Modeled Behavior

I agree with Paul Krugman on the early 80s but disagree with his characterization of the current slump.

The early-80s slump was brought on by a huge rise in the Fed funds rate, which left lots of room for cuts, and was driven by a deep slump in housing, which meant that there was lots of pent-up demand when rates fell again. The 2007-? slump was brought on by the bursting of a housing and debt bubble, and left the Fed largely pushing on a string.

So, on some level it depends on what you mean by “bursting of the bubble.” However, if you were just talking about a collapse in housing prices that left US households underwater and unable to obtain credit then I think that’s wrong.

A Minsky moment could have proceeded in the United States without a downturn of this magnitude, even with the Funds rate already so low.

What would have happened – and what was happening from 2006 – late 2007 was that the dollar was falling fast enough to outweigh the collapse in construction.

And, of course that would have been markets at work perfectly since it would have driven down US consumption and up US tradable output. There would have been a general decline in living standards but little rise in out-and-out unemployment.

Instead, we had a global financial crisis that resulting in a soaring dollar, collapsing demand around the world and the inability for the US to pay down its external debt for lack of a channel.

Thus the (too) slow process of trading private debt for public debt began.

We’ll get GDP later this morning, but as always I don’t know that there is a whole lot to be gleaned from it. Its fairly backwards looking and typically doesn’t tell us anything we don’t already know.

Its useful as a summary stat for people who are not deep in the weeds but can you say that you looked at any GDP report current or past and said “Ah, just looking at Census and BLS data I couldn’t really get a sense for what direction the economy was moving in at the time but now I get it” That means the information content is pretty low.

A couple of things that are of interest. New Claims bounced back and pretty strongly. There was a little more weakness here than I expected and so that always downgrades our estimate of the chances the recovery will catch. Nonetheless, its looking pretty good.

This recovery has shown more churn than in the past, and so we have had stronger job growth relative to new claims as compared to the last 25 years.

Whether that pattern holds will be interesting because the post Global Financial Crisis relationship suggests that we could be getting close to blisteringly fast job growth.

In the upper 300K range.

So a key question is – is the reduction in new claims showing a normalization between the relationship between new claims and job growth or is it suggesting even faster job growth. I actually don’t have a good angle to think about that problem.

The durable goods jump was noticeable enough for me to want to dig further

Naturally, I thought  this likely autos

That seems to be right

New home sales came in at a record low which is not surprising. What is just nutty to my eyes is inventory.

There is nothing wrong with this from a micro perspective. Sales have been at record lows for years. There is no reason to carry excess inventory. However, we are looking at a deviation from trend as strong as the peak of the housing bubble. Moreover, because the numbers are small rather than large the rate at which the market could tighten if things turn exceeds the rate at loosened from the last turn.

This bit of data isn’t new but just to give us a sense of where we are, here is debt service as a percentage of personal income.

I know I have views on debt that are hard for people to square with, but I hope it makes sense when I say the burden of debt is related to how large you actual debt payments are as a fraction of your income.

So, if you owe 100K at 20% this is going to be more burdensome than 1000K at 1%.

Now because net income payments can be negative one can of course make money from accumulated debt but I’ll try to be good and leave that alone for now.

The point here is that the actual debt burden facing households is low and since disposable income has room to rise, it could go lower. This leaves a lot of room for more purchases.

Arnold says

The ratio of nominal GDP to employment is NGDP/L, where L is the level of employment. This can be decomposed into:

NGDP/L = (NGDP/RGDP) x (RGDP/L) = the GDP deflator x productivity

. . .

The way I look at it, this means that the relationship between nominal GDP and employment has almost no theoretical import. In particular, it does not constitute evidence in favor of the AS-AD paradigm. The AS-AD story, as Scott Sumner tells it (and pretty much any mainstream macro would say the same thing), is that changes in nominal GDP cause changes in employment, rather than the other way around.

The PSST story is equally consistent with a correlation between employment and nominal GDP. It just interprets the causality as running the other way. If a bunch of workers are laid off, for whatever reason, nominal GDP will go down, unless productivity and/or inflation rise in order to compensate.

Defining aggregate demand as nominal GDP finesses such difficult issues as defining the money supply or justifying specific parameters of a macroeconomic model. But there is a priced to be paid. And that price is vacuousness.

Ok so the anchor in all of this getting us to a nob that everyone can agree the Fed controls.

So, the key question is do we believe that the Fed can indeed control NGDP? Or, put another way, can the Fed control the total amount of nominal spending in the economy.

If the answer is yes, the we can use that same relation to decompose Fed action into its consequences.  If the decomposition shows – as is Scott and many other’s point – that employment moves, not just inflation or productivity then this is saying that the Fed controls employment.

So the crux of this is whether or not you believe that the Fed can set NGDP. And, if it can we have an important implication.

As I mentioned last year, the message is the policy, and looser Fed policy would like follow the following path

Why is this important. Because the difference between extended period and mid-2013 highlights the significance of the Fed wording. Had this simply meant “so long as appropriate” there really wouldn’t be a difference between extended period and 2013.

This statrment is rightfully viewed as a quasi-commitment by the Fed to keep interest rates at zero for two more years.

What you would want to see is the phrase “at least through mid-2013” repeated over and over in new statements and speeches. That will solidify the commitment.

Remember that the last thing you want to do as a central banker is hurt your credibility. So, repeating specific dates indicates that those dates have real meaning.

If the Fed were to begin to tighten its stance the first thing you would expect to see is the phrase “at least” removed from statements and speeches. Further tightening would move us to something phrasing like “possibly through mid-2013”

How the Fed frames the certainty of its statements tells you how tight the policy is.

Now we have moved to

are likely to warrant exceptionally low levels for the federal funds rate at least through late 2014

What is important here is that this is a loosening of policy. It is not a promise to be loose. It IS loosening.

Why?

Because, what matters to bankers is the entire path of the Fed Funds rate from now into the future.

Suppose, that a developer wants to build a new apartment complex – highly relevant in our current environment.

The first thing you do is get a construction loan. This will last about 18 months or so and will be interest only. It also comes out in draws and there some other issues only tagentally relevant to us.

Part of what the Fed is saying here is: for the length of the construction loan we expect the bank to be able to raise funds at zero cost. That’s nice and it lets me as a banker know that there are going to be no rate shocks during this project.

Now, at the end of that 18 months the apartment developer is going to have to get a new loan. Then use those proceeds to pay me in full. A very important consideration for me is whether or not I think she will be able to get that loan.

The Fed is saying look, one of two things will happen. Either the economy will be growing much steadier or interest rates are still going to be zero. Well in either of those cases my developer has a good chance of rolling her loan.

This means that it is a pretty safe bet for me to go ahead and fund this construction loan today.

So anticipation of what is going to happen tomorrow walks back to the present in a very straight forward way. Its not a complex or esoteric expectations problem. As a banker I need to know what is going to happen to my loan and the Fed is helping me figure that out.

On the more esoteric end of things. The Fed also said

The Committee judges that inflation at the rate of 2 percent, as measured by the annual change in the price index for personal consumption expenditures, is most consistent over the longer run with the Federal Reserve’s statutory mandate.

Now some people might be saying big freaking news. Well maybe not big freaking but not trivial. First of all PCE aint CPI.

As you can core CPI has already broken through 2% year-over-year. On the other hand core PCE has stalled below 2%

The difference between the two is that CPI is attempts to measure what consumers buy or quasi-bought in the case of owner’s equivalent rent. PCE measures all the stuff that is not investment and not direct expenditure by the government.

I’ve noted before that Core CPI and housing costs are basically two different phrases for the same thing. This is less true with CPE, and with housing costs on the rise one can expect core CPI and core PCE to run at different rates.

Next

If you look back at the minutes of previous meetings you say some folks tossing around numbers like 1.25% PCE price index growth as the right target. Basically, those numbers have been overruled, so this is looser than the past Fed.

Last and more weedsy

There is some evidence that a point target is interpreted by financial markets as more flexible than a range. So, if the Fed were to say we want Core PCE somewhere between 1.5% and 2.5% that would actually be thought of as stricter than saying we want Core PCE at 2%.

The reason is that with the range people start saying stuff like “inflation has broken through the Fed’s comfort zone!” and expect immediate tightening. However, with a point target they will say “We have been drifting above 2% for a while and so we expect the Fed will want to bring us back down eventually”

I should have more to say later but that is an off the cuff response. This is looser monetary policy.

Oh, and I will just note that my viceral response to “late 2014” was “mmmhhh” which means that we are moving from “why aren’t we hitting the gas, go, go, go” to “Well, lets talk about this. Late 2014 you say. Do we have an early exit strategy. I wouldn’t mind reviewing. Just in case you know.”

As I mentioned last year, the message is the policy, and looser Fed policy would like follow the following path

Why is this important. Because the difference between extended period and mid-2013 highlights the significance of the Fed wording. Had this simply meant “so long as appropriate” there really wouldn’t be a difference between extended period and 2013.

This statrment is rightfully viewed as a quasi-commitment by the Fed to keep interest rates at zero for two more years.

What you would want to see is the phrase “at least through mid-2013” repeated over and over in new statements and speeches. That will solidify the commitment.

Remember that the last thing you want to do as a central banker is hurt your credibility. So, repeating specific dates indicates that those dates have real meaning.

If the Fed were to begin to tighten its stance the first thing you would expect to see is the phrase “at least” removed from statements and speeches. Further tightening would move us to something phrasing like “possibly through mid-2013”

How the Fed frames the certainty of its statements tells you how tight the policy is.

Now we have moved to

are likely to warrant exceptionally low levels for the federal funds rate at least through late 2014

What is important here is that this is a loosening of policy. It is not a promise to be loose. It IS loosening.

Why?

Because, what matters to bankers is the entire path of the Fed Funds rate from now into the future.

Suppose, that a developer wants to build a new apartment complex – highly relevant in our current environment.

The first thing you do is get a construction loan. This will last about 18 months or so and will be interest only. It also comes out in draws and there some other issues only tagentally relevant to us.

Part of what the Fed is saying here is: for the length of the construction loan we expect the bank to be able to raise funds at zero cost. That’s nice and it lets me as a banker know that there are going to be no rate shocks during this project.

Now, at the end of that 18 months the apartment developer is going to have to get a new loan. Then use those proceeds to pay me in full. A very important consideration for me is whether or not I think she will be able to get that loan.

The Fed is saying look, one of two things will happen. Either the economy will be growing much steadier or interest rates are still going to be zero. Well in either of those cases my developer has a good chance of rolling her loan.

This means that it is a pretty safe bet for me to go ahead and fund this construction loan today.

So anticipation of what is going to happen tomorrow walks back to the present in a very straight forward way. Its not a complex or esoteric expectations problem. As a banker I need to know what is going to happen to my loan and the Fed is helping me figure that out.

On the more esoteric end of things. The Fed also said

The Committee judges that inflation at the rate of 2 percent, as measured by the annual change in the price index for personal consumption expenditures, is most consistent over the longer run with the Federal Reserve’s statutory mandate.

Now some people might be saying big freaking news. Well maybe not big freaking but not trivial. First of all PCE aint CPI.

As you can core CPI has already broken through 2% year-over-year. On the other hand core PCE has stalled below 2%

The difference between the two is that CPI is attempts to measure what consumers buy or quasi-bought in the case of owner’s equivalent rent. PCE measures all the stuff that is not investment and not direct expenditure by the government.

I’ve noted before that Core CPI and housing costs are basically two different phrases for the same thing. This is less true with CPE, and with housing costs on the rise one can expect core CPI and core PCE to run at different rates.

Next

If you look back at the minutes of previous meetings you say some folks tossing around numbers like 1.25% PCE price index growth as the right target. Basically, those numbers have been overruled, so this is looser than the past Fed.

Last and more weedsy

There is some evidence that a point target is interpreted by financial markets as more flexible than a range. So, if the Fed were to say we want Core PCE somewhere between 1.5% and 2.5% that would actually be thought of as stricter than saying we want Core PCE at 2%.

The reason is that with the range people start saying stuff like “inflation has broken through the Fed’s comfort zone!” and expect immediate tightening. However, with a point target they will say “We have been drifting above 2% for a while and so we expect the Fed will want to bring us back down eventually”

I should have more to say later but that is an off the cuff response. This is looser monetary policy.

Oh, and I will just note that my viceral response to “late 2014” was “mmmhhh” which means that we are moving from “why aren’t we hitting the gas, go, go, go” to “Well, lets talk about this. Late 2014 you say. Do we have an early exit strategy. I wouldn’t mind reviewing. Just in case you know.”

Mark Thoma asks for thoughts on the following point

Psychologists mock what economists call the micro­foundations of consumer behavior…. That this framework is suitable for aggregate systems in a globalized economy simply because the tribe called economics has agreed to adhere to these ad hoc assumptions makes no sense. Increased interactions with disciplines that economists have often mocked as unscientific would greatly improve economists’ understanding of the real world and would be more truly scientific. …

For the core questions that economists are interested in, optimization is always a valid framework. Now before I go on, I want to say that I am not sure I get the compulsion to use optimization in all cases. If you just posit some relationships and they work then more power to you.

However, I don’t think there is something missing in optimization.

Optimization is just picking. You have a bunch of different things. You want to say: show me things like this, not things like that. This is an optimization problem. It need not have any normative flavor even in describing the process. You need not be getting the “best” items by any non-trivial definition of the best.

Now in practice economists often imagine that you are dealing with a situation where you take some range on the number line and then match every single real number in that range to a different item in your bunch of things.

We call this an objective function. Its going to allow us to pick items using calculus.

I am of course going to tell you that spacetime is discrete and so at a basic level this simply cannot describe reality. But, that’s fine because economics doesn’t address problems in which the discreteness of reality becomes apparent.

So, we can act as if we can do this matching problem and then boom you have an objective function.

At the same time though you have to recognize that you just have some pile of crap and a number line. That’s it. You don’t want to go around imbuing objective functions with meaning they don’t have.

For example, take utility maximization. Here we have an objective function that matches possible human behaviors to the number line. We set up the matching so that the if we allow the human in question to engage in a larger set of behaviors he or she will in fact engage in a behavior that corresponds to a larger number.

So ultimately what we have done here is set up this relationship between possible things this human can do and numbers on the number line, mediated by observations about what the human actually does.

Fair enough, but what’s the meta-meaning of higher numbers. Nothing. There is no meta-meaning.

Are higher numbers in any sense fundamentally “better?” Not unless you  believe that whatever this person does when the constraints are eased is fundamentally better.

Do higher numbers make the person happier? Maybe. Since happiness is presumably a real thing you need some way to test this. However, there is no underlying reason why higher utility ought to correspond to greater happiness. Not unless you think freedom from constraint is the ne plus ultra of happiness.

I can give you a prime example why this probably isn’t true right here:

The most celebrated technique in this book is a return to swaddling where you wrap a baby like so

Now by all appearances babies seem happier when swaddled.

Maybe someone wants to come along and try to convince me that they have some method of establishing that the baby has higher utility when swaddled. Seeing such an argument is going to be a real treat.

This is a literal constraint on behavior. It only works if the friction of the blanket is enough to simply overwhelm the amount of force the baby can generate. Its hard to generate a scenario that is more oppressive than being completely bound head-to-toe.

Yet, it really, really looks like the baby is happier.

Are the only relevant constraints material? Not if this person acts anything like most people. The line that separates the set of behaviors that do and do not result in being the subject of laughter and ridicule is a pretty strong constraint for most folks.

The line that separates the behaviors that lead to esteem and being the object of sexual desire from the those that do not is also a pretty big deal.

What do I mean by “strong” and “big deal”

I mean this. Take your all material constraints. Look at how much they vary among the population. Now vary them that much on your subject and observe his behavior. How much does it change? How far up and down the number line can we go.

Now, take the material constraint to the least binding of the values you used and move only the ridicule constraint. See if we can sweep out a range of numbers just as large as we got before. I am betting we can.

This means we can do just as much by subjecting this person to various amounts of ridicule as you can by subjecting them to all the various material constraints present among our population.

Put in more human terms it would go like this, even if you are as rich as the wealthiest person in the world or have as many resources at your command as the most powerful person in the world we can make you behave as desperately as any pauper simply by subjecting you to enough ridicule.

That is what it would mean to say, ridicule is a big deal.

But, what does all this have to do with anything?

Three takeaways at least.

One, sticking with optimization doesn’t really limit the phenomena we can model.

Two, despite its name optimization doesn’t tell you anything subjective about what is happening. The proof is always in the pudding. If you like it when folks get to do what they would do if they had fewer constraints then that makes higher utility “better.” If not, then not.

Maybe when people are allowed to do whatever they want they will go out and get a subprime mortgage, move their family into a brand new house, not be able to keep up with the payment and then get foreclosed upon.

If you look at that and say: man that sucks. Then utility maximization is bad in this case.

Three, there is just no reason to suspect that real people will be influenced only by material constraints or that the range of behaviors people display will be tied mostly to changes in material constraints.

Dean keeps saying

It is also important to note that the financial crisis has little direct relevance to the current weakness of the economy. The problem is simply that there is nothing to replace the demand generated by the housing bubble. Consumption is actually unusually high relative to income and investment in equipment and software is back to its pre-recession share of GDP.

I just don’t know in what sense this is a meaningful reading of the facts. CPE is high relative to GDP but this is largely a way of saying that Medicare and Medicaid keep paying on behalf of beneficiaries even during a recession.

As I have mentioned many times, if we look at real retail sales they are no where near recovered.

and of course the gap is largely cars and trucks.

Equipment and Software is growing well, though importantly not in nominal terms in real terms. So, I can’t easily get good charts out of BEA and FRED doesn’t have exactly what I want but consider this

Here is the growth Equipment and Software on the balance sheets of Non Nonfinancial Corporate Business.

Now here is Investment in Equipment and Software from the NIPA tables.

There are a couple of things going on here. One, there is depreciation, which is not counted in the gross investment figures. Two there are financial corporations which are big investors in Equipment and Software, by which we mean, Custom Software.

Three, however, is that in all cases the growth is driven by software. Not even tech generally, but software. Well, software has huge price declines associated with it. So, even if you are spending the same amount of money on software the estimated real investment in software will be going through the roof. That is basically what’s happening.

In terms of raw dollars, investment in Equipment and Software means by and large, transportation equipment.  Cars, trucks, trains, boats, airplanes etc.

This is in the dumps. At one point the truck numbers were unbelievable. I think I saw a 90% collapse in investment in trucks. So, even though transportiona has climbed part way back up, its still pretty low and I don’t think is yet outpacing obsolescence. That is, the commercial vehicle fleet is still shrinking.

David Glasner writes:

It must have been a good feeling when Scott Sumner saw Karl Smith’s blog post last Thursday announcing that he had proved that Scott was right in asserting that Simon Wren-Lewis had committed a logical blunder in his demonstration that Robert Lucas and John Cochrane made a logical blunder in denying, on the basis of Ricardian equivalence, that government spending to build a bridge would be stimulative.

. . .

In Karl’s nonsense result, savings is not equal to investment (because investment has not changed while savings has fallen by 1) and expenditure is not equal to income (because DC + DG + DI > DC + DS + DT). This is just the ABCs of comparative-statics analysis.

Now in a subsequent post, Karl seems to have retracted his “proof,” admitting:

S = –1 is not allowed [because investment has not changed].

I took Scott’s point to be that one must invoke the old Keynesian model in order for Wren-Lewis to have been correct. Its not simply that once one acknowledges consumption smoothing that even a child can see Cochrane was wrong.

The reason I take this to be his position is because in his very first post on the matter Scott states:

As it is, Wren-Lewis and Krugman are showing they don’t understand that not everyone agrees with the Keynesian model, and also that they don’t even know how to defend their own model.  It does no good to “refute” Cochrane with an example that implicitly accepts the crude Keynesian assumption that savings simply disappear down a rat-hole, and cause the economy to shrink.

My sense was that – intentionally or not – Scott was being beat up upon for his lack of comfort with Mathematics. Which is never a reason to beat up on anyone. Indeed, Scott wrote

In a perfect world I’d lay out a concise logical proof that Simon Wren-Lewis and Paul Krugman are wrong.  And number each point.  They’d respond saying which of my points were wrong, and why.  Then I’d reply.

Which is indeed ideal. Rather than just shooshing him away, one could reply as Glasner did to me

In Karl’s nonsense result, savings is not equal to investment (because investment has not changed while savings has fallen by 1)

In which case I would demand that you tell me why investment cannot change.

At this point someone is likely to invoke the IS curve and investment’s indifference to anything but the interest rate. To which Scott or I could respond: so what you are saying is that if the Old Keynesian model is TRUE then it is TRUE.

While that statement is undoubtedly correct, its not immediately obvious why it should be compelling Cochrane or anyone else who rejects the Old Keynesian model.

Now, instead one could have said: Look if you go through a chain of reasoning you will see that you get qualitatively the same results from an Old Keynesian model as you do from an intertemporally optimizing rational agent model, which we all [For Better or Worse] take seriously.

However, you’d also have to give up on simply saying that Cochrane is willfully ignorant of Macro 101.

I understand Brad’s point on Lucas but I am still not sure how I feel about that.

P.S.

Just as a note on the use of Mathematical language. I said

Let . .  DS = –1

Some folks then wanted to ask why this would make any sense or if it jived with a more general model of the economy. However, that’s not how proofs work.

One can’t simply ask“well why should that be”

It should be because in a proof I am effectively God and I can “let” anything I want unless the statement itself is contradictory. So, I cannot let X be a stone so heavy even an omnipotent being could not lift it, since those concepts are grammatically contradictory.

However, I can certainly let X be the day last year when I was crowned by all mankind as the Emperor of Ice Cream. Sadly, in this case, X is the empty set.

Its important that proofs work that way because in an elegant proof it should be clear which let is doing the heavy lifting at each stage. And, ideally there should be no extraneous “lets” to confuse the matter.

Then one can easily say “Ah this entire logical argument depends crucially on that one assumption right there.”

Then we can all at least agree on what precisely we disagree about and hopefully move forward from there.

Paul Krugman is beginning to wax Smithian. Via Mark Thoma

How goes the state of the union? Well, the state of the economy remains terrible. … But there are reasons to think that we’re finally on the (slow) road to better times. And we wouldn’t be on that road if Mr. Obama had given in to Republican demands that he slash spending, or the Federal Reserve had given in to Republican demands that it tighten money.

Why am I letting a bit of optimism break through the clouds? Recent economic data have been a bit better… More important, there’s evidence that the two great problems at the root of our slump — the housing bust and excessive private debt — are finally easing. …

A couple of things.

This would actually be a great issue over which to flush out the relevant narrative. Paul sees housing prices and private debt overhang as the driving concern.

I tend to think that housing prices per se, don’t matter, land prices do and that the private debt overhang is not necessarily a big deal.

If we lived in a world without capital it would be. The only way to get the economy going again would be for natural borrowers to be able to meet the savings demand of natural savers. That can only happen if the debt overhang is reduced.

However, in a world with capital this need not be the case. Natural savers can switch from funding the consumption of natural borrowers to funding the capital investment. In an environment of stable land prices and rising population this is almost a no brainer because structures last a really long time relative to recessions and increasing population means that eventually they will be needed.

If the carrying costs are zero or negative then building is no brainer. The problem is that buildings are attached to land and when land declines in value it upsets the collateral backing a potential loan. This effectively increases the risk premium and means that real interests rates have to be very low or even negative to fund construction.

In any case, what I wanted to touch on here was how fast the recovery can proceed. Most people are still saying years to full employment and that would be my guess, but it is worth noting that the speed limit on the economy is extremely high. Here for example is the closing of the output gap post 1983

From 7 percent to 1 percent in a little over a calendar year.

Now lets look at the output gap as it stands today

So following a similar path we could close the output gap almost completely by the end of this year.

Will that happen. Given the stance of the Federal Reserve so far, I doubt it. However, its important to note that this is a choice. The Fed is deciding that the costs to closing the gap by Q1 2013 outweigh the benefits.

It is clearly and fully within their power to do so and they have done so before.

I’ll follow up on a couple posts on why this is utterly realistic on the ground. As a preview, we have the office space, we have the factory capacity, we have the roadway capacity, we have the electrical power generation in place. We have the storefronts. We have the cranes. We have the bulldozers All the things we need for GDP to increase GDP by 10% over the next year are in existence.

And, – and this is important – we have actual physical counts of these things. We need not speculate. We know how bulldozers there are in America. We know how many square feet of office space are for lease.

The pretense of knowledge is a lot less pretense-full when you have a 1 Terabyte portable Hard Drive and GIS mapping software.

Adam Gurri in a post titled Create Value, Not Jobs, writes

Certainly technology can and is disrupting human labor markets–but that isn’t going to “further weaken the global economy”. It is going to increase our productivity, make it easier to provide consumers value for cheaper. It will make it hard for people replaced by machines to figure out how they can create additional value, for a time.

But we need to get our priorities straight; what we want to do is help people create value. Unless giving someone a job will enable them to create more value than it costs, the existence of that job is counterproductive.

Economists like to say this type of thing. Its counterintuitive, which always fun. And, it helps highlight why certain policies are in fact a bad idea.

The only problem is that as a general statement, its wrong.

Or, more precisely, its either trivially true or false.

If value is simply, that thing which our ideal social objective function maximizes, then its true. But, literally by construction and hence trivially so.

For example, one could just as accurately say

• Unless freeing millions of people from slavery creates more value than it costs, its counterproductive
• Unless preventing the mass rape and murder of innocent children creates more value that it costs, its counterproductive
• Unless asking Hannibal the Cannibal to refrain from devouring all humans on earth and then committing suicide for want of another person to eat creates more value than it costs, its counterproductive

While these statements are all true they are not particularly useful as a guide to policy.

On the other hand, if what you mean is that unless giving someone job on net increases the total value of goods and services produced within the economy, its counterproductive, then this is not true.

First, its not true because of the simple fact that jobs are a means of distributing income and distributing income is not, generically, costless. If we were to levy a tax and use that tax to redistribute income to those without a job this would almost certainly have some Hicksian deadweight loss.

In addition you are going to need some administrative authority to manage this redistribution policy and you have to worry about designing the system so that it does not encourage people to seek joblessness.

All of these things have welfare losses even if they have small or zero losses in terms of the total value of goods and services produced.

Second, people value having a job. They value the narrative that they are taking actions on a daily basis which enrich society, even if they are not actually doing this.

Now I am the first to point out that people can take this way too far. And, you have to balance the value of allowing folks to engage in an extended fiction about their role in the global economy against the material consumption of other human beings. Nonetheless, the value of the fiction is not zero.

If for a total material cost of $1 we could allow 100 Million people to persist in the belief that they are expanding the global pie, even if they are not, this would be a price well worth paying.

The point that I had hoped to make clear with my little proof was that Wren-Lewis does not constrain savings. I specifically set the change in savings equal to –1 so that the multiplier would be zero.

This is supposed to motivate you to tell me why I can’t do that.

Indeed, this is precisely what this graph from Krugman shows

See how Investment is just a horizontal line. And, we know that in the final analysis I = S.  Since, Investment is a horizontal line it cannot change. Hence savings cannot change.

S = –1 is not allowed.

However, the point that Scott was digging around was that this is not only a pretty significant assumption but it underlies the entire Old Keynesian framework.

Yet, neither Krugman nor Wren-Lewis come out and say this or suggest why Cochrane should accept this assumption or the Old Keynesian framework in general. This is important because Cochrane, indeed acknowledges, but then waves away the Old Keynesian model:

Yes, I’m aware that old Keynesian models do give a multiplier to tax financed spending. Also, some new Keynesian models such as Christiano, Eichenbaum and Rebelo (2009) predict huge government spending multipliers whether financed by taxes or by borrowing. However, tax-financed spending is usually thought to have a weaker (if any) effect, which is why the current policy debate is only about borrowing to spend.

Cochrane is saying: yeah you could get that if you were an old Keynesian but most people are suspect of that thinking nowadays.

I think the response to Cochrane and Lucas should go like this:

When the government raises taxes to fund additional spending then in theory the effect on aggregate demand depends crucially on what the money is spent on.

If the money is spent so that raises the marginal utility of consumption then that is going to tend to increase aggregate demand. Likewise if it is spent in a way that increases the marginal product of capital that will also tend to increase aggregate demand.

When Cochrane explicitly and Lucas implicitly thinks in terms of transferring purchasing power from one randomly chosen citizen to another there is no reason to expect that this will have any effect on either the marginal utility of consumption or the marginal product of capital.

Indeed, though Lucas trips himself up in the phrasing when he describes the government using money to purchase a bridge he is almost certainly describing a situation that will have an effect on the marginal utility of consumption and perhaps also the marginal product of capital.

Now, often I see people reasoning on the basis of whether or not the government will recruit idle resources to build the bridge or not. You can walk through the situation like that but I think its easier to see what’s going on by just assuming away that possibility and supposing that all of the resources recruited were not formerly idle.

In that case the government is pulling consumption away from taxpayers and pulling investment away from private investors in order to accumulate the resources necessary to build this bridge.

This mechanism should be highly intuitive to folks who think in a classical, seen-and-unseen, paradigm.

However, the analysis does not stop there. Neither the taxpayer nor the investor should just walk away accepting their fate. For the taxpayer his marginal utility of consumption has risen because he is now consuming less.

For the investor her return on investment has now risen because the marginal investment project has been taken from her. Both the taxpayer and the investor will attempt to borrow from the future to correct this imbalance.

You can think of the “stimulus” as actually occurring at this point. It is the effort of the consumer and the investor to correct for changes in the marginal utility of consumption and the marginal return on investment that expands aggregate demand.

If there are no resources available to fulfill this attempt then prices and interest rates will be driven up until the consumer and the investor are back into intertemporal balance. However, if resources are available then they will be recruited.

My hope is that this closes the intuition around why reasoning from random cash transfers or reasoning from a fully employed economy gives such different results from reasoning about a bridge purchase during a recession.

The key questions and differences are thoroughly microeconomic. What happens to the marginal utility of consumption? What happens to the marginal product of capital investment? What are consumers and investors able to do in response?

Brad Delong writes

Give us another four weeks and we will know where the labor market is…

The clear concern is that enormity of the seasonal adjustment in the new Claims data makes the standard adjustment tricky to interpret. This is only excererbated by the fact that the Global Financial Crisis hit just as winter new claims were peaking, making it hard for the computer to parse apart how much of that huge spike in the middle was the GFC and how much was the fact that winter is just a worse time than it would otherwise estimate.

There are a few tricks to get around this just with your eyes though. Obviously you can go peak-to-peak and trough-to-trough. Though if you think the dynamics really have changed or if the situation is changing rapidly between peaks and troughs that can be hard to eyeball.

You can also look at the following.

This is the year-over-year change in unadjusted new claims plotted as a bar graph.

The trick is that when the area above the line is balanced by area below the line you are back to where you were before the GFC.

This is like taking the derivative of Initial Claims as function of time and then reintegrating to give back the original function. However, because its year-over-year it destroys any seasonal information, which is good for us because most of that is orthogonal to what we want to know and only serves to confuse our eyes.

Scott says

Regular readers are sick of this, so just take a vacation and come back next week.  I keep being told that no one’s interested even as I have record volume of viewers.  (Didn’t Yogi Berra say “nobody goes there anymore, it’s too crowded.”)  I’m interested, and I’m the one who decides.

In a perfect world I’d lay out a concise logical proof that Simon Wren-Lewis and Paul Krugman are wrong.  And number each point.  They’d respond saying which of my points were wrong, and why.  Then I’d reply. . . .

Perhaps I can help.

Wren-Lewis said:

DY = DC + DS + DT = DC + DS + DG Λ DG > 0 Λ  -DC <  DT  ==> DY > 0

Which is false.

Proof by example:

Let DG = DT = 2, DC =  -1, and DS = –1

Then both inequalities are satisfied and by the first equation.

DY = –1 –1 + 2 = 0

Which is what we were required to show.

I don’t expect Paul to respond but I want to continue to press the point because it seems so obvious to me but is so utterly absent from the conversation.

Paul says

I view the primary race through the lens of the FOF theory — that’s for “fools and frauds”. It goes as follows: to be a good Republican right now, you have to affirm your belief in things that any halfway intelligent politician can see are plainly false. This leaves room for only two kinds of candidates: those who just aren’t smart and/or rational enough to understand the problem, and those who are completely cynical, willing to say anything to get ahead.

Why is this cynical rather than selfless?

Something will come to pass. Someone will be elected President of the United States.

If you had the choice to make sure that person was not a “fool” should you not Say Anything to make it happen. Is the personal integrity of one individual worth risking the most powerful executive position in the world?

When the primary season started there was strong reason to believe that in 2013 the world would face a slew of challenges not least of which was continued stagnation in the US, Europe and Japan.

Stagnation exacerbated by foolish not fraudulent policy.

If that matters should one not do whatever he or she can to stop it?

The latest

Industrial production increased 0.4 percent in December after having fallen 0.3 percent in November. For the fourth quarter as a whole, industrial production rose at an annual rate of 3.1 percent, its 10th consecutive quarterly gain. In the manufacturing sector, output advanced 0.9 percent in December with similarly sized gains for both durables and nondurables.

We “needed” this in the sense that the IP numbers were disconcerting going into the end of last year. The big manufacturing gain is especially meaningful as we had seen what was starting to shape up as a “rollover” in manufacturing.

Now, that didn’t really jive with auto and retail sales numbers, but nonetheless was reason for pause. This makes the pause less pause-y.

From Real Time Economics

The National Association of Home Builders said Wednesday its housing market index rose to 25 from 21 in December, reaching its highest point since June 2007. It was the fourth-straight monthly increase.

The results were better than expected, as economists polled by Dow Jones Newswires had forecast a reading of 22.

Some analysts see the results, combined with other recent data, as a sign that the U.S. housing market is gradually emerging from a 5 1/2-year bust that helped thrust the economy into the worst recession in decades.

“This is not another false dawn; it’s the real deal,” said Ian Shepherdson, chief U.S. economist at High Frequency Economics. With mortgage rates hovering near the lowest recorded levels and the job market improving, “people clearly are more willing to take the plunge into housing,” he said,

Scott Sumner had a post a while back on “why no short recessions” and I can’t remember whether I responded to it or not.

However, a point that I want to keep making is that from the top it looks like recessions really are different. Or, to put it in terms I prefer: a recession is a general phenomenon, not a set of phenomena in general.

Here are both Unemployment and Excess Industrial Capacity in the US economy.

First, especially in the unemployment rate, we can play “some of these periods are not like the others.” Specifically the time horizon over which unemployment rises is extremely short and the increases are really fast. The time horizon over which unemployment is declining are long and the declines typically fairly slow.

Second, for the most part these two phenomena move together. That is to say there are workers with out plants and the same time there are plants without workers, and that’s not a coincidence.

A recession doesn’t seem to be when capital and labor both happen to be underutilized but when something happens that underutilizes both capital and labor.

The one of the few really weird periods is the late 90s when excess capacity started to rise but unemployment continued to fall. That really was about a big structural change in the economy where the US was losing manufacturing jobs at the fastest pace on record but was gaining so many tech and service jobs that unemployment continued to fall.

One of the hardest things to keep in mind as an intellectual – and I see this played out in the blogosphere – is that the deep influence is often synonymous with obscurity. Once it makes perfect sense, no one remembers who said it first.

And, they shouldn’t. Intellectual progress is measured by the number of things we are able to stop thinking and talking and arguing about.

Power is not something that you take. Power is something that you have.

Arnold Kling writes

In an actual business, you are not given a demand curve and a cost function; instead, you grope. The internal alignment of an organization cannot be taken for granted; instead, a lot of time and effort goes into just trying to keep people focused on common goals. Day-to-day life in a organization is a soap opera, with individuals and departments often working at cross-purposes. No one, including the CEO, has full knowledge or control.

When I came to think of every organization is a dysfunctional family, it affected my mental model of markets and government. I don’t assume that organizational units know what they are doing. Instead, I ask: what institutional pressures exist that ensure that more effective units survive and less effective units disappear? That in turn leads me to be relatively pessimistic about government as an institution, because I see the tools of voice (elections and representative democracy) as less effective than the tools of exit (consumer choice, leading to profit and loss).

MIT’s contribution to producing technocrats was what it did not teach. It did not teach humility. It did not teach that the world is too complex for technocrats to control.

There is a lot here that I agree with, but I want to push back against the sentiment I suspect underlies the last sentence, in particular.

One cannot not govern. This is true on a meta-physical level. On a more practical level I would point out that even Lassize-Faire must be enforced at the point of a gun.

Violence exists. The government must chose how when and where to suppress violence and when to execute it. Even the choice to never suppress and never to execute is a choice with some set of real consequences.

As such the question is always: what is my best guess at the best use of my power. Humility proper plays no role in the question. You could believe yourself a fool. It does not make the question any less pressing or your decision any less consequential.

If you chose Laizze-Faire and you must chose, then you do so with the belief – well informed or not – that this is the best policy. If you are an idiot and you know you are an idiot then you do this knowing that this may very well be an idiotic choice. But, you must make some choice nonetheless.

To ground this a bit more, the choice of a free society over a totalitarian society is in no way a more humble choice on the part of the leadership.

In both cases your action or inaction will lead to some world. You must believe that this world is better than the world that would have arisen with a different action or inaction. The case for not acting cannot be that it is more humble, for it presumes consequences just as real as acting.

It must be that to not act is better.

Moreover, this is an argument that is not common sense in the cases we often bring up. That to refrain from restricting trade in goods is better than to restrict trade is not a common sense notion.

Therefore, not only is it not less humble on some fundamental, it is not even likely to be advocated by humble people. To think the masses are wrong and you are right requires a fair bit of arrogance.

Lastly, one cannot escape this even by rejecting patterned outcomes altogether. Here you are simply moving the problem to a meta-consequential level. However, you still must say that I believe that this theory of the good is superior to its alternatives, knowing that this choice has real consequences. Either the good will be enacted or it will not.

The JOLTS data provide hree major challenges to any disruptions hypothesis of the Great Recession. That is, any hypothesis that says the United States was engaged in some form of economic production that was disrupted by event X and that led to a huge recession until we could get back on our feet. This includes the vast majority of structural theories.

The first problem is that job destruction fell dramatically during the Great Recession.

Second, Job Hires are typically very close to separations. However, in late 2008 the two broke apart.

Even still the gap, though enormous up to 700K was still small in comparison to the low point in hires 3600K.

What’s more is that third, if you look closely at the pattern of separations and hires, it looks like what happened was that separations stalled in late 2008 while hires continued its downward trajectory.

Here I just used a straight line but if you were to follow the logarithmic path of hires you would wind up with an even smaller gap and even fewer job losses to make up for during the recovery.

So, to really get at the heart of everything we not only have to explain why overall churn including separations and hires started to fall – that is why the employment structure of the economy started changing at a slower rate. We also have to answer why the stall

Arnold Kling says

Circling back to Austrian economics, the crisis we are having does resemble the crisis that Austrians were predicting. That is, they thought that money was too easy and that this would result in malinvestment. In his essay on Austrian economics, Yglesias dismisses this because the decline in the economy proved to be so widespread. However, I would argue that the patterns of specialization and trade are so complex and interdependent that the crash in housing could in fact lead to widespread disruptions. It affects real estate agents, attorneys, firms involved in the manufacture and distribution of household durables, and so on. It has huge relative regional effects. It reverberates through the financial industry. It affects people overseas who had counted on an ongoing mortgage securities market.

I don’t think this is really correct either.

There are several problems but I think biggest is that the readjustment that one would expect, and that we got, went off without hitch and was associated with stable unemployment despite the fact that rebalancing had been going on for roughly 3 years, the unemployment rate in early 2008 was no higher than in 2005 – the year residential investment peaked.

Indeed, a more complete answer might be that rebalancing was halted by a huge increase in the price of oil. That’s what caused that dip in the current account balance going into 2008.

However, while that played a role I don’t think that’s the crux of what went on and its hard to explain why unemployment continued to rise even as rebalancing caught up.

Not to be too, whatever, but I think only guys who got the over outline right were the folks like myself who were harping about collateral values and bank balance sheets and the people who thought that land price declines could have real wealth effects.

My current primary thinking is that something similar occurred. Instead real wealth effects from housing, we had household balance sheet effects. And, in the collateral game the total supply of low risk assets – the collateral crunch – was more important than I anticipated.

I am as I mentioned before also flirting with the notion that part of the whole story of 2000s is a decline in labor’s share of national income and that the drop in inflation expectations and the rise in the dollar in 2008 simply made that adjustment far more difficult.

I should say that Paul Krugman came close. If I remember his argument was that based on Tobin’s Q the US was still over capitalized going in the late 2000s and would have to see a sharp drop in the trade deficit and perhaps even run a surplus.

The fall of the dollar would not be enough to accomplish this and so US consumption would have to contract. However, it would not simply contract on foreign goods but US goods as well and that this would drag the US into recession.

It seemed like that could have been starting to happen in early 2008 but its hard to tell because any possible effects were swamped by the massive balance sheet moves.

Mark Thoma asks

. . . but should economics be value free, at least in principle? I used to think the answer was a clear yes — we should do our best to promote positive analysis and avoid normative — but in recent years I’ve become much more open to other possibilities.

I’m still not fully convinced that we should abandon the principle of promoting positive analysis over normative, I want to believe it’s possible, but as it stands many people disguise normative conclusions behind positive analysis — and these are some of the top people in the profession. (One of the reasons my views have evolved is the surprising and rather blatant political posturing hidden as economic analysis from some top economists on the other side of the political fence — I refuse to sit by idly while those games are being played. It’s also amazing how often economists get theoretical and empirical results that support their political leanings. I’d like to believe that their economics is pure and that it drives their politics, and not the other way around, but given how often prior political beliefs are confirmed through what is supposed to a scientific process, you have to wonder if we aren’t more like lawyers arguing an ideological position than scientists in search of the truth.

I think the vast majority of economics is likely to progress ultimately free of ideological constraint. The simple reason: this too shall pass.

I’ve had conversation with non-economists over whether or not economics will be radically different in the wake of the Great Recession. My answer, is probably not very much. When its all over you will be gone, but we will still be here.

That’s true for most ideologues. When its all over they will go back to doing whatever it was they were doing before. There will be no stimulus package for them to be exercised over. No non-standard monetary policy to make them fret about hyper-inflation. No dismay over progress sending them into the arms of radically alterative statistical accounts of the GDP and inflation.

We will have the luxury afforded to other disciplines, that of being boring.

Some areas will have controversy for the foresee able future – the effects of taxation for example – however, the long project to flush out Daivd Hume’s 350 year old observation that money and industry are somehow connected will recede back into the towers of geekdom.

Reihan Salam writes

There is no denying that corporate profits are reaching stratospheric levels while employment levels are essentially stagnant. If you own a piece of Home Depot or Whole Foods or Amazon, congratulations, 2011 was a banner year for you. But if you’re a typical American worker, well, that’s another story.   

The Commerce Department recently found that personal incomes were $265 billion lower over the years 2008, 2009 and 2010 than had originally been assumed, while corporate profits were $343 billion higher. Indeed, corporate profits now represent 12.6 percent of GDP — the highest number in 60 years.

. . .

An economy that invents more new products and processes will be a wealthier economy — and one that creates more jobs. Until we stop protecting established firms and inhibiting start-ups, we can expect slow growth, high unemployment and ever-increasing resentment toward corporate America.

Obviously its far from clear to me that the owners of corporations necessarily benefit from record corporate profits but lets leave that aside for now.

The issue of corporate profits vs. incomes for the average American I increasingly think plays an important role in the recession.

Though I think of it in a different way. What the macro-economy “wants” to do – for unspecified micro reasons – is to transfer large amounts of national income away from the median household and towards corporations and a working elite.

However, nominal rigidities – in wages, land prices and debt – prevent the macroeconomy from easily accomplishing this. In a smooth world workers incomes would fall, the value of the land that workers live on would fall, the debt burdens of workers would fall and the economy would move forward with a much larger fraction of future output moving into the hands of corporations and small working class.

As a note: I do keep refer to corporations as a residual claimant because I think there are important ways in which corporations actually consume resources as an entity. That is, if you forced the corporation to cash-out to its owners every quarter and then raise cash every quarter, it wouldn’t simply be a transactions cost issue, the resource consumption pattern in the economy would be very different.

In any case, this problem could be solved macroeconomically by increasing the rate of inflation. This would allow real wages to fall, real land prices to fall and real debt levels to fall, while real corporate profits rose to soak up the residual.

The micro issues are more complex and of course its not even completely clear what they all are.

And, to be sure this is just a sense, I am not hanging my hat on this theory.

Another milestone was passed in 1932 when Sears established the store planning and display department. Before merchandise had been fitted into buildings, now buildings were built around merchandise. The first store to be built from the inside out was the Glendale, California store opened in 1935.

. . .

Another important approach to urban customers was made through catalog sales desks, which were installed in the retail stores. In another move, Sears opened catalog sales offices in towns too small to support retail stores.

. . .

In 1969, Sears announced plans to build a new headquarters building in downtown Chicago. The 110-story Sears Tower became the world’s tallest building at 1,454 feet when it was opened in 1973. The staggering amount of materials needed to construct the building included 76,000 tons of steel, 2 million cubic feet of concrete, 16,000 tinted windows, 1,500 miles of electrical wiring and 80 miles of elevator cable.

Sears grew into the largest retailer in the world on the back of path breaking innovation, a position it held until the early 1980s. This morning

Sears Holdings (SHLD.O) suffered a new setback when a major business lender, CIT Group (CIT.N), halted loans that Sears’ suppliers use to finance the goods they sell to the chain.

The news triggered fears that other lenders to the retailer’s suppliers would follow a similar path, making it harder for the company to do business.

"It could start a snowball effect for Sears," said turnaround expert Gene Baldwin of CRG Partners.

Refusal of CIT and other lenders to finance Sears’ suppliers could force it to draw on its line of credit to pay for goods up front, Baldwin said. If too many vendors seek prepayment, banks could be pressured and cut back on lines of credit for Sears, making it harder for Sears to buy inventory.

Not if. When.