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Scott Sumner routinely forgets my name when listing people who thought money was tight, and favored unconventional monetary responses to the recession…but that’s okay. I wasn’t blogging that much in late 2008. In any case, I would like to provide a concise answer to a question Scott raises on his blog today:

The very fact that Congress and the President are ignoring this issue (confirming FRB nominations), pretty much tells me that they are clueless on monetary policy. On the other hand, both groups do favor more AD, so their “heart” is in the right place. And of course I’m a big believer in democracy. So who do I favor making the decisions; the clueless or the heartless? I’m tempted to say “Whoever agrees with me; first tell me the target Congress would set.” But of course that’s cheating. The honest answer is that I don’t know. But it is becoming increasingly clear that we won’t get good policy until this dilemma is resolved.

In my mind, the myth of an independent central bank has pretty much been shattered (Karl’s as well). Every time the theory of why we have an independent central bank has been put to the test in a big way, the Fed has failed miserably.

But maybe the answer is more nuanced than that. Perhaps the Federal Reserve itself is simply a proximate cause. If you take the view that the actions of the Fed represent the consensus of the economics profession, then perhaps it is the economics profession who are the underlying cause.

In either case, it is clear that there should be hard rules in place that the Fed must abide by. At the same time, I think that the Fed should have maximum room to act independent of politics when it really needs to. Our current “dual mandate” provides nothing but an excuse for the Fed to shirk its duties. Thus, I believe that the Federal Reserve Charter should be rewritten to state that it is the Fed’s contractual duty to set an explicit nominal target, level targeting, and do everything in their power to hit that target. If you ask me I favor NGDP, but some people favor price level, and some favor inflation…if you really want to pin the Fed down, write which nominal target the Fed needs to hit into the charter. NGDP will still be here 100 years from now.

However, and this is important, that is the end of Congress’ power. Once they have arbitrated as to what the Fed needs to do, Congress gets out of the way and lets the Fed act. The only point at which Congress should have the authority to intervene is if the Fed is off-target, in which case Congress should have the power to remove the current board (or specific members) and appoint a new one. But, and this should be written into the charter as well, the only circumstances in which Congress can do so is if the Fed is missing its target (or criminal behavior, or other things that don’t have to do with monetary policymaking).

Separating politics from policymaking is definitely a good thing (I even came around on TARP), especially in monetary policymaking. However, having a monetary authority that is gallivanting around, allowing NGDP expectations to plummet 8% with zero recourse is unacceptable.


My NYT column today is about why we can’t move to a three percent inflation target (which I favor, at least for some number of years) and how we might make the leap.

and gives us some political advice

When it comes to inflation, the Fed cannot easily turn to Congress and simply ask to be trusted.

THIS is the sad side story of our financial crisis: especially when it comes to financial matters, a great deal of trust has been lost. There is the prospect of a free lunch right before us, yet it is unclear that we will be able to grab it.

The Federal Open Market Committee, which votes on monetary policy, has three open seats — a situation that may be hindering the taking of decisive action. The Senate has not been willing to hold a confirmation vote on Mr. Obama’s nominations. But filling the seats is not enough; somehow, Fed officials have to believe that Congress is firmly on their side.

Thanks Tyler. Your advice and membership is appreciated.

I would like to believe it matters when thought leaders from across the isle stand shoulder-to-shoulder. It will take a while for traditional pundits to come around but can I count on the blogosphere?

Russ Roberts?

Mark Whitehouse has a chart demonstrating one of the basic issues in a credit crisis. Despite the mythology that consumers have been paying down debt, the reality is that consumers have been defaulting on debt and the banks have declined to loan them any more.


This is because despite Bourgeois ideals to contrary it is almost always better to be deep in debt. I know this is going to be a long hard conversation. It might take us months, but we will get there.

When you borrow money you either have stuff or liquid assets. When you loan money you have a promise. Stuff is typically better than an promise. Liquid assets are wholly superior.


Because, shocker of shockers, not all promises are kept. That is, lenders face default risk, borrowers do not.

Now it is often the case that people with lots of liquid assets – and who are therefore rich – become lenders. Its also the case that people who are short on liquid assets – and therefore poor – become borrowers.

However, the act of borrowing money makes you richer and the lender poorer. This is why the lender charges you interest. He needs to be compensated for his impoverishment. If the lender didn’t charge you interest then you would be getting away with highway robbery.

It also why rich people are more likely to become lenders. They can stand a little impoverishment. Its why your sister dithers when you ask her to front you some cash – she can’t afford the impoverishment.

All of this is to say that it is always going to be in the interest of many if not most borrowers to borrow more money. And, they will if a lender lets them. This is why credit constraints are such a big deal.

Its also why Minksy moments are such a big deal. When creditors suddenly become less willing to lend to borrowers that changes the actual opportunities available to people. Borrowers can’t fulfill the plans they had intended to fulfill. Business activity declines, asset values go down and fear goes even higher. A cascade forms where the closing of opportunities leads to a reduction in credit which leads to further closing of opportunities.

Previously sustainable patterns of specialization and trade are shut down. Not because preferences have changed, not because expectations of future real income have changed but because trust has changed.

Trust is a real input to economic activity and when it goes away economic activity goes away. The interdependent nature of the economy means that the trust between you and your economic partners can decline even when you or your partners have done nothing untrustworthy.

If someone that one of you deals with does something untrustworthy it rattles the whole system. Your partner depends on his other partners to come through so that he can come through. If his partner can’t come through then he might not be able to come through. But, if he doesn’t come through then you might not be able to come through. And, if you can’t come through then everyone who depends on you might not be able to come through.

You’re not just in bed with everyone you’re doing business with. You’re in bed with everyone they are doing business with and everyone they are doing business with and so on.

I experienced my first default as a creditor at the age of 7. It was a harrowing, emotionally painful experience. The debtors were my parents and the asset at stake was my then life savings. The moment of terror – when you find out that the trust you had was misplaced and that now everything that you thought was true is no longer true -  will stay with me for the rest of my life.

It also had long lasting effects on my demand for money. Not wealth – money. Physical cash. After that I kept it hidden in a roll in my sock drawer. I had taken cash that was previously in circulation and hoarded it. An economist might say that my real money balances had gone up and the money multiplier had declined.

Had the US Federal Reserve not accommodated my increase in money demand by printing more dollars the results could have been – well virtually insignificant. I think we were dealing with a max of $150 here. Still, the point stands! An unexpected default led to a surge in money demand.

Multiply that literally billions of times and you have our current situation. However, the Fed is not accommodating the increase in money demand because the Fed Funds rate has hit the zero lower bound and for reasons we won’t debate now, the Fed has chosen to pay banks interest on the money they hoard.

Hence, outstanding credit in the US is falling. There is no need to invoke recalculation. There is no reason to suppose a grand mismatch is upon us. We simply have to believe that in the wake of a string of unexpected defaults lenders have become skittish about lending. That’s all it takes.

Unexpected defaults lead to a hoarding of cash or other safe assets. The hoarding of cash means that some business arrangements have to breakdown. Business transactions require money and that money is now sitting in a sock drawer or a bank reserve account as the case may be.

This decline in business activity leads to further defaults and increased fear. That leads to more hoarding of cash and safe assets. The only way out is to produce more cash or more safe assets. Either by expanding the supply of money in actual circulation or by expanding the supply of AAA government bonds by increasing the deficit.

I favor methods to achieve the first, but I am open to the second.

Tyler Cowen points to an Ebay scam artist who has ripped off my grad school plan to get rich. I will admit there are some differences.

My plan was to be infomercial based and feature has-been b-list celebrities touting the utter joy to be had by my product. Its 100% biodegradable. It produces zero carbon emissions. It arrives immediately. I comes with a lifetime warrantee. It will never break. It will never chip. It is utterly indestructible.

You can take it anywhere and it goes with everything you own. Its pet friendly, kid friendly, hypoallergenic, and gluten-free. It requires absolutely no maintenance and is a snap to clean.

You literally buy it and forget it. You simply have never had another product like it.

All you have to do is call click now!

Yglesias says that TARP exposed the myth of “the Natural Free Market”  I guess the few short years I’ve been in the tower have already messed me up because I didn’t even know this myth was out there.

Who doesn’t defend at least a night watchmen state? Are there some people really pushing free banking? I thought Murray Rothbard died like 15 years ago.


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Tyler Cowen points to Roger Scruton’s new book, “The Uses of Pessimism: And the Danger of False Hope”

I’ve been toying with a book idea that in my mind I call “Beyond All Hope: Passion, Rationality and the Fate of Humanity”

So, naturally, I was intrigued. The publisher’s clip states

Ranging widely over human history and culture, from ancient Greece to the current global economic downturn, Scruton makes a counterintuitive yet persuasive case that optimists and idealists — with their ignorance about the truths of human nature and human society, and their naive hopes about what can be changed — have wrought havoc for centuries.

Scruton’s argument is nuanced, however, and his preference for pessimism is not a dark view of human nature; rather his is a ‘hopeful pessimism’ which urges that instead of utopian efforts to reform human society or human nature, we focus on the only reform that we can truly master — the improvement of ourselves through the cultivation of our better instincts.

You had me at “wrought havoc for centuries”

Though, I am still intrigued because I don’t know if our senses of the world align in the final sentence of the description where it says

we focus on the only reform that we can truly master — the improvement of ourselves through the cultivation of our better instincts.

Off the cuff that sounds like the most naively optimistic statement of them all. Institutions, traditions and direct action, I say. Man’s instincts are determined by forces well beyond our control.

Institutions. We want to indentify which institutions seem to be working and fight to protect them. We want to indentify which institutions are not working and expose them to thoughtful evolution. Think of small improvements that are not likely to be catastrophic. Try them and see how it goes. Some – I am not naming any names – might think a 4% inflation target falls into this camp.

Traditions. Here evolution comes best through cosmopolitanism. We expose a bunch of different traditions to one another and we let the most effective parts of each emerge as a meta-tradition. I would argue that this is the essence of the United States.

Direct Action. If while on a walk together, your friend falls a breaks her leg you are likely to be well aware of her suffering and what can be done to alleviate it. There are times when you will get it wrong, but operating one-on-one, human-to-human you cut down on the chance for both false hope and misguided overreach.

To wit, if you really care about the suffering of Bangladeshis then you need to move to Bangladesh. Talk to the people on the street. What do they need right now, today? Are they thirsty? Bring them water. Are they hungry? Help them look for food? You can help a lot of people this way and you don’t have to worry that you mistakenly broke the entire global water and food distribution system.

Lastly, at least in my use of the term, there is nothing contradictory about being a Pessimist and a Millman Progressive – one who thinks humanity’s best days are yet to come.

Pessimism is simply the idea that most things go wrong, that most ideas are bad ideas, and all stories in the long-run have tragic endings. Yet, I can believe this and still have confidence in the march of progress.

Every summer in the wooded park near my house millions of baby spiders emerge from egg sacks.


Within days most of them will be dead. Within two years every last one of them will be dead.

Their story only has one ending.

For most of them it will come swiftly, coldly and brutally. I see the reality of this every summer and it makes me a spider pessimist. There is little anyone could do to change their fate.

Nevertheless, year-after-year in early spring the most beautifully intricate spider creations can be found littered throughout the park.


These creations don’t come about inspite of the mass death and brutally short lives these spiders face. These creations come about because of the mass death and short lives. This is evolution and it’s tragedy and beauty are one.

I have pursued with gusto the explanation that the current crisis is the result of a rapid decline in credit that came in the wake of the failure of structured debt.

To recap briefly, my view of the world sees the run-up and collapse of housing prices as somewhat coincidental to a general explosion and then implosion in the availability of credit. We thought we had this great tool available called Structured Finance that was going to revolutionize everything – we were wrong.

To make matters worse the magnitude of the credit crunch was so large and inflation was already so low that there was no way the Fed could offset the crisis using traditional monetary policy. Thus our standard way of stabilizing the macroeconomy – a way that had worked well since the early 80s – broke down.

Suppose I am wrong.

What are the alternate explanations? Why would would things change so quickly, so all of a sudden. In particular how can we explain this


This is the log growth of both Disposable Income and Consumption on Goods. As you can see there is a huge check mark in the growth a goods consumption. A sudden downdraft that is not obviously correlated with changes in income.

Moreover, it doesn’t seem immediately obvious that our expectations about income changed because the slope – and hence on a log chart, growth rate – of disposable income is roughly the constant over the last 25 –30 years and hasn’t altered much even in the wake of the crisis.

Yet, the trend of in the buying of physical goods seems to have jumped to a new level. Put another way, what is our alternate explanation for the drops in both durable consumption and inflation. Co-movement between the two is a long standing trend.


The chart above is durable good consumption as a fraction of disposable personal income and growth in the GDP deflator. I chose the deflator as an inflation measure only because its readily available as a quarterly series.

If we give up the idea that the Great Recession is a credit/monetary phenomenon then do we have to give up the idea that money and credit drive the inflation rate?

I’m only kidding, but Bryan has responded to my challenge for him to provide a conceivable story where more vouchers and charter schools lead to an education system that is more “statist” than the status quo, and I’m afraid his reply raises more questions than it answers. Here is his story:

Once vouchers create a massive industry that is almost entirely dependent on vouchers, the industry incessantly propagandizes and lobbies for ever-larger subsidies?  Public schools, teachers’ unions, etc. already do this, of course.  But I’m worried that the private sector’s public and government relations would be slicker and more energetic.

This is not an implausible story. But it sounds like a ringing endorsement for pushing for more choice. If the only blowback that occurs comes after reform has been more successful than anyone would dream, then I would say Bryan’s precautions about pushing for choice are not important here. This is like telling a kid it’s not worth trying to be an astronaut when he grows because he’ll be bored on the moon. “What? So the only possible downside to trying occurs once I’m on the moon and have succeeded beyond my wildest dreams?”

Even if Bryan’s right it’s not too much blowback if you ask me. If you don’t educate your youth properly you end up paying for it later with higher crime rates, lower human capital, and expensive government efforts to fix these things. So I wouldn’t mind spending too much money on an effective school system rather than just the right amount of money on an ineffective one.

In the end Bryan recognizes his “blowback” scenario would be an improvement over the current system and summarizes his position, thusly:

Given a choice between choice and the status quo, I’d still probably choose choice.  But given a choice between choice and austerity, austerity’s the way to go.

I’m glad to see Bryan agreeing at least that more choice and free market reforms are good things, which is a healthy step back from his suspicion that “‘constructive’ free-market reforms like Social Security privatization, school choice, Medicare vouchers, etc. are largely a waste of libertarians’ political capital.” If austerity isn’t on the table and choice is much more likely to succeed, than it’s not a waste of political capital to push for something that Bryan agrees is better than the status quo and won’t result in any blowback until it has succeeded far beyond any reformer’s dreams.

An interesting implication is that if Bryan prefers austerity over choice then surely he must be willing to buy austerity at the cost of choice, which sounds more like Ezra Klein that Bryan Caplan and, yes, just a little bit like a socialist. Would Bryan be willing to accept a completely government run disbursement of food for the poor in exchange for a 10% decrease in food stamps? Shouldn’t he also support a public option for health care? Would he sacrifice all existing charter schools, which only account for 3% of students in the U.S., for a 3% decrease in public school spending? In what programs would he be willing to trade less choice for more austerity?

Overall I think Bryan needs to walk his claim back even further and state that sometimes austerity is better than choice, but sometimes choice is better than austerity.

In a fairly textbook recession (adverse shock to aggregate demand), demand for money increases, while demand for everything else produced in the economy decreases. This raises the real value of money, producing the macroeconomic dislocations resulting from what is popularly known as “price stickiness”. This phenomenon is similarly true (perhaps even more-so) within the labor market. An increase in demand for money reduces the demand for labor, which increases the quantity (and thus average quality) of labor available.

Nick Rowe noticed this phenomenon in the popular small business survey chart that is running around the blogosphere. He then said that if he were more technically capable, he would produce a graph of “poor sales minus labor quality”. I was going to produce one for him, but luckily I found this in the report:

[Click Image to Enlarge]

There is such a stark inverse relationship between the two answers that a separate index is hardly necessary (although I took the liberty of coloring the chart myself). As you will notice, taxes are always a favorite, and since the start of the Great Moderation, interest rates have hardly been of concern — which one would expect from the smoothing of business cycles and increases in foreign exchange.

The blogosphere has jumped on the Small Business Survey. This warms my heart as it demonstrates that economists and blogopundits from all schools of thought regard empirical fact as supreme. In addition, it shows how what enormous returns there are from producing and distributing informative charts.

This is by my count an enormous potential value add from the blogosphere. Excel gurus take note. Play with enough data and sooner or later someone will pick it up.

All that having been said, I think there is some confusion among my libertarian friends. Russ Roberts and Tyler Cowen for example have noted that the Small Business Survey data could just as easily be used to argue that we need lower business taxes and less government regulation. You’ll get no argument from me on that point.

Still the argument over whether Aggregate Demand is at the heart of this recession should not be confused for the argument over whether big government is a good or an ill.

There might be some who want to use pumping-up Aggregate Demand as a reason to expand government. There might be some who are afraid that efforts to increase Aggregate Demand will lead to bigger government. However, the question of whether or not increasing Aggregate Demand will decrease unemployment is an empirical question fundamentally independent of your personal political philosophy. Either it will work or it will not. This is a fact determined by the nature of economy itself, not by our opinions about the socioeconomic ideal.

I don’t want us to lose sight of the goal of understanding and alleviating unemployment because we are too busy arguing over the moral good of stimulus. You don’t like government spending for reasons X, Y and Z? Fine, I’ll take a payroll tax holiday. You’re afraid of the deficit? Fine, I’ll take an increase in the target inflation rate.

My goal here is to find jobs for those people who say they are ready and willing to work but cannot find work. Compared to that, the argument over the size of government is second order at best. I often steal Tobin’s quip that it takes a heap of Harberger Triangles to fill an Okun’s Gap, but I am deadly serious.

There are few more heartbreaking, more disastrous economic calamities than observing men without machines at the very moment there are machines without men. If we can find some way to combine this capital and labor, some way to make productive good out of the resources that are currently sitting idle, then I am all for it.

Arguments about the size of government can wait.

This is no time to be coy. If you don’t think any of these ideas will work then tell me why and tell what if anything you think will work. If you do think any of these ideas will work then yell from the rooftops in the hopes that someone may hear us.

This isn’t a final exam question. This isn’t a faculty seminar. These are real people. They need real solutions. If we are not here to provide those solutions then what are we doing with our lives and why are the people of this nation giving us money?

Even the Daily Caller admits that France is not utterly devoid of motivating incentives.


I post this jokingly but the core point is somewhat sincere. In all societies there are winner-take-all goods and spouse selection is a nontrivial one. Hence, there are significant returns to being rank-order successful and generally well thought of, irrespective of the marginal return on labor.

The St. Louis Fed website is getting better everyday.


I’ve been downloading data from there for years but I can now produce usable charts, maps and even small scale analysis on the fly. The power of this is enormous.

If you don’t know the website check it out.

If you do drop them a line to tell them what good job they are doing.

There is a strong case for the prompt enactment of further timely, targeted and temporary fiscal stimulus…

Larry Summers, 2008

Remember when stimulus was supposed to be temporary, targeted, and timely? The departure from that notion by those calling for short-term austerity has been recognized and ridiculed. But there are those calling for long-term commitments and programs which are just as far afield from ideal stimulus. To wit, Michael Lind  Policy Director at the New America Foundation, calling for permanent increases in the public sector and, yes, a new entitlement program for seniors.

One solution would be direct, permanent expansion of public sector employment in “quality of life” jobs like teaching, child care, public health care, and policing….

…Many democracies in Europe and Asia have had successful experiences with vouchers provided to individuals for in-home services. My colleague at the New America Foundation Lauren Damme and I have proposed a Dignity Voucher program along these lines. Qualified retirees would receive vouchers entitling them to a certain number of hours of in-home help each week.

I’d first like to point out that this is exactly the opposite of what you want in countercyclical stimulus. It’s untargeted, untimely, and permanent. At most you could defend targeted, but “make more teachers, police, and health care workers” isn’t even a very targeted goal, let alone the vast and disparate array of policies necessary to actually accomplish that.  You want to argue that we could get this done quickly? Take another look what he has in mind:

Many of these victims of the Great Recession have limited skills and were employed in low-wage jobs in the luxury sectors like restaurants and retail that catered to the big spenders of the bubble economy. The goal of public policy should be to directly and indirectly provide jobs for many of these workers in service sector jobs that address the needs of mainstream Americans, like health care and education, rather than return them to dead-end menial service jobs where they will work again for the affluent.

Your not going to turn waiters and GAP cashiers into radiologists and teachers overnight. This is going to take a long time.

I understand the need to plan for the long-term health of the economy, but unlike infrastructure spending these suggestions can’t be defended by appealing to long-term growth. Instead, this is a straight up plan for a larger, more redistributive government. One of the biggest problems today is that in the long-run we can’t afford the level of government, and in the short-run we can’t afford to cut back on spending or raise taxes. A slowly rolled out, permanent increase in government payrolls and entitlements doesn’t help either, and will probably make both worse. I mean this guys is seriously arguing for another entitlement program for senior citizens. He’s actually saying this.

Arnold Kling writes

Keynesians think of economic activity as spending in the first place. You measure economic activity as spending by households plus spending by businesses plus spending by government, and then you net out imports and add in exports.

Suppose that we all work at the GDP factory making GDP. Unfortunately, spending is down, so some of us are laid off. The difference between the amount of GDP that the GDP factory could produce using all of us and the amount that is actually demanded is called the Output Gap.

The Output Gap looks like a $20 bill that is being left on the sidewalk. If somebody would just increase spending, it would help close the Output Gap, raising GDP and lowering unemployment. Stimulus certainly must work.

I am not comfortable with the GDP factory picture. We are not all interchangeable inputs producing the identical output. To me, economic activity is patterns of sustainable specialization and trade (PSST). Economic activity takes place only because we produce different things.

There are a lot of smart and clever things that can be said about patterns of sustainable specialization and trade. Arnold being clever and smart says many of them. However, the important question, the only question at the end of the day, is whether or not those smart things accord with cold physical reality.

Using MS Paint, I am going to horribly abuse this chart from Catherine Rampbell  to make a quick and dirty point.


It shows what small businesses answer as their single most important problem. As we can see that taxes and government regulation are perennial favorites. However, I want to isolate Poor Sales. I apologize in advance for the quality.


Lets match this against unemployment.


Unemployment rises when small businesses think sales are the biggest problem and fall when they think everything else is a big problem.

That is, of all the detriments to developing patterns of sustainable specialization and trade – and hence driving down unemployment – the ease at which businesses can sell stuff eats up most of the variance.

There are lots of clever ideas but the one that seems to accord with the data is pretty simple: business hire more workers when sales are good. They don’t when sales are bad.

So I got a call from Ben Smith prior to this article coming out. What I delivered into the phone was likely a barely intelligible rant, which explains why none of my brilliant insights show up as quotes in Ben’s piece.

However let me say this:

A) Read Ben’s piece its pretty good

B) If no one else will defend TARP, I will defend it. I will defend it through any medium, at anytime, under any circumstances. I will be the lone voice in a town hall full of Ron Paul supporters. I will say it at a Code Pink Regional Conference.  I will not let this go.

There are few moments when I have shed a tear over policy. Despite initial missteps what I saw was lawmakers coming together in the face of overwhelming public opposition to protect the future of our society. It made me more confident in our government than any other single event I have ever experienced.

Say a machine is invented that allows one individual to transfer years-of-life to another individual. Should people be allowed to buy and sell their years-of-life or should these exchanges be outlawed?

If your answer is yes, picture the cults that would arise with the sole purpose of breeding and brainwashing people so that they give life-years to their now immortal Leader.

If you’re answer is no, then does the morality of kidney exchanges hinge on the evidence that donating a kidney doesn’t lower life expectancy? As far as I know randomized studies on this have never been done, and the selection bias and unobservables here seems potentially insurmountable. If these results were overturned by a  randomized trial, how many kidney exchange supporters switch positions?

I do support kidney exchanges, but I also don’t have good answers to these questions.

There is always a temporary tradeoff between unemployment and inflation; there is no permanent tradeoff. The temporary tradeoff comes not from inflation per se, but from unanticipated inflation, which generally means, from a rising rate of inflation.

~ Milton Friedman, The Role of Monetary Policy

We can discuss whether there is any sort of permanent trade-off later but for now lets look at the temporary one. The chart below is shows the percentage of small businesses raising or lowering prices. It comes from the NFIB Small Business Economic Trends Report.

One of these periods is not like the others. Can you spot it?


To be fair, the current period isn’t completely different from all the others. We can see mini-versions in 2002 and in 92. What did those periods have in common with today.


Sharp dives in the number of businesses raising prices is coincident with rising unemployment. In particular a large gap between what is really happening and what business say they are planning is also associated with increases in unemployment.


We can see a similar pattern in credit conditions. Though here credit changes lead changes in unemployment.


Interestingly,  there seems to be a decent correspondence between credit conditions and the level of unemployment, not just the change.

Here is the thing that really stays with me. All of this is survey data. We are asking people. People lie. People are biased. People don’t understand the question. All of these are inherently noisy indicators of what is going on, but they tell a consistent story: tight credit leads to higher unemployment and lower pricing power.

Where’s the mismatch?

I can’t resist pointing out that these charts also display optimism bias. Business always plan to raise prices more than they actually do. They also display nostalgia bias. Credit conditions were almost always better in the past than today. Yet, even with those common biases on display the trend story comes through.


it is hard to see how the Fed can do much to cure this [worker mismatch] problem. Monetary stimulus has provided conditions so that manufacturing plants want to hire new workers. But the Fed does not have a means to transform construction workers into manufacturing workers.

~Narayan Kocherlakota, Minneapolis Fed President

Does Kocherlakota think monetary stimulus can do anything about nominal retail sales?  Because by my eye we are still below our pre-recession peak.


Call me old school but I tend to think businesses look for new workers when they intend to produce more product. There is not a lot of incentive to do that when you are moving less product than you were two years ago.  And, that’s before we think about the productivity gains that have occurred over the last two years.

More hiring will only occur when there are more real sales, which means that either nominal spending will go up or prices will go down. Right now it looks like the Fed is choosing the “prices will go down” strategy. In a world with nominal wage rigidities that involves a lot of pain.


Andrew Sullivan defends Obama from charges that, among other thins, he used the economic crisis to get “more protections for unions”:

…[About] protection for unions. Again, there is no card-check legislation. It was not a priority. It was not snuck into the stimulus package.

I agree with Sullivan that Obama has not done everything he could to help unions, and he’s accomplished some thing despite strong union opposition, including parts of Race To The Top. Surely, at the very least President John Edwards would have been many times worse.

However, I do think that the stimulus did suffer as a result of handouts to unions in the form of the prevailing wage provision. This is the part of the Recovery Act that requires that any construction project funded by stimulus must comply with Davis-Bacon. This law prevents companies from areas where labor costs are low from bidding on contracts based on wages they would be willing to pay. So a construction company from a poor county with high unemployment that can pay workers $20 an hour loses it’s competitive advantage when bidding on projects in a nearby high wage county where prevailing wages are $40 an hour. This distortion gives an unfair advantage to local companies, creates less jobs, and means money will be spent more inefficiently.

In addition to creating new programs subject to Davis-Bacon, the ARRA provision meant that many pre-existing programs that were previously exempt would need to comply now that they receive recovery funding. According to a GAO report there are 33 pre-existing programs that are newly subject to Davis-Bacon, and 7 new programs which must comply, 5 of which would not have had to comply under existing laws. In total, $102 billion of stimulus money will be spent in programs complying with Davis-Bacon, $43.7 billion of which would not have complied under existing law. (all but the Broadband Technology Opportunities Program and the State Fiscal Stabilization Fund).

According to that same GAO report, 20% of the 40 new or newly compliant programs indicated that the prevailing wages portion of Davis-Bacon would have a modereate or large impact on program costs, and 32.5% said the same about the act’s administrative restrictions. In addition, 20% indicated that complying would delay the timing of stimulus spending.

One specific example is the Department of Energy’s Weatherization Assistance Program, which has existed since 1976 and has never had to comply with Davis-Bacon. Despite it’s pre-existing status this program was unable to spend it’s funds quickly because of Davis-Bacon compliance.

On top of these problems the actual products and services provided may suffer. For instance, the Washington D.C. Lead Hazard Reduction program stated that they would be able to treat less homes as a result of higher costs of complying.

There isn’t any economic reason for such a provision in the stimulus, and the only purpose is to please labor unions. Maybe he had no choice politically, and maybe this was pretty much up to congress, but this is a pro-union component of the stimulus that happened under his watch, and it’s worth noting.

Bryan Caplan wonders whether any movement towards more liberalized government services will counterintuitively lead to more statism in the long-run. Here is the mechanism he pictures:

1. If anything goes wrong, the market will receive all the blame.  The political backlash could easily lead to policies more statist than ever.

2. In practice, the government will never implement a transparent free-market reform.  Even an idea as simple as “give people the freedom to invest their own payroll taxes in a private account” will quickly morph into a kilo-page Congressional boondoggle.  This further increases the chance that somethingwill go wrong.  And when it does, the market will take all the heat.

I find plausible his speculation that privatizing social security could lead to policies intended to prop up the stock market, like TARP x 100. However, I have a hard time imagining how more school choice could backfire in a way that leads to more a more “statist” education system, another example that he gives.

One possibility is that states will be too lenient in the kind of schools are allowed to receive vouchers and students end up signing up for “virtual school” en masse. This in turn could lead to federal involvement in state education policy in an attempt to enforce standards. But these days organizations that oppose education reforms seem to be more powerful at the state and local level than the federal level. This means that, as it did with Race To The Top, more federal involvement seems just as likely to result in education reforms that move away from rather than towards a more “statist” education system.

My challenge for Bryan is this: tell me a conceivable story where more vouchers and charter schools lead to some sort of blowback that results in an education system that is more “statist” than the status quo.

One final interesting point is to note that this theory is a direct challenge to Tyler Cowen’s Marginal Revolution, where marginal steps in the right direction -and frequently free market ones- are all we have. I would be interested to see a response from Tyler on this.

It is an essential reform. So it is normal for it to trigger concerns and significant strike action, as was the case yesterday.

Hat Tip: Yglesias

On the ground there is a widespread sense that the self-identified libertarian world is split between those trying to convince conservatives to embrace cosmopolitan values and those trying to convince liberals to embrace market mechanisms.

Pew illustrates the dichotomy through the lens of TV news


Libertarians read the Wall Street Journal and watch Stephen Colbert regularly mock the free market. They listen to Glenn Beck and watch John Stewart’s Glenn Beck impersonations.

It would be nice to believe that its the same people splitting their attention but I am inclined to believe it is the libertarian world that is split.

As a side note the Quantcast says that 40% of the readers of this blog are over 50 which was surprising and that over a third have graduate degrees, not as surprising.


Though Pew suggests that older readership is not as unusual for political/policy sites as one might have thought


There is a lot more interesting stuff in this report that hopefully we’ll get to digest over the next couple of days.

A common perception is that people who hire illegal immigrants are necessarily exploiting them with below minimum wage pay and horrible working conditions. The story I linked to yesterday about the effects of illegal immigration crackdowns on some restaurants serves as a useful reminder that this need not be the case:

Mr. Malecot is an active philanthropist in San Diego, contributing to causes including Alzheimer’s and cancer research and education to help victims of torture. His employees describe him as a father figure who has paid for their dental work and babysitting, charters a fishing boat for the annual company party and provides every employee with a week’s paid vacation, extremely rare in restaurants.

Because of his financial troubles as a result of the case, he said, he can no longer afford some of these perks. The next court date is Nov. 29.

“He’s very generous,” Asunción Gallardo, a Mexican immigrant who has cooked at the restaurant for 16 years, said in Spanish, out of earshot of Mr. Malecot. “It’s like we’re all a family. We eat — he gives us three meals a day and food to go. And then he gives out food for the poor.”

People who favor crackdowns in illegal immigration often argue as if they are really looking out for the best interest of illegal immigrants, who are victims being exploited by greedy employers. And this may be true some of the time, but it is clearly not true all of the time. It is important to remember this when people try to overgeneralize about the working conditions faced by illegal immigrations in order to justify kicking them out.

Imagine if there were some productive input, say for example a source of energy, that was cheaper than all of the other alternatives and allowed many businesses to operate with lower costs. Say this productive input was also illegal, but did not cause any externalities. Would right now, in the midst of a terrible recession, be a good time to crack down on this illegal input that many businesses depended on? This is what the Obama administration is doing with their crackdown on illegal immigration, and it is hurting businesses.

A recent story from the New York Times highlights how economically damaging this can be to successful businesses. Michel Malecot, a restaurant owner, faces 30 years in prison, $4 million in fines, and the seizure of his assets for hiring illegal immigrants at his restaurant. The governments indictment is causing him serious economic distress:

Since the indictment, Mr. Malecot said, he has lost at least $500,000 in catering jobs. Catering accounts for about 70 percent of the French Gourmet’s revenues, which so far this year amount to roughly $4.5 million, Mr. Malecot said.

In an industry with that employs an estimated 500,000 illegal immigrants, Mr. Malecot is not alone:

In June, the owner of two Maryland restaurants who pleaded guilty to hiring and harboring illegal immigrants was ordered to forfeit to the government more than $700,000 in assets — in addition to his motorcycle — and faces up to 10 years in prison. In November, a restaurateur in Mississippi who had pleaded guilty to hiring illegal immigrants was sentenced to a year in prison and a year of supervised release. Combined fines in the case, shared among several defendants, amount to $600,000.

I understand the rule of law is important and all that, but is there some pressing reason why choose now, of all times, to crack down on illegal economic activity? Note this is not just Obama fighting illegal immigration as previous presidents have, but “[u]nder a policy that went into effect in April 2009, the Obama administration is taking a much tougher stance on employers who hire illegal immigrants than any administration in decades”.

Now would actually be a good time to be really lax with illegal immigration, not crack down on it. People seem to understand that limitations on international flows of capital, aka protectionism, is a bad idea in a recession. This is true of international flows of labor as well: preventing labor from moving to it’s highest use will reduce global economic growth.

Let me try to rephrase me previous post to make the point more clearly, and -taking off my William Jennings Bryan hat- with less populist righteousness.  Cost-of-living measures attempt to look at quality adjusted price changes. When the rents in a given city increase, the housing portion of the CPI goes up and by that measure so has the cost of living. But this increase can simply reflect the positive amenity value of the city going up; less crime, better parks, etc. If you really wanted to do quality-controlled measure of cost-of-living you would control for the fact that higher priced cities reflect higher amenity values.

So when people say well $250k isn’t a lot when you look at the cost of living in that area, that higher cost of living does not reflect complete controls for quality but in fact measures the higher amenity value of the city. This is just consuming a better, and so more expensive good.

I’m not very sympathetic to the argument that $250,000 doesn’t make you rich if you live somewhere where cost of living expenses are high. Spending your large income on expensive shit doesn’t make you not rich, it makes you someone with the privilege to buy expensive shit and choosing to do so. Living in the most expensive places in the country isn’t some natural expense you’re burdened with like a disability or disease: it’s a choice about how to spend your money.

If someone making $250,000 doesn’t feel rich in Manhattan then they can just move to Queens and feel rich. In fact in most cities there are neighborhoods with really expensive homes less than a mile from neighborhoods with really cheap homes. It would be nonsense for someone living in a $2,000 a month condo they can barely afford and shopping at the expensive local grocery store to say they aren’t rich because their costs are high relative to their $70,000 a year income. They’re simply consuming an expensive neighborhood as an amenity to their home. Note this can be true at the county level as well.

Whether you’re rich or not isn’t a state of mind, nor is it what you spend your money on: it’s a summary statistic. If you make more than 95% of the population you’re rich, even if you don’t feel rich because you’ve spent it all on gold dust to sprinkle on every meal…. Oh, and saying you don’t feel rich when you make $250,000 a year doesn’t just not make you less rich, it also makes you kind of an asshole.

Pictured: £12,000 chocolate cake laced with gold, which is most expensive dessert in the world.

Yesterday I posted about Castro’s sudden change-of-heart regarding communism in Cuba, within the confines of criticizing the characterization of big government as the problem that plagues Cuba.

However, today we learn that Castro remains unrepentant:

Since July 2006, when serious intestinal illness nearly killed Fidel Castro and forced him to cede power to Raul, Cuba has implemented reforms such as allowing the unrestricted sale of cell phones, privatizing some state-run barbershops, licensing more private taxis and distributing fallow government land to private farmers in hopes they could put it to better use.

Still, Cuba’s former “Maximum Leader” maintained Friday that wasn’t what he meant at all.

My idea, as the whole world knows, is that the capitalist system no long works — neither for the United States nor the world, which it steers from crisis to crisis, which are ever more serious, global and repetitive, and from which there is no escape,” Castro said. “How could such a system work for a socialist country like Cuba?

Sadly, it is not the Castro’s who will suffer for their idiocy. However, the United States has not helped matters by allowing the US-Cuban embargo to stand for 50 years. Isolating these types of ideas allows them to incubate, and become more resonant. It gives people like Castro and Chavez an enemy to point to. Liberalizing trade with Cuba would go further than any other action in speeding up the opening of markets in Cuba, and benefiting the Cuban people.

So lets start with US policy.

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.

Does education really teach you anything or is it just a status symbol that allows employers to sort individuals by pre-existing traits? Bryan Caplan has been debating this issue with his former professor, and now his coworker Tyler Cowen is joining in as well. All-in-all I find Cowen more persuasive, and think that for most countries, more education is probably better than less. However, I do want to question one aspect of his story. He argues that education allows people to reinforce their self-perceived characters in positive ways. Here is how he briefly puts it in his debate with Caplan:

Signaling models are important but they are not the only effect and of course a lot of signaling is welfare-improving for reasons of screening and sorting and character reenforcement.

It is only quickly mentioned here, but discussed at greater length in his most recent book, Create Your Own Economy (retitled, expanded, and in paperback here). The story is that education creates a framing effect which allows people to have a more positive narrative about themselves that induces better behavior. People see themselves as a college educated person, which makes them behave as they perceive college educated people to behave; perhaps reading more, working harder, attempting to be more cultured.

I completely agree with Cowen that the framing effect, or character reenforcement, of education is real. My problem with it is that it may be zero-sum, or even negative sum. It may be that the framing effect of college is simply to shed oneself of the burden of the negative framing effect of not going to college.

It is certainly a common refrain in TV, movies and yes, in real life, for non-graduates to explain some negative circumstance or inability to overcome a problem by saying “look, I didn’t go to college,” and then “I can’t…” or “I don’t…”, or some other restraint that fact places upon them. Absent such a framing effect they may believe their odds at achieving something are better, and so they would be willing to work harder at it.

One way to view this is that college sorts people into high-skilled and low-skilled pools, and then individuals perceive themselves as similar to their cohort. The perceived differences in the average skills of these pools is exaggerated because some of college is signaling, which allows those in the high-skilled pool to view themselves as higher skilled than they really are, and vice-versa for those in the low-skilled pool. For high-skilled people this induces positive behavior and for low-skilled this induces negative behavior.

This sorting would increase the disparity of outcomes between high-skilled and low-skilled individuals. Depending on the distribution of skills, a higher percent of the population going to college may increase the disparity in average skill levels between pools, and therefore the wider the disparity in framing effects. (Has this affect exacerbated growing income inequality?)

I’m completely prepared to change my mind about this, but as far as I can tell while it’s true that college creates framing effects and character reenforcement, it’s unclear whether the net effect of this is to induce overall better or worse behavior, and whether the positive effect on college graduates outweigh the negative effect on non-graduates.

As you can probably imagine, I was tickled pink today to learn that the progenitor of one of the most enduring communist dictatorships of our time has finally recanted, acknowledging that Cuba’s economy, largely owned and directed by the state (in absence of price mechanisms), is a failure:

HAVANA – Fidel Castro told a visiting American journalist that Cuba’s communist economic model doesn’t work, a rare comment on domestic affairs from a man who has conspicuously steered clear of local issues since stepping down four years ago.

Unfortunately, all I got out of the story is the nagging thought of how insane is Dan Mitchell? Why? Well, because Mitchell boils all of communism’s problems down to excessive government:

This chart, comparing inflation-adjusted per-capita GDP in Chile and Cuba, is a good illustration of the human cost of excessive government.

He goes on to show a chart of per-capita GDP growth between Chile and Cuba. As if Chile has been the model of restraint over the past few decades. Sure, Chile liberated it’s markets, but Pinochet was a disaster to every individual’s rights — something I’m assuming CATO still stands up for. Liberalization of markets is but one facet of how to analyze a society’s performance…and the question is certainly not about “small” vs “large” government, it’s about the smooth functioning of markets. Since markets exist within the confines of public institutions, it is worth a look at how to structure institutions as to best serve the goal of both economic growth and greater societal need (which are not necessarily mutually exclusive).

It is my inclination to view smaller government as the right level of government interaction with markets…but that’s a case-by-case thing. There are a few of places in the economy where I think heavy government intervention is warranted (like the application of law), and other places where I think it is not (like hair cuts). Just saying small government doesn’t do the job here. Yes, the communism that has plagued Cuba is a disaster, but that has nothing to do with the size of the Cuban government. The institutions which the Cuban government has set up are at odds with both human and economic development — they don’t work. Sure, the government should be scaled back in many ways — but that is still a question of how institutions should be structured, and not some anonymous specter of “big government”.

The Danish government is among the “largest” in the developed world, based on taxation as a fraction of GDP…and Denmark is also one of the most free-market countries on earth by multiple measures…and they continue to head in a more neo-liberal direction (i.e. cutting UI benefits in half).

The bottom line: Cuba’s problem is/has been communism as an institutional arrangment, not so much with the size of the government, per se.

Update: I softened my language in the bottom line, h/t to @jbarro.

That is the title of today’s Wall Street Journal Symposium [Gated]. And the overwhelming answer from preeminent monetary economists? Nothing.

Not that they didn’t answer the question. Most of the panelists’ answers amount to the Fed remaining passive. Here is John Talyor:

To establish Fed policy going forward, the best place to start is to consider what has worked in the past. During the two decades before the recent financial crisis, the Fed employed a reasonably rule-based strategy for adjusting the money supply and the interest rate. The interest rate rose by predictable amounts when inflation increased, and it fell by predictable amounts during recessions.

Fairly predictable. John Taylor has made this point numerous times, and is a very hard rules-based guy. I’m a rules-based guy as well…but I don’t see the inherent virtue in the Taylor rule, however defined. Essentially Taylor seems to want the Fed to stabilize NGDP growth around a Taylor rule at the current (reduced) output level, which puts us permanently behind the previous trend rate of output. As far as I can tell, he doesn’t care to make up the slack…which of course means elevated unemployment for an extended period of time.

Richard Fisher, who is a predictable hawk, lived up to expectations as well:

One might assume that with more than $1 trillion in excess bank reserves and significant amounts of cash held by businesses, the gas tank of those who have the capacity to hire is reasonably full. One might also conclude that the Fed, having cut the cost of interbank overnight lending to near zero and used quantitative easing to coax the entire yield curve downward, has driven the cost of gas to virtually nil for businesses that are creditworthy. And yet businesses still aren’t hiring.

This is a mind-bogglingly insane statement. When suffering an immediate deficiency of aggregate demand, supply-side factors are second order. Yes, we should streamline regulatory hurdles…but that has nothing to do with why firms aren’t hiring. Fisher must have missed a lot of economics, and apparently doesn’t understand that demand for safe assets (which in developed countries equates to cash) drives most recessions (especially during a time where there is a lack of supply of safe [private] assets), and that the Fed decided to pay banks to hoard cash…and so they did. I’m having a hard time figuring out how Fisher landed his current position.

On to the most depressing, Frederic Mishkin:

Purchasing long-term Treasurys might suggest that the Fed is accommodating the fiscal authorities by monetizing the debt—thereby weakening the government’s incentives to come to grips with our long-term fiscal problems. In addition, major holdings of long-term securities expose the Fed’s balance sheet to potentially large losses if interest rates rise.

Such losses would result in severe criticism of the Fed and a weakening of its independence. Both the weakening of its independence and the perception that the Fed is willing to monetize the debt could lead to increased expectations for inflation sometime in the future. That would make it much harder for the Fed to contain inflation and promote a healthy economy.

Expanding the Fed’s balance sheet through large-scale asset purchases can be necessary in extraordinary circumstances, such as during the depths of the recent financial crisis. But in relatively normal times, the costs of using this tool are sufficiently high that it should not be used lightly.

9.5% unemployment, falling CPI and inflation expectations, and exploding national debt due to the political anxiety to “do something” is now ‘normal times’? This amounts to saying that the Fed has the tools, but shouldn’t use them unless we’re in the Great Depression. The Fed’s job is to keep us out of financial panics like the Great Depression, not make its job significantly harder by passively waiting until the depths of the abyss, and then acting. I don’t agree with that at all.

I don’t really know anything about Robert McKinnon, but he is worried about international currency flows, asset bubbles in China, and thinks that the Fed should mediate interbank lending to stabilize the yield curve at “normal interest rates”. I’m fairly confident that China can sterilize any dollar inflows that happen upon its shores…so I don’t see this as a problem that needs to be addressed by anyone but Chinese policymakers, and I happen to think that the Fed should be much more aggressive than stabilizing yield curves AAAAAND raising interest rates now is, of course, insane punditry. Apparently so does the Vincent Reinhart believes the Fed should be more aggressive as well:

As a consequence, the Fed has to be both aggressive and nimble. The Fed should promise to purchase government and mortgage-related securities between its regularly scheduled meetings as long as activity is forecast to be subpar and inflation is low or headed down. Purchases of, say, $100 billion every six-to-eight weeks would add up to a number worthy of shock and awe for those with a somber economic outlook.

All-in-all a very depressing symposium. They should have interviewed Scott Sumner, Bill Woolsey, David Beckworth, Nick Rowe, and Paul Krugman. Then, perhaps, the world could be saved.

Update: Beckworth seems to have beaten me to the punch, linking to Mark Thoma, who did as well…a

James Kwak and I will agree on one thing with respect to his recent post: people who have taken econ 101 will tend to believe that price gouging in a disaster is a good thing. Where Kwak and I disagree is whether price gouging actually is a good thing. Here is how he lays out his case:

…the Econ 101 argument is that raising the price allocates the shovels to people who will derive more utility from them (because they will pay more), thereby increasing social welfare.

But this rests on a huge assumption: that willingness to pay is the same as utility. Unfortunately, however, this assumption fails in the real world; poor people simply can’t pay as much for snow shovels as rich people, and as a result a price increase will allocate shovels to rich people, not to those who need them the most.

James concedes that he doesn’t think “there is a perfect way to allocate the shovels, just that using price isn’t perfect, and does have inequality effects”. Since we can’t directly measure utility, and willingness to pay is just our proxy for it, no it’s not perfect. But it is the best way best possible way available to allocate scarce resources in this scenario. Notice James doesn’t just not offer a “perfect” alternative, he offers no other alternative that he believes will be better. Willingness to pay may not be a perfect measure of utility and to maximize social welfare, but it sure as shit is a better than first-come-first-serve.

If James is trying to play our innate sense of fairness against efficiency criteria he should have chosen a more compelling case. Am I really to believe that the $20 price of snow shovels is really pricing poor people out of the market and that they literally can’t pay for them? Because they could afford them at $15, right? Otherwise, the “price gouging” isn’t really an issue since poor people aren’t being priced out of the market.

I mean if he was talking about how we allocate the seats on the last spaceship off of earth before an asteroid destroys it, then yeah, we get into some serious moral issues where simply allowing markets to determine who gets the seats would give us an outcome that would really seem wrong.

But $20 snow shovels when the price is normally $15? I think that’s probably both efficient and fair. And the fact of the matter is that in the real world this is where most supposed “price gouging” happens, for smaller priced items like water and gasoline. The slight inequality that results from these dozens of dollars is far outweighed by preventing people who value these goods little from hoarding and overusing them simply because they got there first.

One other point is that Kwak may be right that “In this case, supply is fixed in the short term, so raising the price won’t increase supply”, but if you allow prices to rise, then it gives stores more incentive to overstock their shelves the next time they anticipate a snow storm. If you prevent them from raising prices, then they won’t have incentive to overstock.

Price gouging is definitely econ 101 stuff, but it’s one case where econ 101 gets it right. Contrary to James point at the end that “public policy largely follows the dictates of Econ 101”, price gouging is one area Econ 101 conclusions don’t in fact determine public policy. According to this FTC report from 2006, 29 states and D.C. have laws preventing “price gouging” in gas and other commodities during supply disruptions. Clearly Econ 101 still has a long way to go if it’s going to win this one.

UPDATE: Eric Crampton writes in the comments: “Here in earthquakeland, there wasn’t any price gouging; stores predictably ran out of water, bread, batteries. Sigh”

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



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.

Both inspiration and devastation in this story from Smithsonian magazine:

“I’m very lucky to be alive,” Zéphirin told me late one afternoon in the Monnin gallery, where he was putting the finishing touches on his tenth painting since the quake. “I was in a bar on the afternoon of the earthquake, having a beer. But I decided to leave the bar when people starting talking about politics. And I’m glad I left. The earthquake came just one minute later, and 40 people died inside that bar.”…

“That night, I decided I had to paint,” Zéphirin said. “So I took my candle and went to my studio on the beach. I saw a lot of death on the way. I stayed up drinking beer and painting all night. I wanted to paint something for the next generation, so they can know just what I had seen.”

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.

In an update to his popular post, which is causing some interesting commentary on Twitter, my co-blogger Karl Smith has this to say:

My argument is no, this isn’t just another bad experience. Its a failure of our most basic institutions and is leading to pure loss.

Indeed, I think that the wrong way to think about the problem of recessions is that there is a fundamental problem with market economies, or that recessions (no matter how deep) represent a market failure. To me, this recession (both the depth and length) is fairly clearly a monetary failure…and if you catch me on a bad day (or a good day, depending on your disposition I suppose), I’d even go as far as to claim that the type of money system we use makes our economies prone to the types of failures we have recently experienced. In fact, financial crises are not rare. The World Bank has identified 96 banking crises (large enough to cause economy-wie problems) and 176 monetary failures since the dismantling of the Bretton Woods in 1971.[1]

Even before the termination of gold convertibility, massive crashes were remarkably common the world over. From the Holland tulip mania to the Great Crash of 1929, these crashes have happened with frightening regularity. Being as these types of economic issues span countries, time periods, regulatory regimes, and degrees of economic development; I think that it is safe to say we should begin turning a inquiring eye toward the one system that permeates all of these societies throughout time and location.

That, of course, is the type of money we use, the characteristics of which have been replicated by nearly every society since the relinquishment of barter, and the dawn of what we would consider “modern money”. This recession is, of course, no different. An increase in the demand to hold safe assets (of which the medium of exchange is generally the safest, at least in developed economies) causes a disconnect between workers and factories. People and machines sit idle. Productive capacity dwindles, along with hours worked. Price and wage stickiness facilitates a real downward adjustment to market clearing rates to cause grinding deflation (or disinflation, which under a regime of positive trend inflation is similarly problematic).

Is there a bug inherent in the money system that is used the world over that causes these disconnects? I think that analyzing the dynamics of the flow of biomass through natural ecosystems can provide useful insights into how the money we use causes the economy (or sectors of the economy) to become brittle (too brittle to sustain?) and prone to failure.

[1]Caprio and Klingebiel, 1996

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?

There is a critical point that I fear the commentariat is just not getting. In my darker moments I fear that some of my fellow economists aren’t getting it either but we aren’t going to go there.

Look at these two graphs because they tell you the fundamental problem in America today:



We have very low capacity utilization (75%) and very high unemployment (10%).

That is, we have factories sitting idle for lack of workers – low capacity utilization. At the same time we have workers sitting idle for lack of factories – high unemployment.

There are machines waiting to be worked and people waiting to work them but they are not getting together. The labor market is failing to clear.

This is a fucking disaster.

Excuse my language, but you have to get that this is a big deal. This is not a big deal like the GOP doesn’t appreciate public goods. Or, Democrats don’t understand incentives. Or some other such second order debate that could reasonably concern us in different times.

This is a failure of our basic institutions of production. The job of the market is to bring together willing buyers with willing sellers in order to produce value. This is not happening and as a result literally trillions of dollars in value are not being produced.

Let me say that again because I think it fails to sink in – literally trillions of dollars in value are not being produced. Not misallocated. Not spent on programs you don’t approve of or distributed in tax cuts you don’t like. Trillions of dollars in value are not produced at all. Gone from the world entirely. Never to be had, by anyone, anywhere, at any time. Pure unadulterated loss.

Time and time again I see people speak about recessions as if they are a bad harvest – an unfortunate event wherein we have to figure out how to go with less. Some say we should all sacrifice – some say the sacrifice should be based on X or Y. Some say each family should take their lumps as they come.

However, they are all getting the basic idea wrong. This is not a bad harvest. The problem isn’t that there is less to go around. The problem is that we are creating less, building less, making less.

We have people who would be working but are instead watching Judge Judy. We have machines that could be spinning but are literally rusting for lack of use. This is a coordination disaster.

The question is how do we end this thing as quickly as possible. How do we stop wasting our basic resources (men and machines), day-after-day, month-after-month, year-after-year.

So when I hear this debate drift oft into how Republicans don’t appreciate the value of infrastructure – I suffer infinite eye roll. This is the time for this? You would watch the core economy grind down while you argue over the need to fix a pothole!

When I hear the GOP running some nonsense about how Obamacare is scaring small business I find myself beating back the desire for autodefenestration. Can we let this go already! There are real issues that need to be dealt with.

Now maybe some people want to explain to me how what appears to be a massive market failure is actually something else: a skill mismatch, a great recalculation, etc. I am willing to have that debate.

Of those that agree that this is the result of insufficient aggregate demand we can debate the fastest means of spurring such demand: aggressive monetary policy, payroll tax cuts, something else we haven’t thought of – I am all ears.

However, these are the limits of rational disagreement.

Side arguments that are basically proxy battles for your general theory of government are sadistic tribalistic grandstanding. You chatter and dawdle while Rome burns.

UPDATE: Savage Henry asks whether or not I am just pointing out that there is a recession and obviously recessions are a big deal.

My point is the extent to which a recession is a big deal.

Its often taken as a big deal in the simple sense that the experience of recession sucks. But, people say, there are lots of bad experiences and this is just one of them. Sometimes we have to suck it up.

My argument is no, this isn’t just another bad experience. Its a failure of our most basic institutions and is leading to pure loss.

It would be as if the door to your apartment was ripped off and heat was spilling out into the atmosphere and people said “Well you know sometimes you have deal with the cold, lets talk about the ideal size of an apartment. Big ones are draftier you know. No small ones cool down too quickly”

What! No! Lets fix the fucking door. Do you understand: the door is missing. This is not the time to argue about ideal apartment size, this is the time to keep our heat from spilling out purposelessly.

Bob Wright often argues that the evolution of life on Earth looks a whole lot like the product of design.

. . .  biologists agree that a strictly physical system or process—whose workings can be wholly explained in material terms—can have such extraordinary characteristics that it is fair to posit some special creative force as its source and ask about the nature of that force. Darwin inquired into the creative force behind plants and animals, and his answer was evolution. Surely the believer is entitled to ask the same question about evolution: Where did the amazing algorithm of natural selection come from?

Such a believer, by the way, would not here be making an argument for “intelligent design,” the idea that natural selection isn’t adequate to account for human evolution. On the contrary, the idea here is that natural selection is such a powerful mechanism that its origin demands a special explanation; that evolution by natural selection has patterns and properties every bit as extraordinary as an animal’s maturation toward functional integration.

A lot of commentators tend to dismiss this out of hand, but I think that’s too quick. Bob asks an interesting question and one that cannot be as easily dismissed by Occam’s Razor as you might be tempted to think.

For Bob is not saying that we should believe that there is a creator because evolution begs for an explanation. This would indeed violate the principle of parsimony. Bob is suggesting that we should wonder if there is a creator. That is,  he says: the majesty of evolution suggests we should attempt to accumulate more evidence. On the surface this seems highly appropriate.

The reason I am unenthusiastic about such a project is that unlike the mere existence of animal maturation, our evolution does carry with it, its own reason for existing. In short, for there to have never been evolution at all it must have been that case that no sustainable self-replicators were ever created anywhere in the universe. That seems in-and-of-itself implausible.

Once you have any sustainable self-replicator of any sort some, the process of evolution and natural selection is inevitable. Once that is the case you will get the features of maturation Bob is so enthralled by. The apparent majesty of evolutionary maturation is reduced to the existence of some self-replicator.

Now when we ask ourselves: how likely is it that some random assemblage of molecules would form a sustainable self-replicator. It seems quite likely. Indeed, it strikes us as so likely that the deeper mystery might be why the universe isn’t tiled over with self-replicators of all sorts. Why is so much of space apparently dead?

Indeed, as far as we know, we – as in Earth originating life – are the only ones. Now, perhaps this means that we are seriously underestimating the difficulty of making a sustainable self-replicator. However, the question is: why is evolution so much harder than it seems. Not: isn’t evolution so hard that it needs some outside explanation.

Megan McArdle doubts that we could have possibly had a stimulus big enough to restore full employment

How much unemployment reduction you get for a given amount of stimulus spending is, obviously, at best an imperfect estimation. But let’s take the CBO’s estimates as representing a rough consensus of those who favor stimulus:  for our $800 billion, we got a reduction of 0.7 to 1.8 percentage points.

Full employment is perhaps 4.5-5%.  If we assume that stimulus benefits increase linearly, that means we would have needed a stimulus of, on the low end, $2.5 trillion.  On the high end, it would have been in the $4-5 trillion range.

Importantly, however, even to date not all stimulus funds have been spent. Propublica, estimates that only $289 Billion of the spending dollars have gone out and only $223 Billion in tax cuts have gone out since ARRA passed nearly a year and half ago.

This is why I initially argued against spending as stimulus and instead for a full payroll tax holiday. I didn’t dispute the basic model predictions that spending multipliers tend to be bigger than tax cut multipliers.  It is just a lot harder to spend a bunch of money than to give a huge immediate tax break to working Americans and those that employ them.

The US economy was roughly $13 Trillion when we went into recession. At the worst we were shrinking at a rate of 6% annually. Full employment requires lets say 3% annual growth. That makes for a 9% swing or $1.17 Trillion in missing annual economic spending.

Mark Zandi gives an estimate of 1.29 as a multiplier on payroll tax cuts. OMB says the government collected $891 Billion, in payroll taxes in 2009. Back of the envelope then suggests that a payroll tax holiday would have produced $1.15 Trillion in additional spending – essentially the entire amount needed to cover the gap.

The key difference here is that is that payroll tax funds would have been spent nearly three times faster than the stimulus we actually got. At the current rate we were only stimulating a little over $300 Billion a year and nearly half of that was tax cuts.

The gain in multiplier effect from spending is simply dwarfed by the speed at which spending can be efficiently performed. Indeed, if you believe Zandi’s estimates that many of the tax cuts enacted as a part of ARRA had lower multipliers –  in some cases much lower –  than a payroll tax holiday then ARRA may have had no multiplier advantage at all. All we were looking at was a smaller, slower stimulus.

Note that this is argument doesn’t require you think that big government is bad for the economy or that tax cuts for the rich will stimulate entrepreneurship. We are merely analyzing the fastest way to get spending power into the hands of ordinary Americans. It seems clear to me that this was and has always been a payroll tax holiday.


Just to be clear, policy preference hiearchy:

1) Higher Inflation Target (and hence lower real rates)

2) Qualitative Easing (and hence easier credit)

3) Payroll Tax Stimulus (fast and fun!)

4) Other Stimulus (messy but better than nothing)

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