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January 2009

Fama's Fallacy V: Are There Ever Any Wrong Answers in Economics?

Fama's Fallacy V: Are There Ever Any Wrong Answers in Economics?

Montagu Norman here, back from my grave once again. This time it is Greg Mankiw whose words have summoned me...

One thing that used to give me nightmares--and that provoked several of my nervous breakdowns--was how you could never get any economist (except for John Maynard Keynes) to take a definite position. They were always "on the one hand--on the other hand." This was what led Harry Truman in later days to wish for a one-handed economist, a wish that has never been fulfilled--there is in fact a picture of Barack Obama's economic advisor Christina Duckworth Romer in Time (or is it Newsweek?) showing her with four hands...

The "on the one hand--on the other hand" nature of discourse raises the question of whether in economics--a "science" where there is enormous intellectual and ideological and political disagreement about how the world works--there can ever be any wrong answers?. I believe that there can be wrong answers in economics, because examinations in economics tend to take a particular form: instead of asking (i) "do expansionary fiscal policies increase output and employment?" we ask (ii) "in models where there are idle resources and high unemployment, do expansionary fiscal policies increase output and employment?" (ii) is a question about a particular class of models of the economy, and so has a definite right answer--"yes, in that class of models they do"--and a definite wrong answer--"no, in that class of models they don't."

Eugene Fama claimed that "when there are idle resources--unemployment" expansionary fiscal policies had no effect in models in which the NIPA savings-investment identity:

investment = (private savings) - (government deficit)


Now the NIPA savings-investment identity holds in all models--it is, after all, an identity, true by definition and construction. And every single model that has been built in which there is a possibility of high unemployment and idle resources is a model in which fiscal policy works because increases in government spending lead to unexpected declines in inventories and unexpected declines in inventories lead to firms to expand production, which leads to increases in income and saving.

I would, therefore, say that Fama's claim is "wrong". Not only does it not hold in all models in the class, it does not hold in any models in the class.

Greg Mankiw disagrees:

Greg Mankiw's Blog: Fama's arguments make sense in the context of the classical model... presented in Chapter 3 of my intermediate macro textbook.... I would go on to the Keynesian model.... But whether one leaves the classical model behind to embrace the Keynesian model is a judgment call...

Mankiw thinks that Fama is not wrong but is, rather, making a "judgment call."

But Mankiw writes in his chapter 3 that the classical model "assume[s] that the labor force is fully employed." And so Greg gets himself into Cretan Liars' Paradox territory here: Fama says that there is high unemployment and idle resources, while Mankiw says that Fama is not wrong because he makes sense as long as the labor force is fully employed and there are no idle resources.

Is Mankiw's answer here a "wrong" answer, or is he too making a "judgment call"? I seek an empirical test. I seek a Harvard undergraduate to take Greg Mankiw's course this spring, to write the following in an appropriate place:

the classical model of chapter 3 shows us that expansionary fiscal policies have no effect on output even where there are idle resources--unemployment.

and to report back on the reaction of the course instructors.

Adrian Wooldridge Is... the Vicar of Bray!

"The Illustrious House of Hannover,
And Protestant succession,
To these I lustily will swear,
Whilst they can keep possession:
For in my Faith, and Loyalty,
I never once will faulter,
But George, my lawful king shall be,
Except the Times shou'd alter."

Adrian Wooldridge, October 27, 2004:

(with John Micklethwait): [Bush's] presidency has been momentous--two terms rolled into one, by any decent reckoning. He has not only transformed American policy. He has also transformed American conservatism. Mr. Bush's critics like to accuse him of taking partisanship to new depths.... An exaggeration, perhaps. But there is no doubt that he has taken the old injunction about "dancing with the one that brung you" to heart. No Republican president has devoted so much attention to this "right nation" within America.... The past four years have arguably brought more dramatic changes to conservative America than to America as a whole....

The most surprising change has been the rise of "big government conservatism.".... The massive growth in the state during this presidency... is a deliberate strategy. He came to office planning to expand the Department of Education.... Before Mr. Bush, conservatives had assumed that the only way to win the battle against what Michael Barone has dubbed "soft America" was to shrink government. Mr. Bush has pioneered a different strategy--to "harden" government itself.

Mr. Bush... has shifted power dramatically in favor of social conservatives.... A quarter of voters are born-again Christians--and Karl Rove blames his boss's failure to win a resounding victory in 2000 on the failure of four million of these voters to turn up at the polls....

Mr. Bush's boldest contribution to reinventing conservatism--foreign policy.... Mr. Bush's battle against "the axis of evil" is a logical continuation of Reagan's against "the evil empire." But these continuities should not blind conservatives to the radicalism of America's post-Sept. 11 foreign policy.... Mr. Bush has applied his doctrine of spreading democracy to an area of the world where the Reaganites feared to tread....

Yet there is one area where Mr. Bush has exceeded the expectations of everybody on the right--party building. He is arguably the greatest Republican party builder since William McKinley...

Adrian Wooldridge, January 15, 2009:

(with Greg Ip): [Bush] leaves the White House as one of the least popular and most divisive presidents in American history... approval rating... stuck in the 20s... the most catastrophic collapse in America’s reputation since the second world war. The American economy is in deep recession.... Bush family name... now so tainted that Jeb, George’s younger brother, recently decided not to run for the Senate from Florida. A Bush relative describes family gatherings as “funeral wakes”....

Frank Bruni, who covered his election campaign for the New York Times, wrote in 2002 that “the Bush I knew was part scamp and part bumbler, a timeless fraternity boy and heedless cutup, a weekday gym rat and weekend napster.”...

Bush’s presidency was also poisoned by his own ambition. Mr Bruni’s “timeless fraternity boy” wanted to be a great president.... Mr Bush frequently spoke about how much he hated anything that was “small ball”. His close advisers repeatedly described him as a “transformative president”.... Other facets of Mr Bush’s personality mixed with his vaulting ambition to undermine his presidency. Mr Bush is what the British call an inverted snob. A scion of one of America’s most powerful families, he is a devotee of sunbelt populism; a product of Yale and Harvard Business School, he is a scourge of eggheads.... He also styled himself, much like Reagan, as a decider rather than a details man; many people who met him were astonished by what they described as his “lack of inquisitiveness” and his general “passivity”.

This led Mr Bush to distrust the Washington establishment, and even to believe that establishment wisdom was probably wrong simply by virtue of what it was. Fred Barnes, a conservative journalist, entitled his book on Mr Bush “Rebel in Chief”. He quotes one Bush confidante as saying: “One tux a term. That’s our idea of outreach to the Washington community.”

Lack of curiosity also led Mr Bush to suspect intellectuals in general and academic experts in particular. David Frum, who wrote speeches for Mr Bush during his first term, noted that “conspicuous intelligence seemed actively unwelcome in the Bush White House”.... Mr Bush relied heavily on a small inner core of advisers.... Dick Cheney... pushed Mr Bush forcefully to the right on everything....

Karl Rove... obsessed by pursuing his dream of a rolling Republican realignment, subordinating everything to party politics. Mr Rumsfeld regarded the Iraq war... as an opportunity to test the model of an “agile military”....

The fruit of all this can be seen in the three most notable characteristics of the Bush presidency: partisanship, politicisation and incompetence. Mr Bush was the most partisan president in living memory.... Alberto Gonzales, who was forced to resign in disgrace, was only the most visible of an army of over-promoted, ideologically vetted homunculi.... The Iraq war was a case study of what happens when politicisation is mixed with incompetence. A long-standing convention holds that politics stops at the ocean’s edge. But Mr Bush and his inner circle labelled the Democrats “Defeaticrats” whenever they were reluctant to support extending the war from Afghanistan to Iraq. They manipulated intelligence to demonstrate that Saddam Hussein possessed weapons of mass destruction and had close relations with al-Qaeda. This not only divided a country that had been brought together by September 11th; it also undermined popular support for what Mr Bush regarded as the central theme of his presidency, the war on terror....

How will Mr Bush be judged in the light of history? “Many historians”, says Princeton’s Mr Wilentz, “are now wondering whether Bush, in fact, will be remembered as the very worst president in all of American history.”... Mr Bush’s presidency is not without its merits. He supported sensible immigration reform. He proposed tighter regulation of Fannie Mae and Freddie Mac, the now-nationalised mortagage agencies. Congress stymied him on both points.... On trade, too, Mr Bush’s heart was in the right place, though policy was at first subverted by political or strategic priorities....

[H]is policy of cutting taxes while increasing spending—of simultaneously pursuing big government and small government—dramatically swelled the deficit. He inherited a projected ten-year surplus of $5.6 trillion and bequeaths a ten-year deficit of $6 trillion.... Hardly the makings of a positive judgment from future historians. In pursuit of his fiscal ambitions, Mr Bush helped roll over or sweep aside long-standing rules and conventions designed to keep the deficit in check....

The neoconservatives who had such influence over Mr Bush argued that unintended consequences were usually more important than the intended ones. The Bush presidency has proved them right in this, if in little else. A president who laboured to produce Republican hegemony ended up dramatically weakening the Republican Party. The Democratic Party is now in a more powerful position than it has been at any time since the second world war.... Americans who came of age during the Bush years identify with the Democrats by the largest majority recorded for any age cohort since the second world war.

A president who believed that America’s global supremacy was guaranteed by America’s unrivalled military power ended up demonstrating the limits of both.... Iran is more powerful than it was in 2000, and closer to acquiring a nuclear bomb; Russia and China have extended their web of alliances and strengthened their regional influence. Mr Bush’s recalibration of his policies in his second term suggests that even he recognises that America’s loss of soft power has cost it dear....

“I inherited a recession, I’m ending on a recession,” he noted at his press conference on January 12th. He wasn’t asking for pity, only to be judged on what happened in between. Unfortunately, that economic legacy is littered with wasted opportunity, bad judgments and politicised policy. The budget surplus he inherited is now a deficit, the fiscal hole in America’s retiree programmes is bigger than ever, the tax system is an unstable, patched-up mess.

It is not all his fault. But for the most part, good policy repeatedly took a back seat to Mr Bush’s overweening political ambition. Both the country and, ultimately, the Republican Party are left the worse for it.

How the Susan Crawford interview changes everything we know about torture. - By Dahlia Lithwick and Phillipe Sands - Slate Magazine

Dahlia Lithwick and Philippe Sands:

How the Susan Crawford interview changes everything we know about torture: When Vice President Dick Cheney told the Weekly Standard last week, "I think on the left wing of the Democratic Party there are some people who believe that we really tortured," he probably wasn't thinking about Susan J. Crawford, convening authority of the military commissions at Guantanamo Bay.... And that's why everything changed this morning when the Washington Post published a front-page interview by Bob Woodward, in which Crawford stated without equivocation that the treatment of alleged 20th Sept. 11 hijacker Mohammed al-Qahtani at Guantanamo Bay was "torture."

[T]he Senate armed services committee issued a report just last month pointing the finger of responsibility for the military interrogations at then-Secretary of Defense Donald Rumsfeld and his general counsel Jim Haynes. The committee did not use the T-word, however.... Alberto J. Mora, former general counsel of the U.S. Navy, wrote in a letter to the Navy's inspector general: "The interrogation techniques approved by the Secretary [of Defense] should not have been authorized because some (but not all) of them, whether applied singly or in combination, could produce effects reaching the level of torture." The 84-page log of al-Qahtani's interrogation has long been a matter of public record, and there is now little dispute that the treatment it describes rose to the level of torture....

What changes as a result of Crawford expressly using the word torture? First, the administration can no longer hide behind parsing the language of the Geneva Conventions and the torture statute.... Crawford has... repudiated the formalistic (and perennially shifting) definitions of torture as whatever-it-is-we-don't-do. She has admitted that there is a medical and legal definition for torture and also that we have crossed the line into it.

The consequences go further. Crawford also told Woodward that the charges against al-Qahtani were dropped because he was tortured. This has devastating consequences for the Bush administration's entire rationale for the new techniques of interrogation: that they would make the United States safer by producing intelligence and keeping dangerous individuals off the streets. We now know they do neither....

Whether torture occurred and who was responsible will no longer be issues behind which senior members of the administration and their lawyers and policymakers can hide. The only real issue now is: What happens next? The answer to that question takes you to a very different place when the act is torture.... Under the 1984 Torture Convention, its 146 state parties (including the United States) are under an obligation to "ensure that all acts of torture are offences under its criminal law." These states must take any person alleged to have committed torture (or been complicit or participated in an act of torture) who is present in their territories into custody. The convention allows no exceptions, as Sen. Pinochet discovered in 1998. The state party to the Torture Convention must then submit the case to its competent authorities for prosecution or extradition for prosecution in another country.

The former chief judge of the United States Court of Appeals for the Armed Forces and general counsel for the Department of the Army has spoken. Her clear words have been picked up around the world. And that takes the prospects of accountability and criminal investigation onto another level. For the Obama administration, the door to the do-nothing option is now closed. That is why today may come to be seen as the turning point.

Ron Suskind on George W. Bush

If the history of the 2000s is ever truly written, it will star Ron Suskind as the finest reporter of the decade--and as the most ignored. If you read nothing but Suskind (and McClatchy) during the decade, you would have understood what was going on within two years of when it went down. Read anybody else and you would still be largely clueless today.

The politest thing I have seen anybody say about this--in confidence--is that it is "very odd" how the main newspapers have ignored Suskind's work in books and magazines for eight years. Suskind's reporting had documents and on-the-record quotes from former Bush officials.

Here's Ron Suskind in Slate taking one last look back at the incredibly bizarre presidency of George W. Bush:

Slate Magazine: in terms of the reasons for war, the decision to invade, the selling of the war... I think that despite Bob's ardent efforts, there will be many more disclosures and clarifications in the years to come. Just in my last book, The Way of the World, I came across fresh, detailed accounts of battles from January 2002, when senior officials of the Defense Department and CIA were instructed by the White House to begin a one-year, logistical planning process for the invasion. At that point, it was not a matter of if. It was, in essence, a 12-month ticking clock for the execution of an approved policy. What's more, in the spring of 2002, the White House told senior intelligence officials that WMD would be the lead justification for the invasion. The response from intelligence officials, especially those with expertise on Iraq, was that using WMDs as justification for war was a perilous gambit—advice that the White House ignored.

Mind you, this is just one example, a glimpse of the continent that remains in shadows, despite the tireless efforts of journalists with official access (like Bob) or without it (like me and many others). At day's end, many of the self-correcting features of our system of governance—congressional oversight, a strong judiciary, a robust press—failed.... It is, to my mind, an American tragedy that this administration will leave the stage with a host of basic questions left unanswered....

It's a matter of Bush exercising free will. It's his war. He's responsible. What qualities in W's architecture drove events? It was his preternatural faith in the power of confidence. He felt that believing in something with absolute certainty (even if it's willed rather than earned) is the key to victory, the spine of leadership. And once victory is won, no one will ask inconvenient questions about how it was achieved. The Bush view, then, is win first and win big—and if there's a mess, we'll clean it up later. And, someday, the winners will write history. It's the gambler's philosophy, a model that rests on pure nerve, a familiar two-step in the nation's history and culture, and one you see so often of late in public and private spheres in America...

Slate Magazine: What got us into Iraq? Why are we there? Did Bush know, or at least suspect, that there may not be WMD? Did the beast of Iraq spring, fully formed, from Bush's brain, from his Oedipal architecture? Did President Bush take this nation to war under false pretenses?.... Five-plus years into this war—a war, most certainly, of choice—the reasons we invaded Iraq remain largely shrouded in classified files, lost conversations, carefully guarded secrets....

Because Bush was not so much a victim of circumstances and birth order—or of bad advice from ambitious advisers—as he seems in W. He knew more than he's letting on. He made choices of his own free will. And in the fullness of time, he'll be held responsible for his actions, as history eventually demands of all presidents...

Slate Magazine: Bob [Woodward], clearly, has sat in what journalists generally consider "access heaven" in his unmatched colloquies with Bush. You have witnessed Bush jumping out of his chair to make a point, and many other moments from your interviews provide some signature scenes of this period. But, I wonder, Bob, if you think, looking back, that access to Bush has not been as valuable—hour for hour—as it has been with other presidents whom you've interviewed. I think it's fair to say that Bush and his team don't believe that truthful public disclosure and dialogue are among their central obligations. Other presidents have railed against the troublemakers in the press, but they felt, often reluctantly, that letting the American people know their mind—the good-enough reasons that drive action—was part of their job description. Frankly, I think the best book of your quartet is State of Denial—the one for which, I gather, you were not given access to Bush...

Before the First Meeting of Econ 210a

To: S09 Econ 210a Students
From: Brad DeLong
Subject: Before the first meeting of the class, please...
Date: January 15, 2009

Before the first meeting of Econ 210a, please do the following four tasks:

  • (a) Read the readings for January 21: The Malthusian Economy? (DeLong):

Jared Diamond (1987), "The Invention of Agriculture: The Worst Mistake in the History of the Human Race," Discover,

Gregory Clark (2005), "The Logic of the Malthusian Economy," draft of chapter 2 of A Farewell to Alms (published version: Princeton University Press, 2007),

Gregory Clark (2005), "Living Standards in the Malthusian Era," draft of chapter 3 of A Farewell to Alms,

M. I. Finley (1965), "Technical Innovation and Economic Progress in the Ancient World," Economic History Review, New Series, 18:1, pp. 29-45,


(b) Write your first 400 word or so (250-500 words, really) weekly memo in response to this question:

Gregory Clark claims that "the real income in Malthusian economies (all economies after 5000 B.C. and before 1800) was determined from the birth rate and death rate schedules alone." Does this mean that mankind was powerless to improve its material conditions via factors such as technology, social organization, population control, etc.?

Bring two hardcopies of the memo to class, and also email it (.txt, .doc, or .pdf) to and

  • (c) Read the following three snippets:

(i) Exchange and its vicissitudes as fundamental to human psychology and society? Adam Smith: Nobody ever saw a dog make a fair and deliberate exchange of one bone for another with another dog.... When an animal wants to obtain something either of a man or of another animal, it has no other means of persuasion but to gain the favour of those whose service it requires. A puppy fawns upon its dam, and a spaniel endeavours by a thousand attractions to engage the attention of its master who is at dinner, when it wants to be fed by him. Man sometimes uses the same arts with his brethren, and when he has no other means of engaging them to act according to his inclinations, endeavours by every servile and fawning attention to obtain their good will. He has not time, however, to do this upon every occasion. In civilised society he stands at all times in need of the cooperation and assistance of great multitudes, while his whole life is scarce sufficient to gain the friendship of a few persons....

[M]an has almost constant occasion for the help of his brethren, and it is in vain for him to expect it from their benevolence only. He will be more likely to prevail if he can interest their self-love in his favour, and show them that it is for their own advantage to do for him what he requires of them. Whoever offers to another a bargain of any kind, proposes to do this. Give me that which I want, and you shall have this which you want, is the meaning of every such offer; and it is in this manner that we obtain from one another the far greater part of those good offices which we stand in need of. It is not from the benevolence of the butcher, the brewer, or the baker that we expect our dinner, but from their regard to their own interest. We address ourselves, not to their humanity but to their self-love....

[I]t is this same trucking disposition which originally gives occasion to the division of labour. In a tribe of hunters or shepherds a particular person makes bows and arrows, for example, with more readiness and dexterity than any other. He frequently exchanges them for cattle or for venison with his companions; and he finds at last that he can in this manner get more cattle and venison than if he himself went to the field to catch them. From a regard to his own interest, therefore, the making of bows and arrows grows to be his chief business, and he becomes a sort of armourer. Another excels in making the frames and covers of their little huts or movable houses. He is accustomed to be of use in this way to his neighbours, who reward him in the same manner with cattle and with venison, till at last he finds it his interest to dedicate himself entirely to this employment, and to become a sort of house-carpenter.... [T]he certainty of being able to exchange all that surplus part of the produce of his own labour, which is over and above his own consumption, for such parts of the produce of other men's labour as he may have occasion for, encourages every man to apply himself to a particular occupation, and to cultivate and bring to perfection whatever talent or genius he may possess for that particular species of business.

The difference of natural talents in different men is, in reality, much less than we are aware of; and the very different genius which appears to distinguish men... is not upon many occasions so much the cause as the effect of the division of labour. The difference between the most dissimilar characters, between a philosopher and a common street porter, for example, seems to arise not so much from nature as from habit, custom, and education... and widens by degrees, till at last the vanity of the philosopher is willing to acknowledge scarce any resemblance. But without the disposition to truck, barter, and exchange, every man must have procured to himself every necessary and conveniency of life which he wanted. All must have had the same duties to perform, and the same work to do, and there could have been no such difference of employment as could alone give occasion to any great difference of talents.... By nature a philosopher is not in genius and disposition half so different from a street porter, as a mastiff is from a greyhound, or a greyhound from a spaniel, or this last from a shepherd's dog....

Among men... the most dissimilar geniuses are of use to one another; the different produces of their respective talents, by the general disposition to truck, barter, and exchange, being brought, as it were, into a common stock, where every man may purchase whatever part of the produce of other men's talents he has occasion for...

(ii) Different technologies as producers of different societies which give rise to different types of economies? Karl Marx:

Preface to A Contribution to the Critique of Political Economy: In the social production of their life, men enter into definite relations that are indispensable and independent of their will, relations of production which correspond to a definite stage of development of their material productive forces. The sum total of these relations of production constitutes the economic structure of society, the real foundation, on which rises a legal and political superstructure and to which correspond definite forms of social consciousness. The mode of production of material life conditions the social, political and intellectual life process in general. It is not the consciousness of men that determines their being, but, on the contrary, their social being that determines their consciousness.

At a certain stage of their development, the material productive forces of society come in conflict with the existing relations of production, or — what is but a legal expression for the same thing — with the property relations within which they have been at work hitherto. From forms of development of the productive forces these relations turn into their fetters. Then begins an epoch of social revolution. With the change of the economic foundation the entire immense superstructure is more or less rapidly transformed. In considering such transformations a distinction should always be made between the material transformation of the economic conditions of production, which can be determined with the precision of natural science, and the legal, political, religious, aesthetic or philosophic — in short, ideological forms in which men become conscious of this conflict and fight it out....

In broad outlines Asiatic, ancient, feudal, and modern bourgeois modes of production can be designated as progressive epochs in the economic formation of society...

(iii) Robert Solow (1985), "Economic History and Economics"

Economics is a social science. It is subject to Damon Runyon's Law that nothing between human beings is more than three to one. To express the point more formally, much of what we observe cannot be treated as the realization of a stationary stochastic process without straining credulity. Moreover, all narrowly economic activity is embedded in a web of social institutions, customs, beliefs, and attitudes. Concrete outcomes are indubitably affected by these background factors, some of which change slowly and gradually, others erratically. As soon as time-series get long enough to offer hope of discriminating among complex hypotheses, the likelihood that they remain stationary dwindles away, and the noise level gets correspondingly high. Under these circumstances, a little cleverness and persistence can get you almost any result you want. I think that is why so few econometricians have ever been forced by the facts to abandon a firmly held belief. Indeed, some of Fortune's favorites have been known to write scores of empirical articles without once feeling obliged to report a result that contradicts their prior prejudices.

If I am anywhere near right about this, the interests of scientific economics would be better served by a more modest approach. There is enough for us to do without pretending to a degree of completeness and precision which we cannot deliver. To my way of thinking, the true functions of analytical economics are best described informally: to organize our necessarily incomplete perceptions about the economy, to see connections that the untutored eye would miss, to tell plausible-sometimes even convincing-causal stories with the help of a few central principles, and to make rough quantitative judgments about the consequences of economic policy and other exogenous events. In this scheme of things, the end product of economic analysis is likely to be a collection of models contingent on society's circumstances-on the historical context, you might say-and not a single monolithic model for all seasons....

The other direction of influence, what economic history offers to that kind of economic theory, is more interesting. If the proper choice of a model depends on the institutional context-and it should-then economic history performs the nice function of widening the range of observation available to the theorist. Economic theory can only gain from being taught something about the range of possibilities in human societies. Few things should be more interesting to a civilized economic theorist than the opportunity to observe the interplay between social institutions and economic behavior over time and place....

If the project of turning economics into a hard science could succeed, it would surely be worth doing. No doubt some of us should keep trying. If it did succeed, then there would be no difference between economics and economic history other than the source of data.... There are, however, some reasons for pessimism about the project. Hard sciences dealing with complex systems-but possibly less complex than the U.S. economy-like the hydrogen atom or the optic nerve seem to succeed because they can isolate, they can experiment, and they can make repeated observations under controlled conditions. Other sciences, like astronomy, succeed because they can make long series of observations under natural but essentially stationary conditions.... Neither of these roads to success is open to economists....

[T]here is a clear and productive division of labor between the economist and the economic historian. The economist is concerned with making and testing models of the economic world as it now is, or as we think it is. The economic historian can ask whether this or that story rings true when applied in earlier times or other places, and, if not, why not.... [E]conomic history can offer the economist a sense of the variety and flexibility of social arrangements and thus, in particular, a shot at understanding a little better the interaction of economic behavior and other social institutions...

  • (d) Read Brad DeLong's handout on economic growth in the longest run:


Fama's Fallacy IV: The Decline of Chicago

Note to Self: How to make the "crowding out" argument the intellectually coherent way.

Milton Friedman (1972), "Comment on the Critics," Journal of Political Economy 80:5 (September-October), pp. 914-5

I do not share the widespread view that a tax increase which is not matched by higher government spending will necessarily have a strong braking effect on the economy.

True, higher taxes would leave taxpayers less to spend. But this is only part of the story. If government spending were unchanged, more of it would now be financed by the higher taxes, and the government would have to borrow less. The individuals, banks, corporations or other lenders from whom the government would have borrowed now have more left to spend or to lend-and this extra amount is precisely equal to the reduction in the amount available to them and others as taxpayers. If they spend it themselves, this directly offsets any reduction in spending by taxpayers. If they lend it to business enterprises or private individuals--as they can by accepting a lower interest rate for the loans the resulting increase in business investment, expenditures on residential building and so on indirectly offsets any reduction in spending by taxpayers.

To find any net effect on private spending, one must look farther beneath the surface. Lower interest rates make it less expensive for people to hold cash. Hence, some of the funds not borrowed by the Federal government may be added to idle cash balances rather than spent or loaned. In addition, it takes time for borrowers and lenders to adjust to reduced government borrowing. However, any net decrease in spending from these sources is certain to be temporary and likely to be minor.

To have a significant impact on the economy, a tax increase must somehow affect monetary policy--the quantity of money and its rate of growth. (Newsweek, January 23, 1967, p. 86)....

Why "certain to be temporary"? Because the leftward shift in the IS curve is a once-for-all shift.... Put in monetarist terms, the lowered interest rate resulting from the federal government's absorbing a smaller share of annual savings will reduce velocity; the transition to the lower velocity reduces spending for a given money stock....

Why "likely to be minor"? Because the monetarist view is that "saving" and "investment" have to be interpreted much more broadly... that the categories of spending affected by changes in interest rates are far broader than the business capital formation, housing construction, and inventory accumulation to which the neo- Keynesians tend to restrict "investment." Hence, even a fairly substantial tax increase will produce only a minor shift in the IS curve....

Of course, the terms "temporary" and "minor" are highly imprecise. We get closer to a rigorous statement by comparing the changes resulting from a reduced or increased deficit without any change in monetary growth with those that result when a change in the deficit is matched by a dollar-for-dollar change in monetary growth.... [A] deficit financed by borrowing... [is] a once-for-all shift to the right in the IS curve, a higher interest rate, a higher velocity, and a higher level of spending for a given monetary growth path.... [F]inancing the deficit by creating money... shifts the LM curve to the right.... But this is not a once-for-all shift. So long as the deficit continues, and continues to be financed by creating money, the nominal money stock continues to grow and the LM curve (at initial prices) continues to move to the right. Is there any doubt that this effect must swamp the effect of the once-for-all shift of the IS curve?...

We may put this point differently. Assume a one-year increase in the deficit, with the budget then returning to its initial position. If this is financed by borrowing from the public with no change in monetary growth, then, in the most rigid Keynesian system, the IS curve moves to the right and then back again; real and nominal income rise for one year, then return to their initial values. If the one-year increase in the deficit is financed by creating money, the LM curve moves to the right as well, and stays there after the IS curve returns to its initial position. If prices remain constant, real and nominal income stay at a higher level indefinitely. If, as is more reasonable, prices ultimately rise, real income may return to its initial level, but nominal income will stay at a higher level indefinitely. Surely, to paraphrase a remark of Tobin's in another connection, the monetary effect is "alchemy of a much deeper significance" than the fiscal effect...

For Friedman, the NIPA savings-investment identity is the prelude to the analysis: the meat of the analysis involves going deeper by:

  • arguing that savings and income levels will adjust so that the economy will quickly move to a point at which unwanted inventory accumulation is zero (that's the "IS curve").
  • analyzing the combination of possible values for interest rates and output levels at which unwanted accumulation is zero (that's the shape and position of the "IS curve").
  • assessing how the changing financial asset supplies and demands in the economy pick out a particular point on the IS curve (that's the "LM curve").

For Fama, the NIPA savings-investment identity is the completion of the analysis--hence he gets driven to the conclusion that not just fiscal policy via the government deficit but monetary policy via open market operations has no effect on employment and output as well.

This makes me think I should finish writing up one of the talks that I gave in Singapore--the point of which was that Chicago economists today are profoundly ignorant of what the Chicago School of economics--the school of Friedman and Stigler--believes.

Fama's Fallacy, Take III


Greg Mankiw writes:

Fama on Fiscal Stimulus: Eugene Fama is a stimulus skeptic: In fact, he is even more skeptical than I am. I am willing to concede that many Keynesian effects work in the short run, although I prefer monetary policy to fiscal policy and, within fiscal policy, I prefer the use of tax instruments to government spending as a tool for short-run demand management. By contrast, I read Fama's article as a largely wholesale endorsement of the classical model with complete crowding out.

No, Greg. It's not an endorsement of any model. It's just a mistake. Fama mistakes the NIPA savings-investment accounting identity for a behavioral relationship that constrains the behavior of investment: when the government deficit goes up, Fama says, private investment must go down by the same amount.

When the government deficit goes up, private savings could go up by more--and private investment could increase. Private savings could go up by less--and private investment would fall by less than the rise in the government deficit. Private savings could remain unchanged. Or private savings could fall. Determining which of these is most likely to happen would require a model of the economy of some sort--and Fama does not have one: all he has is an accounting identity that he does not understand.

Fama's Fallacy II: Predecessors

Eugene Fama's predecessors in error. The "Treasury View." From G.C. Peden (2004), Keynes and His Critics, p. 80:

F.W. Leith-Ross to Sir Richard Hopkins and P.J. Grigg, 3 April 1929:

Before the government can give increased employment it must obtain resources.... Unless the government is prepared to... bring about an inflation... [it] can only obtain [resources] by taxation or borrowing.... The proposal that we are examining is that all the money required is to be borrowed.... When the Government borrows, it enters the money market as a competitor with all other enterprises.... The resources from which the government must draw... are the savings of the people.... But it is precisely on these that industry relies on.... The competition of the Government with private traders by means of large Government loans would not (apart from inflation) increase the resources available for the employment of labour. It would only mean that a portion of these resources would be directed by the Government instead of being directed by private persons...

Fama, actually, is much worse than the British Treasury economists of the 1920s. They acknowledged that monetary policy could affect the level of employment--could do more than shift resources from one use to another. Fama's argument based on his misinterpretation of the NIPA savings-investment identity has the implication that monetary policy cannot affect the unemployment rate either.

See R.G. Hawtrey (1925), "Public Expenditure and the Demand for Labour," Economica 5, pp. 38-48.

Fama's Fallacy, Take I: Eugene Fama Rederives the "Treasury View"

A Guestpost from Montagu Norman, former Governor of the Bank of England:

Back in the 1920s and 1930s--in the days that overly-clever bisexual academic dilettante John Maynard Keynes was trying to persuade us that if only we got the government to spend more money the unemployment rate might go down--by far the silliest argument against his position was the one put forward by the staff of the Chancellor of the Exchequer: the so-called "Treasury View."

The Treasury View was that nothing could boost employment: not government spending, not tax cuts, not private business decisions to expand their capacity, not irrational exuberance on the part of entrepreneurs--for the level of output was what it was and the unemployment rate was what it was and no fiscal policies or private investment decisions could change it, for all they could do was move resources from one use to another without affecting the total flow of economic activity.

Back on Christmas Eve Paul Krugman whacked Caroline Baum of Bloomberg on the nose for rediscovering the Treasury View. Now Eugene Fama of the University of Chicago has rederived it from scratch (apparently without knowing anything of its history), claiming that the savings-investment national income identity proves that fiscal policy cannot have any effect on output and employment.

This is a howler of such magnitude that it has pulled me from my grave to speak--because we went over and over this in the 1920s starting with R.G. Hawtrey (1925), "Public Expenditure and the Demand for Labour," Economica 5, pp. 38-48, and with F.W. Leith-Ross's various Treasury memos to P.J. Grigg, and thrashed this out to a conclusion that Fama appears not to know. It is very strange: the argument Fama wants to make--that government deficits completely crowd out private investment so that fiscal policy has no effect on output or employment--is, depending on circumstances, sometimes true and usually false, depending on circumstances. But the premise from which Fama attempts to derive complete crowding-out is the savings-investment accounting identity in the National Income and Product Accounts--and an accounting identity is something that must be true by construction, no matter what. The fact that savings equals investment in the NIPA is logically independent of whether the complete crowding-out doctrine is true or false.

Here is Fama:

Bailouts and Stimulus Plans: There is an identity in macroeconomics... private investment [PI] must equal the sum of private savings [PS], corporate savings (retained earnings) [CS], and government savings [GS]....

(1) PI = PS + CS + GS....

The problem is simple: bailouts and stimulus plans are funded by issuing more government debt.... The added debt absorbs savings that would otherwise go to private investment.... [S]timulus plans do not add to current resources in use. They just move resources from one use to another.... I come back to these fundamental points several times below....

The Sad Logic of a Fiscal Stimulus

In a "fiscal stimulus," the government borrows and spends the money on investment projects or gives it away as transfer payments to people or states. The hope is that government spending will put people to work.... Unfortunately, there is a fly in the ointment.... [G]overnment infrastructure investments must be financed -- more government debt. The new government debt absorbs private and corporate savings, which means private investment goes down by the same amount....

Suppose the stimulus plan takes the form of lower taxes... we can't get something for nothing this way either... lower tax receipts must be financed dollar for dollar by more government borrowing. The government gives with one hand but takes them back with the other, with no net effect on current incomes...

Fama's reasoning is that fiscal policies don't change private saving, but fiscal policies do change the government deficit, thus investment must change in an amount equal and opposite to the change in the government deficit. Fama's reasoning is dead wrong. Fama's reasoning is dead wrong for an elementary reason. The accounting identity that savings are equal to investment is true only under a particular definition of investment--one that counts unwanted growth in inventories as part of investment--and under a particular valuation of unexpected inventory accumulation--that which values unwanted inventory accumulation at its cost.

In general, the value of unwanted inventory accumulation can't be equal to its cost--the inventory accumulation is unwanted and unexpected, meaning that they tried to sell it at a normal price and failed, and it is now sitting in a corner of a warehouse somewhere. When Fama writes "bailouts and stimulus plans... absorbs savings that would otherwise go to private investment" he does not think that the rise in public spending is truly useful stuff while the fall in private investment is a decline in unwanted inventory accumulation--a decline in the amount of stuff made at high cost that firms could not sell and then must mark down in value.

This matters a lot because whenever unwanted inventories accumulate the next thing that happens is that incomes and savings drop. (i) NIPA-defined investment is equal to (ii) private savings minus the (iii) government deficit, so if (iii) changes and (ii) doesn't then (i) must change. But if that change in NIPA-defined investment is driven by unwanted inventory accumulation or unexpected inventory declines then private savings do change, and do change quickly and substantially.

Let's tell the story of how:

Suppose that it is Friday, January 2, 2009, and all of a sudden the federal government borrows some money--reducing savings--and buys some extra stuff. Savings is still equal to investment on January 2: savings went down because the government ran a bigger deficit but investment also went down because firms sold extra and so their inventories dropped.

What happens on Monday, January 5? Over the weekend the firms mark the value of the goods in their remaining inventory up: inventories are now scarce. They revisit their production plans. Sunday night they call some extra workers and tell them to show up on Monday--that they are expanding production because they are now short of inventories. So when Monday rolls around more people are at work. Thus incomes are higher on Monday than they were on Friday. And in all likelihood savings will be higher as well, for consumers on Monday probably won't raise their consumption spending by as much as their incomes rose. Maybe on Monday purchases will be back in balance with production, and there will be no more unwanted inventory changes. Maybe it will take until Monday January 12 before the change in inventories is back to its desired level. Maybe it will take until the third quarter of 2009, or perhaps 2010. But when the change in inventories does come back to its wanted level, production, employment, income, savings, and investment will all be higher than they were on January 1: the stimulus will have worked.

Yet at every point--on every single day--savings are equal to investment according to the accounting conventions of the National Income and Product Accounts. Fama's premise holds. His conclusion--that stimulus programs cannot work--doesn't. How can this be? The reason is that his conclusion has nothing at all to do with his premise. Whether there is complete crowding-out depends on circumstances--on how much of offsetting investment changes are unwanted and unexpected changes in inventories, and what the consequences of those unwanted and unexpected changes in inventories are for private savings. But whether there is complete crowding-out or not, savings always equals investment in the NIPA framework by construction, by definition.

Thus Fama's claim that "'stimulus spending must be financed which means it displaces other current uses of the same funds..." rests on Fama's implicitly making one of two assumptions: either that stimulus spending does not lead to any surprise reduction in inventories, or that a surprise fall in inventories does not lead to any change in the flow of saving. Make either of these assumptions, and Fama's argument goes through--but it is those ancillary assumptions taht Fama does not explicitly own up to that drive his conclusion, not his stated premise of the truth of the NIPA savings-investment identity.

But why should you make either assumption? Why would you ever assume that there can't be unwanted growth in inventories? Why would you ever assume that household incomes and saving do not change whenever firms' stocks of unwanted inventories grow ever larger?

The answer is that you never would--but that Fama does not know enough national income accounting to know that that he is making these two ancillary assumptions. He does not understand the identity he deploys as equation (1). He thinks that "investment" means "growth in the value of the capital stock." He simply does not understand what the NIPA investment concept is, or that what he thinks of as "investment" is not in general equal to savings.

All of this is part of the undergraduate sophomore economics curriculum. It is gone over again very quickly in graduate school--for example, David Romer (2006), Advanced Macroeconomics 3e, p. 224:

If one treats goods that a firm produces and then holds as inventories as purchased by the firm, then all output is purchased by someone. Thus actual expenditure equals the economy's output, Y. In equilibrium, planned and actual expenditure must be equal. If planned expenditure falls short of actual expenditure, for example, firms are accumulating unwanted inventories; they will respond by cutting their production...

These mistakes are, literally, elementary ones.

They were elementary when R.G. Hawtrey and the other staffers of the British Treasury made them in the 1920s.

They carry the implication not just that government cannot stimulate or depress the economy, but that no set of private investment or savings decisions can stimulate or depress the economy either, and thus that there can be no business cycle fluctuations from any source whatsoever--because every action that shifts savings or investment simply moves resources from one use to another.

What is extraordinary is that these mistakes are being rederived today, at the end of the 2000s--without any consciousness of their past or of the refutations of them made by past theory and history.

I think it is time to draw a line in the sand: no more economists who know nothing about the economic history of the world or the history of economic thought.

I, the ghost of Montagu Norman, have risen from my grave to say this.

Jeebus save us...

Bob Woodward's Oeuvre

Philoctetes: Are any of Bob Woodward's books worthwhile?

Thrasymakhos: Oh, they are all worthwhile. But in every case the cover page is wrong. Maestro, for example, says in its cover page that it is by Bob Woodward. Actually it is by Alan Greenspan, as told to Bob Woodward. The Agenda is by Paul Begala, as told to Bob Woodward. Plan of Attack is by Donald Rumsfeld, as told to Bob Woodward. All the President's Men and the Watergate stories are by Mark Felt, as told to Bob Woodward. Etc. Etc. Etc.

Philoctetes: But this makes the books useless!

Thrasymakhos: No, it makes them useful--as long as you know who the real author of each one is.

Tomorrow Is Martin Luther King's 90th Birthday...

I wonder if the Obama team is going to take advantage of it. This is the first of many, many, many opportunities all of which make every speechwriter in the world willing to give at least one organ of generation in exchange for the chance to work for the Obama administration.

Modern Liberalism and Libertarianism: An Economist's View

Let me give you what I take to be an American card-carrying modern liberal economist’s take on classical liberalism--which I think is broadly an updated version of Adam Smith's take. It is, in short, that modern liberal economists are wanderers who have been expelled from the garden of classical liberalism by the angel of history and reality with his flaming sword...

It starts with an observation that we are all somewhat more interdependent than classical liberalism allows. It is not completely true that it is from the self-interest and not the benevolence of the butcher that we expect our meat. Self-interest, yes, but benevolence too: a truly self-interested butcher would not trade you his meat for your money but instead slaughter you and sell you as long pig. So this opens up a gap between the libertarian view and the world.

That said, and modulus this basic human--well, call it "sympathy" as Adam Smith did--modern liberal economists were very happy for a long time with classical liberalism. Yes, there were externalities, and increasing returns over a range, and market power--but the presumption was that market failures were tolerable and in a sense optimal because of the magnitudes of government failures that would attend any attempt to compensate for them. The near-consensus of economists was at least crypto-classical liberalism, along the lines of Colbert's exchange with Legendre in the reign of Louis XIV:

"What do you need to help you?" asked Colbert. "Leave us alone" answered Legendre. ("Que faut-il faire pour vous aider?" asked Colbert. "Nous laisser faire" answered Legendre).

Then starting in the late nineteenth century liberal economists were mugged by reality:

  • on issues of income distribution--the Gilded Age--and how laissez-faire did not appear to be producing the reasonable distribution of the fruits of the social division of labor that economists had all expected...
  • on issues of macroeconomic stability--the Great Depression was a big shock--and the argument that the Great Depression arose because markets were not free enough never acquired legs or force outside the theological...
  • on issues of the persistence of "unfree" labor--Adam Smith expected the imminent collapse of slavery, but ending slavery took a war, and the market economy in America did not appear to be doing very much at all to undermine Jim Crow...
  • last and most recently, the fear of the increasing importance of "market failure"--the coming of the "information economy"--caused economists to worry that we were moving from a Smithian to a Schumpeterian world, and even if the presumption of laissez faire works for a Smithian world it is not at all clear that it works for a Schumpeterian world...

The upshot is what Keynes said eighty-four years ago:

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

One way to understand Keynes's General Theory is that Say's Law is false in theory but that we can build the running code for limited, strategic interventions that will make Say's Law roughly true in practice. The modern Ametican liberal economist's view of libertarianism is much the same: libertarianism is false in theory, but it is very much worth figuring out a set of limited, strategic interventions that will make the libertarian promises roughly true in practice.

And let me stop there.

For Stanford January 13 Panel: "Liberals and Libertarians: BFFs or Not?"

Stimulus Spending "Skepticism"...

When Republican Houser leader John Boehner wrote:

Republican Leader John Boehner: ATTENTION ECONOMISTS: ARE YOU A STIMULUS SPENDING SKEPTIC? A recent Associated Press article  quoted transition officials for President-elect Obama as saying “[o]nly one outside economist” contacted by the President-elect’s advisors had “voiced skepticism” about the President-elect’s emerging plans for an economic “stimulus” spending bill with a price tag as large as $1 trillion, with the vast majority of that number going to new spending on government programs and projects.

House Republican Leader John Boehner (R-OH) is compiling a list of credentialed American economists who would like to add their voices to the list of stimulus spending skeptics. If you are an economist who would like to be added to this list, you can join the list here and provide your comments. Also, please feel free to provide links to any papers or publications that support or extend upon your comments.

In Stupidest Party Alive I misread Glen Weyl and took him out of context as being opposed to all stimulus plans, rather than fearing "that the orientation of the Obama plan taking shape at the time, a combination of expansive public spending, unemployment benefits and indiscriminate tax cuts was unlikely to be properly targeted."

It is my error, for which I apologize.

"Weak on Dragons"

From Laura Miller, The Magician's Book:

Eustace Scrubb, in the early chapters of The Voyage of the Dawn Treader, manages to get himself turned into a dragon largely because the books he has read have “a lot to say about exports and imports and governments and drains, but they were weak on dragons.”

I have a sinking feeling that Laura Miller is going to evade The Problem of Susan...

Tomorrow at 3 at Stanford: Liberals and Libertarians: Kissing Cousins or Distant Relatives?

Ah. Here it is:

Liberals and Libertarians: Kissing Cousins or Distant Relatives?: When Jan 13, 2009 3:00 pm (Tuesday). Where: Encina Hall, Philippines Conference Room (C330).

LIBERALS: Joshua Cohen / Political Science, Stanford University. Pamela Karlan / Law, Stanford University. Bradley DeLong / Economics, UC Berkeley

LIBERTARIANS: Brink Lindsay / Cato Institute. Will Wilkinson / Cato Institute, Blogger at FlyBottle. Virginia Postrel / Dynamist

That liberals and libertarians share philosophical origins is clearly implied by the common Latin root for both words, liberalis, meaning open or generous. Both philosophies advocate civil liberties, individual autonomy, limited state interference in private affairs, and a non-bellicose foreign policy. Where the two stances have diverged is with respect to fiscal and regulatory issues. Although liberals generally view markets as the best way of organizing production and distribution, they have been more sympathetic than libertarians to governmental involvement in the management of markets for the public good. Moreover, whereas both liberals and libertarians generally concur that the public sector should avoid excessive spending, the former have been more supportive of government programs to expand opportunity and provide social insurance.

During the 1960s and 1970s, when the public sector was expanding and government spending was rising sharply, libertarians leaned strongly toward a “fusionist” coalition with traditional social conservatives and generally supported the Republican realignment of the 1980s and 1990s. Since 2000, however, the Republican party has succumbed to ideologies that have shifted it steadily away from core libertarian principles by curtailing civil liberties, expanding government intrusions into private affairs, running up huge fiscal deficits, expanding federal control over local institutions such as schools, and launching costly military invasions in the absence of direct threats.

In the wake of these developments, the “fusionist” coalition between libertarians and conservative republicans has substantially frayed and perhaps the time has come to reconsider the historical estrangement between liberals and libertarians. Given shared positions with respect to civil liberties, state involvement in private affairs, fiscal responsibility, and the War in Iraq, it may be fruitful to search for common ground in other areas. Is there room for compromise on contested regulatory and fiscal issues, or are liberals and libertarians destined to be occasional tactical allies with fundamentally conflicting strategic visions? And regardless of possibilities for closer political cooperation, what libertarian insights do liberals need to do a better job of appreciating, and vice versa? 

Spending Stimulus Skeptics: Scraping the Bottom of the Barrel...

Greg Mankiw writes:

More Spending Stimulus Skeptics... Kevin "Dow 36000" Hassett:

We are in the midst of a crisis caused by so many financial institutions borrowing too much money. Somehow, a critical mass of policy makers now believes that the correct response is for the U.S. government to borrow too much money...

Can anybody tell me what the argument is going to be? Is it that the U.S. government's borrowing of an extra 6% of a year's GDP is going to cause the U.S. government to default on its debt? That is the only way that one could try to make sense of Hassett--and that is an absurd claim.

Shame on Bloomberg for not having dumped Hassett as a columnist before this.

The Romer View of Tax and Spending Multipliers Revisited

My statement:

There appears to be an error in N. Gregory Mankiw's "Economic View" column of January 11, 2009. The error is the association of Christina Romer with the proposition that the tax multiplier--the effect on GDP of a tax cut--is twice the spending multiplier. The Romers' article does not distinguish between the two, referring only to the "substantial multiplier... due to the procyclical behavior of investment" (p. 37 of the working paper version, at David Romer in conversation two years ago characterized the paper to me as "hyper-Keynesian... suggesting very large multipliers..." The Romers believe in a tax multiplier no larger than the spending multiplier, and they certainly do not believe that a balanced-budget equivalent reduction in taxes and spending provide any Keynesian stimulus at all.

Mankiw's comparison of the 1.4 estimated spending multiplier from Valerie Ramey's study with the 3.0 estimated tax multiplier from the Romers' study is inappropriate. The two studies use very different methodologies. They are not comparable. For example, the Ramey study on the effects of government spending--while a superb contribution to the literature, and one that I have assigned to my graduate students--does not fully control for the tax increases that often accompany spending increases. Thus it is very likely to understate the effects of spending increases alone: her study assesses the impact of the Korean-War military spending increase without taking account of the fact that it was accompanied by a large tax increase.

What Romer and Romer's study (and their earlier work on monetary policy) shows is not that tax cuts are uniquely effective, but rather that failing to consider the reasons for policy changes leads to underestimates of the effects of all types of stimulus. Because these issues of omitted variable bias are likely to be as strong for spending as for tax changes, the most reasonable interpretation of their paper is that all types of fiscal stimulus are more potent than conventional estimates would lead us to believe.

It is somewhat puzzling that Mankiw appears to believe that the Romers do think that tax multipliers are larger than spending multipliers, as they do not, and this is something that he could have very easily checked.

Marx: The Future Results of British Rule in India

Memo to self: make the 210a students read this:

Karl Marx (1853),"The Future Results of British Rule in India," New York Daily Tribune (August 8): The political unity... imposed by the British sword, will now be strengthened and perpetuated by the electric telegraph. The native army, organized and trained by the British drill-sergeant, was the sine qua non of Indian self-emancipation, and of India ceasing to be the prey of the first foreign intruder. The free press, introduced for the first time into Asiatic society, and managed principally by the common offspring of Hindoos and Europeans, is a new and powerful agent of reconstruction.... From the Indian natives, reluctantly and sparingly educated at Calcutta, under English superintendence, a fresh class is springing up, endowed with the requirements for government and imbued with European science. Steam has brought India into regular and rapid communication with Europe, has connected its chief ports with those of the whole south-eastern ocean.... The day is not far distant when, by a combination of railways and steam-vessels, the distance between England and India, measured by time, will be shortened to eight days, and when that once fabulous country will thus be actually annexed to the Western world.

The ruling classes of Great Britain have had, till now, but an accidental, transitory and exceptional interest in the progress of India. The aristocracy wanted to conquer it, the moneyocracy to plunder it, and the millocracy to undersell it. But now the ... millocracy have discovered that the transformation of India into a reproductive country has become of vital importance to them, and that, to that end, it is necessary, above all, to gift her with means of irrigation and of internal communication. They intend now drawing a net of railroads over India. And they will do it....

I know that the English millocracy intend to endow India with railways with the exclusive view of extracting at diminished expenses the cotton and other raw materials for their manufactures. But when you have once introduced machinery into the locomotion of a country, which possesses iron and coals, you are unable to withhold it from its fabrication. You cannot maintain a net of railways over an immense country without introducing all those industrial processes necessary to meet the immediate and current wants of railway locomotion, and out of which there must grow the application of machinery to those branches of industry not immediately connected with railways. The railway-system will therefore become, in India, truly the forerunner of modern industry. This is the more certain as the Hindoos are allowed by British authorities themselves to possess particular aptitude. for accommodating themselves to entirely new labor, and acquiring the requisite knowledge of machinery. Ample proof of this fact is afforded by the capacities and expertness of the native engineers in the Calcutta mint, where they have been for years employed in working the steam machinery, by the natives attached to the several steam engines in the Burdwan coal districts, and by other instances. Mr. Campbell himself, greatly influenced as he is by the prejudices of the East India Company, is obliged to avow “that the great mass of the Indian people possesses a great industrial energy, is well fitted to accumulate capital, and remarkable for a mathematical clearness of head and talent for figures and exact sciences.” “Their intellects,” he says, “are excellent.”

Modern industry, resulting from the railway system, will dissolve the hereditary divisions of labor, upon which rest the Indian castes, those decisive impediments to Indian progress and Indian power.

All the English bourgeoisie may be forced to do will neither emancipate nor materially mend the social condition of the mass of the people, depending not only on the development of the productive powers, but on their appropriation by the people. But what they will not fail to do is to lay down the material premises for both. Has the bourgeoisie ever done more? Has it ever effected a progress without dragging individuals and people through blood and dirt, through misery and degradation?...

The devastating effects of English industry, when contemplated with regard to India, a country as vast as Europe, and containing 150 millions of acres, are palpable and confounding. But we must not forget... [t]he bourgeois period of history has to create the material basis of the new world — on the one hand universal intercourse founded upon the mutual dependency of mankind, and the means of that intercourse; on the other hand the development of the productive powers of man and the transformation of material production into a scientific domination of natural agencies. Bourgeois industry and commerce create these material conditions of a new world in the same way as geological revolutions have created the surface of the earth. When a great social revolution shall have mastered the results of the bourgeois epoch, the market of the world and the modern powers of production, and subjected them to the common control of the most advanced peoples, then only will human progress cease to resemble that hideous, pagan idol, who would not drink the nectar but from the skulls of the slain.

Note to Self: Tax and Spending Multipliers

Is there any way to interpret Greg Mankiw's Sunday New Yotk Times other than as an elbow to Chtistie's ribs while he thinks the ref's eye is elsewhere?

Christie certainly does not believe that tax multipliers are twice the size of spending multipliers.

On Charles Fried's "Political Crimes and No Punishment"

Charles Fried says that the law is not the law when the crimes are "political crimes" committed by a highly-placed Republican:

The Washington Monthly: But should the high and mighty get off when ordinary people committing the same crimes would go to prison? The answer is that they are not the same crimes. Administration officials were not thieves lining their own pockets. Theirs were political crimes committed by persons whose jobs were to exercise the powers of government on our behalf. And the same is even truer of the lower-level officers who followed their orders....

If you cannot see the difference between Hitler and Dick Cheney, between Stalin and Donald Rumsfeld, between Mao and Alberto Gonzales, there may be no point in our talking. It is not just a difference of scale, but our leaders were defending their country and people -- albeit with an insufficient sense of moral restraint -- against a terrifying threat by ruthless attackers with no sense of moral restraint at all...

Even though Bush, Cheney, et al. did commit what Fried characterizes as crimes, there should be no trials, no findings of fact, and no punishments: "[when] a sane and moderate society... changes leaders and regimes, those left behind should be abandoned to the judgment of history..."

My first thought is: Hmmm. I don't remember Charles Fried out there defending Clinton when the Republicans sought to impeach him for lying to the grand jury. I wonder how he distinguishes the cases in which the high officials are worth defending from those in which they are not.

Hilzoy ripostes:

I can see the difference between Hitler and Dick Cheney. I can also see the difference between Hitler and a shoplifter. That does not mean that I think that the shoplifter should not be punished for his crime.

More to the point, it is possible to commit crimes for comprehensible purposes. Women sometimes kill husbands who beat them, seeing no other way out. People steal to buy their children food or medicine. The fact that in so doing they show an "insufficient sense of moral restraint" is not relevant to the question whether they committed murder or theft.

If Bush and Cheney's motives are in fact an excuse under criminal statutes, then they should get off (and, I would add, the statutes should be changed.) If not, I do not see why invoking their motives is relevant here. This is especially true since I would think that any government official who decided to violate the laws against torture would do so not to line her own pockets -- torture is not normally lucrative -- but because she thought there was a good reason to do so. If we want to make torture by government officials legal, we should just go ahead and change the law. We should not pretend that it is illegal while excusing any torture performed for motives that any government officials who licenses torture will probably share...

I agree with Hilzoy.

If Bush and Cheney and Rumsfeld and Yoo and Addington and the other prime movers want to plead necessity in front of a jury, let them plead necessity--and let the jury find whether their political crimes were in fact necessary. That's what juries do: find out what happened in fact. To say that any rogue vice president's judgment of necessity is unreviewable--well, even the Old Romans required the passage of the senatus consultum de re publica defendenda before the consuls' judgment of necessity trumped the law.

It Must Have Been a Long Time...

...since I looked at the section on nineteenth-century France in Charlie Kindleberger's Financial History of Western Europe. The section on the Credit Foncier and the Credit Agricole is marked with a punch card.

Now if only I could remember why I wanted to mark that section with a punch card...

Barack Obama the Sensible Centrist

Steve Benen is:

The Washington Monthly: reminded... of something Atrios said about a month ago, when he mentioned how satisfied he'd be if Obama's team convinces people that Obama is "a sensible centrist who wants to do sensible centrist things like build SUPERTRAINS, get out of Iraq, not torture people or invade random countries, strengthen labor protections, reduce income inequality, improve education, provide health care for people, and reduce poverty"...

Bush Presidential Accomplishments

Steve Benen presents Jon Swift's version of Fred Barnes's list of Bush presidential accomplishments:

The Washington Monthly: Jon Swift, apparently inspired by Barnes' insightful perspective, thinks there may be something to this. He has a great new list highlighting the brilliance of Bush's presidency:

  • After Hurricane Katrina President Bush kept our cities safe.
  • After the October 2008 stock market correction there have been no Great Depressions.
  • After Iraq and Afghanistan took a turn for the worse, President Bush kept us from losing any wars.
  • After the District Attorney firing scandal, the outing of Valerie Plame and other scandals, President Bush restored integrity to government.
  • After divisive elections President Bush united our country.
  • After Abu Ghraib, President Bush reaffirmed America's adherence to the Geneva Conventions and against torture.
  • After 9/11 President Bush kept America safe from terrorist attacks on American soil.

Well, I certainly can't argue with any of these astute observations.

Stupidest Man Alive Nomination: Bill Whittle

Submitted by Tbogg.

Bill Whittle writes:

Bill Whittle: No longer does Hollywood broadcast America’s mythic virtues to the world.... Now the great creative driving force of Hollywood is to present to America the anti-American hatred of the intellectuals watching in impotent fury out in the rest of the world. Of the six or seven war movies made during the last few years, all – save one – were spectacular failures... these films failed [because] – are you sitting down? – that most of the country, unlike Hollywood, has sons and daughters and fathers and brothers in the military and know for first-hand fact that they are... the bravest, the most capable, the most decent and honorable and just plain competent people we have.

And perhaps, just perhaps, it might enter that navel-gazing, self-centered, dim little brain to reflect that the one war movie that did out-of-the-park business was the one that showed the Marines as the good guys, winning on the battlefield, defending their people and their culture against long odds and full of the heroism and sacrifice that used to be so commonplace in this city… even if the Marines in question wore loincloths and funny helmets and advanced with spears and round shields.

Tbogg comments:

Rollover Bulwer-Lytton and tell Tom Clancy the news.... I assume that the movie  Whittle is referring to is (speaking of ham) 300, and, if I remember correctly... they all die, which is a funny way to go about "winning on the battlefield". 

But then I 'm not a pharmacist in Des Moines, so what the hell do I know?

Letter from Zimbabwe

Chris Blattman sends us to Shanta Devarajan, who writes on the "Africa Can End Poverty Website":

Letter from Zimbabwe: I received this missive from a friend:  

December 11, 2008, Harare, 1.00am: It is just after midnight in Harare. I have just returned from a midnight tour of the ATMs in Harare with a cousin. There are queues of people still waiting to get their weekly cash withdrawal limit of $100,000,000,000 (US$2.50). I saw the queues this morning when I went for my first meeting at 7.45am. I did not know then that I would be seeing them throughout the day. Most of the ATMs had run out of money. Rather than go home, people saved their precious place in the lines by lying down where they stood and taking a nap. Covering themselves with sacks, newspapers and whatever warming clothing they had. Those ATMs that were still paying out cash had queues of policemen and soldiers. I dared not pull out my camera then. When I did pull out my camera, it was of people too tired to care. Needless to say, picture quality from a moving car using a micro camera is not the best. This is not a normal interpretation of 24-hour banking; seven days a week.   Three hours earlier, I had gone to one of the cholera infected areas where my aunt lives. I had not intended to stay long. It is a way out of town and I did not want her worrying about my safety getting back into the city. There was a power outage from 6 p.m. and it had taken us two hours to find a house I last visited 20 years ago as a boy. But I did ask how she was coping in Harare; and to her nephew she poured her heart out. No clean water for weeks on end, no food in the shops and constant power cuts. She drives an hour and half across the township in search of clean drinking water, which she brings back in plastic containers. When the city council water does run through the taps in the house, the water is discolored with sewer water. The shops in the neighborhood are empty of basic necessities including mealie meal. Her husband now lives at their farm in another town so that he can plant, guard and harvest the maize that they will live on next year. There are groceries in some shops in the city, but they are sold in US$ and priced beyond her means. I am glad I brought her a suitcase of groceries. Groceries that, 20 years ago, my parents once drove from Lusaka to Harare to buy when Zambia was going through similar madness in the 1980s.   December 12, 2008: Today the Reserve Bank increased the cash withdrawal limit from $100,000,000 to $200,000,000 (US$4). It also introduced two higher-denomination notes, $200,000,000 and $500,000,000. As expected there was a mad rush to withdraw and spend the cash before it loses value. It is widely expected that retailers will increase their prices in line with the higher withdrawal limits. There were long (and I mean l…l…o…o…n…n…g…g) queues at every single working ATM. Offices were abandoned. I took pictures of the lines outside Barclays bank by walking to the first floor offices of government labor department. In a large pool office with at least 20 desks there was a lone clerk who looked up at me for all of two seconds. As I walked across the room to the window facing the bank, the files lay unattended on people’s desks…probably untouched for weeks. With civil service wages eroded by hyperinflation, people necessarily spend more time in the parallel economy trying to make ends meet. Interestingly, there are no runs on banks. The value of the withdrawals is so meaningless that the banks will be able to meet depositor demands with ease.

Not with dictators like Robert Mugabe, it can't.

New Deal Dreaming

I just dreamed that it was the 1930s and I was briefing the Cravsth lawyers for today's scotus oral argument in Schechter Poultry...

That is all.

Praising with Faint Damns

Tyler Cowen starts out:

Marginal Revolution: What I've been reading: 3. The Overflowing Brain: Information Overload and the Limits of Working Memory, by Torkel Klingberg.  When push comes to shove, the author fails to establish his major thesis...

He continues:

Still, this book is way above average for how seriously it treats the actual science behind its argument.  I learned a great deal from it.

Hoisted from the Archives: Chiang Kai-Shek and the Bush Family

dan k reminds me of the remarkable ignorance of the current generation of the Bush family:

Grasping Reality: Unleash Chiang Kai-Shek: I'm sorry, but this is just too weird: | The Gainesville Sun | Gainesville, Fla.: After more than an hour of solemn ceremony naming Rep. Marco Rubio, R-West Miami, as the 2007-08 House speaker, Gov. Jeb Bush stepped to the podium in the House chamber last week and told a short story about "unleashing Chang," his "mystical warrior" friend. Here are Bush's words, spoken before hundreds of lawmakers and politicians: "Chang is a mystical warrior. Chang is somebody who believes in conservative principles, believes in entrepreneurial capitalism, believes in moral values that underpin a free society. I rely on Chang with great regularity in my public life. He has been by my side and sometimes I let him down. But Chang, this mystical warrior, has never let me down."

Bush then unsheathed a golden sword and gave it to Rubio as a gift. "I'm going to bestow to you the sword of a great conservative warrior," he said, as the crowd roared. The crowd, however, could be excused for not understanding Bush's enigmatic foray into the realm of Eastern mysticism. We're here to help. In a 1989 Washington Post article on the politics of tennis, former President George Bush was quoted as threatening to "unleash Chang" as a means of intimidating other players. The saying was apparently quite popular with Gov. Bush's father, and referred to a legendary warrior named Chang who was called upon to settle political disputes in Chinese dynasties of yore. The phrase has evolved, under Gov. Jeb Bush's use, to mean the need to fix conflicts or disagreements over an issue. Faced with a stalemate, the governor apparently "unleashes Chang" as a rhetorical device, signaling it's time to stop arguing and start agreeing. No word on if Rubio will unleash Chang, or the sword, as he faces squabbles in the future.

When George H. W. Bush in the 1970s and 1980s threatened to "unleash Chang" on his tennis opponents, he was referring to China's onetime strongman and thereafter Taiwan's dictator Chiang Kaishek, leader of the Nationalist Party, the man who had largely reunified China in the 1920s with his army's "Northern Expedition," lost the Chinese Civil War to Mao Zedong's Chinese Communist Party, and then taken refuge with his Guomindang party cadres on Taiwan. After the start of the Korean War, the American 7th Fleet protected Chiang (and Taiwan) from Mao's People's Liberation Army. Republican wingnuts, however, pretended that the 7th Fleet actually protected Mao's Communists (who had, after all, won the Chinese Civil War) from Chiang's Nationalists (who had, after all, lost it) by keeping Chiang Kaishek leashed. They periodically called for the U.S. to "unleash Chiang Kaishek"--so that Chiang, you see, could invade and conquer the Chinese mainland.

When George H. W. Bush, playing tennis (and losing) in the 1970s and 1980s, would threaten to "unleash Chiang," he was mocking the right-wing nuts of his generation. But George H. W. Bush's sons--even the smart one, Jeb--never got the joke. They, you see, didn't know enough about world history or even the history of the Republican Party to know who Chiang Kaishek was, or what "Unleash Chiang!" meant. Hence Jeb Bush's explanation that twentieth-century Chinese nationalist, socialist, general, and dictator Chiang Kaishek was a "mystical warrior... who believes in conservative principles, believes in entrepreneurial capitalism, believes in moral values that underpin a free society."

To me, that level of uncuriosity is scary. Why is this family ruling us, again?

Robert Waldmann on the "Fundamental Values" of Risky, Long-Duration Securities

Robert writes:

Comment on DeLong: What Has Happened to Milton Friedman's Chicago School? DRAFT: What does "impaction" as in "the impaction of information" mean ? Is it like an impact or an impacted wisdom tooth ? I seek wisdom not teeth. I see a fifth cause of the decline in asset values. I think many assets were over-valued in the past, because the ratings agencies were tricked or cashing in on their late lamented excellent reputations (or both). The loss of confidence in said agencies causes an increase in estimated risk not because risk has increased or risk aversion has increased but because the old estimates are now known to be bogus. More generally, risk modelling by traders was similarly complete nonsense. I don't know to what extent the traders were tricked and to what extent they were in on the scam (nor I suspect do they).

Structured finance created a huge illusion of wealth by creating an illusion of safety. The financial engineers knew how the agencies rated (the agencies explained for a consulting fee) and how traders estimate "value at risk". They knew people assumed (or pretended to assume) that all stochastic variables are normally distributed. Thus it was profitable to sell instruments with skewed returns (fat lower tails) unless the rare negative event occured during the testing period (in which case the instruments could be re-engineered). A senior tranche of a pool of moderately risky assets has a skewed distribution. Similarly money could be made by reducing own variance for a given beta by pooling assets and issuing claims on the pool. The variance of an average is less than the average variance. The covariance of an average and the market portfolio is the average covariance. Thus a claim on a pool of BBB rated corporate bonds was rated AAA. Turning BBB to AAA is worth a lot of money except for the fact that it was a scam (investors could pool themselves -- they don't seem to have understood that pre-pooling reduces the benefit to them of their own pooling -- or they were in on the scam).

The risk of a nationwide decline in house prices was estiamted at 0 by S&P (I am not exaggerating). Now there has been such a decline and they must admit that there is the risk of such a decline in the future. The current decline would cost 1 trillion. The future possible declines also cost money. So much of the wealth was an illusion which won't come back soon. This end of systematic miss-estimation of risk is not on your list.

Also institutions took huge gigantic bets against each other (as in AIG lost writing CDSs). This increases counterparty risk. No one knows if a counterparty is solvent. That reduces the value of a huge number of instruments. The damage could have been done without involving the housing industry or the stock market if, say, investment bank CEOs played a really high stakes poker game and all claimed to have won money. Also bankruptcy is costly. Even if the CEOs had played hundred billion ante poker on camera, wealth would have been destroyed and more wealth would have been shifted from investors to lawyers. This is another item not on your list. Finally, much of the strange new finance was designed to help agents avoid prudential rules and regulations which they considered to be costly. Now they have learned two things. First that the regulations weren't so pointless so they will have to pay that cost to avoid bankruptcy. Second they will be audited by banking regulators, trustees etc and found wanting. This last point is semi redundant as it amounts to an increase in perceived risk. However, it explains why I keep speculating that this that or the other operator was in on the scam.

Here Robert Waldmann raises a whole bunch of issues that I was attempting to defer to later. I claimed (correctly) that the collapse of global financial asset values over the past year and a half was overwhelmingly do to increases in the risk and information discounts, and not to changes in expected future cash flows. Robert raises the point that perhaps the current risk and information discounts are "right," or in some sense the appropriate "fundamental values," and that the previous low values of these discounts were in some sense "wrong" or "irrationally exuberant."

To make sense of this claim we need a definition of what "fundamental values" are.

Here is mine:

The fundamental values of asset prices are the money-metric values that the costate variables associated with the commodities would have in some reasonable utilitarian central-planning social-welfare-maximization exercise under reasonable utilitarian preferences.

This entails the following, leaving what happens in Mad-Max scenarios completely out of the picture:

  1. Default discounts should be small (and in fact default discounts are small even now in the recession)--default is not a thing that should happen often to financial assets and should not be a big component of asset pricing in well-functioning asset markets that mimic some reasonable social-welfare-maximization calculation.
  2. Information discounts should be small because they reflect knowledge held by one part of the system and not by another--and well-functioning asset markets should be liquid and full enough of information that they should be able to mimic the low information discounts found in some reasonable social-welfare-maximization calculation.
  3. The proper duration discount--the safe real interest rate--in a social-welfare-maximization calculation is the utility cost of moving wealth ahead in time from one consumer to another or from early to late in a consumer's life. This should be governed by the rate of labor productivity growth divided by a reasonable utilitarian intertemporal elasticity of substitution. A reasonable utilitarian intertemporal elasticity of substitution is one. A reasonable estimate of the rate of productivity growth is 2 percent per year. The duration discount ought to be a real safe interest rate of 2 percent per year.
  4. The proper risk discount is governed by the utilitarian diminishing marginal utility of wealth and the covariance of asset returns with wealth: it is the danger that when assets lose value you find yourselves in states of the world in which your marginal utility of wealth is high. The covariance of asset returns with wealth is low. A reasonable utilitarian diminishing marginal utility of wealth corresponds to a coefficient of relative risk aversion of 1. The risk discount for an equity beta = 1 portfolio ought to be on other order of a long-run real rate of 0.3% per year. The risk discount for financial assets as a whole ought to be on the order of a long-run real rate of 0.2% per year.

Thus my view of fundamental values: financial assets ought to be priced so that safe assets yield a 2% per year real return, and so that financial assets as a whole ought to yield an expected long-run return of 2.2% per year (with equities yielding an expected return of 2.3% per year).

Right now it looks to me as if safe assets yield a real return of -1% per year, and financial assets as a whole yield an expected long-run real return of 5% per year (with equities yielding an expected long-run rate of return of 8% per year). At the peak of the housing bubble as best as I could tell safe assets yielded a real rate of return of 2% per year (about at their fundamental values) and equities yielded an expected long-run real rate of return of 4% per year (about half their fundamental value).

The most important thing about asset prices, I think, is that even in booms and bubbles they don't reach their "fundamental" values. The first-order fact about asset markets is that they currently do and historically have done a really lousy job of mobilizing the long-run risk-bearing capacity of the global economy. The risk tolerance of those who participate in financial markets is a remarkably low fraction of the true fundamental global risk tolerance, the horizon of those who participate in financial markets is a remarkably low fraction of the true social investment-planning horizon, and in addition the views of those who participate in financial markets are extraordinarily more volatile than can be generated by the variation in rational expectations of future growth rates and appropriate fundametnal discounts.

The Obama Fiscal Boost: A Note

Paul Krugman writes:

Romer and Bernstein on stimulus - Paul Krugman Blog - Christina Romer and Jared Bernstein have put out the official (?) Obama estimates of... the... American Recovery and Reinvestment Plan would accomplish.... Kudos, by the way, to the administration-in-waiting for providing this — it will be a joy to argue policy with an administration that provides comprehensible, honest reports, not case studies in how to lie with statistics....[I]t [is] hard to evaluate the reasonableness of the assumed multipliers. But... the estimates appear to be very close to what I’ve been getting.

[T]hey do estimates of effect in the fourth quarter of 2010, which is roughly when the plan is estimated to have its maximum effect. So they say the plan would lower unemployment by about 2 percentage points, I said 1.7.... They have the plan raising GDP by 3.7 percent, but that’s at peak; I thought 2.5 percent or so average over 2 years, again not much difference. So this looks like an estimate from the Obama team itself saying — as best as I can figure it out — that the plan would close only around a third of the output gap over the next two years.

One more point: the estimate of what would happen to the economy in the absence of a stimulus plan seems kind of optimistic. The chart above has unemployment ex-stimulus peaking at 9 percent in the first quarter of 2010... the CBO estimates an average unemployment rate of 9 percent for 2010.... Bottom line: even if I use the Romer-Bernstein estimates instead of my own — there really isn’t much difference — this plan looks too weak.

If I were in the Obama White-House-to-be right now, I would announce that we would be using CBO numbers as our baseline for everything, and focus on providing analytical input to CBO so that its numbers are as good as possible. Doug Elmendorf is honest and reliable and will do his best. And if there is no daylight between the administration and CBO, that is one fewer way that the David Brookses and the John Boehners and the other bad actors can confuse the gullible, lazy, and dishonest among reporters and commentators who do so much to degrade the level of the policy debate.

I agree with Paul that this fiscal boost plan is too small, but I do want to admit that doing this well is harder than it looks. The tax-cut part does not look terribly effective as a stimulus--it is a step toward compensating for higher income inequality and a political play to make it more likely that Republicans will lose politically by trying to block the package rather than a significant boost to employment. Thus I do not think you would want to make the tax-cut part larger. And it is hard to find a lot of additional spending projects that can be ramped up quickly and do a lot of good--relatively soon in that endeavor the short-term fiscal multiplier falls below one. They are trying their best.

Nevertheless, I agree that there best is almost surely not enough. I also believe that conventional monetary policy is tapped out, and unconventional monetary policy is of doubtful efficacy. So I am in favor of doing something else on the banking/finance side. My favorite idea right now is that of nationalizing Fannie Mae and Freddie Mac completely and unleashing them to buy up every single mortgage in the country at market rates. Their ability to borrow at the Treasury rate means that they should be able to make money by doing this. When they own mortgages they can renegotiate and refinance them all with the public interest in mind. And as they squeeze banks out of the mortgage business the fact that banks are looking for yield should push other financial asset prices up--and make it possible for those businesses that should be expanding to get financing right now on terms that make expansion profitable.

So at the moment my preliminary judgment of the Obama fiscal boost is that it is a good first bid, but that the administration ought to be doing a lot more.

Note to Self: The Tax Cut Component of the Obama Fiscal Plan

The tax-cut component of the Obama fiscal boost plan looks much more effective at offsetting rising income inequality than at creating jobs. It also makes it more difficult for Republicans to vote against the plan as a whole--and while I wish we had a sane Republican Party that cared about the nation or a weak Republican Party that could not further disrupt policymaking, we have the Party we have.

Howard Gleckman:

TaxVox: the Tax Policy Center blog :: Obama's $300 Billion Tax Cut: Lots of Buck, Not Much Bang: The soon-to-be Obama Administration floated quite a trial balloon over the weekend: $300 billion in tax cuts for workers and business over the next couple of years. When you get past the eye-popping number, perhaps the most striking element is how conventional most of the ideas are. For individuals, they’d include some version of Obama’s Making Work Pay Credit, a refundable tax credit (aka cash payment) for everyone making roughly $200,000 or less. Obama aides did not say how this money would be distributed, although they hinted they’d try something other than the rebates that the Bush White House turned to three times over the past eight years. One idea: reduced withholding, which would release the funds more slowly than a lump-sum payment would. The research on the last three rebates suggests that people spent between one-third and one-half of the money within nine months of the time it got into their pockets. If Obama pumped $150 billion into these tax cuts and 40 percent, or $60 billion, got spent, the impact on the U.S.’s $14 trillion economy would be real, though modest.

On the business side, Obama aides leaked three ideas. The first: extending bonus depreciation, another Bush measure that would allow companies to write-off the cost of equipment faster. The second: giving companies immediate refunds by letting them use using last year’s losses to reduce prior year tax liabilities. Idea #3: giving businesses a refundable tax credit for each new worker they hire or even each employee they don’t lay off. The net operating loss idea makes some sense. But other than trying to buy votes from pro-business Capitol Hill Republicans, it is hard to see what the other two schemes would accomplish. Bonus depreciation in its many incarnations has been tried a half-dozen times over the past four decades and its benefits are, shall we say, hard to find. It won't help companies with losses (most of them, these days), or non-profits. A year ago, while both were at The Brookings Institution and TPC, Obama advisor Jason Furman and CBO director-designate Doug Elmendorf wrote of the 2001-2003 versions, “bonus depreciation for business investment did not seem to be very effective in spurring economic activity”...

Paul Krugman Fears Deflation, and Wants a Bigger Stimulus

He writes:

Risks of Deflation/a>: CBO is currently projecting an output shortfall from the current slump comparable to the slump of the early 1980s... if you compare the CBO’s projections of unemployment from 2008 through 2012 with its estimate of the natural rate, we’re looking at cumulative excess unemployment of 13.9 point-years; that compares with 13.7 point years from 1980 through 1986.... Now here’s the thing: the slump of the early 1980s produced the Great Disinflation, which brought the core inflation rate down from about 10 to about 4. This time, however, we entered the slump with a core inflation rate of about 2.5 percent. If we experienced a disinflation comparable to that of the 1980s, that would mean ending up with deflation at a rate of -3.5 percent....

So tell me why we aren’t looking at a very large risk of getting into a deflationary trap, in which falling prices make consumers and businesses even less willing to spend. Tell me why this risk wouldn’t remain high, though lower, even with the Obama plan, which as far as I can tell is expected to reduce cumulative excess unemployment by about a third.

I want a bigger fiscal policy boost to the economy as well.

Stupidest Party AliveTM

People who have endorsed the Republican House caucus's objections to the stimulus package:

Donald Luskin, Chief Investment Officer, Trend Macrolytics LLC, Stupidest Man Alive EmeritusTM: "Government spending does not create incentives for labor, innovation and investment. Instead of spending $1 trillion in Washington, let Washington forgive $1 trillion in tax revenues to create incentives for millions of individuals and firms to get the economy going again, one dollar at a time."

People who have not the Republican House caucus's objections to the stimulus package:

Eddie Lazear, Chair, President's Council of Economic Advisers (George W. Bush)
Matthew Slaughter, Member, President's Council of Economic Advisers (George W. Bush)
Katherine Baicker, Member, President's Council of Economic Advisers (George W. Bush)
Ben Bernanke, Chair, President's Council of Economic Advisers (George W. Bush)
Harvey Rosen, Chair, President's Council of Economic Advisers (George W. Bush)
Kristen Forbes, Member, President's Council of Economic Advisers (George W. Bush)
N. Gregory Mankiw, Chair, President's Council of Economic Advisers (George W. Bush)
Randall Kroszner, Member, President's Council of Economic Advisers (George W. Bush)
Mark McClellan, Member, President's Council of Economic Advisers (George W. Bush)
R. Glenn Hubbard, Chair, President's Council of Economic Advisers (George W. Bush)
Paul Wonnacott, Member, President's Council of Economic Advisers (George H. W. Bush)
Richard Schmalensee, Member, President's Council of Economic Advisers (George H. W. Bush)
John Taylor, Member, President's Council of Economic Advisers (George H. W. Bush)
Michael Boskin, Chair, President's Council of Economic Advisers (George H. W. Bush)
Michael Mussa, Member, President's Council of Economic Advisers (Ronald Reagan)
Thomas Moore, Member, President's Council of Economic n SpriyAdvisers (Ronald Reagan)
Beryl Sprinkel, Chair, President's Council of Economic Advisers (Ronald Reagan)
William Poole, Member, President's Council of Economic Advisers (Ronald Reagan)
Martin Feldstein, Chair, President's Council of Economic Advisers (Ronald Reagan)
Jerry Jordan, Member, President's Council of Economic Advisers (Ronald Reagan)
William Niskanen, Member, President's Council of Economic Advisers (Ronald Reagan)
Murray Weidenbaum, Chair, President's Council of Economic Advisers (Ronald Reagan)
Burton Malkiel, Member, President's Council of Economic Advisers (Gerald Ford)
Paul MacAvoy, Member, President's Council of Economic Advisers (Gerald Ford)
Alan Greenspan, Chair, President's Council of Economic Advisers (Gerald Ford)
Gary Seevers, Member, President's Council of Economic Advisers (Gerald Ford)
Marina von Neumann Whitman, Member, President's Council of Economic Advisers (Richard Nixon)
Paul McCracken, Member, President's Council of Economic Advisers (Richard Nixon)

In fact, no current or former member of the President's Council of Economic Advisers--Democrat or Republican, living or dead, sane or insane--has signed up for the Republican House caucus's list of economists opposed to the stimulus package. None. Zero. Nada. Sifr. Efes. Wala sero. Kosong sifar. 'Ole. Knin. Pujyam. Mann. Dim. Nocht. Null. Meden. Hitotsu. Sifuri. Ling. Sunya. Mwac. Ataqan. Saquui. Hun. Illaq. Wanzi. Wanzi. Pagh. Na. Uqua.


That should tell you something about today's Republican Party.

Other ethics-free Republican hacks, whose organizations share in their burning of their own credibility:

Michael Cannon, Cato Institute: "The only way Congress can spend money is to extract it from the private sector – either by taxing it, borrowing it, or seignorage. The question then becomes: will Congress spend that money more wisely than the private sector would have spent it? The answer appears to be no. Congress typically spends according to its political priorities, not economic priorities."

Antony Davies, Associate Professor of Economics, Duquesne University: "It is time for voters to wake up to the fact that government cannot create jobs. It can only shift jobs from one part of the economy to the other. It is entrepreneurs who create jobs, and it is consumers who judge whether those jobs are the best jobs to be created. The government contributes best by establishing a rule of law and protection of property rights that allows entrepreneurs and consumers to act in their best interests."

Joseph Zoric , Associate Professor of Economics, Franciscan University of Steubenville: "The stimulus plan will most probably turn quickly into pork spending. Marginal rate tax cuts would be a much more effective way to stimulate demand along with cuts in the capital gains and corporate tax rates. Evidence shows that marginal tax cut multipliers are much higher than spending multipliers. In addition the Fed is still not out of ammunition."

Edward Lopez, Associate Professor of Law and Economics, San Jose State University: "Fiscal stimulus may have symbolic value and certainly does provide an expedient for distributive politics, but there is NO evidence that it contributes to GDP or economic growth more broadly."

Justin Ross, Assistant Professor of Economics, School of Public and Environmental Affairs, Indiana University: "Empirical evidence overwhelmingly rejects federal government deficit spending as the best method for stimulating the economy, and is generally unsupportive of it having any stimulus effect at all."

Steven Horwitz, Charles A. Dana Professor of Economics, St. Lawrence University: "The stimulus plans assume consumption is the source of economic growth. It is not. It is the consequence of said growth. The ‘stimulus’ is a redistribution of spending, at best, and will do little to help. The next Administration should avoid large scale programs and experimentation and allow the marketplace to correct the errors made by the last 8 years of misguided intervention."

Richard Wagner, Professor of Economics, George Mason University: "Any so-called stimulus program is a ruse. The government can increase its spending only by reducing private spending equivalently. Whether government finances its added spending by increasing taxes, by borrowing, or by inflating the currency, the added spending will be offset by reduced private spending. Furthermore, private spending is generally more efficient than the government spending that would replace it because people act more carefully when they spend their own money than when they spend other people's money."

Stephen Entin, President & Executive Director, Institute for Research on the Economics of Taxation: "Want to grow the economy without inflation? Cut marginal tax rates, slash the corporate rate, expense investment in the first year (instead of depreciation), keep tax rates low on dividends and capital gains, and repeal the death tax. Have the Federal Reserve focus on price stability and a sound dollar, and on not generating a monetary roller coaster. (That, in part, is what caused the housing and commodities bubbles.) Rein in government spending to pay for the tax cuts, and trim senseless regulation."

Gary Wolfram, William Simon Professor of Economics, Hillsdale College: "Rather than old style Keynesianism we should reduce the corporate income tax substantially. The problem is not lack of demand, but rather a lack of investment. By reducing the corporate income tax, among the highest in the industrialized world, we will increase the incentive for companies to invest in new equipment, technology, research and development, and buildings. This will increase productivity in the long run, leading to higher GDP and higher wages.”

Lawrence Franko, Retired Professor, University of Massachusetts Boston, College of Management: "Government ‘infrastructure spending stimulus’ programs in Japan during the 1990s produced no stimulus, but rather a vast overhang of government debt. Bridges, tunnels, roads, and trains to nowhere stimulate nothing. It is productivity growth that counts, and that comes mainly from the private sector – which is why tax cuts have always been a surer way to economic recovery.

Michael Sykuta, Associate Professor, University of Missouri – Columbia: "Government intervention and ‘stimulus’ in the housing market is largely responsible for the current economic crisis. History has shown that the Obama team’s proposed ‘stimulus’ is not only going to have little to no effect in the short run, but will create a larger bureaucratic structure, lead to tremendous investments in unproductive political lobbying among ‘stimulus project’ wannabes, and dissuade/delay private investment, recovery and growth."

David Laband, Professor of Economics and Policy, Auburn University: "Our economy as a whole will [no] benefit from taking money from current or future taxpayers to support a government spending spree. No doubt, certain interest groups will gain from feeding at the public sector trough. But losers surely will outnumber winners by a large margin. Our economy as a whole will benefit from Congress lowering taxes and letting Americans decide for themselves what is worth spending their hard-earned dollars on."

Howard Baetjer, Lecturer, Dept. of Economics, Towson University: "A government-spending ‘stimulus’ is a very bad idea. Because government can spend only what it has taxed or borrowed away from the public, it creates no new demand but merely redirects it. Recovery depends on profit and loss discipline and public confidence that the basic rules underlying free markets will be followed. The latter is hurt by government interventions such as ‘stimulus.’"

Glen Weyl, Junior Fellow at the Society of Fellows and Post-Doctoral Fellow in the Department of Economics, Harvard University: "Nothing about a recession justifies larger government. If we are worried about too few jobs, it makes sense to subsidize private employment (for example, by temporarily lowering payroll taxes or creating a new tax subsidy for new hires)." UPDATED: THIS IS OUT OF CONTEXT AND DOESN'T BELONG HERE: GLEN WEYL IS MAKING A MUCH MORE SOPHISTICATED POINT

Henry Thompson, Professor, Auburn University: "The current recession was caused by government fiddling with the mortgage market and the moral hazard created by the illusion of government monitoring of financial markets. Increased government involvement in the economy is not the solution."

Gene Smiley, Emeritus Professor of Economics, Marquette University: "An ‘economic stimulus’ program will do nothing to correct the serious price and resource misallocations that currently exist and are stopping the economy from moving back toward ‘full-employment.’ In fact, they will likely retard the recovery. They will divert resources from the private sector to the government sector moving us further away from a free-enterprise economy.

Stacie Beck, Professor, University of Delaware: "A spending stimulus will only delay the needed restructuring of the U.S. economy to remain internationally competitive. Tax cuts will facilitate that restructuring far better than spending and job creation by the government."

Steve Entin's presence on this list is sad. He was an economist once upon a time...

Epically Bad Tom Friedman Column Contest

A correspondent suggests this one:

The Whole World Is Watching: Three years ago, I was catching a plane at Boston’s Logan airport and went to buy some magazines for the flight. As I approached the cash register, a woman coming from another direction got there just behind me — I thought. But when I put my money down to pay, the woman said in a very loud voice: “Excuse me! I was here first!” And then she fixed me with a piercing stare that said: “I know who you are.” I said I was very sorry, but I was clearly there first.

If that happened today, I would have had a very different reaction. I would have said: “Miss, I’m so sorry. I am entirely in the wrong. Please, go ahead. And can I buy your magazines for you? May I buy your lunch? Can I shine your shoes?”

Why? Because I’d be thinking there is some chance this woman has a blog or a camera in her cellphone and could, if she so chose, tell the whole world about our encounter — entirely from her perspective — and my utterly rude, boorish, arrogant, thinks-he-can-butt-in-line behavior. >Yikes!...

Other possibilities?

Does David Brooks Write Anything in Good Faith?

The answer is: no.

David Brooks quotes Christina Romer out of context--taking her 1994 argument that monetary policy is more flexible and effective at ending small recessions and misinterpreting it to apply to big recessions like today, which are too big to end via monetary policy alone.

The New York Times editors should have killed Brooks's article. The fact that they didn't tells us something about their commitment to ethics in journalism.

David Brooks writes:

The Confidence Surplus: Christina Romer is Barack Obama’s choice to lead his Council of Economic Advisers. In 1994, Romer and her husband, David, wrote an essay entitled “What Ends Recessions?”... The Romers surveyed the recessions of the previous 50 years to try to reach some conclusions about what works. “Our central conclusion is that monetary policy alone is a sufficiently powerful and flexible tool to end recessions,” they wrote.... “Discretionary fiscal policy, in contrast, does not appear to have had an important role in generating recoveries.”... The Romers’ essay exemplifies the economic doctrine that... fiscal stimulus plans that try to time a recession are dangerous, unproven and unnecessary.

That doctrine has suddenly vanished. But not because we suddenly know how to create effective stimulus plans.... Today there is wide support for fiscal stimulus. It’s just that there is no historical experience to tell us how to do it, and there is no agreement on how to make it work. The economists’ prescriptions are all over the map...

I think there is pretty strong agreement about how to try to make it work. When Marty Feldstein is at the same spot on the map as Christie Romer, that tells you something.

Why oh why can't we have a better press corps?

And U-6 at 13.5%

And U-6--unemployed plus discouraged workers plus unable to fond a full-time job--is now at 13.5% of the labor force--and BLS "discouraged workers" atre a big undercount of the concept...

We Are Going to Need a Bigger Stimulus

This is turning into the JAWS of recessions...

Unemployment on December at 7.2%. 524000 jobs lost in December. 1.9 million jobs lost in the last four months of 2008.

And these numbers are now almost a full month old...