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

A Warning to Slacker Lecturers Everywhere!

Robert Solow has waited sixty years to tell us how bad a lecturer Joseph Schumpeter was:

I knew Joseph Schumpeter only in the last five years of his life, from 1945 until his death in 1950, at the age of sixty-six. To say that I knew him is actually a bit of an exaggeration. First as a returning undergraduate and then as a doctoral student in economics at Harvard, I attended his courses on advanced economic theory and the history of economic thought. The theory lectures bordered on incoherent; they alluded to everything but analyzed nothing. He would say: "Of course you know about X or Y, so I do not have to go into detail." But we didn't know about X or Y, as he must have realized. The history lectures were also disappointing. I do not remember where they began, but at the end of the term they had barely reached Adam Smith. The course felt like a stage display of multilingual erudition. More generally, Schumpeter seemed to be playing the role of grand seigneur, and he tended to flatter where flattery was not due, no doubt satirically. All this went along with his reputation as a casual and easy grader. We used to say that he threw the exam books up a staircase: the ones that stuck at the top got an A, the ones that fell to the bottom an A minus...

Readers, beware! Before you slack off on your lecture preparation, or indulge your vanity, first think hard about what future prominent Nobel Prize winners might be sitting in your courses even now!

(But Solow goes on to write that he wished he had known an earlier Schumpeter:

In 1940... a letter urging [Schumpeter] to stay [at Harvard]... urgent, heartfelt, and mind-felt... signed by twenty-six junior faculty and advanced graduate students. The authors included the flower not only of Harvard-trained economists of that time, but of the future of American economics. You have to admire the man who evoked those words from those people. I wish I had known him then. It is to Schumpeter's eternal credit that, at a time when mediocrity often cottoned to mediocrity in Harvard economics, he stood always for intellectual quality and energy, regardless of ideology, ethnicity, or social position. McCraw makes this very clear, and understands its importance...)

Brendan Nyhan: Wall Street Journal Dissembles on Status of the Poor

Why oh why can't we have a better press corps? The editorial page of the Wall Street Journal and Senator Judd Gregg defecate in the stream of American policy discussion. When Franklin Foer of the New Republic says that liberals should crusade to defend the independence of the Wall Street Journal, this is what he is defending.

Brendan Nyhan reports:

Brendan Nyhan: WSJ dissembles on status of the poor: Time for yet another reminder of why you can never, ever trust the Wall Street Journal editorial page. This is a basic rule for life -- the intellectual equivalent of telling children not to talk to strangers and to look both ways before they cross the street. Here's what the Journal wrote (sub. req.) about a new Congressional Budget Office study (PDF) in an editorial titled "The Poor Get Richer":

It's been a rough week for John Edwards, and now comes more bad news for his "two Americas" campaign theme. A new study by the Congressional Budget Office says the poor have been getting less poor. On average, CBO found that low-wage households with children had incomes after inflation that were more than one-third higher in 2005 than in 1991.

The CBO results don't fit the prevailing media stereotype of the U.S. economy as a richer take all affair -- which may explain why you haven't read about them. Among all families with children, the poorest fifth had the fastest overall earnings growth over the 15 years measured. (See the nearby chart.) The poorest even had higher earnings growth than the richest 20%. The earnings of these poor households are about 80% higher today than in the early 1990s.

The Journal then writes euphemistically that "Earnings growth tapered off as the economy slowed in the early part of this decade, but earnings for low-income families have still nearly doubled in the years since welfare reform became law."

However, as [Jon] Chait points out, this portrayal is highly misleading at best:

But wait. Why fifteen years?... 1991... was a recession year, when incomes for [the poor] group collapsed. So the CBO study that [Judd] Gregg demanded measures the change from a recession year to a boom year. Incomes for the poor -- or anybody -- always rise over the course of a business cycle. The measurement Gregg demanded is simply useless. If you look closely at the study, you find that [more than] all the low-income growth occurred in the 1990s.... It peaked in 2000, and has fallen since....

The interesting question is whether, by the time the current business cycle hits its peak, incomes for people at the bottom will recover to where they were at the peak of the last business cycle. As of 2005 they still haven't caught up.

The answer is: probably not.

Hegemonic Stability Theory at the Council on Foreign Relations

Doug Henwood files from the Upper East Side:

Doug Henwood Talks » Blog Archive » missing hegemon at the CFR: I was at one of those Council on Foreign Relations public events this morning - Larry Summers and Paul Volcker on a successor to the Bretton Woods system, moderated by James Grant.

Coupla things:

1) Summers pronounced himself a “chastened prophet” for saying that the U.S. current account deficit was unsustainable since it has gone on for so long. Volcker agreed. Summers added that it’s interesting that there were more people worried about the U.S. stock market when the Nasdaq was at 2500 than there were at 3500, and quoted his “good friend” Rudi Dornbusch as saying things always go on longer than you expect, and then when they go bad, it all happens much more quickly than you’d expect.

2) From the questions, the CFR audience was seriously concerned about the c/a deficit and the weakening of U.S. power in the world. They’re all very polite, but it sounded like they don’t think Bush has been good for the imperium. One questioner noted that today’s world looks like one without a hegemon, and when that’s happened in the past, bad things ensued (e.g., Depression and world war). He noted that since both Summers and Volcker occupied seats of power when the U.S. was an unchallenged hegemon, how different do they think things would be now were there some sort of financial crisis, esp one featuring the U.S.

Both Summers and Volcker looked stunned into silence for a while, and then Summers said that that was a “powerful” observation couched as a question. And Volcker expressed concern that managing a crisis would be much more difficult now with the U.S. “politically weakened” and the target of so much “antagonism” around the world. He worried that Europe and the Asia might go off on their own. Someone else asked who out there might “lend a hand” if the U.S. hit a wall. Another long pause, and then Volcker doubted anyone would raise his hand as volunteer, which prompted nervous chuckles.

The view that the Great Depression happened because Britain was no longer strong enough to manage the international monetary system and the United States had not--as it ought to have--stepped into the role was the view of my old teacher Charlie Kindleberger. I tend to place more weight on ideology: even had Britain possessed much greater economic strength in the late 1920s and early 1930s, I don't think they would have used it constructively. On the security side, Britain and France ought to have deterred Nazi Germany from launching its invasion of Poland. Their error was in not understanding that Hitler was crazy early enough, and not having taken steps to remove him from power earlier in the 1930s. And World War I... I still don't understand the origins of World War I.

So I don't agree with the premise of the question. But the question is, as Summers said, a powerful observation. Hegemonic stability theory might be true. Certainly Charlie Kindleberger thought that it was.

Learning the Wrong Lessons from the Asian Financial Crisis: Martin Wolf Glosses Nouriel Roubini

Martin Wolf in the FT glosses Nouriel Roubini, but ends this episode with a cliff hanger:

FT.com / Columnists / Martin Wolf - What Asians learnt from their financial crisis: The Asian financial crisis of 10 years ago taught two contrasting lessons: the one the majority of western economists thought the Asians should learn; and the one Asians did learn. The western economists concluded that emerging economies should adopt flexible exchange rates and modern, well-regulated and competitive financial markets. The Asians decided to choose competitive exchange rates, export-led growth and huge accumulations of foreign currency reserves. The question is whether the Asians need to change their choice. The answer, I believe, is “yes”.

When downward pressure on the Thai baht started 10 years ago, nobody expected what followed – its devaluation in early July. That seemingly small event generated a financial tsunami that engulfed most of east Asia and overwhelmed Indonesia, Malaysia, the Philippines, South Korea and Thailand. Exchange rates collapsed, financial systems went bankrupt, governments teetered on the edge of default and economies succumbed to deep recessions....

With the important, but geographically limited, exceptions of Argentina and Turkey in 2001, the crises of 1997-98 have so far been the last in the long series of financial crises that afflicted emerging economies in the 1980s and 1990s. Today, the desire of outside investors to put their money in these economies is overwhelming, as is shown in the strength of their financial markets, the low spreads on external borrowing and the size of the private capital inflow.... The IMF is now almost entirely out of business.

What explains this new stability? As Nouriel Roubini of New York University’s Stern School of Business argues, the Asians did not learn the lessons most western economists thought they should.... [T]he great mistake, Asian policymakers concluded, was not pegged, but overvalued, exchange rates. That error was what had brought the humiliating dictation by IMF officials operating under the thumb of the US Treasury. “Never again” became the watchword. Never again has been the result. Now the east Asian emerging economies are mostly creditor nations. Moreover, much of their accumulation of external assets is in official hands (see chart). By February of this year, the foreign currency reserves of east and south Asian countries had reached $3,280bn....

The scale of the reserve accumulation demonstrates the obvious: these countries have refused to adopt the freely floating exchange rates many outside economists recommended. They have, instead, chosen to keep their exchange rates down. This, in turn, has generated current account surpluses. Sustaining such surpluses requires a stable excess of savings over domestic investment. One instrument they have used has been sterilisation of the monetary consequences of reserve accumulations, to prevent the normal expansion of money and credit, overheating, inflation and so loss of external competitiveness.

If a substantial part of the world economy is generating huge current account surpluses, somebody else has to run offsetting deficits.... It is no accident then that the US has emerged as the world’s chief deficit country – its “borrower of last resort”. It alone is able to be a vast net borrower without risking the health of its financial system.... Mr Roubini argues that... [this] policy generates ultimately unsterilisable increases in foreign currency reserves. This causes excess monetary growth, domestic asset price bubbles, overheating, inflation and the loss in competitiveness that governments had tried to prevent by suppressing the rises in nominal exchange rates. It distorts domestic financial systems, by pushing interest rates below equilibrium levels. It generates a waste of resources in accumulation of low-yielding foreign currency assets exposed to the likelihood of huge capital losses. It makes Asian economies excessively dependent on demand from outside the region. It exacerbates US protectionism. Finally, it compels US monetary authorities to sustain easy monetary policy, in order to offset the leakage from domestic demand caused by the huge current account deficits.

The post-crisis policy system has proved more durable than many (including myself) expected. At its heart, however, is China. Though not affected directly by the crisis, it was one of the countries that learnt its lessons in the Asian way. Today’s result is a dynamic behemoth accumulating foreign currency reserves at a rate of $50bn a month in the first quarter of the year and expected by the IMF to generate a current account surplus of 10 per cent of gross domestic product this year. I do not believe these astonishing trends are desirable or sustainable. Why that is so and what to do about it I intend to discuss next week...

The Death of Ken Sokoloff

Naomi Lamoreaux writes:

With great sadness we announce the death of Kenneth L. Sokoloff, Professor of Economics at UCLA and longtime member of the Economic History Association.

A memorial service will be held at the Chapel at Westwood Village Memorial Park, 1218 Glendon Ave., at 3:00 on Wednesday, May 23.

Donations in his memory may be made to the Kenneth L. Sokoloff Memorial Fund at the Economic History Association, Department of Economics, 500 El Camino Real, Santa Clara University, Santa Clara, CA 95053-0385.

Checks should be made payable to the Economic History Association, with a notation that they are for the Sokoloff endowment, income from which will be used to provide Sokoloff fellowships for the support of young scholars.

So say we all.

A wonderful human being: one of those teachers and scholars who make one proud to be a professor. A tall fellow, in the Newtonian sense. The last thing of his I read was his paper with Stan Engermann, "Digging the Dirt at Public Expense: Governance in the Building of the Erie Canal and Other Public Works"

Does China's Exchange-Rate Policy Matter?

Over at the Wall Street Journal's op-ed page, Matthew Slaughter says that Americans should not care about the magnitude of reserve asset purchases by the People's Bank of China or about the level of the PBoC's peg of the yuan to the dollar. These policy actions, Slaughter says, are not connected with the large and growing American goods-and-services trade deficit vis-a-vis China: "Economic theory and data are very clear.... [This] has no long-run effect on real economic outcoems such as output and trade flows."

Yuan Worries: Fact 1: China runs a large and growing trade surplus with the United States. In 2006, the goods-trade surplus exceeded $232 billion. This was an increase from 2005 of $31 billion, an amount larger than the entire deficit just 12 years ago. Fact 2: China focuses its monetary policy on fixing the exchange value of its currency, the yuan, relative to the U.S. dollar.

Many policymakers and pundits connect these two facts by asserting that an unfairly low value of the dollar-yuan peg is causing the massive bilateral trade imbalance. The 109th Congress introduced 27 pieces of anti-China trade legislation. The current Congress already has over a dozen such bills, many aiming to force an overhaul of China's exchange-rate regime. And late last week dozens of House members were poised to file a Section 301 petition, asking the U.S. Trade Representative to investigate undervaluation of the Chinese yuan.

These misgivings about the dollar-yuan peg are misplaced. Economic theory and data are very clear here on two critical points. Controlling a nominal exchange rate is a form of sovereign monetary policy. And monetary policy, in turn, has no long-run effect on real economic outcomes such as output and trade flows...

And Greg Mankiw applauds Slaughter:

Greg Mankiw's Blog: Slaughter on the Yuan: The dollar-yuan exchange rate is an economic fetish of many people unschooled in basic economics (a topic previously discussed here.) In today's Wall Street Journal (subscription required), Dartmouth economist Matthew Slaughter, fresh from a stint at the CEA, tries to bring some rationality to the issue...

This sends both Milton Friedman and John Maynard Keynes spinning in their graves: Uncle Milton because the thing he disliked most about his successors at Chicago was their claim of "policy irrelevance"--that as long as monetary (including exchange rate) policy was predictable, it didn't matter what it was: production and employment and saving would be the same--which is the claim that Matthew Slaughter is making here. And Uncle Maynard for the same substantive reasons, although he put it more strongly because he was a more forceful debater than Milton Friedman:

Keynes: Tract on Monetary Reform: Now "in the long run" this is probably true. If, after the American Civil War, the American dollar had been stabilized... ten per cent below its present value... [the American money stock today] and [the American price level today] would now be just ten per cent greater than they actually are [with no effect on production and empo.... But this long run is a misleading guide to current affairs. In the long run we are all dead. Economists set themselves too easy, too useless a task if in tempestuous seasons they can only tell us that when the storm is long past the ocean is flat again.

In actual experience, a[ny] change in [monetary or exchange rate policy] is liable to have a reaction both on [the velocity of money] and on [production and employment]...

For the details, because I have been slow in weblogging today I can simply turn the microphone over to the mysterious and vowelless knzn:

Economics and...: Aaaargh!!! (Slaughter on China): Why do economists writing about China pretend not to know the difference between sterilized and non-sterilized [foreign exchange] intervention [policy]? We've been through this before, but the latest case in point is Matthew Slaughter, writing in the Wall Street Journal (and cited uncritically by Greg Mankiw and Mark Thoma).... [I]f the central bank is truly trying to "control one nominal price" with "sovereign monetary policy" the level of [foreign exchange] reserves should not show a dramatic trend over time. As its level of foreign reserves increases, the central bank should recognize the increased demand for money and satisfy that demand by adding domestic reserves to the banking system. That's the way "monetary policy" works.

What the People's Bank of China is doing is something quite different. Even as it maintains its effective dollar peg, it is attempting to cool the economy by raising interest rates. It is not controlling "one nominal price"; rather, it is attempting (with limited success) to control two things at once. It is trying to keep exports strong by keeping the currency weak, and at the same time, it is trying to reduce domestic demand by tightening domestic monetary policy. As a result, it is accumulating a huge, huge, huge quantity of dollar-denominated assets, and this rate of accumulation is clear evidence of a policy conflict...

This policy conflict could end in one of several ways:

1. A sudden large burst of inflation in China, as the PBoC finds that it can no longer maintain both the current exchange-rate peg and a stable effective money stock, and sacrifices the second to the first.
2. A sudden large rise in the value of the yuan, as the PBoC finds that it can no longer maintain both the current exchange-rate peg and a stable effective money stock, and sacrifices the first to the second.
3. Slow and gradual versions of (1) and (2) as holders of nominal yuan assets in the first case and nominal dollar assets in the second let their wealth be gradually but substantially be eroded without ever taking steps to cut their losses.
4. Something more unpleasant.

It's frustrating: Matthew Slaughter's assertions are based on his assumption that full long-run monetary and price-level adjustment has already taken place, yet the pace and magnitude of Chiana's reserve accumulation (and Japan's) are very strong signs that the PBoC and the BoJ are blocking monetary and price-level adjustment--and that is the problem. To state that if we assume that the problem doesn't exist then we conclude we don't have a problem is just not very helpful. And not one in a hundred readers of the WSJ op-ed page will be able to diagnose just how Slaughter's piece is a misleading tautology.

Choosing the Next World Bank President

Dani Rodrik directs us to the Center for Global Development website, where you too can become part of global civil society and express your views on World Bank governance and on who the next president should be:

Center for Global Development : Article: Online Survey: Choosing the Next World Bank President: Invitations to complete the survey are being sent to several thousand people on the CGD mailing list. Members of the development community who are not on the list and wish to participate may take the survey on the CGD website. Responses are anonymous and results will be published daily.

George Borjas Has a Weblog

George Borjas writes:

The Borjas Blog: Hello everyone. I've been thinking about doing a blog for some time now. Some of my colleagues, particularly Dani Rodrik, have started one. If Dani, who has a brand new baby, can somehow manage to find the time to write some first-rate commentary on trade issues, I figure I can at least try to express some of my thoughts on matters that interest me. Plus--there's no time like now to comment on immigration issues...

Hitsville, USA, Increasing Returns, and Path Dependence

Tom Slee writes:

Whimsley: Predicting hits may be like predicting the weather: [P]hysicist turned sociologist Duncan Watts writes about how cultural hits may be, like the weather, impossible to predict. It comes down to how much we like stuff because it's good and how much we like it because other people like it. If it's the latter, then it becomes impossible to predict at some point. What's nice is that they did some experiments to demonstrate some of this in the lab.... A side effect of this would be that there is a strong limit to the effectiveness of recommendation schemes from Amazon and Netflix and so on.... Here's a few paragraphs from the article:

Conventional marketing wisdom holds that predicting success in cultural markets is mostly a matter of anticipating the preferences of the millions of individual people who participate in them.... The common-sense view, however, makes a big assumption: that when people make decisions about what they like, they do so independently of one another. But people almost never make decisions independently... in part because what we often want is not so much to experience the “best” of everything as it is to experience the same things as other people and thereby also experience the benefits of sharing.... Ultimately, we’re all social beings... our mutual dependence has unexpected consequences, one of which is that... when people tend to like what other people like, differences in popularity are subject to what is called “cumulative advantage.”... random fluctuations can blow up, generating potentially enormous long-run differences among even indistinguishable competitors.... Madonna would have been popular in this world, but in some other version of history, she would be a nobody, and someone we have never heard of would be in her place.

Mathing Up "Why Bubbles Are Great for the Economy" (It Has Been Done Before Department)

Hoisted from Comments: Robert Waldmann asks, apropos of Daniel Gross's book Pop!: Why Bubbles Are Great for the Economy:

Grasping Reality with Both Hands: Brad DeLong's Semi-Daily Journal: A Review of Daniel Gross's Book "Pop": Yes, but do you know an academic economist who has formalized this argument [that bubbles are good for the economy by] writing a [formal] model in which irrationality is necessary for growth? It would not be hard. And have you asked yourself "If not me, who? If not now, when?" Posted by: Robert Waldmann | May 13, 2007 at 11:55 PM.

It was done two decades ago, Robert: a model in which the introduction of investors subject to irrational exuberance and panic can either raise or lower the economy's productive capital stock and hence enhance or diminish the economic welfare of others in the economy. The model doesn't have all the channels that Gross discusses, but it has some of them--and enough to make the point.

Unfortunately, the authors were chasing the case in which bubbles and panics were socially harmful--not the case when bubbles are beneficial to the rest of society. But that case is there in the model, if the parameter ρ^∗ is big enough and the shock variance ratio (σ_η²)/(σ_ε²) is small enough.

Here's an excerpt from the core of the argument:

Size and Incidence: There are two reasons why the capital stock [in the absence of bubbles and panics] is different.... If... misperceptions... are on average bullish [i.e., prone to bubbles, investors]... on average demand [more stock].... [I]f noise traders are on average bearish [i.e., prone to panics], the equilibrium capital stock is lower.... [I]nvestors’ demands [also] depend on the risk borne.... The θ²σ_η² term in the denominator of [equation] (15) captures the reduction in the [economy's] capital stock that arises from aversion to noise trader-generated price risk.... The second term dominates, and the capital stock is lower in the presence of noise traders, if:

(17) ρ^∗/(δ -r) < (θ/((1+r)²))((σ_η²)/(σ_ε²))

For ρ^∗≤0 [i.e., a market at least as prone to panics as bubbles], it is always the case that the presence of noise traders reduces the capital stock.

Even if ρ^∗ is positive, only if both the noise trader wealth share θ is small and if noise traders’ opinions are not volatile relative to dividend risk (that is, ((σ_η²)/(σ_ε²)) relatively small) is the ratio of productive capital to wealth increased because of noise traders.

A lower capital stock implies a lower average level of consumption. Since capital gains and losses on stockholdings simply redistribute wealth from one generation to another, the average level of consumption of a generation is simply:

(18) (1+r)W + K^∗(δ-r)

which is an increasing function of the capital stock.

The reference?

J. Bradford DeLong, Andrei Shleifer, Lawrence H. Summers, and Robert J. Waldmann (1989), "The Size and Incidence of Losses from Noise Trading," Journal of Finance 44: 3 (July), pp. 681-696 http://www.j-bradford-delong.net/pdf_files/Noise_Traders_Incidence.pdf.

---

Note: Robert's comment--that the source of utility gains to the sophisticated in DSSW (1990) is different from the source in Gross (2007)--is completely correct. Gross argues that volatility of opinions is good. DSSW argue implicitly that irrational exuberance can be good when such exuberance is not very volatile.