Archive for November 2009


Without a QTM anchor, macro is nothing more than undergrad BS

If you’ve ever taught intro to macro, you know that undergrads like to use “self-fulfilling prophesy” arguments for things they don’t understand.  Thus I am somewhat dismayed to see Robert Shiller use the same basic argument to explain why the economy has started to recover.  And yet, despite the derisive title of this post, I am also a bit sympathetic to Shiller’s recent NYT piece:

Consider this possibility: after all these months, people start to think it’s time for the recession to end. The very thought begins to renew confidence, and some people start spending again “” in turn, generating visible signs of recovery. This may seem absurd, and is rarely mentioned as an explanation for mass behavior late in a recession, but economic theorists have long been fascinated by such a possibility.

The notion isn’t as farfetched as it may appear. As we all know, recessions generally last no more than a couple of years. The current recession began in December 2007, according to the National Bureau of Economic Research, so it is almost two years old. According to the standard schedule, we’re due for recovery. Given this knowledge, the mere passage of time may spur our confidence, though no formal statistical analysis can prove it.

.   .   .

President Roosevelt is widely remembered for saying, in 1933, that “the only thing we have to fear is fear itself.” But he was only repeating an oft-told message.

It wasn’t until 1948 that the Columbia University sociologist Robert K. Merton wrote an article in The Antioch Review titled “The Self-Fulfilling Prophecy,” using the Great Depression as his first example. He is often credited with having invented the “self-fulfilling prophesy” phrase, but by the 1930s the idea was already as commonplace as the breakfast toast made with modern electric toasters. (Interestingly, the same Robert Merton documented the tendency for important ideas to be falsely attributed to celebrities.)

Like Shiller, I think that shifts in expectations are the driving force in business cycles.  But what bothers me about the self-fulfilling prophesy approach is that it treats expectations as sort of a free-floating concept, not anchored to fundamental determinants of long-run AD growth.  And I think there is a reason for this.  In some of my early posts I talked about how deflation always leads to a sort of dark ages of macro.  The problem is that economists use the wrong indicators for the stance of monetary policy; focusing on interest rates and the monetary base.  Both of these indicators tend to behave “perversely” during deflation.  Interest rates fall to low levels, and the public and banks tend to hoard base money.  So it looks like monetary policy is easy.  Once monetary policy is viewed as irrelevant, macroeconomics loses the only variable capable of anchoring long run expected NGDP growth.  And without the anchor provided by the Quantity Theory of Money, it’s all just undergraduate BS.  (No disrespect to any undergrads reading this, I am directing the same complaint against an outstanding Yale economist.)

Shiller is hardly the only economist who has written off monetary policy once rates hit zero.  And I give him credit for intuiting that expectations may be a more important driver of AD than fiscal policy.  But in the end, if macro can’t rely on certain basic principles, such as the long run relation between monetary policy and expected NGDP growth, then we really don’t have anything even worth calling a “social science.”

In the Great Depression many economists reverted to the crude prejudices of the man on the street.  It’s happening again.

Are we serious about regulating banking?

When the sub-prime crisis hit in 2007, we were all bombarded with stories about how this showed the effects of deregulation run amok.  Never mind that the housing and banking industries are heavily regulated, the crisis showed we had the wrong kind of regulation.  Or perhaps it showed that the Bush administration never had their heart in regulation, so they let the banks get away with murder.  I think it’s a bit more complicated than that (Bush did try to rein in Fannie and Freddie) but obviously Bush wasn’t keen on discouraging banks from making housing loans.  Just the opposite, he wanted to create an “ownership society.” 
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The Great Recalculation?

A recent Arnold Kling post discusses how the Great Depression can be seen as an example of recalculation.  Kling provides the following quotations from an article by Bruce Greenwald:

Basically, in the Depression a huge sector of the economy that everyone had always regarded as central, died. And it dies for an almost virtuous reason.

That sector of course is agriculture.

.   .   .

The reason why World War II got us out of the Depression, and the reason that Argentina suffered because it didn’t participate, is that it is actually industrial policy that gets everybody off the farms. . . .One of the great concerns at the end of WWII was that everyone thought we were going to go back to the Great Depression. In Argentina, of course, that happened. In the US and everyplace else, everyone was surprised and relieved. But the reason is that you’ve gotten everyone off the farms and into the cities. It was through both the war industries and in the army.

.   .   .

The problem from the perspective of the US is that if we are importing 9% more of our GDP than we are exporting, it is very difficult to sustain full employment. You basically have to have a zero saving rate or a bubble in the internet or housing. But you have to have some substitute demand. . . .The long-term solution is you have to get people out of manufacturing – and governments have to cooperate in this effort – and get them into industries like health care…

The services people have to buy are lots of health care, custodial services for old people, college education and graduate education, and housing. They are big lumpy expenditures, and the government has to help finance them.

At the end of the remarks by Greenwald, Kling makes the following observation:

I was with Greenwald until the last sentence.

Greenwald lost me at the very first sentence.  People have been gradually moving out of agriculture for over 100 years.  The farm sector was also very depressed during the Roaring 20s.  And shouldn’t urban output have risen if workers were flowing into the cities?  How does a flow of workers from the farm to the cities cause industrial production to fall in half?  (Actually, manufacturing is the sector that “died” in the early 1930s, not farming.)   Obviously I don’t understand something here, perhaps someone can explain.

I have an alternative explanation for unemployment.  Nominal GDP fell in half between 1929 and 1933, and nominal wages were sticky, falling by much less than spending.

I do agree with Kling on one point; it is not obvious why the government should subsidize the movement of workers from dying industries into growing industries.

India and China: The glass is half full (or at least 10% full)

Because there was a lot of interest in my India and China posts, I thought I would report on 4 articles that I read in The Economist, while flying to Texas.  Recall that last May I argued that the Indian election was good news for neoliberals, as the Communist Party did very poorly.  I don’t claim to understand Indian politics well enough to evaluate the policy implications of elections, but the fact that the stock market soared about 17% the next day was all the confirmation I needed.  On the other hand some commenters suggested that the Congress Party was now hostile to reform, and that the election results were not what I claimed.  But a recent article in The Economist suggests that reports of the death of neoliberalism may have been premature:

HLL Lifecare, which until this year was called Hindustan Latex, is one of 246 enterprises owned by India’s central government. Spanning everything from nuclear energy to artificial limbs, these companies employed almost 1.6m people in 2008 and accounted for 8.3% of the country’s GDP. On November 5th the government expressed a new willingness to reduce its stake in these enterprises. It wants the profitable ones to offer at least 10% of their shares to the public.
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India as #1

Since I’ve been making a fool of myself with all these contrarian posts, I might as well get it all out of my system.  When Tyler Cowen asked me for my most absurd belief, one idea that I came up with was that India will have the world’s largest economy in the year 2109.
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