## Bending the Curve on Health Spending: The CBO Is Not a Policy Philosopher-King Office II (Please Think About It Peter Orszag and Doug Elmendorf Department)

Igor Volsky:

Wonk Room: Will The CBO Score Obama’s MedPAC Proposal?: After Congressional Budget Office director Douglas Elmendorf suggested that the current reform legislation would do little to reduce the growth of health care spending, the White House doubled down on its support for establishing a MedPAC-like commission — MedPAC is an independent agency advising Congress on issues affecting the Medicare program — that would help lower future health care spending. Every year, MedPAC publishes two reports chock full of the kind of payment reform that could truly transform the health care system from incentivizing quantity to quality and value of care and every year Congress ignores them. By giving a MedPAC-like panel the power to implement the kind of payment reforms that MedPAC has always advocated, the proposal would free the panel from the constraints of congressional politics and allow it to actually influence Medicare spending patterns.... The President could choose to submit all of MedPAC’s recommendations as a package deal. Congress would have 30 days to intervene, but they couldn’t pick and choose what proposals they’d like – they could only vote up or down on the whole package.” This kind of proposal kicks payment reform into high gear....

Greg Poulsen.... “Unless we get the incentives right, nothing else in health reform really matters.” Poulsen is part of a group of officials at so-called “integrated” institutions that already operate using MedPAC’s many of recommendations and are generally able to provide quality care more efficiently....

The administration is a strong proponent of these reforms, but the challenge lies in pleasing the CBO — which finds savings by following Potter Stewart rule life: “I know it when I see it.” However, since the MedPAC-like proposal is predicated on the President accepting its recommendations and Congress not voting them down, (and MedPAC is only required to not “increase in the aggregate level of net expenditures under the Medicare program,”) the CBO — which rarely defines the criteria of savings — is unlikely to “see” savings.

For CBO to find real money in the transformation from MedPAC to IMAC, it would have to be willing to stand up and say: "We believe that this procedural reform would change your deliberations, Mesdames and Messieurs Congresspersons, in a healthy and cost-reducing direction." They were always very unlikely to do that--to say that congressional action could be constrained or limited by anything other than explicit congressional votes that had a dollar bottom line attached to them.

I see two things that could be done going forward:

1. The Obama administration could, in its IMAC legislative proposal, mandate that each year IMAC come up with payments reform recommendations that it believes will cut $20 billion off the baseline for government health spending, and require as part of the legislative proposal that congress either (a) approve the IMAC recommendations, or (b) approve other alternatives that achieve the same scorable savings as those suggested by IMAC. For those who believe that IMAC would work, the baseline reduction requirement wouldn't impose additional pain on the system. And for those who don't believe that IMAC would work--well, time for them to put their cards on the table as to whether they want to bend the curve on health spending or not. Think about it, please, Peter... 2. The CBO already has gotten a little bit pregnant to the extent of forecasting what congressional action would be in that it presents not just a "baseline" for government spending but an "alternative fiscal scenario." It should score the IMAC proposal in an analogous way: report, first, the effect of approving IMAC on the baseline; and, second, the effect of approving IMAC on the alternative fiscal scenario. That way they could score savings without scoring savings, if you know what I mean. Think about it, please, Doug... ## links for 2009-07-26 • I blogged recently about an interview with Eugene Fama in which he declared that people engage in careful comparisons of home prices, so the housing market should be more or less efficient. And I cited an old Larry Summers paper that mocked finance theorists as “ketchup economists”, who say that because 2-quart bottles of ketchup cost twice as much as 1-quart bottles, the price of ketchup must be right. But I’ve had a further thought.... Can [Fama] be right?... The Nasdaq lost around$3 trillion in value when it plunged, while Microsoft was worth only around $500 billion at the height of the tech boom. So the “1.4 Microsofts” line is way off. Beyond that, however, Microsoft was one of the stocks that soared during the tech boom, and subsequently fell sharply. So Fama was in effect comparing tech stocks with tech stocks, and declaring that because the comparison looked sort of reasonable, tech stocks were properly priced. In other words, more ketchup. • The whole purpose of Mann et al’s 1998 work was to... begin a dialog with other scientists.... The NAS report concluded that while there were issues with the way PCA was used in 1998, the results were confirmed by further work: "The basic conclusion of Mann et al. (1998, 1999) was that the late 20th century warmth in the Northern Hemisphere was unprecedented during at least the last 1,000 years. This conclusion has subsequently been supported by an array of evidence that includes both additional large-scale surface temperature reconstructions and pronounced changes in a variety of local proxy indicators..." In contrast, Professor Muller wrote... "In the end, there was nothing new left in Mann’s papers that the National Academy supported, other than the idea of using principal component analysis..." This is a distortion.... Nature wrote... "[T]he NAS committee more-or-less endorses the work behind the graph. But it criticizes the way that the plot was used..." • Either we are about to continue making history—and not in a good way—or current guesses about the medium-term economy are way too pessimistic. • With Brad DeLong’s caveats I agree with him that Christopher Caldwell’s FT article on the fiscal fiasco in California is quite good. But I do have one additional doubt. Brad wasn’t happy about “a pointless and unfair slam at Venezuela.” The slam in question was Caldwell’s “The state’s laws are shaped by plebiscites to a degree unmatched outside of Venezuela.” That’s not, however, just pointless. It’s actually wrong. California’s laws are shaped by plebiscites to a degree unmatched outside of Switzerland. And yet Switzerland is about as well-governed as anyplace else you care to name. It seems to me that that is what critics of California-style direct democracy need to grapple with. Swiss political institutions are different from California in a whole bunch of ways. But they both rely heavily on plebiscites. And the results are quite different. • I used to think that US Senate Barbara Boxer was an experienced legislator with a solid progressive record on the issues. But then I read this Politico article in which various anonymous people criticize her “abrasive personal style” and “outspoken partisan liberal” demeanor. Big trouble! And then I got to thinking, I recall having read similar critiques of Judge Sonia Sotomayor. And Hillary Clinton as a presidential candidate and now as Secretary of State has been subjected to similar criticism. Nancy Pelosi, too. You’ve really got to wonder what the deal is with the Democratic Party that every woman who comes forward into a position of power and influence is a shrill, castrating harridan. I mean, what are Democrats thinking? What poor judgment! Doesn’t everyone know that politics is a business in which the only people who get ahead are soft-spoken sweethearts like Rahm • Europeans, sensibly, seem to find to be generally a good thing that the mightiest military power on earth is a basically congenial country with a commitment to similar values. But they don’t like reckless policies of world domination. I wouldn’t necessarily attach any huge significance to it, but it does seem notably that France has really rocketed up the tables and became one of the most pro-American countries on earth. • Looks like Yoo cut class on the day his con law professor covered Posse Comitatus Act. Probably had some bun Federalist Society rally to attend. Dear Boalt Hall: When are you going to revoke John Yoo's tenure? Aren't you ashamed to have him on your faculty? Surely there are some deserving wine law professors out there to whom you can award his coveted slot? Maybe they could discuss the finer points of the limits of presidential power over pinot grigio on your sunny deck? Finally, why isn't today's NYT story isn't on your Faculty in the News page? • UPDATE: This is either incredibly offensive, or a very unfortunate coincidence...oh, and why is the President of the Cambridge Police Officers Union able to park illegally? Oh, right. • Shorter Peggy Noonan: "Gin! Methinks they'll tax gin!" • As for social class, however, I am unconvinced by [Douthat's] argument, because Sarah Palin is about as imperfect a test case as one could find. In seeking the second highest office in the land, she garnered uncommonly strident pushback not because she failed to check the Ivy League box, but because she couldn't put a check mark next to any of the boxes that qualifies one for the White House.... Andrew Jackson... fought in the American revolution, heroically commanded forces at the Battle of New Orleans... military governor of Florida... Tennessee constitutional convention, served in the House and in the Senate... the State Supreme Court ... successful businessman. Sarah Palin served a partial term as governor of Alaska, demonstrated policy knowledge on exactly one subject, and excited ththe base. The message to another candidate of similar qualifications should be "don't even think about" [it].... It isn't about social class. It's about everything else. ## Yet More Historical Climate Blogging Michael Mann (2002), "Climate Reconstruction: The Value of Multiple Proxies": Rich Muller emails: Dear Brad: I enjoyed skimming through your discussion of the hockey stick. I was a referee on the National Academy Report on the hockey stick (I am named in their report for this service), and so I am very familiar with what the report actually says. It is frequently misrepresented as "verifying" the hockey stick. That is very inaccurate. The report concluded that Mann's assertion that there was no medieval warm period was not supported by the data. (Mann really did have an error in his analysis.) The National Academy explicitly concluded that the most we can say about the last 2000 years is that we are now in the warmest period of the last 400 years. They criticized Mann for greatly underestimating his error bars on the data prior to 1600, and they concluded that nothing of value could be concluded for that period. The fact that we are now in the warmest period of the last 400 years was well known to everybody prior to Mann's work. That is not disputed. What Mann had "shown" was that there was no little ice age -- the cold period preceding the 20th century had extended back 800 -- then 1000 -- then 2000 years. But this conclusion is not valid according to the NAS review. The NAS review said, in effect, that the hockey stick still exists, but that it extends back only 400 years. That was known in all the earlier IPCC reports. It was the extension to 1000 AD that lead to the dramatic metaphor of the "hockey stick". So some Mann supporters are still defending him. But, in fact, there is nothing left of his publications that is new, or that disagrees with what the IPCC was saying back in 1995. Mann has defended his work by claiming that the hockey stick is still there when he does the analysis after removing the program bug. But if you read his paper, you discover that the hockey stick component that he is claiming is no longer the principle component of the analysis. (I think it was the 3rd component.) The excitement over his data was largely over the fact that the principal component, typically the only one with small error uncertainties, was hockey stick in shape. I am also amused to see that I am not considered a climate expert. I did spend over ten years of my life studying climate cycles, the details of the data and methods of analysis. I published a series of papers in Science, Nature, and elsewhere, and wrote a highly respected technical book on climate change titled "Ice Ages and Astronomical Causes." That is not a popular book. As I mentioned earlier, I was chosen by the National Academy of Sciences to be an expert reviewer on their review of Mann's work. Michael Mann, who had a major mathematical error in his published analysis, is considered an expert but I am not? Michael Mann, who has (I believe) not done any experimental work in the field, is considered an expert, but I am not? (I've analyzed Greenland ice cores for their climate record.) I guess some people pick their experts by looking at the conclusions first, and then eliminating the people who do not agree with them. Rich I am definitely a believer in the Medieval Warm Period. In a middle ages in which the stone to build Norwich Castle is shipped by sea from France, it makes absolutely no sense to argue that high costs of transport from France made it efficient to grow wine grapes in England if England then had the same climate that England does today or had in the Little Ice Age. And I am definitely not a believer in principal components analyses like those used by Mann et al.--we economists have a religious faith instead in Bayesian Kalman filters. ## in Which James Fallows Is a Frog Stepping into Global Warming Water Carrying a Hockey Stick... James Fallows writes a very strange sentence indeed: If this latest George Will opus [i.e., yet another misleading and mendacious column on global warming] serves to drive readers to [Richard] Muller's book [Physics for Future Presidents], it will have done some good... Why does Fallows write this? Will's column does not contain any recommendation that anybody read [Richard] Muller's Physics for Future Presidents or indeed contain any of the words "Muller," "Richard," "physics," "future," or "presidents." (It does, however, contain the word "for.") How can it do any good along those lines? Moreover, Richard Muller's current bottom line on global warming is opposed to Will's climate-change denialism. George Will says: [R]egarding climate change, the U.S. government, rushing to impose unilateral cap-and-trade burdens on the sagging U.S. economy, looks increasingly like someone who bought a closetful of platform shoes and bell-bottom slacks just as disco was dying. While Richard Muller says: http://muller.lbl.gov/teaching/Physics10/PffP_textbook/PffP-10-climate.htm: The temperature of the Earth (averaged over the last decade) is now the warmest that it has been in 400 years. Figure 10.1 below shows the change since 1850 was almost 2°F (about 1oC). That doesn’t seem like a lot, and in some sense it isn’t. The reason some many people worry is that they fear that this is just a portent of what is to come. A substantial part of this rise is very likely a result of human activity, particularly by the burning of fossil fuels. If that is truly the cause, then we expect the temperature to keep rising. Although cheap oil is getting scarce, at$100 per barrel or higher there seems to be lots available. (I’ll show the numbers later in the chapter.) And the countries that need lots of energy appear to have huge amounts of coal. Burn a fossil fuel, and you dump carbon dioxide into the atmosphere, and that’s the problem. Carbon dioxide is very likely to cause significant warming, and as we burn more fossil fuels, the temperature is very likely to continue to go up. In the next 50 years, the best estimates are that the additional increase will be between 3°F and 10°F. That is a lot. Already, warming in Alaska from 1900 to the present has been enough to cause significant portions of the permafrost to melt. A 10°F rise would be enough to make fertile regions in the United States arid and trigger large-scale economic disruption around the world. There is also good reason to believe that the warming will be more intense in the polar regions...

The last time I talked to Richard about this, he said (correctly and accurately) that the real big problem is that if we want to stop the 5 to 15 degree rise in temperature by 2150--the rise that would turn much of America's current agricultural heartland into arid semi-desert--(and I think we do want to stop or at least attenuate it significantly), we need to very quickly convince China and India not to industrialize by burning carbon-based fuels, and they will naturally ask what's in it for them if they do so. There is a sense in which Richard is more of an alarmist than Al Gore: Gore thinks that if the U.S. embarks on a green path its moral authority and diplomatic leverage will then pull the rest of the world along as well. Richard fears that that is not the case.

Given that, I was surprised when I read what Fallows chose to emphasize from Richard's Physics for Future Presidents:

Compare-and-contrast reading on climate change: You can see the beginning of [Richard Muller's] dissection of Gore's famous "hockey stick" chart of rising temperatures, which begins on page 292 of Muller's book, through a Google book-search excerpt here. (The hockey stick, below)

I thought "oh boy." Fallows is going to get into trouble here...

And indeed he is. The frog is on the (global warming) water. And the temperature is rising rapidly.

Let me clear away some underbrush. First of all, it is Michael Mann and his coauthors' "hockey stick" figure, not Al Gore's. Second, the hockey stick shows a 0.5F rise in temperatures between 1900 and 1950 and a 1.3F rise between 1900 and 2000--only 1/5 as large as the rise we are currently projecting under business-as-usual by 2100 and only 1/8 as large as the business-as-usual rise projected for 2150. Third, in global warming scientific uncertainty is not our friend. Scientific uncertainty leads us to do more rather than less than we would do if we knew that the midpoint of current projections accurately described how the world works.

Now, on to the main course: about the "hockey stick" nature of the black line, wikipedia reports:

Hockey stick controversy: In a letter to Nature on August 10, 2006, Bradley, Hughes and Mann pointed at the original title of their 1998 article: "Northern Hemisphere temperatures during the past millennium: inferences, uncertainties, and limitations" and pointed out "more widespread high-resolution data are needed before more confident conclusions can be reached and that the uncertainties were the point of the article." Mann and his colleagues said that it was "hard to imagine how much more explicit" they could have been about the uncertainties surrounding their work and blaming "poor communication by others" for the "subsequent confusion"...

The hockey stick graph has an explicit range of uncertainty around its black central estimate line: the range of uncertainty is provided by the grey. The hockey stick figure itself tells us that it is very possible that the world was warmer back in the Medieval Warm Period than it was in 1950, that it was likely that it was almost as warm, and that any differences in average global temperatures between 1950 and the Middle Ages one way or another are in the tenths of degrees. That seems to be right to me. (I tend to think that the Medieval Warm Period was relatively warm: in the Middle Ages they grew grapes and made wine in England, and not because sea transport from France was impossible--the stone for the walls of Norwich Castle comes from Normandy: if you can transport stone across the English Channel and through the North Sea you can transport wine. They didn't grow wine grapes in England during the Little Ice Age.)

So what, exactly, is Muller's critique of Mann's hockey stick that impressed Fallows?

I went to the Google Books link http://tinyurl.com/dl20090725a Fallows provided, and found that while Muller's pages 292 and 293 were on Google Books, pages 294-6 were not--the Google Books available section picks up on page 297, with the graph of carbon dioxide concentrations vs. temperatures since 600,000 BC. The dissection was not available. So I dropped down to U.C. Berkeley, and found the selected chapters of the textbook version of Muller's book (Google Books has the mass market version) online http://muller.lbl.gov/teaching/Physics10/PffP_textbook/PffP-10-climate.htm. I quickly found the Paleoclimate CO2-temperature figure that is on page 297 of the mass market book: "Climate (and carbon dioxide) for the past 600,000 years." But I could not find the "hockey stick" figure, or any discussion of climate in the twentieth century relative to climate in the Medieval Warm Period.

UPDATE: Sure enough, Fallows got into trouble.

He responds with a link to a "opinions on shape of earth differ" http://climatedebatedaily.com/ website and a link to the intelligent and reliable Center for American Progress http://climateprogress.org/ website, which is a version of "some say the earth is round, others say opinions on shape of earth differ" journalism--not as bad as "opinions on shape of earth differ" journalism, but not good. He responds with promises to respond later, and with quotes from Joseph Romm (who didn't like Muller's book's sections on climate change at all), from a reader "P.J.", from "a Berkeley colleague" (not me!) who says that Richard is "by no means the most authoritative research on climate change available, even on the Berkeley campus. Like Al Gore, he has now become a popularizer, and that task has inherent risks," and from Al Gore's office. On the last, Fallows writes:

Climate pushback #1, from Al Gore's office and others: Finally, a representative of Al Gore's office in Tennessee wrote to object that I had not contacted them before quoting a passage from Muller's book critical of Inconvenient Truth -- and to clarify the origin of the much-debated "hockey stick" chart used in that book and movie. The version of that chart that has been most heavily questioned, including by Muller, is from a scientist whose name I'll leave out right now, since I'm not going to the trouble of contacting him at the moment. According to Al Gore's representative:

The graph that former Vice President Gore refers to in An Inconvenient Truth (which you can verify on pages 63, 64 and 65) was produced by Dr. Lonnie Thompson, one of the country's top glaciologists, not the image that you published in your article...I'd urge you to speak with Dr. Thompson--he was awarded the National Medal of Science by President George W. Bush in 2007--our nation's highest honor for science...

Alas! Al Gore's office is wrong! The figure at issue is indeed in a paper by Thompson et al., but the figure in Thompson's paper is a copy of Michael Mann's figure--Mann being "the scientist whose name [Fallows] will leave out for the moment." Figure 7 in Thompson et al. plots (i) ice cores from South America, (ii) ice cores from Tibet, (iii) average ice cores, and (iv) Mann's estimates. Like this:

http://bprc.osu.edu/Icecore/Thompsonetal-climatic-change-2003.pdf: Thompson, L.G., E. Mosley-Thompson, M.E. Davis, P.-N. Lin, K. Henderson and T.A. Mashiotta. 2002. Tropical glacier and ice core evidence of climate change on annual to millennial time scales. Climatic Change, 59, 137-155.

The point I draw from all this is that Mann et al.'s tree rings look a lot like Thompson et al.'s ice cores. And that Muller's critique of Mann's hockey stick (whatever it might have been) is probably out-of-date--hence not in the "climate" chapter of the textbook for the current version of the course "Physics for Future Presidents."

## The Revolt of the Stenographers...

At the moment, at the top of nytimes.com are four stories:

• A pretty good story by Mark Mazzetti and David Johnston filling in details in stories reported at lest three years ago by Ron Suskind in his The One Percent Doctrine--and, of course, they do not cite or reference Suskind in any way: Mark Mazzetti and David Johnston: Bush Weighed Using Military in Arrests: "The memorandum — written by the lawyers John C. Yoo and Robert J. Delahunty — was directed to Alberto R. Gonzales, then the White House counsel, who had asked the department about a president’s authority to use the military to combat terrorist activities in the United States. The memorandum was declassified in March. But the White House debate about the Lackawanna group is the first evidence that top American officials, after the attacks of Sept. 11, 2001, actually considered using the document to justify deploying the military into an American town to make arrests. Most former officials interviewed for this article spoke only on the condition of anonymity because the deliberations about the case involved classified information...": + 1/2

• Tobin Harshaw well out of his depth on finance: he truly darkeneth counsel without wisdom--it really is too bad that he took Chris Suellentrop's "Opinionator" and trashed it: -1

• Peter Baker and Helene Cooper adding absolutely nothing to the state of play on Crowley-Gates-Obama: 0

• Michael Wilson and Solomon Moore "As Officers Face Heated Words, Their Tactics Vary" with a truly self-parodying headline adding nothing to the state of play on Crowley-Gates-Obama: 0

That's minus one-half for four--a batting average of -0.125.

At the moment, at the top of washingtonpost.com are four stories:

• Ernesto Londono doing real reporting from the urban battlefield in Iraq: "After the Shooting, Another Showdown: Deadly Clash Underscores Rift Over Interpretation of U.S.-Iraq Deal": "When insurgents attacked an American convoy with AK-47 rounds and a couple of grenades on a dusty highway in a Baghdad suburb this week, U.S. soldiers returned fire, chased the suspects through narrow alleyways and raided houses. When the shooting subsided, another confrontation began. A senior Iraqi army commander who arrived at the scene concluded that the Americans had fired indiscriminately at civilians and ordered his men to take the U.S. soldiers into custody. The U.S. military said the soldiers had acted in self-defense and had sought to avoid civilian casualties; U.S. commanders at the scene persuaded the Iraqis to back down. The incident, apparently the first time a senior Iraqi commander has sought to detain U.S. soldiers, signals a potential escalation of tensions between U.S. and Iraqi forces trying to find a new equilibrium as Iraq assumes more responsibility for its security...": +1

• Michael Rosenwald: "Digital Nomads Ditch Their Cubicles for Diners and Pool Decks"--a piece that doesn't even try to provide any information at all about how many "digital nomads" working at coffeeshops there are these days or how their lives have really been changed by the coming of wifi and lattes, and so is more an embarrassment than anything else: 0

• Jason Straziuso and Rahin Faiez doing competent stenography about the war in Afghanistan: "Suicide attackers strike southeastern Afghan city": + 1/2

• Dan Balz sucking hs thumb and adding absolutely nothing to the state of play: Obama's Ambition: Was His Strategy a Mistake?: 0

That's one and a half for four--a batting average of +0.375

Taking the eight lead stories of the New York Times and the Washington Post together, we have a batting average of +0.125.

Now let's take a look at the most recent stories for the eight top feeds in my RSS reader:

• Chris Whalen at The Big Picture on financial regulatory reform: "Is the Fed About to Lose On “Systemic Risk” Legislation?": "It is really fascinating to see how much people underestimate the political staying power of technocrats such as FDIC Chairman Sheila Bair and SEC Chairman Mary Schapiro. I get the distinct feeling that some senior members of the media, analysts and the banking community, still don’t see the ladies as serious players. If you bother to look at the Players’ Roster of American politics, it is clear that the ladies are very much in the ascendancy in Washington, both in government and in the lobbyist community. Consider the movement in terms of legislation on regulatory reform. The ebb and flow of the debate is headed very much in the direction of collective, shared authority for determining when a TBTF bank or, more specifically, a non-bank company such as AIG needs restructuring. This goes directly contrary to the Geithner proposal to give this function to the Fed...": +1

• rdan of Angry Bear sends us to Mark Thoma of Economist's View who tells us to read a 1983 New York Times story about health care reform in Canada: Douglas Martin: "Health Care in Canada: Popular System Now ROcked by Criticism": +1`

• Steve Benen reports and analyzes Obama's attempt to sell health reform: "Not surprisingly, President Obama devoted his weekly multi-media address to health care reform today -- the sixth address to emphasize reform in the last eight weeks. But what I found noteworthy about today's was the target audience of the pitch. In his five-and-a-half minute message, the president didn't mention the word "uninsured." In fact, the address wasn't geared towards the tens of millions of Americans without coverage at all. Instead, Obama talked almost exclusively about the importance of reform on businesses and employers. In fact, the president referenced the words "small business" 11 times in his message this morning...": +1

• Jim Henley of Unqualified Offerings advances the ball on Crowley-Gates-Obama: "These statistics cast an interesting light on Brandon del Pozo’s defense of police doctrine... police work is less dangerous than many other possible occupations, and that less than half that danger stems from violent resistance by suspects – the kind of 'loss of control' that defenders of Officer Crowley’s conduct during the Gates arrest point to as a major danger.... What statistics alone can’t untangle is the impact of police praxis on the danger level: is police work relatively safe because police are hardcases about maintaining control, or is it relatively more dangerous because the provoke confrontations. And the ultimate question begged previously is where police safety ought to rank in the hierarchy: is it better that police feel as safe as possible or that citizens be respected...": +1

• von of Obsidian Wings advances the ball on Crowley-Gates-Obama: "Pithlord makes clear a point that I consider essential, namely 'We all act like dicks sometimes, and I can sort of understand both Gates and Crowley's point-of-view in a subjective sense. I imagine I'd feel pissed off if I was either of them. The difference is Crowley acted illegally and unprofessionally.' (Emphasis mine.) That's a huge difference.  As I've written in comments, I don't know and don't really care if Professor Gates lost his cool and acted like a jerk.  I do know, however, that Gates didn't have a gun and the power to throw Crowley in jail...": +1

• Josh Marshall of Talking Points Memo doesn't advance the ball on Crowley-Gates-Obama: "Henry Louis Gates, Jr. says he'd be happy to have a beer at the White House with Officer Crowley and President Obama...": 0

• Heebie-Geebie on the social isolation of the mother of the neonate in modern American culture: "Lately I've gotten really into making the bed each morning. It only takes a minute, and the room looks so much tidier. I think this means I've got too much time on my hands, or maybe my brain. At least I'm not fretting about imaginary baby symptoms.... Being around babies too much is a kind of sensory-deprivation zone where you start hallucinating symptoms out of sheer boredom...": +1/2

• Steven Teles at The Reality Based Community advances the ball on Crowley-Gates-Obama: [T]his little micro-dispute in Cambridge was fundamentally a conflict about "honor." This whole thing would have been a big nothing if either man were willing to swallow his pride. The cop could have defused it by letting Gates call him a racist and have it roll off his back. He couldn't because, I think, he has a self-conception as precisely not a racist cop.... To back down would have been to... be dishonored. Gates couldn't back down and say "yes, officer, whatever you ask, officer" because he believed he was being treated in a way that was inappropriate to his status as a Harvard professor and because he thought he was being hassled because he was black. To back down would have been untrue to his idea of himself.... So they both stood their ground, and the guy with the gun won. And so Gates retaliates in the media, and with the president.... Now the Cambridge cops think that they are being dishonored.... The question is, is there any way for everyone involved here to retain their honor? That is, can they back out of this thing with the way they understand themselves, and that they want others to understand them, intact?.... Today... Obama seems to have realized that taking sides in this zero-sum conflict was not the right move, at least given his office. Which is why this is so refreshing. Whatever his flaws, Obama knows when he messed up and he knows how to find the right way to clean up his mess. Whatever his flaws, I do believe this is a man who has a touch of greatness--not from being flawless, but from being able to recognize his flaws and counteract them...": +1

That is a score of six and a half out of eight--a batting average of 0.8125: I am 6.5 times as likely to be happy that I have spent my time reading one of the top stories in my RSS reader as I am to be happy that I have spent my time reading one of the top stories printed by the New York Times and the Washington Post.

To some degree this is the "Daily Me" phenomenon: my RSS reader is now tuned to bring me things written by people I learn from, while the editors of the Washington Post and the New York Times select stories on the basis of... bizarre and incomprehensible algorithms. To some degree this is because this is because the WP and the NYT are pitched at a level far below the one I want to read at, in part because they think their audience is less clued-in than I am (Peter Baker and Helene Cooper; Dan Balz) and in part because their reporters are out of their depth (i.e., Tobin Harshaw). In part this is because they are unprofessional (i.e., Mark Mazzetti and David Johnston not situating their article in its proper context in the journalistic enterprise begun by The One-Percent Doctrine). To some degree this is because their reporters know nothing about how representative their anecdotes are and so have absolutely nothing interesting to say (Michael Wilson and Solomon Moore; Michael Rosenwald).

And then there are Jason Straziuso and Rahin Faiez performing the very useful service of writing up the briefings in Kabul, and Ernesto Londono putting his life on the line to inform us about what is going on half the world away.

With this as background, let's consider David Simon's proposals for the future of journalism. Here's David Simon with the mike:

Build the Wall : CJR: To all of the bystanders reading this, pardon us. The true audience for this essay narrows necessarily to a pair of notables who have it in their power to save high-end journalism--two newspaper executives who can rescue an imploding industry and thereby achieve an essential civic good... [and] still have a card to play... the only card that ever really mattered. Arthur Sulzberger Jr. and Katharine Weymouth, publishers of The New York Times and The Washington Post, are at the helms of two organizations trying to find some separate peace with the digital revolution.... Yet incredibly, they delay, even though every day of inertia means another two dozen reporters somewhere are shown the door by a newspaper chain, or another foreign bureau closes, or another once-precise and competent newsroom decides it will make do without a trained city editor, an ombudsman, or a fully staffed copy desk.

This then, is for Mr. Sulzberger and Ms. Weymouth: Content matters. And you must find a way, in the brave new world of digitization, to make people pay for that content. If you do this, you still have a product and there is still an industry.... I know that content wants to be free on the Internet.... I know that commentary--the froth and foam of print journalism--sells itself cheaply and well on thousands of blogs.... I know that if one of you should try to go behind the paywall while the other’s content remains free, then, yes, you would be destroyed.... But also apparent is the fact that absent a radical revisiting of the dynamic between newspapering and the Internet, there will be little cohesive, professional, first-generation journalism at the state and local level, as your national newspapers continue to retrench and regional papers are destroyed outright.

You must act. Together. On a specific date in the near future--let’s say September 1 for the sheer immediacy of it--both news organizations must inform readers that their Web sites will be free to subscribers only.... No half-measures, either. No TimesSelect program that charges for a handful of items and offers the rest for free, no limited availability of certain teaser articles, no bartering with aggregators for a few more crumbs of revenue through microbilling.... You must both also individually inform the wire-service consortiums that unless they limit membership to publications, online or off, that provide content only through paid subscriptions, you intend to withdraw immediately from those consortiums... make a voluntary donation--let’s say $10 million--to a newspaper trade group to establish a legal fund to pursue violations of copyright, either by online aggregators or large-scale blogs, much in the way other industries based on intellectual property have fought to preserve their products.... [T]he need to create a new revenue stream from the twenty-first century’s information-delivery model is, belatedly, apparent to many in the industry. But no one can act if the Times and The Post do not; the unique content of even a functional regional newspaper--state and municipal news, local sports and culture--is insufficient to demand that readers pay online. But add to that the national and international coverage from the national papers that would no longer be available on the Internet for free but could be provided through participation in the news services of the Times and The Post and, finally, there is a mix of journalism that justifies a subscription fee. Time is the enemy, however.... [F]or the Times and The Post--entities that are still providing the lion’s share of journalism’s national, international, and cultural relevance--their reach has never been greater. The proof is that while online aggregation and free newspaper Web sites have combined to batter paid print circulation figures, more people are reading the product of America’s newspapers than ever before.... No doubt some mavens of new media who have read this far have spittle in the corners of their mouths at the thought of the dying, tail-dragging dinosaurs of mainstream journalism resurrecting themselves.... [T]he fledgling efforts of new media to replicate the scope, competence, and consistency of a healthy daily paper have so far yielded little in the way of genuine competition. A blog here, a citizen journalist there, a news Web site getting under way in places where the newspaper is diminished--some of it is quite good, but none of it so far begins to achieve consistently what a vibrant newspaper, staffed with competent, paid beat reporters and editors, once offered. New-media entities are not yet able to truly cover—day after day.... Detroit lost to a better, new product; newspapers, to the vague suggestion of one.... [T]hree factors are worth noting--if only because of their relevance to the online subscription model that is clearly required: • First, there is the familiar industrial dynamic in which leaders raised in one world are taken aback to find they have underestimated the power of an emerging paradigm. When I left my newsroom in 1995, the Internet was a mere whisper, but even five years later, as its potential was becoming a consideration in every other aspect of American life, those in command of The Baltimore Sun were explaining the value of their free Web site in these terms: this is advertising for the newspaper.... Looking back, it sounds comical.... • Second, the industry leaders on both the business and editorial sides came of age in an environment in which circulation had long been a loss leader, when newspapers never charged readers what it actually cost to get the product to their doorstep. Advertising, not content, was all. This specific dynamic maximized everyone’s blindness to the real possibilities of a subscription model.... [I]f there is no profit to be had in delivering the paper product to homes at existing rates, then by all means, jack up those rates—raise hard-copy prices and drive as many readers as possible online, where you charge less, but at a distinct profit.... • Last, and perhaps most disastrous, the rot began at the bottom and it didn’t reach the highest rungs of the profession until far too much damage had been done. As early as the mid-1980s, the civic indifference and contempt of product inherent in chain ownership was apparent in many smaller American markets.... [L]tle was done by the industry to address a dynamic by which men in Los Angeles or Chicago or New York, at the behest of Wall Street, determined what sort of journalism would be practiced in Baltimore, Denver, Hartford, or Dallas. If you happened to labor at a newspaper that was ceding its editorial ambition to the price-per-share, it may have been agony, but if you were at the Times, the Post, The Wall Street Journal, or the Los Angeles Times, you were insulated.... The cancer devouring journalism began somewhere below the knee, and by the time the disease reached the self-satisfied brain of the Washington and New York newsrooms, the prognosis was far worse.... [H]ere are a few possible outcomes, if the Times and The Post go ahead and build that wall. • First scenario: The Times and The Post survive, their revenue streams balanced by still-considerable print advertising, the bump in the price of home delivery and newsstand sales, and, finally, a new influx of cheap yet profitable online subscriptions. And reassured that they can risk going behind the paywall without local readers getting free national, international, and cultural reporting from the national papers, and having seen that the paid-content formula can work, most metro dailies will follow suit.... • Second scenario: In those cities where regional papers collapse, the vacuum creates an opportunity for new, online subscription-based news organizations that cover state and local issues, sports, and finance, generating enough revenue to maintain a slim—but paid—metro desk.... In a metro region the size of Baltimore, where 300,000 once subscribed to a healthy newspaper, imagine an initial market penetration of a tenth of that--30,000 paid subscribers (in a metro region of more than 2.5 million), who are willing to pay$10 per month... for the only product in town that covers local politics, local culture, local sports, and financial news--using paid reporters and paid editors to produce a consistent, professional product. That’s $300,000 a month in revenue, or$3.6 million a year, with zero printing or circulation costs.... At $100,000 a position for editors and reporters, that’s a metro desk of some thirty-five paid souls.... • Third scenario: Except for one in which professional journalism doesn’t endure in any form, this is the worst of all worlds. The Times and The Post survive because their coverage is unique and essential. But the regional dailies, too eviscerated to offer a credible local product, cannot entice enough online subscriptions to make do. They wither and die.... But all of this is, of course, academic. Because at this moment, Mr. Sulzberger and Ms. Weymouth have yet to turn that last card. Until they find the will and the courage to do so, no scenario other than the slow strangulation of paid, professional journalism applies. Meanwhile, we dare to dream of a viable, online future for American newsrooms. A few comments: • I think Simon has gotten the hierarchy wrong. In terms of willingness-to-pay, mine is, in order: (1) the FT; (2) the Economist; (3) the Contra Costa Times; (4) the WSJ (and double if my online subscription came with the editorial page excluded); (5) the New York Times; (6) the San Francisco Chronicle... (666) the Washington Post. • So I don't see the Washington Post surviving in any scenario: what does it have to sell, after all? At the international and national level, there are lots of organizations for whom aggregating up the international and national news makes sense as a loss leader. • I do see the Contra Costa Times surviving: at a local scale, the task of aggregating up all of the press releases and police blotters and local gossip blogs is not of sufficient interest for anyone to do it for free, so there is value there. • I do see the FT and the WSJ and the Economist and--alas! given its employment of the odious Stuart Taylor, Jr., he who slammed Sonia Sotomayor for being insufficiently grateful to Princeton for its beneficence in admitting her--the National Journal surviving: beat-level knowledge and expertise at that level is valuable. • I don't know what is going to happen to the Atlantic and the NYRB and the New Yorker: it could go either way. • I don't know what is going to happen to the New York Times: it could go either way. • And I think Simon has gotten the situation very wrong: if the WP and the NYT move together on September 1 to cut off access, they die immediately and everyone switches to reading the Manchester Guardian, which flourishes. If the WP and the NYT and the LATimes and the Grauniad and the Times of London and the Telegraph all move together on September 1, they die and the Chicago Tribune flourishes. If the CT also cuts off access--if everyone with a White House correspondent cuts off access--then the White House web page becomes America's daily national newspaper, and that State and Treasury webpages become our daily free international and financial newspapers, respectively--with lots of webloggers peering over their shoulders to try to keep them somewhat honest... ## Mark Thoma Tells Us About the 1983 Health Care Reform in Canada Mark Thoma: Economist's View: From 1983: Health Care Reform in Canada: [Here] is an article on health care reform in Canada from February 15, 1983.... "The Canadian health system is really nothing more than an insurance plan for all citizens. The Federal Government and each of the 10 provincial governments put up the money, which comes from income taxes, sales taxes and, in the case of three provinces, premiums. Doctors bill the province for medical services." The issue the Canadian system faced was that some doctors had begun charging the government insurance plans more than the mandated fees, something many saw as a movement toward a private or two-tiered system and hence a threat to public health care in Canada. I was struck by how many similarities there are in the arguments to what we are hearing today. It's also interesting to look back and determine which of the scary stories about the future have come true... ## Glenn Rudebusch vs. John Taylor on the Right Value for the Interest Rate Glenn Rudebusch is making sense. John Taylor is not. Calculated Risk sends us to Jan Hatzius: Calculated Risk: The Taylor Rule Debate: [S]everal highly respected voices have weighed in on this debate, with arguments that imply a smaller need for Fed balance sheet expansion than suggested by our calculations. The first challenge came from Professor John Taylor—father of the eponymous rule—at an Atlanta Fed conference (see “Systemic Risk and the Role of Government,” May 12, 2009). Taylor argued that his rule implies a fed funds rate of +0.5%. He specifically attacked a reported Fed staff estimate of an “optimal” Taylor rate of -5% as having "... both the sign and the decimal point wrong.” What’s going on? The answer can be seen in a note published by Glenn Rudebusch of the San Francisco Fed [in May]; it justifies the Fed’s -5% figure and reads like a direct reaction to Taylor’s criticism, even though it does not reference his speech (see “The Fed’s Monetary Policy Response to the Current Crisis,” FRBSF Economic Letter 2009-17, May 22, 2009). The difference is fully explained by two choices. First, Taylor uses his “original” rule with an assumed (but not econometrically estimated) coefficient of 0.5 on both the output gap and the inflation gap, while the Fed uses an estimated rule with a bigger coefficient on the output gap. Second, Taylor uses current values for both gaps, while the Fed’s estimate of a -5% rate refers to a projection for the end of 2009, assuming a further rise in the output gap and a decline in core inflation. And Glenn Rudebusch: FRBSF Economic Letter: The Fed's Monetary Policy Response to the Current Crisis (2009-17, 5/22/2009): A rough guideline for setting the federal funds rate that captures the Fed's behavior over the past two decades is provided by a simple equation that relates the funds rate to the inflation and unemployment rates... a statistical regression of the funds rate on the inflation rate and on the gap between the unemployment rate and the Congressional Budget Office's estimate of the natural, or normal, rate of unemployment. The resulting empirical policy rule of thumb—a so-called Taylor rule—recommends lowering the funds rate by 1.3 percentage points if core inflation falls by one percentage point and by almost two percentage points if the unemployment rate rises by one percentage point. As shown in Figure 2, this simple rule of thumb captures the broad contours of policy over the past two decades.... The estimated Taylor rule can also be used in conjunction with economic forecasts to provide a rough benchmark for calibrating the appropriate stance of monetary policy going forward.... The recommended future policy setting of the funds rate based on the estimated historical policy rule and these economic forecasts is given as the dashed line in Figure 2.... [I]n order to deliver a degree of future monetary stimulus that is consistent with its past behavior, the FOMC would have to reduce the funds rate to -5% by the end of this year—well below its lower bound of zero.... The shaded area in Figure 2 is the difference between the current zero-constrained level of the funds rate and the level recommended by the policy rule. It represents a monetary policy funds rate shortfall, that is, the desired amount of monetary policy stimulus from a lower funds rate that is unavailable because nominal interest rates can't go below zero. This policy shortfall is sizable.... According to the historical policy rule and FOMC economic forecasts, the funds rate should be near its zero lower bound not just for the next six or nine months, but for several years. The policy shortfall persists even though the economy is expected to start to grow later this year. Given the severe depth of the current recession, it will require several years of strong economic growth before most of the slack in the economy is eliminated and the recommended funds rate turns positive. Economic theory suggests that it is useful for the Fed to communicate the likely duration of any policy shortfall. Monetary policy is in large part a process of shaping private-sector expectations about the future path of short-term interest rates, which affect long-term interest rates and other asset prices, in order to achieve various macroeconomic objectives (McGough, Rudebusch, and Williams 2005). In the current situation, the FOMC (2009) has noted that it "anticipates that economic conditions are likely to warrant exceptionally low levels of the federal funds rate for an extended period." Other central banks have been even more explicit about the duration of low rates. For example, the central bank of Sweden has recently stated explicitly that it expects to keep its policy rate at a low level until the beginning of 2011. Rudebusch and Williams (2008) describe how such revelation of central bank interest rate projections may help a central bank achieve its policy goals... ## Education and Equal Opportunity He writes, in the FT: The mobile society stalls at the gates of academe: Making it has been the American dream for two centuries. Horatio Alger, who died 110 years ago this month, wrote dozens of hugely popular novels (Struggling Upward, Strive and Succeed) that imprinted the aspiration on millions of minds. In their pages boys would rise from poverty to the middle class, often through the kindly intercession of older men but always with a display of grit. The theme spanned the 19th-century Atlantic: Samuel Smiles (1812-1904) promoted the theme of social advancement through individual striving in Self Help (1859) and other works. The career of his fellow Scot Andrew Carnegie, moving from real childhood rags to world-beating riches in early middle age, gave foundation to such exhortations. But where the myth had reality, it now has less. Recent studies show that the US is near the top, and the UK in the upper levels, of the league of developed states in which the poor do not or cannot help themselves to rise. One much quoted study notes that “the idea of the US as ‘the land of opportunity’ persists; and clearly seems misplaced”. Why? Education is at the root. In the land of opportunity, the immigrants of the 19th and early 20th century could rise – or at least their families could – with the burgeoning industrial economy. In 1914, Ford’s workers were three-quarters foreign-born, and their jobs did become as solid and middle-class as Alger imagined – if more through militant unions than kindly benefactors. Now, the good jobs need at least one college degree: a PhD is no longer synonymous with genteel scholarly shabbiness but can be leveraged into great wealth, personal and corporate. George Borjas, the economist, reckons that where children of immigrant parents had, for much of the last century, easily surpassed the earnings of their fathers and mothers, they now more often stick at the same level. Because US immigrants are disproportionately little-educated Mexicans, and because they tend to stay in Hispanic enclaves, their ability and willingness to mount the academic ladder is limited. The lesson travels: acculturation to norms of ambition, improvement through education and willingness to integrate into the broader society (which means a loss of distinct identity) are good ideas for social mobility in all societies. Insofar as some communities – including indigenous working-class communities – wish to emphasise their difference, their place on the lower rungs of class society will remain. Thus, curiously, the university becomes an ambiguous social factor. The more education it confers, the better the possibility for advancement up through the classes. But it also functions as a filter: the professions, and higher earnings, are now so routinely associated with the degrees it gives that those without its benison find the career and class bonds tighter than ever.... This week’s British Cabinet Office report on access to the professions presents the narrowing of access in stark terms, forecasting a kind of caste society in which professionals are drawn largely from the 30 per cent of the most highly educated (and higher social classes) of the population. This is true of all professions in wealthy countries – even as they have recruited more women, as the gender pay gap has fallen and as minority groups have seen their representation in the professions rise.... [I]ndividual and family mobility – another irony – seems better served in states with a strong social democratic tradition. In the Scandinavian countries, Denmark in particular, movement up (and down) is better lubricated. One cannot have everything. The international tables of top universities are dominated by the US and the UK, which cater for global as well as their own elites. Hard-driving and expensive private schools are embedded in the Anglo-American social fabrics; the Cabinet Office report shows that some professions – such as the judiciary and journalism – are at the higher levels dominated by their products. When this writer began in a provincial newsroom, he was one of two graduates; the route to national glory could still be trod by a school leaver with shorthand and sharp elbows. Now, it would be far more difficult.... [P]arents who push for entry to better schools, or better schooling in the one they get, are the real motor forces of a dynamic society. The antidote to social ossification would thus seem to be a new kind of class struggle, a storming of the frozen winter palaces that tutor and employ our increasingly entrenched elites. [1] "Intergenerational mobility in Europe and North America": Blanden, Gregg and Machin (LSE, 2005) Three preliminary points: • First, although the myth of upward relative mobility through luck and pluck did have some reality, it never had much. • Second, very few Ph.D.'s can be "leveraged into great wealth, personal and corporate"--engineering and biotech and finance only, and not all of engineering and biotech and finance. For the overwhelming majority, Ph.D.s are still "synonymous with genteel scholarly shabbiness": don't get a Ph.D. if you aren't driven to spend your life telling people what you know and trying to learn more--it will be ta mistake. • Third, Borjas's findings about income across the generations are mostly due to the stagnation society-wide of all incomes in America save those of the very top of the income distribution; I have seen no evidence that little-educated Mexican-Americans are following any different a path from the one that little-educated Slovak-Americans or Polish-Americans or Greek-Americans or Italian-Americans or Chinese-Americans of a century ago--and the incomes of little-educated Mexican-Americans today are definitely converging to the English-speaking norm much faster than did the incomes of little-educated ex-slave African-Americans of a century and a half ago. And two main points: • First, the more unequal a society is in an "inequality of result" sense, the more important is equality of opportunity--the greater is the injustice done by the deprivation of equality of opportunity--and the harder it is to attain equality of opportunity as parents of greater relative wealth and status have more social power to deploy to gain an edge for their children. It is no mystery, no surprise, and no irony at all that intergenerational social mobility is greater in countries with a strong social-democratic tradition. • Second, it is very difficult to have a great deal of power in this society if you are not exquisitely well-prepared to compete when you are 25--which requires that you have or be able to rapidly acquire patrons and that you went to and took advantage of a good college or did something else functionally equivalent, which requires that you applied yourself in high school, which is very hard to do unless you got a solid foundation in terms of basic skills and study habits in elementary school. This means that (i) people who are scared off from going to college because of the debt it incurs have a very small shot at large amounts of upward mobility, and (ii) the decisions people make when they are seven about how to spend their time shape their lives for the next seventy years. In even a half-good society, one should not be able--it should not be the rule--that one can greatly narrow the possibilities for one's life by what one does or fails to do at seven. I am still not sure whether my beliefs that in a good society higher education--indeed, all education--is free to the students and that elementary-school teaching is a very high-status profession reflect my own biases produced by my own position within this society or whether my beliefs are a rational assessment of reality, but it is worth thinking about... ## links for 2009-07-25 • The science of politics, however, like most other sciences, has received great improvement. The efficacy of various principles is now well understood, which were either not known at all, or imperfectly known to the ancients. The regular distribution of power into distinct departments; the introduction of legislative balances and checks; the institution of courts composed of judges holding their offices during good behavior; the representation of the people in the legislature by deputies of their own election: these are wholly new discoveries, or have made their principal progress towards perfection in modern times. They are means, and powerful means, by which the excellences of republican government may be retained and its imperfections lessened or avoided. • According to the New York Times: 'According to the Labor Department, 5 of the 10 occupations expected to add the most jobs through 2016 are “very low paying,” up to a maximum of about$22,000 a year. They include retail sales jobs and home health aides. Another 3 of the 10 are “low paying,” from roughly $22,000 to$31,000, including customer-service representatives, general office clerks and nurses’ aides.' Those are the careers that are left when high paying manufacturing and white collar jobs are shipped overseas. 8 of 10 jobs will be low or very low paying. That means the median income will surely drop over the next decade, which makes you wonder how consumption can stay robust - without borrowing.
• [T]he creation of the university in 1868 embodied a genuinely noble democratic idea, one simultaneously embracing egalitarianism and excellence. The state of California determined to establish an elite public university that could rival any private institution on the East Coast, and one that, in addition, would be effectively tuition-free to any qualified California resident. There's something admirably American, and perhaps admirably western, about the whole notion. This would be an institution free of class and familial and financial restrictions; it would pursue excellence without regard to such feudal vestiges, and it would open up opportunity to those formerly excluded.... But it now looks as if those days are over. It won't happen overnight, and it won't happen completely. But absent an unlikely, massive injection of private funding, the university is on an inexorable glide path downward.
• If the Democrats' health reform plan really doesn't do anything to cut costs, why is the private health care and insurance industry fighting so hard in the White House and Congress against it? Perhaps it's out of a selfless concern to protect the best health system in the world.

## Christopher Caldwell on a Failure of Direct Democracy

This is his take on what has gone wrong with California's government:

California’s fiscal charade: California’s problems are those of “direct democracy”.... In voting on “propositions”, which sometimes touch on detailed budgetary matters, citizens of the Golden State have stood up consistently for two principles: the state should provide vastly more services to its citizens, and citizens should pay vastly less to the state. In 1978, Proposition 13 halved government’s take from property taxes; a decade later, Proposition 98 required the state to spend 40 per cent of its “general fund” on schools. Adding to the problem is the requirement of supermajorities for raising taxes.

The present impasse reflects a problem of long standing, even if its severity is unprecedented. Ronald Reagan won the state’s governorship in 1966 by promising to do something about the budget deficit, which had by then risen to a calamitous $194m. Today, the state not only has a$26.3bn (£16bn, €19bn) budget gap but is constrained by all sorts of powerful institutions and laws from closing it....

[M]uch of the budget plan hammered out on Monday consists of accounting tricks. Unable to go to the banks to borrow, the state is borrowing billions from local counties and communities by simply not disbursing the money it is supposed to. If cities really want their programmes funded, they can try the credit markets themselves. A payday that was supposed to come next June has been pushed back into July, so that it will fall in the following fiscal year. Another trick is the accelerated withholding of state income tax. Instead of deducting 25 per cent of taxes per quarter, the state will deduct 70 per cent in the first six months of 2010, so that 20 per cent of revenues from the next fiscal year will be brought forward into this one. This is not a solution. This is changing your phone number so you can get some rest from the bill collectors who are dunning you....

It is an enduring mystery why US pundits should see a difference between the philosophy of Democrats (who stand for spending more than you raise) and the Republicans (who stand for raising less than you spend). Typical was a Chronicle editorial blasting Republicans for their insistence that the budget crisis be resolved in a way that did not involve tax hikes.... A stronger case can be made that tax revenues are too unpredictable. Here Proposition 13 is blamed for moving the burden from property to income taxes, which are more sensitive to economic fluctuations. In a boom economy, there is plenty of money to pay for the unemployment benefits that no one needs. When you have 12 per cent unemployment, as California does now, the state is too strapped to do anything. This accusation is true enough....

California’s fiscal difficulties are like a lot of things in life. Everyone warns you that there are certain hard and fast rules – like not confusing wishes with entitlements – that you break at your peril. You begin to break them and what happens? Nothing! Nothing at all, and for the longest time. You are like a ship that has lost its anchor. You can drift very pleasantly, day after day, believing you do not need an anchor at all, before one day you realise, quite suddenly, that you do.

There are three things wrong with Caldwell's piece:

• His denunciation of the media for seeing a difference between California's Democrats--who want to solve the fiscal crisis by a combination of spending cuts, tax hikes, and accounting gimmicks--and California's Republicans--who want to solve the fiscal crisis by a combination of spending cuts and accounting gimmicks.
• A pointless nd unfair slam at Venezuela.
• A strange claim that Iceland "levied too much of its taxes on property" when actually it levied taxes on transactions: transactions taxes are not property taxes--they are turnover taxes.

But all in all, he says some smart things. Alexander Hamilton thought that by the 1780s "the science of politics... has received great improvement" since the age of classical Athens and Rome. Alexnder Hamilton would weep at California today:

Federalist No. 9: It is impossible to read the history of the petty republics of Greece and Italy without feeling sensations of horror and disgust at the distractions with which they were continually agitated... perpetual vibration between the extremes of tyranny and anarchy. If they exhibit occasional calms, these only serve as short-lived contrast to the furious storms that are to succeed. If now and then intervals of felicity open to view, we behold them with a mixture of regret, arising from the reflection that the pleasing scenes before us are soon to be overwhelmed by the tempestuous waves of sedition and party rage. If momentary rays of glory break forth from the gloom, while they dazzle us with a transient and fleeting brilliancy, they at the same time admonish us to lament that the vices of government should pervert the direction and tarnish the lustre of those bright talents and exalted endowments for which the favored soils that produced them have been so justly celebrated.... [I]t not to be denied that the portraits they have sketched of republican government were too just copies of the originals from which they were taken. If it had been found impracticable to have devised models of a more perfect structure, the enlightened friends to liberty would have been obliged to abandon the cause of that species of government as indefensible. The science of politics, however, like most other sciences, has received great improvement. The efficacy of various principles is now well understood, which were either not known at all, or imperfectly known to the ancients...

## Lunch with Neel Sinhababu

Lunch with the Ethical Werewolf...

Sample sentence: "If the provost last year had resigned his job this summer, the provost would probably still be eating lunch here."

I find myself more and more impressed by how close people's real selves are to their virtual selves...

Subject of conversation: "swordfish".

## Barry Eichengreen, the Samwickian Fallacy, the Role of the Economist, and Chinese Economic Policy

Barry Eichengreen said he never understood the math of the stimulus:

All Stimulus Roads Lead to China: Now that the “green shoots” of recovery have withered, the debate over fiscal stimulus is back with a vengeance. In the US, those who argue for another stimulus package observe that it was always wishful thinking to believe that a $787bn package could offset a$3tn fall in private spending. But unemployment has risen even faster and further than expected. Combine this with the continued fall in housing prices, and it is understandable that consumer spending remains depressed. The banks, having been recapitalised only to the extent necessary to keep them afloat, still have weak balance sheets. Their consequent reluctance to lend constrains investment. Meanwhile, state governments, seeing revenues fall as a result of lower taxable incomes last year, are cutting back like mad. If there was a case for additional stimulus back in February, that case is even stronger now...

And then I think Barry takes a misstep:

But the case against additional stimulus is also strong. The US federal deficit is an alarming 12% of GDP, and public debt as a share of national income is already projected to double, to 80% of GDP. The idea that the US can grow out of its debt burden, as did Finland and Sweden following their financial crises in the 1990s, seems unrealistic...

At a 3% per year average inflation rate, the trend growth rate of nominal GDP in America is somewhere between 6% and 7%. The U.S. Treasury can currently borrow at 3 years for a nominal interest rate of 1.62%, for ten years at a nominal interest rate of 3.72%, and for 30 years at a nominal interest rate of 4.58%. When the growth rate of your economy is greater than the interest rate you have to pay, that is the definition of "grow[ing your way] out of [your] debt burden--as long as you can keep your budget in primary balance: keep non-interest spending at or less than your revenues so that your net nominal debt issues are zero.

Is the U.S. in primary balance? Almost--if you take the CBO's "Alternative Fiscal Scenario" as your baseline, which you should, it wouldn't take much in the way of tax increases to get us there by 2012. We should, I firmly believe, put those tax increases in place now: pass legislation with standby triggers so that if we are not in primary surplus by 2012 the surtaxes kick in. And doing so does not seem unrealistic to me at least.

CBO Extended Baseline:

CBO Alternative Baseline:

The fact is that the approporiate fiscal policy for the U.S, right now is to pass: (a) a bigger stimulus over the next two years, (b) a standby tax increase to return the federal budget to primary surplus by 2012, and (c) devout and lengthy prayers that confidence in the dollar doesn't collapse and send interest rates on U.S. Treasuries above the economy's growth rate--in which case the situation changes from its current value of "dire" to "catastrophic."

But Barry appears to think differently:

[M]ore deficit spending will only stoke fears of higher future taxes and inflation... encourage the reemergence of global imbalances... not reassure consumers or investors.... [T]he politics all point in one direction. The US Congress lacks the stomach for another stimulus package.... Disappointment over the effects of the TARP has already destroyed popular – and Congressional – support for more public money to recapitalise the banks. So, even those who find the economic logic of arguments for fiscal activism compelling must acknowledge that the politics are not supportive. A second stimulus simply is not in the cards...

Or does he? I suspect that Barry agrees with me on what the appropriate fiscal policy for the U.S. is, he just believes that it is politically unrealistic to argue for such a policy. I believe that Barry is committing a common fallacy what I call the Samwickian fallacy, after Andrew Samwick's explanation of the failure of the Bush administration Council of Economic Advisers to argue for the imposition of a carbon tax:

Republicans and Gas Taxes: [Politics] sets the framework for all policy outcomes--not the CEA--even on economic issues. CEA... works to generate the best outcomes within that framework. And if the President is not interested in a gas tax, then it becomes a very short conversation...

The Samwickian fallacy is the claim that economists should censor themselves and not argue for the best policies when those policies are not politically attainable, but should instead argue for the best politically-attainable policies. That, I think, mistakes the economist's role. First of all, economists are lousy at figuring out what is and what is not politically attainable. Second, to make powerful and convincing arguments that policies that are not politically attainable are in fact best for the country and the world is the best way to stretch the boundaries of the politically attainable.

It is Barack Obama's, Rahm Emmanuel's, Nancy Pelosi's, and Harry Reid's job to figure out what is politically attainable. It is our job to figure out what it would be best to do. It's not at all clear to me that a combination of (a) more stimulus now, (b) standby taxes later, and (c) health and climate-policy reforms that promise to improve the country's fiscal balance after 2012 will not be very politically possible come September--if those of us who know enough to know that such policies are best for the country and the world spend the rest of the summer strenuously arguing for them.

Barry, however, despairs and seeks to persuade not the U.S. government but the government of China to do what is economically good for the U.S and the world:

If there is going to be more aggregate demand, it can come from only... emerging markets like China. The problem is that China has already done a lot to stimulate domestic demand, both through government spending and by directing its banks to lend. As a result, its stock market is frothy, and it is experiencing an alarming property boom. Through May, property prices were up 18% year on year. Understandably, Chinese officials worry about bubble trouble. The obvious way to square this circle is [for China] to spend more on imports... purchase more industrial machinery, transport equipment, and steelmaking material, which are among its leading imports from the US. Directing spending toward imports of capital equipment would avoid overheating China’s own markets, boost the economy’s productive capacity (and thus its ability to grow in the future), and support demand for US, European, and Japanese products just when such support is needed most. This strategy is not without risks.... But these are risks worth taking if China is serious about assuming a global leadership role.

## David Lat Describes His Panel at the Ninth Circuit Judicial Conference

He is surprised that Monterey is cold in the summer:

At the Ninth Circuit Conference: Kathleen Sullivan and Janet Napolitano - Above the Law - A Legal Tabloid - News, Gossip, and Colorful Commentary on Law Firms and the Legal Profession: Greetings from the Ninth Circuit Judicial Conference. We've been having a great time schmoozing with federal judicial celebrities, here in lovely (but surprisingly chilly) Monterey. Yesterday we participated in an excellent panel discussion about the future of journalism, together with some boldface names: Linda Greenhouse (moderator), former Supreme Court correspondent for the New York Times; Nina Totenberg, of NPR; Judge Robert Lasnik, chief judge of the Western District of Washington; and Hal Fuson, Executive Vice President, Copley Press. We got to play the role of blogger-barbarian at the gate, which was fun...

David is very polite. He did not mention the two "huh?" moments of his panel:

• Nina Totenberg, saying that organizations that lead people to expect that they can get their news without paying for it or watching ads on it are destructive--organizations, that is, like the National Public Radio that pays her her salary...

• Nina Totenberg again, saying that sometimes when she goes on the air in the afternoon she hasn't read the just-released-that-morning Supreme Court case she is talking about...

## Buce on the Birthers

From the Underbelly of Palookaville, CA:

Underbelly: Bernie and the Birth Certificate: One of my favorite undergrad instructors back at Antioch in the 1950s was a guy named Bernie Weisbesrger, who taught Intro to Western Civ. He was not the sort to dress up in costume, but he did do a marvellous rendition of Martin Luther in German to show us, as he said, just how argumentative those Protestant reformers could really sound. That sort of thing.

Bernie's introduction on the first day of the first semester, was an introduction to the historical method.

Good morning, my name is Bernard Weisberger. At least I think it is Bernie Weisberger. Indeed, I sincerely believe it to be so, but of course the sincerity of my own belief is no evidence at all for the truth of the proposition at issue. Aside from my own belief--my mother told me my name was Bernard Weisberger. She perhaps had the attributes of a good witness, but she might have been mistaken, or she might have been lying. I have also seen a birth certificate saying that I am Bernard Weisberger, but of course it might have been forged, or it might not be really mine at all...

You can see where this is going. We were off on a merry romp through the jungles of critical judgment, laced with the darker menace of phyrronism. That, even more than the bare substance, became the agenda for a truly memorable undergraduate course. The lesson, at least as I understood it, was twofold. On the one hand, nothing is certain--certainly not your mother nor the state. On other hand--and I think this was perhaps equally important, if easy to obscure--on the other hand, life goes on. Nothing is certain but we make judgments and act upon them, all the time recognizing that we really do not, in the strict sense, have any idea what we are talking about it.

I think of this whenever I try to follow the allegations about how the holocaust was a fantasy, or that the moon landing was a smoke-and-mirrors show, or any of the rest of the catalog of fantasies in the Rough Guide to Conspiracy Theories (a delightful book, by the way, highly recommended. Strictly speaking, I suppose it is possible that, e.g., umpty ump pretended survivors gave consistent false testimony on the attempted eradication of the Jews. But I don't think it is even remotely likely and I have long since relinquished according the idea any but the most transitory thought.

Still, one remarkable and easy-to-ignore fact about virtually all conspiracy theories, together with urban legends and suchlike, is that they respond to real human concerns.... So it is hardly surprising that some segment of the population sincerely entertains that the proposition that the incumbent President was not born in the place where the (alleged) birth certificate or the (putative) newspaper from that day and place says he is. And they may be right. For all I know, he was born in Kenya; hell, for all I know, his middle name is Murray and he arrived full-blown from the planet Zyrcon. The only surprise, I suppose, is that prominent people in a party that wants to be taken seriously as part of government--that people who look like grownups will struggle so hard not to be seen as such.

## Federal Reserve Balance Sheet with Added Background Image of Ben Bernanke

Phil Izzo emails:

Longtime reader, first-time correspondent. Anyway, I noticed that you put up Jim Hamilton's great Fed balance sheet graph. I was wondering if you had seen the interactive one we put up on RTE. It's dumbed down a bit, but I thought you might think it was cool. http://blogs.wsj.com/economics/2009/07/16/a-look-inside-feds-balance-sheet-71609-update/

No, I hadn't seen it--a flaw in following Real Time Economics via RSS. It is cool, with a brooding picture of Our Overlord Ben Bernanke in the background, and with rollovers...

## The Federal Reserve Balance Sheet

Everybody loves this chart. Nobody can explain it without long and detailed notes. I certainly cannot...

## Robert Waldmann Predicts a Jobless Recovery too...

Well, that's discouraging! I was hoping he would disagree with me!

Robert Waldmann:

Broken Okun ~ Angry Bear: i too predict a jobless recovery.... I can reformulate Brad's model. The key variable is managers' perception of the persistence of shifts in demand for their products. If they think that demand for their products will recover soon, they hoard labor. If they think that it will stay low, they lay off workers until they can just meet current demand. This means that a recession accompanied by a sectoral shift will cause a larger decline in employment. During the recovery, firms in the expanding sector will increase employment slowly as they can only train so many new workers....

Oddly, however, Brad and I have co-authored a paper with [yet] a third explanation: http://ideas.repec.org/a/fip/fedfer/y1997p33-52n1.html

Our claim is that in the USA the Okun's law coefficient is an increasing function of the unemployment rate. The story is simple, if there is high unemployment, firms can lay workers off and then rehire them later, because the workers won't have found new jobs and will just have to wait to get their old jobs off. This suggests that the modified Okun's law gives a nonlinear and in particular concave relationship between unemployment and GNP minus trend (or GNP minus peak or GNP minus last years GNP). This means that the drop in GNP wich corresponds to an increase of unemployment form say 5 to 9% is less than twice the drop in GNP which corresponds to an increase from 5% to 7%. A model in a published paper predicts well out of sample. So why is Brad psychoanalyzing businessmen?

## The Straphangers Pay the Dividends!

Coming soon to my flights to Seattle, Portland, Santa Barbara, Los Angeles, San Diego, and Las Vegas.

Kelly Evans:

Would You Stand on Short Flights if It Meant Cheaper Fares?: Irish-based discount airline Ryanair recently polled 120,000 passengers on its Web site with the following question: would you be willing to stand on short flights? The answer was an overwhelming “yes” — if the tickets were free. Two-thirds of respondents said they’d stand on flights of less than an hour if their tickets were free; 42% were willing to do so for tickets that were half-off. According to Marketwatch.com: A spokesman for Ryanair, Stephen McNamara, said the airline is looking to replace traditional seats with “vertical ones,” which on a typical flight would allow between 50 and 60 additional passengers.

## Jonathan Cohn on the Congressional Budget Office and Health Care Reform

Jonathan Cohb:

Does House Bill Deal With Costs? Yes. No. Maybe: The CBO, again, makes projections based on fairly conservative assumptions about the impact of efficiency changes to health care. In effect, it assumes the worst. As far it's concerned, there are really only a handful of ways to substantially reduce costs--that is, to bend the cost curve down--over the long run. You can cap or eliminate the tax exclusion, which CBO believes will drastically alter incentives and put downward pressure on costs You can create sort of automatic budget mechanism that reduces spending levels if savings don't materialize over time. (The 1993-94 Clinton health care plan had something like this.) You can also take payment policy out of the hands of Congress and put it in the hands of an independent authority.... The House bill has none of these things.  Ergo, CBO Director Doug Elmendorf on Thursday said it would not contain costs. His testimony was widely seen as an effort to put the tax exclusion back on the table, since it's a CBO favorite. I think that reading was accurate--and I think that's why he was so definitive.

Other experts, however, think the CBO is way too pessimistic on this. The most famous is David Cutler, who argues you don't need those three tools to get big savings. He says that a combination of other changes--including better information technology, comparative effectiveness research, bundling of hospital payments, and moving towards integrated care--can do the trick. If Cutler is right, then something like the House bill--with maybe a few more bells and whistles--will indeed reduce costs significantly over the long term.

One thing to keep in mind: There's a vast middle ground between doing nothing about long-term costs and bringing long-term costs "under control." It's entirely possible the House bill, or something like it, will make progress on bending the cost curve--just not as much as some of us would like. If it did that while simultaneously making insurance coverage available to all and making the system more efficient, that'd still be a pretty big accomplishment...

The problem, I think, is that the CBO has a category for cost control but no category for getting system incentives right. It is a budget office, after all, not a philosopher-king office. The problem, however, is that it is the only arbiter out there. And there appear to be a lot of members of congress who think controlling costs = getting system incentives right.

I don't think we should care much about costs: it might be in the future we want to spend a lot on health; it might be that in the future we develop magic treatments and so want to spend a lot less. If we get the system incentives right, then whatever we spend on health will turn out to be the right thing to do.

## Worrying About the Long Run Fiscal Picture: DeLong Smackdown Watch (Conference Call Version)

A snippet from a conversation:

Brad DeLong: For some time I have been lulling myself to sleep every night by saying: "The U.S. Thirty-Year Treasury interest rate is still low; until the bond market is worried about the unsustainability of U.S. fiscal policy and that shows itself in Treasury bond prices I shouldn't worry either." Can I still do so?

Sokrates: I very much doubt, given your general view of the accuracy, rationality, and foresight of asset markets, that you have ever in fact lulled yourself to sleep in that way...

This is a severe problem with my attempt to visualize the Cosmic All. On the one hand, I believe that the financial market is often feeding very wrong prices to the real economy--that the no-free-lunch fact that it is very hard to make lots of money quickly without assuming much risk off a relatively small capital base does not imply the price-is-right version of the efficient market hypothesis.

On the other hand, I do find myself over and over again reaching for asset prices as sources of information about the likely future, or at least the generally expected future, or at least about what average opinion expects average opinion to expect the conventiona wisdom about the likely future to be.

This is a problem...

## When Other Countries Have the Money...

The Chinese government has in the past mostly parked its wealth accumulations in low-yielding Treasuries. Now it is about to shift--in a way that will have important but at this moment hard-to-foresee consequences.

Jamil Anderlini of the FT:

China to deploy foreign reserves: Beijing will use its foreign exchange reserves, the largest in the world, to support and accelerate overseas expansion and acquisitions by Chinese companies, Wen Jiabao, the country’s premier, said in comments published on Tuesday. “We should hasten the implementation of our ‘going out’ strategy and combine the utilisation of foreign exchange reserves with the ‘going out’ of our enterprises,” he told Chinese diplomats late on Monday.

Mr Wen said Beijing also wanted Chinese companies to increase its share of global exports. The “going out” strategy is a slogan for encouraging investment and acquisitions abroad, particularly by big state-owned industrial groups such as PetroChina, Chinalco, China Telecom and Bank of China.

Qu Hongbin, chief China economist at HSBC, said: “This is the first time we have heard an official articulation of this policy ... to directly support corporations to buy offshore assets.” China’s outbound non-financial direct investment rose to $40.7bn last year from just$143m in 2002.

Mr Wen did not elaborate on how much of the $2,132bn of reserves would be channelled to Chinese enterprises but Mr Qu said this was part of a strategy to reduce its reliance on the US dollar as a reserve currency. “This is reserve diversification in a broader sense. Instead of accumulating foreign exchange reserves and short-term financial assets, the government wants the nation to accumulate more long-term corporate real assets.” State-owned groups, particularly in the oil and natural resources sectors, have stepped up their hunt for overseas companies and assets on sale because of the global crisis. China Investment Corp, the$200bn sovereign wealth fund, has been buying stakes in overseas resources companies and has taken a 1.1 per cent stake in Diageo, the British distiller.

In an interview published in state-controlled media, the chairman of China Development Bank said Chinese outbound investment would accelerate but should focus on resource-rich developing economies. “Everyone is saying we should go to the western markets to scoop up [underpriced assets],” said Chen Yuan. “I think we should not go to America’s Wall Street, but should look more to places with natural and energy resources.”

• here are the three key issues we're going to be following in every public comment 1) Timeline. Who's controlling the timeline? Do the White House and the reformers press for bills before the August break or give way to the opponents pushing the agenda of delay? 2) Public option. Particularly, is the White House making it a line in the sand, as Obama seemed for the first time to suggest over the weekend? Or do they continue to play for intentional ambiguity? 3) Aggregate Cost. In many respects, right now this is even more a political issue than a substantive one because of last week's CBO chief's comments, which seemed to push all before it late last week. To be clear, there are numerous complex and very important policy questions not covered here. But that's not the point of this exercise. We trying to understand the terms of the political debate. And I think if you can get clarity on these three points you'll have a very good read on what kind of bill, if any, is going to end up o
• The antediluvian political culture of Coburn and his peers, for all its roots in the race-baiting “Southern strategy” of the Nixon era, is actually of a more recent vintage. It dates back just 15 years, to what my Times colleague Sam Tanenhaus calls conservatism’s “most decadent phase” in his coming book “The Death of Conservatism.” This was the Newt Gingrich revolution, swept into Congress by the midterms of 1994. Its troops came armed with a reform agenda titled the “Contract With America” and a mother lode of piety. Their promises included an end to federal deficits, the restoration of national security, transparent (and fewer) House committees, and “a Congress that respects the values and shares the faith of the American family.” That the class of ’94 failed on almost every count is a matter of history, no matter how hard it has retroactively tried to blame its disastrous record on George W. Bush. Its incompetence may even have been greater than its world-class hypocrisy. Its only
• In his new book... Tyler Cowen writes: "Placebo effects can be very powerful and many supposedly effective medicines do not in fact outperform the placebo. The sorry truth is that no one has compared modern education to a placebo. What if we just gave people lots of face-to-face contact and told them they were being educated?" He reluctantly provides the terrifying conclusion: Maybe that's what current methods of education already consist of.
• Tom Raum offers up a provocative AP story about the fact that we won’t be getting a Mid-Session Review on the budget from OMB for a little while yet.... Now it’s true that this “usually” happens in mid-July. But it’s also “usually” the case that the President in any given July is the same President you had the previous July. In transition years, it’s normal for the budget process to be pushed back in time.... There’s no conspiracy here. Meanwhile, note the annoying tendency of important media actors to “go meta” rather than acknowledging their own role in the process. Tom Raum of the Associated Press is doing the speculating here. But instead of admitting that.... Raum is pretending.... In the current version of the story, graf twenty-two finally gives us “[t]hey blame the delay on the fact that this is a transition year between presidencies” with no acknowledgement that Obama’s schedule is, in fact, identical to the schedules involved in the past two transition years.

## We Are Live at The Week with "The Jobless Recovery Has Begun"...

http://www.theweek.com/article/index/98770/The_jobless_recovery_has_begun: May I beg after the fact for "the jobless reovery may well be about to begin" for a title? I feel a bit overexposed here...

The financial crisis that gathered force from the summer of 2007 through the summer of 2008 and then exploded after the collapse of Lehman Brothers last fall did more damage to the economy than most forecasters had imagined. Last December, economists forecast 2009 unemployment at 7.8 percent. As of this writing, it seems likely to be 9.3 percent or higher—at least 1.5 percentage points higher than originally estimated. Year-2009 real GDP also looks to be lower than predicted—coming in at $11.4 trillion rather than the$11.53 trillion forecast by the Obama administration. Even without the downward revision of GDP, however, the next stretch of road bears all the marks of a jobless recovery.

Back in the 1960s one of President Johnson's economic advisers, Brookings Institution economist Arthur Okun, established a rule of thumb quickly named "Okun's Law." Here is the gist: if GDP (production and incomes, that is) rises or falls two percent due to the business cycle, the unemployment rate will rise or fall by one percent. The magnitude of swings in unemployment will always be half or nearly half the magnitude of swings in GDP.

Why?

Four reasons: (a) businesses will tend to "hoard labor" in recessions, keeping useful workers around and on the payroll even when there is temporarily nothing for them to do; (b) businesses will cut back hours when unemployment rises, reducing output more than proportionately because total hours worked will fall by more than total bodies employed; (c) plant and equipment will run less efficiently when hours are artificially shortened; and (d) some workers who lose their jobs won't show up in the unemployment statistics, choosing instead to retire or drop out of the labor force.

For all four of these reasons, the rise in the unemployment rate during a recession should be a fraction of the decline we see in GDP relative to trend. According to Okun's Law, the unexpected extra 1.2 percent decline in real GDP in 2009 should have been accompanied by a 0.5 or 0.6 percentage-point rise in the unemployment rate. Instead, we experienced a 1.5 percentage point rise in the unemployment rate. I confess this comes as a surprise to me, but it shouldn't. Because evidence has been mounting that Okun's Law is broken—especially with regard to the retention of workers in a downturn.

In 1993—two full years after the National Bureau of Economic Research said that the 1990-1991 recession had ended—the unemployment rate was still higher, and the employment-to-population ratio lower, than it had been at the recession's trough. We saw this same kind of "jobless recovery" after the recession of 2001. It wasn't until 55 months after that recession ended that a greater share of Americans were working than had been working before the contraction.

Now in 2009, we are poised once again for economic recovery. But as the old Texas Ranger George W. Bush liked to say: "Fool me once, shame on you. Fool me twice—we won't get fooled again!"

So get ready for another jobless recovery.

The question is, why the shift? Why is a jobless recovery likely now, and why have there been jobless recoveries for the past two decades?

Paul Krugman has a theory: "[Past] recessions . . . were very different. . . . Each of the slumps—1969-70, 1973-75, and the double-dip slump from 1979 to 1982—were caused, basically, by high interest rates imposed by the Fed to control inflation. In each case housing tanked, then bounced back when interest rates were allowed to fall again. Since the mid 1980s, however . . . recessions haven't been deliberately engineered by the Fed, they just happen when credit bubbles or other things get out of hand. . . . [T]hey've proved hard to end . . . precisely because housing—which is the main thing that responds to monetary policy—has to rise above normal levels rather than recover from an interest-imposed slump."

I'm guessing there is another set of factors at work. Manufacturing firms used to think that their most important asset was skilled workers. Hence they hung onto them, "hoarding labor" in recessions. And they especially did not want to let go of their prime productive asset when the recovery began. Skilled workers were the franchise. Now, by contrast, it looks as though firms think that their workers are much more disposable—that it's their brands or their machines or their procedures and organizations that are key assets. They still want to keep their workers happy in general, they just don't care as much about these particular workers.

The hypothesis is that firms believe that their remaining workers will forgive them if they fire large numbers of workers during a recession out of economic necessity, but not at other times. Hence the start of the recovery is a business's last moment to slim down its labor force and become more efficient and profitable in the coming boom.

At least it is likely to be a recovery. The prevailing forecast right now is for real GDP to contract at a rate of one percent per year or less between the first and second quarters of 2009, followed by growth between the second and third quarters at an annual rate of two percent or so. When the NBER Business Cycle Dating Committee gets around to it, it is most likely to call the end of this recession for June 2009, with the second most likely call for April and a date sometime after June 2009 as a less likely possibility.

Yes, that would mean the recession is over right now. One reason for that is the much-maligned stimulus package, which probably boosted the real GDP annual growth rate by about one percentage point in the second quarter of 2009, and will boost it by another two percentage points between now and the summer of 2010. (After that, its effects will not only tail off, but actually exert a drag on subsequent GDP growth, which is why White House Council of Economic Advisers Chair Christina Romer has been warning of the dangers of pulling the plug on economic stimulus too soon.)

Politically, the question "did the stimulus work?" might well be answered in the affirmative. Democratic members of Congress seeking reelection in 2010 will be able to point to real GDP growth and an official end to the recession in the second quarter of 2009. However, that is probably not the most relevant question to ask.

Comparing the second quarter of this year to the first, work-hours have declined at a rate of six percent annually. Unless new unemployment claims fall precipitously, work-hours from the second to third quarter will decline at a rate of about three percent per year. Productivity is growing not because of new investment in technology but because businesses continue to fire what workers they can, knowing that in so lousy an economy they won't be blamed for it.

Barring much faster real GDP growth than is currently in the cards, we appear destined for another jobless recovery. So the answer to the question "did the stimulus work?" depends on the metric you use. If the metric is the unemployment rate, the answer is very likely to be: No. Why? Because it was too small.

• BRAD DELONG is a professor in the Department of Economics at U.C. Berkeley; chair of its Political Economy major; a research associate at the National Bureau of Economic Research; and from 1993 to 1995 he worked for the U.S. Treasury as a deputy assistant secretary for economic policy. He has written on, among other topics, the evolution and functioning of the U.S. and other nations' stock markets, the course and determinants of long-run economic growth, the making of economic policy, the changing nature of the American business cycle, and the history of economic thought.

## Building Financial Regulatory Institutions on the Fly

###### July 21, 2009; Monterey, CA

Let me start with a little potted history and end with a blizzard of questions...

I guess the place to start is with 1825, when Robert Bank Jenkinson, First Lord of the Treasury and Second Earl of Liverpool, runs to the Bank of England and begs the Governor to do something to boost financial asset prices and keep them from collapsing in panic. We believe in a market economy, his reasoning goes, but not when the prices a market economy produces lead to mass unemployment on the streets of London, Bristol, Liverpool, and Manchester because panicked investors want their money invested in safe cash rather than risky enterprises. And the Bank of England responds: it goes into the market and buys bonds for cash, pushing up the prices of financial assets and expanding the money supply.

Ever since then those times when governments have largely stepped back and let the financial markets work a panic out for themselves--1873 and 1929 come to mind--appear to have turned out badly. And those times when the government has stepped in or has backed and deputized a private investment bank to support the market--1893 and 1907 come to mind, but also the Resolution Trust Corporation at the start of the 1990s and the U.S. Treasury's and IMF's interventions in support of Mexico in 1995 and of the East Asian economies in 1997-98--things appear to have gone less badly. At least, things appear to have gone sufficiently less badly that very few modern governments are willing to wash their hands and say the financial market should heal itself. That would be a radical step indeed.

The Obama administration is thus, in a sense, being conservative. It is following a tradition of policy in financial emergencies dating back to 1825 as it takes a number of steps to support the financial market--to try to boost demand for and the prices of risky financial assets in a whole number of ways ranging from deficit spending programs to boost the amount of government bonds outstanding and thus make private bonds in lower relative supply to guaranteeing risky private debt and recapitalizing banks to buying up auto companies. I understand what they are trying to do, and I am somewhat reluctant to second guess them: I know that Ben Bernanke, Tim Geithner, Larry Summers, Christie Romer, and company are all doing their absolute best, and I know that if I were in any of their shoes I would be making bigger mistakes than they are--different mistakes, probably, but bigger ones for sure.

But I do have questions and worries. They are triggered by how the U.S. government has gotten itself deeply, deeply involved in industrial and financial policy without constructing technocratic institutions like the 1930s RFC and the 1990s RTC that allowed earlier episodes of extraordinary government intervention into the guts of the industrial and financial structure of the economy to turn out relatively well. What we have is not at all how James Madison or even Alexander Hamilton envisioned that things would work, with the executive having rather less discretionary power than George III of the House of Hanover, limited as the American executive was supposed to be by the constitution's definition of its mission as merely one of "faithfully executing" the laws passed by the legislative branch according to the lights of the judicial branch.

So:

• Why didn't the congress follow the RFC/RTC model in authorizing Bush and Obama industrial and financial policy?
• Why did the centrists in congress thus abandon so much of the power that they could exercise as The Most Dangerous Branch to shape the Treasury's and the Federal Reserve's response to this financial crisis?
• And what, if any, assistance can be provided by what if any other governmental actors to try to improve our institutions on the fly as we fly, somewhat blindly, into the future?

## Why Does Mark Halperin Have a Job?

Res Ipsa Loquitur:

Rising Hegemon: Set Phasers to "Ignore" (or "Point and Laugh Hysterically"): Mark Halperin weighs in with some characteristically crack analysis of Sarah Palin's latest bold move: http://wonkette.com/409687/halperin-everyone-not-named-sean-hannity-is-wrong-about-palin

This was my favorite bit of Halperin Campaign 2008 analysis. It was so utterly incomprehensible that even Wee George Stephanapolous couldn't make sense of it. (The setup was that McCain's 2,217 houses was definitely bad news ... for Obama.)

## Tim Fernholz Has a Rant About Robert Samuelson

Well, yes, it is remarkable that the Washington Post and Newsweek publish this. I find it remarkable every time it happens.

Tim:

TAPPED Archive | The American Prospect: Robert Samuelson, typically known for butchering economics in his column, takes a break today in order to butcher political science. He says the stimulus isn't working because it is composed of the wrong programs, and he blames President Obama specifically for not including things like fiscal aid to states.... But if Samuelson were to remember what actually happened last February, or even do some superficial research, he'd realize that it was the moderate members of the Senate, led by Sens. Ben Nelson and Susan Collins, who stripped out much of the state funding.... [T]hese senators never did get around to telling anyone the economic logic of their proposal.... So Samuelson will never criticize moderate senators for passing bad policy, so long as they do so in the name of deficit hawkery, but by God the president who signs such a bill -- a much-needed bill to ameliorate the effects of a major recession -- will be held accountable!

Similarly, Samuelson's criticisms of the tax side of the bill are ridiculous. He thought there should have been huge tax breaks on big purchases like houses and cars -- but these tax breaks are regressive.... Meanwhile, he complains that Obama gave smaller tax cuts to working people, "politically obligated." To recapitulate: When Obama passes tax cuts for workers, that's pandering. If he gave huge tax breaks to the wealthy for cars and homes, that's good policy. There are reasonable arguments in favor of targeting the auto and real-estate sectors, but economic research -- much of it promoted by Mark Zandi, who is quoted in the column -- suggests that tax cuts targeted at working people are more effective stimulus.

I could go on.... But the real point is this: People, even people like Samuelson who are supposed to know what the hell they are talking about, will forget six months from now how major legislation gets made, what compromises were necessary to pass any bill at all, who the obstructing senators were -- and the obstructing senators know this. Whatever comes out of the health-care track or the cap-and-trade track or the financial-regulation track will be owned by the administration. That's why the top priority has to be getting the policy right, not the bipartisan optics.

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

## Economists Unclear on the Meaning of "Political"

Alex Tabarrok:

Marginal Revolution: Independent Central Banks and Inflation: A number of prominent economists have signed a petition calling for Congress and the Executive Branch to reaffirm their support for and defend the independence of the Federal Reserve System."... [T]he petition says that central bank decisions should not be "politicized."...  Why are more independent central banks better at fighting inflation than less independent central banks? There is nothing magical about independence that makes for low-inflation. Suppose we pick someone at random and give them complete power over monetary policy. Such a central banker would be very independent but I wouldn't count on this policy resulting in much in the way of systematically lower inflation.

The primary reason that independent central banks are better at controlling inflation is that absent direct political control the default selection mechanism favors bankers, i.e. lenders, people whose interests make them more favorable towards lower inflation. Thus, independence is a political decision that favors lenders in the decisions of monetary policy.  Now, depending on the alternatives, there may be good reasons for making this choice but we should not fool ourselves into thinking that we have depoliticized money.  We should not be surprised, for example, that "independent" central banks tend to make lender of last resort decisions that protect banks and bankers...

## Another Reason I Could Never Belong to the Republican Party: Mitch McConnell

Jonathan Cohn watches the intellectual and moral train wreck:

Mitch McConnell Makes the Dems Look Good: Ah, there's nothing like a Mitch McConnell interview to put everything into perspective. The Senate Minority Leader appeared on "Meet the Press" Sunday to discuss health reform. And he professed great concern for what President Obama and the Democrats had in mind.“If you're going to do something as comprehensive as the president wants to do,” McConnell said, “you ought to pay for it.”...

I don't recall McConnell being quite so insistent about fiscal responsibility when he voted for the Bush tax cuts. Nor do I recall him agitating for tax increases to pay for the war with Iraq. In fact, I'm pretty sure most Republicans had very little use for arguments about fiscal responsibility when it was their initiatives on the agenda. Gee, could it be that McConnell and the Republicans just don't care what happens to people when they can't pay for their medical care?...

[The] Democrats are being nearly as irresponsible about paying for their ideas as Republicans were during the early parts of the decade. The Democrats have said reform will not add to the deficit. And the plans emerging from Congress seem to be true to that, at least within the confines of the budgeting rules...

## Yet Another Reason Why I Could Never Belong to the Republican Party...

The Chairman of the Republican Party, Michael Steele:

Rachel Slajda: Steele On Health Care: What's Individual Requirement?: Michael Steele, chairman of the RNC, doesn't seem to know the basic terminology of the health care debate. In a Q&A at the National Press Club just now, Steele was asked if Republicans support an individual requirement to get health care (also known as an individual mandate). "What do you mean by an individual requirement?" he asked the moderator. After she explained, he dodged the question. "Again, it's one of those areas where there are different opinions.... I don't do policy," he said. "My point in coming here was to set a tone, a theme if you will."

Steele was taking questions after giving a speech on health care reform, in which he characterized President Obama's plan as a "reckless experiment" that's "too much, too fast, too soon."

The last time when knowing something about an issue was an asset rather than a liability to one's standing in the Republican Party was the era of Gerald Ford. This is simply too humiliating for anybody with an ounce of self-respect to bear...

## David Cay Johnston Has a Regular Column at the Nation

A good idea:

David Cay Johnston: David Cay Johnston, who received a 2001 Pulitzer Prize for his coverage of the tax beat, is a columnist for Tax Notes and teaches the law of the ancient world at Syracuse University's law and management schools. He is the author of Free Lunch: How the Wealthiest Americans Enrich Themselves at Government Expense (and Stick You With the Bill) and Perfectly Legal: The Covert Campaign to Rig Our Tax System to Benefit the Super Rich--and Cheat Everybody Else.

## Needed: Fiscal Policy Rectification of Names

Clive Crook appears to oppose a second stimulus package, but only because he does not call things by their right names. The exploding costs of government health care programs cause large structural deficits in the long run, and are at the moment exerting a contractionary drag on the economy. A larger short-term deficit would provide an effective stimulus to the economy and boost production and employment.

But if you don't distinguish between these two--if you call them both "fiscal policy" and pretend they are the same thing, as Crook does--then you get yourself completely confused. What we need right now is a larger federal deficit in the short-run and better plans to control health spending in the long run. A smaller short-run deficit now will not help control health spending in the long run. The successful control of health spending in the long run will not boost aggregate demand (much) now. The short-term stimulus deficit and the long-term debt growth projections are two different things--not the same thing.

A while ago I wrote that one of the big problems in American governance was that Washington's political class was stupider than the pigs in the Orwell novel Animal Farm. The fundamental slogan of Animalism--"four legs good, two legs bad"--is no more complicated than "cyclical deficit good, structural deficit bad," and if pigs can understand the first why can't members of congress, anchor persons, and op-ed writers understand the second?

Clive Crook:

A rocky road for the fiscal stimulus: Most forecasters agree that output and jobs would have dropped further without the stimulus.... But the centrality of confidence in the economy does complicate the argument.... [T]he role of fiscal policy is ambiguous. The stimulus this year and especially next directly injects demand, which is all to the good. But the stunning scale of the intervention adds to growing alarm about an approaching fiscal crunch. On present policies, the public debt is on a path of explosive growth. The danger is that when it comes to confidence, what the stimulus gives, the debt projections take away.

Fears about public debt are worsening so much that they make the debate about a second stimulus moot. As a matter of practical politics, it cannot be done – not for the moment, at any rate, certainly not with the exuberant marketing of January. Politics more than economics guided the design of the first stimulus, after all. Democrats preferred public spending because they wanted to widen government’s role and repudiate the Republicans’ instinct to cut taxes regardless of the circumstances. But the politics have shifted. The debt projections are genuinely scary. For now, another daring boost is politically impossible...

The best thing for confidence would have been an even bigger short-term stimulus married to a credible plan to bring the deficit under control. It is not too late for the second part...

This genuinely puzzles me: if something is economically advisable, and if all the people who understand the issuye say that it is economically advisable, it generally becomes politically possible. It remains politically impossible only if people who think it is economically advisable do not say so. Why not? It is a mystery.

• Mark Sanford is still sure it’s all about the exciting story of Mark Sanford and God: "COLUMBIA, S.C. (AP) — South Carolina Gov. Mark Sanford, still clinging to office after admitting to an extramarital affair, wrote in an opinion piece released Sunday that God will change him so he can emerge from the scandal a more humble and effective leader..."
• [T[he use of the Bible as a means for reflecting on one’s personal situation in life.... The problem with such use of Biblical imagination is that it simply has no controlling story. Nothing tells us which story to use other than our own imagination (which is generally a deluded part of our mind). A governor gets to play King David, and, surprise, he should be forgiven and not resign his office. A group of white settlers get to play conquering Israelites and feel no compunction about murdering men, women and children. A priest, likely in need of therapy, plays the role of Jonah before a crowd who has no idea they are in a play. The gospel is not preached... the Bible is simply brought into ridicule... There are no special circumstances that, as Bible characters, exempt us from... repentance and responsibility.... The words of Christ... are... “Repent! For the Kingdom of Heaven is at hand.” If such repentance should cost us a political office or even a continent – so be it.
• I don't envy President Obama's predicament in Afghanistan.  It's hard to think of a region that has been less hospitable to foreign interlopers... And yet despite this foreboding track record, it is unclear that President Obama is willing to deviate from that familiar, if tragic, path.... Not that Obama's options are all that attractive.  Bush left him with a mismanaged and directionless occupation.... The exact nature of the hoped-for success via a continued military occupation is hard enough to define, let alone achieve, yet withdrawal has its downsides as well - including the potential for an intense civil war and the return of repressive elements such as the Taliban.... So it is that Obama seems to be trading Bush's muddled vision of Afghanistan for his own, with a vague yet grandiose (if often contradictory) recitation of implausible goals and exaggerated fears, all buttressed by a refusal to acknowledge the costs of continuing our occupation....

## Two "Efficient Market Hypotheses"

A failure to distinguish between the no-free-lunch and the price-is-right versions of the efficient market hypothesis has been the source of a great deal of very bad economics over the past generation:

What Thaler Said: The [Efficient Capital Markets] hypothesis has two parts, [Richard Thaler] says: the “no-free-lunch part and the price-is-right part, and if anything the first part has been strengthened as we have learned that some investment strategies are riskier than they look and it really is difficult to beat the market.” The idea that the market price is the right price, however, has been badly dented...

## Leszek Kolakowski, R.I.P.

Jeet Heer emails:

### How to Be a Conservative-Liberal-Socialist

by Leszek Kolakowski.

Motto: "please step forward to the rear!" This is an approximate translation of a request i once heard on a tram-car in Warsaw. I propose it as a slogan for the mighty International that will never exist.

A conservative believes:

1. That in human life there never have been and never will be improvements that are not paid for with deteriorations and evils; thus, in considering each project of reform and amelioration, its price has to be assessed. Put another way, innumerable evils are compatible (i.e. we can suffer them comprehensively and simultaneously); but many goods limit or cancel each other, and therefore we will never enjoy them fully at the same time. A society in which there is no equality and no liberty of any kind is perfectly possible, yet a social order combining total equality and freedom is not. The same applies to the compatibility of planning and the principle of autonomy, to security and technical progress. Put yet another way, there is no happy ending in human history.

2. That we do not know the extent to which various traditional forms of social life--families, rituals, nations, religious communities--are indispensable if life in a society is to be tolerable or even possible. There are no grounds for believing that when we destroy these forms, or brand them as irrational, we increase the chance of happiness, peace, security, or freedom. We have no certain knowledge of what might occur if, for example, the monogamous family was abrogated, or if the time-honored custom of burying the dead were to give way to the rational recycling of corpses for industrial purposes. But we would do well to expect the worst.

3. That the idee fixe of the enlightenment--that envy, vanity, greed, and aggression are all caused by the deficiencies of social institutions and that they will be swept away once these institutions are reformed--is not only utterly incredible and contrary to all experience, but is highly dangerous. How on earth did all these institutions arise if they were so contrary to the true nature of man? To hope that we can institutionalize brotherhood, love, and altruism is already to have a reliable blueprint for despotism.

A liberal believes:

1. That the ancient idea that the purpose of the state is security still remains valid. It remains valid even if the notion of "security" is expanded to include not only the protection of persons and property by means of the law, but also various provisions of insurance: that people should not starve if they are jobless; that the poor should not be condemned to die through lack of medical help; that children should have free access to education--all these are also part of security. Yet security should never be confused with liberty. The state does not guarantee freedom by action and by regulating various areas of life, but by doing nothing. In fact security can be expanded only at the expense of liberty. In any event, to make people happy is not the function of the state.

2. That human communities are threatened not only by stagnation but also by degradation when they are so organized that there is no longer room for individual initiative and inventiveness. The collective suicide of mankind is conceivable, but a permanent human ant-heap is not, for the simple reason that we are not ants.

3. That it is highly improbable that a society in which all forms of competitiveness have been done away with would continue to have the necessary stimuli for creativity and progress. More equaliity is not an end in itself, but only a means. In other words, there is no point to the struggle for more equality if it results only in the leveling down off those who are better off, and not in the raising up of the underprivileged. Perfect equality is a self-defeating ideal.

A socialist believes:

1. Yhat societies in which the pursuit of profit is the sole regulator of the productive system are threatened with as grievous--perhaps more grievous--catastrophes as are societies in which the profit motive has been entirely eliminated from the production-regulating forces. There are good reasons why freedom of economic activity should be limited for the sake of security, and why money should not automatically produce more money. But the limitation of freedom should be called precisely that, and should not be called a higher form of freedom.

2. That it is absurd and hypocritical to conclude that, simply because a perfect, conflictless society is impossible, every existing form of inequality is inevitable and all ways of profit-making justified. The kind of conservative anthropological pessimism which led to the astonishing belief that a progressive income tax was an inhuman abomination is just as suspect as the kind of historical optimism on which the Gulag Archipelago was based.

3. That the tendency to subject the economy to important social controls should be encouraged, even though the price to be paid is an increase in bureaucracy. Such controls, however, must be exercised within representative democracy. Thus it is essential to plan institutions that counteract the menace to freedom which is produced by the growth of these very controls.

So far as i can see, this set of regulative ideas is not self- contradictory. and therefore it is possible to be a conservative- liberal-socialist. This is equivalent to saying that those three particular designations are no longer mutually exclusive options.

As for the great and powerful International which I mentioned at the outset--it will never exist, because it cannot promise people that they will be happy.

## Who Was that Masked Wise Economist?

Megan McArdle:

What Did the American Taxpayer Get for its Billions? - Megan McArdle: A fellow journalist emails:  "I badly want someone to explain to me whether the taxpayer realizes any benefits from BoA, Citi, Goldman, etc.'s profits. Or was this just a massive "Thanks for nothing, Tim" moment?" Hard to say.  On the one hand, as a wise economist said to me last fall, "You can't bail out the financial system without bailing out those who are long financial assets".  In other words, banks and bankers.  And not bailing out the financial system has been pretty conclusively demonstrated to have ugly, ugly results...

Hey! You can quote me by name, you know...

## The Economist's Take on the State of Macroeconomics Once More...

Paul Krugman thinks that the Economist doesn't give the Pragmatists enough credit for the analyses of financial crises that they did in the late 1990s and early and mid 2000s:

Views on shape of macroeconomics differ: [T]he common claim that economists ignored the financial side and the risks of crisis seems not quite fair--at least from where I sit. In international macro, one of my two home fields, we’ve worried about and tried to analyze crises a lot. Especially after the Asian crisis of 1997-98, financial crises were very much on everyone’s mind. There was a substantial empirical literature from economists like Carmen Reinhart and Graciela Kaminsky (with Ken Rogoff joining in latterly); there was modeling from Guillermo Calvo, Jose Andres (grrr) Velasco, Nouriel Roubini, Paolo Pesenti, and others, including yours truly.... I saw the housing bubble and expected the bust; but I hadn’t appreciated in advance either the vulnerability of the shadow banking system or the leverage of American consumers. Once the crisis was underway, however, I had a more or less ready-made intellectual framework to accommodate these revelations: at a meta level, this was very much the same kind of crisis as Indonesia 1998 or Argentina 2002.... [T]he prevailing trend now is to assert that there are more risks in the economy than were dreamed of in our philosophy; I don’t think that’s fair.

At least where I sat, the prevailing view was that the U.S. housing bubble was (a) not very big and (b) could be easily managed by the Federal Reserve, because (c) a panic and a domestic surge in demand for high-quality assets could be easily met by the Federal Reserve's printing money. The prevailing view was that the truly dangerous financial crisis would be one produced by the unwinding of "global imbalances"--a collapse in the dollar and a panicked flight not toward but away from dollar-denominated cash--that could not be handled by the Federal Reserve because in such a crisis the assets that it would create would be assets that nobody wanted to hold. So I think--surprise, surprise--that Paul Krugman is right here: Pragmatists weren't ignoring the risks of crisis, but they were watching out for the wrong crisis because we had no clue how bad the state of risk management in America's investment banks had become and we overestimated the power of the Federal Reserve. Our analyses were wrong, but not because we were cluelessly off the page.

But Paul has a more serious bone to pick with the Economist:

The Economist reaches, I think, for a false symmetry [between Pragmatists and Purists], and glosses over too easily the sheer ignorance that has become obvious in the debates over fiscal policy...

Here too I think Paul Krugman is right (I really should just abbreviate the phrase "HtItPKir").

When I first ran into the "Purists" back when I was in graduate school, they were gathered under the banner of the so-called "policy ineffectiveness result": maintaining that neither systematic fiscal nor systematic monetary policies could have any effect on production or employment, and that the only thing that either the fiscal or the monetary authority could do was to add pointless and welfare-reducing variance to production and employment by randomly and destructively injecting surprise disturbances into the economy.

The underlying argument went something like this: (i) There is no sense talking about anything like "involuntary unemployment": markets clear, and at all times people work as much as they want to work and firms produce as much as they want to produce. (ii) Workers work more relative to trend when they think their real wages are high, and firms produce more relative to trend when they think real prices for their products are high. (iii) Workers work less relative to trend when they think their real wages are low, and firms produce less relative to trend when they think real prices for their products are low. (iv) Workers and firms have rational expectations, so if they expect government fiscal or monetary policies to expand (or contract) nominal demand they will expect nominal wages or prices to rise (or fall) accordingly. (v) Thus if a predicted government-driven expansion (or contraction) raises (or lowers) nominal demand and thus their nominal wages or prices, they will understand that their real wages or prices have remained unchanged--and hence will not work more or less, and will not produce more or less. (vi) Only if nominal wages or prices rise (or fall) in an unexpected fashion will workers or firms get confused, and work and produce more (or less) than the trend. (vii) But with rational expectations the only cases in which government policy produces unexpected rises or falls in wages and prices is if the government policy is random. (viii) In which case its effects are random. (ix) And so government policies--not just fiscal but monetary policies too--cannot be stabilizing but only destabilizing. (x) Hence the best of all policies sets a predictable and constant rule for monetary and fiscal policy and does not deviate from it no matter what.

The "Purist" position left it unclear what exactly the rule should be: Should the monetary rule be a gold standard, a price-level target, an inflation-rate target, a nominal GDP target, a nominal GDP growth rate target, a nominal wage level target, a nominal wage growth rate target, a money-stock level target, or a money-stock growth target? A floating exchange rate? A fixed exchange rate? They did not have a view: any one should work just about as well as any other. Should the fiscal rule be a budget balanced all the time? A budget balanced on average over the cycle? A budget with a constant deficit that produced a stable debt-to GDP ratio? A budget that swung into surplus in booms and deficit in recession that produced a debt-too-GDP ratio that was stable over the cycle? The Purists did not have a view: any one should work just about as well as any other. The key was to be predictable, and not to deviate from the plan no matter what. The absolute condemnation of discretionary, seat-of-the-pants policy interventions that were not part of a previously well-known and well-specified rule--absolute condemnation of both discretionary fiscal and discretionary monetary policy tuned to the state of the business cycle--was the bedrock principle of the "Purists."

We Pragmatists did not find these answers very convincing, or think that they were going to lead to a constructive research program.

So when the financial crisis began in the summer of 2007, we Pragmatists largely ignored the Purists, for they seemed to have nothing to say. The financial crisis was not accompanied by any sharp fall in productivity that reduced real wages, so the theories of the Purists' "real business cycle" wing had no purchase on what was going on. And the financial crisis was not associated with any sudden collapse in nominal demand--government-caused or otherwise--that pushed nominal wages and prices down and made workers and firms conclude that they should be working or producing less, and so the "monetary misperceptions" wing of the Purists had no purchase on what was going on. And for the first year or so the Purists largely remained silent. I would have expected them to rail against all of the extraordinary policy actions that Ben Bernanke's Federal Reserve was undertaking--these actions were not part of any pre-planned or generally-expected rule of behavior, and the bedrock Purist principle was that government policies that deviated from pre-planned and generally-expected rules of behavior were destabilizing and destructive. But the Purists remained quiet--the only peep I saw was Chari, Christiano, and Kehoe's (2008), "Facts and Myths About the Financial Crisis of 2008": an assertion that the Federal Reserve was making a tempest in a teapot, a mountain out of a molehill, criticized the Federal Reserve for making "mistaken inferences," and argued that:

even if current increase in [interest rate] spreads indicate increases in the riskiness of the underlying projects, by itself, this increase does not necessarily indicate the need for massive government intervention. We call for policymakers to articulate the precise nature of the market failure they see, to present hard evidence that differentiates their view of the data from other views which would not require such [aggressive discretionary] intervention, and to share with the public... logic and evidence... [supporting] the particular intervention they are advocating...

Then, in the late fall of 2008, the Purists surfaced again. But the Purists did not condemn the aggressively expansionary and highly discretionary monetary policy emergency moves that Ben Bernanke and his colleagues were putting into effect--they endorsed them. Somehow, discretionary monetary policy had become good. Yet there was no symmetry: the Purists did not endorse the aggressively expansionary discretionary fiscal policy moves that the incoming Obama administration was planning (and that the incoming McCain administration would have been planning had the election dice rolled differently)--they condemned them.

Why the Purists endorsed discretionary monetary and condemned discretionary fiscal policy moves never became clear. It wasn't the standard policy-ineffectiveness Purist position: that would have led to a condemnation of discretionary monetary policy as well. It was--well, it wasn't clear what it was. As Paul Krugman wrote last January, and htItPKir:

Economists, ideology, and stimulus: This has not been one of the profession’s finest hours.... What’s been disturbing... is the parade of first-rate economists making totally non-serious arguments.... John Taylor arguing for permanent tax cuts as a response to temporary shocks.... John Cochrane going all Andrew-Mellon-liquidationist on us.... Eugene Fama reinventing the long-discredited Treasury View.... Gary Becker apparently unaware that monetary policy has hit the zero lower bound. And you’ve got Greg Mankiw--well, I don’t know what Greg actually believes, he just seems to be approvingly linking to anyone opposed to stimulus, regardless of the quality of their argument.... [They] have... drop[ped] their usual quality-control standards when it comes to economic analysis. Has there been any comparable outbreak of mass bad economics from good liberal economists? I can’t think of one, although maybe that’s my own politics showing. In any case, what’s happening now is pretty disturbing...

It is in summarizing this episode, I think, that the Economist does its readers bad service, writing only that:

Economics: What went wrong with economics: [T]he financial crisis has blown apart the fragile consensus between purists and Keynesians that monetary policy was the best way to smooth the business cycle.... [S]hort-term interest rates are near zero... in a banking crisis monetary policy works less well. With their compromise [monetary policy] tool useless, both sides have retreated to their roots, ignoring the other camp’s ideas. Keynesians, such as Mr Krugman, have become uncritical supporters of fiscal stimulus. Purists are vocal opponents. To outsiders, the cacophony underlines the profession’s uselessness...

I would say that the Purists are ignoring not just the ideas of John Maynard Keynes but of Chicago-School patriarchs like Jacob Viner and Milton Friedman as well. And I would say that us Pragmatists are not ignoring the Purists' ideas--I would say that I don't know what ideas the Purists have. For the life of me I don't. The basic quantity theory of money:

M * V(i) = PY

tells us that nominal demand PY depends on (a) the nominal money stock M, and (b) the velocity of money V, which (c) is an increasing function of the short-term nominal interest rate on government securities i. Monetary policy changes M, and so changes PY (but may, in circumstances like those of today, induce offsetting changes in i and V that neutralize its expansionary effect). Fiscal policy--government deficits--change the quantity supplied of government bonds, and by supply-and-demand things that change the quantity of something change its price, and the price of government bonds is this interest rate i, and so fiscal policy changes the velocity of money V, and so changes PY with no offsetting changes in M to neutralize its effect.[1]

[1] It is true that Robert Barro has an argument that deficits caused by transitory tax cuts ought to create offsetting increases in desired private savings (because the marginal utility of private consumption does not change) that neutralize the effect on bond prices of increasing the supply of government bonds. But I know of no argument that claims the same for deficits caused by transitory government-spending increases (increasing savings then lowers private consumption and raises the marginal utility of private consumption, unless the goods the government buys and distributes with its spending are perfect substitutes for private consumption) for which there is no such neutralization effect...

## Falling Off the Turnip Truck...

The Eatwell Farm turnip truck makes us happier and healthier by once a week delivering a large box of (a) very fresh organic California produce containing (b) many things that are absolutely delicious and (c) some things that we would never, ever voluntarily purchase--but once we have them residual Yankee thriftiness requires that we find some way to actually eat them before they go bad.

This is by and large a very good bargain for us.

But this week: four heads of cabbage? Some of us fled the shtetl and crossed the North Atlantic precisely to avoid having to eat four heads of cabbage n a single week...

## Why Does David Gregory Still Have a Job at NBC?

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

Rising Hegemon: Chip off the old enabler: "...coming on Meet the Press allows you to frame the conversation how you really want to..." Yeah, God forbid David Gregory challenge your bizarro world view, the man calls himself a journalist after all.

## Robert Waldmann Has an Interpretation of Karl Marx that Is New to Me...

I would not have thought it was possible.

Robert Waldmann has an interpretation of Karl Marx's "Critique of the Gotha Program" that I had never seen before.

Robert argues that the correct interpretation of Marx's phrase "from each according to his ability, to each according to his need," in context, is this Shorter Critique of the Gotha Program:

We socialists cannot now--and probably never will--inscribe on our banners the wacka-wacka primitive Christian slogan "from each according to his ability, to each according to his need." And the Lasalleans are really stupid for thinking that we can and should...

I agree with Robert at least to the extent of: Shorter Critique of the Gotha Program:

We socialists cannot now inscribe on our banners the slogan "from each according to his ability, to each according to his need." And the Lasalleans are really stupid for thinking that we can and should...

But Robert goes further, to a place where I do not think I can follow. The question is whether Marx is serious or sneering when he writes:

Critique of the Gotha Program: In a higher phase of communist society, after the enslaving subordination of the individual to the division of labor, and therewith also the antithesis between mental and physical labor, has vanished; after labor has become not only a means of life but life's prime want; after the productive forces have also increased with the all-around development of the individual, and all the springs of co-operative wealth flow more abundantly--only then then can the narrow horizon of bourgeois right be crossed in its entirety and society inscribe on its banners: From each according to his ability, to each according to his needs!...

He might be dead serious and really looking forward someday to the attainment of such a "higher phase of communist society"--but someday, and not now. Or he might (as Robert thinks) merely be making a nasty little inside joke: sneering that the "higher phase of communist society" in which the Lasallean program would be attainable is nothing but the millennium of Christian fellowship, as described in "Acts of the Apostles"--which is where the phrases:

Acts 11:29: "Then the disciples, every man according to his ability, determined to send relief unto the brethren which dwelt in Judaea..." ("τῶν δὲ μαθητῶν καθὼς εὐπορεῖτό τις ὥρισαν ἕκαστος αὐτῶν εἰς διακονίαν πέμψαι τοῖς κατοικοῦσιν ἐν τῇ Ἰουδαίᾳ ἀδελφοῖς...")

and:

Acts 4:35: "And laid them down at the apostles' feet: and distribution was made unto every man according as he had need..." ("καὶ ἐτίθουν παρὰ τοὺς πόδας τῶν ἀποστόλων· διεδίδετο δὲ ἑκάστῳ καθότι ἄν τις χρείαν εἶχεν...")

come from.

I tend to read Marx as a Christian heretic--as writing in an eschatological mode in which the time when "labor has become not only a means of life but life's prime want; after the productive forces have also increased with the all-around development of the individual, and all the springs of co-operative wealth flow more abundantly" is exactly as real and near to him as the expectation of Paul of Tarsus that someday soon: "we which are alive and remain shall be caught up together with them in the clouds, to meet the Lord in the air: and so shall we ever be with the Lord..." (1 Thess. 4:17).

Robert disagrees, and hears a sneer whenever Marx says "come the Millennium" that I cannot...

Robert:

The Critique of the Golgotha Program: Marx famously declared "From each according to his ability, to each according to his needs." This is... the grossest distortion of a quote by removal of context.... The words are (a translation from German) of two prepositional phrases from a sentence from The Critique of the Gotha program (the absence of a verb is a hint that maybe some relevant context may have been removed).... A more accurate but still partial quotation (of a translation) is

not... inscribe on our banner "from each according to his ability to each according to his needs"...

[T]here ought to be an absolute rule that while many words can be decently elided... "not" is not one of them.... The full (translation of) the quote is, IIRC:

It is not until work ceases to be a burden on life and becomes it's chief joy and purpose that we can inscribe on our banner "from each according to his ability, to each according to his need"...

Marx believed... "from each according to his ability, to each according to his needs" to the same extent that he was an anarchist... that is, rather less than not at all.... I think that Marx considered it a good proposal to eliminate the state and give to each according to his need to exactly the same extent that Arthur Laffer aims to increase the amount of money the federal government has to spend....

Over at the First International, Marx had a problem called Bakunin... [who] promised people no capitalists, no private property, and no state. Marx claimed that you could get everything Bakunin was promising from Marx, because in the long long long run the state would wither away....

Later Marx had this problem that his few German followers (the Eisenachers) decided to join with the Social Democrats who had the inexcusable fault of... [following] Lassalle not Karl Marx. Hence the Gotha program and its only lasting fruit "The Critique of the Gotha Program."... [T]he proposal [was] that all workers be paid the same equal wage. Marx said that was nonsense.... Only when (not if -- when) people just work out of public spirit and joy in labor can we even think about demanding perfect equality....

I don't believe Marx's promises about the withering away of the state and the joy of work (comparing our work efforts one can at least understand how Karl and I have very different views about work). I therefore interpret "The Critique of the Gotha Program as implying, in practice:

from each according to his ability, to each according to his needs, starting on the first of never...

OK, so what about those Apostles?... Marx is deliberately conflating [the Gotha Program] with a much much more egalitarian and extreme program as a rhetorical trick.... [T]he man was trying to insult the united Social Democrats and Eisenachers by conflating them with a bunch of lunatic extremists -- the Christians.... he phrases which can be translated (from Greek not German) as "from each according to his ability" and "to each according to his need" and fairly quoted without distortion due to removal of context come neither from "The Critique of the Gotha Program" nor from "The Gotha Program"... but from... "The Acts of the Apostles" which, quite frankly, makes "The Communist Manifesto" look like the McCain platform (with all due respect for McCain, Marx and the Apostles).

The Bible, New King James Version

Acts 4:35: ...they distributed to each as anyone had need...

Acts 11:29: ...the apostles, each according to his ability, determined to send relief to the brethren dwelling in Judea....

[H]istory is a prankster and karma is a bitch. Driven by envy and ambition, Marx decided to claim that when it came to wages Ferdinand Lasalle was an impractical impossiblist extremist just like Simon Peter. As a result, many people have decided that Karl Marx was an impractical impossiblist extremist egalitarian just like Simon Peter. This is crazy...

## But the Economics Profession Right Now *Is* Useless...

The Economist gives us economists too much credit. It writes:

In... the idea that economics as a whole is discredited... backlash has gone far too far.... Economics is less a slavish creed than a prism through which to understand the world...

I would like to draw a distinction between economics as a way of thinking--the way good economists think, at least--and academic economics as a profession. Economics as a way of thinking is, I believe, still very valuable. But academic economics as a profession has proven itself to be not valuable at all in this financial crisis. As the Economist writes later on:

the financial crisis has blown apart the fragile consensus... [about] monetary policy... [because] in a banking crisis monetary policy works less well. With their compromise tool useless, both sides have retreated to their roots, ignoring the other camp’s ideas. Keynesians, such as Mr Krugman, have become uncritical supporters of fiscal stimulus. Purists are vocal opponents. To outsiders, the cacophony underlines the profession’s uselessness...

In my view, when you have Nobel Memorial Prize-caliber economists like Arizona State's Edward Prescott, Chicago's Robert Lucas and Eugene Fama, and Harvard's Robert Barro claiming that there are valid theoretical arguments proving that fiscal stimulus simply cannot work, not even in a deep depression--even though they cannot enunciate such theoretical arguments coherently--it is entirely fair for outsiders to conclude that academic economics as a profession is useless.

And I for the life of me cannot see what the arguments of the "purists" are. The basic quantity theory of money:

(M/P) * V(i) = Y

tells us that output depends on (a) the real money stock M/P, and (b) the velocity of money V, which (c) is an increasing function of the short-term nominal interest rate on government securities i. Fiscal policy--government deficits--change the quantity supplied of government bonds, and by supply-and-demand things that change the quantity of something change its price, and the price of government bonds is this interest rate i. It is true that Robert Barro has an argument that deficits caused by tax-law changes create offsetting changes in desired savings that neutralize the effect of increasing the supply of government bonds, but I know of no argument that claims the same for deficits caused by government-spending changes unless the goods the government buys and distributes with its spending are perfect substitutes for private consumption expenditures.

Some more context:

Economics: What went wrong with economics: OF ALL the economic bubbles that have been pricked, few have burst more spectacularly than the reputation of economics itself. A few years ago, the dismal science was being acclaimed as a way of explaining ever more forms of human behaviour, from drug-dealing to sumo-wrestling. Wall Street ransacked the best universities for game theorists and options modellers. And on the public stage, economists were seen as far more trustworthy than politicians. John McCain joked that Alan Greenspan, then chairman of the Federal Reserve, was so indispensable that if he died, the president should “prop him up and put a pair of dark glasses on him.”

In the wake of the biggest economic calamity in 80 years that reputation has taken a beating.... [T]heir pronouncements are viewed with more scepticism than before. The profession itself is suffering from guilt and rancour. In a recent lecture, Paul Krugman, winner of the Nobel prize in economics in 2008, argued that much of the past 30 years of macroeconomics was “spectacularly useless at best, and positively harmful at worst.” Barry Eichengreen, a prominent American economic historian, says the crisis has “cast into doubt much of what we thought we knew about economics.”...

[T]wo central parts of the discipline—macroeconomics and financial economics—are now, rightly, being severely re-examined.... There are three main critiques: that macro and financial economists helped cause the crisis, that they failed to spot it, and that they have no idea how to fix it. The first charge is half right. Macroeconomists, especially within central banks, were too fixated on taming inflation and too cavalier about asset bubbles. Financial economists, meanwhile, formalised theories of the efficiency of markets, fuelling the notion that markets would regulate themselves and financial innovation was always beneficial. Wall Street’s most esoteric instruments were built on these ideas.

But economists were hardly naive believers in market efficiency. Financial academics have spent much of the past 30 years poking holes in the “efficient market hypothesis”. A recent ranking of academic economists was topped by Joseph Stiglitz and Andrei Shleifer, two prominent hole-pokers. A newly prominent field, behavioural economics, concentrates on the consequences of irrational actions.... But as insights from academia arrived in the rough and tumble of Wall Street, such delicacies were put aside. And absurd assumptions were added.... The charge that most economists failed to see the crisis coming also has merit. To be sure, some warned of trouble. The likes of Robert Shiller of Yale, Nouriel Roubini of New York University and the team at the Bank for International Settlements are now famous for their prescience. But most were blindsided. And even worrywarts who felt something was amiss had no idea of how bad the consequences would be....

Macroeconomists also had a blindspot.... Their framework reflected an uneasy truce between the intellectual heirs of Keynes, who accept that economies can fall short of their potential, and purists who hold that supply must always equal demand. The models that epitomise this synthesis--the sort used in many central banks--incorporate imperfections in labour markets (“sticky” wages, for instance, which allow unemployment to rise), but make no room for such blemishes in finance. By assuming that capital markets worked perfectly, macroeconomists were largely able to ignore the economy’s financial plumbing. But models that ignored finance had little chance of spotting a calamity that stemmed from it.

What about trying to fix it? Here the financial crisis has blown apart the fragile consensus between purists and Keynesians that monetary policy was the best way to smooth the business cycle. In many countries short-term interest rates are near zero and in a banking crisis monetary policy works less well. With their compromise tool useless, both sides have retreated to their roots, ignoring the other camp’s ideas. Keynesians, such as Mr Krugman, have become uncritical supporters of fiscal stimulus. Purists are vocal opponents. To outsiders, the cacophony underlines the profession’s uselessness....

[T]here is a clear case for reinvention, especially in macroeconomics.... [A] broader change in mindset is still needed. Economists need to reach out from their specialised silos: macroeconomists must understand finance, and finance professors need to think harder about the context within which markets work. And everybody needs to work harder on understanding asset bubbles and what happens when they burst. For in the end economists are social scientists, trying to understand the real world. And the financial crisis has changed that world.

The other-worldly philosophers: [M]acroeconomists were not wholly complacent. Many of them thought the housing bubble would pop or the dollar would fall. But they did not expect the financial system to break. Even after the seizure in interbank markets in August 2007, macroeconomists misread the danger. Most were quite sanguine about the prospect of Lehman Brothers going bust in September 2008.

Nor can economists now agree on the best way to resolve the crisis. They mostly overestimated the power of routine monetary policy (ie, central-bank purchases of government bills) to restore prosperity. Some now dismiss the power of fiscal policy (ie, government sales of its securities) to do the same. Others advocate it with passionate intensity.... For Mr Krugman, we are living through a “Dark Age of macroeconomics”, in which the wisdom of the ancients has been lost.

What was this wisdom, and how was it forgotten? The history of macroeconomics begins in intellectual struggle. Keynes wrote the “General Theory of Employment, Interest and Money.”... [The] classical mode of thought held that full employment would prevail, because supply created its own demand... whatever people earn is either spent or saved; and whatever is saved is invested in capital projects. Nothing is hoarded, nothing lies idle. Keynes... [thought] investment was governed by the animal spirits of entrepreneurs, facing an imponderable future. The same uncertainty gave savers a reason to hoard their wealth in liquid assets, like money, rather than committing it to new capital projects. This liquidity-preference, as Keynes called it, governed the price of financial securities and hence the rate of interest. If animal spirits flagged or liquidity-preference surged, the pace of investment would falter, with no obvious market force to restore it. Demand would fall short of supply.... The Keynesian task of “demand management” outlived the Depression, becoming a routine duty of governments... aided by economic advisers.... [T]heir credibility did not survive the oil-price shocks of the 1970s. These condemned Western economies to “stagflation”, a baffling combination of unemployment and inflation, which the Keynesian consensus grasped poorly and failed to prevent.

The Federal Reserve, led by Paul Volcker, eventually defeated American inflation in the early 1980s, albeit at a grievous cost to employment. But victory did not restore the intellectual peace. Macroeconomists split into two camps.... The purists... blamed stagflation on restless central bankers trying to do too much. They started from the classical assumption that markets cleared, leaving no unsold goods or unemployed workers. Efforts by policymakers to smooth the economy’s natural ups and downs did more harm than good.... [P]ragmatists... [saw] the double-digit unemployment that accompanied Mr Volcker’s assault on inflation was proof enough that markets could malfunction. Wages might fail to adjust, and prices might stick. This grit in the economic machine justified some meddling by policymakers. Mr Volcker’s recession bottomed out in 1982. Nothing like it was seen again until last year. In the intervening quarter-century of tranquillity, macroeconomics also recovered its composure. The opposing schools of thought converged.... For about a decade before the crisis, macroeconomists once again appeared to know what they were doing....

[Willem] Buiter... believes the latest academic theories had a profound influence.... He now thinks this influence was baleful... a training in modern macroeconomics was a “severe handicap” at the onset of the financial crisis, when the central bank had to “switch gears” from preserving price stability to safeguarding financial stability. Modern macroeconomists worried about the prices of goods and services, but neglected the prices of assets. This was partly because they had too much faith in financial markets....

Before the crisis, many banks and shadow banks... believed they could always roll over their short-term debts or sell their mortgage-backed securities, if the need arose. The financial crisis made a mockery of both assumptions. Funds dried up, and markets thinned out. In his anatomy of the crisis Mr Brunnermeier shows how both of these constraints fed on each other, producing a “liquidity spiral”. What followed was a furious dash for cash, as investment banks sold whatever they could, commercial banks hoarded reserves and firms drew on lines of credit. Keynes would have interpreted this as an extreme outbreak of liquidity-preference.... But contemporary economics had all but forgotten the term....

In the first months of the crisis, macroeconomists reposed great faith in the powers of the Fed and other central banks.... Frederic Mishkin... presented the results of simulations from the Fed’s FRB/US model. Even if house prices fell by a fifth in the next two years, the slump would knock only 0.25% off GDP, according to his benchmark model... [because] the Fed would respond “aggressively”, by which he meant a cut in the federal funds rate of just one percentage point. He concluded that the central bank had the tools to contain the damage at a “manageable level”. Since his presentation, the Fed has cut its key rate by five percentage points to a mere 0-0.25%. Its conventional weapons have proved insufficient to the task. This has shaken economists’ faith in monetary policy. Unfortunately, they are also horribly divided about what comes next.

Mr Krugman and others advocate a bold fiscal expansion... stimulating resources that might otherwise have lain idle.... Mr Barro thinks the estimates of Barack Obama’s Council of Economic Advisors are absurdly large. Mr Lucas calls them “schlock economics”, contrived to justify Mr Obama’s projections for the budget deficit....

Economists were deprived of earthquakes for a quarter of a century. The Great Moderation, as this period was called, was not conducive to great macroeconomics. Thanks to the seismic events of the past two years, the prestige of macroeconomists is low, but the potential of their subject is much greater. The furious rows that divide them are a blow to their credibility, but may prove to be a spur to creativity.

Financial economics: Efficiency and beyond: IN 1978 Michael Jensen, an American economist, boldly declared that “there is no other proposition in economics which has more solid empirical evidence supporting it than the efficient-markets hypothesis” (EMH). That was quite a claim. The theory’s origins went back to the beginning of the century, but it had come to prominence only a decade or so before. Eugene Fama, of the University of Chicago, defined its essence: that the price of a financial asset reflects all available information that is relevant to its value.

From that idea powerful conclusions were drawn, not least on Wall Street. If the EMH held, then markets would price financial assets broadly correctly. Deviations from equilibrium values could not last for long. If the price of a share, say, was too low, well-informed investors would buy it and make a killing. If it looked too dear, they could sell or short it and make money that way. It also followed that bubbles could not form—or, at any rate, could not last: some wise investor would spot them and pop them. And trying to beat the market was a fool’s errand for almost everyone. If the information was out there, it was already in the price.

On such ideas, and on the complex mathematics that described them, was founded the Wall Street profession of financial engineering. The engineers designed derivatives and securitisations, from simple interest-rate options to ever more intricate credit-default swaps and collateralised debt obligations. All the while, confident in the theoretical underpinnings of their inventions, they reassured any doubters that all this activity was not just making bankers rich. It was making the financial system safer and the economy healthier.

That is why many people view the financial crisis that began in 2007 as a devastating blow to the credibility not only of banks but also of the entire academic discipline of financial economics. That verdict is too simple. Granted, financial economists helped to start the bankers’ party, and some joined in with gusto. But even when the EMH still seemed fresh, economists were picking holes in it.... Academia thus moved on, even if Wall Street did not.... The EMH, to be sure, has loyal defenders. “There are models, and there are those who use the models,” says Myron Scholes, who in 1997 won the Nobel prize in economics for his part in creating the most widely used model in the finance industry—the Black-Scholes formula for pricing options. Mr Scholes thinks much of the blame for the recent woe should be pinned not on economists’ theories and models but on those on Wall Street and in the City who pushed them too far in practice.

Financial firms plugged in data that reflected a “view of the world that was far more benign than it was reasonable to take, emphasising recent inputs over more historic numbers,” says Mr Scholes. “Apparently, a lot of the models used for structured products were pretty good, but the inputs were awful.” Indeed, the vast majority of derivative contracts and securitisations have performed exactly as their models said they would. It was the exceptions that proved disastrous.... Even as financial engineers were designing all sorts of clever products on the assumption that markets were efficient, academic economists were focusing more on how markets fall short....

Behavioural economists were among the first to sound the alarm about trouble in the markets. Notably, Robert Shiller of Yale gave an early warning that America’s housing market was dangerously overvalued. This was his second prescient call. In the 1990s his concerns about the bubbliness of the stockmarket had prompted Alan Greenspan, then chairman of the Federal Reserve, to wonder if the heady share prices of the day were the result of investors’ “irrational exuberance”. The title of Mr Shiller’s latest book, “Animal Spirits” (written with George Akerlof, of the University of California, Berkeley), is taken from John Maynard Keynes’s description of the quirky psychological forces shaping markets. It argues that macroeconomics, too, should draw lessons from psychology. “In some ways, we behavioural economists have won by default, because we have been less arrogant,” says Richard Thaler of the University of Chicago, one of the pioneers of behavioural finance. Those who denied that prices could get out of line, or ever have bubbles, “look foolish”. Mr Scholes, however, insists that the efficient-market paradigm is not dead: “To say something has failed you have to have something to replace it, and so far we don’t have a new paradigm to replace efficient markets.” The trouble with behavioural economics, he adds, is that “it really hasn’t shown in aggregate how it affects prices.”...

One task, also of interest to macroeconomists, is to work out what central bankers should do about bubbles—now that it is plain that they do occur and can cause great damage when they burst. Not even behaviouralists such as Mr Thaler would want to see, say, the Fed trying to set prices in financial markets. He does see an opportunity, however, for governments to “lean into the wind a little more” to reduce the volatility of bubbles and crashes. For instance, when guaranteeing home loans, Freddie Mac and Fannie Mae, America’s giant mortgage companies, could be required to demand higher down-payments as a proportion of the purchase price, the higher house prices are relative to rents. Another priority is to get a better understanding of systemic risk, which Messrs Scholes and Thaler agree has been seriously underestimated. A lot of risk-managers in financial firms believed their risk was perfectly controlled, says Mr Scholes, “but they needed to know what everyone else was doing, to see the aggregate picture.” It turned out that everyone was doing very similar things. So when their VAR models started telling them to sell, they all did—driving prices down further and triggering further model-driven selling...

## Not Yet Time to Worry About the Long-Term Fiscal Outlook

It is still, IMHO, two years to early to start worrying about the long-term sustainability of the U.S. budget: worrying about long-term sustainability now and for the next two years paralyzes needed action without paying any dividends.

But--two years from now or so, I hope--the time will come to shift gears and start worrying. And when that time comes...

http://www.brookings.edu/~/media/Files/rc/papers/2009/06_fiscal_crisis_gale/06_fiscal_crisis_gale.pdf

## Spencer Ackerman's Sober, Measured Take on John Yoo

A measured, appropriate, sober take:

John Yoo’s Defense of Himself Is as Persuasive as Most of His Legal Opinions: This is your horrible, dystopian future: John Yoo, the former Office of Legal Counsel official who had a hand in crafting the Bush administration’s detentions, interrogations and warrantless surveillance abuses, writes endless and endlessly misleading defenses of himself. Some people die because of Yoo’s cavalier relationship with the law — about 100, actually — and others get law school sinecures and limitless op-ed real estate to explain away what they did. Few people write so much for so long with so little self-reflection. You’ll be reading these op-eds in the nursing home. Yoo’s latest comes in response to Friday’s report from five inspectors general about the warrantless surveillance and data-mining escapades of the Bush administration. Welcome to your future.

Yoo starts things off with his typical flourish of disingenuousness:

Suppose an al Qaeda cell in New York, Chicago or Los Angeles was planning a second attack using small arms, conventional explosives or even biological, chemical or nuclear weapons. Our intelligence and law enforcement agencies faced a near impossible task locating them. Now suppose the National Security Agency (NSA), which collects signals intelligence, threw up a virtual net to intercept all electronic communications leaving and entering Osama bin Laden’s Afghanistan headquarters. What better way of detecting follow-up attacks? And what president — of either political party — wouldn’t immediately order the NSA to start, so as to find and stop the attackers?

Evidently, none of the inspectors general of the five leading national security agencies would approve.

Those inspectors general, in Yoo’s imagination, aren’t overworked bureaucrats in wrinkle-free shirts, cotton Dockers and overgrown haircuts, buried under endless reams of paper. They’re useful idiots for Osama bin Laden. In truth, the reason why the inspectors general don’t entertain that scenario is because it’s absurd. If the intelligence community knew what the “electronic communications” signatures heading into and out of Osama bin Laden’s Afghanistan headquarters were, they could very easily obtain warrants under the Foreign Intelligence Surveillance Act of 1978, because they’d possess individualized suspicion. This is an unproblematic case, fitting easily under the aegis of the law on Sept. 12, 2001.  It has absolutely nothing to do with what the inspectors general call the “President’s Surveillance Program.” That’s also why the battery of Justice Department leaders like Acting Attorney General Jim Comey, Associate Attorney General Jack Goldsmith, FBI Director Robert Mueller and Associate Deputy Attorney General Patrick Philbin fought to rein in the surveillance activities — because they were overbroad and outside of FISA, which Congress explicitly made the “exclusive means” for conducting legal foreign surveillance. Yoo continues:

It is absurd to think that a law like FISA should restrict live military operations against potential attacks on the United States.

Actually, it’s absurd to think that a law like FISA does. Yoo cites the 9/11 Commission, saying it found that “FISA’s wall between domestic law enforcement and foreign intelligence” proved to be such a hindrance, but that’s a misrepresentation. FISA has no such wall. The “wall” was an invention of the Justice Department under Janet Reno to separate foreign-collected surveillance from criminal investigations, nothing even close to “live military operations,” and in practice that bureaucratic restriction went too far and inhibited necessary FBI-CIA collaboration. The Bush administration’s response wasn’t to get Congress to change FISA; it was to entirely circumvent it.

Clearly, the five inspectors general were responding to the media-stoked politics of recrimination, not consulting the long history of American presidents who have lived up to their duty in times of crisis. More than a year before the attack on Pearl Harbor, President Franklin Delano Roosevelt authorized the FBI to intercept any communications, domestic or international, of persons “suspected of subversive activities . . . including suspected spies.”

You know what law, passed in 1978, didn’t exist when FDR was president? Yoo goes even further, and takes selective quotations from Jefferson and Hamilton to suggest that his long-discredited theory that presidents have king-like powers during times of war, and yet he never comes out and says it, because even in The Wall Street Journal people can recognize absurdity.

What’s amazing about Yoo’s caustic attack on the inspectors general report is that the report itself embarrasses Yoo but does little else. There’s no suggestion of prosecution, no recommendation of additional investigation, no harsh language. It says simply that Yoo says what he says in this op-ed and that his superiors at OLC were cut out of that loop. That’s all. Yoo’s not even in danger, if reports about Attorney General Eric Holder’s potential new investigation are to be believed, of moving into the crosshairs of the Justice Department. Today’s attack on the inspectors general is Yoo’s response to having his own words quoted back at him. Which, perhaps, is insult enough. It’s like seeing the next 30 years of your life unfold before your horrified eyes.