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There is a very interesting article at the Atlantic from David Just and Brian Wansink from the Cornell Center for Behavioral Economics in Child Nutrition Programs. They discuss their work on improving healthy eating in school cafeterias using the subtle wizardry of behavioral economics. There have been some impressive results:

One school in upstate New York was able to increase consumption of salads by close to 300 percent by simply moving their salad bar six feet from the wall and placing it near a natural bottleneck in the check-out line. Another school increased fruit sales by 105 percent by moving the apples and oranges from stainless steel bins into a well-lit and attractive basket.

It is encouraging to see behavioral economics being put into creative use like this. The authors argue that “It is difficult to teach a high school student how to make healthy choices in the real world if only escarole and tofu on are on the school lunch menu”. But is this teaching them to choose better or tricking them into choosing better? After all, if behavior is so amenable to subtle tricks like this then what hope can there be that any behavioral changes will actually last? I can’t tell if articles like this should make us more or less hopeful. Yes, the good scientists here are making a difference, but are we really so impressionable?

From the NYT

Nearly a quarter of South Korean men over 75 are still in the labor force, as are 14 percent of Japanese men. In the United States, a 10th of such men are working or seeking work, compared with half of 1 percent in France.

Put another way, a Korean man over 75 is more likely to be working than a Frenchman in his early 60s.

One point I hope to consistently make is even consumption functions which are almost completely insensitive to taxation – as I believe people really are – are not insensitive to transfer payment.

For example, the very simple, logarithmic utility function predicts zero net response of individual to changes in taxes or wage rates. Taxes decrease your direct incentive, but they also make you poorer which increases your indirect incentive. In a logarithmic function these two effect always exactly balance.

So, for example we shouldn’t be able to predict whether a woman making $7.50 an hour will work more or less than a woman making $750 an hour. The $750 woman faces a much stronger direct incentive, but couldn’t you easily imagine the $7.50 woman working double shifts to make ends meet. 

Now, note that from the point-of-view of the worker, the former is facing the equivalent of a 99% tax rate on the latter’s salary. That’s a 99% tax rate and we can’t tell off the top of our heads whether it will cause our hypothetical citizen to work more or to work less. If taxes have clear net effects the answer to this question would be laughably obvious – its not.

However, the logarithmic utility function does predict a massive drop off in labor supply from a program like Social Security or other defined benefit pensions. This is because in old age you are much wealthier than you would have been without the plan, but there is no increased incentive to work. The wealth effect is the only game in town and it causes you to quit working.

This will hold for almost any transfer program.

Let me give you another example of why this is important. Some people have suggested that we switch to something like the FairTax which levies a flat tax rate on consumption and then pre-bates revenue back to people.

If the argument I am presenting holds then the reduction in marginal tax rates from moving to a flat system will have little effect on incentives. Yet, the pre-bate will have potentially massive effects on incentives.

The pre-bate will cause marginal workers to simply drop out of the labor force and attempt to live only on the pre-bate. It will cause full-time moms to switch to part-time. It will cause people considering early retirement to go ahead and retire.

Even though you have dramatically lowered marginal tax rates I would expect to see labor supply go down. This is because taxes have offsetting incentive effects but transfers do not.

CBS’s Sunday Morning did a piece on TV campaign ads this morning. Apparently a total of $3 billion will be spent on these types of ads alone. A propos this large number Bob Schieffer asked “are we getting our money’s worth?”. I imagine there are a lot of people asking the same question these days,  but who is the “we” in that question? I certainly didn’t give any money to any campaigns, so I’m not to blame for the auditory and visual pollution. But it does make me wonder about people who have donated to parties, campaigns, and PACs this election season: when they see these stupid, annoying, and non-stop campaign ads on TV, do they feel they’ve gotten their money’s worth?

An older article from the Christian Science Monitor

If you’re planning to add an addition to the house, or maybe replace the downspouts before winter sets in, you might want to consider doing it soon.


The price of building materials is starting to rise. Copper (used in those downspouts), aluminum (think siding and windows), and plastic (pipes and insulation) are all getting more costly.

But the price increases don’t mean the US economy is growing at a healthy pace. Instead, the more expensive materials prices reflect higher worldwide commodity prices where demand is stronger. And many of those commodities are paid for with the greenback, which is down 18 percent over the past year.

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

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

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

Brad DeLong provides it:

When Charles Ferguson writes:

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

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

I know.

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

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

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

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

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

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

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

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

From the AP Wire

Many retailers say they’re ready to tweak orders where they still can or sharpen discounts to adjust to erratic spending. It’s tricky because many holiday orders are usually made six months to a year in advance.

A lot is riding on holiday sales because they account for up to 40 percent of annual revenue for many retailers. For toy merchants, it’s up to 50 percent.

J.C. Penney Co.’s Chairman and CEO Mike Ullman told investors last month that the department store chain was prepared to discount this Christmas season to bring shoppers in, after holding back a little last year.

"I think this year we have chosen to take a bit more pricing liberty," Ullman said.

Kevin Drum asks

Now, there are a bunch of things you might say about this right from the start. Maybe governments shouldn’t be in the business of running nanny state ads about personal nutrition. Maybe this particular ad was disgusting and shouldn’t have been released. Maybe obesity isn’t really that big a deal in the first place. But those weren’t the issues at stake. Rather, it was this single sentence in the ad:

Drinking 1 can of soda a day can make you 10 pounds fatter a year.

What, I thought, could be wrong with that? A can of sugared soda contains about 150 calories, and adding 150 calories a day to your diet would almost certainly produce a ten-pound weight gain over the course of a year or so. There are some caveats, of course:

So I’m curious: what do you all think of this? I’m open to argument here, but it seems crazy to me, less a politicization of science from the health commissioner than a case of geekdom run amok among the scientists. I mean, if you can’t tell people that adding a bunch of calories to your diet will make you gain weight, what can you tell them?

The problem is that the calorie balance interpertation implies a completely false understanding of what is going on. There is an extent to which geekdom can tolerate this level of nonsense and there is a point at which it must be combated.

I will compare to something I know Kevin gets. The calorie balance logic is equivalent to saying.

Government deficits drain savings. Savings are the engine of growth. Therefore, cutting the deficit immediately is our best shot at growth.

In both cases you are taking an accounting identity

  1. Private Savings – Public Borrowing = Net National Investment
  2. Calories-In – Calories-Out = Calories Contained in the Body

And, treating it as if it were a model of the world.

You have to be aware that public borrowing might effect private savings. In particular if public borrowing stimulates the economy it will increase private income which in turn will increase private savings.

You also need to be aware that Calories-In affects energy and hunger levels which not only feeds back to Calories-Out but also to other Calories-In.

I used to post this thing a lot, but since the blog has new readers it might be worth our while to look at how a properly functioning metabolism responds to a rapid increase in Calories-In

The big question we have is why does this stop working in some people? Just to note, there are many, many other feedback loops that are important as well. I point out this one because it so obvious both that it works in the healthy metabolism and that it fails in the unhealthy one.

You are probably aware of the relationship between diabetes and obesity. It is commonly assumed that obesity causes diabetes. This is in part because even some scientists are fixated on the accounting identity. However, there is a reasonable case that diabetes may cause obesity.

That is, the resistance of the muscles to insulin causes the breakdown in the “sugar rush” response (and other loops) which then breaks down the feedback from calories-in to calories-out.

Now, if it is in fact the case that sugary drinks induce insulin resistance this connection may still hold. However, it is almost certain that the simple minded thinking that in general dropping a 150 calorie item from your diet will not feedback on other metabolic components promotes a fundamental misunderstanding of what’s going on.


For the geeks. Yes, in truth even what I have written here is a gross oversimplification and ignores central facts such that an increase in obesity from sugar consumption must be proximately caused by an increase lipogenesis or a decrease in lypolysis both of which are hormonly regulated processess. That is, just as there is no such thing as immaculate transfer there is no such thing as immaculate obesity.

You can’t just throw organic matter at a metabolism and get fat. You actually have to create fatty acids and bind them up into triglycerides. Any model that assumes that you can is going to wind up disappointing you and of course there are a fair bit of disappointed dieters. We need to do better as intellectuals.

David Segal asks

Why do economists argue at all? Given that Fed members and economists are looking at the same data, and given the reams of evidence accumulated over decades — not to mention a few centuries of great minds, great theories and thick books that preceded this crisis — why isn’t a right answer self-evident?

George Bernard Shaw once said, “If all economists were laid end to end they would not reach a conclusion.” How come? What prevents economics from yielding answers the way that physics, chemistry and biology do?

Isn’t Segal puzzled as to how physicists could manage to disagree about something so fundamental as whether we live in a single universe in which observation induces the collapse of the quantum wave function or whether we live in a possibly infinitely pronged mutli-verse? I mean either there are trillions of copies of Segal floating around “somewhere” or there is only one. Why can’t physicists agree on something so basic?

Or a bit more on the mundane side, why is there still so much controversy among chemists on exactly how water is put together.

And, why can’t biologist agree on where the green stuff in plants came from.

Perhaps, Segal isn’t puzzled at these controversies because they have no political significance. However, let hundreds of billions of dollars be connected to whether water is tetrahedral or ringed and watch the knives come out. By the way, you hate America if you say “ringed.”

The very subject matter of Monetary Economics is how the government should throw around billions of dollars. It is amazing that we have the consensus we do.  Stiglitz, Krugman, Sumner, Bernanke, and Plosser may all disagree about the right course of action but if you asked them whether the reversal of disinflation was central to whether the economy will remain mired in a rut or turn around, I am betting they will all say yes.

Also, I have to react to this

“Pride is not in the model. Revenge is not in the model. Fear is not in the model. Even simple things like the disenchantment of people who are fired from their jobs — the model doesn’t account for how devastating that experience can be,” and what that sense of devastation will mean for the economy, he said

But, it’s not not in the model. That is, there is no variable for devastation. However, we do measure hysteresis. This is the study of how past unemployment affects future unemployment. If you asked me casually what the causal mechanism was I would include things like emotional devastations, disaffection, etc.

However, practically what we have are data on past unemployment rates in various places and among various groups and the current unemployment rate. So, that’s what is modeled.

There is a fair amount of support these days for the idea that the government should be getting involved in industrial policy. The argument is that the government can help make the U.S. become a competitive producer of green technologies. This will have several benefits, so the theory goes, including giving us something to export, creating high paid green jobs, and helping the environment. Proponents point to the example of Germany, which has used industrial policy to help create a large solar panel industry. Or they’ll point to China, whose government has a heavy hand in creating their many green manufacturers. Let’s leave aside for now the question of whether those policies are working for those countries, the question is should we do it here?

Many will point out that we are already involved in industrial policy in the energy sector, it’s just that our industrial policy favors dirty energy. The important thing is, Matt Yglesias tweeted yesterday, “that we have bad industrial policy now and should make it explicit and improve it”. I can agree with this sentiment, but I would modify it to say this: we have bad industrial policy now, and we should prove we can fix the existing problems before expanding it’s scope and aim. Now there is a lot of overlap between these two notions, and a fair bit of semantics, but there is at least one crucial difference: I’m arguing if we don’t have good reason to believe we can fix some of the current systematic problems, then just killing bad industrial policy is greatly preferable to attempting to build good industrial policy.

The problems our current industrial energy policy is that it doesn’t have, in fact doesn’t allow, the characteristics that we want of a healthy dynamic industry. In order for industrial policy to work in the long-run it needs to be able to allow subsidies to cease for products, companies, and even industries that become outdated. This means it has to be effective at identifying these industries, and capable of cutting off life-support.  This is what the creative destruction of capitalism provides, and our current policies do not.

I agree with Matt that dirty technologies like coal and oil shouldn’t be given preferential treatment over clean ones like they currently are. Nor should ethanol, our largest attempt at a green industrial energy policy that almost everyone recognizes does not pass cost benefit. Yet if we can’t wind down the inefficient, environmentally devastating subsidies to these industries, why should we believe that the government will ever be able to hit undo if they accidently pick the wrong “winner” this time around, or if today’s “winner” becomes tomorrow’s “loser”?

The reason industrial policy has this problem is that it is explicitly geared towards creating jobs. Once those jobs are created, the goal for policy-makers becomes preserving those jobs. This is the antithesis of creative destruction, and a huge impediment to progress. What happens if we build this giant “green economy” supporting millions of middle class jobs and then a cheaper and more environmentally friendly technology comes along that makes them all redundant? Will the politicians who decide our allocations of energy via mandate and subsidy allow those jobs to go away and progress to occur, or will they fight tooth and nail to preserve the inefficient status quo?

For these reasons I find the idea of an NIH for green technologies compelling. Moneys are doled out by competitive grants to researchers with proven track records and good ideas, and the emphasis is on creating technologies, not jobs. But with respect to subsidies, mandates, and other command-and-control industrial policy, I don’t see how they will overcome the failure problem.

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

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

Reasonable people should agree: this ad is ridiculous.

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

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

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

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

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

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

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

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

The author of the Declaration of Independence speaks out on the horror of men without machines land at the very same time that there is machines land without men.

Another means of silently lessening the inequality of property is to exempt all from taxation below a certain point, and to tax the higher portions or property in geometrical progression as they rise. Whenever there are in any country uncultivated lands and unemployed poor, it is clear that the laws of property have been so far extended as to violate natural right.

Jefferson suggested using the coercive power of the state to keep people from hoarding land. I simply want to use the printing press to keep people from hoarding money.

HT: Mike Huben

Nick Rowe thinks Bernanke is confusing people

The Fed is trying to communicate two things. First, it is trying to communicate that it will buy long term bonds and this policy will be effective by pushing down yields on long term bonds, which should increase consumption and investment demand. Second, it is trying to communicate that this policy will be effective in increasing future inflation and real growth, both of which will push up yields on long term bonds. The Fed’s "communications strategy" is self-contradictory. No single individual can believe both parts of that communications strategy at once.

However, the Fed’s strategy can be summed up succinctly for bankers: get out of long dated nominal Treasuries. In the short run we are pushing down yields, so we are lowering the return you can lock in. In the long run yields are going to pop up so you are going to take capital losses.

Ergo: find some other place to put your money. If you don’t want the zero nominal returns of cash or T-bills, I guess that means heading over to the real economy.

The Kauffman foundation has produced the results of its latest survey of economics bloggers. Included in the survey was a question at the request of Bryan Caplan that I found quite interesting. The survey asked:

The net externality of the birth of an additional child in the United States is… [POSITIVE, ZERO, or NEGATIVE]

The results show that a majority of econo-bloggers believe the externalities to be positive:

This begs the question of the externalities of immigrants. After all, positive externalities for natives probably don’t start appearing until after high school or college, and before that they are on average consuming far more than they produce.

Since the average immigrant age is around 30, that means when they’ve arrived they are already past the stage when they just consume society’s resources, and have begun producing externalities. Doesn’t this suggest that positive externality of immigrants is even larger than that for natives? If you’re going to claim that the average lower education level of immigrants reduces their externalities, keep in mind that immigrants are also more likely to be small business owners and PhDs than natives.

It’s interesting that when immigration is discussed economists quickly jump to the debate about the impact on native wages. I doubt that the 72% of economists above believe that the average externality of people is smaller than 6% of the wages of highschool dropouts, which is around the lowest credible estimate in the literature, so why don’t economists accept that externalities of immigrants trump wage effects and quickly move to arguing for more immigration?

The Fed’s statements have convinced legendary Bond Fund Manger Bill Gross that its time to get out of bonds. That means getting into something else. Emphasis in the original

We will tell them this. Certain Turkeys receive a Thanksgiving pardon or they just run faster than others! We intend PIMCO to be one of the chosen gobblers. We haven’t been around for 35+ years and not figured out a way to avoid the November axe. We are a survivor and our clients are not going to be Turkeys on a platter. You may not be strutting around the barnyard as briskly as you used to – those near 10% annualized yields in stocks and bonds are a thing of the past – but you’re gonna be around next year, and then the next, and the next. Interest rates may be rock bottom, but there are other ways – what we call “safe spread” ways –to beat the axe without taking a lot of risk: developing/emerging market debt with higher yields and non-dollar denominations is one way; high quality global corporate bonds are another. Even U.S. Agency mortgages yielding 200 basis points more than those 1% Treasuries, qualify as “safe spreads.” While our “safe spread” terminology offers no guarantees, it is designed to let you sleep at night with less interest rate volatility. The Fed wants to buy, so come on, Ben Bernanke, show us your best and perhaps last moves on Wednesday next. You are doing what you have to do, and it may or may not work. But either way it will likely signify the end of a great 30-year bull market in bonds and the necessity for bond managers and, yes, equity managers to adjust to a new environment.

A couple of things are happening. Gross is moving money offshore. That means the dollar will decline, which we have discussed before. This will be stimulating for the US economy.

Second Gross is moving into corporate debt and agencies (housing). There are one of two possibilities.

  1. Corporations will actually take Gross’s money and so will homeowners. Businesses will hire and home building will perk up. We’ll party like its 2005. I consider this the less likely alternative.
  2. Corporate and agency yields will crash. Homeowners who can refi will be able to cut their payment. This will help balance sheets, but more importantly it will drive out remaining holders of corporate and agency debt. It may even close Gross’s safe spread, forcing him to seek other returns. Where will they go? I couldn’t say for sure but I have a hard time believing that there are no entrepreneurs left in the US who wouldn’t love a nice low business loan to get started. Here comes the capital.

I am a little late to this party but Arnold asks for a popularization of the Impossibility Theorem. Mine is as follows

You can have a government that is

  1. Rational
  2. Democratic
  3. Free

Choose two.

I like to say it that way because it sounds cute and is therefore more easily remembered. Indeed, you can’t really have a government that is rational and democratic unless you are willing to accept some really weird forms of democracy.

Moreover, it doesn’t just apply to governments but groups in general.

I used to say that this proved that groups were fundamentally different than individuals, because unlike an individual a group can’t really be said to “want” anything. It depends on how you ask the question.

Well, it turns out that it depends on how you ask individuals the question as well. Which shouldn’t come as a surprise given, what looks to me like, increasing evidence that the mind really is a bunch of independent modules.

Not a bang, but a offhand comment from a WaPo Blogger

That’s better than no inflation, but it’s well below the Federal Reserve’s target of 2 percent

What is notable about this is that Klein doesn’t seem to think he needs to tell his readers why some inflation is better than no inflation nor why more would be even better.

I point this out because it can be emotionally deflating. It feels like there should be some sort of climax but there is no climax. Indeed, victory is characterized by its utter lack of drama. In this world you win when everyone forgets about you. When they no longer consider your argument something worth arguing about.

We are obviously not there yet. When Peter Schiff says, “America is doomed. Obama’s deflationary policies are ruining the country and those idiots at the Fed won’t even be able to generate more that 0.5% inflation if they tried.”

That’s what complete victory will look like.

From Lending Club Blog

If you’re really struggling with your budget, consider making most of your spending cash-based. That way, you can literally divide your money into physical piles, so you can actually see how much you have to spend on different things. When the pile is gone, you’ll have the physical reminder that you can’t spend any more there until the next month.

Some utilities and other expenses might require you to pay by check or credit card.  If you have one of these, you can still make your spending cash-based.  Simply take the pile of money and deposit in the bank before you write your check or use your card.

Bernanke discusses the appropriate use of an unfamiliar putter in a game of miniature golf that you are currently winning.

Some reflection should convince you that the best strategy in this situation is to be conservative. In particular, your uncertainty about the response of the ball to your putter implies that you should strike the ball less firmly than you would if you knew precisely how the ball would react to the unfamiliar putter. This conservative approach may well lead your first shot to lie short of the hole. However, this cost is offset by the important benefit of guarding against the risk that the putter is livelier than you expect, so lively that your normal stroke could send the ball well past the cup. Since you expect to win the tournament if you avoid a disastrously bad shot, you approach the hole in a series of short putts (what golf aficionados tell me are called lagged putts). Gradualism in action!

Except that this is exactly wrong. There is no reason to expect that the danger from an overly lively putter outweighs the danger from an overly soft putter in miniature golf. Thus you should strike as normal.

Now in standard golf Bernanke would have a point. Because in standard golf, getting to the putting stage itself is an accomplishment. You are now on the Green and if you screw up royally you could push yourself off the Green and be worse off then where you started. If you tap the ball too lightly then at worse you will be exactly where you started. Thus, the smart strategy is to be conservative.

There is a larger point to this as will hopefully become clear.

Before I  get right to that, however, this is a decent although not entirely appropriate excuse to thrown in some Oakeshott so I am going to take it. From On Being Conservative:

In short, [conservatism] is a disposition appropriate to a man who is
acutely aware of having something to lose which he has learned to
care for; a man in some degree rich in opportunities for enjoyment,
but not so rich that he can afford to be indifferent to loss.

That is, of course, to say resistance to change or conservatism comes more naturally to those who are in a preferable state because most of the states that they could potentially change to are likely to be worse than their current one.  It is natural then for the Fed, having much to lose in terms of position or influence to be conservative. They are – so to speak – already on the Green.

However, where is the economy of which they are supposed to be stewards? Is it on the Green? Or, is it, as I believe, stuck in the sand trap; mired in the worst economic downturn since the Great Depression with the baseline scenario giving us low growth and high unemployment for years to come?

As such it is not appropriate for the Governors in their capacity as agents of the economy to be conservative. Careful and deliberate, yes, but conservative, no. It is not all the case that over striking the ball and winding up with a rapidly growing economy and too much inflation is a superior concern to winding up with a too weak economy and too little inflation.

The members of the Open Market Committee as individuals have a reason to be conservative, but the Members as Members do not.

Noah Millman worries that we can’t stimulate without fearing a foreign capital flight

If the Fed set out to convince the markets that he was actively trying to produce at least 3% inflation, and would not act to reduce inflation until domestic economic conditions were significantly improved, why wouldn’t China shift its portfolio out of Treasuries and into Euros; why wouldn’t investors, domestic and foreign, shift investment out of the U.S. and into jurisdictions that are either producing higher returns without accelerating inflation (such as some emerging markets) or that are still committed to aggressive disinflation (such as the Euro zone)? Quite apart from the direct negative effect this capital flight would have on the American economy, the indirect effect would be to make it much more difficult to finance our high fiscal deficits. Monetary stimulus would then lead to fiscal contraction.

This is actually a channel for stimulus. These things can trip a lot of people up because we are dealing with demand-side issues when the basic problem facing humanity under normal circumstances are supply-side issues. So many things are backwards.

If that made no sense to you fine.

Here is the play-by-play.

Bernanke convinces the world he is raising inflation expectations. Suddenly, dollars don’t look so good anymore. As an investor I move money into Euros.

However, to do this I must sell dollars and buy Euros. Doing so drives down the price of the dollar and up the price of Euros.

Now, as an investor I have my Euro denominated bond. What happens in America?

In America, I pulled out of the Treasury market. However, that is fine because there are tons of bank reserves sitting on the shelf to jump into the Treasury market. Nominal interest rates don’t move.

However, the dollar has fallen. This will make imports from Europe more expensive. No more 5-series BMWs 😦

However, it will make American made goods relatively cheaper for Americans. More 3-series BMWs 🙂 [They are made in South Carolina]

It also means that US goods are cheaper abroad – Woo! hoo! America sells more corn and 737s baby. 🙂

It also means that profits from American owned multinationals will look bigger in dollar terms to America investors. Go S&P 500!

Unfortunately it also means that oil will be relatively more expensive. High gas prices, boo** 😦

The dollar change in-and-of-itself* will lower US consumption. However, it will raise the demand for US products. That’s because a higher fraction of consumption will be American and foreigners will want to buy more American goods.

Thus even though the cheaper dollar means American get fewer things the net effect is simulative because more of those things are made by otherwise unemployed Americans.


*In fact American consumption will probably rise, but that’s because unemployment will fall, cash constraints will loosen and spending will rise. However, that’s most easily thought of as the effect of the stimulus.

** Jim Hamilton worries a lot about higher gas prices. In some sense this could make households more cash-constrained, which is a concern because then they would lower overall spending in an effort to build up cash reserves. Intuitively, it doesn’t seem like this will overwhelm the other affects but I couldn’t guarantee it.

There are rumors swirling that Apple might use some of its cash hoard to buy another company.

I often hear complaints that this is a bad thing because Apple is not spending the money to hire new workers, etc but spending it on another corporation. We also hear this argument in reference to gold and some other commodities. People will shove their money into gold rather than into good and services people use.

However, this misunderstands liquidity in the economy. Lets say Apple buys Facebook. Often this would be done as a stock deal. The owners of Facebook would now become part owners of the new Apple-Facebook.

Lets say, however, that Apple wants to go all fancy pants and do a cash deal. Apple  is going to pay Zuckerberg and his investors $30B in cold hard US cash. Well, then the question is – what is Zuckerberg going to do with that cash.

If he goes out and buys US T-Bills or stuffs it in some other super liquid asset then some bank is just going to sell him that liquid asset and then stuff his billions in their reserve account along with the 100s of other billions they are sitting on. This is bad.

However, if  Zuckerberg goes out and uses the cash to start Petbook (there probably already is a Petbook, but just go with me here) then that cash will actually be put to use. If the buying Facebook just results in moving cash from Apple’s corporate account to Zuckerbergs private account then we have done nothing to decrease money hoarding. However, if Zuckerberg spends it then money hoarding goes down.

The same goes for the seller on the side of a gold transaction. You buy gold and then what does the seller do with that money? Does she spend it on a new car, yeah! On a new small business, double yeah! Or, does she stuff it into a treasury-based cash account, boo.

So, Mergers and Acquisitions are not really a waste of cash. They are a transfer of cash. It depends on what the seller does with that cash.

Now, higher commodity prices can potentially do damage through two channels:

1) They have balance sheet affects. If high oil prices transfer cash from strapped households to flush oil sheiks then that’s not good for overall demand.

2) The expectation of rising commodity prices acts as an increase in the real rate of return on holding commodities. This actually discourages people from producing. They want to leave the oil or copper in the ground so they can dig it up later and sell for even higher prices.

However, this channel typically only operates when there is steadily increasing demand for the commodity.

If the commodity is moving into some sort of bubble then you want to do the opposite. You want to pump out as much as you can now while prices are high before the price crash. This is similarly true if you think the general price level is rising and hence your costs of extraction are going to rise in the future.

So to the extent that commodity prices rise in a one-off bubble the effects should actual be stimulating. To the extent they are rising because overall economic demand is rising they will be relatively destimulating. However, that will be because you have already produced significant stimulation.

Dana Goldstein seems bothered about a new program where teachers from Teach for America work at Goldman Sachs over their summers. Her concern is that this will lure TFA teachers from the profession since a starting position at Goldman pays $60,000 plus bonuses, which is more than double what a starting teacher makes in a poor district. But will this harm retention?

A 2008 study by Morgaen Donaldson looked at “whether, when, and why” TFA teachers leave the profession. One of their findings was that science teachers that majored in science in college were more likely to leave the profession than science teachers who didn’t. Donaldson finds this to be consistent with previous literature showing that science majors are more likely to leave the profession than humanities majors due to the higher salaries they can get in science, technology, and engineering careers. This, the author argues, shows that teachers can be pulled out of a teaching career as well as pushed out.

On the other hand, the ability to intern at Goldman Sachs may increase the lure of enrolling in TFA. There may be potentially talented teachers that would enroll in TFA but choose work at an investment company instead who might now be tempted by this opportunity.

Then again, retention is considered more of a problem for TFA than supply of applicants. Indeed, a frequent criticism of the program is that too many TFA teachers leave the profession, which means it’s potential is extremely limited. But I think the reality here is frequently exaggerated. First, keep in mind that 40-50% of all teachers leave the profession within the first 5-6 years. In addition, 15% of teachers in low income schools leave those schools annually. So the status quo is not so great in this regard.

In comparison, 61% of TFA recruits are teachers for longer than the required 2 years, and 24% stay teachers for at least 6 years. So TFA teachers are less than twice as likely to leave the profession in the first 6 years relative to all public school teachers, which I think is much closer than most would believe. I suspect these rates would be even closer when compared to public school teachers in low-income areas rather than all public school teachers.

The program is only for 20 internships at Goldman right now, so it’s nothing to worry about in either case. But I would argue that the willingness to experiment and break from the traditional mold of teacher education is what made TFA, and they should be encouraged to continue trying different things.

Millenocket, ME. has the right idea. Matthew Yglesias has apparently been to Millenocket, and finds what they are doing funny. I’ve never been there, but as the article points out, it’s a pretty dead town, with horrible weather…so it seems out of place:

Never mind that Millinocket is an hour’s drive from the nearest mall or movie theater, or that it gets an average 93 inches of snow a year. Kenneth Smith, the schools superintendent, is so certain that Chinese students will eventually arrive by the dozen — paying $27,000 a year in tuition, room and board — that he is scouting vacant properties to convert to dormitories.

There are three ways in which I’d like to analyze this development; from an economic standpoint, a human welfare standpoint, and a social standpoint. I will argue that all three a net benefits to the US and the world, and we should make a long-term policy commitment to this type development around the country (and, indeed, other countries should imitate it).

The economics of importing capital through education are fairly straightforward. The long run growth of an economy, given money neutrality, is a function of an economy’s real capital stock. Ceterus paribus, increasing the efficiency of capital increases the ability of an economy to grow in the long run. If the $27,000 spent on educating a Chinese child is more productive than any other investment, which means the real returns to a US education are higher than any other investment available to them (something that is almost surely the case), then this results in an increase in the marginal efficiency of capital. Whether these Chinese immigrants remain in the US, or return to China, the effect on world growth will for the better. Literally everyone will be better off due to the rising of the world Wicksellian equilibrium interest rate as China and other countries become more productive (and thus, richer).

The US is arguably much more efficient at education than the Chinese, so why not export education?

From a human welfare standpoint, consider this analysis from the World Bank:

This volume asks a key question: Where is the Wealth of Nations? Answering this question yields important insights into the prospects for sustainable development in countries around the world. The estimates of total wealth–including produced, natural, and human and institutional capital–suggest that human capital and the value of institutions (as measured by rule of law) constitute the largest share of wealth in virtually all countries.


Growth is essential if developing countries are to meet the Millennium Development Goals by 2015. Growth, however, will be illusory if it is based on mining soils and depleting fisheries and forests. This report provides the indicators needed to manage the total portfolio of assets upon which development depends. Armed with this information, decision makers can direct the development process toward sustainable outcomes.

This analysis looks at the levels of “intangible wealth” that is embedded within human and institutional capital. The US is found to have $418,009 in intangible wealth per capita (comprising 80% of our real capital stock). That means, simply by stepping within the borders of the United States, human productivity is enhanced by this massive stock of wealth embedded in our people and our societal institutions. By contrast, China has just $4,208 per capita (comprising 55% of the total wealth stock).

Now, despite the obvious material living standards present in the United States, access to intangible capital totaling more than 99 times the amount available in China, comprises a vast gain in human welfare for each and every person who comes to the United States to live and be educated.

Finally, from a societal standpoint, having more immigrant workers increases the real wage rate for most people in the US. Not only that, but it because of the increase in marginal productivity of the Chinese worker (assuming that a non-trivial sum of people will return to China), this will increase the wages of Chinese workers — which, in turn, will increase the demand from China for US-produced goods and services. A greater supply of future labor is very important to the future of the wealth creation (and thus, the welfare state), as is evident by Japan’s aging population.

So, let’s overcome this roadblock…

There is one hitch. Under State Department rules, foreign students can attend public high school in the United States for only a year, a system that Dr. Smith considers unfair, given that they can attend private high schools for four years.

…and make a real Pareto improvement in the lives of people around the world. Most of all, the lives of these prospective Chinese immigrants.

To end, a quote from Terry Given, an English teacher:

“I don’t want to sound flip,” Ms. Given said, “but why not? We won’t know until we get the opportunity to know them and give them the opportunity to know us. There’s something to be said for putting ourselves out there to see if we can be the prize that’s claimed.”


Mark Thoma worries about gridlock in the house as a result of the upcoming elections. He has three big concerns that he’s looking at in the short-run that could prove to stall recovery. I want to address what I believe about all three.

The first is that we will be gripped by the austerity movement that has captured Europe and that, as a result, we will withdraw stimulus too soon. Republicans have been promoting policies to reduce the deficit for some time now, spending cuts in particular are on the agenda. Many among the Republican leadership would have canceled the remaining stimulus already, including extensions to unemployment insurance, if they were in control.

Now, according to Nate Silver (@fivethirtyeight), Republicans have a fairly good shot of gaining 52 seats in the House, for a house composition of 231R-204D. This may be enough to stall any new spending, based on the populist rhetoric of the tea-party base…but I don’t think it is enough to move any actual significant budgetary legislation. One reason is that Republicans don’t actually care about budget deficits. Further, the austerity plans that are being implemented in Europe aren’t exactly the most immediate. I don’t think that austerity in Europe is going to cripple any economies, much less their own. The Bank of England in particular has intimated that it would likely offset any contractionary impact of Britain’s budgetary plans. So the question is still very much up in the air as to whether austerity is the death knell for recovery — I, personally, don’t think it is; but that is contingent upon a willing central bank.*

The second concern is related to the first. I expect that we will have a slow, agonizing recovery, particularly for employment. I do not expect a double dip, but it’s not out of the question by any means, and we need to be ready in case it happens. Unfortunately, the election is likely to bring gridlock and it’s doubtful that Congress will be able to act in response to a second downturn. An increase government expenditures in response to a slowdown is certainly off the table. It’s hard to imagine Republicans who have argued — wrongly in my view — that the stimulus did not help the economy getting behind increased spending.

According to recent movements in the markets, there is actually reason to be optimistic. Even so, employment may not come down to traditional “full employment” levels (a situation that I find highly likely). However, after (or if?) we return to the previous trend rate of NGDP**, those are probably more issues of structure (search/match, skill profiles, etc.) that the government may be able to help mitigate, but will likely to be alleviated slowly, simply by the nature of these problems. What does robust growth and stagnating employment look like for the future of economic policy? Protectionism, which highly en vogue among tea partiers and the “labor-left” alike. That is something that I’m worried about.

But my biggest concern is what will happen if new problems emerge in the financial sector. The resolution authority in the Dodd-Frank legislation is supposed to prevent the need for another financial bailout, but I am not at all confident that this will be sufficient to solve widespread problems and threats of failure in the banking system. There’s a good chance that the resolution authority won’t get the job done and that a bailout will be the only way to resolve severe problems. However, if problems do arise and another financial bailout is needed, forget it. Opposition to the banking bailout makes it nearly impossible for Congress to undertake another bailout of the financial system.

This is a problem where Thoma and I seem to disagree about causality. Would the Fed allow NGDP to fall at the fastest rate since 1938 once again, as they did in late 2008? It’s possible, but I don’t think it is likely…and as you may know, I think it was increasingly tight money which led to big financial problems — not the other way around, which I believe is the causality that Thoma is looking at.

Why don’t I welcome gridlock in economic policy that is almost certain in our future? Well, because there are important questions about the response to the recession that need to be answered, that will most likely remain for the foreseeable future under gridlock. The structure of bailouts, the role of Fannie/Freddy in the future of housing policy (and the future of housing policy in general), the supposed “world trade imbalances”, the future health care policy, and to a lesser extent UI, minimum wage and the very structure of taxes in the US. These are all very important questions that affect millions of people, and are very hard to answer under a regime of unanimous opposition that would likely prevail under a gridlocked government.

However, I don’t think the recovery will be endangered by gridlocked government, since the Fed has signaled it intends to take the lead…something it should have done two years ago.

P.S. Should probably note that the Yglesias link above disagrees with the notion that things cannot get done under divided government.

*Ability isn’t really a question in my mind.
**Assuming level-targeting.

Karl responded recently to a post by Barbara Kiviat who wondered “why should we care about the minimum wage?”. Karl’s general point is that the minimum wage is harming lot’s of families, and Barbara’s point is that we shouldn’t spend so much time on a policy that has little affect on the economy and doesn’t help low income families anyway. But if Barabara thinks both sides care too much about this issue, then shouldn’t she be arguing for Democrats take advantage of the Republican’s foolish obsession and trade a repeal of the minimum wage for a policy that actually benefits poor people?

I’ve argued before that the balance of new minimum wage evidence shows that the minimum wage causes unemployment, so I won’t rehash that evidence here (if you’re under the assumption Card/Krueger is the end of the debate, I’d encourage you to follow the link). But I do want to focus on the inefficiency of the minimum wage. This report from the CBO shows that showed the 2007 increase in the minimum wage cost employers $11 billion, of which $1.6 billion benefited poor families. In contrast, an expansion of the earned income tax credit (EITC) would have cost $2.4 billion, $1.4 billion of which would have gone to poor families. The EITC is cheaper and more targeted. Note that this is only the marginal cost of the most recent increase in the federal minimum wage, not the total cost of federal and state minimum wages, which would be much higher.

What the minimum wage does is effectively push the costs of a multi-billion dollar, illusory, anti-poverty program onto employers. It’s an inefficient way to help poor people, and a hidden tax on businsses that forces them to spend $4 so that the government doesn’t have to spend $1.

Considering how low Barbara believes it’s cost would be in terms of impact on poor people,  she should want Democrats exchange a repeal of the minimum wage for a policy that actually helps poor people. After all, what do you do when someone values something more than it’s worth to you? Sell it and buy something better.

How to Get Rich by Investing in CDs

Maintain your CD investments while avoiding the temptation to use the funds for consumption or to purchase riskier assets. Where many people go wrong in terms of money management is by having too much confidence while speculating. At the very least, when you invest in CDs, you maintain your assets. Investing in stocks, real estate, or bonds can leave you with depleted funds after a market crash. The worst that can happen with CDs are slight losses due to inflation, but you will at least have more money in nominal terms.

Paul think the markets are over-reacting

But I really don’t understand this. Granted that QE2 will probably have some positive effect, hopefully bigger than analysis based on the debt-maturity equivalence suggests. Still, the prospect remains that we’ll face multiple years of high unemployment — or, if you prefer, a protracted large output gap(PLOG). And history is clear on what that means: declining inflation:


My guess, then, is that the markets are overreacting; they’re thinking, “The Fed is printing money!”, while forgetting that this ultimately matters, even for inflation, only to the extent that it seriously reduces unemployment.

Market over-reaction is possible sure. On the other hand, how about the parsimonious view: Expected inflation drives down real interest rates, drives people out of cash and into profitable investments thereby increasing the rate of growth and lowering unemployment.

This is the perspective of our basic New Keynesian models and of many economists including of course Paul Krugman! Here is Paul himself circa 1998

Sometimes big problems have small causes; sometimes a simple technical fix can work miracles.

Last spring I decided to sit down and think seriously about Japan’s ills, putting aside conventional wisdom and my own prejudices, following the logic of economic analysis wherever it led. And it led to a surprising conclusion: that there is indeed a simple fix for Japan’s slump – and that the structural obstacles to a quick recovery lie not in the economy itself but in the minds of policymakers.

What is particularly remarkable about the debate over Japan is that it is a case where straightforward economic analysis and policy orthodoxy are in direct conflict. If you apply the most conventional of macroeconomic models to Japan’s unusual plight, you come up with recommendations that are anathema to central bankers and finance ministers. And in this case, I am firmly convinced that the models are right and the officials are wrong.

The models suggest a commitment strategy. The Fed should promise inflation. The whiteboard says it should work. The markets seem to be acting as if it is will work. Maybe it is working?

Now, I am the first to admit that it is easy to get sucked into confirmation bias. Obviously, I am tempted to see evidence for cash hoarding everywhere and likewise am tempted to see rising inflation expectations as implying strong future growth.

However, just because your are vulnerable to bias doesn’t mean you are wrong!

What would be helpful is specific counter-evidence showing that the communication strategy is not in fact working and that we will not begin to see cash moving out safe bank accounts and into productive investments.

Is there any economist who, if given the opportunity to write down a tax system that would bind all mankind for all time, would not write down a progressive consumption or property tax with no levies on business inputs at all?

Aren’t we just arguing over the feasibility of such a proposal or are there deeper concerns?

My Hayek exposure was mostly The Use of Knowledge in Society style stuff. I am  just now reading The Road to Serfdom for the first time.

While his analysis of why markets work has always been wonderful, from what I can tell his political economy seems to echo that of a distinctly left-of-center economist by modern standards.

Probably nothing has done so much harm to the [libertarian] cause as the wooden insistence of some [libertarians] on certain rough rules of thumb, above all the principle of laissez-faire.

We must save capitalism from the unconstrained free-market. Is this Hayek or Robert Reich? Hayek makes repeated reference to the fact that it is only competition as a rough principle that is to be supported. Indeed, he goes on to say

The [proper] attitude of the [libertarian] towards society is like that of the gardener who tends a plant and in order to create the conditions most favourable to its growth must know as much as possible about its structure and the way it functions. No sensible person should have doubted that the crude rules in which the principles of economic policy of the nineteenth century were expressed were only a beginning, that we had yet much to learn, and that there were still immense possibilities of advancement on the lines on which we had moved.

Tell that to Peter Thiel. Additionally

Nor can certain harmful effects of deforestation, or of some methods of farming, or of the smoke and noise of factories, be confined to the owner of the property in question or to those who are willing to submit to the damage for an agreed compensation. In such instances we must find some substitute for the regulation by the price mechanism. But the fact that we have to resort to the substitution of direct regulation by authority where the conditions for the proper working of competition cannot be created, does not prove that we should suppress competition where it can be made to function.

Now of course this is pre Coase Theorem, but Hayek isn’t even pushing Pigou’s The Economics of Welfare. When markets fail he suggests, command-and-control is appropriate.

Note, that I replaced liberal with libertarian to accord with modern American usage.

When the Institute of Medicine recommended broad, draconian regulation of salt last year, I pushed back against the idea, one might say, obsessively. Now, via Marion Nestle, comes a new paper in The American Journal of Clinical Nutrition arguing that the current level of sodium intake is not a problem for the population. The article comes with an accompanying editorial titled  “Science trumps politics: urinary sodium data challenge US dietary sodium guideline” that closes with this appeal:

The analyses of extensive measurements of 24-h UNaV, which these 2 reports have collected from the medical literature over the past 5 decades, are compelling. They provide plausible, scientific evidence of a “normal” range of dietary sodium intake in humans that is consistent with our understanding of the established physiology of sodium regulation in humans. This scientific evidence, not political expediency, should be the foundation of future government policies, thus respecting the known and unknown scientific complexities surrounding sodium’s role in health and disease. Guidance for sodium intake should target specific populations for whom a lower sodium intake is possibly beneficial. Such an approach would avoid broad proscriptive guidelines for the general population for whom the safety and efficacy are not yet defined. An appropriate next step is not to lower the sodium guideline further.

You can find my previous coverage of salt regulation here, herehereherehere, and here.

Tyler Cowen quote and asks

Inflation-protected securities sold at negative yields for the first time ever on Monday as traders anticipate that the Federal Reserve will start a new round of asset purchases.

There are liquidity issues, hedging issues, reinvestment risk issues, supply-side finance management issues, and so on.  This does not show that our real economy has a negative real rate of return.  Maybe, for reasons of institutional constraint, people buy these securities as an inflation hedge rather than investing in the real economy.  Still…

There is more here.

Question: When the measured expected real return is below zero, how well can any recovery program work?

There are of course the issues he mention but at its core is the problem the fact that Treasuries have zero risk. If people are risk averse enough or the uncertainty is high enough then the equilibrium real rate of return will always be negative.

Indeed, we abstract away from this in the growth models but it is entirely consistent for the economy to have constant risk-free negative real rates and be growing like gangbusters.

This would simply mean that people are highly risk adverse and storage costs are high. It takes negative real rates to get people out of treasuries and into those investments with high expected value but high variance as well.

From Pioneer Press

"I think a lot of people who want to buy a house are waiting to see if they can get an even better deal down the road," Anderson said.

Closed sales last month were down 33.5 percent compared with September a year ago in the 13-county Twin Cities metro area, according to the Minneapolis Area Association of Realtors. Pending sales, an indicator of future activity, were down 37.8 percent.

Charles Murray writes one of his classic pieces where he manages to turn controversial and important research into inane talking points. For the record, I think assortative mating and social stratification based on a host of income related personality traits – height, intelligence, beauty, gregariousness, grit* –  is a serious issue that no society has had to face in the same way that the US will face it over the next 40 years.

Nonetheless, I don’t think this is what the Tea Party is all about.

Moreover, the real issue with Ivory Tower isolation is this from Paul Krugman

Wow. I guess I lead an intellectually sheltered life. Until I followed a link from Yves Smith, I had been blissfully unaware that the investment airwaves were full of people yelling that Bernanke is debasing the dollar because the dollar has fallen modestly in recent weeks.

Is it really possible that the CNBC-watching crowd doesn’t understand that right now a weak dollar is good for America? Have the usual suspects turned their backs not only on the insights of Keynes, but on basic monetary economics as well? Is goldbuggism triumphant?

Paul . . . Paul. [shakes fellow academic gently]

These shouts are coming from the 99th maybe 98th percentile in terms financial literacy. Most of the CNBC watching crowd doesn’t even fully understand their argument.

Yes, Peter Schiff is talking over the heads of most business minded people in America. Just let that sink in.


*That was just for you Matt

He writes:

Something that’s been bugging me for a while now is that people largely seem to have forgotten what it is that actually happened in the fall of 2008 as the financial crisis reached its most acute stage. Amar Bhidé’s new book, A Call for Judgment: Sensible Finance for a Dynamic Economy, isn’t primarily a history of this episode but it does contain a handy one-paragraph summary of why it is that the powers that be didn’t just let things fall apart:

The common wisdom was that money market funds were “unrunnable,” because all withdrawals (redemptions) could be met by selling the assets of the fund. The illusion was shattered in September 2008. The pioneering Reserve Fund had large holdings of commercial paper issued by Lehman Brothers; the failure of Lehman triggered redemption requests for more than $20 billion on September 15, but less than half could be honored by selling assets since the markets were frozen.

Watching the paper markets freeze is a experience I won’t ever forget. There was a palpable sense that we might be watching the end of Western Capitalism.

If that seems dramatic you have to realize the inherent liquidity in money markets before Lehman imploded.

For the money markets to freeze would be as if you went to the store and tried to pay with your debit card and the store said “oh we do not accept checks or debit cards from Bank of America anymore, sorry”

Then in a panic you ran to the ATM and the ATM said “only half of funds available.” Enraged you checked it again, this time it says “only 1/3 of funds available” 

You can’t spend your debit card and the ATM won’t give you your money back. If you are not in complete freak out mode right now then you are a utterly cool cat.

Now imagine that this is happening or is about to happen to everyone, with every bank, in every country in the world. You suspect that not all of them will be cool cats.

You spend a second wondering whether you should try to fix this as best you can or make your way quickly and quietly to Wal-Mart before they run out shotgun shells.

That’s what we were watching in the shadow banking system.

Krugman does the kind of two human models that I love to explain how government spending and inflation can help in a depression. However, there is one thing I must point out before the people get up in arms.

Krugman rightfully says

What can be done? One answer is inflation, if you can get it, which will do two things: it will make it possible to have a negative real interest rate, and it will in itself erode the debt of the Sams. Yes, that will in a way be rewarding their past excesses – but economics is not a morality play.

Oh, and just to go back for a moment to my point about debt not being all the same: yes, inflation erodes the assets of the Janets at the same time, and by the same amount, as it erodes the debt of the Sams. But the Sams are balance-sheet constrained, while the Janets aren’t, so this is a net positive for aggregate demand.

Its critically important to understand that all players knew or should have known that these were the rules of the game. In particular the Janets of the world are typically represented by banks who are in the business of knowing that these are the rules of the game, which is why there is a yield curve.

See how the interest rate rises as the length of the borrowing term goes up. That is precisely because Janet knows that she could be exposed to inflation risk and she charges a premium for it.

Inflation targeting is not the government suddenly stepping in and favoring Sam over Janet. It is the government simply abiding by the known rules of the game.

Moreover, Janet knows these rules so well that the primary red light telling us that a recession is coming is this

A “inverted” yield curve is almost a sure sign that something bad is about to happen. Why? There are several ultimately equivalent interpretations but the easiest is to see that Janet thinks the government will FAIL in its attempt to maintain the rules of the game.

Janet believes that inflation will actually fall in the future, perhaps all the way to deflation, and so she is willing to lend money cheaper for longer periods.

Ross Douthat on fiscal policy in a recession

Just four years ago, it’s worth noting, an awful lot of Bush administration officials would have made roughly the argument that Klein makes above when defending their fiscal record. As liberals have enjoyed pointing out, Bush’s first term policies amounted to a kind of right-wing Keynesianism – and as of 2006 or so, the administration could credibly argue that its unfunded tax cuts and spending increases, while budget-busting in the short term, had played some role in pulling the economy up out of its post-Internet-bubble, post-9/11 doldrums.

Note, implicit in Ross’s statement isn’t that Glenn Hubbard, Greg Mankiw and Ben Bernanke – Bush’s CEA Chairmen from 2001 – 2006 – are publically avowed Keynesians. Indeed, they are.

No, Ross seems to suggest that there was some sort of backdoor endorsement of nominal rigidities going on. The endorsement, however, was completely front door. At the signing ceremony Bush declared

“When people have more money, they can spend it on goods and services. And in our society, when they demand an additional good or a service, somebody will produce the good or a service. And when somebody produces that good or a service, it means somebody is more likely to be able to find a job.”

This logic is simply not possible in a world with either Ricardian Equivalence or perfectly flexible wages and prices. In those worlds when the government cuts taxes, either people save every bit of it or the rising deficit crowds-out investment. You have to be a Keynesian to think this will work.

There is a debate over whether Bush’s economic team focused too heavily on reducing what they thought to be the long-term constraints on capital formation rather than addressing the immediate shortfall in demand. That is, some have suggested that the policy amounted to backdoor supply-side economics.

Indeed, that seems to be what Ross is reacting against

Yes, they’d piled up debt for a few years, but the important thing was that the economy was growing (not that quickly, but what wouldn’t we give for Bush-era growth rates today?), which in turn was gradually bringing the budget back into balance and laying the necessary foundation for future deficit reduction.

I don’t think that argument looks nearly as credible today.

To think that tax cuts in 2003 would help curb the deficit in 2010, you would have to be making a supply-side argument. That is, unless you thought the fall in demand from 2001 was enough to push the United States into a 9 year recession. Given that retail sales never actually fell in the 2001 recession – they just stopped growing for a bit – that seems like an extraordinary claim.


To think that tax cuts boost long-term growth enough to pay for themselves is not a Keynesian argument. The Keynesian case is that they boost growth only enough to get us out of a liquidity trap. Once we are out of the liquidity trap the Federal Reserve takes over as the regulator of economic growth.

So, it isn’t that the Bush economic team was a set of secret Keynesians. It is that some had supply side hopes for the Bush tax cut and those supply side hopes did not materialize.

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

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

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

The 10 year breakeven rate seems to be moving higher indicating that the market is expecting inflation. This is the yield on 10 year treasuries minus the yield on inflation protected treasuries. Its not a pure measure of inflation because there seems to be a risk premium built into the TIPS. They have consistently underperformed.

Nonetheless this is an encouraging move upwards since Sep.



The long view: You can see the Lehman crash clearly as well as the early 2010 stall.



In other words, we here at CNET can give you advice about which e-reader to buy, but we can’t tell you whether you’ll actually use it. If you think the answer is maybe not, you might just want to hold off. These devices are only going to get better–and presumably cheaper–moving forward, so you’ll have plenty of time to get on the e-reader bandwagon.

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