Archive for January 2014

 
 

Why history of thought matters

Tyler Cowen linked to a new blog by Chris House:

My guess is that the important insights of these earlier contributions have been, more or less, adequately incorporated into modern textbooks.  I’m fairly sure that few modern biologists read Darwin’s original Origin of Species, and even fewer modern mathematicians read Euclid’s Elements.  If you want to have a good understanding of modern geometry and number theory, you should simply read a good college-level mathematics text on the subject.  The same holds for the study of evolution.  As great as Darwin’s contribution was, our modern understanding of evolution now eclipses his.  This is the reason behind my casual dismissal of the idea of reading the original General Theory.  If you want a good understanding of these ideas, you are better served by consulting say Mankiw’s intermediate-level Macroeconomics than by reading Keynes or Hicks.  For a somewhat more advanced treatment, you can take a look at Chapter 10 in Blanchard and Fisher (1989).

.   .   .

I could of course be completely wrong.  I recall Christy Romer saying that her decision to spend one of her summers in graduate school reading Friedman and Schwarz’s A Monetary History of the United States was one of the best decisions she ever made.  In a course on the history of thought, or on the rhetoric of economics, I would expect the students to read selections of the originals.  And, of course, there are ideas in the earlier works that are poorly understood, underappreciated or simply forgotten.  Remember though, there is a probably a reason these ideas were not incorporated into the contemporary narrative of economics.

I’m in no position to give grad students advice, as I’m a bit out of touch with modern econ programs.  But I will say that whatever modest success I’ve had with this blog is mostly due to my reading of economic history and the history of thought—two fields that I believe are closely intertwined.  A few examples:

1.  I found that the macro environment during the interwar years is much more interesting than post-WWII, mostly because the government did all sorts of wild and crazy policy experiments. What if the world’s central banks sharply raised their gold reserve ratios, and depressed the global money supply?  What if the US devalued the dollar sharply and unexpectedly during a period of zero interest rates and 25% unemployment?  What if the government suddenly and unexpectedly ordered all firms to raise their nominal hourly wage rates by 20%?  All three of these experiments occurred in just a 5 year period.  Yes, the macro data wasn’t quite as good back then, so economists looked at how asset prices responded to policy shocks—which is the right way to do it in any case!

2.  The interwar economists saw this stuff going on and the results helped inform their policy views. It turns out that there are many ways of thinking about the macroeconomy, which is almost infinitely complex.  Consider the identification problem for monetary shocks, which still hasn’t been solved.  Should monetary policy be thought of in terms of the price of money (Mundell) the quantity of money (Friedman) or the rental cost of money (Keynes)?  During the interwar years many economists thought of policy issues using a very different mental framework from what economists use today.  And I would argue that researchers familiar with these alternative perspectives (Christy Romer, Robert Hetzel, David Glasner, etc.) tended to have more useful things to say about the recent crisis than those who were not.

Modern macro seems to have a certain methodological homogeniety, with the DSGE approach being particularly popular.  Even if it is the best single approach (and I’m not convinced it is) it still might be better for the field if researchers tried all sorts of different approaches so that they would be better prepared for crises like 2008.  We are like a city of 10 million clones where no one has immunity to bird flu.  Nick Rowe has a new post showing that from a certain perspective the New Keynesian (interest rate oriented) way of thinking about the world is really strange, and yet almost everyone thinks that way.   Recall that many of our most famous macroeconomists had little to say about the failures of monetary policy in 2008-09, with Romer/Hetzel/Glasner, etc., being notable exceptions.

PS.  It’s debatable as to whether the General Theory’s best ideas are incorporated into IS/LM-style textbooks.  But even if they are, I would suggest students look at the Tract and the Treatise, which are better books.  And then read Fisher, Cassel, Hawtrey, Pigou and the others.

PPS.  Here’s a post on bubbles I did over at Econlog.

About that “struck by lightning” metaphor

People often say; “live for today, you might be hit by a truck tomorrow.”  That doesn’t make me less miserable, just more careful to avoid walking in front of trucks.  But struck by lightning? Yes, that one I’m pretty fatalistic about.  You are walking down the street minding your own business or out playing a round of golf and WHAM, a bolt from the blue and you’re dead.  Most deaths don’t even occur during severe thunderstorms.  Stuck by lightning is a timeless metaphor for how fate or the cruel whims of Yahweh/Zeus/Jupiter/Thor affect us weak mortals.

So 432 people were killed by lightening in America in 1943.  On a per capita basis that would be like 1000 people in 2013.  Exactly 1000 in fact.  On the other hand the population growth has been much more rapid in the risky states like Florida and Arizona, so maybe you’d expect more than 1000 today.  On the other, other hand not everyone is killed instantly, and medical care has improved, so maybe less than 1000.  What would you guess?

I’ll give you a hint.  In 1943 there were 22,727 traffic fatalities.  In 2012 there were 34,080. Because the population more than doubled, the death rate actually fell by 35%.  And people now drive much more, so the death rate per mile fell by almost 90%.  But of course there’s lots of things you can do to reduce auto death rates.  Safer cars, divided highways, drunk driving laws. Back in 1943 cars didn’t even have safety glass.  Lightning strikes?  By the time you hear the boom it’s too late; 186,000 miles per second and all that.

So how many people died from lightning in America in 2013, more or less than 1000?

Twenty three.

PS.  In recent years 82% of victims were men.  More evidence of gender bias in blind fate.

How would the Fed respond to the elimination of extended UI?

This is from a recent editorial by Amanda Alix:

A body blow to a recovering economy
The personal suffering will be terrible enough, but the damage to the fragile economy is sure to cause further disruption. Monthly stipends are recycled back into the economy as recipients buy the necessities of everyday life. Preserving that cash infusion, despite the cost of the program, could increase the country’s gross domestic product by 0.2% this year, while adding another 200,000 jobs.

Another problem involves the unemployment rate, which could drop by 0.5% as the long-term jobless are no longer counted as “looking for work.” A similar scenario occurred last year in North Carolina, when 170,000 people lost jobless benefits in a bid to cut state costs. The state’s unemployment rate dropped quickly to 7.4% from 8.8% as those people were no longer considered unemployed.

A drop in the national unemployment rate could have more serious consequences. The Federal Reserve has specified a jobless rate of 6.5% as one economic indicator that would prompt the Fed to cut back on its accommodative monetary policy and consider raising short-term interest rates.

While the Fed stresses that interest rates will very likely stay low well beyond the time the jobless rate hits the 6.5% mark, a falling unemployment rate will likely spur the speed-up of the so-called taper. It’s very possible the announced reduction of $10 billion in the Fed’s monthly $85 billion bond and mortgage security buying plan could be accelerated if the jobless rate hits 6.5%, particularly if the rate continues to drop.

This could send long-term interest rates surging, hurting housing and the greater economy. Clearly, there are other factors, such as inflation, that the Fed will consider as it moves to wean the economy from its quantitative easing policy. It is notable, however, that the Federal Open Market Committee clearly regards a national unemployment rate of 6.5% as a sign of an improving economic climate — not the byproduct of shutting off the benefit supply to those who have been unable to secure viable employment.

If we learned anything in 2013, it is that the first paragraph is probably wrong, due to monetary offset.  But it’s the final paragraph that perked my interest.  A few comments:

1.  This is a good example of why the Fed should not target the unemployment rate.

2.  The final sentence of the quotation seems wrong.  Not only does the Fed not regard 6.5% as “clearly” the key threshold, a few weeks ago the Fed even went out of their way to state exactly the opposite, that rates would probably stay low well beyond the 6.5% threshold.  Thus the Fed behaved exactly as one would expect if they accepted Amanda Alix’s view that the repeal of extended UI program would quickly reduce the measured unemployment rate without boosting AD and jobs.

I’ve often been critical of the Fed’s willingness to allow NGDP growth to drop sharply over the past 6 years, which boosted joblessness and worsened the financial crisis.  But in fairness the Fed does seem to be pretty good at offsetting the impact of fiscal policy.  There are lots of good (humanitarian) arguments for reducing UI insurance more gradually, but the impact on AD is not one of them.

PS.  For what it’s worth my prediction is that the measured unemployment rate will fall by about 0.7% in 2014, or by 1.2% if extended UI is not re-instated.  This is a very rough guesstimate, as it’s difficult to know how many discouraged workers would come back if the economy improves.

Regardless of what you think about extended UI, everyone should agree on the following:  If we really do need 73 week extended UI 5 years after Obama took office, then the 2009 stimulus bill failed. Perhaps it failed because it was too small, or because the GOP blocked further stimulus, but it clearly failed.

PPS.  The entire unemployment system should be gradually replaced with personal UI accounts, grandfathering in those in the old system.  When people retire any unused funds in their UI accounts could be used for retirement, or for bequests.

PPPS.  I just noticed another article:

“That would mean there is almost a billion dollars we are losing from the economy because of not extending unemployment insurance benefits,” Katz said in a conference call organised by House Democrats.

He later told the Guardian that the calculation was based on the “multiplier effect” of cancelling the benefits program, which had been forecast by the Congressional Budget Office (CBO). Applying the CBO’s estimated multiplier effect to the $400m per week being lost in benefits, Katz said, translated into a cost to the economy of between $600m and $1bn.

“It is actually fiscally irresponsible not to extend unemployment benefits,” he said. “The long-run cost to the taxpayers will be much higher from disconnecting people from the labour market.”

After 2013, it’s hard to believe there are still people who believe in “multipliers.”  Here’s a better argument for extended UI:

“When Congress first past this version of emergency unemployment compensation in 2008, and the president [George W Bush] signed the law, the unemployment rate was 5.6%, and the average duration of unemployment was 17.1 weeks. Today, the unemployment rate is 7%,” Perez said. “The average duration of unemployment is now 36 weeks.”

Interestingly, Brad DeLong predicted that Bush’s decision would boost the unemployment rate by 0.6% points within 4 months, and was exactly right.  Even liberals believe extended UI boosts the unemployment rate when the level of unemployment is close to the natural rate.  Not sure what Bush was thinking . . . 

Monetary stimulus and fiscal austerity: Poland >> Latvia >> Greece

Tyler Cowen recently linked to an article comparing the recoveries (or not) in Latvia and Greece.

I think the debate over “austerity” is the wrong debate.  The demand-siders are right that many countries need more demand.  But if the central bank won’t allow more demand, then the best option might be to boost AS by making your economy as lean and mean as possible.  That might involve shrinking the government.

Poland reacted to the global demand shock by devaluing.  It did far better than Latvia, which stayed fixed to the euro.  And Latvia bit the bullet with austerity before Greece, and it’s doing far better than Greece.  These sorts of comparisons are full of lots of complications, ceteris is never paribus.  So maybe it doesn’t show much.  Let me just say that, given their policies, the relative performance of these three countries doesn’t surprise me.

What a difference a quarter makes

Real GDP growth was a surprisingly strong 4.1% during the 3rd quarter.  During the third quarter, however, lots of people were quite pessimistic:

Here’s a fairly typical story that appeared about 2/3rds of the way through the 3rd quarter:

The meager increase in consumer spending in July has quashed any optimism generated by faster second-quarter U.S. growth.

A handful of Wall Street firms chopped their growth targets for gross domestic product in the third quarter after the government reported Friday morning that spending rose a scant 0.1% in July, based on a preliminary estimate.

RBS slashed its prediction for GDP growth to an annualized rate of 1.5% from 2%; Macroeconomic Advisers cut its projection to 1.6% from 1.8%; Barclays trimmed its forecast to 1.6% from 1.9%; and Morgan Stanley reduced its estimate to 1.9% from 2.1%.

Now suppose you were a liberal Keynesian who was convinced that austerity was madness.  How would you react to this sort of story?  Clearly you’d want to go on record emphasizing the importance of fiscal austerity, and the damage that was being done to the economy.  That way you could say “I told you so” when the dismal 2nd half data came out.  And in October (before the actual 2013:3 GDP data was available) Paul Krugman did exactly that, suggesting that the conventional measures of austerity left out a great deal :

But we shouldn’t stop there, because there are two important aspects of the story that MA leaves out.

First, part of the fiscal cliff deal involved letting the Obama payroll tax cut “” a significant, useful form of economic stimulus “” expire. (Republicans only like tax cuts that go to people with high incomes.) This led to a surprisingly large tax hike in 2013, focused on workers:

Second, GOP opposition to unemployment insurance has been the biggest factor in a very rapid decline in unemployment benefits despite continuing weak job markets:

This hurts the unemployed a lot, but it also hurts the economy, because the unemployed are already living on the edge, and surely must have been forced into spending cuts as benefits expired.

The combination of the payroll take hike and the benefit cuts amounts to about $200 billion of fiscal contraction at an annual rate, or 1.25 percent of GDP, probably with a significant multiplier effect. Add this to the effects of sharp cuts in discretionary spending and the effects of economic uncertainty, however measured, and I don’t think it’s unreasonable to suggest that extortion tactics may have shaved as much as 4 percent off GDP and added 2 points to the unemployment rate.

In other words, we’d be looking at a vastly healthier economy if it weren’t for the GOP takeover of the House in 2010.

Yes, unemployment would be 4.7% w/o the GOP takeover.

BTW.  That horrible GOP takeover led (in 2011) to the 2% payroll tax cut that Krugman thinks was “useful.”

The White House is counting the 2 percent payroll tax cut among its “wins” in the tax deal worked out with congressional Republicans. But it’s a win based on a Republican idea and one that many congressional Republicans support.

You may recall that a payroll tax break or “holiday” was a Republican proposal back in 2009. Conservatives liked the idea then in lieu of a tax credit.

.  .  .

In 2009, the White House rebuffed the idea, preferring its grab bag of stimulus spending programs.

Remember the boost to GDP after payroll taxes were cut in 2011, and the decline after they were raised again?  Neither do I.

PS.  Just to be fair and balanced, I think the stronger growth in recent quarters also undercuts the “it’s not demand it’s Obamacare” story put out by conservatives.  In fact it’s both, but in the short run demand is the dominant factor.

HT:  Thanks to Erik Trygger