Economist's View

"Powerful Interests are Trying to Control the Market"

For the first few years I was doing this, I'd often complain that government regulators weren't doing enough to intervene in cases where firms had substantial market power. But this was mainly an economic worry about how market power leads to the inefficient utilization of resources. Over time, however, I've started to worry more and more about the harm that comes when large firms have the ability to exert undue influence on the political process (see health care, financial, or greenhouse gas emission reform just for starters). So I agree with this call to limit rent-seeking activities:

Powerful interests are trying to control the market, by John Kay, Commentary, Financial times: ...Control of rent-seeking requires decentralisation of economic power. These policies involve limits on the economic role of the state; constraints on the concentration of economic power in large business; constant vigilance at the boundaries between government and industry; and a mixture of external supervision and internal norms to limit the capacity of greedy individuals in large organisations to grab corporate rents for themselves. Vigorous pursuit of these is the difference between a competitive market economy and a laisser-faire regime, and it is a large difference. ...

[T]he scale of corporate rent-seeking activities by business and personal rent-seeking by senior individuals in business and finance has increased sharply.

The outcomes can be seen in the growth of Capitol Hill lobbying and the crowded restaurants of Brussels; in the structure of industries such as pharmaceuticals, media, defence equipment and, of course, financial services; and in the explosion of executive remuneration.

Because innovation is dependent on new entry it is essential to resist concentration of economic power. A stance which is pro-business must be distinguished from a stance which is pro-market. In the two decades since the fall of the Berlin Wall, that distinction has not been appreciated well enough. ... The essence of a free market economy is not that the government does not control it. It is that nobody does.

On government's role in the economy, this is from a previous post:

Free markets - where free simply means minimal government involvement - are not necessarily the same as competitive markets. There is nothing that says what many interpret as freeing markets - lifting all government restrictions - will give us competitive markets, not at all. Government regulation (as well as laws, social norms, etc.) is often necessary to help markets approach competitive ideals. Environmental restrictions that force producers to internalize all costs of production make markets work better, not worse. Rules that require full disclosure, or that impose accounting standards help to prevent asymmetric information improve market outcomes. Breaking up firms that are too large prevents exploitation of monopoly power (or prevents them from becoming "too large to fail") which can distort resource flows and distort the distribution of income. Making sure that labor negotiations between workers and firms are on an equal footing doesn't move markets away from an optimal outcome, just the opposite, it helps to move us toward the efficient, competitive ideal, and it helps to ensure that labor is rewarded according to its productivity (unlike in recent years where real wages have lagged behind). There is example after example where government involvement of some sort helps to ensure markets work better by making sure they are as competitive as possible.

New Blog: Maximum Utility

I have a new blog at CBS MoneyWatch. They named it named Maximum Utility. I will be posting there approximately ten times a month on, for the most part, issues making headlines in the news (nothing will change in terms of what I do on his site). The first post is on the recent release of data showing the unemployment rate exceeds 10%:

Why Employment Might Not Fully Recover Until 2013, by Mark Thoma

Counting the Jobs Produced by the Stimulus

Gary Burtless argues that the job creation numbers the administration issued underestimate the true size of the impact:

Counting the Jobs Produced by the Stimulus, by Gary Burtless, Brookings: When the stimulus package was enacted last winter, the Administration said its goal was to create or save 3½ million jobs by the end of next year. How closely has the Administration come to achieving that goal? A couple of weeks ago the White House issued an interim report on jobs directly created or saved as a result of one part of the stimulus package, the grants or contracts directly made by the federal government or indirectly provided through federal aid to state and local governments. The report has been subject to minor carping and major criticism. ...

In essence, the reports distilled by the White House provided evidence from 150,000 anecdotes.  According to the Administration’s summary, the reports offered evidence that 640,000 jobs have been directly created or saved... Jared Bernstein, the Vice President’s chief economist, emphasized that the 640,000 count represents an incomplete tally of the total jobs added or saved as a result of the stimulus package. It ignores, for example, the jobs created or saved as a result of personal tax cuts or hikes in unemployment compensation checks. We cannot collect anecdotes from Walmart, Safeway, or Disney World telling us how many jobs have been produced by higher consumer spending induced by the stimulus package. ... We must rely on elaborate, less transparent data analysis to uncover the indirect effects of the stimulus package. When the indirect effects are included, White House economists estimate that over a million jobs have so far been added or saved as a result of the stimulus.

The Wall Street Journal suggests that the White House estimate of 640,000 jobs directly saved or created may overstate direct job creation by 20,000 positions. Even if the Journal’s estimate is correct, the difference represents less than 2% of the total number of jobs directly or indirectly saved and created by the stimulus. ...

Unless the labor market deteriorates much further, I am pessimistic about the political prospects for another major stimulus package. The Administration’s opponents have been successful in sowing doubts about the wisdom of the last stimulus. ...

In this political environment it is unlikely Congress will pass a major new stimulus package anytime soon. What is more likely - indeed, what is essential - is the continuation of stimulus programs that are currently scheduled to expire.  Last week the House and Senate extended unemployment protection for workers who have lost jobs in the current recession. These protections ought to be extended until the job market improves significantly... If unemployment is likely to remain over 9% for an extended time, there is a compelling case for additional public infrastructure investment. Given high unemployment in the construction and capital goods industries and federal borrowing costs that remain near a post-war low, it makes sense to invest in public capital projects over the next few years. If the federal government does not have adequate plans for such investments, it should start making them soon.

It's going to take quite awhile for the economy to generate enough jobs to return unemployment to normal levels, and more stimulus to help the process along is certainly needed. But I also think that its hard to imagine a major stimulus package getting through Congress. If Washington's interest in helping wanes as the business and the financial sectors begin to recover even though labor markets continue to struggle, then, despite the professed allegiance of many Democrats to the working class, it will tell you that their true allegiance lies elsewhere.

"What Computer Science Can Teach Economics"

Can real world agents actually find the Nash equilibrium that is used to describe their behavior in economic models?:

What computer science can teach economics, by Larry Hardesty, MIT News Office:  Computer scientists have spent decades developing techniques for answering a single question: How long does a given calculation take to perform? Constantinos Daskalakis, an assistant professor in MIT’s Computer Science and Artificial Intelligence Laboratory, has exported those techniques to game theory, a branch of mathematics with applications in economics, traffic management — on both the Internet and the interstate — and biology, among other things. By showing that some common game-theoretical problems are so hard that they’d take the lifetime of the universe to solve, Daskalakis is suggesting that they can’t accurately represent what happens in the real world.

Game theory is a way to mathematically describe strategic reasoning — of competitors in a market, or drivers on a highway or predators in a habitat. ...

In game theory, a “game” is any mathematical model that correlates different player strategies with different outcomes. One of the simplest examples is the penalty-kick game: In soccer, a penalty kick gives the offensive player a shot on goal with only the goalie defending. The goalie has so little reaction time that she has to guess which half of the goal to protect just as the ball is struck; the shooter tries to go the opposite way. In the game-theory version, the goalie always wins if both players pick the same half of the goal, and the shooter wins if they pick different halves. So each player has two strategies — go left or go right — and there are two outcomes — kicker wins or goalie wins.

It’s probably obvious that the best strategy for both players is to randomly go left or right with equal probability; that way, both will win about half the time. And indeed, that pair of strategies is what’s called the “Nash equilibrium” for the game. Named for John Nash..., the Nash equilibrium is the point in a game where the players have found strategies that none has the incentive to change unilaterally. In this case, for instance, neither player can improve her outcome by going one direction more often than the other.

Of course, most games are more complicated than the penalty-kick game, and their Nash equilibria are more difficult to calculate. But the reason the Nash equilibrium is associated with Nash’s name  — and not the names of other mathematicians who, over the preceding century, had described Nash equilibria for particular games — is that Nash was the first to prove that every game must have a Nash equilibrium. Many economists assume that, while the Nash equilibrium for a particular market may be hard to find, once found, it will accurately describe the market’s behavior.

Daskalakis’s doctoral thesis — which won the Association for Computing Machinery’s 2008 dissertation prize — casts doubts on that assumption. Daskalakis, working with Christos Papadimitriou of the University of California, Berkeley, and the University of Liverpool’s Paul Goldberg, has shown that for some games, the Nash equilibrium is so hard to calculate that all the computers in the world couldn’t find it in the lifetime of the universe. And in those cases, Daskalakis believes, human beings playing the game probably haven’t found it either.

In the real world, competitors in a market or drivers on a highway don’t (usually) calculate the Nash equilibria for their particular games and then adopt the resulting strategies. Rather, they tend to calculate the strategies that will maximize their own outcomes given the current state of play. But if one player shifts strategies, the other players will shift strategies in response, which will drive the first player to shift strategies again, and so on. This kind of feedback will eventually converge toward equilibrium: in the penalty-kick game, for example, if the goalie tries going in one direction more than half the time, the kicker can punish her by always going the opposite direction. But, Daskalakis argues, feedback won’t find the equilibrium more rapidly than computers could calculate it.

The argument has some empirical support. Approximations of the Nash equilibrium for two-player poker have been calculated, and professional poker players tend to adhere to it — particularly if they’ve read any of the many books or articles on game theory’s implications for poker. The Nash equilibrium for three-player poker, however, is intractably hard to calculate, and professional poker players don’t seem to have found it.

How can we tell? Daskalakis’s thesis showed that the Nash equilibrium belongs to a set of problems that is well studied in computer science: those whose solutions may be hard to find but are always relatively easy to verify. The canonical example of such a problem is the factoring of a large number: The solution seems to require trying out lots of different possibilities, but verifying an answer just requires multiplying a few numbers together. In the case of Nash equilibria, however, the solutions are much more complicated than a list of prime numbers. The Nash equilibrium for three-person Texas hold ’em, for instance, would consist of a huge set of strategies for any possible combination of players’ cards, dealers’ cards, and players’ bets. Exhaustively characterizing a given player’s set of strategies is complicated enough in itself, but to the extent that professional poker players’ strategies in three-player games can be characterized, they don’t appear to be in equilibrium.

Anyone who’s into computer science — or who read “Explained: P vs. NP” on the MIT News web site last week — will recognize the set of problems whose solutions can be verified efficiently: It’s the set that computer scientists call NP. Daskalakis proved that the Nash equilibrium belongs to a subset of NP consisting of hard problems with the property that a solution to one can be adapted to solve all the others. ...

That result “is one of the biggest yet in the roughly 10-year-old field of algorithmic game theory,” says Tim Roughgarden, an assistant professor of computer science at Stanford University. It “formalizes the suspicion that the Nash equilibrium is not likely to be an accurate predictor of rational behavior in all strategic environments.”

Given the Nash equilibrium’s unreliability, says Daskalakis, “there are three routes that one can go. One is to say, We know that there exist games that are hard, but maybe most of them are not hard.” In that case, Daskalakis says, “you can seek to identify classes of games that are easy, that are tractable.”

The second route, Daskalakis says, is to find mathematical models other than Nash equilibria to characterize markets — models that describe transition states on the way to equilibrium, for example, or other types of equilibria that aren’t so hard to calculate. Finally, he says, it may be that where the Nash equilibrium is hard to calculate, some approximation of it — where the players’ strategies are almost the best responses to their opponents’ strategies — might not be. In those cases, the approximate equilibrium could turn out to describe the behavior of real-world systems.

As for which of these three routes Daskalakis has chosen, “I’m pursuing all three,” he says.

I've got my hands full trying to figure out what's wrong with macroeconomics, so I'll let the microeconomists handle this one. But it does remind me of this passage from "The Economic Crisis is a Crisis for Economic Theory" questioning the use of representative agent macroeconomic models as a shortcut around the problems associated with the aggregation of heterogeneous agents:

The basic market model has been shown to use remarkably little information when functioning at equilibrium. But as Saari and Simon (1978) have shown, if there were a mechanism that would take a General Equilibrium, (Arrow–Debreu) economy to an equilibrium, that mechanism would require an infinite amount of information. Thus,... starting from individuals with standard preferences and adding them up allows one to show that there is an equilibrium but does not permit one to say how it could be attained.

links for 2009-11-09

• It Wasn't Lax Lending Standards. Really. - The New Republic
• Counting Jobs Saved by Obama’s Fiscal Stimulus - Jeff Frankel
• More on Bullard - Money Supply
• Who’s afraid of the big, bad Fairness Doctrine? - The Boston Globe
• Raising prices can reduce the cost of conservation - Greed, Green and Grains
• Housing and Debt Over the Life Cycle and Over the Business Cycle - NEP-DGE
• The distance puzzle resides in poor economies - voxeu.org
• Is commercial real estate is at bottom? - Richard Green
• Are social networks fundamental? - Daniel Little
• Free market flawed, says survey - BBC News
• Interest rate targeting as a social construction - Nick Rowe
• The Fed Is Already Transparent - Kashyap and  - WSJ.com
• "Where's the Consumption Disaster?" - Econbrowser
• Felix Salmon - links
• New Deal 2.0 - links
• The Stash - links
• Money Supply - links
• FT Alphaville - links
• Economix - links
• Credit Writedowns - links
• Marginal Revolution - links
• Abnormal Returns - links
• naked capitalism - links
• Brad DeLong - links

"Not All Bubbles Present a Risk to the Economy"

Frederic Mishkin says there's no reason to worry that a new bubble is inflating:

Not all bubbles present a risk to the economy, by Frederic Mishkin, Commentary, Financial Times: There is increasing concern that we may be experiencing another round of asset-price bubbles that could pose great danger to the economy. Does this danger provide a case for the US Federal Reserve to exit from its zero-interest-rate policy sooner rather than later, as many commentators have suggested? The answer is no. ...

Asset-price bubbles can be separated into two categories. The first and dangerous category is ... “a credit boom bubble”, in which exuberant expectations about economic prospects or structural changes in financial markets lead to a credit boom. The resulting increased demand for some assets raises their price and, in turn, encourages further lending against these assets, increasing demand, and hence their prices, even more, creating a positive feedback loop. This feedback loop involves increasing leverage, further easing of credit standards, then even higher leverage, and the cycle continues.

Eventually, the bubble bursts and asset prices collapse, leading to a reversal of the feedback loop. ... Indeed, this is what the recent crisis has been all about.

The second category of bubble, what I call the “pure irrational exuberance bubble”, is far less dangerous because it does not involve the cycle of leveraging against higher asset values. Without a credit boom, the bursting of the bubble does not cause the financial system to seize up and so does much less damage. For example, the bubble in technology stocks in the late 1990s was not fueled by a feedback loop between bank lending and rising equity values... This is one of the key reasons that the bursting of the bubble was followed by a relatively mild recession. ...

Because the second category of bubble does not present the same dangers ... as a credit boom bubble, the case for tightening monetary policy to restrain a pure irrational exuberance bubble is much weaker. ... Nonetheless, if a bubble poses a sufficient danger to the economy as credit boom bubbles do, there might be a case for monetary policy to step in. ...

But if bubbles are a possibility now, does it look like they are of the dangerous, credit boom variety? At least in the US and Europe, the answer is clearly no. Our problem is not a credit boom, but that the deleveraging process has not fully ended. Credit markets are still tight and are presenting a serious drag on the economy.

Tightening monetary policy in the US or Europe to restrain a possible bubble makes no sense... At this critical juncture, the Fed must not take its eye off the ball by focusing on possible asset-price bubbles that are not of the dangerous, credit boom variety.

I've mostly heard the worries expressed in terms of inflation. I think the risks are asymmetric. Raising rates too soon and sending the economy tumbling back into a recession is much more costly than an outbreak of inflation that persists until the Fed can bring it back under control.

Brad DeLong Celebrates His DMCA Takedown Notice

In the first year or so after I started doing this I had one or two discussions about the length of excerpts, and I've always complied with any request (though not without first trying to negotiate, which was more than successful in one case), but my only literal take down request was from the Reserve Bank of Australia. I still don't understand that one. (When I asked why, they said that if, say, a graph that was part of the post was found to be in error and they changed it, the error would persist on my site. I decided to comply even though it wasn't an official DMCA notice since if their quality was so bad that that was a significant worry, I didn't want their stuff on my site anyway):

In Celebration of a DMCA Takedown Notice: I Link to Elizabeth Kolbert on “SuperFreakonomics”, by Brad DeLong: Well, this is new. My first ever DMCA takedown notice--from HarperCollins, publisher of Levitt and Dubner's Superfreakonomics. While other publishers these days are happy to have sample chapters of their authors' works read and distributed on the internet, not so with HarperCollins.

One thing I can do in response is--tit-for-tat--to remove my praise of and link to E.M. Halliday's Understanding Thomas Jefferson: there are other better (albeit longer) Jefferson biographies published by firms that have not sent me DMCA notices: read them instead.

I urge everybody--authors and readers alike--to just say no to HarperCollins in the future.

A second thing I can do is to link to Elizabeth Kolbert's review of Superfreaknomics in the New Yorker:

“SuperFreakonomics” and climate change: Then, almost overnight, the crisis passed.... By 1912, autos in New York outnumbered horses, and in 1917 the city’s last horse-drawn streetcar made its final run. All the anxieties about a metropolis inundated by ordure had been misplaced.

This story—call it the Parable of Horseshit—has been told many times, with varying aims. The latest iteration is offered by Steven D. Levitt and Stephen J. Dubner, in their new book, “SuperFreakonomics: Global Cooling, Patriotic Prostitutes, and Why Suicide Bombers Should Buy Life Insurance”.... Levitt and Dubner tell the horseshit story as a prelude to discussing climate change: “Just as equine activity once threatened to stomp out civilization, there is now a fear that human activity will do the same.” As usual, they say, the anxiety is unwarranted. First, the global-warming threat has been exaggerated; there is uncertainty about how, exactly, the earth will respond to rising CO2 levels, and uncertainty has “a nasty way of making us conjure up the very worst possibilities.” Second, solutions are bound to present themselves: “Technological fixes are often far simpler, and therefore cheaper, than the doomsayers could have imagined.”

Paul Krugman: Paranoia Strikes Deep

If the economic crisis allows Republicans to gain enough ground in the midterm elections to gridlock government, watch out:

Paranoia Strikes Deep, by Paul Krugman, Commentary, NY Times: Last Thursday there was a rally outside the U.S. Capitol to protest pending health care legislation, featuring the kinds of things we’ve grown accustomed to, including large signs showing piles of bodies at Dachau with the caption “National Socialist Healthcare.” It was grotesque — and it was also ominous. For what we may be seeing is America starting to be Californiafied.

The key thing to understand about that rally is that it wasn’t a fringe event. It was sponsored by the House Republican leadership — in fact, it was officially billed as a G.O.P. press conference. Senior lawmakers were in attendance, and apparently had no problem with the tone of the proceedings.

True, Eric Cantor, the second-ranking House Republican, offered some mild criticism after the fact. But the operative word is “mild.” The signs were “inappropriate,” said his spokesman, and the use of Hitler comparisons by such people as Rush Limbaugh, said Mr. Cantor, “conjures up images that frankly are not, I think, very helpful.”

What all this shows is that the G.O.P. has been taken over by the people it used to exploit. … Conservatives had long believed that history was on their side, so the G.O.P. establishment could, in effect, urge hard-right activists to wait just a little longer: once the party consolidated its hold on power, they’d get what they wanted. After the Democratic sweep, however, extremists could no longer be fobbed off with promises of future glory.

Furthermore, the loss of both Congress and the White House left a power vacuum in a party accustomed to top-down management. At this point Newt Gingrich is what passes for a sober, reasonable elder statesman of the G.O.P. And he has no authority: Republican voters ignored his call to support a relatively moderate, electable candidate in New York’s special Congressional election.

Real power in the party rests, instead, with the likes of Rush Limbaugh, Glenn Beck and Sarah Palin (who at this point is more a media figure than a conventional politician). Because these people aren’t interested in actually governing, they feed the base’s frenzy instead of trying to curb or channel it. So all the old restraints are gone.

In the short run, this may help Democrats, as it did in that New York race. But maybe not: elections aren’t necessarily won by the candidate with the most rational argument. They’re often determined, instead, by events and economic conditions.

In fact, the party of Limbaugh and Beck could well make major gains in the midterm elections. The Obama administration’s job-creation efforts have fallen short, so that unemployment is likely to stay disastrously high through next year and beyond. The banker-friendly bailout of Wall Street has angered voters, and might even let Republicans claim the mantle of economic populism. Conservatives may not have better ideas, but voters might support them out of sheer frustration.

And if Tea Party Republicans do win big next year, what has already happened in California could happen at the national level. In California, the G.O.P. has essentially shrunk down to a rump party with no interest in actually governing — but that rump remains big enough to prevent anyone else from dealing with the state’s fiscal crisis. If this happens to America as a whole, as it all too easily could, the country could become effectively ungovernable in the midst of an ongoing economic disaster.

The point is that the takeover of the Republican Party by the irrational right is no laughing matter. Something unprecedented is happening here — and it’s very bad for America.

"The World Needs a New Financial Architecture"

George Soros says we need a new world order.

After talking about the need for a new Bretton Woods conference to "establish new international rules, including treatment of financial institutions that are too big to fail and the role of capital controls," and the need for the IMF to "to reflect better the prevailing pecking order among states and to revise its methods of operation," he says:

World needs new financial architecture, by George Soros, Commentary, Project Syndicate: ...Reorganising the world order will need to extend beyond the financial system and involve the United Nations, especially membership of the Security Council. ...China and other developing countries ought to participate as equals. They are reluctant members of the Bretton Woods institutions, which are dominated by countries that are no longer dominant. ...

The system cannot survive in its present form, and the US has more to lose by not being in the forefront of reforming it. The US is still in a position to lead the world, but, without far-sighted leadership, its relative position is likely to continue to erode. It can no longer impose its will on others, as George W Bush’s administration sought to do, but it could lead a co-operative effort to involve both the developed and the developing world, thereby reestablishing American leadership in an acceptable form.

The alternative is frightening, because a declining superpower losing both political and economic dominance but still preserving military supremacy is a dangerous mix. We used to be reassured by the generalization that democratic countries seek peace. After the Bush presidency, that rule no longer holds, if it ever did.

In fact, democracy is in deep trouble in America. The financial crisis has inflicted hardship on a population that does not like to face harsh reality. President Barack Obama has deployed the “confidence multiplier” and claims to have contained the recession. But if there is a “double dip” recession, Americans will become susceptible to all kinds of fear mongering and populist demagogy.

If Obama fails, the next administration will be sorely tempted to create some diversion from troubles at home – at great peril to the world.

Obama has the right vision. He believes in international co-operation, rather than the might-is-right philosophy of the Bush-Cheney era. ...

What is lacking, however, is a general recognition that the system is broken and needs to be reinvented. ... Obama is preoccupied by many pressing problems,... reinventing the international financial system is unlikely to receive his full attention.

China’s leadership needs to be even more far-sighted than Obama is. China is replacing the American consumer as the motor of the world economy. Since it is a smaller motor, the world economy will grow slower, but China’s influence will rise very fast.

For the time being, the Chinese public is willing to subordinate its individual freedom to political stability and economic advancement. But that may not continue indefinitely – and the rest of the world will never subordinate its freedom to the prosperity of the Chinese state.

As China becomes a world leader, it must transform itself into a more open society that the rest of the world is willing to accept as a world leader. Military power relations being what they are, China has no alternative to peaceful, harmonious development. Indeed, the future of the world depends on it.

"There are Families Not Eating at the End of the Month"

From Calculated Risk:

WalMart: Quote of the Night, by Calculated Risk: A quote from a conference this weekend, from the NY Times:

"There are families not eating at the end of the month,” said Stephen Quinn, executive vice president and chief marketing officer at Wal-Mart Stores, and “literally lining up at midnight” at Wal-Mart stores waiting to buy food when paychecks or government checks land in their accounts.

links for 2009-11-08

• How we can restore trust in financial institutions - Gordon Brown
• Against a transactions tax - Chris Dillow
• Jobless Recovery - NYTimes.com
• Offshoring and composition of home employment - voxeu.org
• The Recession’s Over, but Not the Layoffs - NYTimes.com
• In Health Care Bills, a Catalyst for Salaried Doctors - Robert Frank
• Economists Seek to Cure a Defect in National Data - NYTimes.com
• Twenty years after the fall of the Berlin wall - voxeu.org
• On Carry and Other Tales... - Models & Agents
• Sorkin's "Too Big to Fail" - Economics of Contempt
• Long Before Berlin - Economic Principals
• Consequences of the Lehman failure - Econbrowser
• New developments in econometrics, by Wooldridge and Imbens - Bluematter
• Alternative Money As A Macro Stabilizer, The Swiss Case - Barkley Rosser
• Paul Kedrosky - links
• Marginal Revolution - links
• Credit Writedowns - links
• Abnormal Returns - links
• naked capitalism - links
• Brad DeLong - links

Does Doing Nothing Cost Nothing?

Failure to enact health care reform will be costly:

The cost of not enacting health care reform, by Linda J. Bilmes and Rosemarie Day, Commentary, Boston Globe: Much of the health care debate is focused on whether the country can afford the $850 billion the Congressional Budget Office estimates it will cost. ... This debate ... assumes that doing nothing will cost nothing. It turns out that not expanding health insurance is a pretty costly option...

Several major medical studies have determined that people with health insurance have lower death rates compared to the uninsured, fewer medical ailments, and better all-around health. This means more individuals contribute to the economy for longer. Not having health insurance means these economic benefits are lost.

For example,... Americans ... die each year because of a lack of health insurance. These deaths are largely because of failures to diagnose illness and to limited access to good quality care. ... A new study ... puts the number of deaths among Americans between the ages of 18 and 64 associated with lack of health insurance at 44,789 a year.

The premature death of thousands of Americans can be translated into monetary terms using the economic “value of a statistical life." ... US government agencies typically use a figure around $7 million to represent the lost economic output from each death. If we conservatively use only half of the government figure, or $3.5 million, it suggests that the ... cost to the US economy of 40,000 deaths is ... more than a trillion dollars over a 10-year period - even taking future inflation into account - well above the cost of enacting a health care package.

A second way to estimate the cost of not enacting health care legislation is in terms of life expectancy. US life expectancy - at 78.11 years, ranks around 40th in the world and well below countries with universal health care. If we were to match Canadian life expectancy, for example, that would translate into an extra two years and 1 month of life expectancy for every American.

Economists use another measure for the value of an additional year of life, adjusted for the quality of life. ... Most insurance companies, and many countries around the world, ... implicitly ascribe the value of an additional year of human life at $50,000... If the United States ... were able to ... insure at least 15 million more Americans, ...[r]aising the US life expectancy to match Canada ... would translate into $150 billion in economic value over three years.

Less health insurance ... also impairs the quality of life - and hence the productivity - of those who are living. This is evident in comparing the health of Americans who live in states with high levels of insurance with those who do not. ... People living in states with the highest insurance levels have better health indicators, including fewer low birth weight babies, lower infant mortality, and lower death rates from diabetes, heart disease, strokes, Alzheimer’s, and some types of cancer (cervical, colorectal). ... Moreover, the annual death rate ... was lower... It is tricky to put a precise number on the economic loss from poorer life quality, but we can be sure the economic loss is substantial. ...

Without health care reform, the economic cost imposed by premature deaths and avoidable illnesses will continue to grow... Congress needs to weigh carefully the substantial cost of doing nothing.

"Conditional Altruists"

Daniel Little wonders what accounts for the spontaneous occurrence of cooperation and collective action:

Assurance game, by Daniel Little: How does a group of people succeed in coming together to contribute to a collective project over an extended period of time?  For example, what leads a group of unemployed workers to travel to the capital to lobby for an extension of unemployment benefits, or a group of expatriate Burmese people in London to attend demonstrations against the junta?  What motivations are relevant at the individual level? And what circumstances are most conducive to creating and sustaining collective action?

Purely self-interested egoists won't make it -- that is the message of Mancur Olson's Logic of Collective Action: Public Goods. The maximizing egoist will reason that the activity will either succeed or fail independent of his/her own participation.  If it succeeds then he will enjoy the benefits of cooperation; and if it fails he will have avoided the wasted costs of participation.  Either way the egoist does better by refraining from participation.  So collective action in pursuit of a public good is all but impossible within a society of rationally disinterested egoists.  As Amartya Sen observes in "Rational Fools" (link),  "The purely economic man is indeed close to being a social moron." 

But we know that this conclusion does a bad job of describing real social life.  People in villages, communities, political parties, religious organizations, public television audiences, and ethnic groups do in fact often succeed in getting themselves organized and mobilized in pursuit of a public good for the group.  Often the level of mobilization is below the level that would be optimal for production of the good for the population; often it is fairly straightforward to identify the symptoms of incipient free-riding; but ordinary social experience and history alike are replete with examples of voluntary collective action.

Many theories can be articulated in order to account for the spontaneous occurrence of collective action.  People may be irrational; they may be motivated entirely by non-utility considerations; they may be governed by norms of solidarity beyond their rational control; they may be disciplined by grassroots organizations that punish defectors; there may be an evolutionary basis hard-wired into the human cognitive-deliberative system that favors cooperation; or, for that matter, there may be a hard-wired impulse towards punishing defectors from common projects that tips the balance of utility calculation for would-be free-riders.

But here is a factor that seems to be a credible observation about social motivation and that still makes sense of the behavior in deliberative terms.  Many real social actors seem to be what might be called "conditional altruists": they are willing to contribute some effort or personal resource to a collective project if they have grounds for confidence that a reasonable number of other members of the group will contribute as well. (Jon Elster explores the idea in The Cement of Society: A Survey of Social Order.)  And it isn't that these actors make a calculation error along the lines of the fallacy of unanimity -- "I want the benefits of the collective action, and it won't occur without me."  Instead, they seem to reason in ways that would please a communitarian: "I'm a member of this group, I believe that other members will do what's good for the group, and I'm willing to do my part as well."  This is a fairly explicit willingness to sacrifice the benefits of free riding.  But the conditional part is important as well: the conditional altruist is calculating about the likelihood of success in the collective undertaking, and is willing to participate only if he/she judges that enough other people will contribute as well to make the undertaking feasible.

Conditional altruism thus attributes a common moral psychology to social actors, which we might refer to as the "fairness factor."  Individuals are willing to factor collective goods into their calculation of the costs and benefits of action, and they have some degree of motivation to act in accordance with a proposed collective action that would benefit them even if they could evade participation.  They are disposed to act fairly: "If I benefit from the action, I should take my fair share of creating the benefit."  (Allan Gibbard's Wise Choices, Apt Feelings: A Theory of Normative Judgment offers an effort to bring together the evolutionary history of the species with a philosopher's analysis of moral reasoning.)

If fairness or conditional altruism are real components of human agency (for all or many human beings), then we can identify a few factors that are likely to increase the likelihood of cooperation and collective action.  Measures that increase the actor's assurance of the behavior of others will have the effect of eliciting higher levels of collective action.  And it is possible to think of quite a few social circumstances that have this effect.  A shared history of success in collective action is clearly relevant to current actors' level of assurance about future cooperation.  Shared history can be made more powerful in the present through the currency of songs, stories, and performances that highlight earlier successes (Michael Taylor, Community, Anarchy and Liberty).  Researchers who study peasant village communities emphasize the importance of face-to-face relations among villagers; individuals know a good deal about the past behavior of their neighbors, which can provide a better basis for predicting their future cooperative behavior (Robert Netting, Smallholders, Householders: Farm Families and the Ecology of Intensive, Sustainable Agriculture). And members of small, stable communities also know that they will need to interact with each other long into the future -- increasing the cost of non-cooperation today (Robert Axelrod, The Evolution of Cooperation: Revised Edition).

What is particularly interesting about this topic is the fact that actual social outcomes show a wide range of variations in the degree of self-interest and fairness that seems to be present.  Some groups seem to act more like Mancur Olson egoists; others (like Welsh coal miners) seem to act as though they have a very high "solidarity and fairness" quotient.  So no single answer to the question of collective action seems to work: "people are rational egoists," "people are altruists," or "people are conditional altruists."  Rather, a given opportunity for collective action seems to display a mix of all these styles of reasoning.  These variations could be the result of several independent factors: differences in the formation of individuals' moral psychology (emphasizing individualism or community from infancy); differences in current institutional settings (arrangements that make future interactions seem more likely to each participant); even potentially differences in personality or the genetic basis of decision-making across individuals.

I'm sure that there is work in experimental economics that probes the boundaries of this feature of practical reasoning.  Ordinary social experience informs us that people have different levels of willingness to undertake sacrifice for a group's projects.  And having a more nuanced empirical understanding of how people behave in the settings of potential cooperation and collective action would help refine our understanding of the thought-processes and styles of reasoning through which individuals decide what to do. Here is an interesting paper by Ernst Fehr and Klaus Schmidt titled "The Economics of Fairness, Reciprocity and Altruism – Experimental Evidence and New Theories."

[Traveling: Preset to post automatically.]

"Why Do Central Banks Have Assets?"

Nick Rowe says central banks hold assets for three reasons:

Why do central banks have assets?, by Nick Rowe: If you look at the balance sheet of a central bank, you will see it has liabilities (mostly currency) and assets (normally mostly government bonds/bills). Why do central banks have assets? Do they need them?

The wrong answer is that central banks need assets to "back" the value of the currency, and that paper currency would be worthless otherwise. The right answer is: since the government gets all the profits from a central bank anyway, there's no point in giving the government the assets; that owning assets lets the bank reverse course and reduce the money supply if it ever needs to; and it stops the accountants freaking out.

Let's deal with the wrong answer first. According to the "backing" theory of the value of money, the value of a central bank's currency is equal to and determined by the value of the central bank's assets backing the currency. (This is different from the fiscal theory of the price level, which says that the value of currency plus bonds is equal to and determined by the present value of primary fiscal surpluses.)

The backing theory sounds good. How can intrinsically worthless paper money have value? Because it is backed by valuable assets. It's just like shares in a mutual fund, which have value equal to and determined by the value of the assets in the fund.

Here are three arguments against the backing theory of money:

links for 2009-11-07

• In Health Care Bills, a Catalyst for Salaried Doctors - Robert Frank - NYTimes.com
• Trade spat heating up - Free exchange
• Dogs verus SUVs - Salon.com
• Towards a Monetarist theory of Neo-Chartalism - Worthwhile Canadian Initiative
• Decoupling and the future of emerging economies’ growth - voxeu.org
• Liquidity risk charges as a macro-prudential tool - voxeu.org
• Administration Rejects Plan to Buy Fannie Mae Credits - NYTimes.com
• Wages: A Comparison With Past Recessions - Economix Blog - NYTimes.com
• Winners and Losers in Financial Crisis Emerging in Europe - NYTimes.com

Things are the Same Here, But Different

[enlarge]

Let's see, should I sit in my hotel room and blog to make up for not writing much over the last few days, or go wander around Munich.

See ya.

What’s Wrong with Modern Macroeconomics? - Conference Papers

What’s Wrong with Modern Macroeconomics?

CESifo Conference Centre, Munich
6 - 7 November 2009

Programme

Friday, 6 November 2009

Session I
Chair: Gerhard Illing

09:00 – 09:50 The Roles of Ideology, Institutions, Politics and Economic Knowledge in Forecasting Macroeconomic Developments
ALEX CUKIERMAN (Tel-Aviv University) (via video link)
Discussant: Panu Poutvaara (University of Helsinki)

09:50 – 10:40 Uncertainty, Risk-taking and the Business Cycle
FRANK SMETS (ECB)
Discussant: Camilo E. Tovar

Session II
Chair: Efraim Sadka

11:00 - 11:50 Macroeconomic Agenda: Compare Competing Paradigms and Identify Robust Policy Recommendations
VOLKER WIELAND (Goethe University Frankfurt)
Discussant: Antonio Spilimbergo (IMF)

11:50 – 12:40 Liquidity Constraints and Non-market Clearing: A Recipe for Recession?
John Drifill and MARCUS MILLER (University of Warwick)
Discussant: Jouko Vilmunen (Bank of Finland)  

Session III
Chair: Paul de Grauwe

14:00 – 14:50 Analysis of Monetary Policy and Financial Stability: A New Paradigm
Charles Goodhart, Carolina Osorio and DIMITRI TSOMOCOS (Oxford University)
Discussant: Daniel Gros (Center for European Policy Studies)

14:50 – 15:40 Unemployment Risk and Aggregate Consumption Behaviour
XAVIER RAGOT (Banque de France) and Edouard Challe
Discussant: Efraim Sadka (Tel-Aviv University)

Panel discussion
Moderator: Robert M. Solow
Panellists: Hans Gersbach, Charles Goodhart, Hans-Werner Sinn, Mark Thoma, Martin Wolf 

Saturday, 7 November 2009

Session IV
Chair: Volker Wieland

8:30 – 9:10  Top Down or Bottom Up Macroeconomics
PAUL DE GRAUWE (University of Leuven)
Discussant: Casper de Vries (University Rotterdam)

9:10 – 9:50 The Economic Crisis is a Crisis for Economic Theory
ALAN KIRMAN (G.R.E.Q.A.M.)
Discussant: Mark Thoma (University of Oregon)

9:50 – 10:30 Reconstucting Macroeconomics: More is Different
THOMAS LUX (University of Kiel)
Discussant: Pablo Rovira Kaltwasser (University of Leuven)

Session V
Chair: Hans Gerbach

10:50 – 11:30 The Banking Crisis - Capitalism's Business as Usual
PATRICK MINFORD (Cardiff University)
Discussant: Sebastian Watzka (University of Munich)

11:30 – 12:10 What's Wrong with Modern Macroeconomics? Why its Critics Have Missed the Point
MIKE WICKENS (York University)
Discussant: Hans Dewachter (University of Leuven)

12:10 – 13:00 General Discussion

"Why the Renminbi has to Rise to Address Imbalances"

Martin Feldstein joins those arguing that China must let the value of the renminbi rise:

Why the renminbi has to rise to address imbalances, by Martin Feldstein, Commentary, Financial Times: Global leaders have agreed reducing global imbalances is a priority. ...[T]hat agreement means the US must raise its national saving to be less dependent on foreign funds. China must lift domestic spending to maintain high employment without producing so many exports.

Some progress is happening on both fronts. The US household savings rate has risen, driven by the need for US households to rebuild wealth. Corporate retained earnings have also begun to rise. But increasing private saving is not enough ... if federal deficits remain high. The Obama administration must agree a budget that will reduce deficits in the years ahead.

China has succeeded in raising its domestic spending through fiscal incentives and an explosive growth of credit. ... Chinese government spending has also increased domestic demand via major rises in infrastructure investment and building low income housing.

But while these two shifts are necessary to reduce global imbalances, they are not enough..., exchange rates must also adjust.

The dollar must decline relative to other currencies to make US products more attractive to foreign buyers and to cause Americans to substitute US goods and services for imports. ... That is why the recent decline in the dollar relative to the euro, the yen and other currencies is ... natural and desirable...

Unfortunately, the Chinese government has not allowed the renminbi to appreciate. ... With the dollar falling relative to other major currencies, the fixed exchange rate of the renminbi relative to the dollar has caused the Chinese currency to fall relative to the euro, yen and other currencies. The trade-weighted value of the renminbi has therefore been declining, making Chinese exports more attractive and foreign goods more expensive in China.

The result has been an increase in China’s exports from $276bn in the second quarter of the current year to $325bn in the third quarter. This helps lift GDP and jobs in China but prevents reducing global imbalances.

China’s policy of keeping the renminbi weak means that the US dollar must decline more rapidly against the euro, yen and other currencies to achieve the same overall trade-weighted fall of the dollar. China’s weak renminbi policy therefore not only prevents remedying China’s large current account surplus but also reduces Europe’s exports. ...

Although China has agreed to take steps to reduce global imbalances and its trade surplus, it is reluctant to let its currency rise. ... Fortunately, the Chinese economy is expanding rapidly and its growth is becoming less dependent on exports. When it has the confidence to allow the renminbi to rise, we will be on the path to reduced global imbalances.

[Traveling: Scheduled to post at preset time.]

"Demystifying Social Knowledge"

Daniel Little looks at different approaches to "understanding society":

Demystifying social knowledge, by Daniel Little: There seem to be a couple of fundamentally different approaches to the problem of "understanding society." I'm not entirely happy with these labels, but perhaps "empiricist" and "critical" will suffice to characterize them.  We might think of these as styles of sociological thinking.  One emphasizes the ordinariness of the phenomena, and looks at the chief challenges of sociology as embracing the tasks of description, classification, and explanation.  The other highlights the inherent obscurity of the social world, and conceives of sociology as an exercise in philosophical theory, involving the work of presenting, clarifying and critiquing texts and abstract philosophical ideas as well as specific social circumstances.

The first approach looks at the task of social knowing as a fairly straightforward intellectual problem. It could be labeled "empiricist", or it could simply be called an application of ordinary common sense to the challenge of understanding the social world. It is grounded in the idea that the social world is fundamentally accessible to observation and causal discovery.  The elements of the social world are ordinary and visible. There are puzzles, to be sure; but there are no mysteries.  The social world is given as an object of study; it is partially orderly; and the challenge of sociology is to discover the causal processes that give rise to specific observed features of the social world.

This approach begins in the ordinariness of the objects of social knowledge.  We are interested in other people and how and why they behave, we are interested in the relationships and interactions they create, and we are interested in institutions and populations that individuals constitute. We have formulated a range of social concepts in terms of which we analyze and describe the social world and social behavior -- for example, "motive," "interest," "emotion," "aggressive," "cooperative," "patriotic," "state," "group," "ethnicity," "mobilization," "profession," "city," "religion." We know pretty much what we mean by these concepts; we can define them and relate them to ordinary observable behaviors and social formations. And when our attention shifts to larger-scale social entities (states, uprisings, empires, occupational groups), we find that we can observe many characteristics of each of these kinds of social phenomena.  We also observe various patterns and regularities in behavior, institution, and entity that we would like to understand -- the ways in which people from different groups behave towards each other, the patterns of diffusion of information that exist along a transportation system, the features of conflicts among groups in various social settings. There are myriad interesting and visible social patterns which we would like to understand, and sociologists develop a descriptive and theoretical vocabulary in terms of which to describe and explain various kinds of social phenomena.

In short, on this first approach, the social world is visible, and the task of the social scientist is simply to discover some of the observable and causal relations that obtain among social actors, actions, and composites. To be sure, there are hypothetical or theoretical beliefs we have about less observable features of the social world -- but we can relate these beliefs to expectations about more visible forms of social behavior and organization. If we refer to "social class" in an explanation, we can give a definition of what we mean ("position in the property system"), and we can give some open-ended statements about how "class" is expected to relate to observable social and political behavior. And concepts and theories for which we cannot give clear explication should be jettisoned; obscurity is a fatal defect in a theory.  In short, the task of social science research on this approach is to discover some of the visible and observable characteristics of social behavior and entities, and to attempt to answer causal questions about these characteristics.

This is a rough-and-ready empiricism about the social world. But there is another family of approaches to social understanding that looks quite different from this "empiricist" or commonsensical approach: critical theory, Marxist theory, feminist theory, Deleuzian sociology, Foucault's approach to history, the theory of dialectics, and post-modern social theory. These are each highly distinctive programs of understanding, and they are certainly different from each other in multiple ways. But they share a feature in common: they reject the idea that social facts are visible and unambiguous. Instead, they lead the theorist to try to uncover the hidden forces, meanings, and structures that are at work in the social world and that need to be brought to light through critical inquiry. Paul Ricoeur's phrase "the hermeneutics of suspicion" captures the flavor of the approach.  (See Alison Scott-Baumann's Ricoeur and the Hermeneutics of Suspicion for discussion.) Neither our concepts nor our ordinary social observations are unproblematic. There is a deep and sometimes impenetrable difference between appearance and reality in the social realm, and it is the task of the social theorist (and social critic) to lay bare the underlying social realities. The social realities of power and deception help to explain the divergence between appearance and reality: a given set of social relations -- patriarchy, racism, homophobism, class exploitation -- give rise to systematically misleading social concepts and theories in ordinary observers.

Marx's idea of the fetishism of commodities (link) illustrates the point of view taken by many of the theorists in this critical vein: what looks like a very ordinary social fact -- objects have use values and exchange values -- is revealed to mystify or conceal a more complex reality -- a set of relations of domination and control between bosses, workers, and consumers.  With a very different background, a book like Gaston Bachelard's The Psychoanalysis of Fire makes a similar point: the appearance represented by behavior systematically conceals the underlying human reality or meaning.  The word "critique" enters into most of Marx's titles -- for example, "Contribution to a Critique of Political Economy."  And for Marx, the idea of critique is intended to bring forward a methodology of critical reading, unmasking the assumptions about the social world that are implicit in the theorizing of a particular author (Smith, Ricardo, Say, Quesnay).  So Capital: Volume 1: A Critique of Political Economy is a book about the visible realities of capitalism, to be sure; but it is also a book intended to unmask both the deceptive appearances that capitalism presents and the erroneous assumptions that prior theorists have brought into their accounts.

The concepts of ideology and false consciousness have a key role to play in this discussion about the visibility of social reality.  And it turns out to be an ambiguous role.  Here is a paragraph from Slavoj Zizek on the concept of ideology from Mapping Ideology:

These same examples of the actuality of the notion of ideology, however, also render clear the reasons why today one hastens to renounce the notion of ideology: does not the critique of ideology involve a privileged place, somehow exempted from the turmoils of social life, which enables some subject-agent to perceive the very hidden mechanism that regulates social visibility and non-visibility? Is not the claim that we can accede to this place the most obvious case of ideology? Consequently, with reference to today's state of epistemological reflection, is not the notion of ideology self-defeating? So why should we cling to a notion with such obviously outdated epistemological implications (the relationship of 'representation' between thought and reality, etc.)? Is not its utterly ambiguous and elusive character in itself a sufficient reason to abandon it? 'Ideology' can designate anything from a contemplative attitude that misrecognizes its dependence on social reality to an action-orientated set of beliefs, from the indispensable medium in which individuals live out their relations to a social structure to false ideas which legitimate a dominant political power. It seems to pop up precisely when we attempt to avoid it, while it fails to appear where one would clearly expect it to dwell.

Zizek is essentially going a step beyond either of the two positions mentioned above.  The empiricist position says that we can perceive social reality.  The critical position says that we have to discover reality through critical theorizing.  And Zizek's position in this passage is essentially that there is no social reality; there are only a variety of texts.

So we have one style that begins in ordinary observation, hypothesis-formation, deductive explanation, and an insistence on clarity of exposition; and another style that begins in a critical stance, a hermeneutic sensibility, and a confidence in purely philosophical reasoning.  Jurgen Habermas draws attention to something like this distinction in his important text, On the Logic of the Social Sciences (1967), where he contrasts approaches to the social sciences originating in analytical philosophy of science with those originating in philosophical hermeneutics: "The analytic school dismisses the hermeneutic disciplines as prescientific, while the hermeneutic school considers the nomological sciences as characterized by a limited preunderstanding."  (This text as well as several others discussed here are available at AAARG.)  Habermas wants to help to overcome the gap between the two perspectives, and his own work actually illustrates the value of doing so.  His exposition of abstract theoretical ideas is generally rigorous and intelligible, and he makes strenuous efforts to bring his theorizing into relationship to actual social observation and experience. 

A contemporary writer (philosopher? historian? sociologist of science?) is Bruno Latour, who falls generally in the critical zone of the distinction I've drawn here.  An important recent work is Reassembling the Social: An Introduction to Actor-Network-Theory, in which he argues for a deep and critical re-reading of the ways we think the social -- the ways in which we attempt to create a social science. The book is deeply enmeshed in philosophical traditions, including especially Giles Deleuze's writings.  The book describes "Actor-Network-Theory" and the theory of assemblages; and Latour argues that these theories provide a much better way of conceptualizing and knowing the social world.  Here is an intriguing passage that invokes both themes of visibility and invisibility marking the way I've drawn the distinction between the two styles:

Like all sciences, sociology begins in wonder.  The commotion might be registered in many different ways but it's always the paradoxical presence of something at once invisible yet tangible, taken for granted yet surprising, mundane but of baffling subtlety that triggers a passionate attempt to tame the wild beast of the social.  'We live in groups that seem firmly entrenched, and yet how is it that they transform so rapidly?'  ... 'There is something invisible that weights on all of us that is more solid than steel and yet so incredibly labile.'  ...  It would be hard to find a social scientist not shaken by one or more of these bewildering statements.  Are not these conundrums the source of our libido scindi? What pushes us to devote so much energy into unraveling them? (21)

What intrigues many readers of Latour's works is that he too seems to be working towards a coming-together of critical theory with empirical and historical testing of beliefs.  He seems to have a genuine interest in the concrete empirical details of the workings of the sciences or the organization of a city; so he brings both the philosophical-theoretic perspective of the critical style along with the empirical-analytical goal of observational rigor of the analytic style. 

Also interesting, from a more "analytic-empiricist" perspective, are Andrew Abbott, Methods of Discovery: Heuristics for the Social Sciences, and Ian Shapiro, The Flight from Reality in the Human Sciences.  Abbott directly addresses some of the contrasts mentioned here (chapter two); he puts the central assumption of my first style of thought in the formula, "social reality is measurable".  And Shapiro argues for reconnecting the social sciences to practical, observable problems in the contemporary world; his book is a critique of the excessive formalism and model-building of some wings of contemporary political science.

My own sympathies are with the "analytic-empirical" approach.  Positivism brings some additional assumptions that deserve fundamental criticism -- in particular, the idea that all phenomena are governed by nomothetic regularities, or the idea that the social sciences must strive for the same features of abstraction and generality that are characteristic of physics.  But the central empiricist commitments -- fidelity to observation, rigorous reasoning, clear and logical exposition of concepts and theories, and subjection of hypotheses to the test of observation -- are fundamental requirements if we are to arrive at useful and justified social knowledge.  What is intriguing is to pose the question: is there a productive way of bringing insights from both approaches together into a more adequate basis for understanding society?

[Traveling: Scheduled to post at preset time.]

"A New Approach to Gauging Inflation Expectations"

Good news for those worried about inflation: A new measure of inflation expectations indicates that "longer-term inflation expectations remain near historic lows, in the neighborhood of 2 percent":

A New Approach to Gauging Inflation Expectations, by Joseph G. Haubrich, Economic Commentary, FRB Cleveland: This Economic Commentary explains a relatively new method of uncovering inflation expectations, real interest rates, and an inflation-risk premium. It provides estimates of expected inflation from one month to 30 years, an estimate of the inflation-risk premium, and a measure of real interest rates, particularly a short (one-month) rate, which is not readily available from the TIPS market. Calculations using the method suggest that longer-term inflation expectations remain near historic lows. Furthermore, the inflation-risk premium is also low, which in the model means that inflation is not expected to deviate far from expectations.

Policymakers at the Federal Reserve and other central banks continually face the “Goldilocks” question—is monetary policy too tight, too loose, or just right? It would help if the central bank knew what real interest rates and expected inflation actually were, but these are not easy to observe. Visible indicators of these factors, such as Treasury inflation-protected securities (TIPS), survey measures of expected inflation, and nominal interest rates, are useful, but none of them alone quite tells the whole story. Nominal interest rates change with both real rates and expected inflation; survey measures ask about only a few horizons, and measures of inflation expectations coming from inflation-protected securities conflate expectations with risk premia. Uncovering a purer measure is possible, but it takes a careful combination of the available data and the application of economic theory.

This Economic Commentary explains a relatively new method of uncovering inflation expectations and real interest rates and describes what light those numbers can shed on the current status of the U.S. economy.

People’s expectation of inflation enters into nearly every economic decision they make. It enters into large decisions: whether they can afford a mortgage payment on a new house, whether they strike for higher wages, how they invest their retirement funds. It also enters into the smaller decisions, that, in the aggregate, affect the entire economy: whether they wait for the milk to go on sale or buy it before the price goes up.

Real interest rates also play a key role in many economic decisions. When businesses invest—or don’t—in plants and equipment, when families buy—or don’t—a new car or dishwasher, they are making judgments about the real return on the object and the real cost of borrowing. As such, real interest rates can be an important guide to monetary policy. As Alan Greenspan once explained,¹ keeping the real rate around its equilibrium level (which is determined by economic and financial conditions), has a “stabilizing effect on the economy” and it helps direct production “toward its long-term potential.”

links for 2009-11-06

• Yet Another Budget Commission? - Forbes.com
• Why not a WPA? - Paul Krugman
• Nominally misguided (wonkish) - Paul Krugman
• 9.5% productivity growth. How unusual? - Antonio Fatas
• What is systemic risk, anyway? - macroblog

Paul Krugman: Obama Faces His Anzio

The failure to give the economy the fiscal stimulus it needs may be costly Democrats:

Obama Faces His Anzio, by Paul Krugman, Commentary, NY Times: Remember those Republican boasts that they would turn health care into President Obama’s Waterloo? Well, exit polls suggest that to the extent that health care was an issue in Tuesday’s elections, it worked in Democrats’ favor. But while health care won’t be Mr. Obama’s Waterloo, economic policy is starting to look like his Anzio.

True, the elections weren’t a referendum on Mr. Obama. Most voters focused on local issues... Yet there was a national element to the election. Voters ... are in a bad mood, largely because of the still-grim economic situation. And when voters are feeling bad, they turn on whomever currently holds office. ...

This bodes ill for the Democrats in the midterm elections next year ... because all indications are that ... unemployment will still be painfully high. And Republicans may well benefit, despite having become the party of no ideas.

Which brings me to the Anzio analogy.

The World War II battle of Anzio was a classic example of the perils of being too cautious. Allied forces landed far behind enemy lines, catching their opponents by surprise. Instead of following up on this advantage, however, the American commander hunkered down in his beachhead — and soon found himself penned in by German forces on the surrounding hills, suffering heavy casualties.

The parallel with current economic policy runs as follows: early this year, President Obama came into office with a strong mandate and proclaimed the need to take bold action on the economy. His actual actions, however, were cautious... They were enough to pull the economy back from the brink, but not enough to bring unemployment down.

Thus the stimulus bill fell far short of what many economists — including some in the administration itself — considered appropriate. ... Meanwhile, the administration balked at proposals to put large amounts of additional capital into banks, which would probably have required temporary nationalization of the weakest institutions. ...

Administration officials would presumably argue that they were constrained by political realities... But they never tested that assumption, and they also never gave any public indication that they were doing less than they wanted. The official line was that policy was just right, making it hard to explain now why more is needed.

And more is needed. Yes, the economy grew fairly fast in the third quarter — but not fast enough to make significant progress on jobs. And there’s little reason to expect things to look better going forward. The stimulus has already had its maximum effect on growth. ... Many economists predict that the economy’s growth, such as it is, will fade out over the course of next year.

The problem is that it’s not clear what Mr. Obama can do about this prospect. Conventional wisdom in Washington seems to have congealed around the view that budget deficits preclude any further fiscal stimulus — a view that’s all wrong on the economics, but that doesn’t seem to matter. Meanwhile, the Democratic base, so energized last year, has lost much of its passion, at least partly because the administration’s soft-touch approach to Wall Street has seemed to many like a betrayal of their ideals.

The president, then, having failed to exploit his early opportunities, is pinned down in his too-small beachhead.

If the Democrats lose badly in the midterms, the talking heads will say that Mr. Obama tried to do too much, this is a center-right nation, and so on. But the truth is that Mr. Obama put his agenda at risk by doing too little. The fateful decision, early this year, to go for economic half-measures may haunt Democrats for years to come.

"The Great Contraction of 2008-2009"

Kenneth Rogoff doesn't expect a "sustained sharp" worldwide recovery:

The Great Contraction of 2008-2009, by Kenneth Rogoff, Commentary, Project Syndicate: A popular view among economic forecasters and market bulls is that “the deeper the recession, the quicker the recovery.” They are right – up to a point: immediately after a normal recession, economies do, indeed, often grow much faster than usual... Unfortunately, the Great Recession of 2008-2009 is far from being a normal global recession. The Great Recession was turbo-charged by a financial crisis,... a far more insidious affair that typically has far more long-lasting effects.

As Carmen Reinhart and I argue..., the Great Recession is better described as “The Great Contraction,” given the massive ... contraction of global credit, trade, and growth that the world has experienced. ... [T]he legacy of the huge contraction in credit is not likely to go away anytime soon. ... The optimists say not to worry. Credit will soon come to everyone else as easily as it has to the banks. ...

But this ... fails to recognize the fact that balance sheets remain ... impaired... Housing prices are being propped up temporarily by myriad subsidies, while a commercial real-estate tsunami looms. Many banks’ weaknesses are simply being masked by government guarantees.

Indeed, G-20 governments now face the daunting prospect of trying to rein in the monster they have created. It is now very clear that the taxpayer will always be there to guarantee that bondholders get paid. ... Lenders to banks will not bother worrying about what kinds of gambles ... financial institutions are making, or whether regulation is effective.

The good news is that most governments do see the need to implement significant new regulation on financial firms. But here’s the rub: financial regulation is enormously complicated...[I]f regulators take their time to “get it right,” there will be a huge shadow of uncertainty hanging over the financial system. Banks know that they face higher capital requirements... But how much higher? There is much discussion of breaking up banks that are too big to fail. But what will actually happen?

Given this environment, no wonder credit is still contracting... If banks don’t know what the rules of the game are going to be, they have to be very cautious about over-extending their balance sheets.

So government regulators – and ultimately all of us – are caught... Overly strict regulation could seriously impair global growth for decades. But if regulation is too soft, the next monster global financial crisis could come within a decade. And even if regulators take their time to try to get it right,... the world may have to live with weak credit expansion as banks hold back, awaiting a clearer verdict on their future. ...

I am often asked why economies get themselves into such a bind again and again throughout economic history. Unfortunately,... the answer is all too simple: arrogance and ignorance. Investors and policymakers are often altogether ignorant of the myriad historical experiences with financial crises. And the few that are dimly aware of what has happened in other times and other places all too often say, “Don’t worry, this time is different.”

Perhaps the Great Contraction of 2008-2009 will be different from other deep financial crises, and we will see a sustained sharp recovery worldwide. But G-20 policymakers are best advised not to bet on it...

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"A Modern World System?"

Globalization from a different perspective:

A modern world-system?, by Daniel Little: Immanuel Wallerstein created a huge stir in the 1970s with the publication of The Modern World-System: Capitalist Agriculture and the Origins of the European World-Economy in the Sixteenth Century (1974).  The book is an intellectual masterpiece, synthesizing a vast range of fundamental literature on the economic history of Europe and the world.  You could look at the book as the first serious and extended effort to theorize globalization -- a term that barely existed at the time of publication. Or you could look at it as a general theory of colonialism -- an account of the pathways and influences through which the metropole dominated and exploited the periphery. It is worth looking back at this work today to tease out some of the guiding assumptions about history, sociology, and globalization it reflected.

The concept of "world system" is itself a key component of our current understanding of globalization, in that it captures the idea of causal interconnectedness across the globe among major organizations, firms, populations, and states.  Wallerstein observes that earlier social scientists had usually centered their analysis at the level of the political unit -- the nation-state; whereas his own approach is different:

This book makes a radically different assumption.  It assumes that the unit of analysis is an economic entity, the one that is measured by the existence of an effective division of labor, and that the relationship of such economic boundaries to political and cultural boundaries is variable, and therefore must be determined by empirical research for each historical case.  Once we assume that the unit of analysis is such a "world-system" and not the "state" or the "nation" or the "people", then much changes in the outcome of the analysis. (xi)

But what, more exactly, did he mean by a system?  

"Search Technologies and Retail Competition"

Has internet search technology achieved its promise of frictionless commerce?

Search Technologies and Retail Competition, by Glenn Ellison,^* NBER Reporter: When the Internet first came into wide consumer use, one heard a lot about the promise of “frictionless commerce.” New search technologies would make it easy for consumers to find the exact product they wanted at the lowest possible price. Whether such a future comes to pass is obviously of great interest to consumers and online retailers. And, it may have dramatic effects on the traditional retail and media sectors. My recent research has included several projects that aim to improve our understanding of Internet search technologies and retail markets.

Price Search and Obfuscation

The desire to better understand where search frictions come from and how they may evolve motivates my work with Sara Fisher Ellison on Pricewatch. Pricewatch is a specialty search engine serving consumers who want to buy computer parts (such as memory upgrades or video cards) at low prices from no-name e-retailers. One chooses the desired product from a menu on Pricewatch’s first page -- for example, 128 MB PC100 SDRAM memory module -- and Pricewatch returns a list, sorted by price, of dozens of retailers carrying that product. A number of retailers have built businesses by serving Pricewatch consumers, and price competition occurs far more quickly this way than in the traditional retail sector: rankings on the Pricewatch list change throughout the day as firms raise or lower prices by a few dollars to move up or down.

Our choice to study this idiosyncratic environment may seem strange, but it illustrates how empirical work is often done in industrial organization. Developing theoretical models of the interactions between consumers and firms is the only way to address many important questions. Studying atypical environments can be a great way to get insights on how accurate models are. In our case, the simplicity of the business model of a Pricewatch retailer – basically, they just take memory modules off a shelf, put them in cardboard boxes, and mail them – makes it much easier to estimate profit functions. The frequent changes in relative prices let us estimate demand using (presumably random) short-term fluctuations. And, the generic nature of the products and retailers creates extremely price-sensitive demand, which highlights the role played by search frictions in sustaining markups.

From our first look at the Pricewatch environment it was clear that the frictionless ideal had not been fully realized.¹ Yes, prices were very low and close together. But buying a product at the advertised price was rarely simple. Often, one had to search through multiple pages and read a great deal of fine print. Most striking was the litany of automated sales pitches encouraging one to upgrade to a superior product and/or buy additional add-ons to complement what one was trying to buy. We use the term “obfuscation” to describe practices by firms that increase search frictions, and we view Pricewatch as a great environment from which to gain insights on the topic.

links for 2009-11-05

• How to fill the gaps left by dollar decline - FT.com
• Time for a debate on immigration - Martin Wolf
• Greenhouse Gas Emissions Are Down in the Recession. So, Then, Is “Green GDP” Up? - Jeff Frankel
• Winners and Losers in Financial Crisis Emerging in Europe - NYTimes.com
• Some Thoughts Elicited by Reading Some Calibration Papers - Econbrowser
• The lost generation - Paul Krugman
• Mars rover plans its escape - Scientific American

Is Market Efficiency the Culprit?

Eugene Fama defends the efficient market hypothesis against the charge that it helped to cause the financial crisis. He says the EMH couldn't have caused the crisis because hardly anyone believes it (of course he still says it's true "for almost all practical purposes" -- clearly one side or the other is deviating from the rational belief):

Q&A: Is Market Efficiency the Culprit?, by Eugene Fama: Justin Fox ("The Myth of the Rational Market") and many other financial writers claim that much of the blame for the financial meltdown is attributable to a misguided faith in market efficiency that encouraged market participants to accept security prices as the best estimate of value rather than conduct their own investigation. Is this a fair assessment? If so, how should policymakers respond?

EFF: The premise of the Fox book is that our current economic problems are largely due to blind acceptance of the efficient markets hypothesis (EMH), which posits that market prices reflect all available information. The claim is that the world's investors and their advisors in the financial industry bought into this model. Because they ceased to investigate the true value of assets, we have been hit with "bubbles" in asset prices. The most recent is the rise and sharp decline in real estate prices which froze financial markets and led to the worst recession since the Great Depression of the 1930s.

The book is fun reading, but its main premise is fantasy. Most investing is done by active managers who don't believe markets are efficient. For example, despite my taunts of the last 45 years about the poor performance of active managers, about 80% of mutual fund wealth is actively managed. Hedge funds, private equity, and other alternative asset classes, which have attracted big fund inflows in recent years, are built on the proposition that markets are inefficient. The recent problems of commercial and investment banks trace mostly to their trading desks and their proprietary portfolios, and these are always built on the assumption that markets are inefficient. Indeed, if banks and investment banks took market efficiency more seriously, they might have avoided lots of their recent problems. Finally, MBA students who aspire to high paying positions in the financial industry have a tough time finding a job if they accept the EMH.

I continue to believe the EMH is a solid view of the world for almost all practical purposes. But it's pretty clear I'm in the minority. If the EMH took over the investment world, I missed it.

The Fox book is an example of a general phenomenon. Finance, financial markets, and financial institutions are in disrepute. The popular story is that together, they caused the current recession. I think one can take an entirely different position: financial markets and financial institutions were casualties rather than the cause of the recession.

But suppose we buy into the more common negative current view of finance. There is still a big open question. Beginning in the early 1980s, the developed world and some big players in the developing world experienced a period of extraordinary growth. It's reasonable to argue that in facilitating the flow of world savings to productive uses around the world, financial markets and financial institutions played a big role in this growth. Despite any role of finance in the current recession, are the market naysayers really ready to argue that worldwide wealth would be higher today if financial markets and financial institutions didn't develop as they did?

Toward the end of the book, Fox concludes that passive investing is the right choice for almost all investors. My academic friends in behavioral finance (for example, Richard Thaler) almost always end up with a similar conclusion. In my view, this is an admission that the EMH provides a good view of the world for almost all practical purposes. At which point, I say I won.

[Still traveling, but this one's live.]

Update: Justin Fox responds.

Update: Paul Krugman comments on the assertions about growth in developing countries since 1980.

What's Wrong with Modern Macroeconomics?

The travel references are referring to this. (My first trip to Germany - I set up a bunch of posts before I left - through Sunday just in case - but will add what I can.)

Wal-Mart versus Amazon?

James Surowiecki looks at the latest price war:

Priced to Go, by James Surowiecki: In the spring of 1992, the airline industry ... found itself in the middle of a full-fledged price war. In a matter of months, the airlines collectively lost four billion dollars. ...[A]t bottom it was just like other price wars: all the companies involved got hurt.

So you might wonder why Wal-Mart recently decided to start its own price war, taking on Amazon in the online book market. ...Amazon and Wal-Mart are surely losing money every time they sell one of the discounted titles. The more they sell, the less they make. That doesn’t sound like good business.

It’s easy to see how price wars get started. In industries where a lot of competitors are selling the same product—mangoes, gasoline, DVD players—price is the easiest way to distinguish yourself. The hope is that if you cut prices enough you can increase your market share, and ... your profits. But this works only if your competitors won’t, or can’t, follow suit. More likely, they’ll cut prices, too, and you’ll end up selling the same share of mangoes, only at a lower price...: everyone loses. ...

The best way to win a price war, then, is not to play in the first place. Instead, you can compete in other areas: customer service or quality. Or you can collude...—since overt collusion is usually illegal—you can employ subtler tactics ... like making public statements about the importance of “stable pricing.” The idea is to let your competitors know that you’re not eager to slash prices—but that, if a price war does start, you’ll fight to the bitter end. One way to establish that peace-preserving threat of mutual assured destruction is to commit yourself beforehand, which helps explain why so many retailers promise to match any competitor’s advertised price. Consumers view these guarantees as conducive to lower prices. But ... offering a price-matching guarantee should make it less likely that competitors will slash prices, since they know that any cuts they make will immediately be matched. It’s the retail version of the doomsday machine.

These tactics and deterrents don’t always work, though, which is why price wars keep breaking out. Sometimes it’s rational: when a company is genuinely more efficient than its competitors, lowering prices is usually a smart move. (That’s how competition is supposed to work.) More often, price wars are reckless gambles. ...

Amazon and Wal-Mart hardly seem reckless, though. So why did they go to war? The answer is that they didn’t, really. Sure, Wal-Mart is making a statement that it’s a player in the online world, but the real goal of this conflict isn’t to lure readers away from Amazon... It’s to lure them online, away from big booksellers and other retailers, and then sell them other stuff... It’s textbook loss-leader economics. ...

The real competition in this price war is not between Wal-Mart and Amazon but between those behemoths and everyone else—and the damage everyone else is incurring is deliberate, not collateral. Wal-Mart and Amazon have figured out how to fight a price war and win: make sure someone else takes the blows.

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One more time, is CEO pay justified?:

Banker Bonus Rain, by Nancy Folbre, Economix: ...Wall Street firms have always been famous for their generous bonuses to managers and traders — their so-called “rainmakers.” The graph ... shows that employee bonuses have actually exceeded the estimated pre-tax profits of United States securities dealers in many years. What is especially striking is the high level of these bonuses in 2007 and 2008, years in which profits were negative. ...

Much of the justification offered for current pay caps in the United States rests on indignation about government bailouts. As long as companies are not subsidized by taxpayer money, perhaps market forces should be allowed to determine pay.

But do market forces determine pay the way most economists assume? Many arguments to the contrary are effectively mobilized by the University of Massachusetts economist James Crotty in a recent working paper.

Top executives of financial firms often choose the very board members who are expected to monitor their pay decisions.

Investment banking is a demanding job. “Rainmakers” typically work long hours under high stress. Yet the number of highly qualified graduates from top colleges eager to enter investment banking has typically far exceeded the demand. Why hasn’t the excess of supply over demand failed to drive earnings down?

The importance of personal networks and contacts gives rainmakers leverage. As the Nobel laureate Oliver Williamson emphasizes, the threat of withdrawing from or disrupting productive relationships can give employees considerable power. The apprenticeship structure of the job gives senior managers and traders control over their successors.

The very qualities that contribute to success on the trading floor — including aggressive use of technical expertise — may be deployed in joint efforts to reduce competition from new job entrants...

In any case, highly paid employees in finance earn large premiums compared to their counterparts in other industries — pay differences that persist even when virtually all measurable differences in individual characteristics are taken into account. ...

Deregulation made it easier for rainmakers to conceal risks that short-term profits would morph into long-run losses. The oligopolistic structure of the industry — now more concentrated than ever as a result of bank failures and mergers — made it easier for them to collude.

Financial firms are investing heavily in lobbying to block efforts to make the industry more competitive. Their rainmakers are still pretty good at making rain for one another.

The article doesn't directly answer the question "is CEO pay justified?," but I will. No it isn't, and the way the pay is structured has led to bad incentives within these firms that contributed to our current problems (too much emphasis on short-term profits at the expense of what is best for stockholders in the long-run). There are still a few apologists -- those who argue that CEO pay is justified by their high productivity, i.e. by what they add to the firm, but their numbers are dwindling.

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"Selling Stocks Short: Ever Controversial"

Why is there so much controversy over short selling?:

Selling stocks short: Ever controversial, by Gerald P. Dwyer, Macroblog: Selling securities short has been a controversial practice as long as financial markets have existed, and the recent financial crisis brought short selling to the fore yet again. In the last week, a bill to impose new restrictions on short selling was introduced.

And earlier this month in its inaugural conference, the Atlanta Fed's new Center for Financial Innovation and Stability (CenFIS) provided a forum for discussing the topic of short selling.

Why does short selling have such a bad reputation? Financial economists generally have a positive view of short selling because short sellers take positions with risk of loss based on their view of a firm's prospects. Some others, though, generally do not take such a benign view of short selling.

Attitudes toward short selling reflect views about speculation. As Stuart Banner notes, a common historical view was that "[s]peculation was both productive and wasteful; it satisfied an evident demand, but its practitioners added no value to the community" (Banner 1998, p. 23). Banning short selling also has a long history. In the United Kingdom, "An act to prevent the infamous practice of stock-jobbing" was passed in 1734, an effort that attempted to ban short selling and was not repealed until 1860. In the United States, contracts to sell stock not owned at the time of sale were unenforceable in New York courts from 1792 to 1858.

Possibly short selling has a bad reputation partly because of its association with "bear raids." A bear raid is a set of trades in which a stock is sold short at a high price, negative rumors are spread to cause the price to fall, and then the short sales are covered by purchasing the stock at the lower price. Some discussions of bear raids suggest that buying stock on the way back up is a way of adding to the raider's profits from manipulating the stock price.

Bear raids are similar to speculators' manipulation of foreign exchange (Friedman 1953). Both are based on attempts to move a financial market price independent of any underlying development. Successful instances of bear raids and exchange-rate manipulation are similar in another way: They are far less frequent than complaints about them.

Selling securities short has a long and controversial history. While it's not clear whether proposed legislation on short selling will be enacted, it's a good bet that short selling's risks and benefits will be debated for quite some time.

References

Banner, Stuart. 1998. Anglo-American Securities Regulation. Cambridge: Cambridge University Press.

Friedman, Milton. 1953. "The Case for Flexible Exchange Rates." In Essays in Positive Economics, pp. 157-203. Chicago: University of Chicago Press.

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links for 2009-11-4

• The economics of open-air markets - voxeu.org
• With tax break, a big carbon footprint - Glaeser
• The GOP should dump the neocons -- latimes.com
• Increasing returns in a comparative advantage world - Paul Krugman
• David Leonhardt, Wilkins Micawber and the economic recovery - Justin Fox
• Examining the US liquidity trap - FT Alphaville
• Reality check (fiscal policy) - Antonio Fatas
• Credit Writedowns - links
• FT Alphaville - links
• Money Supply - links
• naked capitalism - links
• Brad DeLong - links

Brad DeLong: Slouching Toward Sanity

Brad DeLong says government action during the crisis may have prevented another Great Depression:

Slouching Toward Sanity, by J. Bradford DeLong, Commentary, Project Syndicate: In America today ... the Republican congressional caucus is just saying no: no to short-term deficit spending to put people to work, no to supporting the banking system, and no to increased government oversight or ownership of financial entities. And the banks themselves are back to business-as-usual: anxious to block any financial-sector reform and trusting congressmen eager for campaign contributions to delay and disrupt the legislative process.

I do not claim that policy in recent years has been ideal. If I had been running things 13 months ago, the United States Treasury and Federal Reserve would have let Lehman and AIG fail – but I would have discounted their debt for cash at face value, provided that the debt also came with sufficient equity warrants. That would have preserved the functioning of the system while severely punishing the banking and shadow-banking systems’ equity holders...

If I had been running things 19 months ago, I would have nationalized Fannie Mae and Freddie Mac and ... shifted monetary and financial policy from targeting the Federal Funds rate to targeting the price of mortgages. Ever since 1825, the purpose of monetary policy in a crisis has been to support asset prices to prevent the financial markets from sending to the real economy the price signal that it is time for mass unemployment. Nationalizing Fannie and Freddie, and using them to peg the price of mortgages, would have been the cleanest and easiest way to accomplish that.

Nevertheless, policy over the past two and a half years has been good. A fundamental shock bigger than the one in 1929-1930 hit a financial system that was much more vulnerable to shocks than was the case back then. Despite this, unemployment will peak at around 10%, rather than at 24%, as it did ... during the Great Depression... Nor will we have a lost decade of economic stagnation, as Japan did in the 1990’s. ...

It is worth stepping back and asking: What would the world economy look like today if policymakers had acceded to the populist demand of no support to the bankers? What would the world economy look like today if Congressional Republican opposition to the Troubled Asset Relief Program program and additional deficit spending to stimulate recovery had won the day?

The only natural historical analogy is the Great Depression... That is the only time when (a) a financial crisis caused a widespread, lengthy, and prolonged reinforcing chain of bank failures, and (b) the government neither intervened nor passed the baton to a consortium of private banks to support the system as a whole.

It is now 19 months after Bear Stearns failed ... and industrial production stands 14% below its peak in 2007. By contrast, 19 months after the Bank of the United States ... failed on December 11, 1930 ... industrial production ... was 54% below its 1929 peak.

Opponents of recent economic policy rebel against the hypothesis that an absence of government intervention and support could produce an economic decline of that magnitude today. After all, modern economies are stable and stubborn things. Market systems are resilient... A 54% fall in industrial production between its 2007 peak and today is inconceivable – isn’t it? ...

The problem, though, is that all the theoretical reasons to think that depressions as deep as the Great Depression simply do not happen to market economies applied just as well to the 1930’s as they do to today.

But it did happen. And it could have happened again.

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Greed versus Self-Interest

Political philosopher Michael Sandel:

...Citizens generally who looked at this - at the bailouts and the bonuses and have been outraged - they believe there is a difference between greed and self-interest. But here's no way of capturing that intuition in economic analysis because, according to economic analysis, in any case one is deploying self-interest or greed, which is simply self-interest squared, to serve a social purpose. That's what the economic model says. And you have to introduce some normative assumption about what is excessive pursuit of gain in order to make sense of greed as a vice independent of the self-interest that all of the economic models presuppose. So I think there are intuitions in everyday life that people have that the economic models simply don't capture, and greed is one of them."

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"Tax Cuts and Recoveries"

Do tax cuts spur economic growth?

Tax Cuts and Recoveries, by David Leonhardt, Economix: One big question about the 1983-84 economic boom (a boom I mention in my Wednesday column) is: Was it the tax cut?

Ronald Reagan signed a large tax cut in the summer of 1981, while the economy was in recession. Within a year and a half, the economy was booming. Conservatives, understandably, like to argue that the tax cut helped cause the boom.

I’m open to that argument. ... What’s unclear is how big an effect tax rates have.

In 1982, with the economy in the second part of its double-dip recession, Reagan signed a tax increase, meant to reduce the deficit. Here’s Bruce Bartlett, writing at Forbes.com:

According to a recent Treasury Department study, Ronald Reagan proposed the largest peacetime tax increase in American history as part of a budget deal to get the federal deficit under control. The Tax Equity and Fiscal Responsibility Act (TEFRA) ... took effect on Jan. 1, 1983.

During debate on TEFRA, many conservatives predicted economic disaster. They argued that raising taxes in the midst of a severe recession was exactly the wrong thing to do. ... Said Rep. Newt Gingrich, “I think it will make the economy sicker.” The Chamber of Commerce ... said it had “no doubt that it will curb the economic recovery everyone wants.”

Looking at the data, however, it is very hard to see any evidence that TEFRA had a negative effect on growth. Indeed, one could easily make a case that its enactment stimulated growth.

A little more than a decade later, Mr. Gingrich made the same argument about Bill Clinton’s tax increase. But ... the ... late 1990s expansion was the fastest of any in the past forty years.

Mr. Clinton’s successor, George W. Bush, signed a large tax cut during his first year in office — as Mr. Reagan did. But Mr. Bush never signed a tax increase to reduce the deficit. And growth in the Bush years was slower than in the Reagan years or the Clinton years, even before the financial crisis hit.

The history seems to suggest that tax cuts are not the most reliable strategy for spurring growth, at least in the United States, where top income-tax rates are not sky high.

But maybe readers can offer an analysis that explains this history and still makes the case for tax cuts as the main engine of economic recoveries. ...

Just one quick note - for those anxious about the deficit and eager to do something about it, the Reagan experience shouldn't be used as an excuse to start raising taxes too soon. The time will come when deficit spending is no longer needed to spur the economy and at that point we should reverse course, but we shouldn't make the mistake of 1937-38 when an attempt to balance the budget too soon in the recovery caused the economy to fall back into recession.

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links for 2009-11-03

• NY Times Leonhardt: The Optimistic View - Calculated Risk
• Looking Past a Cloud of Pessimism as a Recession Ends - NYTimes.com
• Has there really been a housing boom? - Bluematter
• Why Nobel Economics Laureates chose economics? - Mostly Economics
• On not listening - Paul Krugman
• Crisis Compels Economists To Reach for New Paradigm - WSJ.com
• Can Learnability Save New-Keynesian Models? - NBER - Cochrane
• Financial Intermediaries and Monetary Economics - FRBNY
• Identifying Government Spending Shocks: It's All in the Timing - NBER - Ramey
• New theory on fairness in economics targets CEO pay - EurekAlert
• Why are stocks up? The answer is disturbing - Daniel Gross
• Calomiris on historical crisis lessons - voxeu.org
• How Obama Can Convince Congress to Enact a Larger Stimulus - Robert Reich
• Economists Forum - links
• The Big Picture - links
• Economix - links
• FT Alphaville - links
• Credit Writedowns - links
• Abnormal Returns - links
• New Deal 2.0 - links
• The Stash - links
• Money Supply - links
• Brad DeLong - links

"Death by Renminbi"

Thomas Palley says China's currency policy must change:

Death by Renminbi, by Thomas I. Palley, Commentary, Project Syndicate: Over the last several weeks, the dollar's depreciation against the euro and yen has grabbed global attention. In a normal world, the dollar's weakening would be welcome, as it would help the United States come to grips with its unsustainable trade deficit.

But, in a world where China links its currency to the dollar at an undervalued parity, the dollar's depreciation risks major global economic damage that will further complicate recovery from the current worldwide recession.

A realignment of the dollar is long overdue. Its overvaluation began with the Mexican peso crisis of 1994, and was officially enshrined by the "strong dollar" policy... That policy produced short-term consumption gains for America,... but it has inflicted major long-term damage ... and contributed to the current crisis.

The overvalued dollar caused the U.S. economy to hemorrhage spending on imports, jobs via off-shoring, and investment to countries with undervalued currencies.

In today's era of globalization, marked by flexible and mobile production networks, exchange rates affect more than exports and imports. They also affect the location of production and investment.

China has been a major beneficiary of America's strong-dollar policy, to which it wedded its own "weak renminbi" policy. As a result, China's trade surplus with the U.S. rose... The undervalued renminbi has also made China a major recipient of foreign direct investment, even leading the world in 2002 ― a staggering achievement for a developing country.

The scale of recent U.S. trade deficits was always unsustainable...
But China retains its undervalued exchange rate policy... When combined with China's rapid growth in manufacturing capacity, this pattern promises to create a new round of global imbalances.

China's policy creates adversarial currency competition with the rest of the world. ... Furthermore, the problem is not only America's. China's currency policy gives it a competitive advantage relative to other countries, allowing it to displace their exports to the U.S. ... Yet a mix of political factors has led to stunning refusal by policymakers to confront China.

On the U.S. side, a lingering Cold War mentality, combined with the presumption of U.S. economic superiority, has meant that economic issues are still deemed subservient to geo-political concerns. That explains the neglect of U.S.-China economic relations, a neglect that is now dangerous to the U.S., given its weakened economic condition.

With regard to the rest of the world, many find it easy to blame the U.S., often owing to resentment at its perceived arrogance. Moreover, there is an old mentality among Southern countries that they can do no wrong in their relationships with the North...

Finally, all countries likely have been shortsighted, imagining that silence will gain them commercial favors from China. But that silence merely allows China to exploit the community of nations.

The world economy has paid dearly for complicity with and silence about the economic policies of the last 15 years... It will pay still more if policymakers remain passive about China's destructive currency policy.

Our problems are not China's fault.

"Stiglitz: U.S. Paying for Not Nationalizing Banks"

Barry Ritholtz:

Stiglitz: U.S. Paying for Not Nationalizing Banks, by Barry Ritholtz:

“We have this very strange situation today in America where we have given banks hundreds of billions of dollars and the president has to beg the banks to lend and they refuse. What we did was the wrong thing. It has weakened the economy and has increased our deficit, making it more difficult for the future.” -- Joseph Stiglitz

Any time Joseph Stiglitz calls out the government on their bad decision making, its worth reading:

“Nobel Prize-winning economist Joseph Stiglitz said the world’s biggest economy is suffering because of the U.S. government’s failure to nationalize banks during the financial crisis.

“If we had done the right thing, we would be able to have more influence over the banks,” Stiglitz told reporters at an economic conference in Shanghai Oct 31. “They would be lending and the economy would be stronger.”

Stiglitz has stuck with his view even after the U.S. economy returned to growth in the third quarter and as banks’ share prices climbed this year…

The U.S. government plans to alter the way that a similar rescue would be handled in the future. Draft legislation proposes that banks, hedge funds and other financial firms holding more than $10 billion in assets would pay to rescue companies whose collapse would shake the financial system.”

Why are we constantly governed by fools?

What I've said is that there is more than one route to get to the same destination, some of which are faster than others. Nationalization would have, I believe, led to a faster recovery. But even if that's not the case, even if the recovery would have gone at the same speed (I don't think it would have been slower), nationalization would have also allowed us to reach the same outcome with a different distribution of the bailout money, a distribution that would have been at least somewhat more acceptable to the public because it wouldn't have required giving so much of the bailout money to those who caused the problems.

"Help Wanted" Needs Help

Mark Zandi joins those calling for the government to do something to help to stimulate employment:

Help Small Businesses Hire Again, by Mark Zandi, Commentary, NY Times: ...It is no accident that the recession ended just as Washington’s fiscal stimulus program began providing its maximum impetus to the economy. ...

Still, the recovery remains fragile. ... In order to ensure that today’s tentative recovery becomes a lasting expansion, the government must now make it a priority to deal with employment — particularly among small businesses.

Small businesses are especially vital to job growth. ... In their recent efforts to recharge the economy, policy makers have all but forgotten small business, finding it both easier and more visible to help large multinational firms. Unfortunately, though, big business can’t provide the jobs needed to power the economy forward.

Businesses ... still aren’t hiring. Unless they start doing so soon, consumers won’t have the wherewithal to keep spending, and the economy could slip back into recession. ...

Employment growth historically lags a pickup in gross domestic product. But firms typically increase production by first increasing workers’ hours and adding temporary help. Neither has happened so far: working hours remain stuck at a record low of 33 hours a week, and the number of temporary jobs is still in decline...

Small firms are now struggling to obtain credit; their principal lenders, small banks, are under intense pressure... Credit card lenders, another key source of loans to small business, have aggressively raised their underwriting standards. Policy makers could offer quick relief by empowering the Small Business Administration to provide more credit. ...

To help small companies with cash flow, policy makers should also extend provisions in the current stimulus bill that allow money-losing firms to receive refunds of taxes paid on profits earned in previous years. (In return, they agree to pay higher taxes in the future.) ...

Finally, the government could help minimize the number of new job losses by promoting work-share programs. Nothing damages morale ... more than layoffs... Layoffs are also costly... Seventeen states offer effective work-share programs. Under these arrangements, employers cut workers’ hours — not their jobs — and states make up a portion of workers’ lost wages with unemployment insurance payments. Congress should provide financing to expand such programs nationwide.

These policy steps would not be free, but they could be surprisingly economical. ... This kind of help from Washington could help sustain the new signs of recovery and firmly put the recession behind us.

It's a start, but more than that is needed (and not all of the help should go to business, e.g. extending unemployment benefits would help households having trouble finding employment and stimulate aggregate demand at the same time).

links for 2009-11-02

• Help Small Businesses Hire Again - NYTimes.com
• Employment under Differing Econometric Specifications - Econbrowser
• Inflation Expectations and the Risk of Deflation - FRBSF Economic Letter
• CRE and the CRA - Paul Krugman
• A fruitless clash of economic opposites - Edmund Phelps
• No saving grace - Paul Krugman
• Growth Still Not Nearly Enough To Cheer About - Market Talk
• The economist's new clothes - BBC - Stephanomics
• Ties Between Subprime Lenders, Financial Literacy Groups - Wash. Indep.
• Libertarians and delusionism - John Quiggin
• FT Alphaville
• Money Supply - links
• New Deal 2.0 - links
• Economix - links
• The Big Picture - links
• Credit Writedowns - links
• Abnormal Returns - links
• The Stash - links
• Marginal Revolution - links
• Free Exchange - links
• naked capitalism - links
• Brad DeLong - links

"Half of US Children -- and Most Black Children -- Will Use Food Stamps"

Following up on the post below this one on poverty, I hope we realize the importance of social insurance for children. Our social insurance programs for children are not as good as they should be, but what we do have does some good:

Half of US children -- and most black children -- will use food stamps, Cornell study reports, EurekAlert: Nearly half of American children – including 90 percent of black children and 90 percent of children who spend their childhoods in single-parent households – will eat meals paid for by food stamps at some point during childhood, reports a Cornell researcher.

Nearly one-quarter of U.S. children will live in homes that receive food stamps for five or more years. Food stamps are important indicators of poverty and risk of food insecurity, "two of the most detrimental economic conditions affecting a child's health," says Thomas A. Hirschl, Cornell professor of development sociology...

The study is based on an analysis of the Panel Study of Income Dynamics, a 32-year study of about 4,800 U.S. households...

"Children in poverty are significantly more likely to experience a range of health problems, including low birth weight, lead poisoning, asthma, mental health disorders, delayed immunization, dental problems and accidental death," write Hirschl and co-author Mark R. Rank of Washington University in St. Louis. "Poverty during childhood is also associated with a host of health, economic and social problems later in life."

It also adds some $22 billion per year in additional health care costs, the researchers report.

And the risk of living in homes using food stamps is far from equitably distributed: Ninety percent of children who live with single parents (compared with 37 percent who live in married and other two-parent households), 90 percent of black children (compared with 37 percent of white children) and 62 percent of those whose head of household did not graduate from high school (compared with 31 percent where the head has more than 12 years of school) "encounter spells of food stamp use," the authors find.

Putting those risk factors together, the researchers found that 97 percent of black children living in non-married households where the household head has less than 12 years of education will have received food stamps, compared with 21 percent of white children living in married households whose head of household has 12 or more years of education.

"The situation is likely bad for children," says Hirschl, "because families eligible for food stamps who participate tend to be worse off nutritionally than eligible families who don't participate." Only about 60 percent of families eligible for food stamps actually participate, he said, because of the stigma associated with government help. Although the sample used is representative of the U.S. populations, it does not reflect the immigrant population.

To pick up another theme in the posts today, this also shows the importance of providing jobs programs that employ low-income workers having trouble finding work due to the recession.

And isn't it nice that children likely go hungry due to the stigma associated with seeking help from the government? Who shall we thank for that?

"Five Myths About Our Land of Opportunity"

Five myths about social mobility from Isabel V. Sawhill and Ron Haskins of Brookings:

Five Myths About Our Land of Opportunity, by Isabel V. Sawhill and Ron Haskins, Brookings: Americans have always believed that their country is unique in providing the opportunity to get ahead. ... But rising unemployment and financial turmoil are puncturing that self-image. The reality of this "land of opportunity" is considerably more complex than the myths would suggest:

1. Americans enjoy more economic opportunity than people in other countries.

Actually, some other advanced economies offer more opportunity than ours does. For example, recent research shows that in the Nordic countries and in the United Kingdom, children born into a lower-income family have a greater chance than those in the United States of forming a substantially higher-income family by the time they're adults.

If you are born into a middle-class family in the United States, you have a roughly even chance of moving up or down the ladder by the time you are an adult. But the story for low-income Americans is quite different; going from rags to riches in a generation is rare. ...

2. In the United States, each generation does better than the past one.

As a result of economic growth, each generation can usually count on having a higher income, in inflation-adjusted dollars, than the previous one. ... But that kind of steady progress appears to have stalled. Today, men in their 30s earn 12 percent less than the previous generation did at the same age.

The main reason today's families have modestly higher overall income than prior generations is simple:... Women have joined the labor force in a big way, and their earnings have increased as well. But with so many families now having two earners, continued progress along this path will be difficult unless wages for both men and women rise more quickly.

3. Immigrant workers and the offshoring of jobs drive poverty and inequality in the United States.

Although immigration and trade are often blamed, a more important reason for our lack of progress against poverty and our growing inequality is a dramatic change in American family life. Almost 30 percent of children now live in single-parent families, up from 12 percent in 1968. Since poverty rates in single-parent households are roughly five times as high as in two-parent households, this shift has helped keep the poverty rate up... Among women under age 30, more than half of all births now occur outside marriage...

In addition, we have seen a growing tendency among well-educated men and women to marry each other, exacerbating income disparities. If we add to these family changes the fact that wages for low-skilled workers have stagnated or declined in recent decades, we can explain most of the increase in poverty and much of the increase in the income gap as well.

4. If we want to increase opportunities for children, we should give their families more income.

Of course money is a factor in upward mobility, but it isn't the only one; it may not even be the most important. Our research shows that if you want to avoid poverty and join the middle class in the United States, you need to complete high school (at a minimum), work full time and marry before you have children. If you do all three, your chances of being poor fall from 12 percent to 2 percent, and your chances of joining the middle class or above rise from 56 to 74 percent. ...

Many American families need supplements to their incomes in the form of food stamps, affordable housing and welfare payments. But such aid should not be given unconditionally. First, the public is concerned that unconditional assistance will end up supporting those who are not trying to help themselves. Second, new research ... has shown that individuals frequently behave in ways that undermine their long-term welfare and can benefit from a government nudge in the right direction.

And third, policies with strings attached have had considerable success. ...[S]ocial policies will be more successful if they encourage people to do things that bring longer-term success.

5. We can fund new programs to boost opportunity by cutting waste and abuse in the federal budget.

Can we cut enough ineffective programs or impose enough new taxes to put better teachers in classrooms, expand child-care assistance for working families and provide more financial aid to disadvantaged students while reducing projected deficits? The answer is a resounding no. ... Just three rapidly growing programs - Medicare, Social Security and Medicaid - along with interest on the debt threaten to crowd out all other spending in a few decades.

So we also need to revise the contract between the generations in a way that gradually reallocates resources from the more affluent elderly to struggling younger families and their children. Such a shift would not only help create more opportunity, it would improve the productivity of the next generation, making its members better able to contribute to the costs of retirement - including their own.

The idea that the poverty problem would be much smaller if people would get married seems to me to avoid the important question of what factors are driving the change in the marriage trend. To the extent that these factors are economic and hence that poverty is also a cause of the falling marriage rate (if it is), then it's more complicated than suggested above.

Also, with respect to the last sentence, retirement funds -- Social Security funding -- is not the long-run budget problem we should be worried about, this can be handled relatively easily with a few minor changes. It's health care costs that are the problem. The argument that we should help people in poverty so that they can help pay for Social Security is far down the list of reasons I'd put forth for helping.

Update: See Mathew Yglesias on single parents and poverty.

Paul Krugman: Too Little of a Good Thing

We need to do more to stimulate employment and the economy, but the political climate is unfavorable:

Too Little of a Good Thing, by Paul Krugman, Commentary, NY Times: The good news is that the American Recovery and Reinvestment Act, a k a the Obama stimulus plan, is working just about the way textbook macroeconomics said it would. But that’s also the bad news — because the same textbook analysis says that the stimulus was far too small given the scale of our economic problems. Unless something changes drastically, we’re looking at many years of high unemployment.

And the really bad news is that “centrists” in Congress aren’t able or willing to draw the obvious conclusion, which is that we need a lot more federal spending on job creation.

About that good news: not that long ago the U.S. economy was in free fall. ... The stimulus ... was enough to break the vicious circle of economic decline. ... And the free fall has ended. Last week’s G.D.P. report showed the economy growing again, at a better-than-expected annual rate of 3.5 percent. ... But it’s not ... enough.

Suppose that the economy were to keep growing at 3.5 percent. The experience of the Clinton era, when the economy grew at an average rate of 3.7 percent for eight years ... suggests ... we’d be lucky to see the unemployment rate fall by half a percentage point per year, meaning that it would take a decade to return to something like full employment.

Worse yet, it’s far from clear that growth will continue at this rate. The effects of the stimulus will build over time..., but its peak impact ... is already behind us. Solid growth will continue only if private spending takes up the baton as the effect of the stimulus fades. And so far there’s no sign that this is happening.

So the government needs to do much more. Unfortunately, the political prospects for further action aren’t good.

What I keep hearing from Washington is ... either (1) the stimulus has failed, unemployment is still rising, so we shouldn’t do any more, or (2) the stimulus has succeeded, G.D.P. is growing, so we don’t need to do any more. The truth, which is that the stimulus ... helped, but it wasn’t big enough — seems to be too complicated for an era of sound-bite politics.

But can we afford to do more? We can’t afford not to.

High unemployment doesn’t just punish the economy today; it punishes the future, too. In the face of a depressed economy, businesses have slashed investment spending... This will hurt the economy’s potential for years to come.

Deficit hawks like to complain that today’s young people will end up having to pay higher taxes to service the debt we’re running up... But anyone who really cared about the prospects of young Americans would be pushing for much more job creation, since the burden of high unemployment falls disproportionately on young workers...

Even the claim that we’ll have to pay for stimulus ... with higher taxes later is mostly wrong. Spending more on recovery will lead to a stronger economy,... and a stronger economy means more government revenue. Stimulus spending probably doesn’t pay for itself, but its true cost ... is only a fraction of the headline number.

O.K., I know I’m being impractical: major economic programs can’t pass Congress without the support of relatively conservative Democrats, and these Democrats have been telling reporters that they have lost their appetite for stimulus.

But I hope their stomachs start rumbling soon. We now know that stimulus works, but we aren’t doing nearly enough of it. For the sake of today’s unemployed, and for the sake of the nation’s future, we need to do much more.

"A Shaky Start"

I have something at Room for Debate (written last Friday) on the the extent to which the recent improvement in GDP growth can be attributed to the stimulus package, and whether more stimulus is needed ("Did the Stimulus Work?").

The link is to the much shorter version that appears on the NYT site. Here's the wordier, unedited version:

A Shaky Start, by Mark Thoma: With the news yesterday that output grew by 3.5% during the third quarter of this year, it appears we may finally be seeing the green shoots that signal the onset of the recovery.  But what is driving the growth in output, what will it take to sustain that growth, and how long will it take to make up for the lost output and employment we experienced during the crisis?

A look beneath the growth numbers announced yesterday answers the first question. Increased consumer spending accounted for 2.4% of the 3.5% increase in growth, and much of the increase in consumption was driven by the Cash for Clunkers and other government stimulus programs. Today’s announcement that consumer spending fell by .5% in September now that the Cash for Clunkers program has ended raises serious questions about the sustainability of the growth we are seeing. Without further help from the government, which has clearly aided the economy despite what you may have heard from naysayers, will the private sector be able to sustain growth on its own?

One of the big dangers we face is that we will declare victory too soon and begin raising interest rates and cutting back on stimulus before the private sector has recovered the ability to sustain growth without help from the government. I believe that we need more stimuli right now to maintain the growth we are seeing, particularly given how far the recovery in employment lags behind the recovery in output, but adding to the stimulus package is a political non-starter. However, amid the worries about the growing deficit and fears of inflation that make further stimulus political poison, we can and must maintain the stimulus that is already in place.

The need to at least maintain the stimulus we have, if not increase it, is enhanced by the fact that even though a 3.5% growth rate is far better than the negative rates we have seen recently, it’s not nearly enough to make up for the output we lost during the crisis in a reasonable amount of time (Paul Krugman says that at this rate, “we wouldn’t reach anything that feels like full employment until well into the second Palin administration”). The recovery period from past recessions were associated with output growth rates of 6-7%, enough to resume the level of growth that existed before the crisis, and to make up for losses in a reasonable amount of time. If those losses had not been recovered, if the level of output had been permanently lower instead of just a temporary deviation from its long-run trend, then employment and income would have also been permanently lower.  That is not a desirable outcome in any case, and in the current recession the weakness in employment markets combined with the stagnation in middle class incomes even before the crisis began makes such an outcome even more undesirable. Unfortunately, at a rate of 3.5% -- which is only slightly above the long-run trend rate of growth -- it will take many, many years to make up for losses and return to the long-run trend, and any further slippage in growth would make the losses permanent.

The recovery we are seeing is being driven, in large part, by government stimulus programs.  The fact that growth is weaker than we need to fully recover losses in a reasonable amount of time, and the even slower recovery we are seeing in employment markets, indicates that the stimulus programs already in place are too small. Thus, even though it’s unlikely to happen, the economy could use more help than it’s getting, but in any case it’s imperative that we avoid cutting back too soon.

The signs are encouraging, and at some point the private sector will be able to sustain growth on its own, but it’s far too soon to declare victory.

Other entries from:

• Jeffrey A. Miron
• Simon Johnson
• Russell Roberts

links for 2009-11-01

• Get Americans Back to Work - Robert Reich
• Assurance game - UnderstandingSociety
• The trade collapse: The role of product quality - voxeu.org
• Misunderstanding Randomness - Aid Watch
• The Amazon Wal-Mart price war - The New Yorker
• What The Woman Lived - Economic Principals
• Abnormal Returns - links
• naked capitalism - links
• Brad DeLong - links
• Marginal Revolution - links

Was the Invisible Hand "Central" to Smith?

Daniel Klein, Professor of Economics at George Mason University and Editor of Econ Journal Watch, asks:

What probably would you put on the truth of a broad hypothesis of deliberate centrality?

Here's more background on the question:

In a Word or Two, Placed in the Middle: The Invisible Hand in Smith’s Tomes, by Daniel B. Klein and Brandon Lucas: Abstract:  The meaning and significance of Smith’s expression “led by an invisible hand” has been long debated, and especially lately. We speak to the large debate only in fine, by focusing on the conjecture, first hinted at by Peter Minowitz, that Smith deliberately placed his central idea, as represented by the phrase “led by an invisible hand,” at the physical center of his masterworks. We bring supportive evidence and argumentation to the conjecture. The four most significant points developed are as follows: (1) The expression “led by an invisible hand” occurs pretty much dead center of the 1^st and 2^nd editions of Wealth of Nations, and of the final edition of the volumes containing Theory of Moral Sentiments. (2) The expression in WN drifted only a bit from the center, only about 5 percent from the center in the final edition (and even less if the index is excluded). (3) The rhetoric lectures show that Smith not only was conscious of deliberate placement of potent words at the center, but thought it significant enough to remark on to his pupils, noting that Thucydides “often expresses all that he labours so much in a word or two, sometimes placed in the middle of the narration.” (4) There numerous and rich ways in which centrality and middle-ness hold special and positive significance in Smith’s thought. In conjunction with larger considerations, these points may be helpful in assessing the significance of Smith’s famous phrase.

Here's a figure showing centrality through the 7 editions of each work.

This is an attempt to rescue the invisible hand from critics who argue that the invisible hand idea that is attributed to Smith was not a central part of his writing (e.g. see Gavin Kennedy).

In answer to the question, it doesn't seem very likely to me that this was intentional.

---

Note: If you are unfamiliar with the debate over the invisible hand, here is Gavin Kennedy:

...Lost Legacy has never been slow in criticizing the ‘Chicago Adam Smith’, a person with ideas that are far from the ideas of the Adam Smith born in Kirkcaldy in 1723.

George Stigler’s boast that “Adam Smith is alive and well and lives in Chicago” (1976) reflects to invention of the Adam Smith of the “invisible hand” (a mere metaphor for Adam Smith whose single use of it in Wealth Of Nations referred to the unintended consequences of the risk-avoidance of some, but not all merchants ... who preferred the home trade), and had nothing to do, at least in Adam Smith’s mind, with how markets worked, ... or how the price system worked.

The belief that the “invisible hand” was a significant ‘idea’, ‘concept’, ‘theory’, or ‘paradigm’ was wholly invented in the 1950s by neo-classical economists on the back of general equilibrium mathematics ... and in support of a worthy criticism of Cold War, Soviet central planning. It is now taught in every economics 101 class as if it had historical validity, mainly by people who have never bothered to read Wealth Of Nations. ...

Update: See " Yet Another Note on Adam Smith's "Invisible Hand": What It Is and What It Is Not" by Brad Delong.

Long-Term Unemployment

[Calculated as the this divided by the this.]

links for 2009-10-31

• Can Citigroup Carry Its Own Weight? - NYTimes.com
• Did the Lehman Failure Do It? - Arnold Kling
• How Health Plan Turns Supply-Side Ideas Upside Down - Mankiw - NYTimes.com
• Why do central banks have assets? - Worthwhile Canadian Initiative
• Democrats Push for Plan to Cut Deficit - NYTimes.com
• Recession Revives Authors’ Interest in Keynes - Review - NYTimes.com
• Books About John Maynard Keynes - Review - NYTimes.com
• Book Review - 'Ayn Rand and the World She Made,' - NYTimes.com
• Scary Halloween Costumes ...- Outside The (Cardboard) Box
• The Big Picture - links
• Economix - links
• New Deal 2.0 - links
• Credit Writedowns - links
• Economists Forum - links
• FT Alphaville - links
• Crisis Talk - links
• Abnormal Returns - links
• Marginal Revolution - links
• Brad DeLong - links