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Brad Delong got me interested in the details of a few of these cases

You can sleep easy if you play by the rules even if you think the rules are non-optimal, as long as you point that out. That’s Milton Friedman.

You cannot sleep easy if you play by the rules if you think the rules give you a license to steal. That’s Robert Nozick, Robert Bork, and Ayn Rand.

That’s the difference between utilitarian and deontological theories. Deontology is a bitch.

To catch up, Robert Nozick freely entered into a lease with his landlord, Eric Segal. After living in apartment for a year or so, Nozick then sued Segal for violating rent control laws and further refused to move out unless paid additional compensation. According to his moral theories this constituted extortion.

Ayn Rand, received Social Security and possible Medicare payments to cover lung cancer treatment. This is despite her characterization of the welfare state as theft and a particularly egregious form of theft because it is legal.

Robert Bork sued the Yale Club after suffer a slip and fall, despite arguing against frivolous lawsuits. I couldn’t find enough information on Bork – in the short time I looked – to get a real sense of his moral philosophy concerning slip and falls.

 

For Nozick and Rand, however, these are clear breaches of the most common interpretations of their moral philosophy. Does this undermine their philosophy at all?

On one level we are of course tempted to say, no what is true is true regardless of whether the popularizer of those truths honors them. On the other hand “ought” implies “can.”  If not even Nozick and Rand can hold to these principles are they a meaningful guide to how we ought to structure our society? While these are by no means view-killing breaches, they do raise the question: is anyone capable of living according to these maxims?

I looked a little in Nozick and Rand’s response. By my reading Nozick’s offers a fair degree of absolution for his philosophy while Rand’s leaves me scratching my head.

Nozick via Julian Sanchez

I knew at the time that when I let my intense irritation with representatives of Erich Segal lead me to invoke against him rent control laws that I opposed and disapproved of, that I would later come to regret it, but sometimes you have to do what you have to do.

This reads to me as this: Yes, what I did was wrong. I knew it at the time, but I was pissed.

This statement moves the onus from the philosophy to the individual. Had Nozick dithered and said “Well, but Segal deserved it” that would be different. Instead, he seems to admit that he acted immorally.

Said another way, its one thing to abandon your principles you when find that they are inconvenient to you. It’s another to fall victim to weakness of will and do something you know you will later regret. We don’t have any philosophy, save perhaps hedonism, that protects people from weakness of will.

Rand on the other hand claimed

It is obvious, in such cases, that a man receives his own money which was taken from him by force, directly and specifically, without his consent, against his own choice. Those who advocated such laws are morally guilty, since they assumed the “right” to force employers and unwilling co-workers. But the victims, who opposed such laws, have a clear right to any refund of their own money—and they would not advance the cause of freedom if they left their money, unclaimed, for the benefit of the welfare-state administration.

This is much iffier. Here she does seem to be saying that different rules apply to her followers simply because they are her followers. This has the feel of ad hocery. There might be significantly more, but it seems to be a more eloquent way of saying “We were just sticking it to the man, that was sticking it to us.”

Doesn’t the taking of benefits imply that more resources will have to be confiscated to support the program? And, while appealing for a refund makes perfect sense, simply using the system without a guarantee that you are matching funds put-in with funds taken-out and certainly without the express permission of the people who are currently being taxed seems morally ambiguous in Rand’s own terms.

A few people have pointed out this Pew poll that shows an inconsistent public. The public, for example, thinks the states should balance their budgets, just not by raising taxes or cutting spending.

Now, some people really might want the states to balance their budgets by magic. However, you don’t need that to get the results Pew finds.

Suppose that you have three people. Adam, who believes in cutting spending to balance the budget. Bill who believes in raising taxes to balance the budget and Chris who believes that state balanced budgets are a pro-cyclical economic destabilizer that should be alleviated by federal transfers, or as he likes to say, “lame.”

Now we are going to ask a few questions.

First we ask: Should the state stick to its balance budget requirement? Adam and Bill say yes. Chris says no. We confidently conclude that the public wants balanced budgets.

Second we ask: Should we cut spending? Adam says yes. Bill and Chris say no. We confidently conclude that the public doesn’t want to cut spending.

Third, we ask: Should we raise taxes? Adam and Chris say no. Bill says yes. We confidently conclude that the public doesn’t want to raise taxes.

But wait a minute! Is the public insane! How can we balance the budget if we don’t cut spending or raise taxes.

No the public as individuals are completely sane, but when aggregated into a whole they become irrational. And, importantly there is no clear way to make them rational, since each person is answering truthfully and with complete knowledge of the facts.

[We are going to leave out intensity scoring for now because its complicated and I don’t think it actually gets you what its proponents think it gets you]

This is one of the reasons why “the individual” is special level of organization. Trying to go below the individual, for example asking what kind of policy your parietal lobe wants, usually yields no meaningful answer. Going above the individual exposes you to this fundamental aggregation problem.

How the brain goes about solving this aggregation problem is still a mystery to us. If it feels like there are dozen distinct urges and desires pulling you in different directions, its because there are. Somehow, however, the brain integrates them into a surprisingly rational whole. As a society we don’t know how to do that.

One practical solution to this problem, employed by the founders of most modern democracies, was to create some form of deliberative legislature where people could hash out deals.

Sometimes these deals would include side payments. For example, Adam and Bill agree to build a bike ramp for Chris if he’ll vote for modest tax increases and modest spending cuts.

Today that type of deal making is under attack. Politicians are lambasted for voting against their party’s preferences. Side deals or pork are criticized as corrupt and immoral.

This is unfortunate because if Pew snapshot is correct, then a legislature that is purely faithful to its voters is a legislature inescapably bound by aggregate irrationality.

Writing in the wake of this impressive effort by Will Wilkinson can only serve to highlight my own deficiencies, nonetheless there is a point to be made.

Steven Landsburg is by his own standards wrong or at least incomplete when he makes the following claim.

Some people claim (perhaps rightly, perhaps wrongly, perhaps absurdly — I lean toward the latter) that gay people, on average, are less successful as parents. In a video that’s begun to go viral, University of Iowa engineering student Zach Wahls attempts to refute this notion without offering a shred of evidence beyond a single cherry-picked case (his own) to prove that children of gay parents sometimes turn out just fine (except, perhaps, for their ability to reason)

The implicit source of Landsburg’s scorn is that one non-random example should not change people’s estimate of population wide averages. However, this is, of course, false.

If one believes that the “content of one’s character” is a stochastic monotonically increasing function of parenting inputs, then the lower the distribution of parenting inputs the lower the distribution of character contents.

For a very-high-content-character, one far off in the tails of the distribution, a parenting sub-sample that was even slightly below mean could radically reduce the probability of it being produced. A single example of a high-enough content character then should radically lower your estimation of the probability that the parenting sub-sample being tested is below the mean.

Said in slightly plainer terms, a truly exceptional kid would require first exceptional parents and then a heaping of luck on top of that. If gays are actually below average in their parenting abilities then you have to pull a double whammy of drawing first, a pair of exceptional gay parents and then they still have to get a lucky in the parenting business.

Indeed, if homosexuality per se degrades a parent’s ability through the corrosive effects of sin, then it becomes a triple whammy because one has to draw two relatively non-sinful homosexuals – though of course there is presumably significant correlation between mating partners.

Depending on the functions you are dealing with its entirely possible that the appearance of even a single gay couple with a child far enough above the mean would rationally cause one to re-estimate that gays are more likely to be good parents. This, clearly, also depends crucially on priors and assumed distributions.

Now, is this the function we are dealing with? I doubt it because I have seen strong evidence that the parenting to character function is virtually non-existent or more precisely, nearly completely random. But, that’s not the point. Some people believe that the correlation is extremely tight, that the causation runs from parents to child’s character and the distribution of exceptional people is extremely narrow. Landsburg doesn’t offer any evidence that they are wrong.

For Mr Wahl’s monologue to be “intellectual misdirection”, Landsburg would first have to establish that the parenting function or distribution of exceptional character is not of this nature and that further that no one supporting the gay marriage ban believes that it is.

Will Wilkinson is always a good blogger, but you can tell when his heart is really in it because he writes like he does in this amazing post taking Steven Landsburg to task:

“Economists like Mr Landsburg specialise in the study of instrumental rationality. To act rationally in this sense is to take the means most conducive to one’s ends. Sadly, means-ends rationality and epistemic rationality are often at odds. Fallacious arguments can be the best means to noble ends. If we were to concede, for the sake of argument, that Mr Wahls did fallaciously attempt to rebut a statistical argument with an anecdote, it may remain that he acted not “in the service of intellectual misdirection”, but instead acted with exemplary rationality and morality by speaking eloquently in the service of justice. The kind of humanising anecdote Mr Wahls offered does in fact tend to elicit sympathy and weaken ill-founded prejudice. Maybe the relatively tolerant attitude of people with gay friends and family flows from some kind of statistical slip-up, but that’s how we are. A rational rhetorician takes his audience’s inclinations, rational or not, into account.”

You really should read the whole post.

One might expect that over time economic forecasters should converge in methodologies, and thus in forecasts, as the competitive market for forecasters creates a natural selection that weeds out unsuccessful strategies and pushes forecasters towards the most successful strategy. However there is still a wide divergence in economic forecasts, which begs the question what part of that natural selection is failing?

One could argue that there is no “most successful” strategy, and that the best model shifts in random in unpredictable ways. But I don’t think actual models change fast enough to account for differences in forecasts.  You could also argue that some forecasting strategies are not public knowledge as forecasters keep them secret. This is  probably true to some extent, but I doubt if everyone had perfectly transparent models we would observe this convergence.

A third, and I believe most important, explanation is the failure of the  assumption that the competitive market for forecasters creates incentives to have the most accurate forecasts possible. A great example of the lack of a direct relationship between accuracy and incentives is Nouriel Roubini, whose forecasting was discussed in a recent article by Joe Keohane in the Boston Globe:

…since he called the Great Recession, he has become about as close to a household name as an economist can be… He’s been called a seer, been brought in to counsel heads of state and titans of industry — the one guy who connected the dots…. He’s a sought-after source for journalists, a guest on talk shows… With the effects of the Great Recession still being keenly felt, Roubini is everywhere.

But here’s another thing about him: For a prophet, he’s wrong an awful lot of the time. In October 2008, he predicted that hundreds of hedge funds were on the verge of failure and that the government would have to close the markets for a week or two in the coming days to cope with the shock. That didn’t happen…

It goes on with several other big forecasts from Roubini that failed to materialize. The article goes on to argue that the market rewards forecasts who predict extreme events while still being more wrong overall. There is some sense to this, since businesses and governments should be disproportionately concerned about extreme outcomes. But this would call for forecasts who can identify extreme outcomes with a non-trivial probability of occurring and also accurately assess that probability, not ones who constantly exaggerate the probability of extreme events.

Via a tweet from Donald Marron (@dmarron) comes a study that supports the notion that forecasters are not trying to minimize forecast errors. The paper, by Owen Lamont, argues the following:

There is significant anecdotal evidence that indicates forecasters are not paid according to their mean squared error. Forecasters seek to enhance their reputation, manipulate perceptions of their quality, and use their forecasts in various ways unrelated to the minimization of mean squared error.

For example, one competitive strategy of forecasters Lamont identified is the “broken clock strategy”:

One practice is the “broken clock” strategy, which consists of always forecasting the same event. An example in the sample is A. Gary Shilling, a well-known recession-caller. Throughout the 1980s, Shilling continually predicted recession. In 15 out of 18 Wall Street Journal surveys in which he participated 1981–1992 (data which are not used elsewhere in this paper), his year-ahead long-bond yield projection was the lowest among all forecasters.

How does this strategy of almost always being wrong benefit Shilling? Lamont quotes a Wall Street Journal article that shows how he was able to market this unsuccessful track record:

A. Gary Shilling & Co., an economic consultant and investment strategist, recently mailed clients material that included a copy of a Wall Street Journal article with a paragraph showing that Mr. Shilling had made the best forecast of 30 years treasury bonds in a survey published about a year ago; but he covered up a paragraph noting that Mr. Shilling was tied for last place with his bond forecast of 6 months ago

Lamont goes on to prevent empirical evidence that forecasters are maximizing perceived reputation rather than minimizing forecast error. Importantly though, he points out that this may not be a socially inefficient outcome if it helps prevent herding behavior. Ideally each forecaster would produce very similar point estimates, but also wide confidence bands reflecting the uncertainty. In this scenario convergence wouldn’t be socially inefficient, as the confidence bands would reflect the probability of extreme outcomes. One could argue that we are in a second-best world in which the distribution of forecasters reflects the uncertainty, and forecasters like Roubini are just providing us with 95% confidence bands. If this is the case it would be more satisfying, to me at least, if the media understood Roubini as “most likely wrong” rather than as some prophet or seer.

A new paper by Nathan Berg and Gerd Gigerenzer asks this question:

For a research program that counts improved empirical realism among its primary goals, it is surprising that behavioral economics appears indistinguishable from neoclassical economics in its reliance on “as-if” arguments. “As-if” arguments are frequently put forward in behavioral economics to justify “psychological” models that add new parameters to fit decision outcome data rather than specifying more realistic or empirically supported psychological processes that genuinely explain these data. Another striking similarity is that both behavioral and neoclassical research programs refer to a common set of axiomatic norms without subjecting them to empirical investigation. Notably missing is investigation of whether people who deviate from axiomatic rationality face economically significant losses. Despite producing prolific documentation of deviations from neoclassical norms, behavioral economics has produced almost no evidence that deviations are correlated with lower earnings, lower happiness, impaired health, inaccurate beliefs, or shorter lives.

My guess is that this critique will bring the behavioralists and neoclassical economists together in joint attack. The authors propose a new approach they call ecological economics, and summarize what the field should do improve like this:

“To make behavioral economics, or psychology and economics, a more rigorously empirical science will require less effort spent extending as-if utility theory to account for biases and deviations, and substantially more careful observation of successful decision makers in their respective domains.”

I – and I believe many of my fellow economics professors – seek not to get our introductory students to learn specific facts or techniques but to begin to “think like an economist.”

I want them to abandon wishful thinking, good vs. evil analogies, just-so-stories and general ad hocery, in favor of treating human behavior as if it stemmed from some (perhaps unknown or even unknowable) set of systematic principles. In particular we are big on the notion that people respond to incentives.

Students it turns out are people. While “thinking like an economist” is often a bitter pill, this semester it went down much easier – and I think I see why. No less than half of the final papers were written on either immigration in general or the DREAM act in particular. A typical paragraph

Immigrants not only join the circular flow of the economy as labor, but also as consumers. They spend money on goods and services which results in firms having more revenue. Higher revenues tend to increase firm production to meet the higher demand of consumers. This increased production most likely would result in more jobs as firms expand to meet the needs of consumers. On a very basic level, this explains why immigration would only serve to expand the economy.

Unlike our discussions of taxes, rent control and the minimum wage “thinking like an economist” gives them in edge in an argument they already want to make: that the US should be more welcoming to immigrants.

While it is encouraging to see the tools taken up so easily, it is a warning that we cannot be sure students or the public generally has abandoned ad hocery when the systematic explanation does in fact suit their immediate needs.

I will engage in some grandiose philosophizing before moving on to economics. Feel free to skip ahead.

Realism is an overused term and no one can be faulted for failing to know what it means in any particular context. Regardless, I am going to push that trend because no other English word covey’s its power and simplicity.

Under my definition of the term, this is from Mark A. Calabria is nearly the antithesis of policy realism.

If Beckworth wants to preach “conservative” values and principles, he might start with the observation that it is savings and work that provide wealth, and reject the Keynesian notions that we can spend or debase our way to prosperity.

Either savings and work produce wealth or they do not. Either Keynesian notions are correct or they are not. Whether one is a conservative, a liberal, purple or orange should have nothing to do with it.

Either we accept that there is a real world whose primal laws are independent of our hopes, dreams and values or we reject that in favor of some form of magic. That magic might operate through Voodoo, divine revelation, or the suggestion that ideology is a guide to fact. If we accept realism, our values become meaningless to the determination of truth.

For those who respond better to poetic pronunciations I offer Eliezer Yudkowsky

That which can be destroyed by the truth should be . . Relinquish the emotion which rests upon a mistaken belief, and seek to feel fully that emotion which fits the facts. . . .  Let yourself say: “If the iron is hot, I desire to believe it is hot, and if it is cool, I desire to believe it is cool.”

Somethings are true. Our mission is to find out what those things are. Are we biased – of course. Should we track down and fight those biases  – of course. Is open debate among the best methods for exposing biases – undoubtedly.

But, we begin with this premise:  At the heart of it all there is a fact of the matter. Our goal is to find it. We may fail, but we should not be unclear about what our mission is.

Now, on to Calabria’s larger statement

First, the good professor argues that spending is far below trend. That is true enough as it goes, but this trend includes a massive housing bubble, where imaginary wealth fueled spending, aided by massive borrowing from abroad. The objective of our economic policies should not be to get back to the top of the previous bubble. It was this desire to replace the lost wealth of the dot-com crash that contributed to the Fed’s juicing of the housing market. All that said, consumption today is higher than at any time during the recent bubble. The primary problem facing our economy is not a lack of demand.

The core question that I believe needs to be answered is: Why are people working less?

The nearly constant source of confusion is two fold

  1. The belief that a recession is a period in which people have to do with less. This is completely wrong. A recession is a period in which people produce less. Suppose the US were suddenly cut off from all world trade and we instantly and seamlessly reorganized our economy. On average everyone would have less but there would be no recession.
  2. That spending is equivalent to consumption. Investment is perfectly good spending and contributes to final demand. Whether they are consuming more or less is interesting and of proximate importance but ultimately irrelevant to whether there is a recession.

So, if the problem were simply that there was a massive spending bubble and people borrowed from abroad to consume more then the natural response would be to lower consumption, increase net exports to repay those from abroad and possibly increase investment so that we will be wealthier tomorrow.

Calabria says that savings is the key to wealth but I assume he means investment. Suppose I saved my money in the belly of whale? Should I expect to become wealthier? Suppose I used that money to create powerful and useful machines? Should I then expect to become wealthier?

It is investment that makes us wealthier, preferably investment in useful things. So if we feel that we are too poor we should be looking to spend our resources on investing in useful things. Instead our resources are sitting idle.

Here is capacity utilization and the employment ratio – that is the percentage of our machines and of our men that are working.

FRED Graph

As you can see they both collapsed during the recession and have not recovered. That is we are using fewer machines and we are employing fewer people.

We are not working and hence not producing. Calabria notes that consumption is back up. True, but several population has risen and productivity has risen. Consumption has not kept up with our ability to produce. This would be fine if investment or net exports had taken its place.

Again, to review net exports is how we repay foreigners. They sent us stuff during the bubble, now we repay them by sending them stuff. Lets look at net exports.

FRED Graph

It rose sharply during the recession but not all the way to the positive. See that’s still a –300 Billion at the top. That was good in more ways than one. It increased demand. Net exports are a part of Aggregate Demand and it helped repay our debts. However, net exports is now falling, hence it is subtracting from Aggregate Demand.

Again, remember, “spending” is not consumption and its certainly not US consumption. If we sell a bunch of bulldozers to China then that is money that is spent on US goods and services.

How about investment. Again, there would be no problem with the collapse in consumption if it was replaced by investment. Lets look at that:

FRED Graph

Investment has fallen from the peak and not recovered. This is a part of spending. Spending on anything that will help build a more productive tomorrow is spending. However, it is low.

I would love to see investment soaring. Unfortunately that’s not how recessions work. Consumption and Investment go down at the same time. Sometimes net exports goes up and that can only happen in a big way if our currency declines in value.

The reason why China persistently undervalues its currency is not because the Chinese government wants to weaken its economy but because the Chinese government understands that a weaker currency contributes to higher spending on Chinese made goods. Again they are looking for spending.

So to recap Spending is not the same as Consumption. Savings does not instantly transform into wealth, it has to be Invested. Both consumption and investment are below trend. Net exports has not altered enough to make up the difference. This implies that total private spending is below trend and this why people are working less. It is also why fewer machines are employed.

One potential remedy would be to increase government spending. If one is worried that this will lead to poor spending choices then one must endevaour to increase private spending. This could be done be done several ways

  1. Increasing net exports, which would mean lowering the value of the dollar.
  2. Increasing consumption which mean putting more money into the hand of liquidity constrained consumers.
  3. Increasing investment which would mean lowering the real interest rate.

Quantitative Easing directly goes after the 1st and the 3rd. It could be used to address the second if major lower income tax cuts were combined.

Why not? Matt Yglesias objects to my post yesterday, holding it up as an example of why nobody likes economists. He says that my analysis ignores the fact that “big part of the point of prostitution prohibition laws is to express social disapproval of prostitutes and prostitution”:

Indeed, people seem generally quite unconcerned about whether prostitution is occurring someplace out of sight and out of mind. But they want to reserve the right to strongly disapprove of both the prostitution and especially the prostitutes. You can analogize a person who engaged in a form of sexual or commercial conduct of which you disapprove by referring to that person as a “whore.” It’s an insult. Its insult status reflects and upholds a social consensus that whores are bad people, not just that whoring is a kind of undesirable nuisance. Side-payments can’t address this issue.

The first thing I would point out is that he seems to agree with me with respect to the actual welfare analysis of the voluntary exchange of prostitution.  This at the very least suggests that there should be a pareto improving legal framework where the only effect of the law is that any visible signs of prostitution are banned, including advertising, streetwalking, etc. This would demonstrate social disapproval while allowing exchange. It also suggests that given that there are anti-prostitution laws, the optimal enforcement, with the exception of the public nuisance element of streetwalkers (which I’ll talk about later), should be zero.

Is this what we observe now? Crackdowns on very secretive and high-priced prostitution rings do occur, and Rhode Island recently passed a law that moved the state from legalized behind-closed-door, no advertising, prostitution to full prohibition.

The other, arguably more important, issue raised here is that I was specifically addressing externalities of prostitution. Should people’s preferences over laws regulating some good or service be considered externalities of that good or service? I think the answer here is clearly no, since they are unrelated to the quantity of the service produced.

However, one might still argue that these preferences should be included in welfare analysis as a cost or benefit of the law. This is an interesting question.

One concern here is that voters have preferences over most laws, and as Bryan Caplan argued in The Myth of the Rational Voter, those preferences suffer from fundamental biases not related to the costs and benefits of those laws. He documents 4 biases:

1. Make-work bias

2. Anti-foreign bias

3. Pessimistic bias

4. Anti-market bias

If we are to accept that voters preferences over laws -as opposed to preferences over the direct outcomes of those laws- should be included in cost benefit analysis, then we should be prepared to consider laws which satisfy voters inherent anti-foreign bias as a legitimate benefit.

One could argue that public policy, and cost-benefit analysis therein, should not weigh the enjoyment some get from lowering the status of others. When weighing protectionist measures, for instance, should we consider the fact that they satisfy anti-foreign bias as a benefit?

Then again, one could make an argument that the costs and benefits of the expressive value of laws should be taken into consideration. After all, if laws lower the status of some group, and they have negative disutility from that which they’d be willing to pay to remove, then that is a real cost. When framing the problem as one of harming some group like this  it seems more worthy of consideration. But both costs and benefits must be considered. This would mean weighing the cost of lower status of prostitutes against the benefits of those who wish to lower their status. Likewise one could weigh the benefits of satisfying anti-foreign bias against the costs to those of us who find that bias reprehensible.

Matt seems to think the reason people don’t like economists is because they miss these things or they ignore them. That’s a fair enough criticism (although again, in my case I was addressing the particular question of externalities). But he should consider Robin Hanson, whose willingness to wrap any cost or benefit into welfare analysis, no matter how egregious, is surely the purest form of economic thinking. No offense to Robin, but I don’t think people would like economists more if they all conducted economic analysis more like him.

More on streetwalkers later.

In the New York Times, Tyler Cowen says we need them:

The current skepticism has deadlocked prospects for immigration reform, even though no one is particularly happy with the status quo. Against that trend, we should be looking to immigration as a creative force in our economic favor. Allowing in more immigrants, skilled and unskilled, wouldn’t just create jobs. It could increase tax revenue, help financeSocial Security, bring new home buyers and improve the business environment.

Read it closely, remember the arguments, convince your friends and family.

Brad DeLong provides it:

When Charles Ferguson writes:

Summers rose up from the audience and attacked [Raghu Rajan], calling him a “Luddite,” dismissing his concerns, and warning that increased regulation would reduce the productivity of the financial sector…

he has gotten the mood and some of the substance of the discussion wrong.

I know.

I was there–not only for the formal session recorded in the transcript, but for the patio-coffee and the lunchtime and dinnertime conversations that followed.

Larry http://www.kansascityfed.org/publicat/sympos/2005/pdf/GD5_2005.pdf did not “dismiss” Raghu concerns… Indeed, for twenty years one of Larry’s conversation openers has been: “You really should write something else good on positive-feedback trading and its dangers for financial markets.”…

And if you think that Larry pulled his punches in August 2005 on the importance of reforming compensation schemes because fourteen months later he was going to take a job at the hedge fund of D.E. Shaw, you attribute an extraordinarily degree of precognition–back in August 2005 I thought Larry had weathered the storms at Harvard and would be president until 2010 or so.

When some journalists write about how economists “failed” in this crisis and did so because of their incentives it sounds extremely conspiratorial and, to be frank, Naomi Klein-ish. And just to be clear, that’s not a compliment. Economics is an extremely combative science. If you want to put forth some argument in the public sphere it will be attacked, mercilessly, even if it’s brilliant and correct.

Journalists and bloggers frequently seem frustrated or confused by the lack of agreement among economists, but it is precisely this disagreement that generates such a robust system of criticism. Even if you’re ideas are absolutely correct and rigorously argued, there will be someone -and probably a Nobelist or two- who disagrees with you and is looking for the weak spot, eager to tear it apart. I just don’t see any room in this environment for money motived research to gain ground.

Say Larry was in fact putting forth weak ideas because of his monetary incentives. Well his biased reasoning would obviously be transparent to colleagues who are immersed in the same literature and researching the same topics as him.  Would highly esteemed and well respected economists across ideologies be willing to line up in droves to coauthor papers with someone whose research displayed a motivated bias? Because the only thing about Larry more impressive than his talent is his list of coauthors. A brief list includes:

  • Olivier Blanchard
  • David Culter
  • Brad DeLong
  • Jonathan Gruber
  • Barry Eichengreen
  • Greg Mankiw
  • Alan Kreuger
  • Lawrence Katz
  • Jeffrey Sachs
  • Martin Feldstein
  • Stanley Fischer

So ask yourself what is more likely to be the case: is Charles Ferguson misjudging Larry Summers, or is this ideologically diverse list of experts misjudging him? Or is it the case that Larry wasn’t biased earlier in his life and spent his whole career as an unbiased researcher until the late 2000s when he could no longer contain himself and gave in to the lurid call of biased research? Again, this sounds to me like Naomi Klein speculating about Milton Friedman and his motives in helping to liberate the Chilean economy. It’s just not plausible to me.

James Fallows at the Atlantic backs up my criticisms of the awfulness of a recent campaign ad against Pennsyulvania U.S. Senate candidate Pat Toomey. Note that Fallows is liberal who supports Sestak and is to the left of my on trade issues, yet recognizes the disgustingness of this ad. He also hones in on the same quote that I do. Here’s Fallows:

The “smoking gun” quote against Toomey, his having once said “It’s great that China is modernizing and growing” — where do I start? Maybe here and here. It would be worse for the U.S. if China were stagnating and stewing. There are problems from a prospering China, sure. But the problems from a billion people unhappily moving backward would be worse.

Reasonable people should agree: this ad is ridiculous.

I once had a macro professor offhandedly suggest -in between demonstrating with Hamiltonians and representative agent models how rational bubbles could exist- that one way to identify a bubble would be the the number of complete amateurs lured into an industry. Similarly, my main data point in identifying the housing bubble was Flip That House and other shows like it.

What was happening on those shows defied everything micro theory says about how a market should behave. It wasn’t just that the behaviors couldn’t be explained by neoclassical, perfect information, Chicago School micro theory. There was no amount of information asymmetries, market power, or principal agent problems that could explain what happened on those shows.  Complete novices buy a house, spend four weeks doing a shoddy remodel, and sell it for 150% what they paid for it. This was clearly Animal Spirits.

“What is happening here cannot last”, I would tell people. If there are such insanely outsized profits to be had, surely professionals will put these amateurs out of business, owners of houses in need of rehabilitation will ask higher and higher prices,  and competition will drive prices down. Yet the shows went on for several seasons, with witless novices making profits that defied gravity.

The longer the show went on the more of a bubble I assumed was building. On the more professional home renovation shows they were leveraging up big time as well. And everyone knows hows it all ended.

I was reminded of all of this today by an excellent post from Mike Konczal pointing out this exact phenomenon across bubbles and industries:

In my personal opinion, in the same way middle-class people turned amateur stock analysts was the sign of a tech bubble, or middle-class people turned amateur realtors was the sign of a housing bubble, middle-class people turned amateur credit risk analysts and credit channel intermediaries was the surest sign of a credit bubble.

The amateur credit risk analysts he is talking about are the person-to-person lending websites that were once very overhyped in terms of their potential. This is an amateur market I had not considered, but it certainly makes sense.

The lesson here is beware the amateurs. Wherever they gather in huge profitable masses a bubble has surely formed, and the longer they are able to walk around blithely picking up $100 bills off the sidewalk, the bigger the bubble is.

A new paper from Resources for the Future summarizes the literature:

…gasoline taxes are a far more cost-effective policy than CAFE standards because they exploit more margins of behavior for reducing gasoline use. Austin and Dinan (2005) and Jacobsen (2010a) estimate that CAFE standards are about 2–3 times more costly than a gasoline tax for a given long-run reduction in fuel consumption. In Jacobsen’s (2010a) study, total welfare costs average about $2 per gallon of fuel saved for a 1 mpg increase in the CAFE standard, while a gasoline tax that saves the same amount of fuel imposes welfare costs of about $0.80 per gallon. The cost disadvantage of fuel economy standards is even more pronounced in the short  run, as fuel taxes give all motorists an immediate incentive to save fuel by driving less, while new vehicle standards only permeate the vehicle fleet gradually.

Yet despite their much higher cost, CAFE standards are more popular than gas taxes. Our desire to have costs hidden from us is a very expensive preference. The Obama administration was able to pass aggressive CAFE increases in 2009, in contrast both democrats and republicans were campaigning on a gas tax cut in the 2008 election. Would either party be receptive to abolishing CAFE standards in exchange for a higher gas tax? I doubt it, but it would be good for the environment and the economy.

Will Wilkinson points to research that confirms my otherwise weakly substantiated biases and so naturally I am inclined to cite it.

Karma is not an exclusively Hindu idea. It combines the universal human desire that moral accounts should be balanced with a belief that, somehow or other, they will be balanced. In 1932, the great developmental psychologist Jean Piaget found that by the age of 6, children begin to believe that bad things that happen to them are punishments for bad things they have done.

My take is simple: Karma is bullshit – the greatest lie ever told. In truth, the arc of the moral universe is long but it bends towards death and destruction. The universe is either utterly indifferent to your suffering or it actively seeks to destroy you and repurpose your molecules for other uses. In no way, shape or form is it your friend. In no way, shape or form is it balanced or just. If there is evil in the world then it is nature. If there is a God then he is a demon. If there is fate then ours is doom.

This story only has one ending and it ends with the extinction of all life. Good will not ultimately be rewarded. Evil will not ultimately be punished. The story will simply end. It is not just. It is not fair. It is not OK.

The only remedy open to us is to fight daily for our survival and our values. To live in open defiance of the physical laws that will eventually extinguish us. To suck every ounce of happiness from the world before it is done. To eat, drink and be merry for tomorrow the universe will grow cold and all life will die.

And, to along the way, ease the suffering of those we can. Suffering is not a lesson or a just dessert. It is an evolved mechanism that serves not our purposes but the purposes of natural selection. Poverty is not the punishment for ills but where the evil of nature has not yet been beaten into temporary submission. It is an uncaring universe crushing our brethren underfoot.

This will not end well, because nothing ends well. In the end, the universe, like the house, always wins. Yet, we do not have to tolerate agony and pain all the way up until our inevitable demise.

We live. We love. We laugh in defiance of that inevitability. If we have our heads on straight we’ll do it right up until the cold, bitter, utterly unjust and utterly unavoidable end. We are mortals – those who die. That fact should infuse our every value and animate our every action.

When my loved ones take ill they sometimes ask me –with hope in their eyes – “Am I going to die?” Yes, I answer, I cannot change that. But not today.

Not today.

Robin Hanson makes a list of warning signs that you are arguing for sport rather than arguing for insight.

My favorites

You have little interest in getting clear on what exactly is the position being argued.

Nailing down mutual definitions and exact positions can be annoying and it is common for certain intellectuals to overinvest here. However, skipping over them completely is a recipe for disaster.

Relatedly, I’d suggest trying to use as a debating point the fact that someone has misused a term is another sign that insight is not what we are after. If the definition of marriage is X then fine, I want narriage which is exactly like marriage except it also includes two dudes.

Realizing that a topic is important and neglected doesn’t make you much interested.

This is a big one. Realizing that not enough people are talking about an important issue is reason to run around like your hair is on fire; not move on to something else.

Likewise, once the conversation moves beyond your ability to contribute its time to look for something else.

You find it easy to conclude that those who disagree with you are insincere or stupid.

My bugaboo. As far as I can tell the number of people who are engaged in a consistent and deliberate attempt to argue for something they know is false is vanishingly small. Moreover, even when you suspect it, it is not worth worrying about because the fact that your opponent is lying or stupid is not somehow worse than the fact the she is just mistaken or confused on a particular point.

Bad actions have bad consequences regardless of why we choose them.

Your opinion doesn’t much change after talking with smart folks who know more

Our opinions should change a little bit even if we are talking to stupid folks who know less. The chances that a person is so stupid and so ignorant that they literally have zero value to add is probably not high enough to measure.

For example, a lot of people are making fun of Christine O’Donnell. However, I’ve learned a lot from listening to her. Despite having some odd opinions she is an incredibly clear communicator and thus a lot of useful information can be transmitted from her.

In particular I have learned from her that many people are not concerned about the expansion of government because they think the government will do a bad job at running the economy. They believe that the government will move to actively oppress them and they are concerned that the government will do a good job at that.

As such pointing out that TARP was actually run fairly well, all things considered, does little to ease their concerns. Indeed, it heightens them.

Will Wilkinson asks, what things are we doing now that our grandchildren will condemn? Both Will and the op-ed that inspired him noted, among other things, industrial meat. I agree with this one.

On the dissenting side, Josh Barro argued in a recent twitter conversation that the slaughter of animals for food is morally equivalent to torturing animals. No, Josh is not a hard-core animal rights activist arguing against carnivorousness, he is arguing for the legality of torturing animals. In contrast, one could embrace his argument as support for banning the slaughter of animals, after all most people are against the legality of animal torture. But I don’t believe that taking an animals life for food is always ethically equivalent to torturing it.

For one thing most people, including those who highly value the utility of animals, are willing to call an animal “better off dead” and say we should “put it out of their misery” much faster than we would for a human. Despite putting not suffering before life, this is widely understood to be the most humane choice. Animals are unable to appreciate life qua life as humans can. A horse would not be content to rest on broken haunches and enjoy its golden years reminiscing and visiting with younger relatives. They want to walk, run, and be as a horse. When they are too injured to do walk we put them down because it’s the most humane thing to do. I don’t think you’d make the same argument for grandma. We seem to intuitively understand that for animals the moral calculus between suffering and dying is different than it is for humans.

This is not to argue that putting an animal out of its misery is the only time it is morally acceptable to kill them, it’s just to show that relative to humans one should weigh suffering higher than the value of life when considering the welfare of animals.

Likewise, I don’t think you can argue that we should be indifferent to the suffering of animals. What is it that privileges human animals such that we should consider their suffering but not other animals? There are surprisingly few mental characteristics that humans have which one could plausibly consider that some animals don’t also have. There are also few characteristics that most humans have that some percent of humans, especially the mentally disabled, do not.

There are also non-humans of the homo genus and non-human intelligent life to consider. Any moral system should be able to encompass previously existing and potentially existing creatures. By what criteria would we decide whether we should consider their suffering or not? Or, for that matter, by what basis should our vastly superior future alien overlords consider our suffering? Or shouldn’t they?

In one place I do think Josh is correct. He argues that there are many things we do to animals in leading up to the slaughterhouse that make the illegality of explicit animal torture hypocritical. As there are many animals in these situations that would be better off dead, I agree with him. Unlike Josh, however, I take the logical conclusion that those kinds of industry practices should be banned, not that animal torture should be legalized.

Because I don’t want to call Josh a monster, I have to presume he is deluding himself to justify egregious conditions in industrial meat industry. Here is why I don’t believe him: imagine if Josh walking down the street and came upon a man beating a perfectly healthy dog to death (it looks exactly like Lassie). Do I really think that Josh wouldn’t a) call out to the policeman, and b) be very, very glad that it is illegal to beat a dog to death. I don’t think this would be a momentary selfish attempt to end something he finds viscerally unappealing. He would go home and be glad it was illegal. He would wake up the next day, still glad it was illegal.

In reality, Josh probably eats meat that has been tortured every day, but rarely witnesses animal torture; it would be a lot harder to end the former than to rationalize the latter. My guess if Josh had to witness more than a little animal torture he would change his mind. And if not then, with all apologies, I actually do think he is a monster. Which would be a shame, since he seems like a nice guy.

As a final note I want to add that deciding the “correct” policies with respect to animal welfare is difficult. At a bare minimum I think explicit torture should be illegal, and that anything where an animal would be fairly judged better off dead should be banned as well.

Why won’t you consider my suffering

in your social welfare function, Mr.Barro? I too

have von NeumannMorgenstern preferences.

Yesterday I wrote this:

If I had to play homeowner psychoanalyst I would guess that homeowners with a strong preference for homeownership saw cap rates were changing and believed house prices were heading towards a permanently higher plateau that would permanently price them out of homeownership. People who would want to buy houses in the future but were currently renting had this fear as well and rushed into the market. Risk aversion here thus did not lead to selling when prices rose as a simple model might predict.

I was drawing on the work of Todd Sinai and Nicholas Souleles who have shown that housing works as a hedge against rental volatility. My thinking was that because owners often have strong preferences for home-ownership and are not indifferent between renting and owning, that those who planned to buy a house in the future would see buying a house now as a hedge against house price risk, much in the same way as the Sinai Souleles model. Well yesterday after I wrote that I came across a brand new paper that makes a very similar argument:

Our contribution is to focus on the importance of ownership as a hedge against future house price risk as individuals move up the ladder. We use a stylized model to show that increasing house price risk acts as an incentive to become a home owner earlier in the life-cycle and, once an owner, to move more rapidly up the housing ladder.

Increases in volatility are shown to increase ownership and to increase the quantity of housing wealth conditional on ownership in earlier periods of the life-cycle. We then establish that these relationships hold empirically using panel data on families in different geographic markets in Britain and in the US.

The authors use data from the UK and US to provide empirical support for their model. This is an under-explored causal mechanism for the bubble: house price risk went up, people bought homes to insure against that risk, which drove prices up, which increased perceived house price risk, etc. The cascading nature of this is clear, and it’s not hard to see how this could create a bubble.

So housing risk makes people want housing even more. I’m not sure if this will comfort or aggravate people like Felix Salmon and Ryan Avent who have been arguing that households are too risky in their housing consumption/investment decisions, but it should help explain why what looks to them like overly risky behavior is in fact caused partly by risk aversion.

However, this explanation for the behavior does offer a potential solution. Local REITs could be created for very small geographic areas designed to help young households who want to insure against price increases in a specific neighborhood but do not yet want to take the large risks of buying a house. They could even be metro area REITs that are heavily weighted in a particular submarket.

If Felix and Ryan want to get households to stop overleveraging themselves in housing debt, maybe their best option is to start looking for venture capital.

Arpit Gupta writes:

Yet Milton Friedman’s arguments against bubbles remains powerful. Why would investors not respond to the addition of crazy money by betting against the bubble? Sure, most investors can’t technically bet against housing, but home owners could choose to rent, there are REITs out there, etc. Why couldn’t rational trading eliminate the mispricing induced by government spending, assuming that the government did intervene in unprecedented amounts before 2002?

I think Arpit is underestimating the difficulty of making negatives bets on housing here. First off, rental markets for single family homes are thin in many areas and the stock of housing there is systematically different than the stock of owner occupied housing. People also do not appear to be strictly indifferent between renting and owning, and transaction costs can be very large.

Even if some homeowners are able to bet against the market, investors not currently owning homes cannot. So you have a market where investors and owners can bid the price up but only owners can bid the price down. It’s not really surprising in this circumstance that when opinions differ about what the relationship between fundamentals and prices should be that a bubble occurs. Without the ability to bet against housing the market essentially becomes an auction where only the highest valuations are observed. When the variance of expected prices among potential market participants increases it’s not surprising that observed prices increase as well, since only those in the high-end of the distribution will be observed.

Another issue is that unlike the market for pork-belly futures, housing markets are dominated by naive investors, e.g. owner-occupied buyers. Given emotional attachments and lack of sophistication about markets is it unsurprising that too many homeowners did not sell but instead held when prices rose above believable levels? In a country with so much owner-occupied housing, investors have a limited ability to affect markets compared to financial markets.

If I had to play homeowner psychoanalyst I would guess that homeowners with a strong preference for homeownership saw cap rates were changing and believed house prices were heading towards a permanently higher plateau that would permanently price them out of homeownership. People who would want to buy houses in the future but were currently renting had this fear as well and rushed into the market. Risk aversion here thus did not lead to selling when prices rose as a simple model might predict. Believable models of how rational households should have behaved in the bubble need to be pretty complex and account for things like this. Not knowing what behavior it prescribes, appeals to rationality here don’t persuade me.

Matt Yglesias made the case recently that we should increase teachers’ salaries in order to raise teacher quality. He provides this graph showing teacher salary compared to per capita GDP in different countries:

Unfortunately for Matt, if he wants to increase teacher salaries the last thing he should be doing is telling people how much teachers make. A 2009 survey by Education Next and Harvard’s Program on Education Policy and Governance surveyed 3,000 people and split them into two groups. In the first group they found that 56% supported increasing teachers’ salaries and 46% supported increased education spending. The second group was first told the average teacher salary in their state and the average spending per pupil and then they asked them the same questions. Support for more teacher pay fell from 56% to 40% and support for more education spending fell from 46% to 38%. Apparently a majority of people favor higher teacher pay, but not when they know how much teachers currently make.

In reality the responses would probably be different if they were shown Matt’s graph rather than just told how much we spend. But the fact that people support higher education spending less when they know more doesn’t bode well for those who want to increase it.

Paul Krugman has linked approvingly to Karl’s post on Fannie and Freddie, and I want to use this renewed attention to his piece as an opportunity to disagree with it. Well, maybe not disagree, but at the very least I want to present an alternative story of Fannie, Freddie, and the bubble that is inconsistent with his, and which I have yet to see a strong argument against.

Whether or not you agree that a bubble had actually started by 2002, it’s clear that fundamentals had become divorced enough from historical levels to begin convincing some people, notably Dean Baker, that a bubble was present. To me this divergence and the subsequent uncertainty around it was a key driver of the huge and indisputable bubble that followed the debatable 2002 and 2003 semi-bubble.

Once fundamentals were potentially outside historical levels, it became unclear to market participants and economists what the fundamentals were anymore. Thus, a signal which traditionally could be used to hold prices in check was gone, and the only signal market participants were left with was prices themselves. It’s as if someone turned out street lights and the only way drivers could navigate is by looking at each others headlights and tail lights. It’s easy to see how this could lead everyone collectively far from the roads despite behaving rationally individually given the information available to them. This uncertainty and unanchoring of fundamentals set off the herd behavior that drove prices even higher, this lured private companies in who eventually crowd Fannie and Freddie out of the market.

Now herd behavior of market participants is also causal here, but that doesn’t mean that the initial divergence of fundamentals that set the herd off was not causal as well. However, this story does make Fannie, Freddie, and their enablers less negligent than typical stories that assign causality to them. This is because few could have foreseen that causing fundamentals to somewhat diverge from historical levels would set off such extreme herding behavior. This unforseeableness of the consequences means you can’t exactly call their policies reckless. In contrast, had they been the primary force continually driving the prices higher and higher to manic levels, as some narratives of the bubble hold, then one might call them reckless.

So that’s one story of Fannie, Freddie, and the bubble. Maybe it’s not the right one, and maybe Karl’s is, but I’ve yet to hear a convincing case for why it’s wrong.

Arnold Kling has become a leading critic of Hydraulic Macro, the notion that you add up economic aggregates pull a few levels and watch the economy respond.

In response he suggests that the economy is incredibly dynamic with millions of jobs being lost or gained every month. He points to JOLTS data as evidence.

image

I couldn’t agree more. I’ve argued that the economy is a dynamic churn ever since graduate school. The thing is – so is hydraulics. All liquids are composed of millions of rolling molecules going to and fro. The net of all of that is what we think of as macro level hydraulics.

Personally, I prefer the comparison to fluid dynamics more generally, which allows for interface instability, distinctions between compressible and non-compressible flow, turbulent and laminar flow, etc.

image

We have millions of particles that are sometimes moving in patterns that can easily be modeled and then sudden breaks where those easy models fall apart completely.

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We have micro world that is much richer and much more dynamic than the marco world we observe.

image

And we have everyday phenomena which are fundamental to our society but scientists still have trouble explaining to laymen why they occur.

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Wikipedia on aerodynamic lift

An explanation of lift frequently encountered in basic or popular sources is the equal transit-time theory. Equal transit-time states that because of the longer path of the upper surface of an airfoil, the air going over the top must go faster in order to catch up with the air flowing around the bottom.[27] i.e. the parcels of air that are divided at the leading edge and travel above and below an airfoil must rejoin when they reach the trailing edge. Bernoulli’s Principle is then cited to conclude that since the air moves faster on the top of the wing the air pressure must be lower. This pressure difference pushes the wing up.

However, equal transit time is not accurate[28] and the fact that this is not generally the case can be readily observed.[29] Although it is true that the air moving over the top of a wing generating lift does move faster, there is no requirement for equal transit time. In fact the air moving over the top of an airfoil generating lift is always moving much faster than the equal transit theory would imply.[6]

The assertion that the air must arrive simultaneously at the trailing edge is sometimes referred to as the “Equal Transit-Time Fallacy”

This is Fluid Dynamics and its not as different from macroeconomics as you might think.

I recently pressed one of my colleagues on whether or not she believed that Public Administration was solvable.  That is, does there exist an algorithm which takes as its input a public policy and gives as its output the set of steps necessary to align reality with the goals of that policy.

She agreed that there was, though as always I am never sure whether consent was achieved through the logic of my arguments or the passion with which I present them. I try to tell myself its the former. Regardless, that’s one down, several thousand Public Administration scholars to go.

Despite the daunting scale of my mission of conversion, I am looking to expand its scope. Its not just Public Administration which solvable. Public Policy itself is.

To wax nerdy for a moment I would say that for any welfare function there exists a set of policies and administrative tools such that the selection of those policies and the application of those tools maximizes the welfare function. Further, I argue for any well-defined sub-objective there also exists a policy and a set of tools which maximizes it.

What the hell does that jargon mean?

It means that there is a right answer to almost all the policy questions that interest us. Its not that there is a conservative approach, a liberal approach, a libertarian approach, etc. By and large there is a right approach and all others are wrong.

To be more specific, if we agree on a goal – say we want lower unemployment in the United States – then there is some policy and administration of that policy that will produce the lowest levels of unemployment. This policy exists independently of any political philosophies, ideological leanings, or even perceptions of the good. It extends directly from the physical laws which guide the interaction of particles (or the basic “stuff” of the universe whatever that might be.)

This is absolute policy reductionism or Policy Realism as like to refer to it. It is the notion that at its heart policy is about choices over various configurations of subatomic particles, that those particles are finite in number, have a finite number of configurations and hence those configurations are orderable by their distance from a particular goal.

What if anything does this mean?

It means for one thing that statements like “I believe free market capitalism is the best path to prosperity” are vacuous. I use that statement because (a) its repeated over and over by economic pundit Larry Kudlow and his guests and (b) it conforms closely to my priors.

Despite that, however, Policy Realism says that our beliefs about these things is a side point. Even our notions of “capitalism” and “free market” are little more than possibly convenient shorthand. The real question is what do we mean by prosperity and do we want it.

Once that question is answered the philosophical debate is now over. What is to be done is a scientific question. We must determine, scientifically, what policy will produce this outcome. This is powerful because we have rules and traditions in scientific inquiry that are quite different that those used in common policy debate.

In particular, science is less interested in making cases than in testing the implications of hypotheses. Its not about how many arguments you can marshal in favor of your idea. Its about thinking up an experiment or other empirical test that will distinguish your idea and its consequences from some alternative idea , then applying that test and recording the result.

There are many objections to my point of view. Perhaps, the most powerful is that it says nothing about tractability. You say, for instance: sure Mr. Reductionism there might be some algorithm out there somewhere but there is no assurance that we could actually crank out the answer even if some day we could find the algorithm.

This is no doubt true. In part, this is why it is so important that sub-goals also display Policy Realism. More directly though I would argue that our general goal is to do the best we can with what we have. Policy Realism makes that explicit.

Perhaps we can neither find nor solve in a reasonable amount of time this ultimate algorithm. Then, however, we are explicitly looking for approximations and we should acknowledge that.

Our question is how close is this policy to what would be chosen in the world where we knew all the variables and we could crunch the numbers with God’s calculator. None of our real world policy prescriptions, then, are right. They are only less wrong and we should think in those terms.  Thinking in those terms makes it clear that this is not a Manichean struggle between our side and theirs but a joint effort to approximate the ideal policy.

It also means that we should expect our policy views to converge and we should question ourselves when they do not.  We are explicitly refining approximations. Tomorrow someone should have a better approximation than today and that ought to be demonstrable. If we hang on to ages old views or see no techniques we can grab from those who are favoring other policies then something is going wrong.

Lastly, it means that we should be comparing notes and laying bear our assumptions. We are dealing in approximations. Some simplifying assumptions will be involved. Those assumptions may produce consistent errors that bound our policy away from the ideal. That is, they may be biased.

If this is the case then we want to know that. We don’t want to hide our assumptions or gloss over them. We want them exposed, examined, reviewed and torn apart. We want them to be picked-up when useful and discarded when not. We want to move together towards better approximations.

And, it matters if we fail to do this. Because there is a right answer our failure to expose our approximations to refinement means that we will delay our progress towards that answer. We will be left with real states of nature, real configurations of subatomic particles, real human experiences, that are demonstrably worse than they would be otherwise.

We will be leaving the world a fundamentally worse place than it has to be. That cannot be seen as anything other than a failure – a waste of our lives as policy folks.

I know it when I see it

~Potter Stewart, 1964

Can it really make sense to vote for the opposite party just because the economy happens to be bad?

Kevin Drum notes the particular oddity that Americans think the poor economy is George Bush’s fault yet plan to vote for Republicans anyway. Will Wilkinson says that just might be him

I might count myself among this 10%. (I say, "I might", because I do not really know myself. Who does?) The "kick the bums out" mechanism leaves a great deal to be desired, though. It is not obviously better to exchange our current bums for new bums as a response to the behaviour of past bums. In this case, however, it is likely that a bum-swap will deliver divided government, a prospect that warms my anti-partisan heart.

That’s one explanation. Another is this. Voter’s don’t really know what they want. Indeed the one’s that matter – swing voters – don’t know even know what it is that they might want. That is, they are ignorant of the policy choice set. Whatever they want, however, they know this ain’t it.

Now, broadly speaking there are two possibilities

1) The horrible state that we are in today is unrelated to government policy

2) The horrible state that we are in today is related to government policy

Suppose that the world is in state (1). Then switching parties does nothing to relieve the horrible state we are in. However, its also fairly low cost, because government policy isn’t related to the horrible state we are in. It might be related to other stuff, but by assumption that stuff is second order.

Suppose the world is in state (2). Then there is a good chance that switching parties will switch policies, which in turn might result in an improvement in the horrible state that we are in.

Thus regardless of the true state of nature I should switch parties.

Now, my democratic readers will be quick to chime in that this analysis is incomplete. It could be the case that the government policy is related to the horrible state that we are in, but that in fact our current policies are making it less horrible.

This is just another way of saying things would be even worse if Republicans were in power. I can easily see why partisan democrats would be inclined to believe that.

However, suppose that I am just a regular voter who hears Dems say things would be even worse without them and the GOP say that things are as bad as they are because of the Dems. What am I to think?

Well that depends on how bad things are compared to the worst they could possibly be. The closer things are to the worst things can possibly be the less likely it seems that the Democrat’s argument is correct.

Note that I don’t have to believe that the Republican argument is correct in order to vote for them. State of nature (1) makes a vote for the GOP low cost. I only need to believe that the Dem argument is likely wrong.

Now lets check the tape

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Ouch.

The current state certainly looks worst than anything ever before. At least anything any of us are old enough to remember.

That makes it hard to buy the Democrat’s argument. And, if you don’t buy the Democrat’s argument then you should vote Republican, regardless of whether you buy the Republican argument.

This is of great interest to me because I am fascinated by the fact that Democracy seems to be a highly effective form of government despite an almost necessary implication that policy will be determined, or at least largely influenced, by the least knowledgeable and indeed least policy interested people in society – swing voters.

So my instinct is that there is an invisible hand at work. A mechanism that leads people towards decent policy even when they have no idea where they are going. Throwing the bums out just might be it.

There was an article last week in the New York Times about economists calling for the government to simply allow house prices fall and reach their bottom, an idea which is gathering more and more support. I think this is a bad idea because the real costs falling home prices are obvious, likely, and severe, while the benefits are vague and speculative.

For starters, as the following chart from Calculated Risk shows, in Q1 2010 there were millions of homeowners who are in a negative equity position. If prices fall another 5%, each of these bars will shift to the left one position. If prices drop 10%, they will shift two.

Lets make the conservative assumption that there are as many people right now in the 0% to +5%, +5% to + 10%, and +10% to +15% bins as there are in the -5% to 0% bin. This means we’ll get another 1.8 million borrowers underwater for each 5% fall in prices. If they fall 15%, that means 5.4 million more.

As you can see though, the numbers of homeowners in each category get larger as they approach zero, going from 1.1, to 1.3, to 1.5, to 1.8 million in the last 4 bins. So it’s likely we’ll actually get upwards of 6 million more homeowners underwater.

In addition, a fall of 15% would push around 1.9 million more homeowners into 50% or more of negative equity, driving this number up to around 6 million. These large increases in total negative equity will drive a wave of foreclosures. The best evidence indicates that foreclosures, in turn, will decrease nearby home values by 1% to 2%, which could exacerbate the foreclosure blights many neighborhoods are already facing.

Why are these foreclosures a problem? Most economically literate readers will be familiar with Bernanke’s famous paper on non-monetary causes of the Great Depression, where he makes the case that an increase in the cost of credit intermediation worsened the Great Depression. In contrast to the argument for how bad things can get when banks fail, few seem to focus on aspect of Bernanke’s paper that focused on defaults and bankruptcies as a mechanism for deepening the depression. In fact Bernanke even discusses the drying up of credit for homeowners as one of the important channels through which the credit system was failing:

Home mortgage lending was another important area of credit activity. In this sphere, private lenders were even more cautious after 1933 than in business lending. They had a reason for conservativism; while business failures fell quite a bit during the recovery, real estate defaults and foreclosures continued high through 1935….

To the extent that the home mortgage market did function in the years immediately following 1933, it was largely due to the direct involvement of the federal government.

Removing the existing government supports for the housing market now will allow this important channel of credit to dry up. As Bernanke recognized, this could worsen and lengthen our recession.

Another problem is that when a buyer defaults they lose a real asset: their credit. As near as I can tell from Googling around, credit scoring agencies have not adjusted their models to decrease the damage that a foreclosures does to your credit score. This seems puzzling to me as economists seem to agree that the huge fall in house prices was largely unpredictable when many of these mortgages were made. Defaulting on a mortgage in 2010, one would think, is not nearly as much of an indicator of lacking creditworthiness as defaulting on a mortgage in, say, 2005.

In any case, when defaults happen a real asset which gives borrowers access to credit goes away and the cumulative creditworthiness of U.S. households falls. In a recession, when borrowing and investing are important means of driving economic activity, this is not a good thing.

I believe the reason that falling home prices are getting support is what Karl calls The Pain Bias. Somehow, falling prices feel like tough love, and it feels like borrowers will be more confident. And it may be the case that another 15% fall in prices will convince people that prices are at a bottom. But along the way to that bottom real economic damage will be done. If that damage is great enough, and hurts economic growth, those rock bottom prices may fall even further.

Will make our lives less worth living until our eventual death anyway.

Paul Krugman complains that its not only the Austerity crowd but the Tight Money crowd that’s switching its tune on the bond markets

So will the OECD call for a drastic shift toward expansionary [monetary] policies, since the clear and present danger, at least according to the bond market, is disinflation (and possibly deflation)?

No, it won’t. The bond market only rules if it tells people what they want to hear.

The odd thing isn’t that people only hear what they want. Confirmation bias is ubiquitous. The odd thing is that so many in positions of authority only want to hear that which justifies greater indifference to human suffering.

Others will see more cynical causes but, my current explanation is that this is a transfer of logic from the way certain body tissues operate. Its clearly the case that skin, muscle and connective tissue respond to stress by growing:  a process known as hypertrophy. This might also be the case with nervous tissue and some other, though importantly not all, tissues. This is an interesting and important phenomenon that details the power of highly complex evolutionary systems. Yet, it is a fool’s errand to apply this to the world writ large.

When you stress most things they don’t grow back stronger, they break. When you apply job losses to an economy people don’t become hardier, they become poorer.  The idea that tough love will lead to a better economy in the long run is just wrong. Not mean. Not heartless. Not insensitive. Wrong.

Monetary policy doesn’t work that way. Fiscal stimulus doesn’t work that way.

More importantly, I want people to question whether or not you believe in economic toughness primarily because you are extrapolating from your experience with muscle fatigue. Human bias is elusive and works in mysterious ways. You may have learned from an early age that “no pain means no gain” and at a minimum that’s a good rule of thumb when dealing with sarcoplasm. However, this phenomenon is deeply dependent on the nature of sarcoplasm and the metabolic process generally. It does not carry over to the world or equilibrium systems on the whole. You will make deep logical errors if you believe that it does.

And getting the right answer matters. What’s important is not whether what you are saying “feels” true. Unlike Paul, I don’t doubt your sincerity. What matters is whether it is true. The world operates on objective facts and their relationships. The world does not operate on whether you subjectively feel like you did the right or responsible thing. We can talk more later about how responsibility  - or compassion for that matter – are mental interpretations. Real world events are the result of the interaction of subatomic particles. Responsibility or irresponsibility can’t cause anything to happen they can only provide an interpretation of events that have actual physical causes. But, like I said more on that later.

The issue today is: what series of logical steps is telling you that we should listen to bond markets when they suggest tighter polices but not when they suggest loose ones?

Calculated Risk tells us the key to fixing the housing market:

The key to the housing market is to absorb the excess inventory. That means more households and fewer new housing units. Luckily housing starts are very low right now, but unfortunately there is very little job growth (and therefore little new household formation).

But job growth is not the only way to get new household formation, as I’ve argued again and again, we have immigration at our disposal. Of course, there are the usual complaints about jobs. But the weakness of this argument can be seen in a new paper Felix Salmon directs us to:

Statistical analysis of state-level data shows that immigrants expand the economy’s productive capacity by stimulating investment and promoting specialization. This produces efficiency gains and boosts income per worker. At the same time, evidence is scant that immigrants diminish the employment opportunities of U.S.-born workers.

It is well understood that the removing capital tariffs and protectionism would increase overall efficiency and incomes. Since immigration restrictions are labor market protectionism we shouldn’t be surprised to see that is has similar positive effects.

Unfortunately, journalists and pundits don’t seem to oppose labor protectionism nearly as much as they oppose capital protectionism. We would see an outcry among op-eds and pundits if we were seeing a worldwide rise in capital protectionism, because they recognize that beggar-thy-neighbor policies make everyone worse off. But no similar reaction has come from the rise in global labor protectionism. Here is how a recent report from the Migration Policy Institute describes the situation:

Confronted with the most severe economic crisis in decades and rising unemployment, governments in locations across the globe embraced a range of policies to suppress the inflow of migrants, encourage their departure, and protect labor markets for native-born workers.

From Malaysia and Thailand to Kazakhstan, Taiwan, Australia, South Korea, and Russia, many governments have sought to restrict access to their labor markets by halting, or at least decreasing, the numbers of work permits for foreigners. Others, such as the United Kingdom, tightened admission requirements. And while the policy focus of many of these countries was on reducing the entry of low-skilled workers, the United States placed restrictions on some companies seeking to bring in the highly skilled.

In addition to the results from Felix above, the wider literature on the issue tells us the quantifiable impact on wages is likely to be minimal compared to the impact on house prices. For instance, research from economist Albert Saiz found

“…a very robust impact on rents and housing prices that is an order of magnitude bigger than the estimates from the wage literature. Immigration inflows equal to 1% of a city’s population were associated with increases in average or median housing rents and prices of about 1%.”

Emphasis his. In previous research, Saiz used a classic example of exogenous immigration from the literature and found effects of a similar magnitude. Looking at the Mariel boatlift, a sudden inflow of immigrants from Cuba which increased the population of Miami by 4%, Saiz found that rents in Miami increased 8%. Overall, there appears to be a robust relationship between immigration and housing prices.

Calculated Risk tells us that “Usually housing is a key engine of recovery, especially for jobs. But this time housing is going to follow the economy.” But this is not because of economics, but politics. Instead of waiting around for the labor market to lead housing recovery, let’s use the tools we have to help housing recovery lead.

Adam, alerts me to Bryan Caplan full-throated embrace of the suicide fallacy. That is the notion that life must be better than never having been born because people could kill themselves but choose not to.

Bryan says

Why would a minor gift of cash be a clear-cut gain, but a massive gift of human capital be a question mark?  In both cases, the recipient seems to have what economists call “free disposal” – a cheap, painless away of getting rid of the unwanted gift.  Don’t want $100?  Drop it on the sidewalk.  Don’t want to be alive?  Drop yourself on the sidewalk.

First, dropping one’s self on the sidewalk is neither cheap nor painless.  I don’t want to dwell to much on the pain of either plummeting to your death or hitting the sidewalk, but there is some chance that these are non-trivial.

More importantly, however, throwing yourself out of the window has consequences not only for yourself but for everyone you leave behind. It will likely cause sadness among your loved ones. It will cause the world to view you and your family differently,  likely with either pity or disdain. Neither of these are desirable for most people and both of them are likely important.

Bryan waves these concerns away but there is evidence that they do indeed weigh heavily in the minds of the suicidal. Suicide watchers say that you should be on high alert when someone starts to say things like

No one would even notice if I am gone

My family would be better off without me

I am just a burden to my family and friends

This tells us that our concern for others is likely a major block to our committing suicide.

Second, and to my mind more importantly, one of the largest downsides of being born is that you have to die. Your death will be painful for your loved ones as discussed above but it’s typically a distinctly unpleasant experience for you as well.

Most people are afraid of death in a way that they are not afraid of non-existence. Thinking about the world just after your death tends to be at minimum unnerving. Thinking about the world billions of years after your death or years before you were born tends not to be so bad.

This indicates that people are concerned about the world in which they have died, not simply about the world in which they don’t exist. Indeed, most people are not troubled that they weren’t born 20 years earlier but would be saddened to know they were going to die 20 years sooner.

Life and death are not smooth inverses of one another because the process of becoming alive creates in most animals a lifelong fear of becoming dead. This is a sunk cost for everyone who is already born but is not for people who are not yet here.

If the reason that people don’t kill themselves is because they are concerned about what will happen to the people they leave behind and because they are afraid of death then these are not arguments for the value of life. Indeed, they are arguments against the value of life.

Why?

Because as soon as someone is born there are condemned to die and almost certainly leave in their wake the pain of loss. The very things they desperately want to avoid have now been made inevitable.

Addendum: I should note that optimism bias is also a likely mitigating factor for suicide. Feelings of hopelessness are another strong warning sign for suicide.

However, evidence suggests that mentally healthy individuals consistently overestimate how hopeful they should be.

In any case we shouldn’t take the low prevalence of suicide as strong evidence for the irrationality of suicide. If suicide were the rational choice then we would expect that humanity would evolve very quickly towards being irrational.

UPDATE: I am not making an argument here that life is on the whole worth having or not. I think that’s an important question and I think a lot about it. However, I lean towards thinking that  (a) Its not a slam-dunk either way, life contains an unpredictable mix of joy and misery and (b) historically some sets of lives have probably had a positive expected value and others not.

It must be, because what else explains this ridiculous optimism?

In an annual survey conducted by the economists Robert J. Shiller and Karl E. Case, hundreds of new owners in four communities — Alameda County near San Francisco, Boston, Orange County south of Los Angeles, and Milwaukee — once again said they believed prices would rise about 10 percent a year for the next decade.

With minor swings in sentiment, the latest results reflect what new buyers always seem to feel. At the boom’s peak in 2005, they said prices would go up. When the market was sliding in 2008, they still said prices would go up.

Reading David Post and Matt Yglesias on copyright and artists has me thinking about the popular justification for copyright laws in contrast to the economic justification.

The economic justification is that free markets will not provide enough profit for artists to undertake some projects for which the social benefits of doing so outweigh the costs. Optimal copyrights will compensate artists just enough so that they are willing to create the works, anything above that is inefficient rents* (you hear that Metallica!).

The popular justification seems to be more about maintaining some “fair” balance between consumer surplus and producer surplus. The measure usually being that people who create things that generate a lot of social benefit (e.g. they write hits) deserve to get proportionally rich. Even after the artists are dead people feel that the benefits should flow to his children, wife, estate, etc. in proportion to the social benefits. This, I suspect, is simply the status quo bias. In this country artists who create very popular art have tended to get very rich from it, ergo we have come to see this as the “fair” outcome.

People seem much less concerned that the payment to roadworkers be in proportion to the benefit that society gets from that roads they created, and that the payments continue to flow long past when the work is done. The same is true of the designers of those roads.

Why should we be disproportionately concerned about artists ability to capture economic rents? Why should we be concerned about the ratio of producer to consumer surplus in the arts and not for other workers? Wouldn’t we be better off in a world full of middle class artists but more art?

This, to me, seems like yet another area for liberaltarian agreement.

*For more on this, see Alex Tabarrok’s “Patent Theory versus Patent Law”.

Is it surprising that conservatives don’t complain more about occupational licensing? On the one hand it’s not, because economists themselves don’t seem to think it’s much of a big deal. In their 2009 paper, Morris Kleiner and Alan Kreuger point out that since 2000 no articles on the issue had been written in what are considered some of the top economic journals: AER, JPE, QJE, Econometrica. In the leading labor economics journals, Industrial and Labor Relations Review and the Journal of Labor Economics, only one article on had appeared. In contrast, there were 16 articles on labor unions in just those labor journals. In a survey of five labor economics textbooks Stephenson and Wendt found that occupational licensing took up a combined total of 10 pages, whereas there were 7 chapters on unions. Clearly the profession is neglecting the issue, so why shouldn’t conservatives?

On the other hand, we have the following graph which shows unionization versus occupational licensing using data from Morris Kleiner*:

Over the last 70 years, occupational licensing come to dominate unionization as a labor market restriction, with growth in the former accelerating in recent years. The most recent estimates are that 30% of the labor force is required to have occupational licensing by a government agency, compare to around 13% that are unionized. Estimates of the impact of licensing on wages are about 10% to 15%, which is comparable to the typical estimates of the union wage premium.

So occupational licensing has the same affect on wages and is more pervasive than unionization; this tells me that conservatives should care a lot about.  So why don’t they? One reason may be that they believe licensing increases quality. As I wrote yesterday, in my post on why liberals should care about occupational licensing, the evidence suggests this is not the case. But I don’t think this fact is generally appreciated.

One explanation is that, in contrast to unionism, licensing typically requires workers to jump through some impressive, expensive, and time consuming hoops, which certainly makes it seem like it should increase service quality. Also, one can certainly imagine that for many occupations there is some theoretically optimal non-zero level of licensing, but that public choice problems –highlighted here by Matt Yglesias– make that impossible.

Many conservatives may not grasp the public choice problem, and instead have too much trust in the institutions that set licensing standards. But these are mandatory government institutions, which conservatives should be skeptical of and instead favor free market, optional ones. At the very least they should favor mandatory testing, registration, and certification which allows people to work in an occupation even if they fail, but without the “Government Certified” stamp of approval.

Dean Baker’s hypothesis is that conservatives, journalists, and other professionals not complaining about occupational licensing is about class; specifically, the professional class. He argues that “free traders” only want free trade in low-skilled labor, and not high-skilled labor like doctors and other professionals. This is why they don’t complain when trade agreements come with restrictions on professional labor markets, like those on foreign doctors, but they do complain when they come with restrictions on low-skilled labor.

Even more puzzling, he argues, is that  people are more concerned about restrictions on low-skilled trade between countries than on high-skilled trade between states:

The “free-trade” crew want to have a single set of standards for all forms of merchandise traded all over the world, but it has apparently escaped their attention that a lawyer from New York can’t practice across the river in New Jersey.

I don’t necessarily believe Dean’s diagnosis that free-traders really want is “cheap nannies”, and that their motivations are selfish. For one thing he frequently charges journalists with this, but are governmental barriers even among the top 10 things stopping a significant number of immigrants from putting journalists out of jobs?  I do think that there is some sort of professionalism bias occurring, but it’s a bias towards believing that high-skilled labor market restrictions are for everyone’s benefit, not just their own.

In any case, whatever their motivations I think conservatives should care more about occupational licensing because it prevents free trade between the states, increases protectionism in professional services, and is a labor market restriction that is as expensive as and more pervasive than unions.

My final comment in this two-part post on occupational licensing is that I would like to see the ideologically diverse individuals and institutions who oppose occupational licensing to work together on this issue. This could be co-sponsoring papers, panels, or entire research programs. Dean Baker at the liberal CEPR, many at the libertarian Reason Foundation, and Matt Yglesias at the liberal Center for American Progress are on the same side and have written passionately about this issue. So why not a CEPR, CAP, Reason joint research program on occupational licensing? Just give me a call when you start handing out research grants.

The post-housing-bubble narrative has been that the unsustainability of prices was obvious ex ante, and so we should be able to call them in the future. This to me seems to be a bit of hindsight bias, but it is always difficult to make a case that claims which turn out to be ex post false were nevertheless ex ante reasonable. Kristopher Gerardi, Christopher Foote, and Paul Willen have a new paper out that I’ve been waiting for someone to write. They go through pre-collapse claims of the housing pessimists, optimists, and agnostics, and evaluate not just who was write and wrong but which beliefs where obviously right and which were debatable. This is a fun and accessible paper starring a well-known cast of characters, with prominent roles for Paul Krugman, Dean Baker, and Robert Shiller, and a quick cameo by The Economist, Calculated Risk, and John Cassidy. I strongly recommend it.

Rereading the cases of the optimists and the agnostics should be a reminder to those who claim to have identified the bubble, and also argue for the identifiability of future bubbles, with a high degree of confidence. The burden of proof on those making those claims is to argue convincingly against, for instance, Himmelberg, Mayer, and Sinai who argue that you can’t just look at price to rent ratios, but must consider changes in the user-cost of housing.

Even more prominent than the housing optimists are the housing agnostics. Rosen and Haines argued that the academic consensus on the issue was that the relationship between prices and fundamentals was sound, and that overpriced markets, if they existed at all, were limited.  The authors find that the beliefs of agnostics can be summarized in this quotation from Davis, Lenhart, and Martin:

If the rent-price ratio were to rise from its level at the end of 2006 up to about its historical average value of 5 percent by mid-2012, house prices might fall by 3 percent per year, depending on rent growth over the period.

There is a tendency to call anyone who bought a home during the late stages of the bubble “irrational”, because prices were obviously unsustainable. But as the authors point out, the consensus of economists gave no indication that this was the case, and so behaving as if it wasn’t was quite reasonable for non-experts. Of course, pointing out that current prices were justified by fundamentals does not rationalize a 120% LTV negative amortization mortgage.

To those who simply point to lower lending standards as sufficient proof for a bubble, the authors offer this:

Did lax lending standards shift out the demand curve for new homes and raise house prices, or did higher house prices reduce the chance of future loan losses, thereby encouraging lenders to relax their standards? Economists will debate this issue for some time. For our part, we simply point out that an in-depth study of lending standards would have been of little help to an economist trying to learn whether the early-to-mid 2000s increase in house prices was sustainable. If one economist argued that lax standards were fueling an unsustainable surge in house prices, another could have responded that reducing credit constraints generally brings asset prices closer to fundamental values, not farther away.

I believe the case for humility about the obviousness and knowability of bubbles is underappreciated. Many, I’m sure, will simply point to the pre-bubble agnostic consensus of economists as more evidence that economists are rational expectations obsessed, over-mathematized fools who don’t know what they’re doing. I think they would benefit from a close reading of this paper.

Adam asks,

what problems do you think are important today that you didn’t think were important in 2004, and what policies would you favor now that you would have opposed then?

For me the answer is obvious, my once unwavering devotion to an independent Federal Reserve has been shattered. If in 2004 someone had suggested that the Federal Reserve should be more accountable to elected officials then at best I would have smiled and humored them. At worst I would have accused them of democratic fundamentalism and weakness-of-will in the face of our society’s ubiquitous pro-democracy propaganda.

Transparency? Oh, no, no, no, I would have said, Greenspan spoke well, when he quipped

I guess I should warn you, if I turn out to be particularly clear, you’ve probably misunderstood what I’ve said

Giving clear answers only encourages a sense of ease and simplicity, which in turn encourages unexamined input. If people wish to understand monetary policy then A Monetary History of the United States is available at most libraries and every major university subscribes to the Journal of Monetary Economics.

The Great Moderation, I felt, was our greatest triumph and it was achieved only by unshackling financial technocrats from their political masters. I cheered Bob Lucas’ 2003 address to the American Economic Association declaring

[Macroeconomics originally] referred to the body of knowledge and expertise that we hoped would prevent the recurrence of that economic disaster.

My thesis in this lecture is that macroeconomics in this original sense has succeeded: Its central problem of depression-prevention has been solved, for all practical purposes, and has in fact been solved for many decades.

Today, I am banging the table asking why Bernanke won’t explain the Fed’s unwillingness to adopt a 4% inflation target. Today I cannot help but wonder whether the Regional Fed presidents aren’t too far removed from the everyday pain of high unemployment. Do they not know policy failure when they see it?

The extent of my current heresy cannot be overestimated. To my former self the idea that the unwashed masses – a term that would have included members of Congress, notable media pundits and CEOs of major corporations -  had anything useful to contribute to monetary policy was as sensible as saying we should set the Federal Funds rate based on an examination of the entrails of a chicken.

Nor, do I think this was or is even today a minority position. What set Kartik Athreya apart was not his opinions but his willingness to share them with society.

I have gone thoroughly native. But, then again, facts have changed

image

It is a common and poor framing of the question to ask whether uncertainty is causing our current economic woes. Just as the path of GDP is more volatile and difficult to forecast than in stable growth years, the path of individual firm sales is similarly more volatile and uncertain. More uncertainty will make households and businesses save more and invest and spend less. There is nothing controversial here. The debate is about the cause of uncertainty, and here I see a troubling correlation between what people think the current villain is and what their non-recession bugaboos are. The narratives struggling to tie the current economic woes to long-run stagnating wages, an undereducated workforce, and anything Democrats do strike me as a tenuous stretch and reflect our tendency to need a compelling narrative when easy explanations do not present themselves.

I think a good test for yourself is to ask “what problems do you think are important today that you didn’t think were important in 2004, and what policies would you favor now that you would have opposed then?”. My answer is that low house prices are a problem today where I would previously said low prices are just transfers from sellers to buyers, and I would favor policies that prop them up when I would previously have opposed them. What are yours?

Jennifer Pollom has a long piece up at Economics 21, which argues that long term spending, not taxes are the problem. By my reading Pollom makes three big points

  • Revenues, even after accounting for the Bush tax cuts, are not that far out of line with historical norms.
  • Spending on the other hand is growing like gangbusters
  • The core of the spending problem is Health Care

Pollum also makes some important comparisons, noting for example that tackling spending growth without touching entitlements would require either scrapping the military or scrapping the entire rest of the government. In fact, even the latter wouldn’t completely do the trick.

Here core argument is essentially correct but there are some important caveats to be made.

First, Pollum, like just about everyone else, leans heavily on this set of graphs.

Revenues and Primary Spending, by Category, Under CBO’s Long-Term Budget Scenarios Through 2080

You see that last date over there in the right-hand corner. If you squint you can make it out. It says 2080. That’s 70 years from now. I know what you are thinking. However, I have to keep making this point: a whole lot can happen in 70 years.

Seventy years ago Hitler had just starting bombing British factories, but the America First Committee was determined to ensure Roosevelt kept his pledge to keep us out of war.  They had good reason to be hopeful, after all public support was with them.

image

A year later that hadn’t turned out as expected. The next 70 years held a lot of surprises as well. The birth of the modern welfare state, the baby boom, Women’s Lib, the Civil Rights movement, the rise and fall of communism as a geopolitical force. I could go on.

The point is American life and Americans’ relationship to their government changed in ways that experts in the 1940s could not have imagined. It is hubris beyond all measure to think that these projections are even a semi-precise portrayal of what is going to happen. We have to always keep that in mind.

Second, this whole Health Care thing. It’s really a ball of knots. However, there are a few things we just have to keep straight.

To start with, the spending issue on health care isn’t a government issue. Its a national issue. Its really a global issue, but we don’t need to go there. The whole country, public and private is being squeezed by the rising cost of health care.

Now you might say, yes but if people were given responsibility for their own health care expenditures they would make more rational choices. The problem is, people have never had responsibility for their own health care expenditures and there is little reason to think that they ever will.

One reason is obvious. The people who are in most dire need of health care aren’t in any condition to be responsible for anything. That’s why they need health care. Second, their loved ones typically aren’t in the most rational state of mind either. In fact, Robin Hanson makes a fair argument that the entire notion of health care is rooted in emotion and fear.

However, even beyond that health care has always been mostly paid for by someone else. Even before the government got into the business of explicitly buying most of the health care in the United States,  health care was actually paid for by insurance companies.  In fact, it is from the study of insurance companies that the notion of moral hazard arose.  The problem people noticed was that when people were spending the insurance company’s money they tended not to be so careful about what they bought. Rascals, I know.

That’s basically the same problem that we have with government. The fact that you have a private entity creating moral hazard doesn’t do much to change its fundamental properties.

We could go back even further, before the rise of medical insurance, and we’d see that most health care was bought either by the local governments, the military or the church. Again, most people were insulated from the cost.

Now, we could say that Health Savings Accounts will solve all that, and in truth they’re not a bad idea. However, they’re not really a solution either. Half of all health care dollars are spent by the sickest 5%; people who would blow right through their HSA caps. The bottom 50%, that’s most of us, account for less than 3% of all spending.

So what’s my takeaway? Its that whether the government buys health care or whether the private market buys health care is not likely to change the fundamental dynamics. Most people don’t make their own fee-for-service decisions, they never have, and they probably never will.

However, there is a bright side, which is this: something that can’t go on forever, will stop. I stole that little gem from Ben Stein’s dad, in case you didn’t know. In relation to health care what that means is that I don’t expect excess cost growth, that is health care cost growing faster than the economy, to go on forever.

Literally, it can’t go on forever. Eventually health care will be the economy and then the two numbers by definition have to match. However, even before we get to that point someone is likely to balk. What we would love to see is a bunch of rational agents, each calmly and carefully deciding exactly how much of their income they are willing to fork over. But, like I said above, that ain’t gonna happen.

What we will see is a national freak-out. One in which all sorts of caps and legal constraints are placed on the growth of health care costs. If we someday have a single payer system this will be done quietly behind the scenes as is now happening in Canada. If we still have a mutli-payer system then its going to be a political firestorm but the end result is going to be the same. Artificial constraints will be placed on the growth of health care costs.

What that means for that big CBO graph is that health care costs are almost certainly not going to keep rising at the same rate for the next 70 years. Something is going to stop them.

So what’s left to be done. Am I saying that we just put Alfred E. Neuman at the helm and forget about it?

No.

There are some important choices to be made. For example, when the clampdown comes we want it to come in such a way that minimizes inefficiency and leaves open the potential for some technological advances to continue. This will not be an easy task, as our most potent tool, the decentralized free market, is not available. However, it is an important task and one that we should begin thinking about.

Oh, and I lied. Turns out I’m a rascal as well. There is a lot more to read on spending, taxes and health care. We haven’t even talked about taxes for example. But, I had to get you through this monstrosity of a post somehow. I couldn’t very well depend on your rational informed consent could I?

Economics 21 has a pretty concise takedown on why Elizabeth Warren should not serve as chair of the Consumer Financial Protection Agency. It highlights concerns about her work on family income and bankruptcy, as well as her position on bank nationalization. Here, Adam, has been critical of her position on high interest lending as well.

Across the blogosphere her defenders have scrambled to poke holes in all of those arguments. My take: E. Warren is no fool. I don’t think she publishes hack reports and I have little doubt that there is a fair defense of her methodology.

That having been said, Paul Krugman is no fool either. He comes to the table with some of the most trenchant analysis available. However, I wouldn’t want Paul chairing the Commission on Partisan Bias. Paul has strong priors and the intellect to defend them. However – and I know I am risking a smack down from Delong – one cannot help but walk away from Paul’s writing feeling that he has been too clever by half when it comes to his take on partisan issues.

You know that Paul is smarter you. You know that his data instincts are keen. Yet, you also know that confirmation bias is real and that as such strong priors and formidable analytical skills can be a dangerous mix. Few people are sharp enough to poke holes in his argument and despite his best intentions he is not going to be able to reliably poke holes in his own.

Likewise, having the formidable, and seemingly strong priored Warren at the head of CPFA is dangerous. She seems to have strong beliefs and the analytical ability to plow through anyone in her way. A cold-hearted pointy head would make a better referee.

That’s not to say that passion has no place in intellectual discourse, but it is why its important that passions balanced. It doesn’t matter how good your intentions are, confirmation bias and a lack of diversity will leave glaring blind spots.

Matthew Yglesias opines on articles about medical practices from Igor Volsky and Ezra Klein:

This is all bad stuff and not primarily because it “costs money.” Rather, it costs people quality of life. People have better things to do with their time than undergoing painful cancer treatments that they don’t need. Gawande writes of a study “showing that terminally ill cancer patients who were put on a mechanical ventilator, given electrical defibrillation or chest compressions, or admitted, near death, to intensive care had a substantially worse quality of life in their last week than those who received no such interventions” and also “six months after their death, their caregivers were three times as likely to suffer major depression.” I don’t think there’s anyone out there who’s terminally ill and saying to himself “I want to handle this in the way most likely to produced major depression for my loved ones” but that’s what happens and it’s horrible.

The “bad stuff” Yglesias refers to is the extreme treatment given to people who are either of questionable risk, or who are “heading out” anyway, and the extra treatment is not only a…less-than-optimal…use of money, but also destroys quality of life.

Ezra’s story, more-so than Igor’s, is a rather extreme example of using medicine to signal our loyalty to people. Presumably, a medical proxy or power of attorney needs to sign off on these extreme end-of-life treatments. What I find interesting — and something that is absent in Matthew’s analysis — is that this type of behavior carries substantial personal (non-monetary) risk in the form of depression!

On that point, I think Matthew has it exactly backward when he makes the statement that concludes the quote above regarding a terminally ill patient. I don’t think that this is a situation where the receiver of “care” is making a selfish decision regarding their final days. Rather, it is those in charge of the “care” decisions; in an attempt to signal that they do, in fact, care, taking drastic steps that have little or nothing to do with either making someone better off health-wise or marginally improving quality of life.

Robin Hanson has argued that we should cut medicine in half. I tend to agree with that. Though one interesting thing that digging into the end-of-life data may shed some light on: The desire to signal that we care obviously fades the “further” we get from the patient in question. I wonder if there is a demonstrable link between the closeness of the medical proxy and the incidence of extreme, unneeded medicine?

And here’s the kicker: Is improving quality of life a possible argument for “death panels”?

I’ll get to this graph in a minute

image

When I was a economics undergrad multinational corporations were the public enemy of choice. We were taught as young defenders of the faith, to look beyond the intuitive connection between profits and evil. We were told that the equilibrium was the result of competing forces and that sometimes what looked like a cause was really a symptom. Sweatshops were a case in point.

Today the villain has a very different face. Its big government and its apparently uncanny ability to screw everything up. If something went wrong government is likely to blame.

Queue the housing crisis.

I watched the housing and financial crisis unfold in real time. I had considerable personal interest in the outcome. It seemed beyond doubt among those biting our nails over whether there would or wouldn’t be a crash, that the key player here was the Collateralized Debt Obligation. It was a newly popular product. It promised fantastic results. It had revolutionized the market and from the very beginning many had complained that it was too good to be true.

From an economic standpoint the argument was a standard one. The modern CDO was a technological innovation. Large scale CDO issuance was impractical before David Li developed a Gaussian Copula model to estimate their performance.

This always happens with new innovations from the Railroads to the Internet. Some nut says that its going to change the world as we know it and some old fogy says its no different than the fax machine. Usually they’re both at least right. We have Googles and we have Webvans and no one knows before hand which will be which.

Yet, and still I didn’t find it surprising when millions poured out to blame the housing crisis on corporate greed. I had been trained to expect it.

What did surprise me is that people wanted to blame it on Fannie Mae and Freddie Mac. Fannie Mae and Freddie Mac? You mean those old stogy has-beens that the CDO was supposed to make obsolete? A 30 year 80-20, that’s for suckers. Those were the days of the 2/28 ARM at 135% LTV. It was truly money for breakfast.

Yet, that’s where the blame went. The government had intervened in the housing market. The housing market had gone bad. Therefore, the government must have screwed up the market. QED.

This theory was pushed by econ-types, business or pro-market pundits who were used to defending corporations. I was sure, however, that eventually their training would kick-in. They would look for auxiliary factors, try to examine competing theories and most importantly check for evidence that would directly contradict that theory. That didn’t happen.

And, that brings me to graph at top. It seems to me that if you believe the American government did something to screw up the American housing market the very first thing you would ask is – what happened in other countries. Its authoritative since government polices are usually defined over government jurisdictions. Its really convenient, as countries usually collect their own data and post it online for you. Its the first place you should look.

A causal glance, however, tells you that there was a bubble all over the world. The US wasn’t even particularly bad and that even the free market wunderkind of Ireland was about to take it in the teeth.  As far as I can tell that’s pretty much what happened. This makes the Fannie/Freddie done-it theory seem highly implausible. Even if there are international spillover effects, at a minimum one would expect Fannie and Freddie to have done it most in America. America actually had one of the least – which might have something to do with Fannie and Freddie, but that’s for another day.

My take away isn’t that government is the answer. I’m generally a Hayekian and I see the information problems associated with government as being often insurmountable. No, the take away is that villains aren’t the answer. When you see things going wrong its a mistake to assume that someone made them go wrong. And, its got to make you at least a little suspicious if the someone you suspect was a person you didn’t like to begin with.

Economists like to say that the economy is not a morality play, where the good are rewarded and the evil punished. Its not a Bond film either, where there is a super villain – business or government – behind it all. Its a complex interaction of forces that we can only hope to understand by careful examination. Sometimes the government will screw up. Sometimes the private sector will screw up. Sometimes shit happens. That’s not always emotionally satisfying but it is the nature of the discipline we have chosen.

Lie to me. I promise I’ll believe. ~Sheryl Crow

Adam gives a rather sophisticated argument against menu labeling that boils down to this: finding out something you’d rather not know makes you worse off.

This presents something of a problem for economics and economists because we typically think of information as determining how closely one’s actions are aligned with one’s preferences. That is, the more you know the more likely you are to get what you want.

Serious analytical problems arise when you have preferences about what you know. That is, when they’re some things that you just don’t want to hear. Yet, this is a deep and undeniable part of being human.

The always entertaining Ricky Gervais made a movie about it called the Invention of Lying. In Gervais’s film no one, until Gervais comes along, ever lies. Yet, as weird as the world in The Invention of Lying is, it doesn’t begin to scratch the surface of how fundamental lying is.

Now let me warn you before I go any further, you are not going to want to hear this. Indeed, that’s my point. I’ll say it anyway because I care much more about the displaying my intellectual prowess than I do about your personal comfort ~ that wasn’t very nice was it?

Lets start with some basics. First off, if social psychology is correct then you are much bigger failure than you realize. In fact, you’ve probably failed at most things. Now, since those things have happened you’ve actually rewritten your preferences to claim that you really didn’t care that much in the first place, the things you succeeded at mattered more, there is a reason for everything, every cloud has a sliver lining, when God closes a door he opens a window, and a whole bunch of other lies.

These lies are almost undeniably helpful because research tells us that the people with the most accurate self-assessments are those that are chronically depressed. That is, the truth hurts – a lot.

But lets not stop there. Perhaps you have children or perhaps you’re planning to. Our best available research tells us that they are probably on net going to make you less happy. You know the only people who are happy to hear that – the middle aged and childless. Almost, everyone else is kind of pissed and goes through intellectual gymnastics to try to deny it. It doesn’t feel great to think that the light of your life is when all is said and done more of a pain in the ass.

It gets worse though. Because as a parent you probably don’t even care that much about your children. Indeed, once your children’s abstract reasoning starts to mature, around 14, they will be sure to tell you exactly how little you care about them or what’s important to them. You know what? They’re right. You don’t. You don’t because you’re not hardwired to care about them. You are hardwired to care about their genes.

Caring about their genes means first and foremost making sure they survive long enough to reproduce with an adequate mate and adequate resources to give you what you really want – healthy grandkids. Getting there might involve a lot of pain for your kids and maybe on some level that irks you, but likely not enough to keep you from driving down their utility in an attempt to drive up yours. If you’re really good at it they will become stunning successes with beautiful successful spouses and lots of wonderful healthy grandchildren. And, there is a good chance they will never forgive you. Nor, should they.

We haven’t even started in on how tribalistic, ethno-centrist and racist you are. Here is a good place to get started on that. Basically, you suck and we’ve got the data to prove it.

All that information is like a breath of fresh air isn’t it?

After you’re done ruminating on the ways in which you’ve been a bastard – e.g. if all my friends have credible stories showing that everyone else is an asshole driver and I’m someone then . . . – perhaps you’d like to stop off for a quick bit to eat. You’re a little overweight sure. I mean you’re an American so chances are. This, however, is a moment to take a break before you face that failure that is your life and trust me it is a failure.

“That’ll be seven ninety-five” the cashier says, “oh and 900 calories (that you definitely could go with out)” I added that last part but you know that you heard her say that in your head. Just one more reminder that you suck. But, hey if this menu labeling works then you could have three more extra years to ruminate on all the things that you wished you’d done but you and I both know you’re too lazy and/or chickenshit to ever do.

Cheers.

Jodi Beggs, aka Economists Do It With Models, argues that paternalism need not be justified by assuming irrational agents, but can simply be an efficient response to an informational problem:

Any Economics 101 course will tell you that a required condition for markets to be efficient (read, value-maximizing for society) is that consumers have full information about the products they are considering consuming. In this way, the calorie-labeling legislation is helping to push the fast food market in the direction of efficiency as much as anything else. What’s so behavioral-y about that?

One counter to this is that markets should be supplying the amount of information that consumers prefer, and that the reason we don’t observe a lot of menu labeling and other information from restaurants is because consumers don’t want to know. Of course, you could argue that they don’t want to know only because of what they don’t know…Wait, what?

Ok, bare with me. Pretend I had a sealed envelope that contained a letter from someone telling you telling you exactly why they hate you. But say you believe that everyone who you care about doesn’t hate you, therefore you assume it’s from someone you don’t care about, and since you don’t want the annoyance of reading hate mail from someone you don’t care about, you choose not to open the letter. But, say that letter is from your wife, who secretly hates you. Well you would want to know why your wife hates you, but since you believe your wife can’t possibly hate you, you won’t get information you want. Basically what I’m saying is that your current information set determines your demand for information.

So what does this have to do with menu labeling regulations? If we assume markets are working, then the level of information we observe is the amount demanded by consumers, which efficient. In this case menu labeling laws would make people worse off by giving them information they don’t want. That is unless the amount of information they are demanding is based on their assumption that restaurant food is kind of unhealthy, but not as unhealthy as it really is. If they had any idea how bad it was, they would want to know. In this case menu labeling laws could make people better off.

Determining the source of the lack of information is critical to knowing whether menu laws are efficient or not. This is especially important because the amount of information can affect demand, which contra Jodi, can change the choice set. She writes:

…the consumer has exactly the same set of choices available to her regardless of whether calorie counts are on the menus or not. Because of this feature, it’s hard to argue that this sort of legislation is significantly bad for anyone- here, the worst-case scenario is that some people keep eating unhealthy food but are no longer blissfully ignorant and instead feel guilty.

But what could happen is that when people are no longer able to be blissfully ignorant, which they prefer, they consume a healthier but lower utility set of products. This in turn could change restaurant supply decisions, which would mean a different choice set.

So what is it:  is our demand for ignorance efficient, or is our ignorance causing us to demand an inefficient amount of ignorance?

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