## Ten Economics Pieces Worth Reading: January 16, 2010

When Bob Lucas was writing that the Great Depression was people taking extended vacations—refusing to take available jobs at low wages—there was another Chicago economist, Albert Rees, who was writing in the Chicago Journal saying, No, wait a minute. There is a lot of evidence that this is not true.

Milton Friedman—he was a macro theorist, but he was less driven by theory and by the desire to construct a single overarching theory than by attempting to answer empirical questions. Again, if you read his empirical books they are full of empirical data. That side of his legacy was neglected, I think.

When Friedman died, a couple of years ago, we had a symposium for the alumni devoted to the Friedman legacy. I was talking about the permanent income hypothesis; Lucas was talking about rational expectations. We have some bright alums. One woman got up and said, “Look at the evidence on 401k plans and how people misuse them, or don’t use them. Are you really saying that people look ahead and plan ahead rationally?” And Lucas said, “Yes, that’s what the theory of rational expectations says, and that’s part of Friedman’s legacy.” I said, “No, it isn’t. He was much more empirically minded than that.” People took one part of his legacy and forgot the rest. They moved too far away from the data.

There are basically four ways to deal with the possibility of severe financial crises.... cross your fingers [and] hope... insure and regulate your economy heavily... have your central bank monitor the fragility of general financial conditions and “take away the punch bowl” when it thinks conditions are in danger of becoming too fragile.... have your central bank target an inflation rate that is high enough to give it a lot of room to respond to a crisis (or an incipient crisis) by cutting interest rates far below the inflation rate.

For most of the past 20 years, the first approach – supported by a liberal dose of optimism that was buttressed (in the US, anyhow) by the experience of several financial crises with only mild consequences – was in favor. It’s suddenly unpopular.... The order of the day seems to be some combination of the second and third.... The only conservative approach to the possibility of financial crises – the only approach that minimizes the damage without relying on authorities to behave better or more presciently than they normally do behave – is the last of the four I mentioned: inflation...

I know you are tired of hearing me make this point, and that many of you disagree, but maybe you'll be convinced by Paul Volcker? Should the fire code designers, inspectors, and enforcers be part of the fire department, or housed in a separate, independent agency? Does, for example, the knowledge inspectors gain about the risks of fire in various buildings along with knowledge about the nature of those risks (e.g. of spreading to particular adjacent buildings) help firefighters plan a more effective response if a fire does break out? Conversely, does the knowledge that firefighters have help the inspectors to know what to regulate and what to look for during inspections? Are there economies of scale from consolidation, e.g. if we want experts on how fires spread from building to building present among both inspectors and firefighters, is it most efficient and effective to concentrate this expertise in a single agency?

Everyone knows that American consumers have been on a binge for the last ten or twenty years. Data connoisseurs could even tell you that the consumption share of GDP rose from an average of 64% in the 1980s to 70% in 2007–8. But while the numbers are accurate, they’re not really telling the story of a binge. Much of the rise has come from spending on health care, not flat-screen TVs. Sad to say, LBO was among the many who made the binge argument. We should have known better. Sorry.

Graphed nearby is a history of the consumption share of GDP, with and without health care spending.... Note the relative flatness of the “ex-medical care” line—its recent level is actually below 1960’s—compared with the relentless ascent of the “total” line.... [A]t the end of 1978, consumption was 61.5% of GDP; in the second quarter of 2008, it had risen to 70.3%, or 8.8 points. Well over half that increase, 5.0 points, came from spending on medical care. The share of GDP devoted to spending on goods actually fell by 4.7 points over that 30-year period. The pattern is preserved if you start the clock in 1997.... Medical spending accounted for almost a third of that rise between 1997 and 2008. Energy accounted for another third. Spending on goods accounted for just... 0.1 point. In other words, the familiar story that Americans went hogwild buying all kinds of stuff is wrong...

The underlying pace of growth is in doubt.  To be sure, manufacturing is getting a boost from inventory correction and pent up demand; the upward trend in industrial production, ISM, capacity utilization, and new order for nondefense, nonair capital goods all look solid. But households are financially hobbled, and net import growth remains lacking.  All told, the net impact is to stem the pace of job losses and, if temporary help is an indication, set the stage for actual gains in nonfarm payrolls in the months ahead.  But a rapid reversal of the dreary employment setting looks elusive, especially given the likelihood that growth slows as government stimulus wanes in the second half of 2010.   Loose cannons like Hoenig aside, all of this should keep monetary policymakers on hold, not pushing to actively contract the Fed's balance.  Further expansion of asset purchases is not out of the cards, as Bullard makes clear.  But the bar to additional purchases looks high; the Fed will wait to see how actively evolves before taking that road.

[R]epresentatives of the labor movement triumphantly announced the details of their excise tax deal, and I'll list them in a moment. Before I do, however, here's the bottom line: The excise tax is virtually unchanged. The major elements of the excise tax are, first, the threshold at which plans begin getting taxed, and second, how quickly that threshold grows. In the Senate bill, the tax begins on family plans costing $23,000 a year, and that sum grows at the rate of inflation in the Consumer Price Index plus one percentage point (so if inflation that year was 3.3 percent, the threshold would grow by 4.3 percent). In the excise tax deal announced today, the threshold becomes$24,000, and the growth rate is exactly the same. The basics of the tax are virtually unchanged.... [I]nsofar as the prospects for long-term cost control go, the excise tax works the same way it did in the Senate bill, applying to virtually all the plans it applied to in the Senate bill, and growing at the same rate -- which is slower than the rate of medical costs -- as it did in the Senate bill...

7) SECOND BEST NON-ECONOMICS THING I HAVE READ TODAY: Chris Hayes: System Failure:

[T]he corporatism on display in Washington is itself a symptom of a broader social illness that I noted above, a democracy that is pitched precariously on the tipping point of oligarchy. In an oligarchy, the only way to get change is to convince the oligarchs that it is in their interest--and increasingly, that's the only kind of change we can get. In 1911 the German democratic socialist Robert Michels... "The Iron Law of Oligarchy." In order for any kind of party or, indeed, any institution with a democratic base to exist, it must have an organization that delegates tasks. As this bureaucratic structure develops, it invests a small group of people with enough power that they can then subvert the very mechanisms by which they can be held to account.... "It is organization which gives birth to the domination of the elected over the electors," he wrote, "of the mandataries over the mandators, of the delegates over the delegators. Who says organization, says oligarchy."

Michels recognized the challenge his work presented to his comrades on the left and viewed the task of democratic socialists as a kind of noble, endless, Sisyphean endeavor.... What the country needs more than higher growth and lower unemployment, greater income equality, a new energy economy and drastically reduced carbon emissions is a redistribution of power, a society-wide epidemic of re-democratization. The crucial moments of American reform and progress have achieved this: from the direct election of senators to the National Labor Relations Act, from the breakup of the trusts to the end of Jim Crow.

So in this new year, while the White House focuses on playing within the existing rules, it's our job as citizens and activists to press constantly for changes to those rules: public financing, an end to the filibuster, the breakup of the banks, legalization for undocumented workers and the passage of the Employee Free Choice Act, to name just a few of the measures that would alter the balance of power and expand the frontiers of the possible.

If I had to bet, I'd say that not of one of these will be won this year. The White House won't be of much help...

8) BEST NON-ECONOMICS THING I HAVE READ TODAY: Matthew Yglesias: Identity Politics for White People:

Sarah Palin delves into America’s racial conflicts: "And that double standard is—and that hypocrisy is another reason why so many Americans are quite disgusted with the political games that are played, not only on both sides of the aisle, but in this case, on the left wing, what they are playing with this game of racism and kind of letting Harry Reid’s comments slide, but having crucified Trent Lott for essentially along the same lines..." I think this right here shows why it’ll be a generation or two before you see a substantial number of black people voting for the Republican Party. Here’s Palin talking about an issue which is either a pointless partisan sideshow, or else a serious complaint about race in America. But the complaint she offers isn’t a complaint on behalf of African-Americans. It’s a complaint offered on behalf of white southern racists. It’s not that it would be unfair to black people for Reid to remain majority leader rather the problem is that it would be unfair to Trent Lott. And surely it’s no surprise that white southern conservatives seem much more likely than actual black people to be making these kind of demands. The idea that white people might want to show some deference to African-Americans’ views of who is and is not their enemy and what is and is not offensive to them is inimical to the conservative project’s determination to zealous advocacy on behalf of the interests of white people.

9) STUPIDEST THING I HAVE READ TODAY: Casey Mulligan yet again. I won't link. I will outsource to Menzie Chinn: What Are Current Small Business Credit Conditions, Really?:

Casey Mulligan titles a post "Credit Study by the Federal Reserve Says No Crunch," citing a Macroblog post. But he neglects to mention that the survey is "A small business snapshot from the Southeast". In contrast, a nation-wide NFIB survey summarizes conditions thusly:

Regular borrowers (accessing capital markets at least once a quarter) continued to report difficulties in arranging credit at the highest frequency since 1983. A net 15 percent reported loans harder to get than in their last attempt, unchanged from November. Still that is not nearly as severe as the financial distress reported in the pre-1983 period. Twenty-four months of recession have sapped the financial strength of many small firms. Thirty-three (33) percent reported regular borrowing, fairly typical of post- 1983 and unchanged from November. Eight percent of all owners reported that their borrowing needs were not satisfied, down two points from November. The remaining 92 percent of all owners either obtained the credit they wanted or were not interested in borrowing. Only 4 percent of the owners reported "finance" as their #1 business problem (down 1 point). Pre-1983, as many as 37 percent cited financing and interest rates as their top problem. The percent of owners reporting higher interest rates on their most recent loan was seven percent, while three percent reported lower rates. The net percent of owners expecting credit conditions to ease in the coming months was a seasonally adjusted net negative 15 percent (more owners expect that it will be "harder" to arrange financing).

For those who have short memories, pre-1983 incorporates back-to-back recessions...

10) HOISTED FROM THE ARCHIVES: October 2003: Cyber-Stalking Paul Krugman:

These days people like David Warsh, who used to write about how the New York Times's editors needed to hold Paul Krugman to "elementary standards of courtesy and fair play," now write that Krugman "turned out to be absolutely right [on the California electricity mess]. The industry’s conduct was the real story in California— 'looting' behavior every bit as shocking... as that of many bankers in the... American savings and loan crisis... And Krugman played the key role in alerting the rest of the world..." So it seems like it's time for an update on Paul Krugman's principal cyber-stalker caballeros. How are they doing[?]...

Andrew Sullivan appears to be continuing his cyber-stalk, and attempted trashing, Paul Krugman. But the stalking and trashing is absolutely pitiful--he's clearly just going through the motions. Here are the last four examples: "October 16, 2003: BAD DAY FOR KRUGMAN: More people are getting jobs..." "September 30, 2003: FINALLY, DIVERSITY: At the NYT, David Brooks writes about Paul Krugman..." "September 30, 2003: And since I'm not part of the Krugmanian Bush-Is-Hitler/Nixon/Saddam crowd, I'll leave the hyper-ventilating to Josh Marshall until we know more..." "September 30, 2003: Jeffrey Sachs , formerly sane Columbia University professor, joining the Krugman wing of the Democrats..."

Note that Sullivan has absolutely no complaints to make about Paul Krugman's writings--how could he? Does he want to argue that the Bush administration was clear and straight with America on the reasons it went into Iraq? That Bush economic policy would not be better if it had been made by bonobos? That Bush social policy is a light unto the nations? So he adopts a bizarre rhetorical strategy--that to call someone a "Krugman" is to call them something bad...