Z: **Inactive:** Brad DeLong--Economics Only

A Very Good Conversation on Supply-Side Economics

Mark Thoma quotes large chunks of Bruce Bartlett's views on supply-side economics:

Economist's View: Bruce Bartlett: How Supply-Side Economics Trickled Down: Bruce Bartlett says we're all supply-siders now... I don't fully agree:

How Supply-Side Economics Trickled Down, by Bruce Bartlett: As one who was present at the creation of “supply-side economics” back in the 1970s, I think it is long past time that the phrase be put to rest. It did its job, creating a new consensus among economists on how to look at the national economy. But today it has become a frequently misleading and meaningless buzzword that gets in the way of good economic policy.

Today, supply-side economics has become associated with an obsession for cutting taxes under any and all circumstances. No longer do its advocates in Congress and elsewhere confine themselves to cutting marginal tax rates — the tax on each additional dollar earned — as the original supply-siders did. Rather, they support even the most gimmicky, economically dubious tax cuts with the same intensity.

The original supply-siders suggested that some tax cuts, under very special circumstances, might actually raise federal revenues. For example, cutting the capital gains tax rate might induce an unlocking effect that would cause more gains to be realized, thus causing more taxes to be paid on such gains even at a lower rate.

But today it is common to hear tax cutters claim, implausibly, that all tax cuts raise revenue.... President Bush.... Senator John McCain.... Steve Forbes... Rudolph Giuliani....

This... threatens to undermine the enormous gains that have been made in economic theory and policy over the last 30 years. Perhaps the best way of preventing that from happening is to kill the phrase “supply-side economics” and give it a decent burial.

It’s important to remember that at the time supply-side economics came into being, Keynesian economics dominated macroeconomic thinking and economic policy.... Among the beliefs held by the Keynesians of that era were these: budget deficits stimulate economic growth; the means by which the government raises revenue is essentially irrelevant economically... personal savings is bad for economic growth; monetary policy is impotent.... These beliefs... lay at the root of stagflation, that awful combination of high inflation and slow growth that bedeviled policy makers in the 1970s. Based on insights derived from the Nobel-winning economists Robert Mundell, Milton Friedman, James Buchanan and Friedrich Hayek, the supply-siders developed a new program based on tight money to stop inflation and cuts in marginal tax rates to stimulate growth.

As the staff economist for Representative Jack Kemp, a Republican of New York, I helped devise the tax plan he co-sponsored with Senator William Roth, a Delaware Republican. Kemp-Roth was intended to bring down the top statutory federal income tax rate to 50 percent from 70 percent and the bottom rate to 10 percent from 14 percent. We modeled this proposal on the Kennedy-Johnson tax cut of 1964.... We believed that our tax plan would stimulate the economy to such a degree that the federal government would not lose $1 of revenue for every $1 of tax cut. Studies of the 1964 tax cut showed that about a third of it was recouped, and we expected similar results. Thus, contrary to common belief, neither Jack Kemp nor William Roth nor Ronald Reagan ever said that there would be no revenue loss associated with an across-the-board cut in tax rates. We just thought it wouldn’t lose as much revenue as predicted by the standard revenue forecasting models.... Furthermore, our belief that we might get back a third of the revenue loss was always a long-run proposition.... Moreover, we were adamant that only permanent cuts in marginal tax rates would stimulate the economy. We thought that temporary tax cuts, tax rebates, tax credits and such were economically worthless, and we strongly opposed them.

Today, hardly any economist believes what the Keynesians believed in the 1970s and most accept the basic ideas of supply-side economics — that incentives matter, that high tax rates are bad for growth, and that inflation is fundamentally a monetary phenomenon. Consequently, there is no longer any meaningful difference between supply-side economics and mainstream economics.... [S]upply-side economics has done its job, just as Keynesian economics did in the 1930s. Those who campaign as its champions are fighting a fight long won — and it is time for supply-side rhetoric to go, with its essential truths embodied in mainstream economics and its perversions discarded for good.

And Mark Thoma comments:

As noted above, I don't fully agree.... [T]here are two types of policies to consider. The first is the use of monetary and fiscal policy to stabilize the economy.... The second type of policy is growth policy.... The goal here is to increase the growth rate of output.... The question... is how much additional growth comes from a cut in taxes.... We'd disagree over the magnitude however. While some types of tax cuts can affect growth, the effect is nowhere near large enough to generate a 33% tax revenue recovery rate... and, in any case, all the low-hanging fruit has already been plucked....

Let me turn next to Keynesians. My focus is on the New Keynesian (NK) school.... New Keynesians attempt to stabilize actual output around the natural rate as shown above. Why does NK policy tend to focus on demand shocks rather than supply shocks? The answer is that although it would be ideal if we could use supply-side polices to smooth short-run fluctuations in output arising from supply shocks, the reality is that we cannot do this. As Bartlett notes, supply-side polices are very blunt, slow-acting policies.... Since supply cannot be managed in the short-run, that leaves demand management policies, i.e. monetary and fiscal policy. As we learned in the 1970s, demand side tools are not very effective instruments for offsetting supply-side shocks - trying to use demand side policy to offset supply shocks helped to generate the stagflation we saw at the time. We've learned since then, but practically we are still somewhat powerless to offset supply side shocks in the short-run - all we can do is manage demand to match changes in supply....

So, here's where we agree. Both NK and RBC advocates [today] see the long-run similarly. Both schools agree that demand side polices have little effect on long-run growth. Both agree that incentives matter, and that we should, of course, strive to enhance efficiency and long-run growth whenever possible. There is a difference in the two schools as to the strength of those incentives, but if that is all that is meant by supply-side polices, then fine, no problem, we're in agreement.

But there is a big disagreement over the short-run. RBC adherents take a hands-off, free market approach.... NK adherents believe government should take an active role in stabilizing the economy and that is something that, contrary to what is implied above, has not changed since the 1960s and 1970s....

And Bruce Bartlett replies:

Bruce Bartlett: Interesting discussion. However, I think Mark misses the historical context of my analysis. In the 1970s, we were unaware of real business cycle theory or New Keynesian theory. We were confronting Old Keynesian theory. What Mark has basically done is take a current theoretical debate and superimposed it on the 1970s. That's fine if one's goal is to understand how the economy really worked in the 1970s or what the actual effects of policies taken at that time were. But as a matter of history, it is misleading. We didn't know any of this stuff because it didn't exist then. We were dealing with a far different situation in terms of what people knew about the economy (or thought they knew) and that's one reason why I believe that terms like "supply-side economics" have outlived their usefulness. The context in which the term had meaning no longer exists and therefore it has become a barrier to communication rather than a facilitator...

Others comment:

Blissex says: I think that Bruce Bartlett here is being a bit of a revisionist, but his conclusions are sounder than that. In the 50s-60s the new-Keynesian betrayal of Keynes was that output problems were essentially always an issue of insufficient demand, a position of extraordinary faith in the markets. The idea was that markets would provide plenty if only insufficient demand traps were avoided. In hindsight that was ridiculous, and the idea that excessive levels of distorting taxation were stifling the operations of the markets, not just insufficient demand, was sound, and that it is now widely accepted is good, as the markets cannot simply adjust to any conditions except insufficient demand. I think however that Bruce Bartlett's memories are gravely wrong in two ways: He compares the ''realistic'' supply siders of the 1970s with the delirious ones of today, but in the heat of political discussion the claims of many influential 1970s supply siders were as extreme as today's, including Reagan's. The great inflation of the 1970s was not cured by supply-side economics, but simply by a change of political objectives. Inflation was as always solely a political phenomenon, the consequence of seignorage. In the 1960s policy was butter-and-guns, and to increase social stability in difficult times with a policy of easy, easy money, favouring debtors and holders of real assets with very low interest rates. In the 1970s politics reversed, as the Vietnam war was wound down, and Volcker implemented a ferocious policy of high interest rates, favouring creditors and holders of financial assets. Very, very little to do with supply side economics...

Bruce Bartlett says: People need to keep in mind that this was not some purely theoretical debate taking place at some academic conference or in the pages of obscure journals. The people I was working with were members of Congress and their staffs and we were battling specific policies by putting forward specific policies of our own. Many people on both sides were unaware of the theoretical underpinnings because they were unstated, implicit. Part of the supply-side strategy was to make those assumptions explicit. I mention some of them in my article...

real person from the real world says: I think one of the points Barlett makes is that an idea was hijacked. A simplistic slogan that was based on an economic concept that you may or may not agree about, was used over and over again, to justify the implementation of some very self serving policies by past Republican administrations, and those who had the bucks used it as their banner. What's been done is done, now is the time to fix the mess that has been created, except the wrong people (corporate America, and the supper wealthy) now have all the power to stymie any pragmatic reform that rocks their nice little boats...

Paul Krugman says: I was a grad student at MIT - the great Keynesian stronghold - in the 1970s, and this bears no resemblance to what was being taught. In fact, I still have my copy of Dornbusch-Fischer, Macroeconomics, the 1978 edition - and it doesn't make any of those assertions. I'm particularly amazed by the "monetary policy is impotent" bit: no mainstream Keynesian in America believed that any time after, say, 1955. Dornbusch-Fischer is mainly about monetary policy, and how important it is. Let me suggest that good economic doctrines don't have to be sold by misrepresenting what other doctrines say...

Bruce Bartlett says: If Paul Krugman is right, then where did all the policy mistakes of the 1970s come from? Why did the Fed act as if the money supply had no linkage to inflation until Volcker changed gears in 1979? Why did the Congressional Budget Office routinely report that a tax rebate, a permanent tax rate reduction, and an increase in government purchases would have exactly the same macroeconomic effect because their only impact was on aggregate spending? I have some of those old reports in my library and can dig them out if necessary.

Of course, there were those in academia who knew better. Maybe Paul was one of them. But they weren't in charge of the Fed or the CBO. Also, I think a lot of economists who lived through the the 1970s and know better today have simply forgotten how screwy some of the economic policies of that time were and how many reputable economists supported them. Go back and read Leonard Silk's columns in the New York Times to see what mainstream economics was all about in those days. Don't go back now and cherry pick the isolated case where someone had it right. We had to do what we were doing in real time without the luxury of long and careful study of all the alternatives. It was a crisis atmosphere and we did the best we could with what we had to work with....

Blissex says: If Paul Krugman is right, then where did all the policy mistakes of the 1970s come from? Why did the Fed act as if the money supply had no linkage to inflation until Volcker changed gears in 1979? They were not mistakes, they were deliberate policies designed to pursue political important goals. Keeping the voters happy during difficult times was deemed more important than price stability.... I think a lot of economists who lived through the the 1970s and know better today have simply forgotten how screwy some of the economic policies of that time were and how many reputable economists supported them. Well, a large part of that was excessive faith in the ability of markets and entrepreneurs to adapt to any conditions. Instead the one great legacy of ''supply side'' was to point out that government policy matters as to creating a suitable climate for business and growth, as the markets and entrepreneurs cannot be given for granted, they can't do their job under all conditions...

Bruce Bartlett: Inflation was indeed the central problem. But policymakers were repeatedly told that to bring it down to tolerable levels would require an economic contraction as long and as deep as the Great Depression. It was hard to argue that the benefits of ending inflation were greater than the negative effects of another Great Depression. So policymakers just kept monetary policy on automatic pilot until the spectre of hyperinflation emerged. At that point, every serious person knew that something had to be done. Where I credit supply-side economics is in making the transition from a high inflation environment to a low inflation environment as quick and painless as possible. Of course, the 1981-82 recession was painful, but it was less painful than the 1974-75 recession, which did little to even moderate inflation, and a lot less painful than the Great Depression. If we hadn't cut tax rates in 1981 and taken the other supply-side measures Reagan took, the transition would have been vastly longer and more painful, in my opinion...

knzn: By most measures, the 1981-82 recession was more painful than the 1974-75 recession, and in fact the latter did moderate inflation, as you can see if you look at the inflation series in the 1975-77 period. The problem was that the Fed pushed the recovery too hard. What Volcker was willing to do, specifically, was to keep the 1981-82 recession going for as long as necessary to get inflation down to an even lower level and then to be very cautious about pushing the recovery. I strongly disagree with the opinion that cutting tax rates prevented the transition from being more painful. Volcker’s credibility helped, but the tax cuts meant that interest rates had to be higher for longer and that traded goods industries suffered long-term damage due to a strong dollar.... Also, I don’t know who was saying that brining inflation down “would require an economic contraction as long and as deep as the Great Depression.” It’s true that conventional Keynesian estimates of the sacrifice ratio were higher than what it turned out to be, but not so dramatically higher. I think you would have a very hard time finding any actual economist of the time who came up with a quantitative estimate of the required contraction that came anywhere near the severity of the Great Depression.

Blissex says: If we hadn't cut tax rates in 1981 and taken the other supply-side measures Reagan took, the transition would have been vastly longer and more painful, in my opinion. As to that I quite agree -- in part because it is sensible, standard Keynes-style fiscal policy ;-), in part because the level of taxation had reached ridiculous levels.

Note however that as remarked long ago, "ridiculous" above does not necessarily mean "damaging", as top tax rates were very high in the fifties too, a golden era. The case against excessively high taxes is mostly moral (confiscation), rather than economic, while the case against excessively low ones is economic (a business and growth friendly infrastructure is expensive) as well as moral.

Howard, for working men in the fifties, it was a much better economy then than it is today. Now I'm not talking about civil rights and the like. Well, that was in part because of politics. Working white men were the pillars of USA conservativism (and they still are, inasmuch they are asset and gun owners), and the inflation of the late 60s and the 70s was in part designed to buy them off; the buying off was in part meant to conserve their support for the war, in part to keep them happy even if blacks and women were given civil rights, in part to detach their interests from those of students and other ''subversive'' elements (the latter especially in Europe)...

Bruce Bartlett says: In an article in the American Economic Review (May 1978), Arthur Okun said that to reduce the basic inflation rate by 0.3% would require raising the basic unemployment rate by one percentage point for one year. With inflation well into double digits by 1980, one can see that it would indeed require unemployment on the scale of the Great Depression to bring inflation down to a tolerable level...

Paul Krugman says: A late entry - I'm on the road. Anyway, Bruce Bartlett's contention that the inflation of the 70s happened because people didn't think money mattered is just bizarre. There was a way too expansionary monetary policy in 1972, not because people didn't think it mattered, but because they did: it's widely believed that Arthur Burns pumped up the economy in an attempt to help Nixon win the election. Nixon's people worried about the effects of monetary policy all the time!

We might also want to mention two horrific oil shocks.

Again, what Bruce is describing is a caricature of an vulgar ultra-Keynesian, circa 1947. People like that never dominated Keynesian thought in the United States, and were pretty much nonexistent by the time supply-side economics came into existence. And no, it's not a matter of policy entrepreneurs versus academics: look at the people who were actually advising Gerald Ford or Jimmy Carter on economic policy, and they were nothing like the caricature Bruce describes.

It's sad, really: to make supply-side economics look respectable, it's apparently necessary to pretend that everyone else was an idiot....

Bruce Bartlett says: I think Paul's memory is just wrong. Has he forgotten how intense the arguments were about monetarism? A lot of people thought Milton Friedman's monetary ideas were crazy. And while it's true that Arthur Burns did a horrible job as Fed chairman, he inherited a situation in which inflation was already a serious problem. Jimmy Carter clearly had no clue about it and appointed G. William Miller as Fed chairman who gave us double digit inflation. I remember him testifying before the JEC that inflation was caused by failure of the anchovy harvest. I'm not making this up. They are used in fertilizer, which raised the cost of farming, which raised the cost of food and so on. Maybe up at MIT, people had it all figured out. But down in Washington, where I was, a lot of important people were seriously clueless...

Ezra Klein: Health Insurance Works

Ezra Klein writes:

Ezra Klein: Health Insurance Works, Trusting Its Detractors Doesn't: Some of you asked me to take a look at The LA Times op-ed by Michael Cannon and Michael Tanner on why universal health care ain't all it's cracked up to be. I should preface this by saying that I like Michael Cannon.... [I]n trying to give him the benefit of the doubt here, I will say only that this article is violently, even surprisingly, misleading.... Cannon and Tanner write, "[y]ou may think it is self-evident that the uninsured may forgo preventive care or receive a lower quality of care. And yet, in reviewing all the academic literature on the subject, Helen Levy of the University of Michigan's Economic Research Initiative on the Uninsured, and David Meltzer of the University of Chicago, were unable to establish a 'causal relationship' between health insurance and better health. Believe it or not, there is 'no evidence', Levy and Meltzer wrote, that expanding insurance coverage is a cost-effective way to promote health."

Believe it or not, Cannon and Tanner are misrepresenting the study's conclusions.... [H]ere's what Levy and Meltzer actually conclude, in their own words:

The results of small quasi-experimental studies provide only mixed evidence that health insurance affects health, while larger quasi-experimental studies and the RAND Health Insurance Experiment provide consistent evidence that health insurance improves health. Only one large-scale quasi-experimental study (Perry and Rosen) fails to show a relationship between health insurance and health, and this study may not have adequate power to rule out the possibility that health insurance improves health. Taken as a whole, these high-quality studies of the health effects of health insurance strongly suggest that policies to expand insurance can also promote health.... We are left with the conclusion that health insurance can improve health but remain unable to say exactly which interventions related to insurance will do so most effectively...

Is there a way out? Or will Ezra have to add Michael Cannon to the list of people we read with great suspicion?

Down the Connecticut River Valley with Binoculars and Camera

At Yale, we saw a tenured professor in his natural habitat: John Geanokoplos, on Hillhouse Avenue in front of the Economics Department, dressed in his Wall Street pants, talking to a sophomore with such complete focus that he didn't see me until I grabbed his hand.

John is a large part of the reason that I am in this business. He taught that brilliantly at the start of Harvard's Economics 2002a in the fall of 1979. Sitting in front of him for that month and a half was one of the peak intellectual experiences of my life.

Benjamin Barber Hates Us for Our Freedom

Benjamin Barber hates us for our freedom: ur freedom to go to restaurants named "Stuff Yer Face" on Easton Ave. in New Brunswick, NJ, that is. Tyler Cowen and his mesnie get properly medieval on Barber:

Marginal Revolution: Benjamin Barber's Consumed:

There is actually [sic] a restaurant in New Jersey called Stuff Yer Face, and fast food generally is about stuffing your face: about nutrition, fueling up, taking in the calories, food as instrumentality, eaters as mere animals responding to biological imperatives.

The subtitle of the new book is How Markets Corrupt Children, Infantalize Adults, and Swallow Citizens Whole. Here is the restaurant's home page, with sound.

Posted by Tyler Cowen on March 28, 2007 at 01:44 PM in Books | Permalink

Comments

The title works even better if you replace "Markets" by "Socialism". Posted by: dearieme at Mar 28, 2007 1:50:41 PM....

Even more surprising is that stuff yer face isn't bad, at least for college food (it's right next to rutgers). It's one of the few places on easton ave serving food that you would eat while sober. The beer selection is pretty good as well. It's not a fantastic place, but it's better than the name suggests. Posted by: Anonymous coward at Mar 28, 2007 3:09:39 PM

Stuff Yer Face was also Mario Batali's first cooking job, while attending Rutgers. As the Anonymous Coward points out, it's decent enough for a stromboli and beer place (it was one of the places where we sent our out of town relatives who came for our wedding and were looking for something to eat the night before the wedding) Posted by: Bg Porter at Mar 28, 2007 3:48:26 PM....

Benjamin Barber is an arrogant gasbag. He believes in replacing his preferences in place of everyone else's. He thinks that "we" should be exporting more jazz and less Britney Spears. His view of markets is more-or-less neo-Rousseauian. He believes in sort of "directed democracy" even though he won't admit it. Barber is the type of dude who gives political theorists a bad name. He's typical of the reason that many of the smarter ones go into PHILOSOPHY departments so that they can be free of his ilk. The dude is a sophist and a very, very, VERY poor man's Michael Walzer. Posted by: Jeebus at Mar 28, 2007 3:50:21 PM

I don't know the context, but at face value it seems really odd to complain about people having an instrumental view of food. Is food supposed to be an end in and of itself? I suppose if you viewed getting pleasurable sensations from consuming food as being an non-instrumental usage of food, he'd kind of have a point, but it can hardly be argued that that is a vice of fast food resturants, which tend to make food that a good chunk of the population does enjoy eating. Posted by: MattXIV at Mar 28, 2007 3:59:43 PM

about nutrition, fueling up, taking in the calories, As opposed to anorexia, malnutrution, and throwing-up? food as instrumentality, As opposed to food as an object of mere aesthetic contemplation? eaters as mere animals responding to biological imperatives, As opposed to space aliens responding to cosmic imperatives? Barber is a sententious twat. And I mean that in the best way possible...

Kash Mansouri Is Very Unhappy with the Economist on Bush on Trade

Kash Mansouri writes:

The Street Light: The Economist on Bush on Trade - Yahoo! News: Economy News : The Economist takes a massive dive today, as they continue to bizarrely and irresponsibly assume the best (or maybe "the least bad" would be more accurate) of the Bush administration. The last two paragraphs of the story contain the offending bits:

Despite a dispiriting start that saw the imposition of steel tariffs, the Bush administration has made great efforts on trade, pushing forward with both multilateral and bilateral deals. Its biggest goal, a substantive deal from the Doha round of World Trade Organisation negotiations, is currently on life support. But the administration has managed to secure a variety of smaller deals, while letting steel tariffs die a death at the hands of the WTO. Now even progress of that sort may end.

Already, the Democratic influence is showing on the administration's trade team. On Friday March 30th it announced that it was imposing countervailing tariffs on Chinese manufacturers of high-gloss paper to offset indirect subsidies they get from the state. America has usually steered clear of this sort of action against state-run economies, saying it is prohibitively difficult to calculate excess subsidies. But the gaping trade deficit with China, and growing protectionist forces, have altered the political calculus. New tariffs of up to 20% will be imposed immediately. The American economy will survive without cheap Chinese paper products. But this could open the way to tariffs on a wide variety of critical products and signals an unwelcome shift in American trade policy.

The Bush administration has made great efforts on trade?!? The Bush administration's imposition of tariffs on China are due to "Democratic influence"?!?

Please. With the imposition of tariffs on China last Friday, the Bush administration acted in exactly the same way that they've acted for their entire 6+ years in office: being in favor of free trade whenever and wherever it helps important friends industries, and being more than happy to impose trade protection whenever and wherever it helps important friends industries. The Bush administration enacted a host of tariffs, quotas, and subsidies during the six years when it had a compliant Congress, and last week's action was just more of the same.

Furthermore, the Doha Round (the round of multilateral trade negotiations that is intended to finally take serious steps toward helping the developing world) is "on life support" in no small measure because the Bush administration has never seriously tried to make it work, instead focusing on small bilateral agreements that make no difference to anyone in the US except for a few individual corporations. And there are good theoretical reasons to think that a bunch of small bilateral trade deals may actually make it harder to conduct multilateral trade negotiations, putting a world-wide level playing field further out of reach than ever before.

The Bush administration's record on trade policy is a hodge-podge of opportunism and indifference, and owes nothing to Democratic pressures or desires. For the Economist to pretend otherwise is a sad continuation of their baffling tolerance of Bush's long record of incompetence and misplaced priorities.

Brad DeLong: The Secret Language of Central Bankers

The secret language of central bankers: 'If I seem unduly clear to you," Alan Greenspan said to his political masters in the United States Congress, "you must have misunderstood what I said."

It was 1987, and the newly-confirmed chair of the Federal Reserve was elaborating on how he had "learned to mumble with great incoherence" in the short months since he had "become a central banker".Greenspan was a strong believer, in practice if not in theory - for who could understand his theory? - that central bankers should speak in an opaque and convoluted dialect. In comparison, the Oracle at Delphi's advice to the King of Lydia - "If you attack Persia, you will destroy a great kingdom" - is clarity itself.

There was an old argument for "Greenspanese": voters or politicians or both are inherently short-sighted and myopic. They would always see and want to grasp the benefits of lower interest rates and a little more demand pressure - more production, more employment, higher wages, and higher profits in the short run. But they would either not see or be cynically indifferent to the problems of stagflation that would inevitably follow. The job of the central bank, according to Greenspan's distant predecessor, William McChesney Martin, was to "take away the punch bowl [of low interest rates] before the party really gets going".

But, the argument went, the Fed could not say that this was what it was doing in clear and transparent language, for, if voters and politicians could understand central bankers, they would then force them into following destructive inflationary policies that would be worse for everyone, at least in the long run. By using an opaque and convoluted idiom, the only outsiders - reporters, politicians, and academics - who would be able to understand what the central bank was saying would be those who had carefully studied the issues and the language. This, in turn, would lead them all (with the rare exception of a maverick critic like William Greider) to understand and approve, and to agree that talking in "Greenspanese" is essential for enabling central banks to ensure price stability.

There seems to be general agreement today that this argument no longer applies, if it was ever truly valid. Voters and politicians today, it seems, fear inflation and are willing to accept occasional economic recessions and unemployment above its natural rate as unfortunate but inevitable consequences of the necessary and beneficial pursuit of long-term price stability. The debate about monetary policy can thus be fruitful and productive even if it is no longer restricted to those who have learned "Greenspanese".

Thus, all across the North Atlantic core of the world economy, central banks have embarked on a "transparency" initiative to make their organisation's goals, guesses, procedures, and policies more widely and clearly known. They are relying on economists' basic predisposition to believe that more information is always better than less, that individuals are good judges of what they need to know, and that they are able to evaluate and place in perspective what they know.

But recently - and increasingly so in recent months - central bankers' doubts about the utility of the transparency initiative have increased. The more central banks talk, and the clearer they try to make their language, the more it seems that markets may be reacting excessively and inappropriately to statements that are not really news at all. More information may be leading not to better knowledge, but to more confusion.

We economists have a hard time figuring out why there appears to be so much static on the communications line. Why were so many people in financial markets so sure that the Fed's late-March meeting statement heralded a likelihood of interest-rate hikes soon, rather than being simply an acknowledgement (as the Fed explicitly stated) that what had been very unlikely was now a possibility? Why are cable TV personalities so eager to overstate how quickly central banks change their view of the likely future? Why do participants in financial markets trade on the advice of cable TV personalities when a small amount of number-crunching reveals that the benefits must be lower than the transactions costs incurred by over-frequent trading?

We don't have answers to these questions. So we really don't know whether we should tell central bankers to brush up on their Greenspanese

Roger Ehrenberg on Blackstone

When a firm whose raison d'etre is that engagement in the public marketplace slows you down and distracts your attention and costs your money decides that it should go public--why, yes, you might reasonably conclude that there is something bubbleicious going on. Maybe they can take it public now, and after the next turn of the macroeconomic wheel take themselves private again in five or ten years:

FT.com / Home UK / UK - Why the Blackstone offer may signify a bubble: We can feel it in our bones. Something is happening here. First, the alternative asset management firm Fortress Investment Group goes public and trades up to previously unheard-of valuations for companies in the investment arena. Next, the private equity colossus Blackstone files for its own initial public offering, with the potential of generating a huge payout for its chairman, Stephen Schwarzman.

These self-motivated, intelligent individuals are trying to tell us something important. The question is: do we have the ability to look beyond their words and actions and intuit motivation? Greed, uncertainty and fear. What are the implications? That the equity markets are in trouble? That the credit markets are on the verge of a sharp sell-off? That we are at the dangerous stage of a private equity bubble?

My assessment is that we are in a private equity bubble of sorts. However, it is not one that has ghastly implications for the overall market but, instead, will have negative outcomes for those invested in private equity funds - and certainly for those buying into the public shares of private equity management companies such as Blackstone.

Consider this: Blackstone is a great firm. Going public will bring even greater riches to those at the top. That said, great riches have already been captured by those up and down the management hierarchy. This is not the case of a go-go high-technology firm that generates little free cash flow and requires an IPO or a sale to crystallise value for its shareholders. Blackstone has been and will continue to be a cash machine that can distribute substantial sums to its minions every year. Therefore, either an IPO or a leveraging of the balance sheet is simply a means of extracting even more cash from the business. Given the friendly nature of today's equity markets, going public offers the best risk/reward decision for Blackstone's existing shareholders. This is an opportunistic step driven by the state of today's equity markets and other considerations such as the state of the private equity market.

Hundreds of billions of dollars of new deal capacity has been created by private equity firms in the past 12 months. This is a classic case of too much liquidity chasing too few opportunities, giving rise to stretched debt-to-cash flow multiples, club deals where multiple private equity firms share risks and rewards and the re-emergence of complex debt instruments that give great flexibility to the private equity issuers but scant protection for debt investors. This cycle we have seen repeated every 20 years or so, the difference here being the scale and number of private equity firms and the leveraged capital at their disposal.

As long as the debt markets co-operate, all is well. But when debt investors wake up to the fact that they are systematically underpricing risk, the highly leveraged deal structures simply will not work. Deals will still get done because private equity firms need to deploy their capital to build franchises and justify their fees but leverage ratios will fall and returns will decline. Bad for the overall market? Not really, because competition for doing deals in general will remain strong owing to liquidity considerations. But bad for private equity investors? Certainly, and now there will be one more constituency at the table: investors in the public equity of these private equity firms. Here is the rub.

Will Blackstone pull off a wildly successful IPO? It is almost a certainty. Will Blackstone trade at a multiple that implies rapid growth in assets under management and therefore in management and performance fees? Absolutely. What will happen when the debt markets grow less friendly and additional equity is required to get deals done? Returns will fall. What will happen to those who have invested in private equity funds? They will not be happy. And those who have invested in common shares of the private equity management company? Unhappier still.

Mr Schwarzman knows this full well, as do his colleagues at Kohlberg Kravis Roberts, Texas Pacific Group, Apollo and others thinking about following in Blackstone's footsteps. They understand that the risk/reward calculus of the private equity business (largely being borne by debt holders in today's frothy environment) could shift rapidly, closing a historically attractive window for them to monetise their franchises. They see the private equity bubble and want to extract value before it pops. But where does that leave the rest of us? Unhappy, indeed.

Bush Acknowledges Rising Income Inequality

The Reality-Based wing of the administration makes a push. Greg Ip and John McKinnon:

Bush Reorients Rhetoric, Acknowledges Income Gap - WSJ.com: 'The term 'income inequality' is a bit misleading because it suggests in a somewhat pejorative way that the rich are getting richer at the expense of the poor," Edward Lazear, a Stanford University labor economist who is now chairman of Mr. Bush's Council of Economic Advisers, said last May. While it's a concern that some people are being left behind, he said, "There is some good news...most of the inequality reflects an increase in returns to 'investing in skills.'"

Mr. Lazear has nurtured his relationship with Mr. Bush. His office is decorated with photos of the two mountain biking. When he gave Mr. Bush a copy of the Economic Report of the President this year, Mr. Bush gave him a bear hug and kissed the top of his bald head, according to people who were present.

Some economists question Mr. Lazear's assertion that, for instance, raising taxes on higher-wage earners will reduce individuals' incentive to acquire new skills. Lawrence Katz, a Harvard University labor economist who served in the Clinton Labor Department, says there's "not a shred of evidence" lower taxes boost educational attainment. "That's first-order goofball."

Even before Republicans' November defeat at the polls, some administration allies were warning that economic insecurity was eroding Republican support. A business coalition hired pollster David Winston to figure out why voters remained so dissatisfied with the economy. His focus groups of middle-income voters in Cincinnati and Pittsburgh found voters going deeper into debt to keep up with rising costs of health care and energy. Executive compensation "is getting to the point where it's obscene," said one focus-group participant.

The more politicians talked about how good the economy was, the worse these voters felt. "It's almost as if these folks are floating around in the ocean, watching the yachts and speedboats go by, thinking, 'Hey, I'm here, someone notice me,'" says Dirk Van Dongen, a co-chairman of the coalition and president of the National Association of Wholesaler-Distributors. Mr. Winston advised Republicans: "Our message should be that while the economy is getting back on track, we need to do more to help people with the cost of living."

But Republican strategists largely ignored the findings. Led by Karl Rove, they wanted to avoid blunting one of their few advantages in the 2006 campaign -- the economy's broad strength. One adviser adds that Iraq would have overshadowed any new economic proposals. Mr. Rove notes the president did talk about health care, college and other pocketbook issues during the campaign.

Over the past several months, debate inside the administration has shifted some. When he ran Goldman Sachs Group Inc., Mr. Paulson had invited former Clinton aides Gene Sperling and Princeton University labor economist Alan Krueger to brief him on the impact of globalization on wages and inequality. At a staff meeting soon after taking the Treasury post in July, he expressed puzzlement about the administration's opposition to raising the minimum wage, a person familiar with the meeting says. He has dispatched Undersecretary Robert Steel, another Goldman alumnus, to scout for ideas to boost the lower middle class.

Other officials -- including White House international-economics aide David McCormick and Matthew Slaughter, until recently a member of Mr. Lazear's council -- argued internally that addressing inequality was needed to damp protectionist sentiment fueled by voters who believe they are hurt, not helped, by globalization, insiders say.

Mr. Bush's acknowledgment that inequality is widening and the renewed focus on health care and revamping aid to dislocated workers suggest the administration appreciates the issue's political potency. "Voters' perceptions of economic health are very different than they used to be," said Mark McKinnon, Mr. Bush's former media adviser and now an adviser to Sen. John McCain, the Arizona Republican seeking to succeed Mr. Bush. "The old indicators that we reliably counted on -- unemployment, the stock market -- don't seem to matter much anymore. And other things do -- health care and pensions."

Adds former Treasury Secretary John Snow, now chairman of private-equity buyout firm Cerberus Capital Management: "The Democrats sense they have an issue here and are going to try to push it, and the Republicans are going to have to have an answer."

Hoisted from the Archives: Information Technology and the Future of Society: My CITRIS Kickoff Speech

My CITRIS kickoff speech: Information Technology and the Future of Society (Hoisted from the Archives)

Information Technology and the Future of Society: For perhaps 9000 years after the beginnings of agriculture the overwhelming proportion of human work lives were spent making things: growing crops, shearing sheep, spinning yarn, weaving cloth, throwing pots, cutting down trees, copying books, and so on, and so forth. Technology did improve enormously over those 9000 years: contrast the clothes-making technology at the disposal of Henry VIII of England with that of Rameses II of Egypt three thousand years before; contrast the triple-crop paddy-irrigated rice- and water-control-based agriculture of the Yangtze Delta in eighteenth-century China with the scratch-the-soil-with-a-hoe agriculture of two thousand years before. But as Thomas Robert Malthus first wrote in the 1790s, rising populations had put enough pressure on scarce natural resources to offset the benefits of better technology and keep living standards nearly constant for the people if not for the elite: American President Thomas Jefferson in 1803 A.D. certainly enjoyed a higher standard of living than Roman Consul Marcus Tullius Cicero in 63 B.C. But did Jefferson's slaves enjoy a higher standard of living than Cicero's? A large amount of archeological evidence has not yet found significant differences.

For the past two hundred and fifty years, since the start of the Industrial Revolution, the productivity of those workers who make things has exploded. Hand-spinners in the eighteenth century took 50,000 hours--20 full work-years--to spin 100 lbs of cotton into thread (Freeman and Louca (2001), and spinning of one sort or another took up perhaps 5% of total labor-time. Today it takes 40 work hours to spin 100 lbs. of cotton: a more than thousand-fold amplification of productivity in this one task.

As our productivity at growing crops and making things has exploded, demand for the things we make has grown too, but not fast enough to keep the crop-growing, food-cooking, mineral-extracting, clothes-making, box-carrying, and other goods-producing share of our economy's labor force from falling. Today those who in any earlier age would be classified as "production workers"--and would have been the overwhelming majority of the labor force--are perhaps 20% of our economy, and the bulk of them are better characterized as machine-watchers and machine-fixers. According to Stanford's Robert Hall, as early as 1980 there were twice as many salesmen in Ford-selling auto dealerships as there were assembly-line workers employed by Ford Motor Company.

So what are the rest of us--the other 80%--doing? In a sense, we all--from U.C. professors to chief technical officers to xerox operators, Ford Salesmen, cashiers, and parking-lot attendants--are and have long been information workers: people whose jobs are, if we examine them closely, largely concerned with determining what exactly the goods-producing sectors should make, how it should be made, where it should go, and to whom it should be distributed--and that is leaving aside the large chunk of our economy that is symbolic communication as an end in itself.

Today we see--not yet sharply, not yet clearly, but no longer dimly--the prospect that the ongoing technological revolutions in data processing and data communications will do for the "information" sectors of the economy something like what the Industrial Revolution did for goods-producing sectors like cotton spinning. As Steve Cohen over in the City Planning department here likes to say, you are now building the equivalent of the industrial-age tools for shaping and handling matter, but you are building tools for thought (Cohen, DeLong, and Zysman (2001)). And if we can figure out how to make these tools for thought fulfill their promise, they should produce a quantum jump in our technological power, economic productivity, and--we hope--quality of life of as many energy levels as the jump of the Industrial Revolution itself.

But there are major problems of social engineering and organizational design that stand in our way. A century or so ago, at the height of the Industrial Revolution, the market economy turned out to have an extraordinarily good fit with the developing industrial technologies of goods-making. It provided a framework of social organization that was extraordinarily effective in providing people with incentives to carry on activities that generated rapid technological development, capital accumulation, and economic growth.

An effective form of social organization faces decision makers with incentives that mirror the impacts of their actions on society as a whole. Because the goods produced by industrial technologies were rival--that is, could only be of use to one person at one time--each person's use of such a good diminished the supply available to the rest of society. Thus it made sense from the viewpoint of efficient distribution to require that users pay a price--diminish their ability to acquire and use other resources--for commodities. And those prices paid then gave producing organizations the resources to carry on and expand their activities. Because the goods produced were excludable--that is, it was by-and-large straightforward to limit control over use to those authorized--it was easy and straightforward to push decision-making outward from the clueless bureaucratic center to the periphery where people on the ground might actually have a good sense of the situation, and of what should be done.

These three advantages--earmarking additional resources for successful and efficient production organizations, providing users with incentives for economically-efficient distribution, and decentralization of decision-making to where the knowledge was likely to be--were delivered by accident by the trade-and-market economic structure of Adam Smith.

But now as we try to realize the technological promise of information technologies, the old forms of economic organization no longer have a natural fit with the requirements of technological development and economic growth. Once an "information good" has been produced, sharing it with another person doesn't reduce the rest of society's resources and opportunities. So there is no efficient-distribution reason to charge a price for it. But where then does the flow of signals to assess which production organizations are efficient come from? In an earlier age we would be more inclined to rely on government funding, but these days we have a keen awareness of the advantages in applied development at least of semi-Darwinian competitive mechanisms, where investigators are responsible to investors seeking profits and not to committees seeking whatever committees seek.

Moreover, it is only with difficulty that information goods are excludable. But if their use can't be restricted to authorized users, then the entire market-as-a-social-calculating-and-signalling mechanism simply breaks down. Unfortunately, attempts to make information goods "excludable" by various forms of use protection waste valuable time and energy: I shudder at the memory of having spent two hours on hold during three phone calls, and having spent another two hours of my time rebooting and reading installation error messages the last time I tried to upgrade one of the Adobe programs--GoLive--on this laptop. I doubt I'll ever be able to face the prospect of buying another Adobe program again.

Two things, however, are clear. First, caught between "government failures" in applied research and the ever-larger "market failures" that will be created as the characteristics of information-age goods clash with the requirements for market efficiency, intermediate forms of organization--like large publicly-funded research universities--need to play an even larger role in research and development in the future than they have in the past. Projects like CITRIS promise the benefits of government research--the wide distribution of knowledge and the acceleration of cumulative research--and the benefits of private entrepreneurship--the willingness to take risks and investigate large numbers of potential development projects rather than just those that have won the stamp of approval of a single central committee. It is the task of chancellors and deans, of course, to make sure that projects like CITRIS don't wind up producing the drawbacks of both forms of organization: the strangulation by bureaucratic red-tape and committee infighting of government, combined with the restrictions on the distribution of information and the use of products that make a large share of private-sector development work duplicative of what has already been done.

Second, realizing the promise of the Societal-Scale Information Systems that are the Holy Grails of this quest will turn out to be a problem of social engineering as well as computer science. I have long wondered just why it was that the first half of the 1980s were the era of the IBM PC rather than of the DEC VAX--when the hardware cost of a VAX was, as best as I can guess, no more than 1/5 that of the equivalent number of 8086 machines, and when thanks largely to Berkeley UNIX there was no comparison at all in software. The answer lies somewhere in social engineering--that somehow paying out five times as much for inferior software was worth not having to wrestle with established MIS bureaucracies. But what the answer is I am not sure.

So let me turn this into a sales pitch for the social scientists at Berkeley interested in information technology--from Manuel Castells in sociology to Pam Samuelson and Mark Lemley at the law school to John Zysman and Steve Weber in political science to Hal Varian and his simians to Suzanne Scotchmer at public policy to the industrial organization and antitrust barons of the business school and the economics department--Glenn Woroch, Rich Gilbert, Dan Rubinfeld, Mike Katz, Carl Shapiro--and a host of others. I do not know of a place with a more vibrant and smarter community of scholars interested in the social engineering aspects of information technology.

And I do not know of a better place than this to assemble the resources to build the Societal-Scale Information Systems that can make information technologies realize their promise.

The Reality-Based Wing of the Administration Twitches a Finger

The Reality-Based wing of the administration twitches a finger. They are not totally dead--not yet. Greg Ip and John McKinnon:

Bush Reorients Rhetoric, Acknowledges Income Gap - WSJ.com: 'The term 'income inequality' is a bit misleading because it suggests in a somewhat pejorative way that the rich are getting richer at the expense of the poor," Edward Lazear, a Stanford University labor economist who is now chairman of Mr. Bush's Council of Economic Advisers, said last May. While it's a concern that some people are being left behind, he said, "There is some good news...most of the inequality reflects an increase in returns to 'investing in skills.'"

Mr. Lazear has nurtured his relationship with Mr. Bush. His office is decorated with photos of the two mountain biking. When he gave Mr. Bush a copy of the Economic Report of the President this year, Mr. Bush gave him a bear hug and kissed the top of his bald head, according to people who were present.

Some economists question Mr. Lazear's assertion that, for instance, raising taxes on higher-wage earners will reduce individuals' incentive to acquire new skills. Lawrence Katz, a Harvard University labor economist who served in the Clinton Labor Department, says there's "not a shred of evidence" lower taxes boost educational attainment. "That's first-order goofball."

Even before Republicans' November defeat at the polls, some administration allies were warning that economic insecurity was eroding Republican support. A business coalition hired pollster David Winston to figure out why voters remained so dissatisfied with the economy. His focus groups of middle-income voters in Cincinnati and Pittsburgh found voters going deeper into debt to keep up with rising costs of health care and energy. Executive compensation "is getting to the point where it's obscene," said one focus-group participant.

The more politicians talked about how good the economy was, the worse these voters felt. "It's almost as if these folks are floating around in the ocean, watching the yachts and speedboats go by, thinking, 'Hey, I'm here, someone notice me,'" says Dirk Van Dongen, a co-chairman of the coalition and president of the National Association of Wholesaler-Distributors. Mr. Winston advised Republicans: "Our message should be that while the economy is getting back on track, we need to do more to help people with the cost of living."

But Republican strategists largely ignored the findings. Led by Karl Rove, they wanted to avoid blunting one of their few advantages in the 2006 campaign -- the economy's broad strength. One adviser adds that Iraq would have overshadowed any new economic proposals. Mr. Rove notes the president did talk about health care, college and other pocketbook issues during the campaign.

Over the past several months, debate inside the administration has shifted some. When he ran Goldman Sachs Group Inc., Mr. Paulson had invited former Clinton aides Gene Sperling and Princeton University labor economist Alan Krueger to brief him on the impact of globalization on wages and inequality. At a staff meeting soon after taking the Treasury post in July, he expressed puzzlement about the administration's opposition to raising the minimum wage, a person familiar with the meeting says. He has dispatched Undersecretary Robert Steel, another Goldman alumnus, to scout for ideas to boost the lower middle class.

Other officials -- including White House international-economics aide David McCormick and Matthew Slaughter, until recently a member of Mr. Lazear's council -- argued internally that addressing inequality was needed to damp protectionist sentiment fueled by voters who believe they are hurt, not helped, by globalization, insiders say.

Mr. Bush's acknowledgment that inequality is widening and the renewed focus on health care and revamping aid to dislocated workers suggest the administration appreciates the issue's political potency. "Voters' perceptions of economic health are very different than they used to be," said Mark McKinnon, Mr. Bush's former media adviser and now an adviser to Sen. John McCain, the Arizona Republican seeking to succeed Mr. Bush. "The old indicators that we reliably counted on -- unemployment, the stock market -- don't seem to matter much anymore. And other things do -- health care and pensions."

Adds former Treasury Secretary John Snow, now chairman of private-equity buyout firm Cerberus Capital Management: "The Democrats sense they have an issue here and are going to try to push it, and the Republicans are going to have to have an answer."