The incredible shrinking General Theory

Tyler Cowen has a series of increasingly persuasive posts criticizing the view that fiscal stimulus is the answer to our problems:

It is incorrect to argue that: “their high-savings export-oriented economy only works if someone else runs a high-debt economy and buys their stuff.”  The Germans do just fine when they trade with current account surplus countries.  If Portugal and Greece were more like Norway or the Netherlands, the German trade surplus might well go down, but the total value of German exports likely would go up (Germany exports mainly “normal goods”) and the German economy would do just fine.

The Germans are well aware that most of their neighbors have not managed their finances nearly as well as they have.  How should we expect them to respond, if we, and others, now tell them that, after all their careful management, it is now time to run up debt to spend more money in their neighbors’ shops?  (And that is in addition to significant ongoing EU transfers from Germany to poorer countries.)  How would we respond to such a request?

.    .    .

How do we speak to the much poorer Chinese?  Do we offer them aid or do we make demands on them?  In this matter, the Germans to me seem more reasonable than the United States.

Some supporters of Keynesian theory act as if it is a well-established theory, as if skeptics are akin to global warming deniers.  Count me as someone who believes in global warming, but has serious doubts about fiscal stimulus.

The first question is which Keynesian model?  Keynes believed that fiscal stimulus almost always had a stimulative effect, because the economy was almost never at full employment.  When I was in school we were taught that it was stimulative in a recession. By the 1990s the standard new Keynesian view was that fiscal policy had no effect if the central bank was doing its job, i.e. was targeting the expected inflation rate.  Because fiscal stimulus works by boosting AD, and because higher AD boosts inflation expectations, any attempt to use fiscal stimulus will be thwarted by central banks that increasing focused on inflation targeting.  Indeed even a flexible inflation target that also incorporated output would be enough to completely neutralize fiscal stimulus.  The old Keynesians crawled into their caves, and monetary policy became the all-important stabilization tool.  The General Theory had become the special theory–only applicable to cases where for some reason monetary stimulus was not an option.

Then something strange happened.  Japan stumbled into a “liquidity trap” (or more specifically a condition of mild deflation and near-zero short term rates.)  Interest rate-oriented monetary rules no longer worked in Japan, and the best and the brightest set out to fix the problem.  Paul Krugman noticed that the Japanese were also running big fiscal deficits, and decided that fiscal stimulus might not be the solution:

But anyway, as a practical concern the main point about fiscal policy in Japan is that it is clearly nearing its limits. Over the course of the past 7 years Japan has experienced a secular trend toward ever-growing fiscal deficits; yet this has not been enough to close the savings-investment gap. One need not claim that fiscal policy is completely ineffective: as Adam Posen has emphasized, fiscal expansion has pushed up Japanese growth when tried. But how much fiscal expansion can the government afford? Between 1991 and 1996 Japan’s consolidated budget went from a surplus of 2.9 percent of GDP to a deficit of 4.3 percent, yet the economy was marked by growing excess capacity. When the Hashimoto government, alarmed by the long-run fiscal position, tried to narrow the deficit in 1997 the result was a recession; now fiscal stimulus is being tried once again. But projections already suggest that Japan may be heading for some awesome deficits – say 10 percent of GDP next fiscal year – with no end to the need for fiscal stimulus in sight. Given that Japan is already in far worse fiscal shape than, say, Brazil on every index I can think of – not just current deficit, but debt to GDP ratio and hidden liabilities arising from an aging population, the need for bank and corporate bailouts, etc., one has to wonder where the fiscal-expansion strategy is leading.

Good question!  Instead the best option was for the Bank of Japan to stimulate the economy.  Krugman said they must “promise to be irresponsible,” i.e. set a higher inflation target.

Then Mr. Bush came along, and Bush derangement syndrome set in among the left.  He was viewed as such a singularly clueless and incompetent President that they assumed anything he supported must be bad.  Bush supported big government, but more importantly he said he opposed big government.  So if Bush said big government was bad, it must be good.  So the old Keynesians started creeping out of their caves, and advancing their fiscal stimulus ideas.  (Ironically, Bush himself was one of those old Keynesians, at least in regard to fiscal stimulus.)

The intellectual leaders of this movement tried to create a more respectable model to dress up their big government policy views.  The far-fetched idea of an “expectations trap” was developed; the idea that markets would understand that central bankers were too conservative to implement higher inflation targets during deflation.  It was never explained how fiscal stimulus would work in that case.  If central banks are really that afraid of inflation, wouldn’t they also tighten up when fiscal stimulus threatened to boost aggregate demand?  And indeed didn’t the Fed do exactly that in 1936-37 when they doubled reserve requirements in response to stronger aggregate demand supposedly coming from fiscal stimulus?  And didn’t the BOJ tighten monetary policy three times in response to fears of inflation (not actual inflation!) during the past decade?  So yes, conservative central banks may be a problem for monetary policy, but they are equally bad news for fiscal stimulus.

With pure theory not offering any answers here, we must turn to the empirical evidence.  The opponents of fiscal stimulus dug up one case after another where fiscal stimulus didn’t seem to work, or where fiscal contraction was associated with strong growth.  Each time the Keynesian said “that doesn’t count; they weren’t at the zero bound.”  OK, so in the entire history if the world we basically have three cases to work with:

1.  The US in the 1930s

2.  Japan post-1994

3.  The period since September 2008

The Great Depression lasted 12 years–so it can hardly be used to show that any policy (fiscal or monetary) is successful at ending recessions faster than they would end without stimulus.  Some point to the effects of WWII.  Yes, if you suddenly draft 13 million men into the military (the equivalent of 30 million today!) and give industry a blank check to produce as much military supplies as they can at profitable prices, you will get a big drop in unemployment.  No one disputes that.  Of course you will also get a drop in consumption, and isn’t the whole point of the multiplier to boost consumption and living standards?

What about the Japanese case?  Japan ran large budget deficits, causing their national debt to balloon to over 100% of GDP.   Even worse for the Keynesians, they did exactly the sort of deficit spending that is supposed to be the most potent, building infrastructure.   And 16 years later, Japan is still in deflation.  But of course that’s not how Keynesians see things.  Today Krugman doesn’t emphasize how much they spent, how little they accomplished, and how big their debts have become, but exactly the opposite.  They really never tried hard enough.  Sure they paved over the once beautiful countryside with wasteful highway and bridge projects, but it wasn’t enough.  If stimulus didn’t work, the answer seems no longer to be more money or more inflation, but rather more fiscal stimulus, more infrastructure, more concrete, still more concrete, and even more concrete.

And of course the same happened in America.  After the $700 billion stimulus was passed unemployment rose by much more than was predicted to occur if no stimulus was enacted.  The recovery was half as fast as the 1983-84 recovery, despite stimulus being twice as large (deficits of 6% of GDP then vs. 12% of GDP this time.)  But again there were excuses—the economy had unexpectedly gotten much worse before the stimulus money was actually spent.  OK, but I thought the new Keynesian models that all this is based on were predicated on the stimulative effect beginning when the policy was announced, not when the money was spent?  Isn’t that the Woodford/Eggertsson approach; the model that the smarter new Keynesians now point too?

So we have a theory that shrinks to the point where it is only applicable in liquidity traps, and then disappears entirely if central banks use unconventional policy tools and/or try to subvert fiscal stimulus with monetary tightness.  In other words, you must assume a bizarre reaction function from the central bank to even make it work in theory.  Then you have little or no empirical evidence of fiscal stimulus actually working in even those rarefied zero rate bound environments.  There may be some utopia where the General Theory is applicable; unfortunately we don’t seem to live there.  (I presume everyone knows the literal meaning of utopia.)  Ross Douthat has a similar take:

Technically, they could be right “” but only in the same way that it’s possible that the Iraq War would have been a ringing success if only we’d invaded with a million extra soldiers. The theory is unfalsifiable because the policy course is imaginary. Maybe in some parallel universe there’s a Congress that would be willing to borrow and spend trillions in stimulus dollars, despite record deficits, if that’s what liberal economists said the situation required. But not in this one.

We don’t need more concrete, we need our central banks to commit to higher prices and NGDP.


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43 Responses to “The incredible shrinking General Theory”

  1. Gravatar of Kevin Dick Kevin Dick
    23. June 2010 at 08:28

    Ironically, I think if you examined the theory of anthropogenic global warming with the same level of effort that you do monetary theory, you’d probably also come up with a “contrarian” position and for many of the same reasons :-)

  2. Gravatar of Benjamin Cole Benjamin Cole
    23. June 2010 at 08:40

    Interesting piece, very persuasive.
    As a sometime Keynesian, I am not sure I ever crawled back into a cave however. Maybe a hovel. Even defeated theorists have some pride.
    However, I do agree (if I read correctly) that having a “tight” monetary policy has nearly become a fetish in some circles, and may be destructive.
    An aside: Given that money and capital flows easily across borders, what does that mean about domestic monetary policy?

  3. Gravatar of scott sumner scott sumner
    23. June 2010 at 08:59

    Kevin, Actually, I have read many of the scientific papers on global warming. But I’m not sure many global warming deniers have. Perhaps I am wrong. I have also read many articles written by global warming skeptics, and found none to be persuasive. If you find a good one, let me know.

    Benjamin, Thanks. You can still control domestic monetary policy as long as you have flexible exchange rates.

  4. Gravatar of Brett Brett
    23. June 2010 at 09:11

    Today Krugman doesn’t emphasize how much they spent, how little they accomplished, and how big their debts have become, but exactly the opposite. They really never tried hard enough.

    Krugman would argue exactly that – that the Japanese (and the US in the 1930s) never really committed to a full fiscal stimulus policy. He’s pointed out before that the Japanese basically played stop-and-go on their fiscal stimulus, and that the US dampened stimulus efforts in 1937 or 1938.

    To be fair to the 1930s US, they really just didn’t know a lot better. Not so much the Japanese.

    Sure they paved over the once beautiful countryside with wasteful highway and bridge projects, but it wasn’t enough. If stimulus didn’t work, the answer seems no longer to be more money or more inflation, but rather more fiscal stimulus, more infrastructure, more concrete, still more concrete, and even more concrete.

    That sounds more like “not all stimulus is equal in its long-term effects on the economy” than “fiscal stimulus is bad.” The Japanese government blew a ton of money on random construction projects all over the place, and particularly in rural areas (these also happened to be LDP strongholds), such as this town.

    Kevin, Actually, I have read many of the scientific papers on global warming. But I’m not sure many global warming deniers have. Perhaps I am wrong. I have also read many articles written by global warming skeptics, and found none to be persuasive. If you find a good one, let me know.

    Same here.

  5. Gravatar of Dilip Dilip
    23. June 2010 at 09:38

    Dean Baker did address many of the recent spate of columns on Deficit reduction and the failure of stimulus pending. I don’t know if I emailed them to you but here are they for the benefit of a larger audience:

    http://www.cepr.net/index.php/blogs/beat-the-press/david-brooks-and-the-power-of-magical-thinking-at-the-nyt/

    http://www.cepr.net/index.php/blogs/beat-the-press/theory-stimulus-unemployed-workers-and-unemployed-politicians/

  6. Gravatar of William William
    23. June 2010 at 10:05

    Scott,

    On this topic, I stumbled upon this exchange with Milton Friedman in Snowdon and Vane (p. 213) yesterday and was wondering if you’d care to give a quick comment.

    “S&V: In the light of your work on the consumption function and monetary economics in general, what role do you see for fiscal policy in a macroeconomic context?

    Friedman: None. I believe that fiscal policy will contribute most if it doesn’t try to offset short-term movements in the economy. I’m expressing a minority view here but it’s my belief that fiscal policy is not an effective instrument for controlling short-term movements in the economy. One of the things I have tried to do over the years is to find cases where fiscal policy is going in one direction and monetary policy is going in the opposite. In every case the actual course of events follows monetary policy. I have never found a case in which fiscal policy dominated monetary policy and I suggest to you as a test to find a counter-example.”

    I think the interview was in 1996. How close or far from the truth is Friedman’s position these days?

  7. Gravatar of OGT OGT
    23. June 2010 at 10:18

    Via Martin Wolf, here’s an interesting study by Eichengreen and a couple of less famous Economists:

    Cross-country comparisons can thus help us untie the Gordian Knot and move the debate from the realm of ideology to that of evidence. Our project therefore focuses on assembling annual data on growth, budgets and central bank policy rates, mainly from League of Nations sources, for 27 countries covering the period 1925-39…

    This leaves the question of what model or empirical technique to apply. Rather than prejudging the answer, we employ a battery of empirical methods… The details of the results differ, but the overall conclusions do not. They show that where fiscal policy was tried, it was effective…

    The results for monetary policy are less robust but point in the same direction. A positive shock to the central bank discount rate leads to a fall in GDP (Figure 2). The fall in output just misses statistical significance at conventional levels (that is, the confidence bands just barely span the horizontal line denoting no change.) Under alternative assumptions about the ordering of the variables, however (Figure 3), the direction of the effect is the same, and this time it is significant.

    As Martin Wolf notes, we appear ready to engage in a new global fiscal austerity experiment. My guess is that it will mot end well, but Cowen and Kling may be about to get their wishes.

    http://www.voxeu.org/index.php?q=node/4227

    http://www.ft.com/cms/s/0/969c17c6-7e2b-11df-94a8-00144feabdc0.html

  8. Gravatar of jsalvati jsalvati
    23. June 2010 at 10:20

    http://economistsview.typepad.com/economistsview/2010/06/is-the-feds-caution-justified.html

    Thoma seems to believe that while Monetary Stimulus is desirable, fiscal stimulus is actually *better* than monetary stimulus.

  9. Gravatar of Alex F. Alex F.
    23. June 2010 at 10:44

    Yeah, but isn’t your solution even more without historical precedent? When did a central bank ever fought deflation like they fought inflation?

    Here in Germany everybody is a natural born inflation hawk. People on the street don’t even know what deflation is. And if you explain it to them, they think it’s a good thing. Conservative Libertarians in Germany like this guy: http://mises.org/daily/1254

    Historically the depression endet with WWII, which was a case of fiscal policy. Austrian Austerity seems to end up in Military Keynesianism.

  10. Gravatar of Ram Ram
    23. June 2010 at 10:54

    Maybe the reason that central banks are being too conservative is that they are worried about their credibility with investors when deploying unconventional MONETARY policies (Bernanke, for one, has said as much). Your response, I presume, is that fiscal authorities ought to be just as worried about their credibility with investors when deploying fiscal stimulus, and if they’re not then the central banks certainly are. But maybe not. If the Fed is, as you suggest, acting to offset additional fiscal stimulus to meet their inflation/NGDP target, that means they know how to offset the inflationary effects of said stimulus. So why should they be so worried about its credibility? The combined credibility of fiscal stimulus + central bank hawkishness on excess inflation may be adequate to assauge investors, no? Is this not reflected in the relative calm markets seem to be showing vis a vis inflation?

    That was a rambling paragraph. All I mean to ask is, isn’t it theoretically possible that the Fed for example is confident in the credibility of its interest rate policies, confident in its ability to choke off any excess inflationary effects of fiscal stimulus, but not so confident when pursuing, e.g., an interest penalty on reserves, or much more expansive quantitative easing?

  11. Gravatar of Mattias Mattias
    23. June 2010 at 11:15

    Scott,

    I would be interested to hear what you mean by the term Keynesian. Is it just the idea of fiscal stimulus?

    When I read about Keynes I think he comes across as a savvy guy who followed the markets closely and was quite pragmatic. I’m just not convinced that he wouldn’t have modified his theory if he had lived today.

  12. Gravatar of malavel malavel
    23. June 2010 at 11:38

    Here’s one good skeptic article:

    http://www.skeptic.com/the_magazine/featured_articles/v14n01_climate_of_belief.html

  13. Gravatar of scott sumner scott sumner
    23. June 2010 at 12:18

    Brett, Look at the passage I quoted, and then ask whether you have seen even a remotely similar appraisal of Japan’s fiscal stimulus in Krugman’s blog over the past 5 years.

    We are not far apart. Even if it was never really tried in the 1930s, or in Japan, that means we have zero evidence that it works at the zero bound. And since the theory behind it is exceedingly feeble, we don’t have much to go on.

    Dilip, Thanks, I did read one you sent me, I’ll look at the other.

    William, He’s right. He’s probably thinking of the tax increase of 1968, that didn’t slow inflation, and the big tax cut of 1981-83, which was associated with much lower inflation. In each case monetary policy went the other way.

    OGT, There is a huge identification problem is accounting for monetary policy, which makes those studies suspect. But I do agree that the huge military build-ups going into WWII did raise real GDP. So if that’s the argument, I agree.

    jsalvati, Yes, I saw that too. He’s never been a big monetary stimulus fan.

    Alex, I discussed WWII in the post. In 1933 FDR used monetary stimulus to raise prices in the mother of all liquidity traps. And it worked. So there is an example.

    Ram, I’m not sure I follow, I agree that the tight money is preventing the fiscal expansion from increasing inflation. I also think it is a bad idea, and that the Fed should create more inflation. I believe the markets would welcome more inflation just as they reacted very negatively to the deflation of late 2008.

    Mattias, Yes, Keynes was a savvy guy. I am talking about the view that fiscal stimulus is the way out of a recession.

    Malavel, Thanks, but I don’t follow that argument. I see how increased cloud cover from global warming could reduce the amount of warming, and the models take that into account. But it couldn’t actually produce cooler temperatures, could it?

    I’d be interested in hearing what climate scientists think of that hypothesis (the author is a chemist.) It is not like they don’t consider the feedback effects in their models (and some of the feedback effects are also quite likely to make global warming worse.) But the median estimate is still for warmer temps, unless I am mistaken. And temps are gradually getting warmer.

  14. Gravatar of Ram Ram
    23. June 2010 at 13:10

    What I have in mind is the following: (1) the Bernanke Fed rapidly reduced the Federal Funds Rate in line with a standard version of the Taylor rule (e.g., http://gregmankiw.blogspot.com/2010/06/when-will-fed-raise-rates.html) until it ran up against the zero lower bound; (2) Bernanke expressed support for a fiscal stimulus package towards the beginning of the Obama administration, after the zero lower bound had nearly been reached; (3) the Bernanke Fed began experimenting with unconventional policies, most prominently quantitative easing, though only in half-steps, again after approaching the zero lower bound.

    The standard cynical take on all of this in the blogosphere seems to be that Bernanke has some sort of target in mind and is preventing any overshooting of it, and that target has 10% unemployment as a side-effect, and that Bernanke supported the fiscal stimulus in order to get on Obama’s good side prior to potentially being renominated. That may be. A more charitable take, however, is that Bernanke confidently addressed the shortfall in AD with rapid interest rate cuts until he ran up against the limit of conventional policy. Subsequently, he favored pursuing unconventional policies of various kinds with greater caution, given the uncertainties and credibility issues posed by said policies.

    One such unconventional policy is quantitative easing; another is fiscal stimulus. Maybe what Bernanke is saying in his own defense is the truth — that he was aggressive when he could be so safely, and that he’s being more cautious now that he’s operating in uncharted waters. If so, there’s no reason why he should try to offset any fiscal stimulus that he has explicitly endorsed.

    I don’t know what the right story is — I can’t peak into Bernanke’s head. But it certainly seems possible that Bernanke pursued standard measures aggressively, and is now cautiously supporting alternatives (i.e., not counteracting them). In such an environment, your concerns about the Fed moving last would not matter. I hope that makes more sense.

  15. Gravatar of Doc Merlin Doc Merlin
    23. June 2010 at 13:52

    “When I read about Keynes I think he comes across as a savvy guy who followed the markets closely and was quite pragmatic. I’m just not convinced that he wouldn’t have modified his theory if he had lived today.”

    He did modify his theory, within his own lifetime due to criticisms from Hayek and others… no one else modified it, but he did. For example: by the time he died he scaled it back from a theory of all the time, to just a theory of recessions.

  16. Gravatar of Rafael Rafael
    23. June 2010 at 16:04

    Scott,

    Brad DeLong links to a NBER working paper which deserves comment:

    http://delong.typepad.com/sdj/2010/06/paul-einzig-was-wrong.html

  17. Gravatar of Mattias Mattias
    23. June 2010 at 21:54

    Scott,

    “the view that fiscal stimulus is the way out of a recession”

    Do you also think that Germany, UK and others that plan to cut their deficits will not create a problem? I’m not arguing with you, I just wonder how much I should worry about Martin Wolf’s and others warnings of a second self inflicted downturn because of this new austerity.

  18. Gravatar of mbk mbk
    23. June 2010 at 22:12

    Scott, re: climate, you seem to have a lot of trust in the “hard” sciences. But there are a lot of things that can’t be predicted easily in those sciences either.

    Climate predictions depend to a large extent on complex models of the Earth system because the relationships between measurable parameters are not simple. Even in hindsight causality can often not be attributed clearly (say, was there ‘global dimming’ due to aerosols in the 50’s to 70’s leading to the observed temperature stagnation or decline? or was it some other effect that delayed the CO2 induced warming that one would have expected from current opinion?). The multitude of feedbacks, known and unknown, positive and negative, make this modeling exercise somewhat similar to econometric modeling and forecasting.

    Economic modeling has of course the huge advantage that its input data are much much better known than in the Earth and biological sciences. You can routinely find papers, say about biogeochemical cycles, that claim that some effect has been over or underestimated by a factor of two, or ten (examples, tropical forest CO2 uptake, wetland and permafrost methane releases dues to warming etc). Sometimes, even the sign of a feedback is debatable (positive or negative?).

    In other words, compared to climate research, economics as a science has it real good.

  19. Gravatar of scott sumner scott sumner
    24. June 2010 at 06:00

    Ram, Part of the problem is the Taylor rule. You say he cut rates fast, but rates were not cut once between April and early October 2008, which is precisely when the US economy was falling off a cliff. From my perspective they moved very slowly.

    Then you mention unconventional steps. But the most important unconventional step was paying interest on reserves, which the Fed itself admits was contractionary. So that suggests the problem was not a lack of ammunition.

    You say the Fed wouldn’t undermine fiscal stimulus. But prior to the Greek crisis they hinted that they would start exiting the stimulus if the economy improved a bit more (perhaps 8% or 9% unemployment.) Those signals undercut current monetary stimulus. If they are willing to undercut their own policy, I see no reason why they wouldn’t undercut fiscal stimulus.

    Even if QE was the right way to go, the Fed did not do enough. Why would they call for fiscal stimulus rather than doing larger amounts of QE? It makes no sense.

    The Fed acted very similarly to the BOJ. Yet Bernanke criticized the BOJ in 2003 and said they needed to do price level targeting. Now the Fed refuses to do price level targeting, and isn’t even hitting its inflation target. So why not follow the advice we gave the Japanese?

    When I presented a paper at the New York Fed in 1988 or 1989, I advocated using futures markets to guide monetary policy. They responded that they already had the tools they needed to steer AD. My response today: OK, then do it.

    Doc Merlin, Yes, he modified his theory several times, moving right, then left, then right again.

    Rafael, That came up in an earlier post. I said there is a huge indentification problem with monetary policy. But I do not dispute that the massive military build-ups going into WWII did raise RGDP (but not consumption.) In addition, there are countries where the fiscal and monetary authorities worked together. I’m sure the German central bank wasn’t trying to offset the impact of fiscal stimulus. As an aside, the main reason Germany recovered faster than the US was that they didn’t follow the US and French high wage polices.

    I don’t think anyone disputes that the military buildup in the US during the 1940s raised measured RGDP.

    Mattias, I doubt it would make things much worse than they are now, and I think Britain at least really needs to trim back a little bit. It all depends how their central banks react. If the BOE is inflation targeting, then I think everyone agrees that a cut in spending won’t hurt AD. The question is whether the BOE is inflation targeting.

    Does anyone know how the European equity markets are reacting to these austerity moves? (especially newsworthy policy announcements) I have an open mind on the issue, as it is a game theory problem–meaning a question that can’t be answered by technical models.

    mbk, You said;

    “Scott, re: climate, you seem to have a lot of trust in the “hard” sciences.”

    I have less trust in the hard sciences than almost any other blogger on the internet. I think it quite likely that Einstein’s E=MC2 will eventually be shown to be wrong, just as Newton’s theories were superseded by Einstein’s. And I don’t even see climate science as a hard science, it seems very soft to me. My point is the weight of evidence supports the global warming model:

    1. Very well established theory predicts that more CO2 will, ceteris paribus, warm the Earth. There are secondary effects that could strengthen or weaken that conclusion, but the basic theory says the Earth is likely to warm.

    2. Data shows the Earth is warming.

    Those two items don’t prove man-made global warming, but they suggest it is likely to be occurring.

    Suppose the sun got hotter, and the Earth started warming. Wouldn’t it be plausible to connect the two? Someone could argue “the warmer sum might evaporate water, create more clouds, and cool the Earth. Yes, that’s theoretically possible. But if the sun is getting warmer, isn’t the more likely effect that it will warm the Earth, especially if the Earth is in fact warming. But that’s essentially the counterargument of the skeptics–secondary effects will prevent warming. Everyone agrees that more CO2, by itself, warms the Earth. And almost everyone agrees the Earth is getting warmer. And everyone agrees there is more CO2 in the air.

    I don’t agree that economics is a more rigorous science than climate science. I think they are very similar, both very imprecise.

    I am not in the Al Gore camp, BTW. I think we should proceed slowly, there is no need to panic. We should adopt a carbon tax. Energy consumption produces many different externalities, not just global warming. A carbon tax combined with a cut in the corporate tax rate would make our economy much more efficient, even if global warming isn’t a problem, and would be a nice insurance policy if it is.

    Why can’t Obama and the GOP agree on something like that?

  20. Gravatar of William Newman William Newman
    24. June 2010 at 07:24

    Scott Sumner, “denier” is an inappropriately vicious choice of term when actual mass murder isn’t involved. Since you believe that technical criticisms of IPCC-related positions are laughably stupid, it’s natural to vent in the strongest applicable terms: “flat-earther,” e.g. But even if you are convinced that the economic impact of the question is so large that billions of lives are potentially at stake, “denier” remains dishonestly vile: the word might sometimes be appropriately used in factual disagreements like those associated with Robert Conquest, but not like those associated with, e.g., Milton Friedman or Norman Borlaug.

    And I freely grant that “flat-earther” is, alas, a highly appropriate way to characterize various IPCC critics in the AGW controversy. But alas alas and still more alas, in this controversy as in many politicized controversies, “flat-earther” is more generally an accurate way to characterize various advocates in every large faction. I presume that you have already noticed examples of head-in-the-sand flat-earthers. As an example of chicken-little flat-earthers, I nominate a weather severity analysis from the current presidential administration, described and linked to at
    http://www.coyoteblog.com/coyote_blog/2009/12/my-personal-experience-with-climate-alarmist-spin.html

    Setting aside various stunningly stupid arguments and focusing on more plausible criticism of the main IPCC positions, it seems as though the debate between critics with “lukewarmer” positions (roughly that there has indeed been a substantial rise in temperature since 1800 and the anthropogenic contribution is most likely about as large as simplistic first-order perturbation theory would suggest) and the IPCC position (roughly, that we can say with high confidence that net feedback from CO2 effects is so strongly positive that the anthropogenic forcing is much larger than that) is disturbingly similar to the debate between the insurgents and the mainstream in 1968 macroeconomics. The insurgents can’t completely eliminate the chance the mainstream is right, but their theory is more plausible on its face than the mainstream’s, and the mainstream’s evidence is not strong enough to justify the mainstreamers’ professed confidence in their position. Moreover, given that, the mainstream does not display a healthy interest in understanding and engaging the strongest arguments against their position. (Note, incidentally that this sizable disagreement in temperature impact tends to correspond to an even more significant disagreement about economic dislocations, much the way that the economic dislocations from an $6 increase in minimum wage could be more than twice as large as a $3 increase.)

    Also, today’s mainstream climate science displays some very disturbing procedural/ethical problems unlike anything I know of from the 1968 macro debate, e.g., refusing to release data or details of calculations behind key papers. Because of problems like this, it’s hard to give some key results as much weight as IPCC supporters would like them to be given.

  21. Gravatar of William Newman William Newman
    24. June 2010 at 07:42

    Scott Sumner wrote “Why can’t Obama and the GOP agree on something like that?”

    I am a libertarian, there are lots of reasons that current policy leaves me scratching my head. But at a guess: thoughtful Republicans aren’t any more convinced by the scary predictions than I am. And besides all the free-floating political toxicity leaking in from other controversies, the partisan attitudes of Republicans in this controversy are paricularly poisoned by how even when Earth Is In Terrible Danger And Science Is Being Denied And We Need To Rethink Things In This Crisis, the consequence is somehow supposed to be very largely new taxes and dirigisme, without the logical amount of policy spillover into Democratic sacred cows like licensing of nuclear power plants and disposal of radioactive waste.

    (For some remarks by a working politician on this kind of perception of bad faith, and also for an interesting time capsule on history of this kind of thing, see “Getting Along With Doomsday” by Bryan Magee in the summer 1975 issue of _Horizon_ magazine.)

  22. Gravatar of malavel malavel
    24. June 2010 at 07:57

    Scott,

    “I see how increased cloud cover from global warming could reduce the amount of warming, and the models take that into account. But it couldn’t actually produce cooler temperatures, could it?”

    I have no idea. I assume the author was just doing some simple mathematical error projections within the models.

    We seem to have a similar view on this issue. So I would label you a sceptic like me. :)

    My policy preference, however, would be to do nothing but continue with research (including some geoengineering).

    But what are your views on the damages? Perhaps a degree higher average temperature would be a good thing for human life. Agriculture tends to prefer warm weather. Would you support CO2 emission subsidies if that were the case?

  23. Gravatar of mbk mbk
    24. June 2010 at 09:27

    Scott,

    sorry: I was being ironic. Yes, like you I believe economics and climatology share similar issues, including but not limited to, a dearth of mechanistic, clear cut causality in the macro picture, an inability to draw the micro truly into the macro, dependence on shifting consensus opinion instead of universal laws testable by replicable experiments, and a tendency to replace theory by modeling, not to mention limited prediction abilities. I do insist though, the input data in economic modeling are much better than the input data in Earth or biological science modeling. Economic modeling should therefore be more precise and achieve better forecasts than than climate modeling. This alone should be food for thought. As it is, climate modeling of course uses economic modeling in its inputs as well ( in the form of world economic scenarios). So we have in effect both at the same time when we look at a climate forecast.

    William Newman summed up the situation very nicely, I didn’t want to get into the details. The politicization of climate science (to a degree similar to everything related to smoking and health) is very disturbing. In addition, in the climate debate the descriptive and the prescriptive are routinely confused, i.e., if one determines that climate is indeed changing in a certain way, it does not necessarily follow that the consequences must all be bad, nor that one necessarily has to do something about it. It may well be wise, but one does not necessarily follow from the other. To start with, were pre-industrial global average temperatures somehwat optimal? For whom? And must they be preserved / restored at any cost? These are valid questions, but they are normative, and they have mostly social or political answers – not scientific ones.

    The carbon tax idea is all well but once again, I do not share your optimism that it would be a game changer unless it is economically crippling, and even then. Economic productivity is to a large extent tied to energy consumption: it’s not manual labor that multiplied productivity. And in case you say it’s information more than materials these days, I have seen estimates that claim global IT demand for energy matches the energy demand of global air travel. As a rule the energy intensity of economies goes down as they develop (consumption/GDP unit) but this is due to development, not taxes, and total energy consumption always goes up. Europe has long had much higher energy taxes than the US, especially on gas for cars, in some countries the VAT rates on cars has been tied differentially for decades to their energy efficiency or their carbon footprint, and many countries (Germany, e.g.) have stellar subsidy programs for alternative energies. But the overall trajectory or nature of energy consumption in Europe is not much different from the US (though per capita consumption is lower as a rule – but so is GDP). Another example of energy taxation, cars in Singapore. The tax on new cars is 110%, the license plates are limited supply and are auctioned off at prices of currently ca. US$20,0000 (valid 10 years), road taxes are significant, on top of which there is electronic road pricing in many locations on a usage basis, gas prices are similar to Europe at ca. US$ 5/gallon, all this with air conditioned, ubiquitous, clean and safe public transport available cheaply as an alternative, and guess what? Still lots of cars, and lots of traffic, and people who can afford cars, will usually buy them (or use taxis which has pretty much the same environmental effect). This shows how incredibly inelastic the demand for spontaneous mobility (a.k.a., “cars”) really is, universally so. Not to mention air conditioning or heating (think Minnesota). So I doubt the demand for energy can be curbed significantly (read: not by 10% but by 50 or 80%) with a tax, even a large tax. With some luck, a carbon tax might shift the balance to some other energy source that is a good substitute, but for that to happen, such a source has to exist.

    FWIW there is an economic law, Jevon’s law, http://en.wikipedia.org/wiki/Jevons_paradox
    from the 19th century, that claims that any attempt at saving energy will end up enhancing consumption because it will lead to more efficiency, hence higher growth.

  24. Gravatar of John Papola John Papola
    24. June 2010 at 15:33

    Aren’t “New Keynesians” basically monetarists with a rigorous study program in price stickiness? The name seems like misnomer.

  25. Gravatar of scott sumner scott sumner
    25. June 2010 at 11:59

    William, Very well put, and you probably know more about this than I do. I didn’t mean to suggest that I go around calling people global warming deniers. Rather I was suggesting that those on the left who do use that term, also tend to think about Keynesian opponents in the same way. I agree that there is much uncertainty about the actual size of the problem, and also agree that the debate has become politicized to a disturbing extent. I think there is a non-trivial probability that the IPCC is wrong. On the other hand a non-trivial probability wouldn’t affect my preference for a carbon tax. But I can’t really disagree with anything you wrote, as I either agree, or am not well enough informed to debate the point.

    William#2, Those are good points. Perhaps the Republicans could call the environmentalist bluff as follows:

    1. A big carbon tax.
    2. The tax is revenue neutral because of offsetting cuts in corporate tax rates.
    3. Easier approval for nukes.

    That’s strongly pro-environment position that doesn’t increase net taxes paid, and makes our tax system more progressive.

    Call their bluff–see how much the Dems really want to solve a problem that they claim is destroying our planet. It would actually help the planet more than cap and trade, and would (should?) be supported by Republicans who think we should tax capital less and consumption more. Any takers? If the GOP doesn’t go for something like that, then they really will become marginalized.

    malavel, I’m not very concerned about one more degree, it’s the risk of 5 more degrees (centigrade.) I support looking at geoengineering, and once wrote a paper that discussed that option. And I favor creating climate futures markets to see where the market consensus is on this issue.

    mbk, There is a very fundamental reason why forecasting is harder in economics–expectations matter and markets are efficient. To forecast you have to be smarter than the next guy. Not true in climate science.

    You talk a lot about cars, but they aren’t the main problem–perhaps 10% of global CO2 comes from cars? Carbon taxes could push us toward more efficient electricity production. There is a huge difference in carbon emission between France and Australia, despite similar incomes.

    Generally I agree with much of what you say, which makes me pessimistic about the environment. But I’m told that traffic is considerably less jammed in Singapore than other Asian cities, and the air is clearer. Not sure that’s true, but it’s what I’ve read. On the other hand Americans would never accept those taxes.

    John, I always thought they should have been called new new monetarists. But the intellectually respectable view is always left of center. Hence “neoliberalism” not neoconservatism for free market reforms. Liberals will always label the consensus in such a way that they look good, as they are always the majority.

    DeLong once published an article pointing out that much of new Keynesianism was actually monetarist.

  26. Gravatar of William Newman William Newman
    25. June 2010 at 17:27

    Thank you for your answer.

    I expect that some large fraction of small government types wouldn’t see #1 combined with #2 as a very convincing tradeoff, for reasons independent of the AGW controversy. There’s a pretty common perception that a new tax tends to act like the nose of a camel that will never get out of the tent, while a tax reduction can be highly temporary. One possible argument against that perception is how reductions in income taxes to somewhere arguably high-altitude on the Laffer curve have endured for decades in many countries including ours, and seem to be on track to endure longer. But that exception, important though it is, doesn’t give much support to the idea that a tax reduction to qualitatively less than the Lafferesque maximum revenue will endure for very long.

    The Democrats “could” dodge this problem by offering #3 alone, but the scare quotes are because I judge our intra-party political dysfunction to be roughly as severe as inter-party dysfunction. Therefore, I think it would be merely be funny and sad to see them try to get agreement among themselves to support #3. If Democrats somehow did achieve that agreement among themselves, though, I’d be very surprised if Republicans displayed much enthusiasm for opposing it, though they might well not manage to put together a big majority supporting it.

    AGWers truly could (no scare quotes) dodge a related problem by advocating #3 alone as an important second-best to the preferred combination of #1+#3. For catastrophic forecasts of CO2-induced warming, #3 seems to be (broadly speaking, ignoring the devil in the details of ways that rewriting regulations can be done horribly wrong) a very good idea. Somewhat similarly, GM crops by potentially being more efficient (though sometimes only nicer in some other way, e.g., prettier) tend to increase options both for efficiently reducing CO2 output and for adapting to climate change. So it can seem a bit strange (and can sometimes even provoke dark suspicions about real agendas from nonbelievers) to see a catastrophic AGW policy advocate avoiding ruffling the feathers of nuclear flat-earthers and GM crop flat-earthers while waxing furious about “climate deniers.”

  27. Gravatar of mbk mbk
    25. June 2010 at 20:58

    Scott,
    “There is a very fundamental reason why forecasting is harder in economics-expectations matter and markets are efficient. ”
    On the other hand in economics we can infer largely rational expectations, while climate and weather are often non stationary chaos prone processes with inherent unpredictability. And human motivation is better known to us than a host of geophysical and biological data and feedbacks. Nancy Cartwright’s “how the laws of physics lie” makes the nice point that if you say dropped a $100 bill from a tall building, no atmospheric scientist could reasonably predict where it will land with any accuracy, although all relevant “laws” of physics are know. But the complexity of the situation precludes forecasting. Meanwhile a bunch of social scientists would probably have a much better predictive ability in forecasting the fate of that $100 bill once it hits the ground, in a city…

    “You talk a lot about cars, but they aren’t the main problem-perhaps 10% of global CO2 comes from cars? Carbon taxes could push us toward more efficient electricity production. There is a huge difference in carbon emission between France and Australia, despite similar incomes. ”

    I am fully aware of this. I took cars as a proxy to argue inelastic demand for energy. And not to forget, in environmental discussion cars are presented as the main boogeyman (especially in Europe) regardless of their true contribution, similar to hedge funds vs. problems in finance. And the potential solution (public transport) is usually presented without checking whether it is actually feasible. Therefore “cars” are a nice proxy for the kinds of arguments that are being made politically in this area.

    France vs Australia has a point, then again a continent sized country with huge decentralized demand for transportation doing mainly commodities doesn’t quite compare to a compact country doing industry and services.

    William, Scott re: carbon taxes, nuclear: I’d also much rather see a general diversification of the entire energy food chain. One seldom discussed problem is that alternatives (biomass, solar, wind, nuclear) once scaled up to the total global demand, all develop their own huge environmental problems – in the case of nuclear the price of the fuel would certainly move up too; biomass, wind and solar have massive costs in land use, biomass has additional costs in biodiversity cost, fertilizers, up to and including emission of almost as much greenhouse gases as are being “saved” due to production emissions. Oil and gas sadly happen to be a very nice compact fuel (energy density) that has no real rival in its many advantages. Natural gas with its very high molecular hydrogen content to me is the most promising near future replacement for “oil” and coal, it would move all of us close to a hydrogen economy with little adaptation cost of existing technology. I wonder why it is so little talked about as an alternative.

  28. Gravatar of ssumner ssumner
    26. June 2010 at 06:30

    William, You may be right about taxes, but in that case there is really no point in discussing public policy options in any sort of idealistic way. Anything is possible in a corrupt world. The Dems could adopt a carbon tax without cutting the corporate tax rate. And if you say the GOP would block that, then why couldn’t they block a later increase in the corporate tax rate? I’m not saying you’re wrong, but you have to make some assumptions when discussing public policy options. We aren’t as civic-minded as the Danes, but if we are completely corrupt than all is lost in the long run in any case, and I refuce to believe that.

    I share your view that many environmentalists have their head in the sand about nukes and biotech.

    mbk, You said;

    “On the other hand in economics we can infer largely rational expectations, while climate and weather are often non stationary chaos prone processes with inherent unpredictability.”

    There is not “other hand” here. It is precisely because expectations are rational that it is so hard to forecast. But I do sort of agree with you about climate science. BTW, everyone forgets that climate science is 100% applied physics. So it isn’t true that physics is a harder science than economics. Physicists like to think so, but only because they don’t get their hands dirty with complex real world physics problems.

    I agree with some of your observations, such as that cars are made to be the boogyman. But as for this:

    “France vs Australia has a point, then again a continent sized country with huge decentralized demand for transportation doing mainly commodities doesn’t quite compare to a compact country doing industry and services.”

    I am pretty sure the big difference is that Australia gets elctricity from coal, and France from nuclear.

    Anyone, Someone on NPR claimed that gas is just as bad as coal, because although it burns cleaner a lot of methane is emitted from the new techniques (fracturing rocks) for extracting gas. I am dubious, as all the press reports I read say that gas is much better. Anyone know anything about this?

  29. Gravatar of mbk mbk
    26. June 2010 at 09:40

    Scott I seem to make myself radically unclear. We violently agree:
    “So it isn’t true that physics is a harder science than economics. Physicists like to think so, but only because they don’t get their hands dirty with complex real world physics problems.”
    Absolutely. That is the point of the entire Cartwright book I quoted. And climate science is not just applied physics. CO2 was removed from the atmosphere by the biosphere in the first place (hence oil and coal: biofuels of old). And yet, the IPCC reports mention the “physical basis” for climate affairs, while biological processes and feedbacks get much less attention except as lumped sinks or sources of gases.

    Gas as bad as coal: Well. Who would have thought. There was a piece, I forgot where, where a (Finnish?) politician bitterly complained that environmentalism’s biggest failure is to never really look at technological solutions to current problems, presumably because of a hostility to any and all technology. The result is that over the past few decades many technological alternatives such as nuclear were reflexively opposed by mainstream environmentalists – disclosure, I used to oppose it too. And a few “soft” looking alternatives such as biofuels or wind were reflexively embraced without considering the side effects.

    But the true state of affairs, that technologies are not good or bad per se, but come with different sets of trade-offs, is hardly ever mentioned. These trade offs result in political choices and not as one would have the public believe, in scientific “thou shalt”‘s. One of my favorite authors here is the late Aaron Wildavsky, e.g. “Searching for safety” (out of print but available 2nd hand).

    So I suppose gas is now presented as a no-no for the same reason as nuclear has long been a no-no: it would possibly alleviate the problem pretty good without upsetting business as usual too badly. Yes it would involve trade-offs and some new risks. Everything does. In this spirit though I’d prefer derivatives of well known technologies any time to entirely unproven geo-engineering on a grand scale.

  30. Gravatar of Doc Merlin Doc Merlin
    27. June 2010 at 03:42

    “Does anyone know how the European equity markets are reacting to these austerity moves? (especially newsworthy policy announcements) I have an open mind on the issue, as it is a game theory problem-meaning a question that can’t be answered by technical models.”

    It is really hard (I will say impossible) to gauge future equity prices in real terms, because monetary expansion and relative expected changing values of currencies matter a lot more than just price inflation for affecting equity prices.

    There are also all sorts of compounding problems, for example, the germans banned short selling, which knocked the FTSE for a loop.

  31. Gravatar of ssumner ssumner
    27. June 2010 at 06:52

    mbk, I agree.

    Doc Merlin, I was wondering if there was some high profile annoucement of budget cuts that was unexpected. If so, did markets move suddenly on the news. This is something one occasionally sees with monetary policy announcements.

  32. Gravatar of Doc Merlin Doc Merlin
    27. June 2010 at 07:05

    In the German markets? I don’t know of one. Merkel and the center-right alliance has been talking about budget cuts since they got into power. Germany has been weathering this remarkably well, however, probably in part due to the right to build being in their constitution.

  33. Gravatar of Greg Ransom Greg Ransom
    27. June 2010 at 13:31

    I’m guessing you never read Keynes’ introduction to the German edition of his General Theory or the last chapter of that book.

    “The Great Depression lasted 12 years-so it can hardly be used to show that any policy (fiscal or monetary) is successful at ending recessions faster than they would end without stimulus.  Some point to the effects of WWII.  Yes, if you suddenly draft 13 million men into the military (the equivalent of 30 million today!) and give industry a blank check to produce as much military supplies as they can at profitable prices, you will get a big drop in unemployment.  No one disputes that.  Of course you will also get a drop in consumption, and isn’t the whole point of the multiplier to boost consumption and living standards? “

  34. Gravatar of Greg Ransom Greg Ransom
    27. June 2010 at 13:46

    Shadow money depends on easily traded assets with reliable value — the collapse of shadow money is one important source of deflation.

    Taking wealth and money out of the economy and wasting it on stuff that doesn’t have much tradeable value makes the problem of deflation worse not better — you are making the stock of shadow money continually smaller.

    Krugman’s reputation for intelligence and economic competence is overrated to the extent that he does got such basic stuff.

  35. Gravatar of ssumner ssumner
    28. June 2010 at 07:05

    Doc Merlin, Thanks. This morning stocks opened up higher. It was attributed to the G-20 agreement to reduce deficits. But I don’t put much weight on those sorts of stories without a lot more evidence.

    Greg. You said;

    “I’m guessing you never read Keynes’ introduction to the German edition of his General Theory or the last chapter of that book.”

    You guessed right.

    I agree that Krugman puts too much weight on fiscal stimulus.

  36. Gravatar of Greg Ransom Greg Ransom
    28. June 2010 at 11:57

    In Keynes’ preface to the German edition he says that the Nazi system is designed far better than others for implementing his conceptions for top down control of investment, aggregate demand, and other aggregate variables.

    At the end of the General Theory Keynes states that the implementation of his program really requires the socialization of investment — consistent with his demand for the euthanasia of the investor class.

  37. Gravatar of Greg Ransom Greg Ransom
    28. June 2010 at 12:05

    Here’s Keynes writing for the German’ in the late 1930s:

    “Much of the following book is illustrated and expounded mainly with reference to the conditions existing in the Anglo-Saxon countries. Nevertheless the theory of output as a whole, which is what the following book purports to provide, is much more easily adapted to the conditions of a totalitarian state, than is the theory of the production and distribution of a given output produced under conditions of free competition and a large measure of laissez-fair”

  38. Gravatar of Greg Ransom Greg Ransom
    28. June 2010 at 12:10

    More on Keynes the anti-liberal statist with deep Fabian / fascist tendencies here:

    http://www.lewrockwell.com/raico/raico29.1.html

  39. Gravatar of ssumner ssumner
    29. June 2010 at 07:58

    Greg, Interesting. Of course his views were always changing. He had nice things to say about The Road to Serfdom.

    During the 1930s most intellectuals had either facist or communist leanings, at least to some extent. Of course I don’t agree with those views, just pointing out that he wasn’t unusual.

  40. Gravatar of Greg Ransom Greg Ransom
    29. June 2010 at 15:58

    Keynes’ letter to Hayek on The Road to Serfdom seems a big missing the point moment to me.

  41. Gravatar of Greg Ransom Greg Ransom
    29. June 2010 at 16:00

    In the 1930s many people read Hayek and Mises and moved away from the left and toward neo-liberalism, e.g. Lippmann, Eastman, and Popper, among others.

    Hayek’s own move came in the 1920s.

  42. Gravatar of How come under a MONETARY Expansion Interest rates go down and under a FISCAL Expansion interest rates go up? | US INTEREST RATE How come under a MONETARY Expansion Interest rates go down and under a FISCAL Expansion interest rates go up? | US INTEREST RATE
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  43. Gravatar of ssumner ssumner
    30. June 2010 at 05:50

    Greg, I also wondered about Keynes’s letter. How much of the Road to Serfdom did he really agree with? But I do know that Keynes became somewhat less left wing after 1936.

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