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Likewise the overconsumption theory of recessions makes no sense. On a slightly different matter a frequent commenter writes
I’d rather have economists in charge of the financial system than politicians, if for no other reason than I hate most politicians far more than I hate most economists. But the argument that most of the good times in the past decades were due to economists’ strong hand at the tiller is unpersuasive: anybody can live well for quite some time on credit cards, whether they just run up bills with abandon or do it in a logical and academically justified way.
If I am reading the commenter’s intention right then imbedded in his words is a common misperception. This is a response is to that general misperception not the specific commenter.
I think people are confusing cyclical prosperity with personal luxury. In your personal life you might feel like you are doing well because you have a new house or a new car, etc.
However, this is not how we measure the cyclical wealth of nations. We measure it by employment and production. We say the economy is “doing well” when a lot of people are going to work and making stuff.
For example, we say that Germany’s economy seems to be recovering. However, consumption in Germany is not rising. Consumption is flat. Working is rising. Employment is rising. That is what it means to be doing well. It means that more people are doing more work.
This is why it makes no sense to say that a recession is inevitable because we overconsumed. Because we bought too much it is now inevitable that we work less? Why does that make fundamental sense? Surely something is going wrong. Shouldn’t we be working more to pay for all the stuff we bought.
Some people might say that the “something” is structural readjustment. We have to move towards an investment based economy and there are frictions. However, that story also works in reverse. A country could be consuming too little and then has to suddenly switch away from an investment based economy and will face frictions. Recessions in that story are not a punishment for overconsumption, they are a result of suddenly realizing that you have to shift paths. There are still problems here but they are on a deeper level about more subtle things.
The overconsumption theory by contrast says that the recession is natural because we bought too much stuff during the 2000s. Too many houses. Too many big screens. That’s why you are not working now. Its balance.
Steve Waldman says I shouldn’t tell people that economics is not a morality play. How about this then – that morality play is completely F-ed up. That morality play says that we should sit on the couch and rest our backs because that way we’ll learn not to drink so much. You bought too much so now you have to work less. How does that balance anything?
On what planet is it your just desert that after partying all night you are forced to sit on the couch rather than get the rest of your work done. Maybe in some perverse Brewster’s Millions kind of way. But, I don’t think that what the universe has in mind.
If suddenly everyone stopped buying big screen TVs and started building factories, investing in the future and laying the path for the next generation then there would be no recession. There is a recession because fewer factories are being built. There is a recession because less work is being done.
Let me be very clear about this. I am not saying that it might seem as if the world works according to common sense but when you study hard and look at lots of equations then you will see that in some abstract way it is wrong.
No, not at all.
I am saying the overconsumption view is completely at odds with what is in front of our faces. It doesn’t even make basic logical sense. The morality play is one without any morals.
I don’t know if Andrew Sullivan still reads my posts but I want to cajole him into responding because I sense that he is sympathetic to the overconsumption view and I know he understands that “To see what is in front of one’s nose needs a constant struggle”
The overconsumption view is an example of just that. If we consumed too much then shouldn’t we need to work extra hard? Why is society working less? What about spending too much money implies that the natural reaction is that people should go home and sit on the couch?
Even Casey Mulligan – who subscribes to a completely different view of the macroeconomy – is trying to tell a story involving the minimum wage and mortgage modifications that answers this key question:
WHY ARE PEOPLE WORKING LESS?
Update: This post is attracting more attention than I expected. Perhaps, I should venture non-technical rants more often. However, for those kind enough to read this far I’d like to give you the upshot. Once we accept that the recession can’t be as simple as “we overspent our credit cards and are now feeling the pain” we can better analyze solutions without prejudice. We can consider the possibilities of stimulus spending or monetary expansion without the off the cuff reaction that you can’t cure overspending with more spending. Something deeper is at work here and perhaps there is a role for stimulus or monetary expansion.
There are still arguments to be had and the cases of structural frictions and the type of negative incentives that Casey Mulligan bring up. However,
One of the biggest problems with regulations is their inflexibility. You try and regulate one product that is viewed by some as potentially dangerous, and as a result you end up harming a product that shares enough qualities to make it fall under the regulation, yet does not share the qualities that motivated the regulation in the first place. For instance, when safety regulations targeting large toy manufacturers put handmade toy companies out of business. This is exactly what has happened with the Four Loko regulation, which has also banned a small microbrew that uses caffeine.
The beer is called Moonshot ’69, and it was created by one of the founders of Sam Adams. The New York Times provides the details, including the fact that the beer was going to be sold at a beer festival this month, and that the owner has $25,000 worth of inventory she can’t get rid of.
As you read about Moonshot ’69 you may find yourself thinking that the regulation was clearly not designed to affect a microbrew like this, and that the ban shouldn’t affect the kind of beers that get sold at beer festivals. This is because while the regulation is ostensibly about caffeinated beer, as Robin Hanson argues, it’s actually about regulating a “particular vaguely-imagined classes of people”. Politicians want to regulate Four Loko drinkers, not caffeinated beer.
If you find this troubling just be glad that you and all the former Four Loko and Moonshot ’69 drinkers can, for some strange reason, console yourselves with a Redbull and Vodka. That is, for now.
On Facebook Bryan Caplan bring up an old post of his in which he discusses statistical discrimination.
Judging everyone as an individual is expensive, and relying on statistical generalizations is a cheap and effective alternative. You don’t clutch your purse when you see a bunch of little old ladies approaching on a deserted street. You don’t offer a policeman a joint. You don’t hire a guy with a mohawk as a receptionist at a law firm – even if he promises to get a hair cut. Why not? Because on average, little old ladies don’t commit violent crimes, policemen arrest people for possession of marijuana, and guys with mohawks have trouble with authority.
Of course, the inevitable existence of some statistical discrimination doesn’t make the practice immune to criticism. You can grant that it’s OK to some degree, but – even if the law is silent – still limited by ethics and/or etiquette. But precisely what limitations do you think are justified, and why?
It seems to me that statistical discrimination arises out of a form of social pollution. They are multiple players in the production of this pollutant but the discriminator is one of them.
Suppose that John is bald. Suppose also that many bald men are extremely irresponsible employees, drink on the job and shout sexual obscenities at female coworkers.
Absent either legal or social pressure employers would then be less likely to hire John than a similarly qualified full headed person. John has suffered because of the poor actions of other bald people. He is the victim of an externality – sort of like pollution.
It seems natural to say that the other bald men should be forced to internalize the externality. That they should bear an extra cost when they behave badly. However, the optimal solution should involve both a reduction in bad behavior on the part of the bald guys and a reduction in discrimination on the part of employers.
Well both parties are enjoying some benefits at John’s expense. The other bald guys are presumably getting enjoyment from their bad behavior and the employer is lowering costs by discriminating against bald men. Together both of these actions lead to bad consequences for John but John had nothing to do with either of them.
Then in a Pigouvian world we would place a tax both on the bad behaving bald men and the employer. We could think about it as first putting a tax on the employer because this is the direct action harming John. However, then the existence of the employer tax means that the bad behaving bald guys are now imposing an externality on the employer which they are taxed for.
However, suppose for reasons of monitoring or general liberty, it is not possible to place a tax on the bald guys. It is still the case that some tax should be placed on the employer.
Again, the employer is taking an action which helps himself – statistical discrimination. However, this action hurts John, even though John did nothing to bring this situation about.
For example, the employer could engage in discrimination abatement, a sort of capture and storage program for snap judgments. He could monitor his employees especially closely after they are hired or conduct a more careful interview.
Now, sharp readers will object that the employer is only imposing a pecuniary externality on John and those don’t count. That is, John could simply get around this by offering his services for less.
However, is that how people really feel? If you are told that you probably won’t be hired at such an such business because you didn’t go to college you might feel upset and you might offer to “prove yourself at a lower wage.” However, the fact in theory you could have gone to college quells your ill feelings.
Now imagine that you are told that you probably won’t be hired because you are a conservative, or a Jew, or bald. The offer to prove yourself is not as readily forthcoming and the rage or sadness is more forthcoming.
For most people, being judged by a criteria which they cannot control is deeply upsetting. For that reason its a real externality and not just a pecuniary one.
Jim Manzi replied to my defense of economics saying
What Smith is describing here is intelligent and data-driven theory-building. What’s missing is the part where the theory is tested, and proven to be reliable.
In other words: You say that you have the ability to predict the effect of stimulus. Prove it.
I don’t think think I am saying this. At least, not how I think Jim means it. I am saying I have reason to believe that the effects of stimulus will be X and I can make an argument for it.
If you want to hear that argument then I am more than willing to spell it out in great detail.
Moreover, this is all virtually anyone in any discipline has. I sometimes tell my students that scientists don’t prove, mathematicians and philosophers prove. Scientists accumulate evidence that seems to suggest.
This I think is true in all fields of science and is doubly true when that science is applied to actually engineering results in the real world. Not only have well relied upon theories in physics been upended upon careful examination but there is no one I know of who can design an airplane using a physics textbook. Nor, would many people trust an airplane to fly without testing it first.
And, despite despite all of the testing that is done, airplanes can a do malfunction and crash. There simply isn’t a “proving it” when it comes to making predictions about the real world. What we hope to do is give an answer that’s better than random and better than folk wisdom.
Now perhaps Jim is not confident that we can achieve our goal of beating randomness and folk wisdom. There are two basic lines of reasoning I can offer.
One is evidence and logic. We can talk about why in this case stimulus makes sense, why the evidence looks like it points in the direction that it does and why it seems to be telling us something different than mere folk wisdom.
Throughout human history evidence and logic have shown themselves useful. They are by no means omnipotent. The smartest people make mistakes. The most carefully argued cases are sometimes wrong. Nonetheless, as a general guide evidence and logic are useful.
Thus you should “rely” on my predication because you follow my evidence and logic. And, if you don’t follow my evidence and logic then we should talk about it. I talk about this for a living and am more than willing to devote as much time to it as Jim or anyone else wants. I crave the opportunity to offer evidence and logic for these positions. This what I hope to do with this blog.
So, to be clear, I am not asking at all that you simply submit to my superior knowledge, modeling or intuition. I am offering that intuition and if you want to see behind the hood and understand why I say all of these things then I am offering that too.
The second line I offer is that of experience. That when economists had the helm we really were able to produce results. In the 1980s Central Banks were largely turned over to their economists who produced low inflation and low unemployment by manipulating the overnight lending rate.
Indeed, the two major failures in that period, Japan and the current recession, coincided with the overnight lending rate hitting zero and thus no longer being under the economist’s control. So our basic argument was that we can steady the economy so long as we have control over the overnight rate seems to be validated.
Moreover, its validated in the direction we predicted. We argued that if the overnight rate was lower than we wanted the result would be inflation. If the overnight rate was higher than we wanted the result would be recession and disinflation.
This is key, because lots of pronouncements were issued when the recession started. Monetary economists said “we are running into the Zero Lower Bound and thus there will be high unemployment and disinflation.” Particularly, on the disinflation point, many people disagreed. But, we were right, there was high unemployment and disinflation.
So we have one example were the economists themselves got to run the institutions and the macro results confirmed what we said and were widely regarded as good.
Now that that tool is not available. So we are talking about other tools, fiscal stimulus, quantitative easing, etc.
If you are arguing that I don’t know for sure that these tools will work then you are right. I don’t know. What I am suggesting is that the same logic and evidence that worked for controlling the overnight rate is telling me certain things now.
I don’t ask that you simply trust this. We can go through the models. We can go through the logic. We can look at all the evidence. However, at the end of the day we have to make a choice. Even the choice to do nothing is a choice, with consequences for which we will be responsible.
I think making our choice based on logic, evidence and the experience of the Great Moderation is the way to go.
A new NBER working paper from Morris Kleiner and Kyoung Won Park looks at the struggle between dentists and dental hygienists, both of which are covered by occupational licenses. Here is the abstract:
….In this study, we examine dentists and dental hygienists, who are both universally licensed and provide complementary services to patients, but may also be substitutes as service providers…. We find that states that allow hygienists to be self-employed have about 10 percent higher earnings, and that dentists in those states have lower earnings and slower employment growth… Our estimates are consistent with the view that winning the policy and legal battle in the legislature and courts on the independence of work rules matters in the labor market for these occupations.
As I’ve argued before, occupational licensing that benefit dentists at the expense of dental hygienists should be an issue that motivates liberal opposition. After all, this is a highly regressive transfer to a male dominated, higher educated, higher paid job from a female dominated, lower educated, lower paid job. Yet aside from tireless occupational licensing critic Matt Yglesias, occupational licensing receives relatively little attention. It’s not just liberals though, conservatives also don’t seem to care about this issue as much as they should.
Morris Kleiner has done much to try and focus labor economists on the institution of occupational licensing, but for the most part the research in this area is done by a handful of economists, and it still receives vastly less attention than the much less prevalent and economically important minimum wages.
I don’t know what the regulatory answer to occupational licensing is, but I’d be interested in proposals to subject these laws to more anti-trust scrutiny, or perhaps legislation requiring state and locally mandated licensing to be subject cost-benefit analysis.
The question of how immigration affects the wages and employment of natives is a frequent topic of research in the U.S. With respect to wages, a simple model of course suggests an increase in supply will decrease prices, thus more immigrants bring down native wages. Some research, notably the work of George Borjas, supports this. Another model is one where immigrant labor is complimentary to native labor, and thus more immigration increases native wages. Other research supports this model, which was described recently by Tyler Cowen in the New York Times. Similar stories are told for employment. Unsurprisingly, a similar question of immigrant and native complementarity exists in other countries. A new paper sheds some light on this issue with respect to China:
Hundreds of millions of rural migrants have moved into Chinese cities since the early 1990s contributing greatly to economic growth, yet, they are often blamed for reducing urban ‘native’ workers’ employment opportunities, suppressing their wages and increasing pressure on infrastructure and other public facilities. This paper examines the causal relationship between rural-urban migration and urban native workers’ labour market outcomes in Chinese cities. After controlling for the endogeneity problem our results show that rural migrants in urban China have modest positive or zero effects on the average employment and insignificant impact on earnings of urban workers. When examine the impact on unskilled labours we once again find it to be positive and insignificant. We conjecture that the reason for the lack of adverse effects is due partially to the labour market segregation between the migrants and urban natives, and partially due to the complementarities between the two groups of workers. Further investigation reveals that the increase in migrant inflow is related to the demand expansion and that if the economic growth continues, elimination of labour market segregation may not necessarily lead to an adverse impact of migration on urban native labour market outcomes.
As I’ve said before, I think people who are sympathetic to more restrictive immigration regime in the U.S. should ask themselves, especially in the face of such contrary evidence, whether they think China should restrict immigration to possibly preserve the wages for the relatively well-off at the definite expense of poorer immigrants from rural China or from immigrants from other countries.
As everyone probably knows, SKUs were a big deal when the X-Box 360 and Playstation 3 came out. They both offered multiple platforms of entry, at different prices. I’m most familiar with the PS3, which offered a 40-, 60-, and 80 gigabyte version. There were also hardware differences between the 40gb version and others (USB ports, etc.)
In today’s ads, I saw nothing of different tiers for the PS3, with all advertisements boasting the 160gb version of the PS3 slim for $299.99. However, X-Box has stuck with this formula, offering a very anemic 4gb version for $199.99 and a beefier 60gb bundle for $299.99.
Storage is, for all intents and purposes, mind-blowingly cheap. Did price discrimination fail in this market, or is there another explanation for the absence of a tiered option for the PS3?
P.S. I realize that this isn’t the exact definition of price discrimination. I think it is close, but the scheme has a different name that escapes me at the moment…and the retail use of each system is the same.
My sloppy writing makes it sound as if I am saying Reihan should read up on the Fisher effect. What I mean to say is that Reihan brought up the fact that people fear inflation eroding savings. These fears are common. I have had many a Facebook debate over them. Indeed, Ron Paul has repeatedly pointed to this has his main reason for fearing debasement of the currency.
I believe that the Fisher effect is controversial among Austrians, and Keynes didn’t believe in the relationship at all, except under hyperinflation. Using price inflation in the Fisher equation makes a lot of things confusing, because the composition of output under recession circumstances (less than full employment — or a flat SRAS) is that raising inflation expectations to, say, 3% from 2% will likely cause an increase in real output, leaving inflation at it’s long-run target. Indeed, the Fed isn’t even interested in boosting inflation expectations past its set 2%, and has made that very clear. What the Fed wants is higher NGDP…but unfortunately it operates under a target for nominal interest rates.
Scott Sumner has a post about how inflation is, counterintuitively, good for savers. The thrust of it is that raising NGDP expectations will raise the Wicksellian real interest rate. People will spend more on investment (maybe not consumption, but probably), and we will get far more output, while trend inflation remains intact (and if it doesn’t, then the Fed can act as necessary). This is a boon to savers, as it raises not only the interest rate on savings accounts, CD’s, and the yield on bonds…it raises other asset prices as well, like stocks, real estate, commodities, etc. All are vehicles for saving, and a higher level of NGDP causes every type of investment to increase its yield.
This is the fundamental reason inflation is confusing. People think a lot about cash, but not many people save in cash (as in safes) under a normal positive trend inflation rate — criminals mostly. I think that price inflation is just muddying the debate here, and is completely useless.
A little late, I know, but Happy Thanksgiving everyone!
As part of my Unsubstantiated Claims post I said
Reihan: Reihan Salam has written a bunch of stuff I have been meaning to respond to but haven’t. The only point I want to address because its real quick is that inflation does not erode savings. It only erodes cash and the value of long bonds taken out before the inflation set in. However, the Fed is buying long bonds and propping their value. The only thing that is eroded in this scenario is cash. I have had this conversation with a number people and Ron Paul keeps saying this, so I think it deserves attention. Before I can get to that Google Fisher Effect and read a bunch of the piecemeal explanations. Lots of them revolve around equations but the upshot is that inflation is priced into assets including bonds and savings accounts. Only bonds issued before the unexpected inflation and maturing long after are affected.
My sloppy writing makes it sound as if I am saying Reihan should read up on the Fisher effect. What I mean to say is that Reihan brought up the fact that people fear inflation eroding savings. These fears are common. I have had many a Facebook debate over them. Indeed, Ron Paul has repeatedly pointed to this has his main reason for fearing debasement of the currency.
I think, but am not certain that fear of eroded savings is the central driver behind populist anti-inflation sentiments. This needs to be addressed and in my experience convincing people that inflation is priced into financial assets takes a long time and lots of charts and graphs.
However, I did not mean to suggest that Reihan doesn’t get the Fisher effect himself.
Will Wilkinson who I agree with overwhelmingly on the topic at hand and in particular in this post states
If we take a moment to note that the United States contains 40% of the world’s billionaires, and stop to see how America’s wealthiest people came by their fortunes, it’s easy to conclude that the statistic Mr Kristof waves about like a bloody shirt actually reflects the fact that American institutions are unsually conducive to innovation and the creation (as opposed to the expropriation) of immense wealth. I do worry that America’s nexus of political and financial institutions in particular have made it too easy for a small class of people to hoover up massive amounts of cash while producing little of value to the rest of us. But it’s worth noting that the people at the top of the Forbes list have grown rich mostly by making useful stuff, or making or selling useful stuff more efficiently. I don’t think American innovation would much suffer were these folks to face somewhat higher income-tax rates. At the same time, the fact that innovation is so richly rewarded in America surely has something to do with why America produces so much of it.
I am less and less sure of this. Would Jobs had said “Aw fuck it, why boher” if the Apple turn around only made him $200 Million rather than billions.” Assuming of course that his rank ordering among other billionaires would be the same – I do think being among the richest probably matters a lot regardless of the absolute level – I am guessing he wouldn’t have worked an hour less even if his paycheck was cut by 90%
Same with our other billionaire innovators.
Our innovators are so richly rewarded, I would argue, because we tolerate so much innovation. The natural human propensity to tinker and tweak can produce breakthroughs that have unimaginable social value. Allowing as many of those breakthroughs to thrive means a population with people earning vast fortunes.
This is probably independent of whether or not we use those fortunes to finance public goods, redistribution, etc.
I know Will is sympathetic to this point but maximizing the space for innovation, entrepreneurship and dynamism may be almost completely orthogonal to personal financial gains from doing so.
Ezra Klein recently advocated donating to non-profits that can affect policy rather than charities:
If you donate money to a food bank, it can provide only as much food as your money can buy. If you donate it to a nonprofit that specializes in food policy issues, it can persuade legislators to pass a new program – or reform an existing one – that can do much more than any single food bank.
Robin Hanson disagrees with Ezra, arguing that these types of think tanks and organizations will mostly spend effort on partisan issues which he argues are likely wasteful:
Assuming all parties think they seek good, partisan changes can only be good if some parties are right while others are wrong about what is good. In contrast, you can be right about a non-partisan change without others being wrong…..
Donations to change policy within the partisan subspace, however, only achieve good when they happen to be on the right side of partisan disagreements. Averaged over the disagreeing parties, such donations cannot on average achieve good unless there is a correlation between between donations, or donation effectiveness, and which sides are right. Even if you think you are right at the moment on your particular partisan policy opinions, you can’t think it good on average to encourage partisan donations, unless you think donations tend overall to go to the good or more donation-effective sides.
There are a couple of ways to look at this with respect to Ezra, his donations, and his advocating for such donations. On average, Ezra surely believes he and the organizations he donates to are on the right side of partisan disagreements. Also, being that Ezra’s reading audience probably on average agrees with him, he also probably believes they are on average on the right side. So I think Ezra could agree with Robin that if you’re writing for a random or sufficiently broad audience, advocating for donations to policy organizations would do no good, while also believing that he should make such donations and advocate for his audience to do so.
On the other hand, I’m not convinced that equal donations to, say, the Center on Budget and Policy Priorities and the Cato institute are zero sum. I see part of the function of these organizations as pushing politicians towards empirically grounded and efficient policies and away from populist, extremist, and obviously inefficient ones. I see raising the influence of these institutions relative to populism as raising the probability for any given outcome the government tries to achieve, whether it’s more liberal or more conservative, the policy used is more efficient.
For instance, I’d venture that obviously inefficient and suboptimal policies like the minimum wage, tariffs, and the gold standard are much less popular among the median think tank, or think tank dollar, than they are among the median voter. Think tank solutions on average tend to utilize more transfers and market oriented allocation and less government mandated quotas and prices than what popular support calls for. In addition, I’d venture that futarchy and policies that seek to cut medical spending –two of Robin’s favorites– would be, on average, much more popular within the walls of a random think tank than within the walls of a random U.S. home.
In short, these places think like economists. Even if they cancel each other out along partisan lines, think tank donations push policies away from the biases of the rationally irrational voter.
One test of this idea is to ask whether people on the right would agree that we’d have better policies if the CBPP was more influential on the left. Likewise, would people on the left agree that we’d have better policies if Cato were more influential on the right? Perhaps it reflects my personal policy biases, but I happen to think the answer is yes.
The title of this post series refers to the fact that I am just writing off the top of my head without checking either the writings I am talking about or any data.
I don’t mean it to suggest that I am debunking or attacking unsubstantiated claims but that I am making them.
Usually I try to at least quote people or look up facts. Though of course editing verboten since I am a terrible speller and horrible at typos so it would basically triple the time I spent blogging if I worked out those kinks.
Tyler points to two headlines
From the UK article
The UK economy expanded by an unrevised 0.8 per cent in the third quarter helped by an unexpected boost from trade, but consumer spending has been weakening even before the government cuts bite.
The German article doesn’t have a sectoral breakout but the editor’s choice box does reference the following article
Domestic demand to lift German economy
A lasting revival in domestic demand will help Germany’s economy expand by almost 4 per cent this year and contribute significantly to reducing “global imbalances,” the government in Berlin has been told.
The article concludes with the following facts
Unemployment was expected to drop from 8.2 per cent of the work force last year, to 7.7 per cent in 2010 and 7 per cent in 2011. Consumer spending was expected to be broadly flat this year but then expand by 1.6 per cent in 2011
So Britain grows on based on exports. Germany is seeing a boost in domestic demand, which means flat so which implies much of its growth is coming from exports.
Now The numbers from the US BLS
Gross Domestic Product
Real gross domestic product — the output of goods and services produced by labor and property located in the United States — increased at an annual rate of 2.5 percent in the third quarter of 2010,(that is, from the second quarter to the third quarter), according to the “second” estimate released by the Bureau of Economic Analysis.
Gross domestic purchases
Real gross domestic purchases — purchases by U.S. residents of goods and services whereverproduced — increased 4.2 percent in the third quarter, compared with an increase of 5.1 percent in thesecond.
Aggregate Demand in the US is increasing by 4.2%, however, production is increasing by only 2.5%
While in Britain and Germany consumer purchases are flat to low but production is growing. It is no wonder that they fear a falling dollar.
I have to take this one. Paul Ryan asks
Name me a nation in history that has prospered by devaluing its currency.
How about the United States
See that turning point in 1933. There is a lot of dispute about what caused it but some people with a long interest in Monetary Policy have argued that it was Executive Order 6102. Drafted as follows.
And announced to the public as follows
Those of us who think recessions are caused by the hoarding of money would expect this type of thing to have extreme effects. Hard money folks would suspect that this would result in a debasement of the currency. Indeed, unlike the modern metaphorical use of the word debasement this was literal debasement. The base of the currency was confiscated at gun point, melted down and reissued in a less valuable form.
The transferability of dollars into gold shifted from $20 an ounce to $35 an ounce. This was again a literal debasement done by threat of imprisonment. I wish I had ready access to pictures of private safety deposit boxes being torn open and the gold taken out. Nonetheless, there are numerous reports of this happening.
Not exactly a free market move and vastly more extreme than anything I contemplate tolerating. However, what was the economic effect?
From April to July on 1933 Industrial Production in the United States surged 57%. Here year-over-year growth in Industrial production from the year before debasement until the year after
We move immediately from shrinking Industrial production to surging production. With year-over-year growth rates reaching 60% in July of 1933.
I don’t want to pick a fight with my more liberal friends but I would argue that it was this move that made it seem as if Roosevelt had magical economic powers and gave cover to what were on the whole probably ineffectual at best industrial policies.
However, even if there are those who are afraid that a more smooth and free market debasement will likewise cover over what they regard as the poor policies of the Obama administration, I ask you to take another look at that chart above. 60% growth from 30% collapse just a year earlier. You really want to throw that away because you are worried that it might possibly help in a fight over a health care policy less extensive than the one that is “crippling” the budget of our whacky neighbors to the North?
There are a lot of issues here but if what you are concerned about is piling up government debt than growth is your friend and debasement is the way to get there.
Before the Holidays begin I want to make a few points.
- Manzi: Jim Manzi has responded to me again. One of the things I love about Jim is that he is really willing to keep a conversation going. Not only that but he has responded at the Corner which opens our conversation beyond the econo-nerd sphere. Generally speaking I sense at the rate Jim an dI are going we may not have much left to disagree about after a few more exchanges. Still his last post requires a more thoughtful response than I can pull off the fly.
- Reihan: Reihan Salam has written a bunch of stuff I have been meaning to respond to but haven’t. The only point I want to address because its real quick is that inflation does not erode savings. It only erodes cash and the value of long bonds taken out before the inflation set in. However, the Fed is buying long bonds and propping their value. The only thing that is eroded in this scenario is cash. I have had this conversation with a number people and Ron Paul keeps saying this, so I think it deserves attention. Before I can get to that Google Fisher Effect and read a bunch of the piecemeal explanations. Lots of them revolve around equations but the upshot is that inflation is priced into assets including bonds and savings accounts. Only bonds issued before the unexpected inflation and maturing long after are affected.
- Profit!: Corporate profits. I saw some conflicting reports. Some saying highest, then Matt Yglesias pushing back. Possible point of confusion is the issue of domestic profits. Around 50% IRC of US profits come in from overseas – exorbitant privilege, dark matter of trade, type stuff. Basically we sell the world Treasury bills which literally pay no interest and then build semiconductor fabrication facilities in their countries which pour cash back to the US. This is not the time to go in depth but I repeatedly remind people that it is a strange thing to say the US is the world’s biggest debtor when at the end of the year the world pays us more interest than we pay themb. I think that arrangement is usually called a bank.
- Krugman: I’ve started Krugman’s Conscience of a Liberal. A number of points
- I know, I know I am way behind on popular books. Surprisingly, the incentives to read them as a Prof are pretty low, which is sad for a whole host of reasons. That having been said, I much more understand his core claim than I did from reading his columns and blogs. I am only part way through but I would say that his core-core-core claim is that the equity-efficiency tradeoff is not as pervasive as most economists think. The book has a lot there is a lot score settling and a true but I think slightly salt-in-wounds arc about the relationship between movement conservatism and racism
- However, if I ask myself “why don’t Paul Krugman and Greg Mankiw agree on the direction for America” Its because Paul thinks the equity-efficiency tradeoff is fairly weak as witnessed by a booming but equitable Great Compression. While Mankiw thinks its strong as witnessed by a lagging Europe. This is where I get to jump and say they are both right/wrong. In truth, I like everyone else don’t know, but my guess is that Paul is right about taxes and Greg is right about regulations. If you tax the wazhoo out an otherwise laissez-faire economy you would get strong growth and low inequality.
- Taxes just reduce the return to working – lets forget about capital taxes. The return to working for the highest earners is literally 1000 time that of the the average middle class worker. Yet, we don’t see large differences in household labor supply. The net effect has to be fairly weak. As always this holds for taxes but NOT for benefits. Even mild benefits could have massive labor supply consequences. So there is an issue around structuring “pro-growth” benefits. And, of course I tend to favor cash over in-kind benefits for the standard reasons, though I am more passionate about them
- Lastly on Krugman. Maybe he addresses this earlier but is it possible that Great contraction was also caused by pension plans. Rough thought, in the Gilded Age you have a lot of people living off capital and some of them were simply the children of entrepreneurs meaning they are just rolling in profits. However, once Pension Plans and other big savers get in the game then the return to just sitting on money collapses. You are forced to seek higher returns through innovation and that means hiring a bunch of professional capitalist. Over time it is precisely those people who have begun to take over the highest income positions. This is not well thought out – just a guess.
- Cochrane: I really, really want to get to John Cochrane’s latest take on stimulus because I think its wonderfully lucid and wrong. Hopefully there will be opportunities between turkey for that.
- Money and QE: Barro is among the latest saying that QE2 will be weak. There is of course a chorus saying the QE2 will usher in the apocalypse. They can’t both be right. Indeed, they are both wrong. The reason QE was in fact working is because it SIGNALLED a commitment by the bank to holdling short rates low for a long time. That is, the “exit” problem that people describe is the very feature of the program that caused it to mildly raise inflation expectations. Remember that a central banks naturally tendency in the post Mundell world is to be tight not loose. Market participants needs some assurance that these tendencies won’t come back just as they have made costly investments.
- Folksy: So I have been thinking of starting up a series explaining some economic facts in a folksy way. One of them is this. You may be hearing some people say the recovery want start because of fear of taxes hikes. Others are saying credit conditions. Ask your self this, in your daily life are you more afraid worried about the IRS or the Credit Card companies and your Mortgage lender. While a few Americans will say the former. Most will say the later. That’s way we think credit is a bigger deal than taxes.
The profit model of credit cards, checking accounts, and other types of consumer lending used to look a lot like banks doing what they could to take advantage of information asymmetries. Through various fees and penalties they could charge low rates for well-informed, or sophisticated, borrowers by price discriminating against poorly informed, or naive, borrowers. Another way to look at it is price discriminating against people with high discount rates. In either case, the outcome seems undesirable to many people, since this regime is likely to on average subsidize the economically better off at the expense of the economically worse off. So by popular demand regulators have been pushing the industry away from this model. So what is the new profit model for consumer finance?
One choice is broad and even fees. For example, free checking accounts might go away and be replaced by a fee. This is one way to go, but it may push some low-income people of out checking accounts. It’s desirable for people to have access to credit and banking, and the lower we can make the fixed cost to access these things the better. This is not to say that broad and even fees are worse for low-income people than the previous regime of overdraft fees and other penalties. I’m just saying that, ceterus paribus, it would be preferrable to have lower fixed costs to accessing banking.
So what options does this leave us? Ideally banks could find ways to price discriminate against people with a high willingness to pay who aren’t economically disadvantaged. The Kardashian Kard seems like a step in the right direction. This is a Mastercard prepaid debit card that have pictures of reality TV stars the Kardashians on the front. What makes the cards noteworthy are the fees. Annie Lowery at Slate provides a rundown:
First there are the upfront costs. For a six-month card customers pay $59.95, or $99.95 for a 12-month card. (The median fee for similar, non-Kardashian-festooned products is $10.) After those six or 12 months, there is the $7.95 monthly fee to keep using it. Users pay a $1.50 fee to withdraw cash at an ATM and a $1 fee to check their balance. They pay $1.50 to speak with a customer service representative. If they lose their card, they have to pay $9.95 to replace it. If they want to cancel their card, they have to pay $6.
These fees do seem exorbitant. And Lowery provides an illustrative example of how a teen using the card for a $200 a month allowance could easily pay $80.40 in fees whereas a debit card would have cost them between nothing and $36. But is this a bad thing?
It seems likely to me that parents who are willing pay between $59.95 and $99.95 up-front for a prepaid debit card emblazoned with B-list celebrities for their teen daughters are not going to be predominantely low-income people. Price discriminating against individuals with enough disposable income to pay so much for such frivolous vanities seems both efficient and fair to me.
In addition, I’d wager that a large percent of teenage consumption is just inefficient status signaling like, oh I don’t know, the Kardashian Kard, which seems like desirable consumption to tax in order to subsidize the financial system.
If programs like this allows banks to offer cheaper services like free banking to the rest of us, then I hope they can find more of them.
According to a new paper from Byron Lutz, Raven Molloy, and Hui Shan from the Federal Reserve, the answer is “not as much as you might think”. They identify five channels through which low house prices can affect state and local government tax revenues:
1) property taxes
2) home sales transfer taxes
3) sales taxes via spending on construction materials
4) sales taxes via impact on consumption of lower housing wealth
5) personal income tax
Compared to the 1995-2002 trend, state tax revenues in 2009 were $31 billion below where they otherwise would be, which is 5% of total revenues. Looking at the short-run trend, the total 2005-2009 shortfall is only $15 billion.
Partly driving this result is that property taxes are based on assessments which are lagged, so that falling prices do not show up immediately. As a result, in 2008 and 2009 property taxes rose 5%. This can be seen clearly in the figure below.
This is helpful for local governments, because it means their tax base does not dry up during a recession. However, it does create something of a anti-Keynesian policy where property taxes continue to rise as prices plummet. A 5% increase in assessed value on top of a 15% decline in house prices means an $85,000 house is being taxes as a $105,000 house.
Megan McArdle notes that China continues to turn our economic theories upside down.
Everyone–including most of the economists and NGOs–seems to think this is swell. No fiddling around with archaic, unplanned systems; just figure out what the country needs and do it!
Perhaps it is just my ideological blindness that makes me believe that this cannot, in the long run, turn out well. But there’s a plausible story that the early boom was mostly a matter of removing distortions (and taking advantage of capital, human and otherwise, accumulated in Hong Kong and China). Now the government is much more directly picking winners and losers. They’re not trying to manage growth; they’re trying to cause it in places where it shows little sign of happening organically.
My gut response is that China is two fold. First, from the anecdote I’ve head – and I would be really interested in Megan’s take – the Chinese government allows local knowledge to drive particular business decisions.
For example, I remember a story of a small manufacturer in China from National Geographic some years ago. An entrepreneur had been in the brassier assembly business but profits were dwindling. He knew he had to make a move. So he and an associate sat a bra on the table and went through it piece by piece. When they got to the clasp one of them asked, who makes this?
It turns out the claps came from some Western firm. They figured they could undercut this firm and so they set up shop to create bra clasps cheaper than anyone in the world. Within a few years they dominated the market. This is capitalism at its core. A producer with detailed local knowledge specifically looking for an edge. As long as the great industrial plan provides room for this I think the core element of a market economy is satisfied.
Generally speaking I think people focus too much on incentives and not enough on entrepreneurial freedom. Even if the price structure is not accurately conveying all the right information, if I guy with a good idea can make happen then productivity growth can still be attained.
Adam Smith notes a naturally propensity of man to truck, barter and exchange. I think just as important is the natural tendency to Tinker and Tweak. The open source movement shows that a non-trivial number of people will do this at price zero.
Second, the fact that China is in catch-up mode likely makes genuine planning easier. The rough outline of an industrial society are easy to observe after the fact and the planners can emulate that. What I suspect is that the Chinese government will have greater and greater difficulty as it moves to the industrial frontier.
The planners will not be able to guess the next big thing as effectively. Large scale resource allocations will become more common and the central government will begin to weigh on the economy.
However, as long as the spirit of entrepreneurship is alive and individual innovators can tinker and tweak, China will grow. Its just that rather than everyone being all smiles about the central government they will begin to groan and complain.
Paul Krugman states
Seriously: there’s nothing wrong with [Bernanke asking for Fiscal Stimulus], but the time when saying it might have done some good was maybe a year ago. Now there’s no chance whatsoever of getting more stimulus through Congress.
I understand why Bernanke was cautious about seeming to insert himself into the political debate — but it’s unforgivable all the same. The inadequacy of the policies we have to reduce unemployment to less-than-catastrophic levels has been obvious for a long time; and everyone who might have been in a position to do something played it safe, until it was too late to do anything.
I am clearly sympathetic to what Paul is saying. Though, if we are all going to be honest here it should be pointed out that much larger but nonetheless progressive tax cuts probably could have been passed in lieu of ARRA. Instead, there was a push for more direct spending on multiplier grounds when we could have gotten a much larger stimulus through tax cuts.
Imagine a newly elected popular Democratic President proposing the largest tax cut in the nations history – a complete suspension of payroll taxes for both employers and employees. That would have been $900 Billion per year right there.
Then the President could have come back and asked for COBRA and Unemployment extensions on humanitarian grounds and passed it through a Democratic congress. The label “stimulus” however would be attached to the tax cut.
He could have even come back later and asked for infrastructure spending because of collapsing bridges and leaking levees. But, nonetheless, the label “stimulus” would have gone to the tax cuts.
So, I don’t think Paul’s tact was necessarily most powerful positioning to begin with.
Now, all of that having been said, I remind my political friends that we make policy with the electorate we have, not the one we wish we had. Similarly for policy folks we pass laws with the politicians we have, not the politicians you wish we had.
If the current politicians want nothing labeled spending then we have to figure out how to do this without anything labeled spending. Indeed, instead of criticizing those politicians for saying “tax cuts don’t have to be paid for” we should be saying “oh you don’t think tax cuts have to be paid for, well great because I happen to have some very important tax cuts right here”
Lets try FICA Tax Credit
Bunny: Why do they call it the quantitative easing? Why don’t they just call it printing money?
JDH: Actually no money is going to be printed. The Fed will pay for these purchases by crediting accounts that banks have with the Fed. Although it is true that banks could ask to withdraw these funds in the form of green currency, they currently are showing no interest in doing so. And before banks did start to want to withdraw these funds as money, the Fed plans to sell the assets off to bring the reserves back in. There is no plan now or in the future to "print a ton of money"
I understand Hamilton’s rationale for responding this way. He wants to assuage fears that we are headed towards some sort of Zimbabwean hyperinflation.
However, it doesn’t attack the misunderstanding head on. It leaves the sympathetic reader with a false sense of Fed policy and it leaves the unsympathetic reader with the feeling that he is being duped.
It is a tougher slog but a more productive one, in my opinion, to explain that traditional monetary policy involves printing money. If you didn’t fear that we were entering the last refuges of a dying economy when Paul Volker was cutting rates in the mid 1980s then you shouldn’t fear it now.
Will Wilkinson writes the best blog post I have read in some time. The issue is immigration, and more specifically, the DREAM act. With all due respect to The Economist and the Democracy in American blog, this should piece should be run as an op-ed in the New York Times, or even better, USA Today, as it deserves a very wide audience. Here is one great paragraph, but definitely read the whole thing:
The DREAM Act sends the message that although American immigration law in effect tries to make water run uphill, we are not monsters. It says that we will not hobble the prospects of young people raised and schooled in America just because we were so perverse to demand that their parents wait in a line before a door that never opens. It signals that we were once a nation of immigrants, and even if we have become too fearful and small to properly honour that noble legacy, America in some small way remains a land of opportunity.
In the comments to a post by Tyler Cowen, George Selgin describes the use and potential for free banking from a gradualist perspective:
The debate about whether the Fed has failed or not shouldn’t be confused with a debate about whether we should, were it possible to do so, want to flip a switch today that would shut the FOMC and discount window, leaving us with a frozen base, and then let private markets take charge from there.
Free banking isn’t what we’d have if we did that. Free banking is the sort of private market banking system that develops over time in the absence of special regulatory restrictions on banks. Our banking system hasn’t developed in that (I believe) healthy manner. It now has some features of free banking, like nationwide branching and market-based interest rates, that it was long denied. But in other respects, and especially that of being utterly dependent on explicit and implicit guarantees, it is less free than ever, and therefore less capable of standing on its own feet and of being able to reliably meet this country’s monetary needs without breaking down.
So I personally am too much a gradualist to want to flip that switch. I favor gradualist reforms that take account of the weakness of the present private banking system. Nevertheless, I think that free banking does offer a long-run ideal worth taking seriously in light of historical experience. And I also believe that continued attempts to reform our monetary and banking system without heeding the lessons of that experience, including attempts to shore up the system by expanding the Fed’s discretionary powers, while continuing to treat guarantees as a substitute for market discipline, are doomed to fail.
I’m not agreeing with Selgin’s argument, but many appeals against the Fed are wrapped in radical free market rhetoric, and it’s worth reading how one could cautiously support free banking and avoid calling for radical changes. One of my chief concerns is that even if free bankers are right and we can never count on the Fed for effective countercyclical monetary policy, if you remove the possibility for monetary policy it will not remove the demand for countercyclical policies. In a recession people will demand something be done, and this will leave only fiscal policy. However bad monetary policy is -if free banking critics are right- fiscal policy is worse.
Arnold Kling is working on a nice metaphor of two types of economists.
The Hoh rain forest has park rangers. They do not try to regulate the rain forest. They regulate other humans, to keep them from disturbing the forest.
Park rangers study the rain forest, but not with a view toward controlling it. They study it out of curiosity. They recognize that as much as they learn, they cannot know everything about how the rain forest works.
At the U.S. Botanic Garden, there are what I would call museum curators. They designed the indoor rain forest, and they implement the design. Nothing grows where it shouldn’t, and anything that is at risk of dying will either be restored to health or replaced.
I see park rangers as a metaphor for how economists ought to stand relative to the market. We should study it out of curiosity, rather than from a desire to control it. We should not be inclined to regulate it.
The museum curators are a metaphor for mainstream economics. If they came to the Hoh rain forest, mainstream economists would look for "market failure’" in which some species overgrow and others fail to thrive. They would see a lack of organization. They would see a need to better regulate temperature and moisture.
I’d like to offer the third alternative of an economists as an Arborist. We study the forest. Have a deep respect for it and appreciate that we will never live to see the day when mankind fully understands it. Arnold might suggest that this day will never come. I tend to think that one it probably will, but not in my lifetime.
In any case I do think we now enough to be able to roughly identify diseases. This is not to say we completely understand the process of botanical diseases or even always get the diagnosis correct.
However, we can through experience learn to recognize major ailments and work to ameliorate some of their worst effects.
Where we have to be careful is in thinking that we know what is best for the forest or can meaningfully direct its action. We also want to be vigilant in impressing upon others the interconnectivity of the forest ecosystem and the danger of rushing in where angels fear to tread.
However, we shouldn’t sit by while a new virus sweeps through and destroys the trees we love. In perhaps the grandest sense we could say, that yes these trees may die but we don’t worry because eventually they will be replaced by other trees in a never ending circle of life.
This is very true. But, we care for and love these trees — and that matters. On a deepest level it matters because our emotions are the ultimate source of value. At their core the trees are just another set of molecules. They are beautiful because they are beautiful to us.
In the same way we could sit by and watch markets fail and say yes one day everything will be better. In the case of a debt deflation for example, it will eventually be better if because of nothing else, then because all of the debtors will one day die.
This is natural and its is true that the forces of economic evolution will rebuild a market from the diseased economy that we observe. But, we care about people. We care about suffering. We don’t want them to be downtrodden until they are removed by death.
The market itself only matters because it makes people’s lives better. The economy only matters because we care about the people who make it up.
Thus it is right that take the knowledge of market failure that we have and do what we can to alleviate what suffering we can.
No we should not pretend that we know best where the economy should end up or that our cognition is any match for evolution. However, we set aside all value if we say that we cannot use what little we do know to ease what pain we can.
Casey Mulligan hammers a point I think is important
What is striking about the data is how little they changed over the years. Capital income rates were almost always between 4.5 and 6.0 percent. Although the population more than doubled, our economy grew by a factor of five or six, and tax laws changed many times, the owners of capital at the end of the 20th century were earning at rates much like the owners 50 years earlier.
Being in favor of a Rawlsian-esque redistribution scheme and wanting to tax capital are not equivalent positions.
It is true that many rich people are heavily invested in capital. However, it does not follow that the burden of capital taxation falls on the rich. Two powerful striking features of the past 60 years or so for which we have good data, is that the after-tax return to capital is relatively constant and the after-tax supply of labor is relatively constant (as a percentage of all labor in the country.)
This implies that taxes on capital reduce its supply so as to hold its after tax return constant where taxes on labor reduce its after tax return so as to hold its supply constant.
The result is that taxes on capital may be highly destructive while, within the range we’ve experienced over the last 60 years, taxes on labor have virtually no economic effect at all.
It’s my inclination to be drawn to studies showing that we waste money on medical care. This is probably because the fact that so much medical care has no impact, or worse, on actual health outcomes is a underappreciated and counterintuitive truth than the fact that some medical care has benefits that exceed costs. Even after reading many of them, marginal studies showing the former are still always more interesting to me than the latter. But it’s important to focus as well on studies that demonstrate places where medical care has real value.
In this vein, an abstract from a new paper in The Quarterly Journal of Economics has really stuck with me all week for it’s empirical ingenuity and it’s results:
A key policy question is whether the benefits of additional medical expenditures exceed their costs. We propose a new approach for estimating marginal returns to medical spending based on variation in medical inputs generated by diagnostic thresholds. Specifically, we combine regression discontinuity estimates that compare health outcomes and medical treatment provision for newborns on either side of the very low birth weight threshold at 1,500 grams… Under an assumption that observed medical spending fully captures the impact of the “very low birth weight” designation on mortality, our estimates suggest that the cost of saving a statistical life of a newborn with birth weight near 1,500 grams is on the order of $550,000 in 2006 dollars.
ADDENDUM: See Mark Thoma in the comments. The paper’s results may actually be spurious. So much for some good news.
The deficit commission proposals are bringing forward a lot of conversations that I would have thought needed to wait. In that sense I have been pleasantly surprised. Regular readers know that I am skeptical of the general practice of trying to head off problems long before they occur.
Nonetheless, there is useful conversation to be had. Ezra Klein notes on cost control
On the bright side, conservatives have now found a better way: "If the left embraces the Domenici-Rivlin approach to Medicare, I’ll dance in the streets," Reihan Salam writes. For those who don’t know, Reihan is an excellent dancer (not to mention freestyle lyricist), and so this is an attractive prospect. But if you look hard at Domenici-Rivlin, it’s hard to see what makes him so happy..
[It’s] a credible way to cut costs. But it’s vastly more aggressive than anything in the Affordable Care Act. So here’s my question: What’s the theory of American politics by which Domenici-Rivlin can be implemented, but the much milder cost controls in PPACA cannot be?
Which is precisely why I am skeptical of any voucher based program. When the vouchers fail to cover health care costs people will simply vote to increase the vouchers.
More fundamentally, because health care is still privately chosen some people will choose to buy outrageously expensive procedures. Those procedures will become known and then the general public will demand that they also get to buy these procedures. The cost of the procedure will then raise the cost of health care and the public will demand that the size of its vouchers be raised.
The only way ultimately to keep a cap on health care spending is to prevent these procedures from being created in the first place. That is, to crush the general market for health care innovation.
This is obviously an extremely high risk strategy as we may end up crushing procedures that could have done a lot of good. One would have to trust that such procedures could slip through the cracks as it were. Or, be delivered by government sponsored research.
I am not overly confident about either of these sources of success.
If I were dictator I would be inclined to abandon public funding of health care all together and replace it massive wage subsidies to the poor and allow them to purchase whatever they wanted.
Actually that’s not true because removing such a popular entitlement is a good way to lose your position as dictator. Even totalitarian governments must ultimately bend to public pressure.
This is the crux of the health care problem. Health care isn’t just another good. Health care has a special psychological meaning to people. Its not simply a service that the poor might not be able to afford. Taking care of our sick and wounded is among the deepest of human emotional obligations.
The obligation feels so deep that for much of human history people have been willing to buy questionable medical services because they wanted to do everything they could for the sick and wounded.
I argue that we still live in such an age. There are a few truly revolutionary medical innovations such antibiotics, vaccines, sterilized instruments, anesthesia, etc. However, the majority of medicine is not particularly effective.
Still, the fact that a procedure exists induces me to want to spend enormous amounts of money on it even if my resulting satisfaction is no different. Whether the procedure exists or not my loved one is going to die and that is going to be a horrible experience.
Indeed, many procedures won’t even prolong this horrible event with any level of certainty. There is a chance that if the procedure works we might get some more time. Often, however, we will have no more time.
This implies that I am getting very little. Only a chance that the inevitable will be delayed by a short bit. Yet, I am deeply compelled to spend almost anything on that chance because the pain of loss is so great.
In this world the creation of more procedures makes me worse off, not better. I go more broke. I spend more out of desperation. I grasp at more straws. All in an effort to delay that which our current technology cannot significantly delay.
Ezra Klein share some dinner party ideas
I was at a dinner last night where everyone in the room had to name a few policies that they thought would increase economic growth in the coming decades. Increasing the number of visas we give to high-skill immigrants got the most votes, followed closely by loosening intellectual property laws. I favor both.
My big item, however, is eliminating the filibuster. Most people don’t think of this as a deficit-reduction measure, but they should. Deficit reduction is difficult.
. . . the harder we make this, the more likely both parties are to shy away from it. And if no one does anything, we’re hurtling toward a fiscal crisis — and those are really bad for growth.
I am not sure about loosening intellectual property laws. I lean towards favoring that policy but the effect on growth is not immediately apparent to me.
I would expand high skilled immigration to immigration period. Based on those two responses it seems like the guests are implicitly thinking of ways to increase per capita GDP or more likely consumption among high income folks. Its pretty clear that weaker intellectual property laws would result in vast near term increases in the quality of consumption regardless of the growth effects.
However, letting in a bunch of low skilled workers is nonetheless good for growth because more workers mean that more things are made. It’s also good for the medium term deficit since most of our costs are fixed costs in the short run.
Where I seriously depart is on the notion that we are headed for fiscal crisis. Are we? I am not confident of this. It is true that our current trends cannot be sustained. Yet, my best guess is that then they simply won’t be sustained.
I mean there is a significant freak out about the deficit now, when arguably the major problem facing the United States is that the deficit is too low. That makes me think that if a problem really started to materialize there would be major measures to stop it.
My guess is that natural response would be big tax hikes and freezes in reimbursement rates on medical services but this is just a guess. We are talking about a country and a culture possibly 30 to 40 years away.
The real question in my mind is thinking through ways to deal with exploding deficits if and when they come. What types of solutions do we want to be reaching for? What pitfalls might do we want to watch out for? In particular is it possible to get a handle on what to do about medicine?
Not just in a mechanical how do we structure payments kind of way but more deeply are we going to begin questioning the usefulness of the medical enterprise generally. This is not an easy question but unless there is a tech revolution in medicine it will become an important one moving forward.
The paper straight forward and compelling. It essentially models the discussion we’ve been having on the blogs and outlines why monetary and fiscal policy are compelling at the zero lower bound.
The core difference from the basic model is of course that some people are forced in the short run to pay down debts. The paper doesn’t say a lot about how or why and at this stage that’s useful since there is more disagreement about how this comes about than that something like that exists.
My forecast at the outset of the crisis was that impatient households were going to be cut-off and that this would produce the liquidity constraints. I would ask for a show hands from the audience as to how many people were saving. Lots of people would raise their hands. Then I would say, “Well how then can the savings rate be zero? Someone must be constantly dis-saving. That person just got their credit card cut up.”
However, from watching the crisis unfold I would say there seems to be a significant amount of repaying going on as well.
In any case the point is that some segment of the populace is liquidity constrained and that’s the driver.
The model shows how something like a money financed payroll tax holiday would be particularly useful. My stance is still to cut taxes as far as possible for as long as possible in as progressive a manner as possible. I argued this before but looking through the model gives me more confidence in it.
Of course, it is the case that targeting debt relief to the individuals who are actually underwater would give more bang for the buck but that has incentive and fairness problems.
Government spending is also more bang for the bucky but has rent seeking problems. Additionally, it still seems to me that more bucks can be moved through the tax system.
My one quibble off the bat is with the statement
It is commonly argued that price and wage flexibility helps minimize the losses from adverse demand shocks. Thus Hamilton (2007), discussing the Great Depression, argues that “What is supposed to help the economy recover is that a substantial pool of unemployed workers should result in a fall in wages and prices that would restore equilibrium in the labor market, as long as the government just keeps the money supply from falling.” The usual criticism of New Deal policies is that they inhibited wage and price flexibility, thus blocking recovery.
Our model suggests, however, that when the economy is faced by a large deleveraging shock, increased price flexibility – which we can represent as a steeper aggregate supply curve – actually makes things worse, not better.
This is not quite right. Debt-deflation produces a countervailing force that means some measure of price-flexibility is worse. However, as prices become more and more flexible the adjustment to consumption will outweigh the debt-deflation effect.
This is clear because a vertical AS curve would result in no recession.
Jim Manzi responds to my post. It seems I came off a bit harsher than I intended. Other posts lead me to think that some believe I’m rejecting Manzi’s argument against overconfidence in models. Quite the contrary I am suggesting that academics don’t actually have the level of confidence Manzi and Brooks ascribe.
This post is going to be a bit long but I it seems our miscommunication is deep and it will take a bit to get us back on track.
The basic insight – echoed by Manzi and Brooks – that there are unintended consequences and that the economy is cannot be meaningfully guided by government is core to everything we do. The further insight that we cannot even build a model that roughly estimates all the particular decisions that private actors make was hammered further home by the failure of the infamous 500 equation models.
Some of these models are still up and running but they serve more of a war gamming function than an actual policy calculators. If you look at how the Fed policy makers talk about choices its in very general terms. If you look at how macro theoretic models are written they are in a very general form.
Manzi and Brooks seem to believe that policy advice comes plugging and chugging on the big models but instead it comes from an intuition honed by working with both the simple theoretic models and war gamming the big models.
I shouldn’t speak for other academics but when I advise that stimulus be undertaken or that money be loosened it is not because I think that I have a model which accurately maps how said stimulus will impact the various sectors of the economy. I would laugh at such an assumption and I am an explicit model builder. I am indeed, currently working on a model to allow war gamming on long term state budgets.
The basic tact both in the models and in my thinking is that for the most part markets work and that they will direct resources to whatever their best use is.
Our task is to deal with particular market failures. In the case of recession the market failure is that we do not have perfectly flexible wages and prices. If we did there would be no recessions as we know them.
I sense that I need to write more on this because many smart commentators still see recessions as either a calamity akin to a crop failure or as punishment for excesses. If that was what a recession was then the result should be our working harder to overcome the calamity or make up for our excesses.
However, the key feature of an actual recession is that Aggregate Hours worked FALLS. That is, people work less, produce less, create less. This is not a solution to a calamity or overconsumption.
In a world of perfectly clearing markets a fall in Aggregate Hours would represent a Great Vacation. That doesn’t seem like the proper response to a calamity or previous irresponsibility. Thus our search for a market failure.
When we work through our best guess at the source of this failure the answer tells me that: lower taxes, higher government spending and looser money would all serve to lean against this particular market failure.
I tend to advocate looser money for a variety of reasons. However, not least is that its “cleaner” than the other approaches. Hopefully it will become clear why.
Several times I have accused Manzi of slipping into industrial policy.
What I mean here is that Manzi is thinking of policies not in terms how then lean against the problem of inflexible prices, but in how they might set the stage for long term economic growth. This is a question that a lot of people are interested in but it is a distinctly different question than “how do we smooth the business cycle”
Nonetheless, once we open the door to government spending people are going to naturally want to engage in industrial policy. To paraphrase Keynes , burying hundred dollar bills in abandoned mine shafts is perfectly good stimulus. Indeed, it would likely have a higher multiplier than other forms we have tried.
The reason people turn to building roads, or funding research is because they hope not only to get stimulus but that the newly employed labor will serve a useful service for society going forward. The question then becomes: what would be a useful service for society going forward. This general becomes a question of industrial policy.
Manzi is right that industrial policy is hard. This is why I argue that we should not attempt to mix it with stimulus and instead fiscal stimulus should be performed by sending the needy or state governments cash.
The larger point, however, is that one shouldn’t confuse the argument for stimulus with the argument for industrial policy. Nor should we think that either the big war gamming models or the simple theoretical models have anything to say about industrial policy.
So one can rightfully criticize industrial policy without criticizing stimulus. Now before I move on I should say that you could also take a market failure approach to spending money. For example, you might argue that infrastructure is a public good and therefore we should spend more on infrastructure to cure two market failures at once. This is different than industrial policy because the argument is not that infrastructure will produce growth or an expansion of industry.
The argument is simply that left to its own devices the market will produce too little infrastructure. The benefit could be lower congestion, fewer fatalities or more trips to Atlantic Beach. We don’t know what people’s preferences are and we are not aiming for a particular result. We are simply saying that whatever the preferences are, the market will produce too few roads.
Now, to be clear Paul Krugman, for one, explicitly rejected this rationale for government spending in a recession, saying that he only preferred government spending because of its greater traction.
That is, cutting taxes and loosening money work assuming that there aren’t other major market failings besides the sticky price problem. Government spending should work in the presence of a host of market failures.
A second stimulus approach would be to cut taxes. This is more complex than government spending because to work against the particular market failure of sticky prices people must spend the money. Now spending doesn’t necessarily mean consumption. Investment is perfectly good spending.
What they cannot do is buy short term government bonds or place their money in a simple savings vehicle which will then in turn invest in short term government bonds. In times of uncertainty, however, people have a tendency to do just that.
There is still some tendency to spend more because of tax cuts. Measuring it is difficult for reasons I’ll have to save till later.
Taxes, however, often slide into some of the same messy issues as government spending. Not only is their fighting over who will get the tax cut but there are attempt to create tax cuts which some believe will have long term effects. These effects are sometimes referred to as supply side effects because they are attempt to boost Aggregate Supply not Aggregate Demand. Broadly speaking recessions are a problem of Aggregate Demand while growth is an issue of Aggregate Supply.
Thus once again concerns about long run growth are mixed with concerns about stimulus. One may or may not think supply side tax cuts are a good idea but this is separate from whether one thinks stimulus is a good idea. Just as we should not confuse government stimulus with industrial policy, we should not confuse tax cut based stimulus with supply side growth based cuts.
Like the two above monetary policy should induce stimulus. Indeed, I tend to think that the other two only work because they implicitly act through monetary policy but that is a debate for another time. The important thing is that monetary policy works to lean against the specific market failure inflexible prices.
Fortunately from my perspective pure monetary policy involves swapping one government liability for another. The Fed buys Treasury bonds and issues Federal Reserve Notes, also known as money.
There is in this action no necessary presumption about how the private sector should allocate resources. The Fed is simply discouraging private actors from attempting to give their money to the government by lowering the supply of bonds and discouraging them from holding excess cash by increasing the rate of inflation.
If that means that private agents invest in new technologies, then so be it. If it means that they buy a bunch of X-box games, then so be it. So long as they refrain from holding government assets as a store of value then it is entirely up to them what they choose to hold or whether they choose to spend.
In addition, once wages and prices adjust the long term affect of monetary policy should disappear. We will have a different price level but the relative prices of all goods should be essentially the same.
It is true as some people point out that if people engage in investment that they would have otherwise forgone then this will raise the level of growth. This is true but unless that investment is in the form of a non-decreasing returns to scale technology it should not affect the long run.
More investment today lowers the return on investment tomorrow. This is why developing countries can grow so much faster than developed countries once they have the proper institutions. They have had less investment in the past and so each unit of investment is more productive.
In the long run though everyone is stuck in the vicinity of the technological frontier. We could shoot ahead but we would simply be slowed down later.
Thus monetary policy should have no large predictable effects on the economy. There are always butterfly effect type stories we could tell – a crucial company getting funding at just the right time, etc – but from our perspective this is white noise. We could just as easily crush the butterfly as set him free.
Ta-Nehisi Coates at the Atlantic has observed in his comments that some topics are difficult to discuss productively:
The following goes for this particular space, and not for the net at large: I think education is hard. I think anything dealing with food choices is hard. As a corollary, I think anything dealing with weight is hard. I think feminism–though not necessarily gender–is really effing hard. Israel is is probably the hardest–indeed, I avoid it, whenever possible. I think Sharia is really effing hard. Perhaps there’s a through-line here that I’m missing. I’d love it if someone can connect that dots.
Despite being unable to find a through-line that connects these issues, he offers a hypothesis as to why some topics are hard for him and his blog and yet others, which seem like they should be, aren’t:
…I find that the easiest thing to handle here is that which much of society struggles with–race. One view might hold that, being liberals, race is something we all agree on, thus making it easy to discuss. I think that’s partially true, but I also think that authority allows you to keep conversations on track….
…In that vein, I think, a really smart medical doctor who’s studied obesity might be better able to conduct a thread on weight….
Authority, of course, springs from more then in-group membership. I think you also have to be willing to examine evidence that undermines your working theories. I think you can’t dismiss discomfiting arguments out of hand. I think you have to be willing to disagree with those in your own camp, but not so much that you become the one unscrupulous partisans trot out to advance their agenda… These tools, paired with personal experience and interest, allow people to assume a kind of sincerity that they otherwise might not.
So the ingredients are authority, which can come in part from in-group membership and experience, and a reputation as an honest broker. These all seem like good common-sense ingredients for a thoughtful, productive conversation about sensitive topics. So this is useful if your looking for advice about how to have these conversations, but as TNC recognizes, it does not provide a deeper explanation for the phenomenon.
So this is my challenge: why are some topics difficult to have productive conversations about and others not? And why do we heavily weigh experiential and in-group authority on some topics and not on others? In particular, I would be interested to hear the George Mason/Robin Hanson style explanation for this phenomenon.
Like David Brooks, Jim Manzi has some wrong ideas about how economics works.
Manzi begins with the standard critique
In practice, the problem of excessive abstraction by economic theory that Brooks identifies becomes increasingly severe as we try to evaluate the effects of proposed interventions and programs over years and decades, rather than months and quarters.
First, this is backwards. With cyclical policy its generally speaking easier to access the effect of interventions over longer and longer horizons because the economy increasingly resembles a frictionless market as you extend time in to the future.
For example, if you asked what effect would properly done fiscal stimulus today have on the economy 20 years from now, the fairly easy and straight forward answer is, none.
Stimulus is not central planning or industrial policy. It should have no lasting effects. If it does, then you did it wrong. What’s more difficult is the short run.
Manzi continues mixes monetary and industrial policy. He says
Consider the role of very low interest rates in stimulating economic growth in the software industry where I work. Easy monetary policy, along with various other forms of stimulus, has at least in part, likely worked as advertised; it has likely stimulated some extremely-difficult-to-quantify general economic growth, which has in turn created demand for enterprise software, among many other things. And low interest rates probably have resulted in certain additional development projects within large companies being greenlighted because they face a lower discount rate. In fact, many traditional large enterprise software companies have built large cash hoards. But they are mostly using them to finance acquisitions, not to expand capacity and increase aggregate output. Why this is so turns out to be important for understanding the potential effects of this policy on the industry.
A good central banker has absolutely no interest in what the effect of this policy is on your industry. That is your problem as a manager.
The idea is that in a market economy, someone, somewhere, will find a way to capitalize on increasing demand. It may be the software industry, it may be the restaurant industry, it may be traditional manufacturing. In our experience, traditional manufacturing moves the most in response to cyclical forces, but we are not picking winners here.
We are trusting that in a market someone, somewhere will find a product that they can sell if demand is high.
He goes on to confuse two-party transactions with economy wide effects
One major effect of a Fed policy of easy money, then, is that large software companies can go borrow lots of money cheaply, and then use this acquire entrepreneurial companies that usually require more equity financing rather than debt financing. This does not add capacity to world, but simply transfers management control over some very important assets from entrepreneurs to incumbents.
That single transaction does not, but it is a part of chain that does. The money flows from the incumbent to former entrepreneurs. One potential effect is that the entrepreneurs have a sudden wealth effect which they can use either to purchase more consumption, invest in new companies they might want to start or hoard as low return cash.
If they choose the later they will face the same incentives that pushed the large company to acquire the smaller one.
Another potential effect, is that likely the incumbent is doing this because its increasing its internal return on assets. This means that while the incumbent formerly was simply a cash cow building up ever higher cash reserves, it now has a new department which can use that cash effectively.
Note, that the viability of the paragraph I just wrote depends on a breakdown of Modigliani-Miller. That is, an explicit recognition that some important conjectures may not hold.
Still another potential effect is that upon seeing the wave of buy-ups new companies start-up with the thought that they don’t have to dethrone the incumbent, they simply have to be threatening enough or creative enough to be bought out. This soaks up capacity.
Again, the goal is not to get the software incumbents or entrepreneurs to do anything in particular. It is to change the general set of incentives in the economy and assume that someone will respond.
Manzi asks again
Will this lead to higher or lower economic output in 2015, 2020 and 2030? I don’t know. But then again, neither does anybody else.
There might be some minor knock-on effects because you are dealing with the high growth software industry but the standard answer should be the same. It will have no effect on economic output by 2030.
He goes on to critique the model and again mix stimulus with industrial policy
Where is any of this complexity captured in econometric models that purport to explain how fiscal deficits, interest rates and quantitative easing are driving everything from car dealerships to television broadcasters to consumers of dog food, all of whom face their own unique dynamics? But without it, I doubt the ability of any model to forecast the long-run impacts of a multi-trillion dollar program to intervene in the economy in the name of creating self-sustaining growth in the long -term. All I can say with confidence is that if you believe as I do that a good rough rule-of-thumb is that “over any sustained period markets supported by an appropriate culture will do a better job than politicians in allocating resources to generate high economic growth,” then at some point, the distortions created by such a policy would likely outweigh any benefits it can create.
This complexity is captured in most models that have a no-arbitrage condition. That is the model implicitly assumes that if there is a clear way to make profit some entrepreneur will take it. The model assumes that if product A is better than product B then the consumer will buy it. It makes no assumptions about how this profit will be made or which products the consumers will choose.
Indeed, its faith in the web of interconnections that leads economists to say, market participants will arbitrage away the internal difficulties leaving us with a black-box in which stimulus comes goes in one side and production comes out of the other.
Its not the belief that we can understand all the frictions that leads to the simplest models but the belief that we can’t but the market participants can.
Most importantly, however, there is no “no policy” option.
One cannot have “no monetary policy.” Policy must either be tight or loose. Interest rates in every period must be something and that something is determined by what the Fed chooses. Even if we returned to a gold standard, the policy would be that the Fed prints money until the price of gold has reached a certain level and then stops. That’s still a policy.
So, it is not as if the Fed for example is saying – look we have digested the intricacies of business better than the market participants and have decided that you are doing the wrong thing and need to be adjusted.
No, the Fed says, by necessity we have a policy. Is this policy helping or hurting based on the broad set of incentives we know this policy has?
A similar situation happens with taxes. The federal government is going to have some tax policy. Even if the policy were to eliminate all taxes, that itself would be a policy and would have consequences.
Thus, the question facing the government is whether or not the tax policy is helping or hurting? Would lower taxes, which are akin to looser money, encourage or discourage business activity.
Likewise the government will have some deficit policy. Even running a balanced budget is itself a policy. For example running a balanced budget would make tax hike during a recession almost inevitable. Is this a good idea?
Again, we can’t have no policy. We have to have some policy and the question is, is the policy helpful or not.
What we are expressly not doing is industrial policy. That is, we are not saying – look corporation should really be doing X and we are going to make them do it regardless of the private sector incentives.
We are saying corporations are responding to the incentive structure we as public institutions inevitably create and we wondering how can this structure be as supportive of growth as possible.
Manzi end with
Despite confident assertions by academicians, the Law of Unintended Consequences remains in force.
That law sounds like something Manzi picked up from an academician.
I want to follow Karl’s comments about bailouts with some scattered thoughts of my own. If I read him correctly, I think he is arguing that bailouts with risk taking are a second best outcome, and that we can’t have both risk taking and no bailouts unless we want financial panics as well.
One response to his argument that bailouts are needed because we want firms to take risks is to point out that risk taking is important in all industries, and so we should have bailouts in manufacturing and retail industries to encourage more risk taking?
The difference is that it’s the natural state of financial markets, the argument goes, that risk taking will induce occasional panics. This is not true of other markets because consumers don’t panic in other markets, and the nature of fractional reserve banking makes it sensitive to panics.
One response to the notion that panics are the “natural state” if banking is an argument I’ve occasionally made, which is that regulations that separate banking from other types of commerce prevents experimentation with other models for finance that may not be subject to panics and may not require bailouts. I’m not optimistic that we will experiment with new business models here, but I think there is potential.
There are those who blame the FDIC and the implicit guarantee of central bankers as lenders-of-last resort for the panics that occur in banking. I am not convinced by this. I believe that banking as it exists in most countries today and as it has existed in most forms in the past is subject to panics. I am not convinced, however, that this is true of all forms of the banking that could exist were it allowed to evolve. Of course one could argue that the costs of experimentation may be too costly to make it worth walking down that path.
A final point that I think is underemphasized today is that we should be concerned about profitable bailouts. No matter how necessary bailouts are at some points in time we want them to be costly both for those being bailed out and for those doing the bailing. Long in the future when the economy is back at full employment, the argument that “we bailed out banks before and made money on it” or “we bailed out G.M. before and made money on it” will be more salient than today’s popular anti-bailout sentiments are. It is an easy debate point that I am afraid will stand the test of time whereas the popular backlash will fade into memory.
When future politicians are deciding whether to bail out or not, it is best if everyone understands they will be voted out of office if they vote for a bailout. They already know that they will be voted out if they fail to bail out when it is necessary to prevent a panic, so the choice in a real panic will then be to end their career by preventing a panic or end it by failing to prevent a panic. I believe the desire to not end up the latter scenario will be enough to overcome coordination problems and freeloader issues.
In contrast, if you can profit on a bailout and create the illusion that you prevented a panic that never was, then I believe we will have too many bailouts. At the very least today’s bailout profitability provides an ex ante justification for one round of future bailouts, even if those bailouts are unprofitable. This is why it’s important that bailouts always come with a political cost, and having them be unprofitable is a good one.
You could argue bailouts will inevitably be followed by populist backlash that will cost politicians, but I think if we had a combination of profitable bailouts and low unemployment now the bailout would be quite popular. It is not bailouts per se that are unpopular, but bailouts that failed to prevent high unemployment. Bailouts in fake panics will always prevent high unemployment, and will thus be popular.
And in any case, even if ex post backlash is inevitable, today’s profitability will be more salient in the future than today’s backlash, which will provide future unnecessary bailouts with ex ante justification.
I know that the time isn’t right for this yet but I want to prep the conversation for whether or not bailouts as a general policy aren’t simply a good idea.
The obvious retort is that it just encourages risk taking. The question, however, is – are we certain that that is a bad thing?
Take TARP. The bank portion of TARP made a profit. However, some people fear that it only encouraged banks to take risks in the future. However, if in the future we bailout more banks and earn additional profits, are we sure this is necessarily a bad arrangement?
The gut reaction is that risk is bad and of course risk taking is unpleasant for most people. However, risk-taking is also the foundation for growth. Taking calculated risks is a social good and produces externalities.
Thus in the aggregate we should expect the problem society faces is not that people take too many risks but that they take too few. In such a case, subsidizing risk taking is exactly the right thing to do.
Now, at the same time there was a massive recession in spite of TARP. This is why the question of whether a more powerful monetary response could have beaten back the recession is so important.
I think monetary policy failed us this time around, but I think it failed for predictable reasons. We were too close to zero lower bound, we did not have price level targeting and there was widespread resistance to quantitative monetary policy. These conditions make a large drop in aggregate demand from any source dangerous.
I would suggest that a higher baseline level of inflation combined with some form of level targeting – I am open to NGDP or nominal spending – would have allowed the Fed to keep its winning streak.
If we have a means of stopping a wide spread bank panic and we have a means of stopping a general recession then we effectively have means of neutralizing the downside risks from financial implosions.
This may sound like unhinged purely academic musings but we do this all of the time. The most obvious example is the FDIC, which provides regular bailouts to depositors of commercial banks and for the most part has been extremely successful.
Even more fundamentally we regularly bailout actual fires. Fire spreading from one building to the next is a danger in a packed city and we could require that people build further apart to prevent this externality. However, density also offers enormous positive externalities.
We handle these dueling externalities by allowing very dense buildings and then employing a public fire department to cover the increase in fire risk. Most people have found this relationship highly advantageous.
So in the same way that we regularly bailout home fires, it might be in our interest to regularly bailout economic risk takers of various stripes. The core question is how important is risk taking to our economic system. I tend to think “extremely” but there is much more debate to be had.
BLS report is out today and since concerns about inflation are a major topic I thought I would offer another look at the data.
Rather than year-over-year this is the month-to-month change, annualized. That is, what would inflation look like if we had a whole year just like the past month.
This is important because big one month changes will carry through for a while. For example that plunge in the beginning of 2010 has been holding down the year over year numbers and so we could see a bump as it rolls out of the 12 month window.
At the same time, however, the last two months have been pretty tepid and they will be with us for a while. On net we might expect a brief rise in the year-over-year followed by a decline later in 2011. We might be tempted to interpret these moves as responses to various concurrent policies. There are many reasons that this would be a mistake but not least is because the movement is already baked into the cake.
I completely agree with every statement Matt Yglesias makes here
Can I get my hands on some of this money to back up the claims of the private equity industry? It seems to me that they’re clearly correct. Widely dispersed ownership of publicly traded firms presents massive problems of governance and huge misallocations of resources. It’s a necessary evil because it allows for the mobilization of capital that would otherwise be sitting around uselessly. But clearly insofar as private equity dudes are able to mobilize capital in other ways, that’s fine. If there’s a problem of some people getting too stinking rich as a consequence, then those people should pay more taxes. But there’s nothing wrong with there being an industry in that field as such.
I’d say more, but I hereby resolve to not write another word on the subject until someone cuts me a fat check to do so. I’m not too proud to beg.
The question for American Business is whether or not the last two years will wind up producing the highest profits on record or merely the fastest growing profits on record. Deutsche Bank is putting its money on the highest profits on record. From Catherine Rampbell
“Not only are we seeing a tremendous V-shaped recovery in corporate profits, but we are in fact seeing the biggest corporate profit recovery ever,” said Joseph A. LaVorgna, the chief United States economist at Deutsche Bank. “That means that the equity market is dirt cheap. That also means that companies have more money than they know what to do with.”
To be clear, I think soaring corporate profits are great and wonderful accomplishment that the Treasury and Fed should rightly be proud of. If the economic collapse were deeper than it was, we wouldn’t see these type of numbers.
However, the job is not done and the clear concern moving forward is not on the cost side. Unit labor costs are falling. That means workers are getting relatively cheaper to hire.
Perhaps, regulatory uncertainty is so high that its overwhelming the general trend of falling labor costs and corporations fear that the good times are coming to an end.
However, I still maintain that the key driver is not on the cost side but on the sell side, where business is still reeling from the largest drop ever recorded. The Commerce Department started recording in 1947.
When you ask businesses about their problems they report poor sales. Which is consistent with the fact that sales really are low.
Now, at the same time I am sure a lot of managers talk to reporters about their managing the new political climate. This is because navigating the political climate is something over which the manager has control.
Aggregate demand is simply the air that business breathes. It doesn’t make sense to say, “yeah what I am working on today is getting Americans generally to shop and invest more,” because the average CEO has no control over this. She simply takes it as given.
The only thing she can do to increase sales is to lower relative prices, either by offering more innovative products or cutting the headline price. Both, of which businesses seem to be doing.
Indeed, that’s why consistent price cuts across all businesses are a sign for economists that Aggregate Demand is falling.
However, the basic issue that Aggregate Demand is low doesn’t percolate up for the average manager because there is nothing that she can to change it.
It’s rare that a plea for regulation presents as clear of a picture of the slippery slope as Oregon D.A. Rob Bovett’s recent op-ed in the New York Times did. He asks us to walk with him farther down the slope, acknowledging that we’re already on it, and offering a preview of what’s next.
The regulation he is proposing concerns pseudoephedrine, an ingredient in several allergy medicines and, unfortunately, methamphetamine. Where we are on the slope right now is that it can only be sold from behind the counter and buyers are required to present some for of photo identification. Purchases are recorded and buyers are prevented from going over a certain amount in a given time-period. Lost your allergy medicine? Too bad, we gave you 10 days worth, so you have to wait 10 days before you can get more.
This, however, has not stopped the determined meth makers who still manage to get enough pseudoephedrine to keep the streets supplied. Which brings us to the next step on the slippery slope. Bob Bovett wants us to follow Oregon and Mississippi’s leads and require a prescription for any drugs with pseudoephedrine.
Uncharacteristically for regulation advocates, he provides a glimpse into the next and final step on the slippery slope: complete prohibition.
In 2009, Mexico, which had been the source of most of the methamphetamine on the streets of the United States, went further, banning pseudoephedrine entirely. The potency of meth from Mexico has since plummeted. This is great news. But now the ball is back in our court.
You will notice not an inkling that Mexico may have gone too far. Clearly he believes that if prohibition is what it takes to reduce the potency of meth (notice he’s not even promising it would get rid of it) then it’s worth it.
So we tried putting it behind the counter. That was step one on the slope, and it didn’t work. Now he wants us to require a prescription, that’s the second step. When that doesn’t work, he’s shown all indication that he’d be willing to push for complete prohibition. I’m not sure what we’ll do when that won’t actually get rid of meth users but simply reduces the potency of their meth. I guess from then on it will just be asking for more funding for enforcement, and stricter penalties for violators.
It’s also worth noting that the first step above isn’t really the first step down the slippery slope of pseudoephedrine regulation, just the most notable. There’s a long history of gradually increasing regulations, detailed nicely in this paper from the American Economic Review:
There were significant changes in the federal regulations enacted in 1988, 1993, 1996, 1997, 2000, and 2005. In 1988 the Chemical Diversion and Trafficking Act (CDTA) imposed reporting, record-keeping, and import/export notification requirements for regulated transactions in bulk (powder) ephedrine and pseudoephedrine. However, it did not control tablets or capsules. The Domestic Chemical Diversion Control Act (DCDCA) was passed in 1993 and implemented in 1994 and 1995. The legislation removed the record-keeping and reporting exemption for single-entity ephedrine products. The DCDCA also required distributors, importers, and exporters of List I chemicals to register with the DEA. The DEA could deny or revoke a company’s registration without proof of criminal intent. In 1996 the Methamphetamine Control Act (MCA 1996) regulated access to over-the-counter medicines containing ephedrine. The following year, the Methamphetamine Control Act (MCA 1997) regulated products containing pseudoephedrine or phenylpropanolamine with or without other active ingredients. Significant elements of the MCA were implemented in early 1998. In 2000, the Methamphetamine Anti- Proliferation Act (MAPA) established thresholds for pseudoephedrine drug products. Finally, in 2005 the Combat Methamphetamine Epidemic Act (CMEA) included limits on retail over-the-counter sales of products containing ephedrine, pseudoephedrine, and phenylpropanolamine.
Some of these may have been perfectly reasonable regulations, but it’s important to see where these seemingly sensible regulations have brought us, and where they appear to be leading us.
Also important is the result of the aforementioned study, which looked at the impact of a huge supply disruption in the illicit pseudoephedrine market by the DEA. Despite the huge success of the crackdowns in reducing supply and increasing prices, the long-run results they found are not encouraging for those who want to stop meth use by supply disruption:
The DEA successfully shutting down two major precursor suppliers in mid-1995 significantly disrupted the supply of methamphetamine. The evidence suggests that, at the peak of the short-age, supply was reduced by over 50 percent in California. During the four months after the intervention, the price per gram of methamphetamine tripled, and purity dropped from 90 percent to less than 20 percent. Prices recovered within 4 months, while purity required 18 months to recover to 85 percent of its original level.
…This is quite possibly the DEA’s greatest success in disrupting the supply of a major illicit substance. This success was the result of a highly concentrated input supply market and consequently may be difficult to replicate for drugs with less centralized sources of supply, such as cocaine and heroin. That this massive market disruption resulted in only a temporary reduction in adverse health events and drug arrests, and did not reduce property and violent crimes, is disappointing.
The slogan for regulation like this should be “Contrary our assurances that they would, the powers you’ve granted us to stop this problem have not worked. Therefore we need more powers, and we assure you they will work.”
Something tells me I’m not going to like the plan that emerges from this brain trust:
Last Friday Sen. Bernie Sanders (D-Vt.) announced he will work with seniors’ organizations, unions, and members of Congress, to develop an alternative to the Simpson-Bowles recommendations.
What’s that old joke about when a socialist, a union member, and a senior citizen walk into a a bar together? I don’t remember exactly how it goes, but somehow I think the punch-line is going to be higher taxes.
Felix Salmon says
Part of the problem is that QE has become, in part, a game of “kill all the shorts”—a game which a glance atIOC or OPEN or even UTA will tell you is being played very well indeed. Correlations are high, which is always a bad sign, and that weakens the raison d’être of the entire market, which is to allocate capital efficiently. Instead, the stock market becomes a place where people park their money in the hope that it will go up and in the expectation that if it goes down, the Fed will step in and rescue them.
So in a perfectly rational world stock prices represent the discounted future profits of a corporation. But discounted by what? Presumably, by the interest rate on bonds which are equally risky.
Thus, if the Fed drives down interest rate that should on a completely rational basis drive up stock prices.
Now, in a more real world setting you could think of the Fed as pushing private investors out of Treasuries. The Fed is driving down the yield and so you want to go somewhere else. One of the places you might want to go is stocks.
However, this is precisely how the policy is supposed to work. It increases Tobin’s Q which in turn encourages investments. In the real world this means that companies should be less inclined to buy back their own stock as the price rises, this encourages them to use cash on hand to either increase dividends or increase capacity.
It also means that venture capitalists are selling into a richer market. This encourages them to take chances on more firms. Lastly, it means that struggling companies can get a better deal issuing additional equity.
All of these make real investment, that is the buying of equipment, software and fixed structures more attractive
There has been a lot of back and forth on whether or not government workers are overpaid. If I were a good blog citizen I would track down the links for you.
Instead, I am just going to throw in my two cents. Causal empiricism would lead many professionals to scoff at the idea government workers are overpaid. Who ever says, “man I want to go into the public sector where the bucks really start rolling in.”
The problem is that this has a significant observation bias. Many public sector workers are not professionals and its precisely among the non-professional staff that allegations of overpayment are targeted.
Underpayment of public employees would be hard to measure. It wouldn’t mean, as some have suggested, that government workers would be better off fired. It would mean that the government would be better off replacing its current workers with higher quality workers who demand higher salary. It means the government is currently scraping the bottom of the barrel.
Overpayment could take two forms. It could mean that many government workers are overqualified; that there is no reason to put a person so highly sought after in such a low return position. It could also mean that the current workers are being paid more than their market price.
Luckily the second is easy to tell as it presents itself as oversupply, workers beating down the doors to get these jobs. There is undoubtedly some of this in the public sector given the existence of collective bargaining. However, when its really out of whack we can tell because we get stories like this:
By Associated Press | August 19, 2004
LOS ANGELES — Hundreds of thousands of applicants are competing for 3,000 temporary jobs at the ports of Long Beach and Los Angeles, hoping for lucrative wages in an otherwise weak labor market.
The jobs, which pay $20 to $28 an hour, were created to handle a record amount of cargo coming through both ports.
A Long Beach post office spokesman said Tuesday that a conservative estimate put the number of mailed-in applications at 220,000 to 250,000.
”This is almost like going to the horse track and betting on the long shot," said Raymond Sheets, a 47-year-old tree trimmer from San Diego who hopes to land a job at the harbor.
The point isn’t that $20 to $28 is more than these workers could possibly be worth. We aren’t even asking what the qualifications are. We are simply noting that there is enormous evidence of a failure of this labor market to clear. Lots of people want this job – only 1 in 100 will get it.