Or until a vacuum tube blows."

--Francis Spufford, Red Plenty

Daniel Kuehn on John Maynard Keynes on Banks in a Financial Crisis

Daniel Kuehn:

Facts & other stubborn things: Keynes on the incentives of banks in a depression: [A]s Brad DeLong often points out, any insightful points you make about economics have more often than not already been made (and made more eloquently) by John Maynard Keynes. This is from the beginning of "The Consequences to the Banks of a Collapse in Money Values" (1931), a piece that I've actually been wanting to have a reason to share on here (he talks about 1921 in here, which is another reason why I like it). I think it speaks to the points about the incentives of banks under free banking that I made in the prior post.

John Maynard Keynes:

A year ago it was the failure of agriculture, mining, manufactures, and transport to make normal profits, and the unemployment and waste of productive resources ensuing on this, which was the leading feature of the economic situation. To-day, in many parts of the world, it is the serious embarrassment of the banks which is the cause of our gravest concern. The shattering German crisis of July 1931, which took the world more by surprise than it should, was in its essence a banking crisis, though precipitated, no doubt, by political events and political fears.

That the top-heavy position, which ultimately crumbled to the ground, should have been built up at all, was, in my judgement, a sin against the principles of sound banking. One watched its erection with amazement and terror. But the fact which was primarily responsible for bringing it down was a factor for which the individual bankers were not responsible and which very few people foresaw—namely, the enormous change in the value of gold money and consequently in the burden of indebtedness which debtors, in all countries adhering to the gold standard, had contracted to pay in terms of gold.

Let us begin at the beginning of the argument. There is a multitude of real assets in the world which constitute our capital wealth—buildings, stocks of commodities, goods in course of manufacture and of transport, and so forth. The nominal owners of these assets, however, have not infrequently borrowed money in order to become possessed of them. To a corresponding extent the actual owners of wealth have claims, not on real assets, but on money. A considerable part of this "financing" takes place through the banking system, which interposes its guarantee between its depositors who lend it money, and its borrowing customers to whom it loans money wherewith to finance the purchase of real assets.

The interposition of this veil of money between the real asset and the wealth owner is a specially marked characteristic of the modern world. Partly as a result of the increasing confidence felt in recent years in the leading banking systems, the practice has grown to formidable dimensions. The bank-deposits of all kinds in the United States, for example, stand in round figures at $50,000,000,000; those of Great Britain at £2,000,000,000. In addition to this there is the great mass of bonded and mortgage indebtedness held by individuals.

All this is familiar enough in general terms. We are also familiar with the idea that a change in the value of money can gravely upset the relative positions of those who possess claims to money and those who owe money. For, of course, a fall in prices, which is the same thing as a rise in the value of claims on money, means that real wealth is transferred from the debtor in favour of the creditor, so that a larger proportion of the real asset is represented by the claims of the depositor, and a smaller proportion belongs to the nominal owner of the asset who has borrowed in order to buy it. This, we all know, is one of the reasons why changes in prices are upsetting.

But it is not to this familiar feature of falling prices that I wish to invite attention. It is to a further development which we can ordinarily afford to neglect but which leaps to importance when the change in the value of money is very large—when it exceeds a more or less determinate amount.

Modest fluctuations in the value of money, such as those which we have frequently experienced in the past, do not vitally concern the banks which have interposed their guarantee between the depositor and the debtor. For the banks allow beforehand for some measure of fluctuation in the value both of particular assets and of real assets in general, by requiring from the borrower what is conveniently called a "margin." That is to say, they will only lend him money up to a certain proportion of the value of the asset which is the "security" offered by the borrower to the lender. Experience has led to the fixing of conventional percentages for the "margin" as being reasonably safe in all ordinary circumstances. The amount will, of course, vary in different cases within wide limits. But for marketable assets a "margin" of 20 per cent to 30 per cent is conventionally considered as adequate, and a "margin" of as much as 50 per cent as highly conservative.

Thus, provided the amount of the downward change in the money value of assets is well within these conventional figures, the direct interest of the banks is not excessive;—they owe money to their depositors on one side of their balance-sheet and are owed it on the other, and it is no vital concern of theirs just what the money is worth.

But consider what happens when the downward change in the money value of assets within a brief period of time exceeds the amount of the conventional "margin" over a large part of the assets against which money has been borrowed. The horrible possibilities to the banks are immediately obvious. Fortunately, this is a very rare, indeed a unique event. For it had never occurred in the modern history of the world prior to the year 1931. There have been large upward movements in the money value of assets in those countries where inflation has proceeded to great lengths. But this, however disastrous in other ways, did nothing to jeopardise the position of the banks; for it increased the amount of their "margins." There was a large downward movement in the slump of 1921, but that was from an exceptionally high level of values which had ruled for only a few months or weeks, so that only a small proportion of the banks' loans had been based on such values and these values had not lasted long enough to be trusted.

Never before has there been such a world-wide collapse over almost the whole field of the money values of real assets as we have experienced in the last two years. And, finally, during the last few months—so recently that the bankers themselves have, as yet, scarcely appreciated it—it has come to exceed in very many cases the amount of the conventional "margins." In the language of the market the "margins" have run off.

The exact details of this are not likely to come to the notice of the outsider until some special event—perhaps some almost accidental event—occurs which brings the situation to a dangerous head. For, so long as a bank is in a position to wait quietly for better times and to ignore meanwhile the fact that the security against many of its loans is no longer as good as it was when the loans were first made, nothing appears on the surface and there is no cause for panic.

Nevertheless, even at this stage the underlying position is likely to have a very adverse effect on new business. For the banks, being aware that many of their advances are in fact "frozen" and involve a larger latent risk than they would voluntarily carry, become particularly anxious that the remainder of their assets should be as liquid and as free from risk as it is possible to make them. This reacts in all sorts of silent and unobserved ways on new enterprise. For it means that the banks are less willing than they would normally be to finance any project which may involve a lock-up of their resources.

And Daniel comments:

To say that banks are less willing to lock up their resources is equivalent to saying that banks have liquidity preference too.

An advantage of central bankers - maybe even their one saving grace - is that central bankers do not have any liquidity preference to speak of.

Looking Forward, Many Zeroes and Double-Zeroes on the Global Roulette Wheel

Project Syndicate: Looking Forward, Many Zeroes and Double-Zeroes on the Global Roulette Wheel

Four times in the past century, a large chunk of the industrial world economy has fallen into a depression of high unemployment that was both deep and long: the United States in the 1930s, industrialized western Europe in the 1930s, western Europe in the 1980s, and Japan in the 1990s. Two of those times the economic downturn has cast a long and black shadow on the particular region’s economic future: western Europe in the 1980s and Japan in the 1990s. In both, if they ever got or will get back to something like the pre-downturn trend of economic growth, it took decades before they did or will do so. One of these times we do not know what would have happened: at the end of the 1930s Europe became the battlefield as Adolf Hitler launched World War II. And one time the long-run growth trend was undisturbed: it is difficult to see any significant macroecnomic impact of the Great Depression on U.S. production and employment after World War II. Of course, in the absence of U.S. mobilization for World War II it is possible and even likely that the Great Depression would have cast a shadow on post-1940 U.S. economic growth: certainly that is how things looked, with signs of high levels of structural unemployment and a capital stock below trend, at the end of the 1930s before mobilization for World War II began in earnest.

In the United States we can already see signs that the downturn that started in 2008 is casting its shadow on the future. Reputable forecasters--both private and public--have been marking-down their estimates of U.S. potential GDP in the long run. Labor force participation, which usually stops falling and starts rising after the business-cycle trough, has been steadily declining over the past two and a half years. At least some monetary policymakers are seeing reductions in the unemployment rate that come from falling labor force participation as equally good reasons for shifting to more austere monetary policies as reductions in the unemployment rate that come from increases in employment. And much the same processes are at work with even stronger force in Europe.

Most important, however, has been what from today’s perspective looks to be a permanent collapse in the risk-bearing capacity of the private marketplace, and a permanent and large increase in the perceived riskiness of financial assets and of the businesses whose cash flows underpin them worldwide. In a world of aging industrial-core populations, large commitments from governments to social-insurance systems, and no clear plans for balancing government budgets in the long run, we would expect to see perhaps not substantial but clearly visible inflation and risk premiums priced into the Treasury debt of even the largest and richest economies. Sometime over the past generation the price levels of the U.S., Japan, and Germany might go up substantially as some government short-sightedly finds it plausible to attempt to finance some of its social-welfare expenditures via seigniorage. The price levels are unlikely to go down. Yet the desire to hold assets that avoid the medium-term risks associated with the business cycle has overwhelmed this long-run fundamental risk factor.

But this risk that the globe’s investors are currently rushing into U.S., Japanese, and German Treasury debt to avoid is not a “fundamental” risk. There is nothing in our psychological preferences, in the natural resources we have available, or in our growing technologies that makes investing in private enterprises riskier than it was five years ago. Rather, it is the demonstration that governments will not when push comes to shove perform their task of matching aggregate demand to aggregate supply to avoid mass unemployment that is the driver. It is the job of governments to manage aggregate demand so that even though Say’s law that supply creates its own demand is false in theory, it is nevertheless true enough in practice that enterpreneurs and enterprises can bet and bank on it.

“If”, John Maynard Keynes wrote 76 years ago, the government falls down on the job and “demand is deficient… the individual enterpriser... is operating with the odds loaded against him. The game of hazard which he plays is furnished with many zeros.... the increment of the world’s wealth has fallen short of... savings... [because of] the losses of those whose courage and initiative have not been supplemented by exceptional skill or unusual good fortune. But if effective demand is adequate, average skill and average good fortune will be enough…”

For sixty-two years, from 1945-2007, with some sharp but temporary and regionalized interruptions, entrepreneurs and enterprisers could bet that the demand would be there if they created the supply. This played a significant role in setting the stage for the fastest two generations of global economic growth the world has ever seen. Now the stage is no longer set.

Quotation of the Day: March 26, 2012

"Europe is solid with herself. France, Germany, Italy, Austria and Holland, Russia and Roumania and Poland, throb together, and their structure and civilization are essentially one. They flourished together, they have rocked together in a war, which we, in spite of our enormous contributions and sacrifices (like though in a less degree than America), economically stood outside, and they may fall together. In this lies the destructive significance of the Peace of Paris. If the European Civil War is to end with France and Italy abusing their momentary victorious power to destroy Germany and Austria-Hungary now prostrate, they invite their own destruction also, being so deeply and inextricably intertwined with their victims by hidden psychic and economic bonds….

"[The] Paris [Peace Conference of 1919] was a nightmare, and every one there was morbid. A sense of impending catastrophe overhung the frivolous scene; the futility and smallness of man before the great events confronting him; the mingled significance and unreality of the decisions; levity, blindness, insolence, confused cries from without,—all the elements of ancient tragedy were there. Seated indeed amid the theatrical trappings of the French Saloons of State, one could wonder if the extraordinary visages of Wilson and of Clemenceau, with their fixed hue and unchanging characterization, were really faces at all and not the tragi-comic masks of some strange drama or puppet-show.

"The proceedings of Paris all had this air of extraordinary importance and unimportance at the same time. The decisions seemed charged with consequences to the future of human society; yet the air whispered that the word was not flesh, that it was futile, insignificant, of no effect, dissociated from events; and one felt most strongly the impression, described by Tolstoy in War and Peace or by Hardy in The Dynasts, of events marching on to their fated conclusion uninfluenced and unaffected by the cerebrations of Statesmen in Council…"

--John Maynard Keynes, The Economic Consequences of the Peace

John Maynard Keynes (1936): Full-Employment Policy Is Structural Growth Policy

How many of what I regard as my smartest insights are just things thrown up by the John Maynard Keynes emulator that I have running in background on my wetware?

John Maynard Keynes (1936):

[I]f effective demand is deficient… the individual enterpriser who seeks to bring these resources into action is operating with the odds loaded against him. The game of hazard which he plays is furnished with many zeros, so that the players as a whole will lose if they have the energy and hope to deal all the cards. Hitherto the increment of the world’s wealth has fallen short of the aggregate of positive individual savings; and the difference has been made up by the losses of those whose courage and initiative have not been supplemented by exceptional skill or unusual good fortune. But if effective demand is adequate, average skill and average good fortune will be enough…

And:

[If we] succeed in establishing an aggregate volume of output corresponding to full employment as nearly as is practicable, the classical theory comes into its own again…. [T]here is no objection to be raised against the modern classical theory as to the degree of consilience between private and public advantage in conditions of perfect and imperfect competition…. When 9,000,000 men are employed out of 10,000,000 willing and able to work, there is no evidence that the labour of these 9,000,000 men is misdirected. The complaint… [is] that tasks should be available for the remaining 1,000,000 men. It is in determining the volume, not the direction, of actual employment that the existing system has broken down….

[T]he traditional advantages of individualism will still hold good… efficiency — the advantages of decentralisation and of the play of self-interest… individualism… is the best safeguard of personal liberty… greatly widens the field for the exercise of personal choice… best safeguard of the variety of life… the loss of which is the greatest of all the losses of the homogeneous or totalitarian state… and, being the handmaid of experiment as well as of tradition and of fancy, it is the most powerful instrument to better the future.

Whilst… [the policies I recommend] would seem to a nineteenth-century publicist or to a contemporary American financier to be a terrific encroachment on individualism, I defend… [them] as the only practicable means of avoiding the destruction of existing economic forms in their entirety and as the condition of the successful functioning of individual initiative…

Brookings Panel on Economic Activity: Spring 2012

http://www.brookings.edu/economics/bpea.aspx

NOTE: MOST OF THESE COMMENTS WERE NOT REPEAT NOT DELIVERED AT THE CONFERENCE:

"Fiscal Policy in a Depressed Economy", by J. Bradford DeLong, University of California, Berkeley and Lawrence Summers, Harvard University.

"Disentangling the Channels of the 2007-2009 Recession", by James Stock, Harvard University and Mark Watson, Princeton University:

Comments: Stock and Watson say policy uncertainty is liquidity squeeze is risk spreads: there is one single "financial shock". Stock and Watson say the old factors and old coefficient macro dynamics predict the macro dynamics of this recent recession. Thus the current business cycle is still the standard business cycle--only bigger, driven by bigger financial shocks. Alan Blinder queries: how can this recession be the same? It wan't caused by either inflation-fighting monetary policy or by an oil shock. So it ought to have been different, shouldn't it? In Ricardo Caballero's framework, a normal post-WWII recession was caused by a liquidity squeeze, but this was caused by a safety squeeze--there would have been a liquidity squeeze if not for extraordinary Fed action, and Milton Friedman would have said that fixing the liquidity squeeze would fix the problem. And it didn't...

If I understood Martin Baily, I think he was wondering whether an error-correction framework would show more of an anomaly in the recent episode. I want to second that.

"Macroeconomic Effects of FOMC Forward Guidance", by Jeffrey Campbell, Charles Evans, Jonas Fisher, Alejandro Justiniano, Federal Reserve Bank of Chicago

Comment: First, let me thank Michael Woodford for finally telling me how to pronounce Goy-tee. I have never before dared say anything other than "Eggertsson". Second, the point about nominal levels: when velocity undershot in the early 1980s Paul Volcker laid down the principle that base drift would not be reversd--admittedly, then it was base drift in the money stock. That precedent creates some difficulties for the Fed to adopt level targeting.

Third, with respect to commitments. The FOMC's voting membership turns over rather quickly. That makes commitment difficult. Commitment via appointing central bankers who are conservative in the Rogoff sense in having an unreasoning distaste for inflation solves some commitment problems, but not others. Odyssean commitment via QE is also difficult because QE transactions can easily and costlessly be reversed. So if you are a central bank that wants to commit to a higher future money stock, the natural way to do it is to increase the money supply by expanding your portfolio in ways that cannot be reversed. So, instead of buying GSE MBSs, buy bridges, human capital for twelve year olds, and biomedical knowledge--transactions the Fed cannot unwind. And Eggertsson and Woodford optimal ZLB monetary policy has just become monetary base-financed expansionary fiscal policy.

"Is the Debt Overhang Holding Back Consumption?", by Karen Dynan, Brookings Institution

Comment: Are the quarter of mortgage debtors who are underwater more of a drag on the economy than other homeowners who have lost wealth? Yes, clearly they are.

"The Euro’s Three Crises", by Jay Shambaugh, Georgetown University

Comment: Yes, interest rates have to be very high indeed for austerity to be worthwhile even on the metric of debt service burden alone...

When Jay's excellent paper arrived, I was rereading the late Charlie Kindleberger and thinking about his old line that Europe fell into the Great Depression in the 1930s because the world lacked an international monetary and financial hegemony, and also reading the transcript of the Bretton Woods Conference--where White and Keynes appear well aware of this, and working their hardest to make sure that this does not happen again by creating a hegemon: the IMF. Yet here we are again. And I think it is safe to say that we would not be here, but rather in an at least somewhat better place, either if the IMF had in the late 1990s been recapitalized at much more than its current scope or if Iceland, Ireland, and Greece had incorporated themselves in Delaware as bank holding companies and joined the Federal Reserve System.

If White and Keynes were here now, I think they would yell at us: of course, they would say, a dozen national governments cannot quickly strike a Coasian bargain under these circumstances. You need a hegemony. We gave you a hegemony. What have you done with it?

We are probably going to dodge the biggest bullets coming at us this time. But it really is not too early to start building institutions that will allow us to, next time, avoid both the policy mistakes of the 1970s and the policy mistakes of the 2000s so that we can make new and more original policy mistakes.

"Democratic Change in the Arab World, Past and Present," by Eric Chaney, Harvard University:

Comment: I like the focus of the long-term historical impact of "slaves on horses": the interaction of the ulema and the mamelukes from the Ummayid dynasty on, a pattern found in the regions of the 7th century conquests and the resultant expansion of the community of believers, but not elsewhere. I feel like I should channel the medieval historian Ibn Khaldun and wonder whether it is not 8th century institutions but rather, as Linda noted, desert ecology. The 7th century conquests are (with the exception of what is now Iran) places where desert power is important. And in deserts agriculture is not very productive: it is hard for the ruling institution to tax the surplus. Herding is even harder to tax. So the ruling institution taxes commerce, especially long-distance commerce, and does not embed its revenue sources in society. Thus you get a succession of dynasties playing the game of thrones whose major interest in the bulk of the population is autocratic domination rather than economic development, and this ecologically-driven political-economic equilibrium echoes down the centuries. It is then powerfully reinforced by oil.

Unfortunately, I see only one data point that was part of the 7th century conquests where desert power is not terribly important: the collapse of the Sassanid Empire. While the Byzantine Empire survived, and held the line where the desert turned into the Anatolian Plateau, the Sassanids collapsed and the Arab Conquest extended over the Iranian Plateau.

If Iran makes a successful democratic transition in the next fifty years, I would characterize that as strong evidence against Eric's hypothesis.

Joe Weisenthal: Ben Bernanke vs. the Gold Standard

Joe Weisenthal:

Ben Bernanke Murders The Gold Standard: Ben Bernanke just gave the first lecture of his 4-part series on the origins of the Fed. We'll have full transcripts and slides later, but one thing really stood out…. He spent a lot of time talking about the gold standard, and he just murdered it.

Among his points:

To have a gold standard, you have to go dig up gold in South Africa and put it in a basement in New York. It's nonsensical.

The gold standard ends up linking everyone's currencies, causing policy in one country to transmit to another country (sort of how U.S. policy now transmits to China, because they've fixed the yuan price to the dollar). So for example, if the U.K. fixes the number of pounds to an ounce of gold, and the U.S. fixes the number of dollars to an ounce of gold, then the pound and the U.S. dollar inadvertently become linked.

It creates deflation, as William Jennings Bryan noted. The meaning of the "cross of gold" speech: Because farmers had debts fixed in gold, loss of pricing power in commodities killed them.

The gold standard tends to cause interest rates to rise during downturns and interest rates to fall during good times, the exact opposite of what monetary policy should be doing.

The economy was far more volatile under the gold standard (all the depressions and recessions back in the pre-Fed days).

The only way the gold standard works is if people are convinced that the central bank ONLY cares about maintaining the gold standard. The moment there's a hint of another priority (leaking falling unemployment) it all falls apart.

Gold standards leave central banks open to speculative runs, since they usually don't hold all the gold...

Robert J. Gordon and Robert Krenn: "The End of the Great Depression 1939-41: Policy Contributions and Fiscal Multipliers"

http://www.nber.org/papers/w16380

Origins of American Finance

Alexander Hamilton to Robert Morris, April 30, 1781:

Sir:

I was among the first who were convinced that an administration by single men was essential to the proper management of the affairs of this country. I am persuaded now it is the only resource we have to extricate ourselves from the distresses which threaten the subversion of our cause. It is palpable that the people have lost all confidence in our public councils; and it is a fact, of which I dare say you are as well apprised as myself, that our friends in Europe are in the same disposition. I have been in a situation that has enabled me to obtain a better idea of this than most others; and I venture to assert that the Court of France will never give half the succors to this country, while Congress holds the reins of administration in their own hands, which they would grant, if these were entrusted to individuals of established reputation, and conspicuous for probity, abilities, and fortune.

With respect to ourselves, there is so universal and rooted a diffidence of the government, that, if we could be assured the future measures of Congress would be dictated by the most perfect wisdom and public spirit, there would be still a necessity for a change in the forms of our administration, to give a new spring and current to the passions and hopes of the people.

To me it appears evident that an executive ministry, composed of men with the qualifications I have described, would speedily restore the credit of government abroad and at home—would induce our allies to greater exertions in our behalf—would inspire confidence in moneyed men in Europe, as well as in America, to lend us those sums of which it may be demonstrated we stand in need, from the disproportion of our national wealth to the expenses of the war.

I hope, sir, you will not consider it as a compliment, when I assure you that I heard, with the greatest satisfaction, of your nomination to the department of finance. In a letter of mine last summer to Mr. Duane, urging, among other things, the plan of an executive ministry, I mentioned you as the person who ought to fill that department. I know of no other in America, who unites so many advantages; and of course every impediment to your acceptance is to me a subject of chagrin. I flatter myself Congress will not preclude the public from your services by an obstinate refusal of reasonable conditions; and, as one deeply interested in the event, I am happy in believing you will not easily be discouraged from undertaking an office, by which you may render America, and the world, no less a service than the establishment of American independence! ’T is by introducing order into our finances—by restoring public credit—not by gaining battles, that we are finally to gain our object. ’T is by putting ourselves in a condition to continue the war—not by temporary, violent, and unnatural efforts to bring it to a decisive issue, that we shall, in reality, bring it to a speedy and successful one. In the frankness of truth I believe, sir, you are the man best capable of performing this great work.

Econ 210a: Spring 2012: U.C. Berkeley: March 21, 2012: Globalization and Crises

Econ 210a: Spring 2012: U.C. Berkeley: March 21, 2012: Globalization and Crises:

• Class Slides

Econ 210a: Spring 2012: U.C. Berkeley: March 21, 2012: Globalization and Crisis

March 21. Globalization and Crisis (DeLong)

Globalization:

• Douglas Irwin (1998), “Did Late Nineteen Century U.S. Tariffs Promote Infant Industries? Evidence from the Tinplate Industry,” NBER Working Paper no. 6835 (December). http://www.nber.org/papers/w6835

• Richard Baldwin and Philippe Martin (1999), “Two Waves of Globalization: Superficial Similarities, Fundamental Differences,” NBER Working Paper no.6904 (January). http://www.nber.org/papers/w6904

Crisis:

• Barry Eichengreen and Michael Bordo (2002), “Crises Now and Then: What Lessons from the Last Era of Financial Globalization?” NBER Working Paper no. 8716 (January). http://www.nber.org/papers/w8716

---

Memo Question for March 21, 2012::

From our present perspective, what did Barry Eichengreen and Michael Bordo miss back in 2002 when they tried to draw lessons for the then future about financial crises from the pre-1914 record of growth, development, and financial deepening?

Sectoral Shifts and Income Inequality

Karl Smith:

Where Middle Class America Has Gone « Modeled Behavior: The long term trend in goods and government vs. everything else I think also shows part of what has happened to the American middle class. Goods and Government are what we might have thought about as backbone jobs. These are police officers, fire fighters, school teachers, factory workers, construction workers. When you think of a stereotypical 1950s American, they are doing one of these jobs. And, in the 1950s half of Americans were employed in these sectors. Yet, since then the labor market has radically shifted.

Notice these two are plotted on the same axis so from 1939  to 1965 – not including the war boom – goods and government was roughly half of the nonfarm labor force. Then a rapid falling off. One thing I hadn’t considered but is probably true is that goods (via the magic of boxes) and government via transfers between jurisdictions, is not as dependent on urbanization as the rest of the economy. This probably supported the stagnation in land rents that occurred over this period, which also supported real wages.

And:

Anatomy of a Recession and a Recovery « Modeled Behavior: The following chart I have found useful in analyzing the baseline for this entire recession and seeing past lots of what I would consider noise about the causes and consequences. Here I basically split the labor market into two parts: Goods and Government and everything else.

Everything else hit a wall in 2008 but as you can see it was a nice natural V. It was not even the job-less U of 2000. And since the beginning of 2010 everything else has been growing just as fast as the last recovery. As we moved into 2012 job growth seems to be speeding up faster than anything we saw last time around.

The difference this time was goods and government. To cut it down to the micro-level I like we are largely talking about construction workers, metal and automotive workers, and school teachers. These workers are massively influenced by credit constraints. One cannot build a building without credit. One cannot buy a vehicle without credit and state and local governments have very little credit room by statute. So what we need for job growth to really hit its stride is for construction to comeback, cars to comeback and school teachers to come back.

The process is well on its way with cars, though could be derailed. Construction is building and my best guess is that school teachers will start to be rehired in about 12 – 18 months. Though again because these sectors respond so much to liquidity the job recovery is still fragile.

Mark Thoma on Chris Dillow on Bordo and Meissner

Mark Thoma:

Economist's View: Did Inequality Cause the Crisis?: I've always been a bit uncomfortable with assertions that the income inequality causes bubbles. If there's a correlation between the two, it's not clear which way causality runs. It could be that bubbles cause inequality, not the other way around. And recent research by Michael Bordo and Christopher Meissner suggests even more caution in making such as claim (though one paper should not be considered the last word on the topic). However, Chris Dillow is not ready to concede…

Chris Dillow:

Inequality & the crisis: The fact that crises are not often preceded by rising inequality does not disprove that inequality - along with other mechanisms - had a role in this particular crisis. And there are two other mechanisms…. Insofar as rising inequality in the 00s was correlated with a rise in wages in the financial sector relative to other industries, it attracted “talent” into banking. And this contributed to its downfall, because “talent” produces not stability but rent-seeking and overconfidence. Remember - banks survived for decades by employing doddering Captain Mainwarings but collapsed soon after hiring physics PhDs…. Top-down management structures produce bosses who combine domineering arrogance with ignorance. As Julian Birkinshaw has said (pdf), the management model in investment banks was one in which “Aggressive and intimidating behaviour is tolerated; effective teamwork and sharing of ideas are rare.” And even if inequality did not cause the crisis, it is correlated with it. The same growth of Asian economies that gave us an excess supply of cheap labour which depressed unskilled wages in the west also gave us the savings glut that produced the housing boom and malinvestments in mortgage derivatives.

But does it much matter whether income inequality contributed to the crisis or not? The Left argued that high inequality was a bad thing long before the crisis, for intrinsic as well as instrumental reasons. Those arguments are as strong (or as weak!) as they ever have been.

Yes, inequality is a very bad thing. Since social welfare is much better measured by the geometric mean of consumption rather than per capita consumption, higher inequality becomes very expensive for a society rather quickly.

I still find myself attracted to the idea that high inequality produces both high leverage (as the non-rich desperately scramble to keep up with the Joneses), high savings (on the part of the rich), and low interest rates. The first makes the collapse of bubbles damaging. The third makes the chance of bubbles higher.

But Bordo and Meissner are definitely leading me to think again...

Austerity, American Style

Paul Krugman:

Austerity, American Style: Via Mark Thoma, Antonio Fatas has a good piece on the exceptional weakness of government spending in this recovery. I thought I might add to that observation. Let’s look at real government… purchases of goods and services — from all levels of government during three recoveries: the current expansion, the Bush Boom (such as it was), and Morning in America…. Which one is different? Now, this doesn’t include safety-net spending…. But actual government purchases have been uniquely weak, largely because of budget distress at the state and local level…

The Changing Multiplier Since 1925...

The largest shifts in economists’s views of what the value of the multiplier is over the last eighty or so years have been the result not of changing views about the structure of demand, but rather of changing views about the conduct of monetary policy.

The IS-LM framework remains the best way to summarize the issues. (See David Romer (2012), Short Run Fluctuations.) With the long-term risky real interest rates on the vertical axis and the level of real GDP on the horizontal axis, the IS curve summarizes the flow-of-funds through financial markets equilibrium condition--or, if you prefer, the representative agent's Euler equation (for they are the same thing, or rather the second is a very special representative-agent version of the general theory that is the first). But that by itself does not pin down the economy's path. Another condition is needed, a monetary policy condition.

Decompose the long-term real risky interest rate that you need for the flow-of-funds equilibrium condition into four pieces: a risk premium; a term premium; an inflation component; and the short term safe nominal interest rate that comes out of the money market, and equilibrates money supply to money demand.

In the years since Hicks laid out this framework in 1937, the economy has transitted through five different monetary policy regimes.

In not historical but rather logical logical sequence:

First in logical order is monetary dominance: the monetary authority has a view of what level of real spending right now is consistent with its long-run inflation target, and it pushes the money stock wherever it needs to in order to hit that target. Real GDP will be set by the monetary authority as a function of inflation and perhaps other variables according to its monetary policy rule.

On the IS-LM diagram under this monetary policy régime, the counterpart curve to the IS curve is not an LM curve but rather an MP curve, a monetary policy curve. And this monetary policy curve is vertical. Under such a monetary policy regime, the multiplier μ is zero. Whatever effect expansionary fiscal policy has on the IS curve will show up 100% as a change in interest rates and 0% as a change in output levels. This was the monetary policy regime that the Clinton administration believed it was operating under when it proposed a substantial deficit-reduction package in the late winter of 1993, even though the unemployment rate was less than a year past its recession peak.

Figure 3A.1: Monetary Dominance: μ=0

Second in logical order is the Friedman rule: the monetary authority has a smoothly growing target for the money stock, and it takes steps to hit that target. If the Friedman rule is credible, expectations of inflation will not vary: shifts in the inflation premium will not tilt what is now an LM curve up or down on the IS-LM diagram as real GDP increases or decreases. However, under the Friedman rule the LM curve is not vertical: it has a positive slope. Higher nominal interest rates raise the velocity of money. A more prosperous economy makes bankruptcy less likely and reduces the risk premium. In this monetary policy regime, the government purchases multiplier exists: μ is not zero. However, μ is likely to be small because of the likelihood of substantial interest-rate, and perhaps price-level crowding out. How much crowding-out there would be was the subject of debate between Tobin and Friedman, with Tobin stating that it was an empirical issue, and Friedman claiming the multiplier was too small to matter unless the interest elasticity of money demand was near infinity.

Figure 3A.2: Friedman Rule: μ Small

 Third in logical sequence comes the gold standard: the monetary base is fixed but the money supply is elastic because banks respond to higher demand for loans and deposits by taking more risks. A Friedman rule central-bank is not passive: it is strongly leaning against the wind, cutting the monetary base in the boom and increasing the monetary base in the slump. A gold standard central bank is almost an oxymoron: if it is actively managing the monetary base, it is not really a gold standard anymore. Under a true gold standard the LM curve is no longer quite an LM curve—although it is also not right to call it an MP curve either. Whatever it is, the fact of an elastic money supply makes it even flatter than the Friedman-rule LM curve.

Figure 3A.3: Gold Standard: μ Moderate

Fourth in logical sequence is a central bank that targets the real rate of interest: call this the “constant monetary conditions” multiplier. This is the multiplier that would be estimated by cross-state fiscal-policy regressions in the United States, or cross-country fiscal-policy regressions in a monetary union, were there neither demand spillovers nor cross-jurisdiction factor mobility to bias the estimated coefficient one way or another.

Figure 3A.4: Real Interest Rate Targeting: μ Larger Still

 Note that a monetary authority that targets the real rate of interest is likely to be pursuing a policy in which nominal interest rates are rather strongly procyclical. Inflation will surely rise with higher levels of real GDP. Risk spreads are likely to fall as well. Both of these must be compensated for by rising nominal interest rates if the monetary authority is truly going to pursue a policy that keeps the real interest rate constant. The multiplier μ under such a monetary policy rule is likely to be rather large: there is neither investment-based nor export-based interest-rate crowding out, since the purpose of the policy is to ensure that the interest rate does not move.

Fifth and last in logical sequence is when the monetary authority finds itself in a liquidity trap, at the zero-nominal interest rate lower bound. In this case the MP monetary policy curve slopes not upward but downward. As output increases and as expectations of inflation rise, the short-term safe real interest rate declines. An economy with higher output is one with fewer bankruptcies and lower risk premia: spreads fall as well, and the short-term real risky interest rate declines even more along this MP curve.

Figure 3A.5: Zero Lower Bound: μ Large 

Under all the other monetary policy régimes the monetary authority could, if it thought wise, shift the MP or LM curve to provide further monetary expansion. Under monetary dominance it would simply change its near-future real GDP target. Under the Friedman rule it would boost the money stock growth rate. Under a gold standard it could sell some of its own gold holdings or change the gold parity. Under a constant real interest rate régime it could change the target real interest rate.

But at the zero nominal lower bound the monetary authority’s available tools are much weaker, and active monetary policy seems likely to be of limited effectiveness. The monetary authority can promise higher inflation in the future—but how is it to make that promise effective and credible, especially in a political and technocratic environment averse to even moderate inflation? Quantitative easing to boost the money stock can always be reversed if the assets purchased by the monetary authority as it issues more cash are traded in thick markets. And if the monetary authority issues cash and wishes to demonstrate that the transaction will not be unwound by using the cash to purchase assets that cannot easily be sold off —bridges, highway interchanges, and the human capital of twelve-year-olds, for example—that looks a lot more like fiscal than monetary policy, albeit a fiscal policy conducted by the monetary authority.

The monetary authority can attempt to reduce risk and duration premia directly by taking default and duration risk onto its own balance sheet, but portfolio balance considerations suggest that the power of such non-standard monetary policy tools is likely to be small.

The flip side of the likely limited power of change in the monetary authority’s policy rule at the zero nominal lower bound is that the fiscal policy multiplier μ appears likely to be at its largest. The fact that the monetary policy régime produces an MP curve that slopes “the wrong way” means that equilibrium levels are fragile in the sense that small shocks can cause the economy to jump a long way—in either direction.

Clark Kerr on Dorothea Lange and Paul Taylor

About Dorothea Lange: Lange's Berkeley Connections: Professor emeritus Clark Kerr, former Berkeley chancellor and President of the University of California, earned his Ph.D. in 1939 under Paul Schuster Taylor, M.A. '20, Ph.D. '22. Taylor achieved international notice for his writing and for the work he did with his wife, photographer Dorothea Lange, on the poor and dispossessed. Kerr's recollections of these two Californians are adapted from his chapter in Dorothea Lange: A Visual Life, edited by Elizabeth Partridge '74 and published by Smithsonian Press.

Clark Kerr, 1994:

Paul Schuster Taylor was an explorer, not of seas and continents, but of nearly unnoticed social events as they began to take form. He was among the first to put several of these events on the map of history, to make them part of terra cognito. He began with the early migration of Mexicans to California, to south Texas, to Colorado, to Chicago, to Bethlehem, Pennsylvania, in a series of studies published by the University in the late 1920s and early 1930s.

He turned then to the unemployed, when one-quarter of the American labor force was fully unemployed and another quarter was partially unemployed. It was at this point that I first met Paul; he invited me to be his research assistant, starting in the fall of 1933.

I had hardly arrived in Berkeley when the largest and bloodiest strike of agricultural workers in American history began in the San Joaquin Valley. I spent six weeks in the Valley, and Paul came down on weekends. He gave me only two instructions: to record what people said -- their own words -- and to send him my notes as soon as possible. I gathered later that these were the same instructions Paul first gave to Dorothea Lange, except that she worked with photographs and I with notes.

Paul first came in contact with Dorothea's photographs in the summer of 1934, when he saw her picture of a strike orator in a local art gallery. Dorothea was then a studio portrait photographer of local fame in San Francisco, but she also had started to go out into the streets in the deep Depression years. Thus she was already moving toward Paul's history-in-the-making before she met him. Their joint interests moved her all the way in that direction, and she became one of the great documentary photographers of all time.

Paul and Dorothea had complementary skills but contrasting personalities. She was always moving, mostly talking, reacting in a flash, living in the moment. Paul thought carefully about everything, spoke seldom and then softly. An illustration: During the cotton picker's strike, he drove us back to Berkeley one Sunday night in my Model A Ford roadster. We stopped at a rural gas station, and he got out. Another car -- identical to mine -- drove up and the driver also got out. I was asleep in the front seat of my car and woke as the driver of the second car -- which was now missing -- yanked open the door and grabbed me by the throat. He wanted to know what I had done with his wife! Once I grasped the situation, I wanted to know what he had done with my professor!

Some time later, Paul drove up and got into my car, and off we went to Berkeley. I sat there wondering: Did the wife wake up screaming? Did he suddenly realize that his research assistant was not female? All the way back to Berkeley, he never said a word.

While Dorothea was not interested in politics -- she was interested in people -- Paul did have political concerns in addition to human compassion. He was appalled at mass unemployment and at exploitation in the fields and of the fields. This was not the America he had fought for in World War I as a lieutenant in the Marines, commanding a platoon with 95 percent casualties, himself one of them, at Château-Thierry and Belleau Wood. (He prized his Marine uniform all his life.) Paul was also the subject of Red-baiting due to his support of sanitary labor camps for agricultural workers and his long opposition to the illegal diversion of water intended for family farms to the owners of the vast "factories in the fields."

Although Paul's original interest in Dorothea stemmed from his conception of the camera as a tool of research, their relationship became far more than a professional collaboration. It became a great love affair. Paul later said: "It was always a wonderful thing to see her. Always. Just to come into the room where she was." Years later, I would visit Paul in the old redwood house on Euclid Avenue which Dorothea had chosen for them. As Paul played Beethoven softly on his hi-fi set, we would talk about being on the ground in the Thirties. Dorothea' name would come up and Paul would sit there with tears streaming down his face as I recalled his tender words -- "just to come into the room where she was."

Dorothea in her very last days said what a pleasure it was to take a picture and to see that what you have done is "true." Paul and Dorothea wrote, in An American Exodus, "We have let them speak to you face to face." The "them" were the unemployed man in the breadline; the migrant mother and the children clinging to her; the Okie in the Model T Ford, moving west, fleeing the dust; the Mexicans living alongside the irrigation ditches; the Japanese Americans crowded into detention camps. Through the notes and the photographs of Paul and Dorothea, we are indeed brought face to face with "them" and with their histories, which are a part of the history of our nation, and we know that what we read and see is true.

David Glasner vs. Kurt Schuler on the Gold Standard

David Glasner:

Am I Being Unfair to the Gold Standard? « Uneasy Money: A free-banking system based on a gold standard is thus likely to be subject to a shift in demand from holding bank money to holding gold, when it is least able to accommodate such a shift, making a free-banking system based on a gold standard potentially vulnerable to a the sort of vicious deflationary cycle that characterized the Great Depression. The only way out of such a cycle would be to suspend convertibility. Such suspensions might or might not be tolerated, but it is not at all clear whether or how a mechanism to trigger such a suspension could be created. Insofar as such suspensions were expected, the mere anticipation of a liquidity problem might be sufficient to trigger a shift in demand away from holding bank money toward holding gold, thereby forcing a suspension of convertibility.  Chronic suspensions of convertibility would tend to undermine convertibility.

In short, there is a really serious problem inherent in any banking system in which the standard is itself a medium of exchange. The very fact that gold is money means that, in any fractional reserve system based on gold, there is an inherent tendency for the system to implode when there is a loss of confidence in bank money that causes a shift in demand from bank money to gold. In principle, what would be most desirable is a system in which the monetary standard is not itself money.  Alternatively, the monetary standard could be an asset whose supply may be increased without limit to meet an increase in demand, an asset like, you guessed it, Federal Reserve notes and reserves. But that very defect is precisely what makes the Ron Pauls of this world think that the gold standard is such a wonderful idea.  And that is a scary — as in terrifying — thought.

Marginal Products and Earnings in Historical Perspective...

In 1183 A.D., Reynaud de Chatillon--Prince of Antioch, Castellan of Kerak in Moab, Lord of Oultrejourdain, one of the leading nobles of the Latin Kingdom of Jerusalem, tall, strong, handsome, wielding his two-handed sword In Nomine Domine, and suffering from severe impulse-control problems--had much, much higher earnings than I would have had had I been back in the Latin Kingdom of Jerusalem in 1183.

Today, by contrast, I sit here outdoors in the warm Berkeley winter sun with a Treasury-Department Family Economic Income concept eight times the U.S. median, and were Reynaud de Chatillon to be here now he would be working the loading dock at Target at near-minimum wage and on Thorazine, for the skills that were his comparative advantage are to typically highly rewarded today--if he were not in Folsom Prison.

And perhaps in future centuries the wheel will turn again:

Ryan Avent:

Technology: Cognitive inequality: LAST week, I participated in a panel discussion on open questions in economics with professor and economics blogger extraordinaire Karl Smith. We got to talking about inequality, and I ran through a few of the bog standard interpretations of rising income gaps: mismatches between the supply of and demand for skills, superstar effects at the very top, and improved rent-seeking in the financial sector. Mr Smith offered something dramatically different, some of which he gets at in this post:

I want to make the point that this consistent with my long thesis that we are returning to an environment where productivity gains do not accrue to unskilled labor because they are imbedded in the brains of the innovators. A factory is really big and hard to keep secret. Computer code less so. When you simply write down the process you want or draw the object you want and the computer translates it for you the seep down [keeping the relative income distribution from blowing apart] will grind to [a] complete halt….

I want to stop there and use this thought to begin to tie a few threads together. Politicians, and many economists, are increasingly focused on the importance of global supply chains…. [W]hat most people seem to gloss over is the fact that the most important parts of modern supply chains are embedded in the heads of innovators and… in the space… in which discussions about innovation take place…. [T]he most important parts of the Apple supply chain are Steve Jobs' brain and the community of engineers tasked with turning Jobs' musings into actual, revolutionary products.

This has significant implications…. Someone with an outstanding analytical framework and a talent for manipulating information has probably (or at least potentially) enjoyed huge productivity and consumption gains from the internet and related technologies. Others have gotten some benefits from the internet, but it's far from clear that those benefits are outweighed by, say, the impact of increased outsourcing on the wage they can command….

[I]s this an iron rule of innovation in information technology—that the cheaper information becomes and the easier it becomes to manipulate it the greater will be the gap, productive and otherwise, between the informationally capable and the rest?

That's certainly possible….

I'm not sure we should be confident that continued innovation won't ultimately augment cognition generally, and perhaps in relatively surprising ways. Maybe as the internal aspect of cognition shrinks relative to the external, technological aspect, the differences in internal characteristics across the population will cease to matter very much. The more I rely on the same cloud brain that's available to anyone else, the less the strengths or weaknesses of my meat brain may matter…

But it probably will not turn again back in the direction of Raynaud de Chatillon.

Econ 210a: U.C. Berkeley: Spring 2012: Memo Question for February 29: The Uneven Spread of Industrialization

Memo Question for February 29: The Uneven Spread of Industrialization:

By the end of the nineteenth century, the classic Industrial Revolution technologies of coal, steam, textile machinery, rails, locomotives, and precision metalworking--plus a large number of follow-on technologies, as witnessed by the growth of a Johannesburg centered around leading-edge organic chemicals--were or could be profitable pretty much everywhere in the world, if the organization and resources could be assembled. Why then did industrialization spread from Britain in the years up to 1900 only to western Europe, the temperate zones of the Americas and Australasia, and Japan? What answers do this week's readings suggest to you?

Econ 210a: U.C. Berkeley: Spring 2012: February 29: The Uneven Spread of Industrialization

February 29. The Uneven Spread of Industrialization (DeLong)

• Tom Nicholas (2011), “The Origins of Japanese Technological Modernization,” Explorations in Economic History 48:2, pp. 272-291. http://www.sciencedirect.com/science/journal/00144983/48/2

• Justin Lin (1995), “The Needham Puzzle: Why the Industrial Revolution Did Not Originate in China,” Economic Development and Cultural Change 43:2, pp. 269-292. http://www.jstor.org/stable/i248445

• Carol Schiue and Wolfgang Keller (2004), “Markets in China and Europe on the Eve of the Industrial Revolution,” NBER Working Paper no.10778. http://www.nber.org/papers/w10778

• Indijrat Ray (2009), “Identifying the Woes of the Cotton Textile Industry in Bengal: Tales of the 19th Century,” Economic History Review 62:4, pp. 857-892. http://onlinelibrary.wiley.com/doi/10.1111/j.1468-0289.2009.00444.x/abstract

Quote of the Day: February 17, 2012

"1. TEMPERANCE. Eat not to dullness; drink not to elevation. 2. SILENCE. Speak not but what may benefit others or yourself; avoid trifling conversation. 3. ORDER. Let all your things have their places; let each part of your business have its time. 4. RESOLUTION. Resolve to perform what you ought; perform without fail what you resolve. 5. FRUGALITY. Make no expense but to do good to others or yourself; i.e., waste nothing. 6. INDUSTRY. Lose no time; be always employ'd in something useful; cut off all unnecessary actions."

--Benjamin Franklin, The Autobiography of Benjamin Franklin

Effects of the 2009 Recovery Act: Heartening News About What Economists Think--Although Caroline Hoxby and Ed Lazear Do Go All-in for Team Republican...

The University of Chicago's IGM Forum:

Poll Results | IGM Forum: Question A: Because of the American Recovery and Reinvestment Act of 2009, the U.S. unemployment rate was lower at the end of 2010 than it would have been without the stimulus bill.

At the time, back at the start of 2009, arguments that the Recovery Act would not push the unemployment rate down over the two years after its enactment took one of three lines:

1. Unemployment is really not cyclical but structural, so whatever boost to spending it might generate would show up in higher prices and wages as businesses trying to satisfy demand bid against each other for a fixed pool of non-zero-marginal-product workers.

2. Government purchases must be financed by issuing government debt, and debt issues would push up interest rates and so would discourage private investment spending.

3. Government purchases must be financed by issuing government debt, and the future taxes needed to amortize the extra debt would frighten businesses and investors, so we would see equity prices tank as this fear would discourage private investment.

None of those things happened. And that is why the Chicago panel agrees 80%-4% with the statement that the Recovery Act the unemployment rate in 2010 below what it would otherwise have been.

And in this context it is worth noting that the two members who want to go on record agreeing with the Republican Party line and disagreeing with the statement appear to do so very carefully. We have only two of their polled economists: Caroline Hoxby and Ed Lazear, both of Stanford:

Note that Hoxby appears to be evaluating a different statement--that the ARRA was worth doing--rather than the question asked--that the ARRA reduced the unemployment rate in 2010 below what it would otherwise have been. At least, that is how I read her claim that "the depressing effects of future liabilities likely exceed benefits".

And note that Lazear's comments--"the estimates [of the Recovery Act's effects] are varied and the highest are based on ex-ante models, not experience-based data. The upper bound estimate is low"--appear to justify the position that he is uncertain about the truth of the statement, not that he disagrees with the statement.

From one perspective, this is quite heartening: 183 years after John Stuart Mill and Jean-Baptiste Say agreed that Say's Law applies in the long run but not in the short business-cycle run, 4 years after what John Quiggin calls its zombie-like rising from the grave, the claim that increases in government purchases must by the metaphysical necessity of the case--no matter what happens to asset or commodity prices--crowd out an equal and opposite amount of private spending appears to be dead.

And staked.

Again.

To Be Continued...

Robert Allen: The British Industrial Revolution in Global Perspective

Everytime I reread http://www.ehs.org.uk/ehs/conference2007/Assets/AllenIIA.pdf, I think: Robert Allen is a fracking genius!:

The Industrial Revolution is one of the most celebrated watersheds in human history. It is no longer regarded as the abrupt discontinuity that its name suggests, for it was the result of an economic expansion that started in the sixteenth century. Nevertheless, the eighteenth century does represent a decisive break in the history of technology and the economy. The famous inventions–the spinning jenny, the steam engine, coke smelting, and so forth–deserve their renown1, for they mark the start of a process that has carried the West, at least, to the mass prosperity of the twenty-first century. The purpose of this essay is to explain why they occurred in the eighteenth century, in Britain, and how the process of their invention has transformed the world... […]

The industrial revolution was fundamentally a technological revolution, and progress in understanding it can be made by focussing on the sources of invention.... [T]he reason the industrial revolution happened in Britain, in the eighteenth and nineteenth centuries, was not because of luck (Crafts 1977) or British genius or culture or the rise of science. Rather it was Britain’s success in the international economy that set in train economic developments that presented Britain’s inventors with unique and highly remunerative possibilities. The industrial revolution was a response to the opportunity… […]

What commercial success did for Britain was to create a structure of wages and prices that differentiated Britain from the continent and, indeed, Asia: In Britain, wages were remarkably high and energy cheap. This wage and price history was a fundamental reason for the technological breakthroughs of the eighteenth century whose object was to substitute capital and energy for labour. Scientific discoveries and scientific culture do not explain why Britain differed from the rest of Europe. They may have been necessary conditions for the industrial revolution, but they were not sufficient: Without Britain’s distinctive wage and price environment, Newton would have produced as little economic progress in England as Galileo produced in Italy... [...]

The working assumption of this paper is that technology was invented by people in order to make money.... [L]abour was particularly expensive and energy particularly cheap in Britain, so inventors in Britain were led to invent machines that substituted energy and capital for labour.... The scale of the mining industry in eighteenth century Britain was much greater than anywhere else, so the return to inventing improved drainage machinery (a.k.a. the steam engine) was greater in Britain than in France or China. Third, patents that allow the inventor to capture all of the gains created by his invention raise the rate of return and encourage invention... [...]

Britain was a high wage economy in four senses:1. At the exchange rate, British wages were higher than those of its competitors. 2. High silver wages translated into higher living standards than elsewhere. 3. British wages were high relative to capital prices. 4. Wages in northern and western Britain were exceptionally high relative to energy prices...

The different trajectories of the wage-rental ratio created different incentives to mechanize production in the two parts of Europe. In England, the continuous rise in the cost of labour relative to capital led to an increasingly greater incentive to invent ways of substituting capital for labour in production. On the continent, the reverse was true…. It was not Newtonian science that inclined British inventors and entrepreneurs to seek machines that raised labour productivity but the rising cost of labour... [...]

Britain’s unusual wages and prices were due to two factors. The first was Britain’s success in the global economy, which was in part the result of state policy. The second was geographical–Britain had vast and readily worked coal deposits…. The superior real wage performance of northwestern Europe was due to a boom in international trade…. In a mercantilist age, imperialism was necessary to expand trade, and greater trade led to urbanization.... Coal deposits were a second factor contributing to England’s unusual wage and price structure…. First, inexpensive coal raised the ratio of the price of labour to the price of energy (Figure 4), and, thereby, contributed to the demand for energy-using technology. In addition, energy was an important input in the production of metals and bricks, which dominated the index of the price of capital services.... [C]oal is a ‘natural’ resource, but the coal industry was not a natural phenomenon.... It was the growth of London in the late sixteenth century, however, that caused the coal industry to take off. The Dutch cities provide a contrast that reinforces the point (Pounds and Parker 1957, de Vries and van der Woude 1997, Unger 1984). The coal deposits that stretched from northeastern France across Belgium and into Germany were as useful and accessible as Britain’s.... The pivotal question is why city growth in the Netherlands did not precipitate the exploitation of Ruhr coal in a process parallel to the exploitation of Northern English coal. Urbanization in the Low Countries also led to a rise in the demand for fuel. In the first instance, however, it was met by exploiting Dutch peat. This checked the rise in fuel prices, so that there was no economic return to improving transport on the Ruhr or resolving the political-taxation issues related to shipping coal down the Rhine. Once the Newcastle industry was established, coal could be delivered as cheaply to the Low Countries as it could be to London, and that trade put a ceiling on the price of energy in the Dutch Republic that forestalled the development of German coal. This was portentous: Had German coal been developed in the sixteenth century rather than the nineteenth, the industrial revolution might have been a Dutch-German breakthrough rather than a British achievement... [...]

The following generalizations apply to many inventions including the most famous: 1. The British inventions were biased. They were labour saving and energy and capital using.... 2. As a result of 1, cost reductions were greatest at British factor prices, so the new technologies were adopted in Britain and not on the continent.... [C]oke smelting was not profitable in France or Germany before the mid-nineteenth century (Fremdling 2000). Continuing with charcoal was rational behaviour in view of continental factor prices. This result looks general; in which case, adoption lags mean that British technology was not cost-effective at continental input prices. 3. The famous inventions of the industrial revolution were made in Britain rather than elsewhere in the world because the necessary R&D was profitable in Britain (under British conditions) but unprofitable elsewhere.... 4. Once British technology was put into use, engineers continued to improved it, often by economizing on the inputs that were cheap in Britain. This made British technology cost-effective in more places and led to its spread across the continent later in the nineteenth century.... The theory advanced here explains the technological breakthroughs of the industrial revolution in terms of the economic base of society–natural resources, international trade, profit opportunities. Through their impact on wages and prices, these prime movers affected both the demand for technology and its supply... [...]

Why did the French ignore the new spinning machines? Cost calculations for France are not robust, but the available figures indicate that jennies achieved consistent savings only at high count work, which was not the typical application (Ballot 1923, pp. 48-9). In France, a 60 spindle jenny cost 280 livre tournois in 1790 (Chassagne 1991, p. 191), while a labourer in the provinces earned about three quarters of a livre tournois per day, so the jenny cost 373 days labour. In England, a jenny cost 140 shillings and a labourer earned about one shilling per day, so the jenny was worth 140 days labour (Chapman and Butt 1988, p. 107). In France, the value of the labour saved with the jenny was not worth the extra capital cost, while in England it was. French cost comparisons show that Arkwright’s water frame, a much more capital intensive technique, was no more economical than the jenny. The reverse was true in England where water frames were rapidly overtaking jennies. The French lag in mechanization was the result of the low French wage… […]

Why did the industrial revolution lead to modern economic growth? 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. This is one reason that the Industrial Revolution was British. But why did those inventions matter? The French were certainly active inventors, and the scientific revolution was a pan-European phenomenon. Wouldn’t the French, or the Germans, or the Italians, have produced an industrial revolution by another route? Weren’t there alternative paths to the twentieth century? These questions are closely related to another important question asked by Mokyr: Why didn’t the industrial revolution peter out after 1815? He is right that there were previous occasions when important inventions were made. The result, however, was a one-shot rise in productivity that 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 is that scientific knowledge increased enough to allow continuous invention. Technological improvement was certainly at the heart of the matter, but it was not due to discoveries in science–at least not before 1900. The reason that incomes continued to grow in the hundred years after Waterloo was because Britain’s pre-1815 inventions were particularly transformative, much more so than continental inventions. That is a second reason that the Industrial Revolution was British and also the reason that growth continued throughout the nineteenth century.... The nineteenth century engineering industry was a spin-off of the coal industry. All three of the developments that raised productivity in the nineteenth century depended on two things–the steam engine and cheap iron. Both of these, as we have seen, were closely related to coal. The steam engine was invented to drain coal mines, and it burnt coal. Cheap iron required the substitution of coke for charcoal and was prompted by cheap coal. (A further tie- in with coal was geological–Britain’s iron deposits were often found in proximity to coal deposits.) There were more connections: The railroad, in particular, was a spin-off of the coal industry. Railways were invented in the seventeenth century to haul coal in mines and from mines to canals or rivers. Once established, railways invited continuous experimentation to improve road beds and rails. Iron rails were developed in the eighteenth century as a result, and alternative dimensions and profiles were explored. Furthermore, the need for traction provided the first market for locomotives. There was no market for steam-powered land vehicles because roads were unpaved and too uneven to support a steam vehicle (as Cugnot and Trevithick discovered). Railways, however, provided a controlled surface on which steam vehicles could function, and colliery railways were the first purchasers of steam locomotives. When George Stephenson developed the Rocket for the Rainhill trials, he tested his design ideas by incorporating them in locomotives he was building for coal railways. In this way, the commercial operation of primitive versions of technology promoted further development as R&D expenses were absorbed as normal business costs.... The reason that the British inventions of the eighteenth century–cheap iron and the steam engine, in particular–were so transformative was because of the possibilities they created for the further development of technology. Technologies invented in France–in paper production, glass, knitting–did not lead to general mechanization or globalization. One of the social benefits of an invention is the door it opens to further improvements. British technology in the eighteenth century had much greater possibilities in this regard than French inventions. The British were not more rational or prescient than the French in developing coal-based technologies: The British were 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 steam ship, or the global economy. In other words, there was only one route to the twentieth century–and it went through northern Britain...

Econ 210a: Spring 2012: U.C. Berkeley: The Industrial Revolution: February 15, 2012

February 15. The Industrial Revolution (DeLong):

• Robert C. Allen (2011), “Why the Industrial Revolution Was British: Commerce, Induced Invention and the Scientific Revolution,” Economic History Review 64, pp. 357-384. http://onlinelibrary.wiley.com/doi/10.1111/j.1468-0289.2010.00532.x/pdf

• Jeffrey Williamson (1984), "Why Was British Economic Growth So Slow During the Industrial Revolution?" Journal of Economic History 44:3, pp. 687-712. http://www.jstor.org/stable/2124148

• Nicholas Crafts (2002), "The Solow Productivity Paradox in Historical Perspective," CEPR Discussion Paper no.3142. http://www.j-bradford-delong.net/articles_of_the_month/pdf/Newsolow.pdf

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Industrial Revolution Memo Question

Tracking the Forward March of Human Liberty...

From my perspective the nadir of human liberty in the twentieth century comes in the first half of the 1930s. Thereafter we have a long march--a march that was fastest in the North Atlantic from 1942 to 1975 or so, and that has continued (albeit at a slower pace) since then. But Milton Friedman thought not. And now it turns out that a surprisingly large number of people think not, even today.

With Friedman I think I understand. He was curiously blind to racism, sexism, etc.--and to the importance of their decline. As I see it, he saw only the failures of social democratic regulation (transportation, professional practice, nimbyism, drug war, etc.) and none of the successes (telecommunications, federalization of food and drug regulation, finance, etc.) and none of the places where society in 1980 was still underregulated (pollution, medical insurance, etc.). From my perspective, Friedman had a touching but naive faith in the bona fides, competence, and benevolence of his political masters. And he had a great overestimation of how successful the policies he believed in--stable money stock growth, deregulation, "starve the beast" through low taxes--would turn out to be.

With people today I don't understand. I really don't see a rationale for believing today that 1980 was in any sense a nadir of human liberty--a point well down the Road to Serfdom--or for believing that the progress of human liberty has been materially more rapid after 1980 than it was in the 50 years before.

Noah Smith performs the public good of picking up the litter with respect to John Cochrane:

Noahpinion: A standard intellectual-Republican narrative of history: John Cochrane has a new post up in which he discusses the historical importance of Milton Friedman's book Free to Choose…. The first half of the post is a discussion of the difference between negative and positive rights, with which I largely (but not completely) agree. But the second half consists of a reading of events since 1980 with which I take a number of exceptions….

1980 was an inflection point for the advance of freedom…! Yes, some of the Friedmans' dark worries did not pan out. Why not? Because people read the book! The Friedmans were fighting against the "tide of history." And turned it back…

[Cochrane's] appears to me to be a very standard intellectual Republican narrative of recent history; if you surveyed registered Republicans with postgraduate degrees, and then took an  average of their responses, it seems like you might get something like this. Now, standard narratives are not necessarily wrong. But this narrative happens to be one about which my feelings are quite mixed…. I agree about China. I basically agree about India (though where did Keynes support a "license raj"??). I agree about the Cold War and the spread of democracy. I agree about inflation. None of these positive developments should be forgotten or ignored.

But there are some points with which I strongly disagree. Let me address these:

1. "[1980] was the end of stagnation in the US and UK." What? Really?? What about the Bush years? You know, the 8 years when the inflation-adjusted stock market did worse than in the 1970s, income stagnated, and GDP growth underperformed past booms, all despite massive tax cuts and substantial deregulation?

2. "The economic and political ills of the 1970s seem to be returning." Really? Inflation?? No. I know there are some people who believe that a fiscally induced hyperinflation is just around the corner, but that is pure speculation...

3. "US and UK inflation -- the result of mindless "stimulus"" Really?? But budget deficits were low in the 1970s, and only exploded in the Reagan years (and again in the Bush years). And most economists believe that the 70s inflation was caused by loose monetary policy (and possibly oil shocks), not by fiscal policy.

Basically, in 2000, this Republican narrative was looking pretty good - though not entirely thanks to Republicans. Bill Clinton seemed to have proven that market liberalism did not require exploding deficits and exploding inequality (the ills of the Reagan years) in order to create prosperity. But then came the Bush years, and America doubled down on the Milton Friedman program with more tax cuts, more deregulation, more privatization. And income stagnated, stocks stagnated, and growth was lackluster, while debt and inequality resumed the explosive growth of the Reagan years. By the eve of the financial crisis, the Republican narrative was looking pretty shopworn…

I would quibble with one point. I would say that it was not the Republican narrative of ever-more deregulation, ever-greater tax cuts, ever-higher degrees of inequality, and ever-larger structural deficits that looked good as of 2000. I would say it was, rather, the Clinton narrative of smart neoliberalism: using market incentives and mechanisms to achieve social democratic goals.

Paul Krugman piles on. Many hands make light work:

Reaganite Delusions: The great era of US economic growth was the postwar generation; even during the good years of the 90s we didn’t achieve comparable growth, and overall, the post-Reagan era was marked by slower growth than the equivalent period of time pre-Reagan. And I haven’t even gotten into the income distribution thing.

All of which makes me wonder: what goes on in these peoples’ minds? Do they never even think of actually looking at the numbers, because they know that Reagan ushered in a great boom? Inquiring minds (which they obviously don’t have) want to know.

I will leave the discussion of negative and positive liberty to the trained professionals in the field--but I would say that if you have not listened very closely on these issues to Amartya Sen, you should not claim to be an economist.

On the data issues... I am thinking, increasingly, that what is going on is a combination of selection by right-wing funding sources for complaisant intellectuals, of subservience to whatever their political masters set forth as the party line (individual mandate as a conservative responsibility principle, anybody?), and is at some level a simple lack of work ethic: people unwilling to open up their web browsers to look at the data, people unwilling to do their homework, and people unwilling to take even small steps to see whether their prejudices meet the test when marked to market. It is, after all, very hard not to notice that for America's lower, working, and middle classes, the economic stagnation in real compensation per hour that started in the early 1970s did not magically come to an end on January 21, 1981 but has--alas!--continued (with a short interruption in the Clinton years) to this day.

That is really hard to miss.

Econ 210a: UC Berkeley: Spring 2012: Memo Question: To what extent should we view the late eighteenth and early nineteenth centuries in Britain as a unique turning point in economic and social development?

Econ 210a: UC Berkeley: Spring 2012: Memo Question:

To what extent should we view the late eighteenth and early nineteenth centuries in Britain as a unique turning point in economic and social development?

Quote of the Day: February 7, 2012

"The failure of the duly elected [Weimar German] government to build a new Army that would be faithful to its own democratic spirit and subordinate to the cabinet and the Reichstag was a fatal mistake for the Republic, as time would tell. The failure to clean out the judiciary was another. The administrators of the law became one of the centers of the counterrevolution, perverting justice for reactionary political ends.'

--William Shirer, The Rise and Fall of the Third Reich

Andrei Shleifer: Seven Lessons Learned from Watching the Transition from Communism to Capitalism

AS:

Seven things I learned about the transition from communism: First, in all countries in Eastern Europe and the former Soviet Union, economic activity shrunk at the beginning of transition, in some very sharply.  In many countries, economic decline started earlier, but still continued. In Russia, the steepness and the length of the decline (almost a decade) was a big surprise. Countries with the biggest trade shocks (such as Poland and Czechoslovakia) experienced the mildest declines. To be sure, the true declines were considerably milder than what was officially recorded… but this does not take away from the basic fact that declines occurred and were surprising. These declines contradicted at least the simple economic theory that a move to free prices should immediately improve resource allocation. The main lesson of this experience is for reformers not to count on an immediate return to growth. Economic transformation takes time.

Second, the decline was not permanent. Following these declines, recovery and rapid growth occurred nearly everywhere. Over 20 years, living standards in most transition countries have increased substantially for most people…. [C]apitalism worked and living standards improved enormously…. [But] for a time things looked glum. So lesson learned: have faith – capitalism really does work.

Third, the declines in output nowhere led to populist revolts – as many economists had feared…. Instead of populism, politics in many countries came to be dominated by new economic elites, the so-called oligarchs, who combined wealth with substantial political influence. From the perspective of 1992, this came as a huge surprise…. [T]the lesson is clear: a reformer should fear… capture of politics by the new elites.

Fourth, economists and reformers overstated both their ability to sequence reforms, and the importance of particular tactical choices…. Politics and competence frequently intervened and dictated to a large extent most of the tactical choices. Still, most countries, despite different choices, ended up with largely similar outcomes (notable and sad exceptions are Belarus, Uzbekistan, and Turkmenistan)… privatisation and macroeconomic stabilisation as well as legal and institutional reform…. Lesson learned: do not over-plan the move to markets, but, more importantly, do not delay in the hope of having a tidier reform later.

Fifth, economists have greatly exaggerated the benefits of incentives by themselves, without changes in people…. Winners in the communist system turned out not to be so good in a market economy. Transition to markets is accomplished by new people, not by old people with better incentives….

Sixth, it is important not to overestimate the long-run consequences of macroeconomic crises…. Debt restructurings do not necessarily make permanent scars. This experience bears a profound lesson for reformers, who are always intimidated by the international financial community: do not panic about crises; they blow over fast.

Seventh, it is much easier to forecast economic than political evolution. Although nearly all transition countries have eventually converged to some form of capitalism, there has been a broader range of political experiences, from full democracies, to primitive dictatorships, to just about everything in between… middle-income countries eventually slouch toward democracy, but not nearly in as direct or consistent a way as they move toward capitalism.

Memo Question for February 8, 2012: Slavery and Serfdom

Memo Question for February 8, 2012: Slavery and Serfdom:

Adam Smith in the Wealth of Nations has a theory about unfree labor. It is, he says, economically inefficient. But wherever demand is very high relative to supply masters will resort to slave labor because it yields them powerful psychic income:

The experience of all ages and nations, I believe, demonstrates that the work done by slaves, though it appears to cost only their maintenance, is in the end the dearest of any…. Whatever work he does beyond what is sufficient to purchase his own maintenance, can be squeezed out of him by violence only, and not by any interest of his own. In ancient Italy, how much the cultivation of corn degenerated, how unprofitable it became to the master, when it fell under the management of slaves, is remarked both by Pliny and Columella….

The pride of man makes him love to domineer, and nothing mortifies him so much as to be obliged to condescend to persuade his inferiors. Wherever the law allows it, and the nature of the work can afford it, therefore, he will generally prefer the service of slaves to that of freemen. The planting of sugar and tobacco can afford the expense of slave cultivation. The raising of corn, it seems, in the present times, cannot. In the English colonies, of which the principal produce is corn, the far greater part of the work is done by freemen…. The profits of a sugar plantation in any of our West Indian colonies, are generally much greater than those of any other cultivation that is known either in Europe or America; and the profits of a tobacco plantation, though inferior to those of sugar, are superior to those of corn, as has already been observed. Both can afford the expense of slave cultivation…

Was he right? Was he wrong?

Economics 210a: U.C. Berkeley: Spring 2012: Apropos of the Agricultural Revolution in Britain

Food for thought related to Allen on nitrogen:

Henry Farrell and Cosma Shalizi, "Evolutionary Theory and the Dynamics of Institutional Change"

Econ 210a: Spring 2012: U.C. Berkeley: The Agricultural Revolution

• Class Slides

Britain in the 1930s and Britain Today

We are live at Project Syndicate:

Neville Chamberlain is remembered today as the British prime minister who, as an avatar of appeasement of Nazi Germany in the late 1930’s, helped to usher Europe into World War II. But, earlier in that fateful decade, relatively soon after the start of the Great Depression, the British economy was rapidly returning to its previous level of output, thanks to Chancellor of the Exchequer Neville Chamberlain’s pursuit of stimulus to restore the price level to its pre-depression trajectory.

Compare that approach to the expansion-through-austerity policy being pursued nowadays by British Prime Minister David Cameron’s government (with Chancellor of the Exchequer George Osborne leading the cheering squad). The country’s real GDP has flat-lined, and the odds are high that British real GDP is headed down again.

Indeed, in less than a year, if current forecasts are correct, Britain’s Cameron-Osborne Depression will not merely be the worst depression in Britain since the Great Depression, but probably the worst depression in Britain…ever.

That is quite an accomplishment. As Phillip Inman of The Guardian recently put it:

[T]he UK’s plan for recovery from the financial crisis was based on a full-throttle recovery in 2012....[C]onsumer confidence, business investment, and general spending would converge to send the economy on a trajectory of above-average growth.

It did not work: government ministers:

have done what the right-wing economists told them to do and moved out of the way – the theory being that public-sector spending and investment was ‘crowding out’ the private sector.

Instead, as Inman says, “Spain is showing the way with its austerity-driven recession. Where the weak tread, we [in Britain] look keen to follow...”

The failure of expansionary austerity in Britain should give all of its advocates around the world reason to reflect on and rethink their policy calculations. Britain is a highly open economy with a flexible exchange rate and some room for further monetary easing. There is no risk or default premium baked into British interest rates to indicate that fear of political-economic chaos down the road is discouraging investment.

There is an argument – not necessarily true, but an argument nonetheless – that, while in office from 1997 to May 2010, the Labour governments of Tony Blair and Gordon Brown overshot long-term sustainable government spending as a share of GDP. Their actions stand in contrast to countries that reduced their debt-to-GDP levels in the 2000’s, and to the United States, where the problem was not excessive spending but insufficient taxation under the Bush administration.

Yet, if one takes this view seriously, Britain, with a ten-year nominal interest rate of less than 2.1% per year, should already be in a boom. If there was ever a place where expansionary austerity should work well – where private investment and exports should stand up as government purchases stood down, confirming its advocates’ view of the world – it is Britain today.

But Britain today is not that place. And if expansionary austerity is not working in Britain, how well can it possibly work in countries that are less open, that can’t use the exchange-rate channel to boost exports, and that lack the long-term confidence that investors and businesses have in Britain?

Nick Clegg, Britain’s deputy prime minister and the leader of Cameron’s coalition partner, the Liberal Democrats, should end this farce today. He ought to tell Queen Elizabeth II that his party has no confidence in Her Majesty’s government, and humbly suggest that she ask Labour Party leader Ed Miliband to form a new one.

To be sure, if Clegg did this, his political career would probably be finished, and his party’s electoral prospects would be damaged for a long time to come. But Clegg’s political career and his party’s fortunes will be shaky for a long time to come in any case, given the economic hardship that Britain is enduring (and will continue to endure). At least defection from the ill-advised Conservative-Liberal coalition now would benefit his country.

Policymakers elsewhere in the world take note: starving yourself is not the road to health, and pushing unemployment higher is not a formula for market confidence.

Econ 210a: UC Berkeley: Spring 2012: Readings for February 1, 2012: The Agricultural Revolution

February 1. The Agricultural Revolution (DeLong)

• Donald McCloskey (1972), “The Enclosure of Open Fields,” Journal of Economic History 32, pp. 15-35. http://www.jstor.org/stable/2117175

• Robert Allen (2008), “The Nitrogen Hypothesis and the English Agricultural Revolution: A Biological Analysis,” Journal of Economic History 68, pp. 182-210. http://journals.cambridge.org/action/displayIssue?jid=JEH&volumeId=68&issueId=01&iid=1740956

• Robert C. Allen (1999), “Tracking the Agricultural Revolution in England,” Economic History Review , New Series 52:2 (May), pp. 209-235 http://www.jstor.org/stable/2599937

Econ 210a: U.C. Berkeley: Spring 2012: Memo Question for February 1, 2012: Agricultural Revolution

Does the Agricultural Revolution deserve its "R"? That is, is it well-conceptualized as a "Revolution" rather than as something much slower and much more gradual?

Econ 210a: UC Berkeley: Spring 2012: The Commercial Revolution

January 25. The Commercial Revolution (DeLong): Readings

• Karl Marx (1867), "The So-called Primitive Capital Accumulation," Capital, Vol. 1, Part VIII, Chapters 26-32. http://tinyurl.com/dl20090112k

• Daron Acemoglu, Simon Johnson, and James Robinson (2005), "The Rise of Europe: Atlantic Trade, Institutional Change, and Economic Growth," American Economic Review 95:3, pp. 546-79. http://www.jstor.org/stable/i387682

• Jan de Vries (2010) "The Limits to Globalization in the Early Modern World," Economic History Review 63:3, pp. 710-33. http://web.ebscohost.com/ehost/results?sid=2ed5a63b-2aff-4c71-9e08-a3ca196c942a%40sessionmgr104&vid=2&hid=125&bquery=(JN+%26amp%3bquot%3bEconomic+History+Review%26amp%3bquot%3b+AND+DT+20100801)&bdata=JmRiPWJ0aCZ0eXBlPTEmc2l0ZT1laG9zdC1saXZl

• Jeffrey Williamson and Kevin O'Rourke (2002), "After Columbus: Explaining Europe's Overseas Trade Boom, 1500-1800," Journal of Economic History 62, pp. 417-56. http://www.nber.org/papers/w8186

Discussion Powerpoint

Earl Cook's Estimates of Energy Capture...

"Early agriculturalists" means Fertile Crescent ca. 5000 BC; "advanced agriculturalists" means northwest Europe ca. 1400; "industrial" means northwest Europe ca. 1860; "technological" means North Atlantic ca. 1970.

Source: Ian Morris, Why the West Rules--for Now