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Scott Sumner lists some sources of inequality. He says

I’d like to make some observations about inequality.  First as a person, then as an economist.  These are based on 56 years of observing all kinds of people, in all sorts of different situations.  The various inequalities are not meant to be equally important; indeed I’ve purposely added a few trivial ones for perspective.  But they are all assumed to affect utility (although I don’t know that they all do.)  Then I’ll return to this issue as an economist, and draw some conclusions.

My major comment  is that I didn’t notice the trivial ones. Read whole list.

My only quibble is that the Scott seems to discount the high level of correlation between the various measures of inequality. This is why I think in terms of generalized psycho-social impairment.

You can find the stupid ugly lazy grumpy rich person but they are not common. The reason they are not common is because

A) Developmental interdiction is generally undesirable because there are a lot more ways for something to go wrong than to go right

B) Undesirable factors lead to undesirable outcomes.

C) Assortative mating concentrates less desirable genes

Byran Caplan asks

Suppose half of the sectors of the economy grow forever at 4%, while the rest completely stagnate.  I’m strongly tempted to say that this economy’s growth rate equals 2% forever.  Anyone tempted to disagree?  If so, why?

Before you answer: Would it matter if the 4%-growth sectors were all in "virtual reality" – and the stagnant sectors were for actual food, shelter, cars, etc.?  If it matters, why does it matter?

At first I was puzzled because the answer seemed so obviously to be 4%.

However, I suppose it depends on what you mean by “grows at 4%” 

If you mean that when you look up the real output of this sector in the NIPA tables its four percent larger each year than the year before, while the other sector is always equal to what is was the year before then of course the growth rate of total GDP will converge to 4%

If you mean that the quantity index of one sector grows at 4% while the quantity index of the other sector grows at 0% then the answer could range between 0 and 4% depending on the fraction of budget shares that went into each sector.

For example, suppose that the total quantity of virtual reality grew at 4% but total spending on virtual reality fell by 3% each year because productivity was growing at 7%. Then the growth rate of the economy would converge to zero as virtual reality became a trivial expenditure share.

To get Bryan’s answer then you would need spending on VR and the rest of the economy to remain in equal proportion.

Arnold Kling files this under the myth of the macroeconomy, which confuses me. I think it’s a very important point but its not immediately clear why its makes a myth of macro notions.

I quote Arnold, quoting Bryan Arthur:

Physical jobs are disappearing into the second economy, and I believe this effect is dwarfing the much more publicized effect of jobs disappearing to places like India and China.

the main challenge of the economy is shifting from producing prosperity to distributing prosperity. The second economy will produce wealth no matter what we do; distributing that wealth has become the main problem. For centuries, wealth has traditionally been apportioned in the West through jobs, and jobs have always been forthcoming. When farm jobs disappeared, we still had manufacturing jobs, and when these disappeared we migrated to service jobs. With this digital transformation, this last repository of jobs is shrinking–fewer of us in the future may have white-collar business process jobs–and we face a problem.


This phrases well one of the points I have been trying to make. I don’t think jobs are solely about wealth distribution but that is a lot of what’s going on.

And, when people say “the economy is bad” they do not mean to suggest we have a problem producing prosperity. They mean to suggest we have a problem distributing prosperity.

This is why it can be the case that Net Worth, Consumption, Output, the Size of the Capital Stock, etc, are all higher now than in 1998 but in 1998 the economy was good but now it is bad.

Its also why suggesting that government interference would mean “zero unemployment but nothing to eat” falls on deaf ears today. We have no shortage of prosperity.

That people can see goods and services in the shop window but have no money to buy them is the classic failure of capitalism. That people have money but there are no goods in the shop window is the classic failure of socialism.

Not to be too simplistic but our current problem looks more like the first than the second.

Posting has been and may continue to be light, however, I wanted to make a few notes on my economic outlook.

I have been less concerned than others with the possibility of a coming double dip and that concern has waned based on recent data.

It does seem to me that much of the factory slowdown was supply chain related.

Monetary policy is not as loose as I would like it to be but let us remember that it is still quite loose as things go.

The marginal return to capital in the US is rising. Put in terms that are more familiar to lay people: rents are going up, the vehicle fleet is aging and computing is entering a new device generation – tablets and the cloud.

All of these things will pull investment forward and as long as monetary policy doesn’t stand in the way, boost economic output.

Moreover, the microdata seems consistent with this. More mulit-family building permits are being filed. Used car prices are rising. Vacancy rates at apartments are dropping.

For those who see this and say yes but what about the rest of the economy. Think of it this way: housing, autos and computing represent stimulus for the rest of the economy. It can be negative stimulus or positive stimulus.

My crystal ball says that they will be adding positive stimulus. My best guess right now is that it will be enough to overcome the negative stimulus of fiscal contraction.

Also, on Europe. If the bank capitalization plan works – and right now I think it will -  I still think there is a decent chance that a Europe that declines due to tight money will be a net positive for the United States. Of course, it depends on contagion and other factors but so long as the Euro retains strength I see the primary transmission channels as working in America’s favor.

That is not saying we should wish our European counterparts ill, but simply from a forecasting standpoint that leads me to believe the outlook for the US is still fairly positive.

I want to use this chart from EPI for my own evil purposes.


Lots of people want to focus on the right end of this graph. I want to focus on the left.

Look at the entire period of the 70s. Stagflation, awful economy. However, look how few businesses are reporting “poor sales” as a problem. That’s because they weren’t.

Which is why its important to point out that poor sales is not simply a way of saying the economy is doing poorly. It refers to a specific kind of doing poorly and that is on the demand side.

A recent back and forth between Paul Krugman and Russ Roberts on Keynesian economics reminded me of something I discussed briefly on twitter some time ago and wanted elevate it blog post level. Here’s what Russ said:

Krugman is a Keynesian because he wants bigger government. I’m an anti-Keynesian because I want smaller government. Both of us can find evidence for our worldviews.

Now there are many places where I think “better government” is more important than less government, and sometimes better even means more, but I’m broadly supportive of the notion that government should be smaller. And yet I find myself in much more agreement with Keynesian economists than those like Russ Roberts about what we should do about the recession.

But I think Russ’ point tends to be very true, and is exemplified by what, I think, Ezra Klein called “Now-More-Than-Everism”. This is when someone argues that the solution for any given problem is simply that their favored policies are needed Now More Than Ever. We find ourselves in an extended recession-like economy, obviously Now More Than Ever we need to gut the EPA, or Now More Than Ever we need green energy subsidies.

In the anti-spirit of this mindset I want to focus on Now-Less-Than-Everism. I’ll let Krugman go first:

“Here’s an example: is economic inequality the source of our macroeconomic malaise? Many people think so — and I’ve written a lot about the evils of soaring inequality. But I have not gone that route. I’m not ruling out a connection between inequality and the mess we’re in, but for now I don’t see a clear mechanism, and I often annoy liberal audiences by saying that it’s probably possible to have a full-employment economy largely producing luxury goods for the richest 1 percent. More equality would be good, but not, as far as I can tell, because it would restore full employment.”

Now my turn. I think education reform is a really important issue, and I think charter schools and some parts of the reform movement are extremely important. But we’re not going to get to full employment through education reform. And what we really don’t need right now is mass layoffs of teachers. Or postal workers. Structural adjustments are easier to make when we are at full employment, if these things need to come the future is better than now.

The home mortgage interest deduction is a terrible policy. And I don’t see any good reason why Fannie or Freddie should exist. But we need to get out of these bad policies now less than ever. The housing market continues to be a drag on the economy, and it’s worth putting off reforms until a time when so many homeowners aren’t underwater and are in a better position to absorb negative equity shocks. This isn’t to say we couldn’t begin instituting a long phase out to the deduction, but long term, smart, cautious reforms are needed here, not pulling the rug out. In full employment I’d support pulling the rug out.

Deregulation is important, and necessary, and too much regulation is a problem. But it’s not the problem the economy is facing right now. Attempts to focus on regulation are a distraction, and we’re not going to deregulate our way to full employment. We need to focus on deregulation now less than ever.

I am a creative destruction proponent and regulatory burden is a big long-term concern of mine. I wish that was what was causing our current malaise, I really do. Everyone likes to have their beliefs confirmed, and Now More Than Everism feels good. But it isn’t the problem.

So now it’s your turn. Help prove Russ Roberts’ cynicism wrong, and tell us what favorite policies of yours we need Now Less Than Ever. These can be things that either would be downright harmful now, or that we simply shouldn’t be focusing on and aren’t as important as actual recession cures.

Lots of folks are piling on Russ Roberts but I want to focus on one thing he says here

I recently interviewed Valerie Ramey on the multiplier. In her work, the multiplier ranges from .8 to 1.2. A multiplier of 1 means there is no stimulus from the spending–GDP rises by the amount of the increase in G but by no more. Private spending doesn’t grow. When you include the taxes (either today or in the future to pay back debt from the increase in spending) that finance the government spending, it’s particularly costly.

I think this is substantively wrong. A multiplier of zero means there is no stimulus.

It might be easier to dispense with the term stimulus to see why.

A multiplier of zero implies complete crowding out of the private sector by government. The government spends more and the private sector offsets this exactly by spending less.

A multiplier between zero and one means that there is some crowding out by the private sector. The government spends more, the private sector spends less but not enough to offset government spending.

A multiplier of 1 would suggest no crowding out. The government spends more and private spending is unaffected on net.

A multiplier above one would suggest crowding-in. The government spends more and this increases private as well as public spending.

So now suppose the multiplier was one and invariant to the level of spending. Then the government could choose whatever level of unemployment it wanted without reducing the production of private goods.

That would mean that for example the government could have lowered the unemployment rate from in 2009 by two or three percentage points had it chosen a large enough expenditure [Added: with no loss of private production. This is vastly strong claim than simply we could assist in easing the pain]

As for the total cost, it depends in large part on whether you place any value on those expenditures. So if we are buying roads and schools, you may not believe that are as useful as private construction spending might be, but are they 100% useless?  If they are even only 50% useless then you have come out ahead.

How the borrowed funds affect the long run economy is complex and depends on what the monetary response is, in large part. However, note that the government does not ever have to pay the bonds back and in general does not even have to tax the population in order to service them.

That’s because when the recovery hits the interest rate on t-bills is less that than nominal growth rate.

FRED Graph

So even rolling in the interest payments continually will result in a declining debt-to-GDP ratio. Eventually the debt will just shrink away.

A multiplier above one suggests that when the government spends more we get more government goods AND more private sector goods. There is crowding-in.

Here it makes sense to do spending even if the project you are spending on is worthless. This is digging ditches just to fill them back up again territory.

Now that having been said I think people worry too much about the multiplier.

I heard lots of people suggesting that we should do direct spending over tax cuts because the multiplier is bigger, but this is not the right way to think about it.

You have to consider the logistics of actually spending this money and the effect that its going to have on the economy.

If you have some project sitting on the shelf that you wanted to do anyway and it has lots of return then you should do that. Trying to assemble projects is going to be more difficult and the side-benefits are going to be less. Plus if the only reason you are doing this project is to lower unemployment then you have to consider the distorting effects it has on the economy.

One great thing about tax cuts is that they are really easy to implement and we don’t have to worry about trying to direct resources to some end.

People can direct resources to whatever end they want. We also get the benefit of being able to do a broad based stimulus that directly benefits lots of people at once.

People often think of tax cuts as being less progressive, but we could make them progressive by cutting taxes that poorer folks pay. So there is little reason to worry about that. Of course, if you don’t care about progressivity then you don’t even have to worry about this, you could cut upper marginal rates or something else.

There is much more to say here but this is really important

I hold my ideology for a wide range of reasons many of which are based on what I observe about the world and human behavior along with a set of beliefs about how the world would work if my ideology were more prominent in policy decisions. But I don’t pretend I’m against government spending because the multiplier is small.

Yes, but you can think the multiplier is small and still be a Keynesian. More importantly you can be against government spending and still be Keynesian.

What if you just hated the government? Say the government raped and killed your family and you still haven’t gotten over it. One could easily say, look I believe that sticky prices cause general disequilbrium and real effects from monetary shocks. I also recognize that when the central bank sets the interest rate on government debt that government borrowing is expansionary.

But, I’ll be damned if I want to hand over more power to the very people who destroyed everything I hold dear.

That’s thoroughly Keynesian and thoroughly anti-government.

Arnold Kling answers them and so do I, below.

1. The unemployment rate is stuck at 9.1%. The U.S. isn’t adding enough jobs to keep up with the growth of the labor force. What’s done is done — the fiscal stimulus, the Federal Reserve’s quantitative easing, etc. What specific policies would you adopt today to quicken the pace of economic growth and hiring?

First, I would suspend all payroll taxes for 12 months, and the phase them back in over the next 12 months. No attempt would be made to “pay for this”

Second, I would open up immigration. My preferred policy is that anyone can come to the US who is willing to pay a $5000 fee and have a background check. The fee is per person. It is sent to the local government that the immigrant moves to as an impact fee to allow them to build out support infrastructure

I image that a private network of lenders will emerge to support paying this fee for just about anyone who has a decent prospect of being able to get a job. Many skilled workers will be able to borrow enough to move their whole family at once. Less skilled workers may have to work and save to bring more family members over.

Once in through this channel a person has legal rights as a permanent resident.

2. If raising taxes would be bad for the economy, how would cutting spending and eliminating government jobs now be good for the economy?

It’s not “good for the economy” in a stabilization sense, though some people might prefer a smaller government.

Its important, however, to understand what the government actually does. Nearly half of all civilian government employees work in education. The majority of total federal government employees work in the military.

While I am for less wars and more school choice these are not changes that can occur overnight and so restructuring government employment will not happen overnight.

3. Housing remains a major drag on the U.S. economy. About one in five Americans with a mortgage owes more than the value of his or her house. More than half Americans with equity in their home have a mortgage with an interest rate above 5%, but hasn’t refinanced. Home-building is at historic lows. Can government policy do more to rescue housing? If so, what?

Yes, but indirectly. The best thing for housing is a growing economy. As the economy picks up the housing market will heal and there will be a self-reinforcing boom.

We could help this process along by allowing more immigrants into the country and by temporarily reducing taxes.

4. Several of you have expressed displeasure with Federal Reserve Chairman Ben Bernanke? Who would you prefer to see in that job?

I don’t think the Chairman is “the problem.” While the central bank is far more timid than I would like I think this is a structural issue due to the nature of powerful bureaucratic organizations.

We don’t put passionate men and women in charge of the money supply for a reason. Unfortunately that has negative as well as positive consequences.

5. Will the middle class have to bear some of the burden — either in higher taxes or fewer government benefits — to bring the federal deficit under control?

Yes, most likely in the form of higher taxes. No country that I am aware of has significantly decreased the path of government benefit expenditures, in part because they are so dominated by health care and spending on the elderly.

The sick and the old are incredibly sympathetic constituencies. I do not think it likely that the United States will cut these expenditures in a purposeful way, though health care has a lot of uncertainty attached to its future cost numbers.

The likelihood is that taxes will need to rise over the coming decades and the middle class will have to pay that.

6. Are there any tax increases of any kind that you would accept over the next decade?

Yes, I would prefer scrapping the current tax system and imposing a flat tax on all personal income sources, capital gains adjusted for inflation and business profits. To cover all expenses for the government in the coming decades this tax rate will have to slowly rise into at least the mid 20% range depending on how many immigrants we have.

Obviously the more immigrants the lower the tax rate as military and past debt expenditure are spread over a larger base. Also, it would lower the current cost of medicine and retirement spending as the average age of the population is likely to fall dramatically in the wake of large immigration.

To introduce progressivity into the system I would work towards federalizing and expanding Medicaid, thus reducing state taxes that tend to be even more regressive than a national flat tax. I would also push for voucherization of K12 paid for through the federal tax.

This will cause the flat tax rate to rise to around 30% or so, but would allow State and Local taxes to collapse, and give lower income folks a huge break, relative to income, on health and education expenses.

7. What’s the best way to slow the growth of health care costs in the U.S. over the next quarter-century?

Reduce barriers to entry in medicine and pharmaceuticals. Allow more nurses to write scripts with only limited educational requirements. Push for OTC of more medicine. Do not require that new procedures and pharmaceuticals show efficacy, only safety. Allow IT to develop tech for medicine without facing heavy regulation or large civil liabilities.

This is a fine line to walk but I would reduce the “consumer protections” in medicine as far as the public would tolerate. I think they would tolerate a significant reduction if it was done slowly and carefully.

8. Mitt Romney backs the imposition of U.S. tariffs on Chinese imports if China doesn’t allow its currency to float freely on international markets. The Senate is taking up similar legislation. Do you support the pending Senate bill?

I am hesitant. I think there are better ways to boost Aggregate Demand than straining relations with China

9. The living standards of our children and our grandchildren’s generation depend on investments we make today that pay off in future productivity later. What, if anything, should the government spend money on today with that objective in mind?

Developing prizes for achieving goals in computer science and engineering; particularly along the road map to artificial intelligence. One might also want prizes for “electric power storage” or “generation of electric power from solar radiation” setting objectives for efficacy and cost in terms of raw materials.

The conditions of the prize are that the tech has to be made freely available to anyone who wants to implement it.

10. How specifically, if at all, should government policy respond to the persistent widening of the gap between winners and losers in the U.S. economy?

Strengthening the safety net by providing increased humanitarian benefits to the losers like guaranteed health care, education and retirement.

No specific effort should be made to reduce the winnings of the winners.

Paul Krugman lays out part of the case and Russ Roberts responds

The evidence for the Keynesian worldview is very mixed. Most economists come down in favor or against it because of their prior ideological beliefs. Krugman is a Keynesian because he wants bigger government. I’m an anti-Keynesian because I want smaller government. Both of us can find evidence for our worldviews. Whose evidence is better? I’m not sure it’s a meaningful question. My empirical points about Keynesianism won’t convince Krugman. His point don’t convince me. I am not saying that we will never get any kind of decisive evidence on the question. I’m saying it sure isn’t here now.

Well, this clearly lays the groundwork for a very long conversation. I don’t think we have to be shackled by our ideological beliefs and that reason and evidence can lead us at least to a common state of ignorance.

That is, we might not know the answer but at least we can agree on what we do and do not know.

There are two big points that I want to address right off. First, sticky prices

Keynesian models assume sticky prices, prices are sticky, therefore? Therefore what? Therefore Keynesian models have somewhat realistic assumptions. That isn’t the most convincing selling point.

So no we don’t want to suggest that because a model has the assumption of sticky prices it must be better. What we do want to think is, “what do sticky prices imply about the world?”

Suppose everything thing else in traditional microeconomics was true except that prices were sticky. How would that change our conclusions about what happened in general equilibrium?

Importantly, I think we get the concept of Aggregate Demand. Markets no longer wash. In my mind I think of a pool of water. When markets wash its like when you put your hand in one part of the pool and the water level instantly rises everywhere so that there is no indention from your hand.

Now make the liquid in the pool ever more viscous. It no longer washes it forms an imprint from where you pressed on it. The stickier the bigger the imprint and so you can meaningfully say that portion of the pool has been depressed.

So the fact that markets are viscous means that your dynamics are going to change in a particular set of ways. This is a big deal.

Second, monetary policy

Yes, there is plenty of evidence that monetary policy can have real effects. So why isn’t there plenty of evidence of fiscal policy having real effects? He has to say that in the models (whose? which ones? All of them?) that presume monetary policy works, so does fiscal policy.

I actually think this is a bigger deal. Indeed, for the key fact that the monetary authority sets the short term interest rate on government debt makes it hard to understand how the basic mechanics of Keynesianism could not work.

To keep it simple, if you think that people respond to prices then the fact that the government can issue or retire debt without changing the price of that debt is a huge deal.

Its also why I like to focus on borrowing as the instrument by which fiscal policy takes place.

Especially when start talking about spending, stimulus is quickly confused with industrial policy. And, often stimulus is used as a cover for industrial policy so the confusion is understandable.

However, whether or not the government takes command of real goods and services is not central to fiscal policy. What is central is that the issues bonds and the central bank exchanges those bonds for cash.

The government could simply use that cash to finance tax cuts, which is my preferred course of action.

People often want to talk multiplier and we can. Though, I think there is less here than meets the eye. Monetary financed tax cuts are not costly and so there is no reason to attempt to economize on them.

In any case, once you accept the basics of monetary policy its really hard to describe why fiscal policy should not also work. You might be able to come up with reasons why government spending has such bad side effects that it shouldn’t be tried, but that’s a different question from whether the Keynesian effects exist.

A couple of replies. Russ both says

Does Tyler really believe that the median male worker of today has the same standard of living today as in 1969? My original challenge to Tyler was to give me his interpretation of data points like the one he invokes here. It is certainly consistent with his story but it’s too consistent. Per capita GDP has increased a lot since 1969. Did none of it go to the median male worker? Besides problems with inflation measurement in the wage data, there is also a problem with benefits. By the way, the income data leaves out a great deal as well.

First, unless we are getting into issues between the Implicit GDP deflator and the Consumer Price Index, then inflation bias is not going to explain the deviation of real per capita GDP from real median income. Both are deflated figures.

Also, I think it helps here to move away from the median, that way we can avoid discussions about filtering down.

A core question is whether or not increases in GDP are being reflected in market wages and if so for whom. Below I graph per capita GDP versus mean male and female income.


You can see that even mean growth for men lags far behind GDP per capita. Moreover there were two broad periods of stagnation from 1969 to 1993 and from 1998 to now. That can’t be explained merely by recession. We have only one period of clear growth.

Now, lets look at indices, to get a better look at relative change.


Check that out. Female income tracks GDP per capita almost dead-on. These two series are not derived from the same underlying data. So, the fact that female mean income tracks real GDP is notable.

This makes it harder to say that this is simply something about the difference between per capita GDP and real income.

Now lets dispense with the difference between male and female. Easy to come by data only goes back to 1974 here but we still see the same phase pattern we saw in the male data if less pronounced.


Now, lets do GDP per hour worked. Here we can see a pick up in GDP per hours worked in the 90s as well though unlike the boost in mean incomes it persists through the dot-com recession.


I think the take away is that there are genuine phases, or put another way, the 90s really were different. Something was going in the economy from 1969 to at least 2011 with the exception of a brief period in the 90s.

I don’t think it can be explained away by appeals to inflation bias.

Second, Russ says,

I bring up the distorting effect of divorce on the data not because I think it redeems the last 40 years. That’s not what we’re talking about. We’re talking about whether the economy is broken. If the average person does not share in economic growth of the magnitude we’ve had in the last 40 years then we should have a revolution not a modest increase in taxes on the rich or a hike in the minimum wage.

I don’t know if we should go around having revolutions regardless of what the median income data say.

However, more to the point: the economy in and of itself cannot be broken. The economy simply is.

We might have certain feelings about the economy but “the economy is broken” is not fundamentally a statement about the economy it is a statement about our emotions.

How people feel is important, but it is not at issue here and on a more basic level I don’t know if its really relevant what the income data say when it comes to that. If people are sad or upset then they are sad or upset. This needs to be addressed.

Analyzing the income data, however, is not likely to make many sad people happy or many happy people sad.

As for the deviation of real per capita GDP from mean income I think we have some plausible candidates for the discrepancy – health care seems to be the big driver, but we’ll have to look at that evidence in a later post.

So this is similar to the point Scott Sumner made in Oil and Money don’t mix but cast through my frame of looking at the world. This result may be well known but I have not heard it stated before.

My simple conjecture is this: A rise in the price of oil in the face of a constant interest rate represents a tightening of monetary policy.


Because so much oil is imported from overseas and because oil profits are deposited into US T-Bills.

So, what happens when the price of oil goes up. US consumers ship lots of money to Oil Producing Countries.

Those oil producing countries then buy US T-Bills. This would tend to drive down the US T-Bill rate. However, the T-Bill rate must wash with the Fed Funds rate.

So money goes out of T-Bills and into overnight reserve market. This tends to push down the Fed Funds rate. The Open Market Operations Desk responds by selling T-Bills (or buying fewer) and destroying (or creating fewer) reserves.

This tightens monetary policy in the United States.

Another way to think about it would be this.

Higher oil prices transfer money from consumers with a high propensity to spend on consumer goods to oil producing countries with a high propensity to save.

The natural response of this change would be to drive down interest rates thereby encouraging businesses to invest more and soak up the savings.

However, the interest rate cannot fall because it is targeted by the Central Bank. Thus savings rise but investment does not. The net effect is contraction in Aggregate Demand.

This is only worsened by the fact that a central bank may respond to higher oil prices by actually raising the nominal interest rate.

Scott Sumner still doesn’t like my example

This entire post seems like a slight of hand. You are assuming a tax doesn’t fall on a certain group, and then arguing that if it doesn’t, then that group won’t change it’s behavior. Yes, but that doesn’t tell us anything important about the implications of actually taxing that group (i.e. the people not being taxed in your example.) It would be like advocating that employers pay 100% of the payroll tax (instead of 50%), on the basis that it wouldn’t deter them from hiring. Yes, but only because they wouldn’t actually be bearing any more of the tax than they do today.

Yes, but if someone were going around saying that we shouldn’t put all of the payroll tax on employers because it would deter hiring, I would be making the point that in the long run this is not going to matter.

My long point on billionaires is not simply that they do not bear the burden, however. Its that you can tell the burden is extremely light in utility terms because it could be so easily shifted.

In reality I actually don’t think taxes would crowd out charity 100%. But, that’s an optimal choice. Meaning that billionaires could completely avoid the burden of taxation, but don’t because its not really that big of a deal anyway.

Now this doesn’t mean that you should necessarily tax billionaires. Indeed, no one seems to bring up the very important issue that taxes wealthy investors moves capital out of the hands of people who have a proven track record of efficiently allocating it.

In other words the reason not to tax Buffet is not because he will stop investing, but because he won’t have that specific money to invest. It really seems like he knows what he is doing with those resources so society would be better off if he didn’t relinquish control of them just yet.

Indeed, I think he recognizes this because allegedly he and his ex-wife disagreed about charitable giving. She wanted to give all the money away now, he wanted to wait until he was dead.

His point was that he could accumulate even more money and give even more to charity if he waited and I think that is exactly right.

However, the issue that I am addressing is that

1) People are saying that billionaire taxes are going to harm work effort; and

2) They really seem to believe what they are saying.

Its not like the work effort argument is just a rhetorical device for getting some policy end. I think people believe that it is true. And, I believe that they are wrong. Which is why I want to correct this issue.

Now if you want to talk about other issues with taxes, like the very important point that Hicksian deadweight loss is not the same as Marshallian deadweight loss then we can and we should.

But, we should not be thinking that the reduction in work effort is big when evidence and reason tell us that it is likely small.

As usual there is a lot more to say on this than I will get a chance to say, but I wanted to at least take a stab at this piece by Leonhardt before the body turned cold.

I pick it out in part because it’s a good expression of what I think is a popular error and in part because lots of folks have praised it, making it a good target for a contrarian post.

Leonhardt says

In recent years, on the other hand, the economy has not done an especially good job of building its productive capacity. Yes, innovations like the iPad and Twitter have altered daily life. And, yes, companies have figured out how to produce just as many goods and services with fewer workers. But the country has not developed any major new industries that employ large and growing numbers of workers.

Its entirely possible for employment to grow while living standards fall. A quick and dirty measure of that comes from this widely circulated chart.

You might think all sorts of things about 2005, but do you feel like the economy was worse then than it was in 2008 – 2009, because median household income was lower.

Not only that but as you can see there is a rough correlation between median household income and the unemployment rate. Higher median income, the higher unemployment.

There is a lot going on here – not least of which is that a growing economy as more jobs and higher gas prices – but the core point is that increasing value and increasing employment are not the same.

People keep mixing this up.

I emailed a fellow economists on this issue so maybe I will have a good jumping off point later in the day but look it:

Prices on the NASDAQ, for example, go up and they go down. That can be good or bad for you. But, the market clears. It doesn’t matter what happens in tech or to or if we weren’t as wealthy as we though we were or all kinds of other junk. The market clears.

Why aren’t market’s clearing? This is the question? Why do I have houses piling up foresale? Why do I have workers filling out resume after resume? Why did I at the worst of the recession have inventories of real goods piling up at record rates? Why do I still have 2009 model year cars on my lots? Why do I have assembly lines that are not turning?

Why aren’t my markets clearing?

We lose a bunch of wealth fine. We got the balance sheets wrong fine. There is no new tech fine. There is not enough oil fine. All fine, whatever.

Why aren’t my markets clearing?

In response to my last post Scott Sumner asks

I don’t follow this argument. If the money isn’t coming out of consumption, then the rich aren’t really paying the tax–someone else is. The question of interest is whether taxes that reduce consumption also reduce work effort, investment, etc.

It seems like you are arguing that if the tax revenue comes out of the pockets of starving people in the Third World, then it doesn’t reduce the incentive of the rich to work. I’m skeptical, but let’s say that’s true. What are the implications? Should we impose heavy taxes on staving people in the third world?

The bolded sentence is basically my point accept phrased a different way.

My point is that if taxes crowded out charity 100% then how big of a deal could taxes be to the people who are statutorily being taxed.

That is, would they say I am not going to bother creating this company and generating great new products unless I what I get in return is the ability to give money to the International Red Cross.


But, that’s a lot of love for the Red Cross. Their whole business career is geared around what they can and cannot donate to the IRC? Seems unlikely. That tells us the economic response is likely muted. At least from an incentive perspective.


There is another issue with taxes that has to do with redistributing income away from people who are good at allocating it, but that’s another story.


Now, what’s the implication. There isn’t one. Indeed, I specifically tried to create an example where there was a lot of moral ambiguity about what was going on. Maybe the International Red Cross is better. Maybe income inequality is tearing at the fabric of the United States and the preservation of the world’s most powerful democracy depends on these taxes.

Who knows?

And, that’s precisely the point, because our analysis of whether or not taxes reduce work effort should not be clouded by our feelings about whether or not taxes are a good idea. So lets create a thought experiment where common intuition about the morality of the rich and taxes is confused, so that we can focus on the economic response.

I have relentlessly pushed back against the idea that higher marginal tax rates would discourage people from attempting to accumulate, work in high paying industries or invest in good projects.

I think there are lots of key facts to support this but one is the ever increasing amount that the wealthy give to charity.

For example consider the Billionaire Charity Pledge. From Aug 2010 Reuters story:

Based on Forbes magazine’s estimates of the billionaires’ wealth, at least $150 billion could be given away.

Among the rich joining The Giving Pledge campaign are New York Mayor Michael Bloomberg, media moguls Barry Diller and Ted Turner, Oracle co-founder Larry Ellison, "Star Wars" movie maker George Lucas and energy tycoon T. Boone Pickens.

A total of 40 of the richest people in the United States, including Microsoft founder Gates and investor Buffett, now have taken the pledge.

Since launching the campaign in June [2010], Buffett, Gates and his wife Melinda have spoken to about 20 percent of the wealthiest people in the United States — 70 to 80 billionaires — in a bid to persuade them to give away their fortunes.

"In most cases we had reason to believe that the people already had an interest in philanthropy," Buffett said. "It was a very soft sell but 40 have signed up."

For one months worth of work this is a pretty high take up rate on a voluntary tax additional marginal tax rate of 50%.

Of course they get to donate to the charity of their choice but think about what we have to be saying. Here are two scenarios

Scenario One: You start a company make $10 Billion after taxes and give $5 Billion to the International Red Cross leaving you with $5 Billion for whatever else you want.

Scenario Two: You start a company but because of the much higher marginal tax rates you only wind up making $6 Billion and as a result wind up only giving $1 Billion to International Red Cross leaving you with $ 5 Billion for whatever else you want.

Now, in those two scenarios building the economy required the same risks, the same sleepless nights, the same heartache and the same sacrifice. At in both scenarios you winded up $5 Billion for consumption or other purposes.

The difference is that in the first you were able to give $5 Billion to the International Red Cross while in the later you were only able to give $1 Billion.

Does it seem plausible that people would say: well then screw it, if I can’t give another $4 Billion to the Red Cross then all of this sacrifice just isn’t worth it to me?


But, that seems hard to swallow.

I picked this story because it helps us divorce the question, “do marginal tax rates on the very wealthy significantly impact incentives” from “are increases in marginal tax rates a good idea”

In this scenario taxes purely crowded out private charity. Not only that but a charity that goes to some of the hardest hit disaster victims all around the world. Its incredibly likely that by depriving disaster victims of funds, the tax increase was a net loss to humanity.

Yet, that’s totally different than from the question: do taxes significantly impact the incentives of very wealthy people? When lots of the wealthy are giving tons to charity its hard to see that they do.

Via Don Boudreaux; Baker, Bloom and Davis have a new paper on policy uncertainty. I draw your attention to this graph.


There are a couple of interesting things here.

1) Neither The Stimulus, nor ObamaCare show up on this index. The you can see Obama’s election. You can see the 2010 midterms. However, between those is a valley of “relative” calm.

2) The Debt Ceiling Debate is huge, much bigger policy uncertainty than Lehman.

Those two points are interesting because if you look through this graph, the elections, wars and financial panic produce economic policy uncertainty. I am not really sure if you can see a tax or spending package besides the minor Bush stimulus. You can’t see HillaryCare. You can’t see Medicare Part D. You can’t see the Clinton tax increases or the Bush tax cuts.

You can sort of see Gramm-Rudman but it barely beats out normal spikes.

You don’t see the fall of the Berlin Wall. You don’t see the passage of NAFTA. You don’t see the crack-up of the former Soviet Union. You don’t see the death of Deng Xiaoping. You don’t see the “Gore Bill” You don’t see the repeal of Glass-Steagall.

And, I mean you don’t see these in anyway, positive or negative. They are just not meaningful policy events according to this index. In some ways that raises questions but it could simply mean that these things don’t matter as far as the macroeconomy is concerned.

Now, back to point (2), you see the debt-ceiling debate as being the high point of uncertainty in the last 25 years. That certainly rings true for me. That thing was no joke.

However, it went well, while Lehman went bad. So it will be interesting to see what happens to growth in the wake of these two events. Just riffing off the chart you would expect the debt-ceiling debate to have been worse than Lehman but obviously that seems a little crazy to me.

However, we shall see.

Russ Roberts on Aggregate Demand

Saying that poor sales is the biggest problem facing small business is like saying that the biggest problem facing the economy is that it’s not doing very well. It has no content. It tells you nothing about an amorphous concept called “aggregate demand”

This is obviously a long conversation, but I take the doubt on this seriously. At least one important component of the concept of aggregate demand is the fact that lots of markets seem to expand or contract at the same time.

Here is just one brick in the wall, industrial produciton on a variety of products types moving together.

FRED Graph

Updated a bit for clarity, since this post is purely a product of my own mind and might otherwise be really confusing if I didn’t check over it. There are still tons of mistakes I am sure, but hopefully its readable.

Paul Krugman says

[IS-LM] makes it clear that what we’re basically doing is the minimal model that has goods, bonds, and money — that there is nothing arbitrary about the whole thing, that this is basically what you have to do if you want a minimal model of the things that matter for short-run macro. Mark reminds me, by the way, that I published a paper on all this (pdf) a decade ago; you know you’re getting old when you don’t remember all the papers you’ve written.

Except do you really need goods, money and bonds? What about goods, money and banks.

Well, banks and bonds are basically the same thing you might say. My reply is that they are kind of the same thing, but not quite and to the extent they are different the world acts more like its banking matters.

So, why adopt an inferior set of terms? I fully admit we are all talking about the same basic process.

However, IS-LM would make it harder for you to describe what was going on in the Great Recession and indeed, if you took the labels too seriously would have been difficult for you to predict its severity.

On the other hand BL-MP would have led you to think that the end of the world may very well have been nigh.

You could have tried to explain 2008 as a rapid increase in liquidity demand, in which case short term nominal interest rates should have spiked. We have a little of that but not much.

FRED Graph

That implies that all of your action could not have been on your LM/MP/MR curve. As you move that curve output and interest rates ought to go in opposite directions.

However, out put was collapsing as interest rates were collapsing. That tells us the action is happening on the opposing curve.

But, how do you make that make sense with IS, per se? You could say that animal spirits for investment dropped off or you could say that desired savings skyrocketed. None of those I think fits the timing.

Here are Total Financial Assets of Households. Its tanking

FRED Graph

Yeah, yeah, but that is influenced by stock prices. Okay, lets take out stock prices.

FRED Graph

Maybe its just deposits that matter, at least those are rising.

FRED Graph

Though take a step back and see that nothing unusual is going on here.

FRED Graph

Okay maybe its animal spirits. Planned investment declined, driving the IS curve down.

FRED Graph

Now at least we are getting some movement in the right direction. Still I think the timing tells another story. For example, retail sales drops off before New Orders.

FRED Graph

Is our story that forward thinking consumers for saw an otherwise unexplained drop in planned business investment? Maybe. But, if so what did they see. At this point we are probably already telling some story about banks.

There is another problem with thinking in terms of planned investment being the driver. It wasn’t worse than Dot-Com.

FRED Graph

But Housing Investment you say, I am forgetting the drop in housing investment. Nope. We can look at this a couple of ways. The common way and the one I prefer. Lets start common by looking at Residential Fixed Investment.

Over our five year horizon you see no change in the path. RFI had peaked in 2005.

FRED Graph

If anything decline slows slightly just as the US is beginning recession.

We can back up a pit and add my preferred indicator of residential investment, construction spending. It is monthly and does not include net purchases of existing structures or brokers commission’s  on existing structures.

FRED Graph

So I am not sure what simple story we tell about IS curve that makes sense of all this. We can of course always say that such-and-such happened in the financial markets and that influenced investment.

However, I think we are going to be tempted to move the LM curve when we think about financial markets and that doesn’t explain why we get interest rates – both real and nominal – and output declining at the same time.

We can tell a very straight forward story about the BL curve. If we look at a measure of the tightness of lending standards, its rising (above zero) and at an accelerating rate as we go into the recession.

FRED Graph

I am going to switch to bar graph because zero is a significant number here. Zero indicates just as many banks tightening and loosening standards.

FRED Graph

We see lending standards tightening just as the recession starts completely consistent with the BL story. This tells you the BL curve is on the move, irrespective of what savers or investors plan to do.

And what happens if the BL curve is contracting? Interest rates are going down at the same time that output is going down.

Lets zoon out to get some perspective.

FRED Graph

Even though this is just a diffusion index and doesn’t tell us anything about how much tightening is going on just what fraction, it still tells us immediately that the Great Recession was a different beast. For one thing, standards tighten more severely and more quickly. For another, they tighten immediately for consumers, foreshadowing, the historic drop in retail sales.

FRED Graph

Russ Roberts is skeptical of The Great Stagnation

Panel data that tell a different story? Go here for one example: when you follow the same people over time, you see that since the late 1970′s, children grow up to have a much higher standard of living than their parents, (even with lousy measures of inflation) and the biggest gains are for the poorest people. This is inconsistent with the Great Stagnation.

Let put the chart Russ links to front and center

There are two issues here that both have to do with looking at parents and children.

The first is simple regression to the mean, and its well on display in the black families. That is, the children of poor parents did better than there parents, the children of rich parents did worse than there parents.

Suppose there is some underlying family income propensity plus a random variable. The random variable could be anything including the particular circumstances of the year in which you interviewed them.

Then we are going to see this. Some poor parents will be poor precisely because they had an unusually low random draw, we would expect the children to do better. Conversely, some parents will be rich precisely because they got a high random draw. We would expect the kids to do worse.

In the white family data you can see the same thing if you extract an upward trend. That would suggest family income growing on average but poor families likely growing more and rich families likely growing less.

However, the upward trend doesn’t tell us much either because people can change classes.

A story where all of the GDP was going to the top one-percent would be completely consistent with this data, so long as the every white kid has some positive probability of making it into the top one percent.

On average every white parent should expect that his or her child will be richer because every white parent has some chance of producing a child that will be in the top 1%.

Also Russ says

The other challenge to the Great Stagnation is that per-capita GDP is way up since the 1970′s. The left argues that the rich got all the gains. The mechanisms they propose to explain this (lower rates of unionization, slow growth in the nominal minimum wage) are not convincing. Unionization rates have been falling steadily since the 1950′s and the minimum wage never covered enough people to make it important. How does the left (or Tyler) then explain this disconnect between national growth and the effect on the middle? They don’t have a convincing story.

So to echo Peter Thiel the first question is whether or not the phenomenon exists. Jumping ahead to why just confuses the matter. Why might be something that we never thought of. It could be something totally off the wall.

First, we try to figure out if this is actually happening. Then if it is we can think about why.

There are a bunch of other points that Russ makes, some of which Tyler addresses and some of which I think call for more data.

A couple of things

1) All Keynesian models assume the same basic dyanmics in the background. Whether we choose IS-LM, or IS-MP, or IS-PC-MR or what I am pushing here, BL-MP, is really just about terminology and helping us easily relate what happens in the real world to what happens in the picture.  The deep underlying models are all the same.

2) By focusing our attention on bank lending we can see a couple of things

  • A liquidity trap is better described as no worthwhile lending opportunities rather than animal spirits causing a drop in borrowing. This is because the risk premium is so high. This could be because of real factors or it could be because bank balance sheets are all torn up and they cannot afford to take risks.


  • Government borrowing changes the game not because of marginal propensities to consume but because the government is a different type of borrower. The government is always a good credit risk. Indeed, in a world where reserves are swapped for government bonds the government can’t not be a good credit risk.  Thus I rise in government borrowing suddenly makes overall lending safer and the BL curve moves out.
  • Governments which may directly default (rather than inflate) lose traction on the BL curve. It is not at all clear that Greece can move the BL curve.
  • Banks have a special role in the economy such that a trillion dollar loss by banking institutions is a much different thing then a trillion dollar loss by households. Dot-Com vs Subprime.

3) Raising inflation expectations works by making lending safer and pushing out the BL curve. Holding the Fed Funds rate constant higher inflation means that each borrower is more likely to be able to pay back any loan at any given interest rate for any give project.

I like this because it helps nominalize our thinking. Too much thinking – in my opinion – is done in real terms. What’s the real interest rate? What’s the real return on investment?

Does this actually matter in the world we live in? The opportunity cost of funds simply is the federal funds rate. As long as the overnight lending market is functioning, nothing in the real economy can change that. Thus an expanding nominal economy – what ever the source of the expansion – makes it a better idea to lend.

There are some other things I think could be worked out but this is the basic idea.

A few posts back I made the point that mocking your intellectual opponents is a bad idea because only raises the cost of them changing their mind. if you mock them, your opponent has to admit that he or she is a fool.

Its much better to downplay differences and disagreements as honest mistakes that anyone could have made. This way if people want to switch their views its far less painful for them.

However, this post from Kevin Drum is enlightening.

Are there some crackpots at the Occupy Wall Street protests who will be gleefully quoted by Fox News? Sure. Are some of the organizers anarchists or socialists or whatnot? Sure. Is it sometimes hard to discern a real set of grievances from the protesters? Sure.

But so what. Ignore it. Dismiss it. Explain it away. Do whatever strikes your fancy. But don’t let any of this scare you off. We can put up with a bit of mockery if we keep the chart above firmly in front of our faces.

Kevin, is trying to pump his supporters up to withstand mockery. I assume he knows what he is doing, which tells me that progressives respond to mockery far different than does the rest of the population. Here I am including, traditional conservatives, libertarians, moderates and people who are generally apathetic about politics.

These other folks – who constitute the bulk of the population – get naturally defensive when you mock them. They do not feel scared off in the slightest. Indeed, they might have otherwise been charming and friendly but your mockery will turn them into blood enemies.

Now, as is my wont, I am going to attribute this to some systemic difference in the brain structure of progressives, that probably has to do with why they are progressives.

For example, the exact same brain structure might make one more acutely sensitive to the grievances of minorities and the local poor as well as the admonishment of climate scientists.

However, the larger point is to recognize that most people are definitely not built this way – whatever “this way” is – and mocking them is not going to get them to shy away. Its going to get them to dig in deeper.

I know this conversation is getting tired but it has forced me to think about the difference between the way I talk about the economy and the pictures I draw. The way I talk is likely better represented in an economy that looks like this



Combine this with an expectations augmented Phillips Curve a NAIRU Phillips curve where movements away from sustainable unemployment cause changes in the inflation rate. and a Taylor Rule to close the model to consider the effects of inflation. Only now think of unexpected changes in unemployment pulling on inflation.

A couple key ideas

  • Bankers are the gate keepers on Aggregate Demand. If you are willing to lend someone is willing to borrow. This is because of the fundamental asymmetry between borrowers and lenders.
  • The Fed Funds rate is the key rate in the economy because it determines the opportunity cost of reserves.
  • Central Government borrowing pushes out the BL curve by offering a risk free lending opportunity.
  • Riskiness in the economy contracts the BL curve by making most loans a worse deal.
  • Losses to bank balance sheets drags the BL curve way in
  • A Fed that targets only inflation (horizontal MP curve) will give more power to the fiscal authorities and make fiscal policy inflationary/deflationary
  • A Fed that targets on inflation will also be very vulnerable to bank sector shocks.

I don’t have any grand conclusion from this yet but I just think its interesting.

Here is the unemployment rate considering only people who lost their job as opposed to those who quit or just started looking for work.

FRED Graph

Its declining much more sharply.

Does that tell us anything important about the recession?

So I wanted to look into Bob Lucas’s suggestion that

A) Europe is suffering from tax policies that discourage married women from working

B) The recession in the US is lingering because we are adopting European style policies, presumably thus discouraging married women from working.

Here is the raw ratio of labor force participation level of married women to married men over time in the United States. I had to back it out from the employment level and unemployment rate so the arithmetic is a little involved but here are the results.

FRED Graph

There is clearly a trend but it seemed to level out sometime in the early 90s, interestingly before booming employment and growth set in. It dipped in the 2000s and is actually higher in the wake of the Great Recession.

We can take a close up over the last 20 years

FRED Graph

We can see a strong step up in the ratio after the Clinton tax increases, reaching a peak around 2000. In the wake of the Bush tax cuts, the ratio begins to decline hitting a local low around 2005. Yet, note that after the passage of ObamaCare the ratio spike significantly and remains near record highs.

From this evidence one might deduce that tax cuts decrease the relative incentive of married women to seek work.

Now, I personally think that narrative is a line of crap and that what’s really at work here are changes in the market. Basically an effort to decrease class sizes in K12 drove an increase in female employment during the 1990s. This was counteracted by increasing construction employment which peaked around 2005.

Over the long run and in the recent episodes I don’t think you really see tax policy as an effect.

Also just because I think it should be done, here is the long run trend in logs

FRED Graph

And the growth in the trend

FRED Graph

Both of these confirm that the strongest growth was in the late sixties. However, even in the late 60s / early 70s the bump in the trend growth rate is not that wild. That is, what I interpret – I am not a historian here – as the peak of the women’s rights movement didn’t move the dial that much. These things are deep, really deep. If you can’t alter them with radical social movements you are not going to alter them with relatively small changes in marginal tax rates.

There is still more to be said about taxes and household labor supply but I do not think a simple story about married women’s work efforts fits the facts.

Sorry but I keep thinking of notes on this – probably because I am supposed to be writing an exam.

Tyler Cowen said

[IS-LM] leads you to think that the distinction between non-interest bearing currency and short-term interest-bearing securities is a critical wedge for the economy.  It also implies that if all currency paid interest (a minor change, most likely, macroeconomically speaking), the economy would behave in a totally screwy way.  It probably wouldn’t.

This is a perfect opportunity for me to point out that paying interest on reserves does cause the economy to act in “screwy” ways.

Or to be more specific it means that the interest rate paid on reserves and not the quantity of reserves or the dynamics of the overnight lending market are determinate in monetary policy.

This is because the overnight lending rate is bound by the interest paid on reserves. You could drive reserves up to $5 trillion dollar and it won’t make a difference. Print all the money you like. Buy all the bonds you like. Lending won’t change.

That’s very different from a world where open market operations are determinant of how banks respond.

If I may be so bold I think the debate over IS-LM boils down to simple miscommunication.

Matt Rognile seems to favor IS-MP and both he and Tyler Cowen see that as bolstering Tyler’s complaint.

However, if you prefer IS-MP to IS-LM then in my words you just think IS-LM is inconvenient because it’s the same model. To my knowledge there is nothing we could describe in IS-MP that we can’t describe in IS-LM you just have to move the curves more and they represent implicit actions rather than explicit ones.

If you have an MP curve the you can say: And the Fed decides to lower interest rates and its really clear what happens. But, you could also say that the Fed conducts open market operation which increases the supply of reserves and lowers the overnight rate.

As a note, I think it is easiest to call “the interest rate” the overnight rate and for that to be what is depicted on both graphs. The long term rates and “real rates” descend from the overnight rate.

However, in all cases banks stand at the center of the transmission apparatus between Investment, Savings and Monetary Policy and banks look at the overnight rate.

This is also helpful because your investment decisions over the long term must match up against what you think the long term evolution of the overnight rate is. Inflation be damned.

If you know exactly what the overnight rate is going to be over the next several years then you know exactly what your net return on lending needs to be. What the rate of inflation is, is irrelevant.

If you beat the overnight rate you win. If you don’t beat the overnight rate you lose. Absolutely nothing else matters as long as the overnight market is completely liquid. Now, it might be that the path overnight rate is consistent with everyone taking home a wad of cash. Or the overnight rate is consistent with everyone going out of business.

However, that’s really neither here nor there. There is nothing you can do about that. The only thing you can do is beat the overnight rate. Its literally the opportunity cost of not having that cash.

Wait so both Bryan Caplan and David Henderson are set to take Bob Muprhy’s hard earned cash.

I know that a while ago I made two inflation bets, one with Bryan Caplan and a much more serious one with David Henderson.

Now, I don’t know why Bob doesn’t just buy the heck out of TIPS which are calling for roughly 2% inflation over the next two years. Even if there is no inflation at all he doesn’t stand to loose as much as in his bets with Bryan and David.

However, far be it from me not to take cash when its being offered. Is there a new bet Bob is interested in making. He says

Feel free to say I can’t tell when it’s coming, but please believe me when I say I know what price inflation is.

I made the above bets in December 2009. Things are obviously not progressing on the timetable I had thought (as has been well documented on these pages), but I’m still confident in my bet with Bryan and would make it again. The one with David is obviously looming much more menacingly. If it weren’t for the crisis in Europe (which is pushing people to flock into dollars), I would still be fine with it, but it may turn into a nailbiter.

And per my earlier post the problem I see today is that money is too tight not too loose, and contra Ron Paul I would suppose that free banking would result in a weaker dollar not a stronger one. You don’t have to be right for the right reason to be right.

Matt Yglesias asks

Even at the height of Microsoft’s power in the late-’90s, Windows 98 was oddly ugly. Surely the richest company on the planet could hire someone to design a better logo than this, right? Why were the default color combinations on Excel charts so wretched? Why didn’t anyone else bother to design power adaptors that look good?

The story I was telling well into the mid 2000s was that Steve Jobs thought computers should be easy to use and appealing to the eye. Bill Gates thought they should be cheaper than dirt. And, Bill Gates was right.

I think Felix Salmon is right about what really happened. The Gates strategy of a Model T in every garage was correct when the tech was new an expensive. You cut corners in every way possible, you do anything to push the price down. Send it out half baked, full of holes and ugly as hell, but just send it out cheap.

I think Bill Gates is still mostly right about software. Cheap rulz.

However, the price of hardware collapsed so fast that Jobs-esque hardware could be produced at prices people could easily afford. You could cut $40 off the price of the Ipad by just settling for something a bit uglier, but that wouldn’t really improve sales.

That’s also, why Apple has only been successful when the software was married to the hardware. To my knowledge no one is buying OS X to install on their own Linux box.

There is not much to report. It seems like a fairly mild report overall. Up 103K, 137K, private sector. Its not consistent with the economy currently being in recession but I didn’t think that was likely anyway.

A few areas of note

  • Government dropped 34K jobs. Local Government 35K, with State and Federal gaining a net 1K. Out of that 24K were local government jobs in education.  This is, of course, not “good” jobs wise. Some people might think its good for the overall balance of the nation, but I am not here to debate that. What I am here to say is that from a forecasting perspective this is something that is likely to level out in the coming months. I don’t predict a big surge in Local Government education hiring any time soon, but the drag should stop.
  • Manufacturing dropped 13K jobs. This is consistent with the ISM reports that showed tepid manufacturing. Though -13K is not that bad a number. Manufacturing employment usually declines. It’s the rate of decline that should concern us and this is not particularly fast. And, I expect new orders for autos to be increasing in the coming months
  • Construction up 26K. Looks inline, I expect this to accelerate.
  • Health Care up 43K. We had actually seen some decline in employment at hospitals and doctors offices but we are making record highs again, as per usual.
  • Preforming Arts, Accommodation and Gambling and Amusement all saw declines. That seems strange to me give the hotel occupancy data. I thought we were recovering from the summer slowdown here, but apparently not yet.

Bill Woosley asks

Are you just saying that the “balance sheet recession” involves requires a change in the allocation of resources, more structural unemployment and so a higher NAIRU?

How does higher inflation help avoid higher structural unemployment?

Yes, we could say that a Balance Sheet recession involves more structural unemployment. However, we want to differentiate between a change in structure that comes from technological change and is likely permanent; and a change in structure that comes from sudden credit constraints and is likely temporary.

So suppose that we have two representative agents Amanda and Ben. They are exactly the same accept Amanda is a safe saver and Ben is a risky investor.

Now to be clear neither Amanda nor Ben are directly involved in the building up of the capital stock. Ben is not a venture capitalist or a real estate developer. He merely owns the capital stock that is created in the background via the magic of the K-dot equation.

The there is a sudden collapse in asset values. Lets just say that someone thought there was a way to mitigate the risk involved in providing owner occupied homes to households with poor credit, but turned out be wrong and so the price of owner occupied housing collapsed. This example is purely hypothetical mind you.

Now the central bank is really good here, so any increase in liquidity demand was matched by appropriate monetary policy. There was no effective tightening and the economy did not spiral into a Great Recession.

However, unemployment still rose. Why? Because Ben now credit constrained and has to cut back on consumption across the board. Amanda faces roughly the same set of net constraints and so her consumption doesn’t change.

To make markets balance the economy must shift from consumption that was going to Ben to the accumulation of more capital. And, indeed the real interest rate has fallen to make that happen because we have great central bankers.

However, we also have workers that were skilled at consumption who now have to shift to capital. This is a structural readjustment that raises structural unemployment.

However, it is not forever. It is just until Ben is no longer credit constrained. Then he will resume his normal consumption behavior and workers must flow back into consumption industries from capital industries.

This process is brought more quickly to an end by an increase in the rate of inflation which burns down Ben’s debt and gets him out of the credit constraint trap.

So there is a temporary increase in structural unemployment as the economy is forced to reconfigure around Ben’s credit constrained status. However, it is not permanent as would be a shift in technology and it can be brought to an end more quickly with higher inflation. 

Matt Rognile argues that they don’t

So yes, deleveraging can be very bad for the economy. But this is only because monetary policy doesn’t adjust enough to match the market.

In failing to understand this core logic, most commentary about “deleveraging” is rather bizarre. At some level, it’s the same cluelessness that we once saw from central planners: they’d trip over themselves in the complexity of fixing a shortage in one market or a glut in another, never quite realizing that the price mechanism would do their work for them. Right now, historically low inflation expectations and below-potential output are prima facie evidence that real interest rates are too high. That’s what every macro model tells us is associated with contractionary policy by the Fed. Yet we see pundits lost in all kinds of complicated, small-bore proposals to stimulate the economy—when the fundamental, overriding dilemma is getting the price (in this case, the interest rate) right.

I don’t think this is quite right. The overwhelming problem in the economy is that real interest rate is too high and this is caused our cyclical sectors to see contraction and a weak recovery.

However, we would still be having balance sheet problems even if the real interest rate could fall further.

To put it another way, a balance sheet recession raises the NAIRU, by altering the relationship between Aggregate Demand and spending in non-cyclical sectors.

Now, I think Matt and I would agree that the proper response to this is to accept higher inflation. However, it is important that all of the work cannot be done by the interest rate alone even if we weren’t running into the zero lower bound.

The distribution of debt and assets has to change or else the NAIRU will rise.

However, yes to be perfectly clear, the perception that you just can’t do anything about unemployment because it’s a balance sheet recession strikes me as deeply wrong.

I have been a staunch supporter of an independent central bank technocratically solving the problem of macroeconomic management

Yet, now I must watch as one of the most powerful Central Bank in the world, the Federal Reserve, can’t come to consensus on what it wants to do and has decided that perhaps Rome should burn just a little bit more while it has additional meetings on the relative merits of bucket brigades versus opening the aqueducts.

Its counterpart the European Central Bank, has apparently decided that what the fire really needs is a bit more oil, lest the people think the bank is more committed to putting out fires than lecturing people on fire prevention.

Let us not even speak of the Bank of Japan which perhaps should be disbanded out of mercy for the central bankers if nothing else.

I have not lost all faith –Sweden and Switzerland still stand – but it is hard to watch this carnival of human suffering and believe that we supporters of central banking are not part of the problem.

Obviously the European Central Bank (ECB) has nearly unlimited power to inflict suffering on the people of the Eurozone. And, from the looks of it they it intend to use it. Power unused is unless power, and all that.

“Have we delivered price stability? Yes, we have delivered price stability,” he said. “Are we credible in delivering price stability over the next 10 years? Yes. These are not words, these are deeds.”

However, lets suppose that the ECB is able to make good on its promise to stabilize the European banking system while simultaneously throwing as many Europeans on to the breadline as possible delivering stable prices over the next 10 years. What does that mean for America?

I’ll be the first to admit that I need to think harder and more carefully about international capital flows but I have to say at this point that it looks like a net positive for the US economy. As sad as that might be, I think its true.

Here is my reasoning.

So, core in my assumption is the power of the overnight lending markets to swamp what happens in other capital markets. European stock indices may collapse. Loans to European companies and consumers might be in the toilet. Yet, if the German and French banks are stable and the overnight lending rate is elevated then ultimately it will attract global capital.

This will cause the Euro to rise against the Dollar. Now US exports to Europe might still fall as European consumption decline.  However, holding capital flows constant this is going to put even more upward pressure on the Euro which means that US imports from Europe should fall even more.

Now I take the Fed at its word that it sees both inflation as too low and unemployment as too high and would like to stimulate the US economy but is finding a hard time reaching consensus on the proper tools.

Collapsing imports from Europe gives them a tool. It raises the price level in the United States by eliminating cheaper European goods and increases employment by having consumers switch to American made goods.

None of this is undone through monetary policy because its consistent with where the Fed wants to go.

Or looking at it through another lens. As the current account reverses direction dollar bills flow from Europe to America, while capital flows from America to Europe.

This provides monetary stimulus to America and monetary contraction to Europe. Both are consistent with the goals of the respective central banks and so no policy moves offset these flows.

In the end America grows as Europe falters.

Let’s be realistic, probably nothing. But I could be proven wrong by a new film he stars in that has the potential, at least, to raise some interesting ethical questions. Here is the summary from Wikipedia:

In a retro-future when the aging gene has been switched off, people stop aging at 25 years old. However, stamped on their arm is a clock of how long they will live. To avoid overpopulation, time has become the currency and the way people pay for luxuries and necessities. The rich can live forever, while the rest try to negotiate for their immortality.

And here is the trailer:

A frequent argument made in favor of organ markets is that donating a kidney does not lower life expectancy. But is the morality of kidney markets contingent on this fact, and how certain are we of this? I’ve written about this issue before.

The question is, do you object to markets in life years? If so, then it would seem that the argument that kidney donations do not decrease the life expectancy of the donor isn’t just an argument in favor allowing it, but a necessary condition for it.

This raises the importance of this question significantly. Has there ever been a randomized study done on kidney donation?  Clearly there is a selection bias here in that unhealthy people are unlikely to donate. If it turns out that kidney donations do decrease life expectancy, will supporters of these markets (like myself) change their minds? Or does the morality really hinge on whether there is a net increase in lifespan?

Another question about markets in life years is that it is just an explicit version of trade that is already occurring. Miners, commercial fisherman, and others in dangerous occupations already trade expected life expectancy for money.  Does the narrowing of the variance around that expectation increase the immorality of the transaction? Or is there some certainty threshold you cross where it becomes immoral? Surely it isn’t 100% certainty, right?

Anyway, these are the amateur philosophical thoughts of an economist tossing these ideas around. I’m sure more philosophically sophisticated people than I can explain clearly and persuasively the right, wrong, and unsettled of this issue.

Due to it’s decentralized nature, it’s hard to get a grasp on what the specific goals and complaints of Occupy Wall Street are. But it seems pretty clear at least one complaint of theirs is that “big banks are too big”. But if you think this is true, and you wanted to end it, then why would you occupy Wall Street of all places? What do they expect Wall Street to do about this? Voluntarily shrink? Even if they managed to convince current bank management to do this because… um… the drum circle had a persuasive beat, those managers would be kicked out by shareholders, and rightfully so. And what do they expect Washington to do about this? Break up the big banks? This is probably what they have in mind, but it’s a pipe dream.

Not that there’s anything wrong in protesting in favor of pipe dreams, but if occupying Wall Street and occupying Washington won’t actually help shrink big banks, then what will? Occupy your neighbors, friends, families, and anyone you know who uses the big banks. Tell them to take their deposits out and put them in a local credit union or small bank. Tell them to take loans from these places. Big banks are big for a reason: they have a lot of assets and make a lot of money. They need your deposits, they need to charge you fees. If Americans don’t want Big Banks to be big, then stop using them. There is a very simple way for everyone to vote with their pocketbooks and put their money where their mouths are. So instead of yelling at banks to stop taking deposits and fees, yell at the people around you to stop giving them.

From the Washington Post:

The European Central Bank offered new emergency loans to banks on Thursday to help them through the turmoil of the government debt crisis, but decided to keep interest rates on hold despite fears of an economic slowdown.

Remember what happened last time a central bank failed to let rates fall to zero (nay, failed to let rates fall at all!), failed to commit to an explicit level target, and instead made what were widely understood to be temporary injections into the banking sector? Here’s a hint, it happened in October 2008, in the United States.

Also, this is nearing sadistic:

“Have we delivered price stability? Yes, we have delivered price stability,” he (Trichet) said. “Are we credible in delivering price stability over the next 10 years? Yes. These are not words, these are deeds.”

[h/t Matt Yglesias]

Alabama law now makes it a crime for an illegal immigrant to solicit work and makes it legal to detain people indefinitely on suspicion of being an illegal immigrant.

The law allows police to detain people indefinitely if they are suspected of being in the country illegally and requires schools to check the status of new students when they enroll. Those elements make it perhaps the toughest law in nation.

The law targets employers by forbidding drivers from stopping along a road to hire temporary workers. It also bars businesses from taking tax deductions for wages paid to illegal workers and makes it a crime for an illegal immigrant to solicit work. A federal judge has temporarily blocked those sections of the law so she can study them more.

So any pretext of being concerned about folks coming here to be a burden on the system is completely abandoned. It is now extra illegal to even try to work and feed your family.

Capital having nowhere else to go is contemplating going where its needed most. From CNBC

Africa share valuations are compelling and the region is ripe for investment, Graham Stock, chief strategist at Insparo Asset Management, told CNBC Thursday.

“Now is absolutely the right time [to invest in Africa],” said the Africa expert.

“Valuations are very attractive. We are talking about price-earnings ratios in the low single digits in some cases. There are some very attractive opportunities across a wide range of countries.”

Stock described Africa as one of the fastest-growing regions in the world, predicting growth of 5.5 percent to 6 percent in both 2011 and 2012.

He added that the continent’s growth prospects are relatively immune to the sovereign debt crisis in Europe, as growth is being driven by a combination of domestic demand (particularly from the expanding middle classes), “tremendous” resource endowment, and investment from China and India.

Just shut up, ok. You had me at disinflation.

Via Tyler Cowen, I see this piece at Between the Balance Sheets, which purports to show the untold side.

The original article on which Krugman’s piece was based is even more interesting. The authors came to a very different conclusion from the professor, however, which has significant implications for today’s debates on monetary policy and the economy.

Yet, I don’t see anything here which deviates from the core lessons we would learn from this story.

The author of the blog post says

Krugman’s account focused on the way the co-op used monetary policy to deal with its “recession” after it had already occurred:

By contrast, the original story focused on the cause of the “recession.” The problem was that the co-op economy was very sensitive to monetary shocks because the price of going out was fixed:

There was a shortage of scrip. There was so little scrip to go around that holders were reluctant to squander it by going out. Those who wanted to go out but didn’t have scrip were desperate to get sitting jobs. The scrip-price of baby sitting couldn’t adjust, and the shortage worsened.

The bolded passage makes all the difference in the world. Recall that a unit of scrip was defined in terms of the number of hours of baby-sitting it could purchase. The price of going out was fixed in terms of scrip, so when the supply of scrip fell, the cost of going out surged.

First, Krugman off-handedly mentions the reason why the recession occurred, because of taxation. However, that’s not particularly material to the core insight.

On the other hand the note about sticky prices is material to the core insight but its also – if I may be so bold – the point of the Sweenys’ telling of the story, Krugman’s telling of the story, and my frequent telling of the story. The idea is to help people understand liquidity demand; that we don’t need and industrial economy or bonds in order to have a recession. We just need money, prices and exchange.

It’s the anti-PSST story. No patterns whatsoever.

On my bus ride home I toy with a story that even eliminates the exchange. There are only money and prices. What it’s the price of – well you have to wait and see if I can finish the story for that – but there are no goods or services, or anything that could be meaningfully called output or employment.

When the economy goes into recession it manifests itself solely in a reduction in the velocity of money, yet we can easily see that this makes the participants sad and they could be made happier by monetary and fiscal policy.

I think also that we can even have a bank and a bank run, but that is much more sketchy.

Long story short, I what Under the Balance Sheets identifies as the key message is what we all think is the key message.

The only place where I see a difference is when Under the Balance Sheets seems to conclude that the whole thing is an indictment of macro-management. The post author says.

This is the third lesson: experts cannot manage the economy.

As they asked at the end, ”if goodhearted people in an area that offers little scope for chicanery can so bungle economic management, can we really be surprised at the results of turning our economy over to the tender mercies of political experts?”

I totally took a way the lesson that this is not a political problem, nor a problem of people of bad faith or class warfare. This is a monetary problem pure and simple.

Indeed the final two paragraphs are this:

The monetary nature of the co-op crisis is clear (to you and us). The recession-inflation seesaw developed when the number of units of scrip per member got out of line. Very well. Get it back in line and see to it that turnover the growth (or shrinkage) cannot change this ratio. There are lots of ways to do this, though the tendency to look for moral failings as the cause of difficulties makes discretion in the hands of the officers more than a bit iffy. One way to cut the knot is to fix the number of units per member at an amount that seems right on the basis of past ups and downs, and freeze the ratio there. Of course, the ratio may be a little off and the "best" ratio may change from time to time. But this may merely be the cost of avoiding a conversation grilling you about why you haven’t sat for four weeks. Unfortunately, the co-op members seem not to understand all this. When crisis finally stirs the majority to action, who can say monetary wisdom will prevail.

There are a few practical morals to draw from this unhappy tale. One is that the co-op is an organization of persons, with social and personal relations—and it’s also an economy. It is simply foolish not to design the management of the economy right to begin with. The main lesson may be that there is an economy embedded in many social relationships, and while a well-run economy is no guarantee of love and peace and happiness, a poorly run economy may well prevent these goodies. Now, if goodhearted people in an area that offers little scope for chicanery can so bungle economic management, can we really be surprise at the results of turning our economy over to the tender mercies of political experts? Indeed, unlike the co-op, the national economy seems virtually indestructible, not having died yet

This seems to me to a pure endorsement of technocracy. That the problem is not political, its technical.

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