Archive for February 2010


DeLong and the Republicans are both wrong

Tyler Cowen and Greg Mankiw linked to a Keith Hennessey graph that has been getting a lot of attention.  It shows the ratio of spending to GDP over the next 10 years as estimated in Obama’s proposed 2010 budget (last year), as well as the spending/GDP ratios expected in his current budget.

It’s easy to look at the graph and assume spending is out of control, and that Obama hasn’t kept his promise to reduce spending in the out years.  But that is slightly misleading, as DeLong argues here:

Left out of Hennessey’s “analysis” is the reason that an 8.3% of GDP deficit is warranted: that the economy is very weak.

Left out of Hennessey’s “analysis” is the reason that President Obama projects bigger deficits this year than he did last year–that the economy is extremely weak, and is much weaker than we expected it to be, and when the economy is weak the deficit goes up as revenues fall and social-insurance spending rises: a year ago the administration expected the unemployment rate now to be 7.7%, but it’s 10.0%; a year ago the administration expected the unemployment rate at the start of fiscal 2011 to be 7.0%, but now it expects it to be 9.8%; a year ago the administration expected the unemployment rate at the start of fiscal 2012 to be 6.4%, but now it expects it to be 8.9%.

All very good points, but in the end they lead to a dead end.  If Hennessey is wrong, then DeLong is just as wrong, albeit for two different reasons.

DeLong says we need more fiscal stimulus because the recession is far worse than predicted.  Let’s stop right there.  Last January Obama knew exactly the sort of financial crisis we faced.  He proposed a major stimulus, which he claimed would spur the economy.  New Keynesian models say that the expansionary effect of stimulus begins occurring when it is announced.  New Keynesian theory suggests that current AD is strongly influenced by changes in future expected AD.  So here is my question; what was the impact of the first stimulus package?  Yes, we know it wasn’t as big as DeLong would like, but what was its impact?

To answer that question, it would seem logical to look at how NGDP grew, and compare that growth to the trajectory expected in the absence of the stimulus.  Trust me, if you are a Keynesian you don’t want to do that.  Instead, a Keynesian would argue that things quickly deteriorated after the first projections were made, but the stimulus somehow prevented the deterioration from being even worse.  Possibly, but there are two problems with that explanation.  It still leaves us without a shred of evidence that the stimulus worked, it merely indicates there might be an excuse for it seeming not to work.  Even worse, that near-term deterioration is not supposed to happen in forward-looking New Keynesian models where the stimulus is expected to boost output later.  So the Keynesians don’t have any good explanation for the horrible performance of NGDP in 2009 relative to the expectations back in January.  Banking problems?  We already knew about that, they occurred in 2008.  Mysterious drop in consumer confidence?  Animal spirits?  Those are terms people throw around when they haven’t a clue as to what’s going on.

To summarize, the Keynesian complaint is “the economy deteriorated far more severely than we expected when we proposed our massive $800 billion dollar stimulus, consumer confidence has been shattered by all those scary stories on FoxNews about a government near bankruptcy, so we need to run even bigger deficits.”

I admit all this is highly debatable, but here is my real complaint with DeLong’s post, (or the Republican view for that matter.)  Everyone wants to set the debate up as follows:

1.  Do you favor massive deficits or are you content to have the economy self-correct, risking high unemployment for several years?

I want to scream when I see the debate structured that way.  That is not the issue.  Rather there are two distinct issues:

1.  Is more AD desirable, or should we let the recovery take its natural course?

2.  If we need more AD, is monetary expansion preferable to massive budget deficits?

Let’s review a few simple ideas.  Fiscal stimulus does not boost AS, it boosts AD.  (OK, MTR cuts can boost AS, but Obama’s opposed to those.  And some public investment like education might have a long-term payoff.  But let’s get serious.  We are talking about high unemployment over the next 5 years.  A more educated workforce won’t have much short term impact.)  So if fiscal stimulus is to help the recovery, it does so by exactly the same method as monetary stimulus—boosting AD.

I happen to favor more stimulus, although I understand that some thoughtful economists disagree with me.  I happen to think monetary stimulus is preferable to fiscal stimulus, and in this case there aren’t any thoughtful economists who disagree with me.  Not one.  If there was going to be one, it would be Paul Krugman.  But even he admitted late last year that monetary stimulus is the first choice, and you only move on to fiscal stimulus is the Fed won’t play ball.

So here is the debate:  Do we need more monetary stimulus, or should we let the economy recover naturally.  But DeLong wants to say the debate is between fiscal stimulus and stagnation.  How can he do that?  Buy simply assuming away monetary stimulus.  Presumably he would say that Obama doesn’t control monetary policy, so he can hardly be blamed for relying on fiscal stimulus.  Has Obama made a single public statement calling on the Fed to promote higher NGDP growth, or higher inflation, or higher whatever?  And then there is the little problem that Obama just re-appointed Ben Bernanke last month.  Bernanke’s now his guy at the Fed.

I am actually not trying to blame Obama personally.  As with all other politicians I assume he does not understand that low interest rates don’t mean easy money.  Most economists don’t even seem to understand that.  Rather as with any President, the term ‘Obama’ is really shorthand for the entire policy-making apparatus.

Don’t get me wrong, I’m not that naive.  I understand it would be very hard getting the Fed to change its ways at this point.  But can we at least have a debate?  I was about to ask if we’ve reached the level of passivity of the Japanese, but then I recalled that they are engaged in a fierce debate right now, and Finance Minister Kan is putting strong pressure on the BOJ for more stimulus.  So compared to us, the new Japanese administration is almost Rooseveltian.

If Obama doesn’t want to have that debate, that’s fine.  But then don’t tell us fiscal stimulus is the only answer to high unemployment.  And don’t tell us that Obama doesn’t understand monetary policy.  I thought the whole point of replacing Bush with Obama was to get an intellectual in the White House.  Someone who understood the issues.  If we have “grown-up” intellectuals in the White House, then let’s have that debate.  Let’s see some discussion of unconventional monetary stimulus.  Can’t Congress at least pass a law repealing the interest on reserves program?

BTW, I’m just as frustrated at the right-wingers at the Fed.  We are running up trillions of dollars in debt precisely because the elected leaders of our country think we need more AD, and the Fed doesn’t.  I understand the need for the Fed to be independent, but how about some honesty at least.  If these inflation hawks really believe what they are saying, show some guts and come out and say “We are not doing more monetary stimulus because we feel a need to offset what we regard as excessive fiscal stimulus, and prevent it from raising the expected inflation rate.”  If they really have the courage of their convictions, then why not admit what they are doing?

In February I said fiscal stimulus wouldn’t work, as the Fed had some sort of nominal aggregate target in mind, and was going to simply offset the fiscal stimulus.  And that is what happened.  In March when things looked scary, like a Depression was possible, the Fed announced its big program of buying Treasuries and MBSs.  Later in the year when things picked up a bit, and we were clearly going to avoid a depression, the Fed started furiously back-peddling.  They started talking about ending the bond buying program and “exit strategies.”  Ask yourself this; what does that back and forth behavior tell you?  It tells me the Fed has some sort of implicit nominal target, and if the economy seems to fall short they’ll pull out all the stops and flood the economy with liquidity.  That’s why the $800 billion dollar fiscal stimulus was a complete waste of money; the Fed wasn’t going to allow NGDP to fall much further than the actual 2.5% it fell.  Shame on us for not figuring that out, and shame on the Fed for not explaining that to us.

Oh, and shame on the Fed for not having a more aggressive policy even with the stimulus.

And shame on me for writing this post just one day after I resolved to be less opinionated.

Seeing the world in a different way (one year later)

Be careful what you wish for.  Last February 2nd I started this blog with very low expectations.  During the first three weeks most of the comments were from Aaron Jackson and Bill Woolsey.  I knew I wasn’t a good writer, years ago I got a referee report back from an anonymous referee (named McCloskey) who said “if the author had used no commas at all, his use of commas would have been more nearly correct.”  Ouch!  But it was true, others said similar things.  And I was also pretty sure that the content was not of much interest to anyone.

Now my biggest problem is time—I spend 6 to 10 hours a day on the blog, seven days a week.  Several hours are spent responding to reader comments and the rest is spent writing long-winded posts and checking other economics blogs.  And I still miss many blogs that I feel I should be reading.  In part 2 I’ll talk a bit more about the personal side of blogging, but first I’d like to take stock of what I have done in the first year.

As you may know, I don’t think much of the official methodology in macroeconomics.  Many of my fellow economists seem to have a Popperian view of the social sciences.  You develop a model.  You go out and get some data.  And then you try to refute the model with some sort of regression analysis.  If you can’t refute it, then the model is assumed to be supported by the data, although papers usually end by noting “further research is necessary,” as models can never really be proved, only refuted.

My problem with this view is that it doesn’t reflect the way macro and finance actually work.  Instead the models are often data-driven.  Journals want to publish positive results, not negative.  So thousands of macroeconomists keep running tests until they find a “statistically significant” VAR model, or a statistically significant “anomaly” in the EMH.  Unfortunately, because the statistical testing is often used to generate the models, and determine which get published, the tests of statistical significance are meaningless.

I’m not trying to be a nihilist here, or a Luddite who wants to go back to the era before computers.  I do regressions in my research, and find them very useful.  But I don’t consider the results of a statistical regression to be a test of a model, rather they represent a piece of descriptive statistics, like a graph, which may or may not usefully supplement a more complex argument that relies on many different methods, not a single “Official Method.”

An example of this is the post I did on liquidity traps, which argued against reductionist models that “it all boils down to” cash and T-bills being prefect substitutes, or “it all boils down to” central bank credibility, etc.  Rather a liquidity trap is a phenomenon that must be analyzed by considering economic factors like the ability of the central bank to buy alternative assets, or to charge interest penalties on excess reserves, or to set an inflation target, or to engage in currency depreciation, or to target the price of gold, or to do quantitative easing, or the relative merits of inflation and price level targeting, or the issue of central bank independence, or whether central banks can target CPI futures contracts.  And I could go on and on.  It is a complex problem that requires analysis at the level of politics, economics, psychology, diplomacy, etc.

At the same time (and this may seem to contradict what I just said), I believe strongly in Occam’s Razor.  If you want to study NGDP, focus on the impact of monetary policy on NGDP growth expectations.  Don’t make things needlessly complex by looking at C, I , G, NX, the credit markets, etc.  It’s not that those things don’t matter, but rather they are best examined by considering how they impact monetary policy.

Over the past year I have mostly ignored supply-side economics, focusing on what I thought was the most pressing policy issue, the shortfall in AD.  Thus I started with a simple NGDP model, and kept making it more complex by looking deeper and deeper at factors that impact the supply and demand for base money.  I looked at the technical mistakes the Fed made, and then the faulty models that led them astray.  I even argued that cognitive biases often led them to ignore their own models, as when they assumed a sharp fall in NGDP was a “real” problem, when all of modern macro suggests it was a failure of monetary policy.

I like Rorty’s pragmatism; his view that scientific models don’t literally correspond to reality, or mirror reality.  Rorty says that one should look for models that are “coherent,” that help us to make sense of a wide variety of facts.  I want people who read my blog to be saying to themselves “aha, now I understand why the economy continues to drag along despite low interest rates,” as they recall that low rates are not an indication of monetary stimulus.  I think Deirdre McCloskey once used the term ‘ooomph’ to describe models that are powerful enough to make sense out of a wide range of seemingly meaningless and unrelated observations.  It’s all about persuasion.  And people are persuaded by coherent models.

OK,  so how am I doing?  Over the last year, I have found that most people (in and out of economics) judge models by their predictive prowess.  But what can we do with models like mine, which says that it almost impossible to outguess the markets, or to predict turning points in the business cycle?  Recall my maxim “good economists don’t make predictions, they infer market predictions.”  So I don’t think simple prediction is the right test.  It’s more complicated than that.  I’m going to throw you a curve ball and mention 5 items off the top of my head.  By themselves, none are particularly important.  But I will argue that each one is like a pixil on a high def TV set.  Something that gradually brings the picture into focus, that helps one see the world in a new way:

1.  A couple months ago I noticed that the Fed’s reserve requirement increases of 1937 raised short term rates by about a quarter point.

2.  Last summer I noticed that almost all the economists who had publically supported policies of targeting the forecast, thought monetary policy was much too tight in late 2008.

3.  Last summer Svensson got the Swedish Riksbank to adopt negative rates on reserves.

4.  Late last year there was a big upsurge on criticism of the Fed by liberal bloggers.

5.  Last month I discovered a 1999 Bernanke paper that criticized the BOJ in much the same way I am criticizing the Fed.

According to the Official Method, none of these tidbits matter.  But I have noticed that they have had some impact on my readers.  They are each slightly persuasive about some aspect of my argument.

1.  All year I was criticized for dwelling on the contractionary impact of the Fed IOR program, which paid only a quarter point after December 2008.  Then I discovered that the 1937 program, which has been widely criticized by economic historians for increasing the demand for reserves and reducing the multiplier, also raised rates by only a quarter point. It doesn’t make me right—everyone else may be wrong about 1937’s RR increases being important, but it is interesting.

2.  The second observation helped me explain that once you start to think about policy in terms of targeting the forecast, the whole subject of “policy lags” seems much different.  Now you see policy failing in real time, and watch with a sense of helplessness while others blandly assure us that eventually the Fed’s “easy money” policy will pay off, even though the markets expect it to fail.  It was nice to see people like Hetzel and Hall and Thompson and Glasner and Woolsey and Jackson also notice that policy was too tight in late 2008.  I.e. people who have advocated targeting the forecast.

3.  When I proposed negative rates on reserves, lots of commenters told me I didn’t understand central banks.  That they’d never consider the idea and it wouldn’t work.  The actual Swedish program was too watered down to have much effect either way.  But what was important was that it was adopted.  Immediately it seemed like my commenters took me a bit more seriously.  Here was an unknown economist at Bentley recommending a seemingly crazy idea that none of the big names considered, and then a famous Princeton professor gets the Riksbank to adopt it.  And other well-known economists like Hall and Mankiw start discussing the idea.

4.  I first got a lot of attention with an open letter to Krugman asking him to join me in supporting unconventional QE (longer term securities) and also inflation or NGDP targets.  In March he swatted me away, although it wasn’t clear exactly which point he disagreed with.  I also had several posts saying fiscal stimulus won’t work and the Dems would face a debacle in the 2010 elections unless the Fed gets much more aggressive.  When many liberal bloggers became much more critical of the Fed late in the year, I sensed that my supporters saw this as an “I told you so” moment.  Maybe that’s unfair to the liberals, as it seems unlikely that the Fed is going to do anything useful in response, but at least it seemed to confirm my earlier view that the Fed was our only hope.

5.  I was quite shocked when Marcus sent me the 1999 paper by Bernanke criticizing the BOJ.  Several of my commenters said the paper could have been written by me.  Not just the call for monetary stimulus, or (in another paper at that time) the call for level targeting.  Bernanke also made comments about how people confuse low rates with easy money, with how falling NGDP is a foolproof indicator that money is too tight relative to the needs of the economy.  In other words, the whole package.  And once again this had an effect.  People thought “here was the highly respected Bernanke making all of the same arguments that monetary crank Sumner is making.”

So that’s the goal of my blog, to constantly use theoretical arguments, empirical data, clever metaphors, and historical analogies that make people see the current situation in a new way.  Whatever works, as long as it is not dishonest.  At the same time I cannot escape the world we actually live in.  I will be judged on the basis of predictions I make, and even predictions that I haven’t made but that I seem to have made.  I realize that if the US suffers from very high inflation in the next few years it will be widely seen as discrediting my model, no matter how often I point out that the EMH merely tells us that the market forecast is the optimal forecast, not perfect foresight.  Bob Murphy will haunt my dreams.

If I had had this blog for the past 10 years, I would have gotten a lot of credit for my constant complaints that Fannie and Freddie were dangerous time bombs waiting to explode.  But I would not have deserved that credit, as I never thought this kind of disaster had even a 50% likelihood.  I just thought it was bad public policy to take the risk.  And I would have been blamed for missing the housing bubble, again for the wrong reason.  I still don’t think the Fed should target bubbles, I think they should target NGDP expectations.  But that’s how the game is played, whether I like it or not.  It’s like on those Sunday football shows.  Each pre-game commentator will be judged on his win/loss record in predictions, even though it’s just luck, and says nothing about the astuteness of his analysis of football strategy and coaching.

Part 2.  Don’t ask me to become a blogger

While I am trying to get people to see the world of macroeconomics in a new way, blogging has led me to see reality in a new way.  In late February last year I woke up and started my daily routine of reading the internet (which is my newspaper.)  When I saw my name mentioned in a Tyler Cowen post, it was kind of a shock.  It was at that point that my view of reality began to change.  Of course even today I am far from famous, I’m sure most economists have never heard of me.  But I have gone from being almost totally obscure, to being well-known in the money/macro blogging community.  The blog has had over 10,000 comments and around a million hits.

I used to have lots of free time.  When I would email a more famous economist I usually got no response.  I was surprised and disappointed by this non-reaction.  Now I understand why they would often ignore me.  You cannot become highly successful and continue to be polite to everyone (unless of course your name is Tyler Cowen.)  There just aren’t enough hours in the day.

In addition, you notice that as you become better known, you don’t seem to have any more influence than before.  I used to wonder why Krugman always seemed to downplay his influence.  He’s got the best blogging gig in the world, at the NYT.  He might be the favorite economist of the Democrats who now run Washington.  He’s got his Nobel Prize.  He must feel like he’s on top of the world, the James Cameron of blogging.  But as the Chinese like to say, “Desire is a valley that can never be filled.”  You always want more influence.  I can now see how Krugman would be frustrated that no one paid attention to his argument that we needed more stimulus.  So imagine how un-influential I feel, despite my minor success this year.

In the real world I am not nearly as successful as it may appear from my blog.  I got turned down by the AEA convention.  In 2008 and 2009 I sent papers on the economic crisis out to journals like the JMCB and the JPE, journals that I have published at in the past.  But now for the first time in my life the articles come back without even being sent out to a referee.  “It’s not the sort of thing we publish” they’d say.  I gather this means they don’t see enough equations.  I hope it doesn’t mean “because it addresses the most important macroeconomic problem since the 1930s.”  If you look at macro journals from the early 1930s they were actually discussing the current problems with the economy.  Indeed as recently as the 1990s I often published non-technical papers in the JMCB.  But those days are gone.  They are looking for more VAR studies, more DSGE models.  So at the higher levels of economics I am pretty much a dinosaur.

When I am in a “sour grapes” mood, I take comfort from the fact that Friedman was a dinosaur in the last 25 years of his life.  I know what you’re thinking “yeah, but he actually did some extremely influential work before he became dismissed as irrelevant.”  I do things backward.  I published zero papers before getting tenure, and 30 afterwards.  Maybe my ideas will catch on after I’m dead.  I know, only one out of every 1,000,000 people who thinks they’re another van Gogh, actually is.  Maybe it will be Nick Rowe, not me.  (My hunch is it will be Robin Hanson–he’s a true innovator.  I’m just a pack rat that re-arranges the ideas of others in provocative ways.)  But without hope life is impossible.  Speaking of the dead, my “ideal reader” for my monetary posts was Friedman, who unfortunately died in 2006.  I wouldn’t have had to explain to him that low rates don’t mean easy money.  Or the difference between easy money and easy credit.   In terms of still living “ideal readers,” I had in mind Tyler Cowen.   So it was a weird coincidence that he was the first to promote my blog.

Regrets?  I’m pretty fatalistic about things.  I suppose it wasn’t a smart career move to spend so much time on the blog.  If I had ignored my commenters I could have had my manuscript revised by now.  But I think everything happens for a reason.  (Yeah, I know, but are they good reasons.)  The commenters played an important role in the blog.  By constantly having to defend myself against their criticism, I further refined my arguments.  In addition, I got a better idea of how other people look at monetary economics.  I don’t have any major regrets.  I suppose at times I was too grouchy with commenters.  You forget that even though you’ve heard the fallacious argument 50 times, it might be the first time they made it.  I wish I could always be as polite as Nick Rowe.  Perhaps I poked fun at Krugman too much.  But I see him as a sort of public figure.  And anyway, I also said lots of nice things about him.  In contrast, he’s not prone to equivocate with “to be sure” very often when he’s trashing some Chicago school Nobel Prize-winner.  So I can always point to someone even less polite.

But on the bright side it has been a lot of fun interacting with other economists, people I’d never get a chance to debate if not for my blog.  I had online debates or discussions with Mark Thoma, Lee Ohanian, John Cochrane, and, at the Cato Unbound, with James Hamilton, Jeffrey Hummel and George Selgin.  Then there have been interactions with other monetary bloggers, such as Bill Woolsey, Nick Rowe, Arnold Kling, David Beckworth, Josh Hendrickson, Bob Murphy and Ambrosini.  (Woolsey helped me immensely by pointing out errors in some of my early posts.)  Or with other bloggers who don’t even specialize in monetary economics, like Greg Mankiw, Matt Yglesias, Megan McArdle, Ryan Avent, Will Wilkinson, Michael Pettis and (infuriating as they can seem at times) DeLong and Krugman.  And how could I forget all the George Mason bloggers.  It was Tyler Cowen who first put me on the map, and he and his colleagues (plus Mankiw) are most responsible for my limited success.  I’d cut off my right arm to be able to attend those GMU faculty lunches everyday with Cowen, Caplan, Hanson, Roberts and all the rest of the geniuses.  (Fortunately I’m left handed.)

Update:  I forgot that David Henderson at Econlog is not at GMU, I should have mentioned his name as well.  And I’m sure there are a few others I forgot, my memory isn’t very good.  The three bloggers at Econlog are outstanding.  And of course I forgot Alex Tabarrok at MarginalRevolution.  I never should have started naming people, someone is always left out.

Happiness isn’t based on anything you achieve, but rather the anticipation of future happiness.  As sports fans know the most fun position to be in is the underdog challenging the evil empire.  So that aspect of the blog has been kind on an enjoyable fantasy, even if on close inspection it’s all nonsense.  Ambrosini had a recent post subtitled “Dude, you’ve already won the debate.”  If only.  But whether I in some sense “win” in the long run isn’t really that important to me.  I’ve already got most of what I wanted, which is for people I respect to find my arguments intriguing.  BTW, he then took me to task for continuing my easy money crusade after its sell by date.  OK Ambrosini, my new year’s resolution for 2011 is to stop obsessing about tight money unless we have fallen into outright deflation.

So where do I go from here?  This question reminds me of a comment made by Joseph Conrad (my favorite novelist) after he got his first book published.  He is referring to his editor:

If he had said to me , “Why not go on writing, I should have been paralyzed.  I could not have done it.  But he said to me, “You have written one book, it is very good.  Why not write another?  Do you see what a difference that made?  Another?  Yes, I would do that. I could do that.  Many others I could not.  Another I could.  That is how Edward made me go on writing.  That is what made me an author.

I used to think I had just a few ideas, and once I used those up I’d have nothing more to say.  As you’ve noticed (sometimes painfully) that is not my problem.  I suppose it came from being a loner for several decades.  As I weighed ideas in my mind I’d go from A to B to C, and then back to A.  Even when I’d think of a different angle, I’d rarely write it down and therefore I would soon forget.  Once I started blogging I realized I had more than three ideas, and even better, my interaction with commenters kept triggering new ways of thinking about the problem.  It’s not that I have come up with any earthshaking ideas, but it allows me to keep refining the argument, continually probing at the issue from different angles.  If you’d told me last year “write 1000 pages on monetary policy,” I would have recoiled in horror.  I figured I’d do a couple dozen posts, run out of ideas, and then merely comment on current events.  I had no idea that writing is thinking.  But now here I am a year later, and my blog is 1000 pages of sprawling essays.  Yes, there’s plenty of repetition, but even if you sliced out all the filler, I bet you could find a 200 page book in there somewhere.

Still, at the current pace my blog is gradually swallowing my life.  Soon I won’t be able to get anything else done.  And I really don’t get any support from Bentley, as far as I know the higher ups don’t even know I have a blog.  So I just did 2500 hours of uncompensated labor.  I hope someone got some value out of it.  Right now I just want my life back.

But I suppose I could do one more post.

And after that, maybe one more final post wouldn’t seem so difficult.

But please don’t ask me to become a blogger.  It’d be like asking me whether I ever considered becoming a heroin addict.  Just one more post.  One day at a time. . . .

Random links

Part 1.  Meanwhile, back in the real world.

Krugman is assuring us that the new banking regulations will soon make our system as conservative as the Canadian system.  I must have missed the part about 20% down payments.  In any case, back in the real world things are going in the opposite direction.  The FHA is now trying to get into the housing speculation business.  This reminds me of gambling.  First the government bans the evil vice.  Then they set up their own numbers racket, and don’t allow any competition.

Both the FHA and the Fannie programs, while temporary, are designed to spur home buying and particularly buying of foreclosed properties. They also both add risk to the system, because any time you give a buyer more money upfront, that buyer will likely bite off that much more than they can probably chew. I’m not saying they’re bad programs, especially in these desperate times, but I continue to be concerned that many of these so-called “assistance” programs are opening the housing market up again to questionable buyers…which of course is how we got in this mess in the first place. Combine the Fannie assistance with the first time home buyer tax credit, and you’re giving homes away for little to no cash all over again.

Nick, is that how they do things in Canada?  BTW; In this old post I discuss Nick Rowe’s views on the Canadian system.  He doesn’t seem to agree with Krugman’s assertion that the Canadian system is much more regulated than the US system.  And unlike Krugman, Nick is actually a Canadian economist.  But who cares what you call it.  Krugman and I both favor swapping our banking system for the Canadian model.

Part 2.  DeLong criticizes Cochrane

Surprisingly I agree about 80% with DeLong on this one.  Cochrane argues the crash of late 2008 was partly caused by the panic associated with the government’s sudden withdrawal of its implicit “too big to fail” policy, which occurred when they allowed Lehman to fail.  Cochrane also noted that the direct losses from the subprime fiasco were simply too small to explain the financial meltdown:

The underlying decline in wealth from the housing bust was not that large…. Most estimates put subprime losses around $400 billion. The stock market absorbs losses like that in days…

DeLong agrees:

Cochrane makes the true and obvious but understressed point on the origins of our macroeconomic crisis that mortgage defaults in the desert between Los Angeles and Albuquerque are simply not large enough to justify the $25 trillion global fall in the value of financial assets that has hit our economies:

But in the end DeLong doesn’t buy Cochrane’s argument:

To see what is wrong Cochrane’s story, let’s start by summarizing it: It is that (i) the failure to rescue Lehman caused fears that the government would not rescue anybody, and so (ii) it was rational for everyone to panic and try to dump their risky assets. In Cochrane’s view, the problem is that asset prices collapsed when financiers realized that the government’s promise to bail-out too-big-to-fail banks was empty. That shock sent the real economy into a tailspin. And the solution is never to make any bail-out promises to begin with: if the promises aren’t made, then people cannot fear that the promises are empty, that fear cannot generate a sudden collapse in asset prices, and so the economy cannot be sent into a tailspin.

But remember what happened in the immediate aftermath of Lehman: the U.S. government nationalized AIG and settled its liabilities at 100¢ on the $; Hank Paulson got down on his knees before Nancy Pelosi; the Treasury was given $700 billion to spend to make sure that there were no more Lehmans. After the creation of the TARP, we were all much surer that the U.S. government would rescue Citi if it needed rescue than we had been in the months between Bear-Stearns and Lehman. In point of fact, the government’s promises to rescue too-big-to-fail banks weren’t empty: the government has lived up to them.

The logic of Cochrane’s argument implies that the passage of the TARP should have fixed the problem: the aftermath of Lehman saw “[no] secondary wave of creditors forced into bankruptcy by Lehman losses… [some] issues… easy to fix… Lehman’s failure did not carry any news about asset values…” and the passage of the TARP is good news for the likelihood of bailouts. So, Cochrane’s story leads us to think, everything should have been completely fine in the aftermath of the TARP: asset prices should have immediately bounced themselves back up to their pre-Lehman levels, and the storm clouds should have dissipated.

So why are we still in a deep recession?

I suppose Cochrane could contest some of this, but I have to side with DeLong on this one.  Only a sharp fall in expected NGDP could produce the financial meltdown we saw in late 2008.  That slowdown would be expected to do two things; produce a severe recession all across the economy (depressing asset prices), and also dramatically worsen the financial crisis.  And it did in fact do the two things it would be expected to do.

What caused NGDP to fall sharply?  I’d say a failure of monetary policy.  DeLong might say (and this is pure speculation) a sharp cutback in lending, a Minsky moment, a decline in consumer confidence, and all sorts of other factors.  In any case, one could argue that this sort of argument would be merely the other side of the coin from my argument.  Lots of stuff causing V to fall sharply; or the Fed not offsetting a sharp fall in V with a more expansionary policy.  Either way it comes to the same thing, a sharp fall in NGDP expectations.

I hate to see University of Chicago economists building explanations of the crisis that make the private economy seem very fragile.  The genius of Friedman and Schwartz’s Monetary History was that it showed the private economy is actually pretty robust, as long as the Fed keeps NGDP from falling.  What’s DeLong’s sarcastic remark?  Something like; “Where oh where is the old Chicago School?”  And keep in mind that on 90% of economics issues I agree with Cochrane and disagree with DeLong.  But conservatives need to come to grips with aggregate demand.  The failure to do so opens the door to much greater evils—like a national debt that is headed toward 80% of GDP.

[Oh wait, I forgot.  All the liberal bloggers are now saying conservatives don’t care about the national debt.  They are evil nihilists who want the country to fail.  And what makes this argument so persuasive is that conservative politicians actually don’t have any answers.  But I’m not a politician.  So I can advocate the Singapore system without fear of losing an election.]

Part 3:  Robin Hanson has a nice post on “uppity China.”

Part 4.  For one brief shining moment

It looked like the BOJ might actually be willing to stop the deflation:

THE situation has “completely changed,” says an ebullient Keisuke Tsumura, an elected official in the newish government’s Cabinet Office. The Bank of Japan (BoJ) “has redefined its understanding of price stability. Some market participants now regard it as de facto inflation-targeting.”

That would be something to get excited about. Since the start of Japan’s deflationary era in 1999, the BoJ has stoutly resisted calls to set an inflation target against which it can be judged””and by which it can be embarrassed if it misses. Its inflation objective is defined in the loosest terms, as a rate between zero and 2%, with no time-frame to achieve it and no penalty for failure.

But in November Naoto Kan, who has since become Japan’s finance minister, made what aides proudly call his “deflation declaration”, urging the BoJ to redouble its efforts to combat falling prices. Days later the BoJ offered ¥10 trillion ($112 billion) of virtually interest-free liquidity to the banking system to fight deflation. A few weeks after that it indicated it would not tolerate an inflation rate at or below zero. Was it setting a more explicit goal? Mr Kan and his aides clearly hoped so.

But it was all too good to be true:

The markets at first joined the celebratory mood. Foreign investors have long shunned Japanese stocks, but they sensed the possibility of a big rally if the BoJ stepped up its provision of liquidity, weakening the yen and boosting the earnings of exporters. As the yen came off its highs, investors piled into shares (see chart). But since then the yen has rebounded with barely a squeak from the BoJ. After its board met on January 26th, the bank made it clear it still sees consumer prices, excluding fresh food, falling until the end of the 2011 fiscal year (albeit at a slightly slower pace than it had predicted three months ago). Its growth projections were left largely unchanged.

Couldn’t the BOJ have given the Japanese people just a tiny taste of punch before taking away the punch bowl?  The GDP deflator is now about 15% below 1994 levels.  Back in 2007 the yen was 120 to the dollar, and I don’t recall any American complaints about the exchange rate; the focus was all on China.  Now the yen is 90 to the dollar.  Please . . . just one sip?

Part 5.  Looking for money in all the wrong places

Daniel Gross disproves the EMH at Davos.  I know I am going to be accused of being humorless and pedantic, but I just want to make sure that people realize the $100 bill on the sidewalk is a joke.  What the EMH actually says is that if you look at any given piece of sidewalk; don’t expect to find a $100 dollar bill lying there.  People do occasionally overhear takeover rumors on the NYC subway.  And once and a while people do find $100 bills on the sidewalk.

HT:  Alex Tabarrok

Part 6.  When you want moral indignation, call in Christopher Hitchens

No one does it better:

Here are the two most shattering facts about North Korea. First, when viewed by satellite photography at night, it is an area of unrelieved darkness. Barely a scintilla of light is visible even in the capital city. (See this famous photograph.) Second, a North Korean is on average six inches shorter than a South Korean. You may care to imagine how much surplus value has been wrung out of such a slave, and for how long, in order to feed and sustain the militarized crime family that completely owns both the country and its people.

But this is what proves Myers right. Unlike previous racist dictatorships, the North Korean one has actually succeeded in producing a sort of new species. Starving and stunted dwarves, living in the dark, kept in perpetual ignorance and fear, brainwashed into the hatred of others, regimented and coerced and inculcated with a death cult: This horror show is in our future, and is so ghastly that our own darling leaders dare not face it and can only peep through their fingers at what is coming.

George Orwell would have liked Hitchens.

Part 7.  Man bites dog

Obama wants to ax moon mission, privatize space travel.  Republicans favor big government bureaucracy status quo.

Part 8.  Colin Marshall has no psychic power

This is from a discussion of the work of documentarian Errol Morris:

Note that Morris, despite his yen for documentation of his own trips into the small, fantastical psychological capsules of individuals, doesn’t consider himself any less intellectually imprisoned than his subjects. Small concession to make, you might say, not exempting himself from the human condition. But isn’t it all too rare for public thinkers not to declare or imply themselves cured of the malady with which they diagnose the rest of the world?

This is most visible by its unsubtlety in politics, especially political punditry. If you’ll indulge moment of ideological asymmetry here, I find it even more pervasive on the left than on the right. Think of the endlessly multiplying theorists who, ostensibly defending the interests of the downtrodden common man, operate on the premise that everyone has been hoodwinked by corporations, crooked politicians and the military-industrial complex “” everyone but them. But even outside this realm, certain types of claims set off my brain’s automatic find/replace:

  • “The Bush Regime plays the American public like a fiddle” = “I have psychic powers (to recognize and avoid the techniques of said fiddling)”
  • “That work of art is pretentious” = “I have psychic powers (to know the artist’s intention)”
  • “Most people are lazy” = “I have psychic powers (to know others’ willingness to work)”

This is why, when I hear someone I haven’t met described as “opinionated,” I tend to assume that means “dumb,” “delusional, “too insecure to not to have an opinion,” “believes themselves to possess superhuman brain abilities” or various permutations thereof. If only they’d just chill out a little bit. Maybe shoot a documentary or two. 

Pretty wise for a 25-year old.  Please remind me of this when I get too opinionated. I wonder what he thinks of the EMH?  Or perhaps I should put it this way; I wonder what he thinks of people who say, “Yes, the market values the asset at X, but I know its intrinsic value is Y”