Brad DeLong

David Glasner Is Also a Wicksteed Fan...

http://uneasymoney.com/2012/10/22/theres-a-whole-lot-of-bubbling-going-on/

Failure to Understand Basic Macroeconomics

If China were to decide to spend less of its earnings from exports to the U.S. buying our debt and more buying our goods, interest rates would not go up--remember, the Federal Reserve is pegging short-term safe nominal interest rates at zero--but production and employment would.

Paging Rob Portman to the white courtesy phone, please.

The fact that Republican High Politicians do not get briefings teaching them basic income-expenditure macroeconomics is one of many, many, many reasons not to vote Republican. And it is a reason to ask senior Republican economists--I'm looking at you, Glenn Hubbard, Greg Mankiw, John Taylor, Marty Feldstein, Eddie Lazear--what the f*&$ they think they are doing.

Paul Krugman tries, once again, to teach the lesson:

Fear-of-China Syndrome: Rob Portman… offered a nice break from all the lies in Tampa… offered us some good old-fashioned bad macroeconomics… castigated the Obama administration for not taking a tougher line on China--which is actually something I’ve complained about too--then offered a completely wrong explanation. Obama won’t take on China, Portman said, because

Obama could not run up his record trillion dollar deficits if the Chinese did not buy our bonds to finance them

OK, let’s ask the question: how much overseas financing does the United States as a whole need? The answer is… an accounting identity: capital inflows = current account deficit…. So what has happened to the current account deficit as a share of GDP in the Obama era? Um, it’s way down…. How is it possible that we’re borrowing much less from foreigners when the government deficit has gone up so much? The answer is that the private sector is deleveraging…. So who’s actually financing the US budget deficit? The US private sector. We don’t need Chinese bond purchases….

To make excuses for Portman, lots of people keep getting this wrong, even after all these years. But really, truly, the last thing we need to worry about is whether the Chinese love our bonds.

The Very Smart David Glasner: Two Devastating Problems with Austrian Business-Cycle Theoryy

David Glasner:

Two Problems with Austrian Business-Cycle Theory:

[T]o counter Selgin’s argument – which is to say, the central argument of Austrian Business-Cycle Theory – one has to take a step back and ask why a price bubble, or a distortion of interest rates, caused by central-bank policy should have any macroeconomic significance. In any conceivable real-world economy, entrepreneurial error is a fact of life. Malinvestments occur all the time; resources are, as a consequence, constantly being reallocated…. To be sure, the rate of interest is a comprehensive price potentially affecting how all resources are allocated. But that doesn’t mean that a temporary disequilibrium in the rate of interest would trigger a major economy-wide breakdown….

Joshua Gans: A Nobel Prize for Market Design: Roth and Shapley

http://www.digitopoly.org/2012/10/15/a-nobel-prize-for-market-design/

Paul Krugman: The Austerians of Today Are the Austerians of 1931

Paul Krugman:

Same As It Ever Was: FT Alphaville went trawling through the New York Times archives to look at what people were saying about monetary policy in 1929-33, and produced a wonderful piece that’s both deeply reassuring and deeply frustrating. The thing that’s both reassuring and frustrating is how much it sounds just like the discussions and debates we have today….

[A]s a card-carrying model-building economist, my justification for existence relies on the belief that the issues and fundamental stories in economics are fairly stable…. [A] liquidity trap in the 1930s is recognizably the same kind of animal as a liquidity trap in the 21st century…. Keynes’s and FDR’s economy, it turns out, was enough like ours that the same stylized models still apply.

Now the disturbing part… it’s a huge failure of economics as a practical discipline that we’re hashing over the same debates our grandfathers had (and making many of the same mistakes). Some of this reflects the refusal of policy makers to listen… a lot of it reflects the deliberate forgetting of many economists, and the resulting lack of any clear professional guidance.

Gavyn Davies's Morning Meeting Reading List

Macro blogroll for the morning meeting:

I admit that I have only belatedly realised just how much essential economic information and discussion is freely available in the blogosphere. The internet has given everyone the chance to become a journalist, and many macro economists have taken full advantage. How times have changed. When I started work as an economist in the financial markets in the 1970s, it was easy to prepare for client presentations or for the firm’s morning meetings (which even then had assumed great importance, though they normally started at the civilised hour of 9.30am). Essentially, I read three journalists in the papers on the way to work in the City: Samuel Brittan in the Financial Times, and Peter Jay and David Blake in The Times. With Martin Wolf still ensconced inside the four walls of the World Bank, that covered about 95 per cent of the questions I was likely to get at the time. Any other questions were easily dismissed as irrelevant to the markets…. Morning meetings nowadays are full of debate about macro-economic ideas, the speeches of central bankers, and the writings of academia. The blogs are pivotal. Diversity of opinion reigns. No one in the investment community is safe from the ideas of the macro thinkers…. In the list below, I have selected only a small sample of the total universe of economics blogs, focusing exclusively on those that cover my particular subject…. I have tried not to choose personal favourites…. I have excluded many other great blogs for no reason other than the need for brevity…. In no particular order… the current list is:

1. Economists View – Mark Thoma http://economistsview.typepad.com/economistsview/
2. Paul Krugman Conscience of a Liberal http://krugman.blogs.nytimes.com/
3. Grumpy Economist – John Cochrane’s blog http://johnhcochrane.blogspot.co.uk/
4. Grabbing Reality With Both Hands – Brad DeLong http://delong.typepad.com/sdj/
5. Economics One – John Taylor http://johnbtaylorsblog.blogspot.co.uk/
6. Econbrowser – Jim Hamilton and Menzie Chinn http://www.econbrowser.com/
7. Fed Watch – Tim Duy http://economistsview.typepad.com/timduy/
8. Confessions of a Supply Side Liberal – Miles Kimball http://blog.supplysideliberal.com/
9. Noahpinion – Noah Smith http://noahpinionblog.blogspot.co.uk/
10. J.P.Koning Blog http://jpkoning.blogspot.co.uk/
11. The Money Illusion – Scott Sumner http://www.themoneyillusion.com/
12. Uneasy Money – David Glasner http://uneasymoney.com/
13. New Monetarist Economics – Stephen Williamson http://newmonetarism.blogspot.co.uk/
14. VoxEU – Portal for the Centre for Economic Policy Research http://voxeu.org/
15. Bruegel Blog http://www.bruegel.org/blog/
16. China Financial Markets – Michael Pettis http://www.mpettis.com/
17. Key Trends in Globalisation – John Ross http://ablog.typepad.com/
18. Not the Treasury View – Jonathan Portes http://notthetreasuryview.blogspot.co.uk/
19. Mainly Macro – Simon Wren Lewis http://mainlymacro.blogspot.co.uk/
20. Money Supply – FT http://blogs.ft.com/money-supply/#axzz26dkdgIc3
21. Alphaville – FT http://ftalphaville.ft.com/
22. Martin Wolf’s Exchange – FT http://blogs.ft.com/martin-wolf-exchange/#axzz26dkdgIc3
23. Free Exchange – The Economist http://www.economist.com/blogs/freeexchange

If I were Davies, I would dump (5): John Taylor looks to me right now to be much more interested in seeking high federal office than in analyzing the world out there. I would also dump (3)--it is true that John Cochrane is no longer peddling simplistic cash-in-advance models in which nominal GDP moves proportionately (albeit perhaps with lags) with the stock of nominal money and nothing else matters, but this does not mean that he has done his homework: now he peddles simplistic fiscal-dominance models in which nominal GDP moves proportionately (albeit perhaps with lags) with the stock of nominal debt, and that is not a net improvement.

I would replace them with the nonpareil that is Marginal Revolution http://marginalrevolution.com, and with Felix Salmon http://blogs.reuters.com/felix-salmon and Joe Weisenthal http://twitter.com/TheStalwart and Matt O'Brien http://www.theatlantic.com/matthew-obrien/...

Paul Krugman Asks a Question: On the "Austrian" Hatred of Fractional Reserve Banking, Paper Money, etc. Weblogging

Paul Krugman asks a question:

Ron Paul on Money Market Funds: [T]he Ron Paul link, in which [Ron Paul] condemned fractional reserve banking, prodded me to ask a question I’ve been meaning to ask: How do the Austrians propose dealing with money market funds?

I mean, it has always been a peculiarity of that school of thought that it praises markets and opposes government intervention — but that at the same time it demands that the government step in to prevent the free market from providing a certain kind of financial service. As I understand it, the intellectual trick here is to convince oneself that fractional reserve banking, in which banks don’t keep 100 percent of deposits in a vault, is somehow an artificial creation of the government. This is historically wrong…. But consider a more recent innovation: money market funds. Such funds are just a particular type of mutual fund — and surely the Austrians don’t want to ban financial intermediation (or do they?). Yet shares in a MMF are very clearly a form of money — you can even write checks on them — created out of thin air by financial institutions, with very few pieces of green paper behind them.

So are such funds illegitimate? What about repo, which has many of the same features?

One of the key lessons of the 2008 crisis was precisely that banks are defined by what they do, not by what they look like, and there are a whole range of financial arrangements that in economic terms act a lot like fractional reserve banking. So would a Ron Paul regulatory regime have teams of “honest money” inquisitors fanning across the landscape, chasing and closing down anyone illegitimately creating claims that might compete with gold and silver? How is this supposed to work?

OK, I don’t expect a serious answer. But it’s scary that this has become the more or less official doctrine of the GOP.

Well, in its origins it springs out of Medieval Christian (and earlier) condemnations of usury as unjust enrichment:

And by the 1920s it's part of a general fear of Jews, intellectuals, homosexuals, financiers, and people who weren't born rich but might be smarter and become richer than you. For example, Churchill's Secretary P.J. Grigg on Keynes:

I distrust utterly those economists who have with great but deplorable ingenuity taught that it is not only possible but praiseworthy for a whole country to live beyond its mens on its wits and who in Mr. Shaw's description tech that it is possible to make a community rich by calling a penny two pence, in short who have sought to make economics a vade mecum for political spivs...

But on the doctrinal level? I tried to untangle it. I am not sure whether I was successful. In any event, here it is all in one place:

Yes. Economists Are Not Hobbists. They Are Lockeans. Why Do You Ask?: Noah Smith Is an Example Weblogging

Noah Smith establishing the common ground among economists so the debate can begin:

@modeledbehavior Voluntary exchange is the fundamental idea behind *all* free market ideas.

— Noah Smith (@Noahpinion) September 15, 2012

See: That's Lockean--people have stuff, and exist peacefully together in civil society, and have the opportunity to engage in mutually-beneficial exchange relationships. That is not Hobbist. That is not Hobbist at all.

What Economists' Reading of Isaiah Chapter 60 Tells Us About Economists: Views of the Tetragrammaton Blogging

At the Brookings Panel Michael Klein presented a paper: "Capital Controls: Gates and Walls: Central Banks’ Recent Experiments with Capital Controls Not Very Effective".

During his presentation he said that he had recently heard Isaiah 60:11 in Temple--"Thy gates also shall be open continually; they shall not be shut day nor night; that men may bring unto thee the wealth of the nations"--and that it struck him as apposite that Isaiah was for free trade and opposed to the closing of gates, so he put it up on the screen.

This made me sit up for two reasons:

First, I had never before seen Stanford's Bob Hall and Harvard's Marty Feldstein huddling together whispering to each other as they interpreted a verse of the Nevi'im Aharonim…

John Taylor Has Made David Glasner Unhappy

I feel his pain.

David Glasner: Taylor Rules?: What I find especially noteworthy, aside from the remarkable fact that, as Scott Sumner noted, Taylor’s preferred rule would have called for a rate increase in early 2008, when the economy was already in recession, and on the verge of one of the sharpest one-quarter declines in real GDP on record, in the third quarter of 2008 even before the Lehman panic of September-October, is that both versions of the Taylor rule implied a target interest rate substantially higher than the Fed Funds rate actually in effect for  most of 2008. So Taylor is implicitly endorsing a far tighter monetary policy in 2008, after the economy had already entered a recession and started a rapid contraction, than the disastrously tight policy to which the economy was then being subjected by the FOMC….

In retrospect, some of the time the FOMC seems to have done better than the Taylor rules, and some of the time one or both of the Taylor rules seem to have done better than the FOMC. Not exactly an overwhelmingly good performance. So why should anyone assume that adopting the Taylor rule would be an improvement, all things considered, over the exercise of discretion?

Taylor wants to argue that the exercise of discretion is bad in and of itself. But which is The Taylor rule? Taylor likes one version of the rule, but he can’t provide any argument…. And even now, though he claims to like one version better than the other, he can only conclude his post by saying that more research on the relative merits of the rules is necessary. In other words, adopting the Taylor rule is not sufficient to eliminate policy uncertainty…. The upshot of all this is just that for Taylor to suggest that adopting his rule would somehow reduce policy uncertainty when there is clearly no way to specify the parameters necessary to generate a predictable value for the interest rate target implied by the rule is simply disingenuous… to suggest that there is any evidence that following the Taylor rule… would have led to better outcomes… is just laughable.

Mark Thoma Has Smart Things to Say About the Federal Reserve's Policy Shift:

Economist's View: Woodford on Optimal Monetary Policy Rules:

I have supported more aggressive action from the Fed throughout the crisis, though perhaps with a bit less confidence that such action would have big effects than some others, and I have supported nominal GDP targeting. It's a way for the the Fed to be more aggressive without running into political opposition. After all, the Fed is simply stabilizing… people's incomes, and the real/nominal distinction will be lost on most people. But I haven't jumped fully onto the NGDP bandwagon…. The theoretical underpinnings of this particular rule are not clear. I have asked supporters to answer a question, more than once, "in what class or classes of models is NGDP targeting the optimal policy rule?," but there was no response…. So where are the limits? When is this the best policy rule?>Fortunately… Michael Woodford notes that he has looked at this question, and guess what? It turns out that NGDP has desirable properties, and sometimes it is the optimal policy, but not always. What's important… is the inclusion of both growth and level variables in the policy rule (which to include, output growth, output levels, price growth -- we call this inflation -- or price levels depends critically on the nature of the underlying friction in the model, there is no set rule, which leads one to ask about robust rules across various models, and here I think NGDP targeting might do well, but someone needs to check…). This is Woodford….

I didn’t specifically prefer to use that formalism of a nominal GDP target, which is why I’m not particularly associated with that specific proposal. What I’ve been writing about for quite a while… is the desirability of committing to rules where there’s a nominal level variable rather than purely referring to the rate of growth of a nominal variable. The idea was that if the nominal growth in the economy undershoots or overshoots, either one, there should be a commitment to getting back to the target path…. The idea that purely forward looking approaches are undesirable is something I’ve been emphasizing in various papers since the 1990s….

Can't Anybody Play This Game?: Harvey Rosen and Martin Feldstein Work for the Romney Campaign Edition...

… ran out onto the field eager to attack the analysis of William Gale et al. of Romney's tax promises, which concluded that it is arithmetically impossible for Romney not to give a tax cut to those making more than $200K/year in AGI. They simply do not have enough deductions and loopholes that Romney has not yet taken off the table for any conceivable base-broadening to collect enough revenue from the $200K/year crowd to offset the tax losses from the rate cuts.

The first odd and extraordinary thing about both Feldstein and Rosen is that they claim to be disproving Gale et al., and yet they do no such thing. Taking their analyses at face value (which you shouldn't do), they say that if Romney keeps his tax-policy promises it is arithmetically necessary for him to give a tax cut to the $200K/year and above crowd, but that it is also arithmetically possible for him to pay for that by raising taxes on the $100K/year - $200K/year crowd, leaving the less than $100K/year "middle class" and "working class" untouched. For both Feldstein and Rosen to spin that as "Romney won't cut taxes on the rich" seems to me for each of them to do himself substantial damage…

Brad DeLong Resmackdown Watch: Cosma Shalizi Argues That Brad DeLong Is an Atypical Economist

Hoisted from Comments: Cosma Shalizi:

1. The practice of one member of the discipline isn't enough. If it was, I could point to Sam Bowles and Herb Gintis and say that being an economist means a profound engagement with traditions of social thought broadly inspired by Marx and emphasizing the contingency of social roles and institutions, but corrected by evolutionary game theory. Or I could point to Mark Blaug to say that being an economist means according basically no normative weight to the two fundamental theorems of welfare economics whatsoever. Or I could point to Edward Prescott and say that being an economist means re-inventing statistical wheels, and deciding that they should be hexagons. Or I could point to D. McCloskey and whatever it is they're into this decade.

2. I don't think "Berkeley economist" will do. There was a reason I specifically mentioned Varian's micro textbook, and Varian and Shapiro's business book about profiting by exploiting customers and manipulating standards-setting.

3. I think that, as the discipline has developed, the thought of The Theory of the Moral Sentiments and even much (most?) of The Wealth of Nations has, in fact, become profoundly alien to what most of the profession sees as the core ideas of economics. This could change; I hope it does change; if it changes, I expect that the practitioners' histories will edit out the fact that it was a change.

4. If I had to put it in a slogan, I would say that it's not so much that you're not an economist, as that you (like Sam and Herb) are a harbinger of a different and better economics.

I think my response has to follow three tracks: what your standard economist does, what I do, and what the canonical political scientist does.

Every Time I Read David Glasner, I Think That the Academic Prestige Hierarchy of Economists Writing About Monetary Policy Is Badly Inverted: Think of the Alternative Monetary Policy Strategy Spaces Department

Not, mind you, that I think David is a better monetary economist than Mike Woodford--I do find I learn more from paying careful attention to Mike than to David. But I can't think of anybody else I reliably learn more from paying careful attention to…

David Glasner:

Uneasy Money: In my previous post, I criticized Ben Bernanke’s speech last week at the annual symposium on monetary policy at Jackson Hole, Wyoming. It turns out that the big event at the symposium was not Bernanke’s speech but a 98-page paper by Michael Woodford, of Columbia University. Woodford’s paper was important, because he is widely considered the world’s top monetary theorist, and he endorsed the idea proposed by the intrepid, indefatigable and indispensable Scott Sumner that the Fed stop targeting inflation and instead target a steady growth path of nominal GDP. That endorsement constitutes a rather stunning turn of events in which Sumner’s idea (OK, Scott didn’t invent the idea, but he made a big deal out of it when nobody else was paying any attention) has gone from being a fringe idea to the newly emerging orthodoxy in monetary economics.

John Cochrane, however, is definitely not with the program…. I am going to challenge two assertions that Cochrane makes. These aren’t the only ones that could be challenged, but it’s getting late.

Republican Politicians' Indiscipline and Economists' Discipline

Paul Krugman:

Discipline and Indiscipline: [T]he story from Tampa [was]n’t the policy ideas, which are just what we already knew; it’s the personal indiscipline…. Chris Christie had his big moment, his chance to set himself up as the heir apparent. Instead, he gave a demonstration of his monstrous self-absorption, going two-thirds of the way through his speech before so much as mentioning the name of his party’s presidential nominee. And Paul Ryan’s speech was just lazy. Rolling out the Janesville thing again, despite having been called on it already? Doing the Medicare cuts thing when everyone in the media was already on the case for his prior advocacy of the same cuts? Doing Bowles-Simpson when, again, everyone in the media knows that he played a large role in undercutting the panel (for which, by the way, we should thank him)? I mean, good policy aside, where was the craftsmanship?

Put it this way, if you’re going to be deceptive, you should at least put in the effort to avoid offering targets that even the most diffident, balance-loving reporters will have a hard time hitting missing.

So as I said, indiscipline has ruled the last two days.

But meanwhile, on a front closer to home for me, the awesome discipline of Republican-leaning economists — their willingness to say anything, do any amount of damage to their professional reputations, for the cause, even when they have no personal hope of being rewarded with high office — remains in place. I wonder what the incentives are; is it just social pressure?

Failure to Understand Basic Macroeconomics

If China were to decide to spend less of its earnings from exports to the U.S. buying our debt and more buying our goods, interest rates would not go up--remember, the Federal Reserve is pegging short-term safe nominal interest rates at zero--but production and employment would.

Paging Rob Portman to the white courtesy phone, please.

The fact that Republican High Politicians do not get briefings teaching them basic income-expenditure macroeconomics is one of many, many, many reasons not to vote Republican. And it is a reason to ask senior Republican economists--I'm looking at you, Glenn Hubbard, Greg Mankiw, John Taylor, Marty Feldstein, Eddie Lazear--what the f*&$ they think they are doing.

Paul Krugman:

Fear-of-China Syndrome: Rob Portman… offered a nice break from all the lies in Tampa… offered us some good old-fashioned bad macroeconomics… castigated the Obama administration for not taking a tougher line on China--which is actually something I’ve complained about too--then offered a completely wrong explanation. Obama won’t take on China, Portman said, because

Obama could not run up his record trillion dollar deficits if the Chinese did not buy our bonds to finance them

OK, let’s ask the question: how much overseas financing does the United States as a whole need? The answer is… an accounting identity: capital inflows = current account deficit…. So what has happened to the current account deficit as a share of GDP in the Obama era? Um, it’s way down…. How is it possible that we’re borrowing much less from foreigners when the government deficit has gone up so much? The answer is that the private sector is deleveraging…. So who’s actually financing the US budget deficit? The US private sector. We don’t need Chinese bond purchases….

To make excuses for Portman, lots of people keep getting this wrong, even after all these years. But really, truly, the last thing we need to worry about is whether the Chinese love our bonds.

Hoisted from the Archives (2010): Is Macroeconomics Hard? No

Brad DeLong: Is Macroeconomics Hard? No: "Math is hard," said Malibu Barbie, famously--and a ton of criticism came down on her for the implicit message that her auditors should go off and do other, easier, things instead and leave the math to the trained professionals. Is macroeconomics hard in this sense? I confess that I do not think so. I think that macro is pretty easy...[1]

Let's go back in time almost two centuries, to the days when--first after the end of the Napoleonic Wars and then in 1825-6--the nascent intellectual community of economists confronted the question of whether the circular flow of economic activity as mediated by the market system could break down and the economy become afflicted by a "general glut" of commodities.

There was no question that there could be a "glut" of particular commodities. An example may make this clear:

Suppose--this is Berkeley, after all--that households decide that they want to spend less than they have been spending on electricity to power large-screen video and audio entertainment systems and more on yoga lessons to seek inner peace. The immediate consequence--within the "market day," as late-nineteenth century British economist Alfred Marshall would have put it--of this shift in preferences is excess demand for yoga instructors and excess supply of electric power. Prices of electricity (and of large-screen TVs, and of audio systems) fall as unsold inventories pile up in stores and as generators spin down and stand idle. Yoga instructors, by contrast, find themselves overscheduled, working ten-hour days, and stressed out--and find the prices they can charge for their lessons going through the roof. Workers in electric power distribution and in video and audio production and sales find that they must either accept lower wages or find themselves out on the street without jobs.

Over time the market system provides individuals with changing incentives that resolve the excess-supply excess-demand disequilibrium and restore the economy to equilibrium balance. Seeing the fortunes to be earned by teaching yoga, more young people learn to properly regulate their svadisthana chakra and teach others to do so. Seeing unemployment and stagnant wages in electrical engineering, fewer people major in EECS. The supply of yoga instructors grows. The supply of electrical engineers shrinks. Wages of yoga instructors fall back towards normal. Wages of electrical engineers rise. And balanced equilibrium is restored.

Thus we understand how there can be a glut of a particular commodity--in this case, electric power. And we understand that it is matched by an excess demand for another commodity--in this case, yoga instructor services to properly align your svadisthana chakra.

But can there be a general glut, a glut of everything?

Some economists early in the nineteenth century said yes--and that the economy was experiencing one, and that the fact that such "general gluts" could manifest themselves was a problem with the market system that economists needed to figure out how to solve. Thomas Robert Malthus was the most prominent of those who protested. He agreed that the then-fashionable economic theory said that a glut in one market had to be balanced by a surplus of excess demand in another. But, he said, so much the worse for economic theory:

Malthus on Ricardo: [A]ccording to [Ricardo's]... theory of profits... the master manufacturers would have been in a state of the most extraordinary prosperity, and the rapid accumulation of their capitals would soon have employed all the workmen that could have been found. But, instead of this, we hear of glutted markets, falling prices, and cotton goods selling at Kamschatka lower than the costs of production. It may be said, perhaps, that the cotton trade happens to be glutted; and it is a tenet of the new doctrine on profits and demand, that if one trade be overstocked with capital, it is a certain sign that some other trade is understocked. But where, I would ask, is there any considerable trade that is confessedly under-stocked, and where high profits have been long pleading in vain for additional capital? The [Napoleonic] war has now been at an end above four years; and though the removal of capital generally occasions some partial loss, yet it is seldom long in taking place, if it be tempted to remove by great demand and high profits; but if it be only discouraged from proceeding in its accustomed course by falling profits, while the profits in all other trades, owing to general low prices, are falling at the same time, though not perhaps precisely in the same degree, it is highly probable that its motions will be slow and hesitating...

Jean-Baptiste Say defended the theory. He wrote to Malthus claiming that theory was sound, and that the idea of a "general glut" was logically inconceivable:

Letters to Mr. Malthus: I shall not attempt, Sir, to add... in pointing out the just and ingenious observations in your book; the undertaking would be too laborious.... [And] I should be sorry to annoy either you or the public with dull and unprofitable disputes. But, I regret to say, that I find in your doctrines some fundamental principles which... would occasion a retrograde movement in a science of which your extensive information and great talents are so well calculated to assist the progress.... What is the cause of the general glut of all the markets in the world, to which merchandize is incessantly carried to be sold at a loss?... Since the time of Adam Smith, political economists have agreed that we do not in reality buy the objects we consume, with the money or circulating coin which we pay for them. We must in the first place have bought this money itself by the sale of productions of our own. To the proprietor of the mines whence this money is obtained, it is a production with which he purchases such commodities as he may have occasion for.... From these premises I had drawn a conclusion... “that if certain goods remain unsold, it is because other goods are not produced; and that it is production alone which opens markets to produce.”... [W]henever there is a glut, a superabundance, [an excess supply] of several sorts of merchandize, it is because other articles [in excess demand] are not produced in sufficient quantities... if those who produce the latter could provide more... the former would then find the vent which they required.... You, on the contrary, assert that there may be a superabundance of goods of all sorts at once; and you adduce several facts in favour of your opinion. M. Sismondi had already opposed my doctrine...

As the young John Stuart Mill put it, the core of the argument of Say, Ricard, and their school was that:

There can never, it is said, be a want of buyers for all commodities; because whoever offers a commodity for sale, desires to obtain a commodity in exchange for it, and is therefore a buyer by the mere fact of his being a seller. The sellers and the buyers, for all commodities taken together, must, by the metaphysical necessity of the case, be an exact equipoise to each other; and if there be more sellers than buyers of one thing, there must be more buyers than sellers for another...

Thus a general glut was as impossible as a square circle or a solid gas.

Yet Say changed his mind. By 1829, in his analysis of the British financial panic and recession of 1825-6, Jean-Baptiste Say was writing that there could indeed be such a thing as a general glut of commodities after all: "every type of merchandise had sunk below its costs of production, a multitude of workers were without work. Many bankruptcies were declared..."

The general glut, Say wrote in 1829, had been triggered by a panicked financial flight to quality which had led the Bank of England to shrink its liabilities:

The Bank [of England], legally obliged to redeem its banknotes in specie... [t]o limit its losses... forced the return of its banknotes, and ceased to put new notes into circulation. It was then obliged to cease to discount commercial bills. Provincial banks were in consequence obliged to follow the same course, and commerce found itself deprived at a stroke of the advances on which it had counted, be it to create new businesses, or to give a lease of life to the old. As the bills that businessmen had discounted came to maturity, they were obliged to meet them, and finding no more advances from the bankers, each was forced to use up all the resources at his disposal. They sold goods for half what they had cost. Business assets could not be sold at any price. As every type of merchandise had sunk below its costs of production, a multitude of workers were without work. Many bankruptcies were declared among merchants and among bankers, who having placed more bills in circulation than their personal wealth could cover, could no longer find guarantees to cover their issues beyond the undertakings of individuals, many of whom had themselves become bankrupt...

What was going on?

The answer was nailed by John Stuart Mill in that same year.

Mill's explanation: there was indeed a "general glut" of newly-produced commodities for sale and of workers to hire. But it was also the case that the excess supply of goods, services, and labor was balanced by an excess demand elsewhere in the economy. The excess demand was an excess demand not for any newly-produced commodity, but instead an excess demand for financial assets, for "money":

Although he who sells, really sells only to buy, he needs not buy at the same moment when he sells... there may be, at some given time, a very general inclination to sell with as little delay as possible, accompanied with an equally general inclination to defer all purchases as long as possible.... In order to render the argument for the impossibility of an excess of all commodities applicable... money must itself be considered as a commodity....

Those who have... affirmed that there was an excess of all commodities, never pretended that money was one of these commodities.... What it amounted to was, that persons in general, at that particular time, from a general expectation of being called upon to meet sudden demands, liked better to possess money than any other commodity. Money, consequently, was in request, and all other commodities were in comparative disrepute....

The result is, that all commodities fall in price, or become unsaleable.... [A]s there may be a temporary excess of any one article considered separately, so may there of commodities generally, not in consequence of over-production, but of a want of commercial confidence...

How, exactly, should economists characterize the excess demand in financial markets? Where was it, exactly? That became a subject of running dispute, and the dispute has been running for more than 150 years, with different economists placing the cause of the "general glut" that was excess supply of newly-produced goods and of labor at the door of different parts of the financial system.

The contestants are:

1. Fisher-Friedman: monetarism: a depression is the result of an excess demand for money--for those liquid assets generally accepted as means of payment that people hold in their portfolios to grease their market transactions. You fix a depression by having the central bank boost the money stock. Eliminating the excess demand for money also brings the goods and labor markets into balance and out of excess supply.

2. Wicksell-Keynes (Keynes of the Treatise on Money, that is): a depression happens when there is an excess demand for bonds--for ways of moving purchasing power from the present into the future. The workings of the banking system lead the market rate of interest to be above the natural rate of interest which balances the supply of funds saved and the demand for funds to finance business investment. You fix a depression by either reducing the market rate of interest (via expansionary monetary policy) or raising the natural rate of interest (via expansionary fiscal policy) in order to bring them back into equality. Then, with no more excess demand for bonds, the goods and labor markets will also be back in balance and out of excess supply.

3. Bagehot-Minsky-Kindleberger: a depression happens because of a panic and a flight to quality, as everybody tries to sell their risky assets and cuts back on their spending in order to try to shift their portfolio in the direction of safe, high-quality assets--which, of course, everybody cannot all do at the same time. The excess demand is an excess demand for high-quality AAA assets in particular, not of money (although outside money and some inside money are AAA assets) and not of bonds (some of which are AAA assets, but not all). You fix a depression by restoring market confidence and so shrinking demand for AAA assets and by increasing the supply of AAA assets. Eliminating the excess demand for high-quality assets is eliminated will bring the goods and labor markets out of excess supply and back into balance.

From the perspective of this Malthus-Say-Mill framework Keynes's General Theory is a not entirely consistent mixture of (1), (2), and (3)...

Note that these financial market excess demands can have any of a wide variety of causes: episodes of irrational panic, the restoration of realistic expectations after a period of irrational exuberance, bad news about future profits and technology, bad news about the solvency of government or of private corporations, bad government policy that inappropriately shrinks asset stocks, et cetera. Nevertheless, in this Malthus-Say-Mill framework it seems as if there is always or almost always something that the government can do to affect asset supplies and demands that promises a welfare improvement over, say, waiting for prolonged nominal deflation to raise the real stock of liquid money, of bonds, or of high-quality AAA assets. Monetary policy open market operations swap AAA bonds for money. Quantitative easing that raises expected inflation diminishes demand for money and for AAA assets by taxing them. Non-standard monetary policy interventions swap risky bonds for AAA bonds or money. Fiscal policy affects both demand for goods and labor and the supply of AAA assets--as long as fiscal policy does not crack the status of government debt as AAA and diminish rather than increasing the supply of AAA assets. Government guarantees transform risky bonds into AAA assets. Et cetera...

And then there are, of course, those who never read their John Stuart Mill of 1829, and who never noticed that Jean-Baptiste Say in 1829 had retracted his 1803 claim that a general glut is impossible. They continue claim that a depression is not an economic disequilibrium that can be cured by proper government policy at all--but rather an economic equilibrium that can only be made even less pleasant by government intervention. Think of Karl Marx, Friedrich Hayek, Ludwig von Mises, Andrew Mellon, Robert Lucas, et cetera.

This fraction maintains that in a depression there is no excess supply of goods and labor in any meaningful sense. But, instead, they say:

1. goods and labor markets are in balance--no government policy to raise employment and production is welfare-increasing--it is just that technological regress has lowered the productivity of labor, and employment is low because real wages are low and workers would rather be unemployed; or

2. goods and labor markets are in balance---no government policy to raise employment and production is welfare-increasing--it is just that workers have an increased taste for leisure that has raised their reservation wage, and employment is low because real wages are high and businesses would rather not hire; or

3. goods and labor markets are in balance---no government policy to raise employment and production is welfare-increasing--it is just that previous overinvestment has given us a capital stock that is too large and misallocated, and employment is low because workers cannot quickly be redeployed into jobs in the consumption goods sector; or

4. goods and labor markets are in balance---no government policy to raise employment and production is welfare-increasing--it is just that workers have mistaken nominal shocks for real shocks, and think that real wages are lower than they are because they misperceive the price level.

It is pretty clear that they are wrong.

Indeed, John Stuart Mill and Jean-Baptiste Say back in 1829 had pretty clear and convincing arguments that this no-disequilibrium fraction is wrong. And Mill's and Say's arguments have not become less clear and convincing in the past 180 years.

I like this Malthus-Say-Mill framework. I think that this framework allows me to at least characterize every position on our current macroeconomic dilemmas that I have heard--like, for example, that the advocates of austerity are convinced that further debt issue by the U.S. government will crack the U.S. Treasury bond's status as a safe asset and thus increase, not decrease, the excess demand for AAA assets and increase, not decrease, the excess supply of recently-produced commodities and labor.

And it is not rocket science.

But it is, however, cutting-edge economics--cutting edge for 1829, that is.

[1] People who, along with me, took Olivier Blanchard's Economics 2410b course in spring 1983 will note how closely this tracks what Olivier was trying to teach us in the three classes--the week and a half--he spent on Lloyd Metzler's "Wealth, Savings, and the Rate of Interest." (The only distinction Metzler is missing that I think is needed is the distinction between safe and risky bonds.) And, of course, Edmond Malinvaud's Theory of Unemployment Reconsidered

: http://delong.typepad.com/sdj/2010/06/is-macroeconomics-hard.html

Spinning for Romney: Momma Always Told Me That If You Can't Say Something Nice Don't Say Anything at All Department

Robert Waldmann: contrasts Alan Blinder:

You definitely don’t want to draw attention to differences [in opinion] at all. You’re not helping the candidate. [The candidate] should know that you think he’s wrong on this or that, but you shouldn’t go blasting that to the media…

Douglas Holtz-Eakin:

The candidate takes the policy position and you as an individual or economist might have some different ideas but you support the policies the candidate’s chosen. Once the decision’s made, you’re done.

And Glenn Hubbard:

Consider keeping Bernanke, top Romney adviser says: Glenn Hubbard, economic adviser to the Republican presidential candidate, said he would advise a possible President Romney that Bernanke should "get every consideration" to stay on beyond January 2014…. "Ben is a model technocrat. He gets paid nothing for getting kicked around all the time. I think they ought to pat him on the back…. I may or may not agree with him, but that's very different from saying I question his motives. I wish politicians would stop doing that…"

The context is Mitt Romney's declaration that Ben Bernanke does not share his economic views, and does not focus on "maintaining the monetary stability that leads to a strong dollar".

What Blinder leaves out is that it is not clear that you always want to help the candidate: perhaps the candidate's policies are so whacka-whacka that the candidate is the greater evil, or perhaps by drawing a line in the sand now you can materially increase the chances of better policies in the future for only a small chance of worse policies now.

What Holtz-Eakin leaves out is that an economic advisor's job is not "done" when a soundbite that sounds good to a spinmaster has been selected in the heat of the campaign, and that the fact that Holtz-Eakin thinks it is is a good argument for keeping him far from high federal office.

Glenn Hubbard is simply saying what he believes--and what I believe Romney believes--to be true.

Scott Sumner vs. the Less-than-Thoughtful Austrian Hordes

Scott Sumner:

TheMoneyIllusion » Are you a central planner?: So I see that the usual suspects are accusing me of being a “central planner” because I have the audacity to offer an opinion on whether the Chinese are building too many houses.  Of course by that logic anyone who offers an opinion on whether the Chinese (or Americans) are building too many houses is a central planner.  And that means that all those who now think the Chinese are building too many houses, or who believed (in 2005) the Americans were building too many houses, are central planners.  After all, only the market can know whether too many houses are being built…. I’m not sure what school of thought all these omniscient commenters belong to, but they talk a lot about Hayek, Rothbard, and von Mises.

I am currently in Shanghai, a city that seems at first glance to have far too little housing for its 23 million residents, and which is absorbing over 600,000 new migrants every single year. OK all you experts who claim to know exactly how many houses China should build; answer the much simpler question of how many houses the city of Shanghai should be building each year. There’s also the issue of what type of houses should be built in China. The market is currently trying to build houses for the rich…

Matthew Yglesias (2010): Why We Should Fear That Paul Ryan Talks to John Cochrane…

Matthew Yglesias (2010):

Paul Ryan's Monetary Economics: Paul Ryan says that “monetary policy was always my first love” but he doesn’t seem to know very much about it: “There is nothing more insidious that a government can do to its people than to debase its currency,” Ryan said. Just as harmful, Ryan warns, is that the proliferation of newly printed dollars inevitably unleashes inflation and throws the economy out of kilter in other ways. “Inflation is a killer of wealth. It wipes out the middle class. It eviscerates the standard of living for people who have retired or are living on fixed incomes,” he said. “Name me a nation in history that has prospered by devaluing its currency.” [...]

So to sum up, right now inflation is running lower than it was in the 1990s and 2000s. What’s more, in the 1990s and 2000s it was running lower than it was in the 1980s. And what the Fed is trying to do is to bring inflation back not to the levels of the Ronald Reagan Era, but to the rate we enjoyed in the 1990s and 2000s. Maybe Ryan’s a madman rather than a hypocrite…

Why Do European Economists Write Letters While US Economists Endorse Candidates?

Simon Wren-Lewis has some very smart observations this morning:

mainly macro: Why do European Economists write Letters while US Economists Endorse Candidates?: In February 2010, 20 economists including a number of academics of note signed a letter that endorsed the Conservative Party’s deficit reduction plan for the UK. Although 20 is a small number (I’m sure many more – like me – were asked to sign and did not), they made up in quality what they lacked in quantity. The New Statesman magazine recently had the bright idea of asking them “whether they regretted signing the letter and what they would do to stimulate growth”. It published the results yesterday.

Half of the signatories replied. The headline was that most have changed their mind.

Ah. A Republican "Economists for Romney" Letter

I see that there is a Republican "Economists for Romney" letter: http://economistsforromney.com/.

I wonder how many of the signers have second thoughts now that the Republicans have a vice presidential candidate whose guru on economics demands not just a gold standard but a gold coinage. Lucas, Scholes, and Mundell must be wincing--Becker and Prescott are beyond shame. If I were them, I would back out now while they still can…

The conventional way to score these things is to look at how many members of your party's Council of Economic Advisers could be induced to sign this thing. By that count, on a scale where 10 is perfect agreement, the score is…

3.7!

That is a remarkably low score at this game: less than 4 out of 10 economists appointed by Republicans to the Council of Economic Advisors want to be associated with this…

Scott Sumner Needs a Better Work Ethic: Use the Google! It's Not That Difficult! Department

Scott Sumner snarks:

TheMoneyIllusion: Suppose we picked on Paul Krugman or Brad DeLong.  Then we’d dig up quotations from early 2009 insisting we needed fiscal stimulus because the Fed was out of ammunition, and from 2012 demanding that the Fed do more because a sluggish economy could put the barbarians back in power in November…. I’ve been 100% consistent from day one.

But he doesn't do the diving. Let's do the two minutes of work needed. We find things like… this: Brad DeLong: Kick-Starting Employment:

Unemployment is currently rising like a rocket, because businesses that normally would be expanding and hiring are not, and those businesses that would normally be contracting and shedding workers are doing so very rapidly. Businesses that ought to be expanding and hiring cannot, because the depressed general level of financial asset prices prevents them from borrowing money or selling bonds on profitable terms.

In response, central banks should purchase government bonds for cash in as large a quantity as needed to push their prices up as high as possible. Expensive government bonds will shift demand to mortgage or corporate bonds, pushing up their prices.

Even after central banks have pushed government bond prices as high as they can go, they should keep buying government bonds for cash, in the hope that people whose pockets are full of cash will spend more of it, and that this will directly pull people out of joblessness and into employment.

In addition, governments need to run extra-large deficits. Spending – whether by the United States government during World War II, following the Reagan tax cuts of 1981, by Silicon Valley during the late 1990’s, or by home buyers in America’s south and on its coasts in the 2000’s – boosts employment and reduces unemployment. And government spending is as good as anybody else’s.

Finally, governments should undertake additional measures to boost financial asset prices, and so make it easier for those firms that ought to be expanding and hiring to obtain finance on terms that allow them to expand and hire. It is this point that brings us to US Treasury Secretary Timothy Geithner’s plan to take about $465 billion of government money, combine it with $35 billion of private-sector money, and use it to buy up risky financial assets…. The appearance of an extra $500 billion in demand for risky assets will reduce the quantity of risky assets that other private investors will have to hold…. With higher financial asset prices, those firms that ought to be expanding and hiring will be able to get money on more attractive terms.

The problem is that the Geithner Plan appears to me to be too small – between one-eight and one-half of what it needs to be. Even though the US government is doing other things as well –fiscal stimulus, quantitative easing, and other uses of bailout funds – it is not doing everything it should…

Doesn't say what Scott said it would say, does it? Doesn't say that the government should do expansionary fiscal policy because the Fed is out of ammunition, does it? Says, rather, that the government should do everything--fiscal, monetary, and banking policy.

What Should Be Done About HHMT?

Simon Wren-Lewis:

mainly macro: Giving Economics a Bad Name: What can economics as a discipline do about this sad state of affairs? The answer is pretty obvious, to economists in particular, and that is changing the incentives where we can. However we cannot do much about the incentives provided by politics and the media. I have been pretty pessimistic about this in the past, but in a future post I will try and be more positive and talk about one possible way forward.

Why History of Economic Thought Is Important: Whack-a-Mole Wall Street Journal/Arthur Laffer Edition

Why oh why can't we have a better press corps? Why oh why can't we have better right-wing economists?

As every even casual student of the history of economic thought knows, back before 1829 whether it was sensible to talk about increases in economic agents' planned spending raising and decreases lowering economic activity in the short run was an active research question in economic theory. Back then Say's Law ruled: since nobody produces for sale without intending to purchase, by "metaphysical necessity" planned spending must be equal to and could not be raised above or lowered below production. Thomas Malthus complained that this "Say-Ricardo doctrine" seemed sound in theory but did not appear to fit the world in practice, but he had no theoretical resolution to the problem.

As every even casual student of the history of economic thought knows, the question was definitively resolved by John Stuart Mill in 1829. Mill observed that people plan to spend their incomes not just on currently-produced goods and services, but also on financial assets. When economic agents in total plan to leverage up, planned spending in the short run is in excess of production--and then production rises and the economy booms. When economic agents in total plan to deleverage, planned spending in the short run is below production--and then production falls and the economy slumps.

James K. Glassman Is the Bad, Evil, Mendacious Hack Glassman...

James E. Glassman of J.P. Morgan Chase, formerly of Fed Monetary Affairs and Research and Statistics, is the good, intelligent, sensible, sane Glassman--who is always worth reading.

Use middle initials when referring to Glassmans!

They Also Serve Who Play Whack-a-Mole with People Who Do Not Understand the Gordon Equation for Valuing the Stock Market: The Last Kevin Hassett Post (For Now)

Right now, I feel exactly like Major Prathachulthorn of the Terragens Marines feels in David Brin's The Uplift War as he gets strangled into unconsciousness by a mutinous super-intelligent over-aggressive chimpanzee:

Distantly, she heard Prathachulthorn mutter to himself: “This universe is a goddam awful place"…

Suppose that you had told me, 15 or 30 years ago, that there was an economist who did not understand the Gordon equation for stock market valuation: somebody who, instead of knowing that the Gordon equation was P=D/(r-g) (where P is the value of the stock index, D is the dividend paid on the index, and r and g are the required rates of return and expected dividend growth rates respectively) thought instead that it was P=E/(r-g) (where E is the account earnings of the index). Suppose you had told me that that somebody would be a respected senior economic adviser to Republican presidential candidates. Suppose you had told me that that somebody would be taken seriously by the press as an authority. And suppose you had told me that I would feel compelled to play whack-a-mole, in a largely vain attempt to limit the spread of misinformation…

I would simply not have believed you…

I would've said that the Republican policy oriented economists could keep their own house well, not clean, but at least no more than 1 inch deep in toxic sludge.?.

I would have been wrong.

Oh, well: They also serve who play whack-a-mole with people who do not understand the Gordon equation for valuing the stock market.

Posted with Blogsy

Things I Forgot to Post Months Ago: Does Stephen Williamson Understand the Monetary Economics He Teaches Edition?

Sorry. This should have gone up… months ago...

I see Stephen Williamson is [was] ranting about how he teaches people monetary theory while I teach them John Stuart Mill, Wicksell, Fisher, Friedman, and Hicks…

From my perspective, the problem is that Stephen Williamson does not understand the monetary theory he purports to teach--and does not understand it because he does not know Mill, Wicksell, Fisher, Friedman, and Hicks. Consider Stephen Williamson's

Suppose a cash-in-advance model with a representative consumer, period utility u(c), discount factor b, constant aggregate endowment y. c is consumption. The consumer needs cash to buy c each period. Suppose y is a fixed quantity of output received by a firm, which is sold for cash within the period, and then the cash is paid as a dividend to the consumer at the end of the period. Have the money stock grow at a constant rate m. The real interest rate is constant at 1/b - 1. The nominal interest rate is (1+m)/b - 1, and the inflation rate is m. Constant m implies a constant nominal interest rate and a constant inflation rate. If m < 0, there is deflation, and the nominal interest rate is sufficiently low to support the deflation. I can think of the instrument the central bank sets as either the money growth rate or the nominal interest rate - that part is irrelevant.... What's the problem?"

This is simply wrong, wrong, wrong, wrong, wrong.

Setting a credible forward path for the nominal interest rate is not at all the same thing as setting a credible forward path for the money stock growth rate. The strategy spaces are different. And that makes a difference.

The problem, of course, is that Williamson does not have a model--a set of behavioral relationships and equilibrium conditions. Rather, all he has is a set of equilibrium conditions. But in order to figure out whether an economy is or can be expected to be evolving along a steady-state equilibrium path, you need not just the equilibrium conditions but the behavioral relationships. You need a model. And Williamson ain't got one.

The standard, conventional monetary theoretic model for the case when the Fed chooses a nominal interest rate target can be drawn on a graph with the nominal interest rate i on the vertical axis and the inflation rate π on the horizontal axis. This model has a "Wicksellian balance" condition--Williamson's r* = i - π --that does not hold at all times but, rather, is a steady-state equilibrium condition: if the economy is to the left of and above the Wicksellian balance line so that the real interest rate will be high, inflation is falling; if the economy is to the right of and below the Wicksellian balance line so that the real interest rate is low, inflation will be rising. And the Federal Reserve will not achieve its target interest rate all the time either: if the interest rate i above the red policy rule line, the nominal interest rate will be falling as the Federal Reserve pumps out the money; if the economy is below the interest rate will be falling as the Fed sells bonds for cash:

In this model the point where the blue and the red curves cross--the point where Williamson says inflation and nominal interest rates are constant--ain't a point where inflation and nominal interest rates are constant: we do not expect the economy to be there. What we expect to happen is that if the economy starts to the left of the green line it heads off toward deflationary Valhalla at point C, and if it starts to the right of the green line it heads off to inflationary Valhalla.

Of course, nobody believes that when inflation reaches 120% per year the Fed will still maintain its policy of pegging the nominal interest rate at 2% and so pumping out the money at 120% per year. Instead, we all believe that at some point--when inflation is too high--the Fed will abandon its nominal interest peg and cut back on money growth, and so its policy rule line will have a kink in it, like so:

We expect that if the economy starts to the right of the green line it will ultimately head for point A--and that if it starts to the left it will still head for deflationary Valhalla at point C. In this model, lowering the leftmost constant-nominal-interest rate peg arm of the policy rule is not a way to reduce inflation. Instead, it is a way of moving the green line to the left and increasing the set of initial conditions for which the economy converges to point A.

By contrast, the model in which the central bank sets a money-stock growth rule has very different dynamics--no explosion to either deflationary or inflationary Valhalla...

You cannot "think of the instrument the central bank sets as either the money growth rate or the nominal interest rate - that part is irrelevant". That part is not irrelevant. The two different instruments imply very different dynamics for the economy.

Jonathan Portes Makes Me Blush...

Jonathan Portes:

Not the Treasury view...: Which (macro)-economists are worth listening to?: [W]hen economists argue about the correct stance of policy, who should we (policymakers, commentators, and the general public) listen to? This question was prompted by a recent exchange I had with Ed Vaizey and Simon Hughes on the BBC's Daily Politics: I pointed out that not only was the government's decision in 2010 to cut the deficit too quickly doing considerable economic damage, but that this was both predictable and predicted by economists such as Paul Krugman and Martin Wolf. Their response was essentially "how were we to know which economists to listen to? Others were saying the opposite"….

[P]olicymakers and the public should listen to economists who… have made empirically testable predictions (conditional or unconditional - see Krugman here) that have proved, by and large, to be broadly consistent with the data; and, second, they base those predictions on an analytic framework (not necessarily a formal model) that is persuasive…. My shortlist… is something like the following: Krugman, Delong and Wren-Lewis on fiscal policy… Adam Posen on monetary policy… Paul de Grauwe on sovereign and eurozone debt; Martin Wolf on private sector savings and public sector deficits (the financial balance approach); Richard Koo on the implications of a "balance sheet recession"

Not all of these economists agree with each other on everything, nor do I necessarily agree with them about everything…. But they each have clear analytic frameworks for thinking about the economy, and have used them to make empirically testable claims; and have largely been vindicated….

[There is] an obvious list of economists or those commenting on economic issues who got it completely wrong, usually because they were using analytic frameworks that were incoherent or lacked empirical evidence. I won't name individuals here, so I leave that to readers, but a short list of influential bodies that should have known better… those… writing editorials at the Financial Times, macroeconomic forecasters at the OECD, the European Department at the IMF… their recent stuff on both UK and eurozone has been pretty good… the senior leadership at the Bank of England and the Treasury, and probably worst of all senior economic policymakers at the ECB and European Commission.  Oh, and the credit ratings agencies….

It is worth mentioning two economists who I respect, admire and find interesting but do not in my view qualify for inclusion on my shortlist. They are Nouriel Roubini and Ken Rogoff. In both cases, I - and maybe this is partly my fault - don't understand what, if any, analytic framework they are using, so I find it difficult to impossible to evaluate their advice….

Finally, let me just point out that this is not hindsight on my part.  Most of those mentioned above were on the list of economists I read and, whenever possible, consulted when I was still a civil servant involved in policy advice on these issues (2008-11). And I put this specific list together more than a year ago now in preparation for a talk I gave to a group of government economists. And this matters. I don't think there's any doubt that if policymakers, both in the UK and elsewhere (especially in the eurozone) had, during the intervening period, listened to these people rather than their own economic advisers, the state of the UK and world economies would be significantly better than it is now.

Is the U.S. at Immediate Risk of Rapidly Becoming "Argentina" as a Result of Expansionary Counter-Cyclical Policies?: The Bet with Noah Smith: Noah Bravely Takes the Cochrane-Argentina Side…

The bet:

If, at any time between 7/28/2012 and 7/28/2015, core consumer prices, as recorded in the FRED database series CPILFESL, are up more than 5% in the preceding 12 months, and if over the same 1-year period monthly U3 unemployment (as recorded in FRED database series UNRATE) has not averaged below 6%, then Brad DeLong agrees to buy Noah Smith one dinner at Zachary's Pizza at 1853 Solano Ave. in Berkeley CA, and to pay Noah 49 times the cost--including tax but excluding tip--of Noah's meal at Zachary's in Federal Reserve notes, or in alternative means of payment accepted by Zachary's should Zachary's Pizza no longer be accepting Federal Reserve notes at the date of the dinner. This cost will be assessed as the total cost of the dinner to all, divided by the number of people present, regardless of how much pizza is consumed by or how much alcohol is drunk by specific individuals.

If however, the above condition is not satisfied, Noah agrees to buy Brad one dinner at Zachary's.

Miles Kimball will be the judge in charge of refereeing the bet. The decisions of the judge will be final and unappealable.

Furthermore, Noah's brave and gracious willingness to take the Cochrane-Argentina side of this bet at odds of only 50-1 will not be construed as a statement of his confidence in or of his support for any economist or position of economic analysis that judges expansionary fiscal policy at the zero lower nominal interest rate bound to be "insane" or that judges "1932" to currently be a less dire risk for the U.S. than "Argentina".

The start was my noting that Sebastian Mallaby these days is sounding like a normal reality-based economist--and is far, far from the guy who back in March 2009 thought that what the audience at his CFR conference really needed to hear was the (unrebutted: the panel was stacked) opinions of John Cochrane:

What Do the 1930s Teach About Reforming Today's Financial Markets?: [T]he danger now is inflation.  And I would say it's a greater danger than most of the other people have said.  Our danger now is a run on Treasury debt.  It's not just can the Fed soak this stuff back up again, but can it soak this enormous amount of debt back up again when people don't want either money or Treasury bills or anything labeled "U.S. Government."  The danger is not 1932; the danger is Argentina, a massive run from Treasury debt.  And then monetary policy will not be able to do anything.  You can fool around with interest rates all you want.  When people don't want Treasury bills or money you're stuck….

The system is much more resilient than it was because of deregulation. Back in the Great Depression… if the Bailey Savings and Loan goes under, there is no way that JP Morgan, financed by an equity infusion from the sovereign wealth fund of Kuwait can come in and take over and start lending.  You're just stuck.  Well, we're not in that situation anymore….

Policy is chaotic. Who would invest in this climate?  It's not about toxic assets; it's about who wants to go in on a deal with Darth Vadar [sic], who can change his mind at any moment?  That's the uncertainty that's keeping things from getting going and that's what's slowing the rebuilding of financial markets.  We're facing growth-destroying marginal tax rates, an excuse for the government takeover of large and completely unrelated sectors, class warfare, vindictive ex post taxations….

My great hope is that the bounce-back will be quick before the quack medicine can be said to have worked.  (Chuckles.)  Just as we sort of -- as people think that this insane idea of fiscal stimulus -- which I'll go on with later if I get a chance -- came from Roosevelt's experience with no reason why it should work, there is a danger of thinking all of the crazy stuff they're doing now will have caused the bounce-back….

Cochrane than protested (sounding to my ear much like an old-line Marxist who claims that Marx never said real wages will fall but only that there was a tendency for the real wage to fall) that he had not said that unless the expansionary fiscal and monetary policies of 2009 were reversed the U.S. was about to experience an Argentina-like upward explosion of inflation, but only that there was a risk that, unless the expansionary fiscal and monetary policies of 2009 were reversed, the U.S. was about to experience an Argentina-like upward explosion of inflation.

And Noah Smith said that was a fair point.

I in turn counter-protested to Noah:

There was no reason to think that the expansion of the Fed balance sheet from $700B to $1.7T in mid-2009 would create too-much money chasing too-few goods--for as long as the economy was at the zero nominal interest rate lower bound expanding the Fed's balance sheet simply swapped one very low-yield nominal government liability for another with little effect on anybody's net liquidity or risk exposure. The marginal expansion of the projected national debt from the Recovery Act was absolutely trivial, and since the prospect of future health-care spending deficits had not provoked "Argentina" by 2008 there was no risk the additional marginal borrowing of the Recovery Act would provoke "Argentina" in the context of a depressed economy. Financial markets were not pricing in any chance of an upward explosion of inflation. Cochrane could neither (a) point at elements in the configuration of asset (and other) prices demonstrating that people besides him thought "Argentina" was a substantial risk, or (b) explain the market failure that kept people from hedging against the risk in such a way that we could see their hedges in market prices.

Thus Cochrane's point that he was just pointing out a "risk of Argentina" did not seem to me to be a fair point at all. If it really was a significant risk, than people ought--at the appropriate odds--to be willing to bet that that risk would actually come to pass. So I asked Noah if he was so willing...

Hence we decided on:

• Zachary's pizza because we like pizza.
• A three year term because we are hungry and would like to eat our pizza.
• A twelve-month core CPI change of 5% as our definition of "Argentina"--yes, I realize that that is really absurd and is defining "Argentina" way, way down, but work with us on this…
• An unemployment rate of 6% as marking exit from the depressed-economy régime--the transition from the "involuntary unemployment" to the "inflation" region on the Malinvaud diagram--and entry into a régime in which we would expect inflation to respond in the medium-term to expansionary policies
• 50-1 as the appropriate odds: a 2% chance of the deficits and monetary base expansions of the past four and the next three years triggering the transformation of the U.S. into "Argentina".

I must say that Noah appears to me to not be an expected utility maximizer, or to have a substantially different assessment of the odds than I do: I would have demanded 200-1 to take the Cochrane side of this bet…

Mark your calendars now for August 2015…

Noah Smith: Weak Defenses of the Lucas/Prescott Program

Noah Smith:

Noahpinion: Weak defenses of the Lucas/Prescott Program: The first research program that came along and tried to answer the Lucas Critique was the "Real Business Cycle" program. This program, spearheaded by researchers such as Ed Prescott, made use of a new modeling approach called "DSGE". It also incorporated Robert Lucas' "Rational Expectations Hypothesis". Lucas didn't invent all of this stuff, but since A) it was invented in response to his Critique, B) he invented some of it, and C) he seemed to sign off on the parts he didn't invent, I feel justified in calling this new research program the "Lucas/Prescott Program"….

Noahpinion: What If You Have Garbage Microfoundations?

Noah Smith:

Noahpinion: Why bother with microfoundations?: [W]hat we call “microfoundations” are not like physical laws. Heck, they’re not even true. Maximizing consumers are just a metaphor, possibly useful in making sense of behavior, but possibly not. The metaphors we use for microfoundations have no claim to be regarded as representing a higher order of truth than the ad hoc aggregate metaphors we use in IS-LM or whatever…. Using wrong descriptions of how people behave may or may not yield aggregate relationships that really do describe the economy. But the presence of the incorrect microfoundations will not give the aggregate results a leg up over models that simply started with the aggregates…. When I look at the macro models that have been constructed since Lucas first published his critique in the 1970s, I see a whole bunch of microfoundations that would be rejected by any sort of empirical or experimental evidence….

Macroeconomists seem to have basically nodded in the direction of the Lucas critique and in the direction of microeconomics as a whole, and then done one of two things: either A) gone right on using aggregate models, while writing down some "microfoundations" to please journal editors, or B) drawn policy recommendations directly from incorrect models of individual behavior.

Brad DeLong puts this rather more pithily:

I now have the most bizarre image in my mind: A seminar at the Library of Alexandria in 300 A.D., with an astronomer trying to provide micro foundations in the form of calculations of how large their wings must be and how fast their wings must beat for the angels to push the planets on their tracks through the quintessential spheres…

The Need for a Higher Rate of Increase in Prices: Sebastian Mallaby Is Forty Months Late Department

Back in the spring of 2009, when Sebastian Mallaby of the Council on Foreign Relations put together a symposium on the then-gathering depression, his idea of the kind of people whom he really needed to push up onto the stage were people like… John Cochrane, claiming that the "danger is not 1932; the danger is Argentina, a massive run from Treasury debt" and "this insane idea of fiscal stimulus".:

John Cochrane, March 30, 2009: The New Financial Deal: What Do the 1930s Teach About Reforming Today's Financial Markets?: [T]he danger now is inflation. And I would say it's a greater danger than most of the other people [who have mentioned it] have said. Our danger now is a run on Treasury debt. It's not just can the Fed soak this stuff back up again, but can it soak this enormous amount of debt back up again when people don't want either money or Treasury bills or anything labeled "U.S. Government." The danger is not 1932; the danger is Argentina, a massive run from Treasury debt. And then monetary policy will not be able to do anything. You can fool around with interest rates all you want. When people don't want Treasury bills or money you're stuck.

Many things are depressingly the same [as in the Great Depression.] Policy is chaotic.  Who would invest in this climate?  [The problem is] not about toxic assets; [The problem is] about who wants to go in on a deal with Darth Vader [the government], who can change his mind at any moment?  That's the uncertainty that's keeping things from getting going and that's what's slowing the rebuilding of financial markets.  We're facing growth-destroying marginal tax rates, an excuse for the government takeover of large and completely unrelated sectors, class warfare, vindictive ex post taxations.  This is the chance for a credit crunch -- which normally resolves itself fairly quickly -- to turn into a Great Depression.  And perhaps most of all there is the danger of learning the wrong lessons; that our grandchildren will have to come back to the next meeting to say, what were the lessons -- the lessons mis-learned of the last time around?

My great hope is that the bounce-back will be quick before the quack medicine can be said to have worked.  (Chuckles.) Just as we sort of -- as people think that this insane idea of fiscal stimulus -- which I'll go on with later if I get a chance -- came from Roosevelt's experience with no reason why it should work, there is a danger of thinking all of the crazy stuff they're doing now will have caused the bounce-back, if that happens, in five years, but my only hope is that it happens quickly and doesn't leave us with another Great Depression…

I cannot think of a single sentence in that passage that makes John Cochrane look half-intelligent. Can you?

Today Sebastian Mallaby does not seem to be listening to the likes of John Cochrane any more:

Show some real audacity at the Fed: Mr Bernanke… last week… was rebuked by Republicans for his presumed recklessness, while Democrats appeared to feel he was pushing policy as far as he could. But there is nothing particularly wild about the Fed’s money printing. Its purpose is merely to effect a change in private balance sheets. Banks sell their Treasuries to the Fed in exchange for newly minted dollars (in the case of quantitative easing) or for shorter-term government securities (in the case of the current Operation Twist). Given that risk-free government securities are treated as cash equivalents by financial institutions, this is not radical.

Most assessments of quantitative easing find that it has worked…. But these positive verdicts conceal a less uplifting message. The first round of quantitative easing was most powerful – it was the largest, and its novelty inspired shock and awe. The second round, from November 2010 to June 2011, was less effective. The current Operation Twist is the limpest of all.

Unless the Fed can rekindle the shock value of the first round, more quantitative easing is unlikely to work. Success depends on a whole range of actors deciding that the Fed is determined to accelerate recovery rather than repeat a tired trick that they have seen before…. Quantitative easing that fails to spark risk-taking could actually make things worse….

With inflation below target and unemployment far above the neutral rate, there is a clear case for stimulus…. One possible measure is to cancel interest on excess reserves…. [T]he Fed could couple more quantitative easing with a formal announcement of a higher inflation target. Some Fed leaders are open to this. Charles Evans, the Chicago Fed president, has floated the idea of a 3 per cent target, effective until unemployment falls below 7 per cent…. Financiers would embrace risk assets rather than safe ones with real returns that would be clearly negative. Companies, expecting more growth, would step up investments…. The time has come for some fresh thinking. A Fed that can escape the myth of its audacity might be able to do more.

We really could have used this from him forty months ago, when it might have mattered.

Mark Thoma Worries at the Question: Why Didn't Economists Do a Better Job?

Mark Thoma:

Bubbles and Bailouts: Why Some Economists Failed: [M]acroeconomists, as a group, did not see the signs of the disaster that was about to hit the economy. There were a few lonely voices who warned that a dangerous bubble was building in the housing market…. [I]t took macroeconomists longer than it should have to correctly diagnose the problem as a balance sheet recession. But once macroeconomists understood the nature of the difficulties we were experiencing, policies to effectively battle this type of recession were proposed. Unfortunately, the proposals were mostly ignored….

The question is why nobody listened.

For fiscal policy the answer is clear and simple. Congress is broken…. And that dysfunction coupled with the influence of big money interests caused Congress to listen to the wrong voices…. [T]he people who favored deregulation of the financial sector, assured us there was no housing bubble, and told us problems could be easily contained even if there was a bubble are the very same people who brought us the push for austerity, the fear of inflation, the fear of bond vigilantes, and so on, none of which was helpful.

These economists told Republicans and centrist Democrats in Congress what they wanted to hear… given prominence in policy discussions. The economists who got it mostly right disagreed with these policies in no uncertain terms, but Congress didn't want to hear what they had to say and fiscal policy suffered because of it.

But how can we explain the problems with monetary policy?… [T]he Fed has been much too timid and apprehensive in its response to the recession… is presently missing both its inflation and unemployment targets…. [T]he Fed has been sitting on its hands in the “wait and see” mode that has left it behind the curve again and again over the last several years….

The continued push from some economists for austerity, interest rate increases, and other policies that satisfy political and ideological goals but work against the recovery, and the failure of economists in charge of monetary policy to adopt policies consistent with the Fed’s mandate undermine any attempt to fully defend the economics profession.

We can fix our economic models, at least I hope we can, and maybe we can fix our political institutions, we shall see, but how do we fix the economists?…

The failure of many, many people to do their homework and the fact that others who were at least willing to try to do their job got so much so wrong is remarkable.

Even more remarkable is the extraordinary reluctance of those who did get so much wrong to mark their beliefs to market…

Department of "Huh!?!?": Knut Wicksell Rules OK! Edition

In the neo-Wicksellian framework that Krugman likes to use when the economy is at its zero nominal interest rate bound, the central immediate problem with the economy is that because private households want to deleverage--planned saving at full employment is high--and because private businesses do not want to leverage--planned investment at full employment is low--planned spending is less than expected income and the economy spirals downward.

So why in the Holy Name of the One Who Is does Steven Keen write:

The Crisis in 1000 words—or less: Rising aggregate private debt adds to demand, and falling debt subtracts from it. This point is vehemently denied on conventional theoretical grounds by economists like Paul Krugman…

?

The neo-Wicksellian framework is not a denial that times of falling debt are times of depression. The neo-Wicksellian framework is an explanation of why times of falling debt are times of depression.

"Explanation" ≠ "denial"…

Does Allan Meltzer Even Know What He Is Talking About?

Mark Dow:

@ReformedBroker Meltzer article pointed to neg TIPs yields as indic of infl expectations. Sad he doesn't even know gauge is TIP breakevens

— Mark Dow (@mark_dow) July 15, 2012

The State of "Modern" "Macro"

Via Lars Syll. Bob Solow:

Dumb and dumber in modern macroeconomics: [When modern macroeconomists] speak of macroeconomics as being firmly grounded in economic theory, we know what they mean … They mean a macroeconomics that is deduced from a model in which a single immortal consumer-worker-owner maximizes a perfectly conventional time-additive utility function over an infinite horizon, under perfect foresight or rational expectations, and in an institutional and technological environment that favors universal price-taking behavior …

No one would be driven to accept this story because of its obvious “rightness”. After all, a modern economy is populated by consumers, workers, pensioners, owners, managers, investors, entrepreneurs, bankers, and others, with different and sometimes conflicting desires, information, expectations, capacities, beliefs, and rules of behavior … To ignore all this in principle does not seem to qualify as mere abstraction – that is setting aside inessential details. It seems more like the arbitrary suppression of clues merely because they are inconvenient for cherished preconceptions …

FLASH: Allan Meltzer Has Failed to Mark Any of His Beliefs to Market

Paul Krugman:

Is Our Economists Learning?: David Glasner is unhappy with Allan Meltzer, who wrote an absurd op-ed in the WSJ in which Meltzer, among other things, just makes stuff up — claiming that markets are signaling fear of inflation when they are in fact doing no such thing…. But it’s actually much worse than Glasner acknowledges. Meltzer has been banging the same drum for more than three years…. You might think that the complete failure of the predicted inflation takeoff to materialize would at least give him pause. But no: his dogmatism is completely unshaken. And the thing is, he’s typical….

[H]as even one prominent economist or economic prognosticator who got everything wrong admitted it, or shown even a hint of humility? Has anyone perhaps hinted that the policy recommendations he was making might not be right, given the total failure of events to go the way he predicted?

I can’t think of one.

Glasner suggests that Meltzer has been corrupted by Murdoch’s influence. I disagree; I hold no affection for Murdoch, but one of the many unpleasant things we’ve learned in this crisis is that there was plenty of intellectual corruption in the economics profession from the get-go.

Jeff Sachs Calls for Ponynomics!

Jeff Sachs:

[W]e need new economic strategies to overhaul broken systems of finance, labour markets, taxation, ecological management, budget management and investment incentives…. The new approaches must be long-term, structural, sensitive to inequalities of skills and education, aligned with the need for more sustainable technologies and “smarter” infrastructure (empowered by information technology) and congruent with long-term demographic trends…

Duncan Black on Jeffrey Sachs

Duncan Black:

Eschaton: The Trouble With Sachs: I read the Sachs article in question as basically:

Keynesians are stupid children who are not Very Serious At All

[…]

Word salad with vague suggestions about how one might go about building a pony.

More generally, all this anti-Keynesian stuff is really so weird. Keynes got associated with "activist government," conservatives hate government, so conservatives decided Keynes was all wrong about everything and also, too, a communist. Or something. But Keynesian demand management really just says there are times when things won't right themselves automatically in a timely fashion, that government should step in to boost demand. It isn't about stealing from the rich to buy Cadillacs for strapping young bucks, or just how many SUPERTRAINS should be built, it just says there are times when the government, using fiscal and/or monetary policy, can actually improve the economy by boosting demand. That this is even controversial is mindboggling.

Ryan Avent Goes All-in On the Shrill: Ben Bernanke Is in Over His Head Edition

Ryan Avent:

Monetary policy: QE sera, sera: In the bitterest of ironies, Mr Bernanke is giving America a Japanese recovery. He is doing so, seemingly, because pushing inflation temporarily above an arbitrary target is an unthinkable prospect, even though doing so would almost certainly, by his own convincing argument, have a huge impact on America's enormously costly unemployment problem. I suspect that the Ben Bernanke of 1999 would characterise this as a moral and intellectual failure of staggering proportions. Maybe the Ben Bernanke of 2012 has a convincing rebuttal; if so, he certainly hasn't shared it with us. Maybe one day we'll all be lucky enough to hear it. It had better be one hell of a good excuse.

---

And now it is time to ask the readership:

Create your free online surveys with SurveyMonkey, the world's leading questionnaire tool.

If you haven't updated your views in the face of new experiences, you're not doing your job

Twitter / TheStalwart:

Money quote = RT @mbusigin: Krugman: "If you haven't updated your views in the face of new experiences, you're not doing your job"

"Rare Events" and Asset Prices

Noah Smith writes:

Noahpinion: Robot Barro?: Robert Barro is the third most cited economist in the world. He's the true inventor of "Ricardian" Equivalence, to which he was too humble to attach his own name. He's also the creator of the "rare events" theory of asset pricing, which I personally believe to be an epic win for finance theory…

Be careful...

I would note that Barro's "rare events" theory predicts that the stock market will be high when people are greatly scared of a major macroeconomic disaster in the near future. Why are stock prices then high? In the model, holding stocks is the only way to move purchasing power from the present into the future. The supply of stocks is fixed. When people fear their future income might be low because there is a high chance of a future macroeconomic disaster they frantically try to shift purchasing power into the future. They thus buy stocks. Demand for stocks is then high. Supply is fixed. And so the price of stocks is high.

Thus Barro’s “rare events” theory says that stock prices were very high in 2000 because people were then really pessimistic and terrified about the future. The dot-com bubble emerged because terrified people were willing to pay almost any price for stocks as a way of moving purchasing power from the present to the future, and thus insuring themselves against the forthcoming likely macroeconomic catastrophe.

The theory says that stock prices were low in March 2009 because people thought that the future was bright, that their future incomes were almost certain to be high, and so people were selling stocks because they did not think that they needed insurance against any future macroeconomic catastrophe.

This seems to me to get it exactly backward: when stocks are high, they are not high because people are pessimistic about the future. Rather, stocks are high when people are optimistic about the future.

Barro might say that his theory is not a theory about asset prices but about the equity premium--about the spread between stock and bond returns. He might say that his theory says that when the future is gloomy stock prices are high but bond prices are even higher, and that when the future is bright stock prices are low but bond prices are even lower, and so his theory fits the equity premium well. He might say that the fact that the theory’s predictions about the levels of asset prices are backward is not a fatal defect...

First Appearance I Can Find of: "When My Information Changes, I Alter My Conclusions…"

It is here:

A treatise of melancholie - Timothie Bright.

Hoisted from the Archives (2010): Mr. Hicks and "Mr Keynes and the 'Classics': A Suggested Interpretation

Mr. Hicks and "Mr Keynes and the 'Classics': A Suggested Interpretation":

In his "Mr. Keynes and the 'Classics': A Suggested Interpretation," John Hicks says that he is building a model of John Maynard Keynes's General Theory of Employment, Interest and Money. He is not. What he is actually doing is creating a framework that combines the monetarist theories of Irving Fisher, the financial-market insights of Knut Wicksell, and the multiplier insights of Richard Kahn into one package.

Irving Fisher had a model with two commodities: the flow of goods-and-services currently being produced on the one hand and the economy's stock of "money"--of liquid assets generally accepted as and held in people's portfolios because of their usefulness as means of payment. Excess demand for money was, by Walras's Law, associated with excess supply of goods and services--and thus with falling production, employment, capacity utilization, and consumer prices. Excess supply of money was, by Walras's Law, associated with excess demand for goods and services--and rising production, employment, capacity utilization, and consumer prices. In Fisher's framework the way to restore the economy to full-employment balance is to boost or shrink the money stock to its proper level, via gold mining, gold shipments, open-market operations, internal drains or the reverse, or changes in bank reserve-to-deposit ratios. Return the money stock to it's proper full-employment equilibrium value and you have solved yours depression problem.

Knut Wicksell had a model with two commodities: the flow of goods-and-services currently being produced, on the one hand, and the stock of bonds on the other. Excess demand for bonds--a "market" rate of interest above the "natural" rate of interest that balanced demand for and supply of bonds at full employment--was associated with excess supply of goods and services, ewe deter. Excess supply of bonds--a "market" rate of interest lower than the "natural" rate--was associated with excess demand for goods and services, et cetera.

Wicksell paid special attention to dynamics: an excess demand for bonds that sets in motion a decline in the price level would, he thought, drive the natural rate of interest down: seeing deflation and expecting more deflation, businesses would be loath to issue more bonds unless they could do so on very good terms indeed. Thus the gap between the (nominal) market and the natural rate of interest would increase--the disequilibrium would widen--as the market system reacted to the initial depression-causing disequilibrium. This cumulative process, as Wicksell called it, meant that at least over a range the economy was unstable: depression begat greater depression, and boom begat greater boom.

By contrast, Fisher's dynamics were at least to some degree stabilizing: a depression produces a deflation which raises the real money stock and so diminishes the excess demand for money. (With expected inflation and leverage-induced deflation bankruptcies a complicating factor.)

Richard Kahn had yet another analysis: consumption spending depends positively on income; production is the sum of consumption spending and autonomous spending; and--by Walras's Law once again--total income equals total production. Thus, Kahn thought, a reduction in autonomous spending would reduce production and income--and that reduction in income would reduce consumption spending, which would set off another round of reductions in production and income.

Irving Fisher's monetarism had two commodities--"money" and "goods-and-services"--and one price-that-moved, the consumer price level. The key to fixing depressions was to get the consumer price level to the right level given the nominal money stock (or, preferably), to get the money stock to the right value given the price level). Knut Wicksell's flow-of-funds model also had two commodities--"bonds" and "goods-and-services"--and one price-that-moved: the (nominal) market interest rate. The key to fixing depressions was to get the banking system to set the market interest rate at a value that matched the natural interest rate at which savings equalled investment at full employment and thus demand equalled supply in the market for goods-and-services. Richard Kahn's multiplier analysis had one commodity, goods-and-services, and had no prices: just a dependence on consumption spending on income and an assertion that income equalled spending.

Hicks's "Mr. Keynes and the 'Classics'" throws all these together into a stewpot, mixes them together, and cooks them up in a formally-consistent way: three commodities--goods-and-services, money, and bonds--two prices that can move--the interest rate and the consumer price level--and the multiplier in the form of the dependence of savings on total income which is the amount of production and spending in the goods-and-services market. And it works. That is what has made it such an effective workhorse for thinking about depressions in the real world for three generations now.

But what does all this have to do with John Maynard Keynes and his General Theory? Keynes was very anxious not to get tied down to any particular formalism--either the one he set out in the General Theory or Hicks's IS-LM. Instead, he wrote in the 1937 Quarterly Journal of Economics:

I am more attached to the comparatively simple fundamental ideas which underlie my theory than to the particular forms in which I have embodied them, and I have no desire that the latter should be crystallised at the present stage of the debate. If the simple basic ideas can become familiar and acceptable, time and experience and the collaboration of a number of minds will discover the best way of expressing them. I would, therefore, prefer to... re-express some of these ideas....

[W]e have, as a rule, only the vaguest idea of any but the most direct consequences of our acts. Sometimes we are not much concerned with their remoter consequences.... But sometimes we are intensely concerned with them.... Now of all human activities which are affected by this remoter preoccupation, it happens that one of the most important is economic in character, namely, wealth. The whole object of the accumulation of wealth is to produce results, or potential results, at a comparatively distant, and sometimes indefinitely distant, date. Thus the fact that our knowledge of the future is fluctuating, vague and uncertain, renders wealth a peculiarly unsuitable subject for the methods of the classical economic theory. This theory might work very well in a world in which economic goods were necessarily consumed within a short interval of their being produced. But it requires, I suggest, considerable amendment if it is to be applied to a world in which the accumulation of wealth for an indefinitely postponed future is an important factor....

By ‘uncertain’ knowledge, let me explain, I do not mean merely to distinguish what is known for certain from what is only probable. The game of roulette is not subject, in this sense, to uncertainty; nor is the prospect of a Victory bond being drawn. Or, again, the expectation of life is only slightly uncertain.... The sense in which I am using the term is that in which the prospect of an European war is uncertain, or the price of copper and the rate of interest twenty years hence, or the obsolescence of a new invention, or the position of private wealth-owners in the social system in 1970. About these matters their is no scientific basis on which to form any calculable probability whatever. We simply do not know. Nevertheless, the necessity for action and for decision compels us as practical men to do our best to overlook this awkward fact and to behave exactly as we should if we had behind us a good Benthamite calculation.... How do we manage?... (1) We assume that the present is a much more serviceable guide to the future than a candid examination of past experience would show it.... (2) We assume that the existing state of opinion as expressed in prices and the character of existing output is based on a correct summing up of future prospects.... (3) Knowing that our individual judgment is worthless, we endeavour to fall back on the judgment of the rest of the world which is perhaps better informed....

Now a practical theory of the future based on these three principles has certain marked characteristics. In particular, being based on so flimsy a foundation, it is subject to sudden and violent changes. The practice of calmness and immobility, of certainty and security, suddenly breaks down. New fears and hopes will, without warning, take charge of human conduct.... At all times the vague panic fears and equally vague and unreasoned hopes are not really lulled, and lie but a little way below the surface.

Perhaps the reader feels that this general, philosophical disquisition... is somewhat remote from the economic theory.... But I think not.... [O]ur first step must be to elucidate more clearly the functions of money... money of account... facilitates exchanges... is a convenience... devoid of significance.... [Money as] a store of wealth.... But in the world of the classical economy, what an insane use to which to put it! For it is a recognised characteristic of money as a store of wealth that it is barren; whereas practically every other form of storing wealth yields some interest or profit. Why should anyone outside a lunatic asylum wish to use money as a store of wealth?

Because... our desire to hold Money as a store of wealth is a barometer of the degree of our distrust of our own calculations and conventions concerning the future.... The significance of this characteristic of money has usually been overlooked; and in so far as it has been noticed, the essential nature of the phenomenon has been misdescribed. For what has attracted attention has been the quantity of money which has been hoarded... supposed to have a direct proportionate effect on the price level through affecting the velocity of circulation. But the quantity of hoards can only be altered either if the total quantity of money is changed or if the quantity of current money income (I speak broadly) is changed; whereas fluctuations in the degree of confidence are capable of... modifying... the premium which has to be offered to induce people not to hoard. And changes in... liquidity preference... affect, not [consumer] prices, but the rate of interest....

The owner of wealth, who has been induced not to hold his wealth in the shape of hoarded money, still has two alternatives.... He can lend his money at the current rate of money interest or he can purchase some kind of capital asset.... The prices of capital assets move until, having regard to their prospective yields... they offer an equal apparent advantage to the marginal investor.... This does not mean, of course, that the rate of interest is the only fluctuating influence on these prices. Opinions as to their prospective yield are themselves subject to sharp fluctuations, precisely for... the flimsiness of the basis of knowledge on which they depend.... It is not surprising that the volume of investment, thus determined, should fluctuate widely from time to time. For it depends on two sets of judgments about the future, neither of which rests on an adequate or secure foundation—on the propensity to hoard and on the opinions of the future yield of capital assets.... This completes the first chapter of the argument, namely, the liability of the scale of investment to fluctuate for reasons quite distinct (a) from those which determine the propensity of the individual to save out of a given income and (b) from those physical conditions of technical capacity to aid production....

My next difference from the traditional theory concerns its apparent conviction that there is no necessity to work out a theory of demand and supply of output as a whole. Will a fluctuation in investment, arising for the reasons just described, have any effect on the demand for output as a whole, and consequently on the scale of output and employment? What answer can the traditional theory make to this question? I believe that it makes no answer at all, never having given the matter a single thought.... My own answer... involves... investment expenditure... consumption expenditure... [which] depends mainly on the level of income.... [T]he consequences which follow from [this multiplier] are at the same time unfamiliar and of the greatest possible importance.... [A]ggregate output depends on the propensity to hoard, on the policy of the monetary authority as it affects the quantity of money, on the state of confidence concerning the prospective yield of capital assets, on the propensity to spend and on the social factors which influence the level of the money wage. But of these several factors it is those which determine the rate of investment which are most unreliable, since it is they which are influenced by our views of the future about which we know so little. This that I offer is, therefore, a theory of why output and employment are so liable to fluctuation. It does not offer a ready-made remedy as to how to avoid these fluctuations and to maintain output at a steady optimum level....

Naturally I am interested not only in the diagnosis, but also in the cure.... But I consider that my suggestions for a cure, which, avowedly, are not worked out completely, are on a different plane from the diagnosis. They are not meant to be definitive; they are subject to all sorts of special assumptions and are necessarily related to the particular conditions of the time. But my main reasons for departing from the traditional theory go much deeper than this. They are of a highly general character and are meant to be definitive.

I sum up, therefore, the main grounds for my departure as follows: (1) The orthodox theory assumes that we have a knowledge of the future of a kind quite different from that which we actually possess.... (2) The orthodox theory... ignored the need for a theory of the supply and demand for output as a whole. I doubt if many modern economists really accept Say’s Law that supply creates its own demand. But they have not been aware that they were tacitly assuming it...

Another Economist Who Got It Largely Right in Real Time: Mark Thoma

Mark Thoma: Why Employment Might Not Fully Recover Until 2013:

Employment lags changes in output because firms usually wait to see if a recovery is permanent rather than a temporary uptick before committing to the costly task of hiring new people. But the reason for the change in the relationship between output and unemployment after 1990 is not fully understood, making it harder to know how to battle the problem using government policies designed to stimulate employment…. It's not just the lag between the turning points in output and employment that leads to a pessimistic outlook for labor numbers. Once unemployment does peak, output still needs to return to its normal growth level before we see a return to full employment. The San Francisco Fed doesn't expect a return to normal growth until the middle of 2012, and this means that unemployment likely won't fully recover until somewhere in 2013.

The reason for the slow recovery is partly due to the depth of the recession -- the deeper the hole, the longer it takes to crawl out of it -- but it's also because of the large amount of structural change that the economy must go through before it can recover….

[T]here's still a long road ahead, particularly for labor, and for that reason I am very much in favor of additional government policy targeted directly at the employment problem. In addition, given the record levels of long-term unemployment we are experiencing (those unemployed 27 weeks or more now constitute 35.6 percent of the unemployed; see here for a graphical representation of the situation), the recent vote to extend unemployment benefits was overdue and very welcome.

Steven Keen Is One Very Unhappy Camper!

People who say what I write is utter hubris, drivel, cant, and delusional mutterings all because there names are not included on a short non-exclusive list need to chill, badly.

Steven Keen:

What utter self-serving drivel, Brad Delong!: I can scarcely believe what Brad Delong has dared to publish… utter hubris and drivel!… the cant Delong has spewed forth… Delong’s delusional mutterings…

And his commentators:

Maybe Brad is from an alternate reality… something in the water at Berkeley… propagandic triangulation… He knows he has been wrong but now wants to plant some stories that gradually paint him and Krugman as having been right…. His type is very worried about their reputation… Mr. Delong must either lack a modicum of self awareness, or he knows he is being dishonest… he is interested not in argument, but in seeming superior and acting as though he’s got the moral high ground (because this works with certain groups of people…

And his twitterers:

I literally got nauseous… depressing read… What utter self-serving drivel, Brad @Delong…

And Steven Keen again:

[Y]ou should have cited me as one of the followers of Minsky etc. I’m sorry, but you popping over here and calling me “splitter” is hilarious. If you want to form alliances, then put out a revised article citing me, Wray, etc., as “fellow Minsky followers”…

And so it develops that Keen's real problem is that I wrote:

economists like Paul Krugman, Christy Romer, Gary Gorton, Carmen Reinhart, Ken Rogoff, Raghuram Rajan, Larry Summers, Barry Eichengreen, Olivier Blanchard and their peers…

when Keen thinks that I should have written:

Steve Keen and Randy Wray…

Keen:

Why just 9 names Brad? Was there a word limit that stopped you adding just 2 more “Steve Keen” and “Randy Wray”? And if there was, then yes, Blanchard and Summers could surely have been dropped…

(Complaints about those malefactors Krugman, Reinhart, and Rogoff omitted.)

To which I respond:

1. It's not supposed to be an exhaustive list of sheep, with all others being goats: I say "economists like" my nine, and my nine "and their peers".

2. Larry and Olivier definitely belong on the list. Larry and Olivier (along with Barry Eichengreen and Charlie Kindleberger) taught me Bagehot-Minsky-Kindleberger stuff. It is Larry who says that the three economists whose analyses of 2007-9 are best are "Bagehot, Minsky, Kindleberger.

3. Yes, there is a limited number of names you can include on a list in a very short piece. 11 is much less effective than 9. 9 is less effective than 7. 7 is less effective than 5. In pushing my list of names above 5--Krugman, Romer, Gorton, Rajan, and Eichengreen--I was already stretching it.

4. That said, if I were to push my list of names up to 15, the next six I would add would be: Simon Johnson, Jamie Galbraith, Dean Baker, Maury Obstfeld, Pierre-Olivier Gourinchas, and Adam Posen.

Glenn Hubbard, Behave Yourself!

Jon Ward:

Romney econ adviser Glenn Hubbard: "It's not that difficult to get government spending back to 20 percnt of GDP." http://huff.to/NOxr3c 

Glenn: I worked for the Clinton administration. Throughout the entire 8 years of the Clinton administration--without a single Republican vote to help us when the heavy lifting needed to be done--we reduced the share of federal government spending as a share of potential GDP from 22.2% to 19.3%--by 0.3625%/year.

It was not easy. It was not moderately difficult. It was very difficult. It was brutal.

We did it. We know of what we speak. It is enormously difficult to get federal spending down--and it is much more difficult now, after two additional decades of Republicans blocking almost every single possible sensible cost-saving health-care reform, than it was when we started back in 1993.

Glenn: You worked for the Bush administration. At the end of 2007--before the recession and the consequent demands for spending to cushion the downturn hit--you raised federal government spending as a share of potential GDP from 19.3% to 21.4%. You raised it at a pace of 0.3%/year--and the two years you held high federal office as a cabinet-rank official were slightly worse than the average Bush years.

Glenn: If it is so easy, why didn't you do it?

And if it is--as it is--difficult, why claim that it isn't?

---

A Man for All Seasons (1966):

Thomas More: May I see that chain Richard?
Richard Rich: Certainly.
Thomas More: It is a fine chain.
Richard Rich: It has pleased His Majesty to make me Justiciar for Wales.
Thomas More: Why Richard, it profits a man nothing to give his soul for the whole world... but for Wales?

The Krugman-Layard Manifesto for Economic Non-Nonsense

Paul Krugman and Richard Layard:

More than four years after the financial crisis began, the world’s major advanced economies remain deeply depressed, in a scene all too reminiscent of the 1930s. The reason is simple: we are relying on the same ideas that governed policy during that decade. These ideas, long since disproved, involve profound errors both about the causes of the crisis, its nature and the appropriate response….

The causes. Many policy makers insist that the crisis was caused by irresponsible public borrowing. With very few exceptions – such as Greece – this is false. Instead, the conditions for the crisis were created by excessive private sector borrowing and lending, including by over-leveraged banks. The bursting of this bubble led to large falls in output and thus in tax revenue. Today’s government deficits are a consequence of the crisis, not a cause.

The nature of the crisis. When property bubbles burst on both sides of the Atlantic, many parts of the private sector slashed spending in an attempt to pay down past debts. This was a rational response on the part of individuals, but has proved to be collectively self-defeating, because one person’s spending is another person’s income. The result of the spending collapse has been an economic depression that has worsened the public debt.

The appropriate response. At a time when the private sector is engaged in a collective effort to spend less, public policy should act as a stabilising force, attempting to sustain spending. At the very least, we should not be making things worse with big cuts in government spending or big increases in tax rates on ordinary people.

The big mistake. After responding well in the first, acute phase of the crisis, policy took a wrong turn – focusing on government deficits in tandem with the private sector. Instead of playing a stabilising role, fiscal policy has ended up reinforcing the damping effects of private-sector spending cuts.

In the face of a less severe shock, monetary policy could take up the slack. But with interest rates close to zero, monetary policy – while it should do all it can – cannot do the whole job. There must of course be a medium-term plan for reducing the government deficit. But if this is too front-loaded it can easily be self-defeating by aborting the recovery. A key priority is to reduce unemployment, before it becomes endemic, making recovery and future deficit reduction even more difficult.

How do those who support the existing approach respond to ours? They typically use two arguments:

1. The confidence argument. Their first argument is that government deficits will raise interest rates and thus prevent recovery. By contrast, austerity will increase confidence and encourage recovery. But there is no evidence in favour of this argument. Despite exceptionally high deficits, interest rates are unprecedentedly low in all major countries where there is a normally functioning central bank. Interest rates are only high in some eurozone countries, because the European Central Bank is not allowed to act as lender of last resort to the government. Elsewhere the central bank can always, if needed, fund the deficit, leaving the bond market unaffected. Experience includes no relevant case where budget cuts have actually generated increased economic activity. The International Monetary Fund has studied 173 cases of budget cuts in individual countries and found that the consistent result is economic contraction. That is what is happening: the countries with the biggest budget cuts have experienced the biggest falls in output. For the truth, as we can now see, is that budget cuts do not inspire business confidence. Companies will only invest when they can foresee enough customers with enough income to spend. Austerity discourages investment.

2. The structural argument. A second argument against expanding demand is that output is in fact constrained on the supply side – by structural imbalances. If this theory were right, however, at least some parts of our economies ought to be at full stretch, and so should some occupations. But in most countries that is not the case. So the problem must be a general lack of spending and demand. In the 1930s the same structural argument was used against proactive spending policies in the US. But as spending rose between 1940 and 1942, output rose by 20 per cent. So the problem in the 1930s, as now, was a shortage of demand, not of supply.

As a result of their mistaken ideas, many western policy makers are inflicting massive suffering on their peoples. But the ideas they espouse about how to handle recessions were rejected by nearly all economists after the disasters of the 1930s. It is tragic that in recent years the old ideas have again taken root. The best policies will differ between countries and will require debate. But they must be based on a correct analysis of the problem. We therefore urge all economists and others who agree with the broad thrust of this manifesto for economic sense to register their agreement online and to publicly argue the case for a sounder approach. The whole world suffers when men and women are silent about what they know is wrong.

Robert J. Gordon: Is Modern Macro or 1978‐era Macro More Relevant to the Understanding of the Current Economic Crisis?

Robert J. Gordon: Is Modern Macro or 1978‐era Macro More Relevant to the Understanding of the Current Economic Crisis?:

This paper differs from other recent critiques of “modern macro” based on DSGE models. It goes beyond criticizing these models for their assumptions of complete and efficient markets by proposing an alternative macroeconomic paradigm that is more suitable for tracing the links between financial bubbles and the commodity and labor markets of the real economy.

The paper provides a fundamental critique of DSGE and the related core assumptions of modern business cycle macroeconomics. By attempting to combine sticky Calvo‐like prices in a theoretical setting that otherwise assumes that markets clear, DSGE macro becomes tangled in a web of contradictions. Once prices are sticky, markets fail to clear. Once markets fail to clear, workers are not moving back and forth on their voluntary labor supply curves, so the elasticity of such curves is irrelevant. Once markets fail to clear, firms are not sliding back and forth on their labor demand curves, and so it is irrelevant whether the price‐cost markup (i.e., slope of the labor demand curve) is negative or positive.

The paper resurrects “1978‐era” macroeconomics that combines non‐market‐clearing aggregate demand based on incomplete price adjustment, together with a supply‐side invented in the mid‐1970s that recognizes the co‐existence of flexible auction‐market prices for commodities like oil and sticky prices for the remaining non‐oil economy. As combined in 1978‐era theories, empirical work, and pioneering intermediate macro textbooks, this merger of demand and supply resulted in a well‐articulated dynamic aggregate demand‐supply model that has stood the test of time in explaining both the multiplicity of links between the financial and real economies, as well as why inflation and unemployment can be both negatively and positively correlated.

Along the way, the paper goes beyond most recent accounts of the worldwide economic crisis by pointing out numerous similarities between the leverage cycles of 1927‐29 and 2003‐06, particularly parallel regulatory failings in both episodes, and it links tightly the empirical lack of realism in the demand and supply sides of modern DSGE models with the empirical reality that has long been built into the 1978‐era paradigm resurrected here.