Archive for October 2018


The new Rubb/Sumner principles textbook

I’m very pleased to announce that my 5-year project to write a principles textbook is now complete. Macmillan/Worth has just released the new book I co-authored with Steve Rubb, which is aimed at the mainstream principles of economics market.

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Like Hubbard and O’Brien’s principles textbook, it has a business flavor that should make the subject more interesting for many students.  Our book tries to be shorter and more concise, however, as many of today’s students simply don’t have the time to read an 1176 page textbook like H&O.  Ours came in just under 800 pages—with a word count that is probably pretty similar to Mankiw’s relatively concise principles text.  (Ours is actually 100 pages shorter than Mankiw, but each page is a bit bigger.)  This picture shows our new text (in blue) next to Hubbard and O’Brien (in white).
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Don’t be fooled by the business flavor, we still cover all the basics of economics, including important public policy issues such as price controls, externalities, labor, inequality, health care, and fiscal and monetary policy.

This book should be of interest to both monetarist and Keynesian instructors.  Obviously my own views lean more monetarist, but we’ve covered the material to reflect the views of the profession as a whole. Thus there is much more coverage of inflation than NGDP, reflecting the consensus of the profession.  Keynesians will find an optional “aggregate expenditure” chapter containing the Keynesian cross, if they are so inclined.  If I were still teaching I would not cover the Keynesian cross, but would cover the part of the AE chapter that discusses the intuition behind Keynesian economics.  Although I’m not a fan of fiscal stimulus, I believe it’s important for students to understand why these policies are so popular.

We also have the normal mainstream macro chapters, including a three chapter sequence of AS/AD, fiscal policy and monetary policy, as well as a two chapter money sequence that looks first at the basics of how the Fed controls the supply of money, and then the classical theory of inflation (i.e. money and prices in the long run.)  I especially like our money/inflation and economic growth chapters.

In my view, the book is most successful at adding a business flavor in the micro chapters, especially those covering market structure.  I believe students will find those chapters to be especially interesting, with lots of good real world examples.  But we’ve tried to add as many business examples as fit at various spots throughout the book.  Many students take economics because they have an interest in business.

As far as my own views, we’ve sprinkled the “never reason from a price change” concept into several of those chapters, including both S&D and AS/AD.  There’s a brief discussion of monetary offset of fiscal policy in the section that covers issues such as crowding out.  And there is some coverage of the logic behind NGDP targeting toward the end of the macro section.  In monetary policy, we point out that low interest rates can reflect either easy money or a weak economy/low inflation.

But again, I didn’t think it appropriate to use a principles text to try to indoctrinate students into my own views where I have not (yet) been successful in convincing my colleagues.  Students need to begin with the well-established basics.  As a result, readers will occasionally run across statements in the text that conflict with opinions offered in this blog.  That doesn’t worry me at all, indeed it’s appropriate.

For instance, you won’t come across “inflation doesn’t matter, only NGDP matters” in this textbook.  You won’t find “fiscal policy is useless” in this textbook.  Both monetarists and Keynesians should be quite comfortable with the presentation.  When I taught at Bentley, most students were not aware of my views on economics—indeed were just as likely to view me as liberal than as conservative.  The book reflects that balance.

If you do like my views on economics, I’d argue that we do a better job of presenting many macro topics than what you see in the other textbooks.  For instance, our transition from MV=PY to the AS/AD model (using Y = C + I + G) is far more understandable than in most other textbooks. Indeed students would be utterly confused by this transition in many other textbooks (although Cowen and Tabarrok are an excellent exception.)  I also like the way we explain topics such as the quantity theory of money, or the challenges of doing monetary policy when interest rates are zero.  The fiscal chapter includes both supply and demand-side perspectives.  Like some other newer texts, the economic growth chapter emphasizes the importance of good institutions, not just a mechanical model with “labor”, “capital” and “natural resources”.

Toward the end we have an optional chapter on expectations, covering issues such as the Phillips Curve and rational expectations.  I believe we do a particularly good job of explaining the concept of expectations.  At the end of this chapter is a brief section on how the Phillips Curve approach could be applied to NGDP growth instead of inflation (Ignore “FPO”, an editorial note not contained in the final version):

Screen Shot 2018-10-30 at 6.29.31 PMIn terms of level, I suppose it’s in the eye of the beholder.  In my view our book is aimed at the middle of the market—not too difficult, but not dumbed down so much as to be misleading.  Note that the preceding graph comes in a chapter that has already covered the pros and cons of the basic Phillips Curve, with inflation on the vertical axis.

BTW, if I could do a book with no constraints, I’d make it even shorter.  However, textbooks are expensive projects for publishers and you need to address the preferences of the instructors.  They each have topics that they view as essential.

Did he really say that?

It’s hard to keep up with the President’s logic, but this has me especially confused:

President Trump on Wednesday again sought to turn the nation’s attention to his hard-line stance on immigration ahead of next week’s midterm elections, claiming that birthright citizenship is not covered by the U.S. Constitution and vowing the issue will ultimately be settled by the Supreme Court.

“So-called Birthright Citizenship, which costs our Country billions of dollars and is very unfair to our citizens, will be ended one way or the other,” Trump tweeted.

The concept of birthright citizenship, which grants citizenship to everyone born in the United States, is guaranteed by the 14th Amendment to the Constitution. It reads: “All persons born or naturalized in the United States, and subject to the jurisdiction thereof, are citizens of the United States.” . . .

“It is not covered by the 14th Amendment because of the words ‘subject to the jurisdiction thereof,’” the president said, adding that “many legal scholars agree” with him. Most legal experts disagree, interpreting the clause narrowly, to exclude, for example, the families of foreign diplomats residing in the United States.

Is the President saying that children born in the US to non-residents are not subject to the jurisdiction of the US?  If not, what is he saying?  And if the answer is yes, isn’t that pretty shocking?  Do these kids really have immunity to our laws?  I know, we are long past being shocked . . . but still.

BTW, have you noticed how conservatives interpret the Constitution:

A well regulated Militia, being necessary to the security of a free State, the right of the people to keep and bear Arms, shall not be infringed.

All persons born or naturalized in the United States, and subject to the jurisdiction thereof, are citizens of the United States.

Both really confusing. Right?

I’m sure we can trust Brett Kavanaugh to figure it all out.

Do low interest rates stimulate housing?

If you answer this question with a “yes”, then you are reasoning from a price change. I thought of this when reading the abstract to a paper by David W. Berger, Konstantin Milbradt, Fabrice Tourre, Joseph Vavra on monetary policy and mortgage interest:

How much ability does the Fed have to stimulate the economy by cutting interest rates? We argue that the presence of substantial household debt in fixed-rate prepayable mortgages means that this question cannot be answered by looking only at how far current rates are from zero. Using a household model of mortgage prepayment with endogenous mortgage pricing, wealth distributions and consumption matched to detailed loan-level evidence on the relationship between prepayment and rate incentives, we argue that the ability to stimulate the economy by cutting rates depends not just on the level of current interest rates but also on their previous path: 1) Holding current rates constant, monetary policy is less effective if previous rates were low. 2) Monetary policy “reloads” stimulative power slowly after raising rates. 3) The strength of monetary policy via the mortgage prepayment channel has been amplified by the 30-year secular decline in mortgage rates. All three conclusions imply that even if the Fed raises rates substantially before the next recession arrives, it will likely have less ammunition available for stimulus than in recent recessions.

People tend to refinance mortgages when long-term interest rates fall.  So what type of monetary policy generally causes long-term interest rates to decline?  I’d say the answer is contractionary, whereas the authors of this study seem to assume the answer is expansionary.  (I base this assumption on the first sentence of the abstract.  I have not read the entire paper, so it’s very possible I misinterpreted their claim.)

This is actually a complex question, and my reading of the evidence is that long-term rates will usually increase when monetary policy is made more expansionary (as in the 1960s and 1970s), but not always.  Of course it partly depends on how you define “expansionary”.

Consider the Fed announcements of January 2001 and September 2007.  In both cases, the Fed cut rates for the first time in years.  In both cases, the policy rate was cut by 0.5%, not the usual 0.25%.  In both cases, stocks soared on the unexpectedly expansionary policy news.  In both cases, long-term bond yields increased on the news (dramatically in January 2001), even as short term rates declined. If a highly liquid NGDP futures market had existed, then NGDP futures prices would have probably also increased.  On the other hand, you can also find lots of examples where short and long-term interest rates move in the same direction.  But the two cases I cited are important because they were so easily identifiable–the dramatic market responses at 2:15 pm seemed clearly linked to the Fed announcements.  “Identification” of policy shocks is easier in that case.

If I’m right that falling long-term bond yields generally reflect a contractionary monetary policy, then I think it’s a mistake to rely too much on the mortgage refinance channel when the Fed is trying to stimulate the economy.

I believe that monetary policy is always highly effective, even at zero interest rates.  We have lots of historical evidence to support that claim.  But if it is effective, it’s not because lower interest rates stimulate demand, rather it is because monetary stimulus increases the monetary base and/or reduces base demand, which boosts NGDP.  And higher NGDP leads to higher employment in a world with sticky wages.  In most cases, long term interest rates will also increase.

HT:  Tyler Cowen

Why lies matter

After the Berlin Wall came down, there was a brief period of liberalism in Eastern Europe:

The contemporary left disdains the open society as a neo-liberal capitalist dream; the right fears its skepticism toward tradition. But for the last five decades, most of America and Europe’s prosperity and peace have been based on an open society consensus, which for a brief moment after the end of the Cold War, it looked like Western thinkers like Soros had succeeded in importing to Eastern Europe. Markets opened to foreign investors. In 1991, Soros founded the Central European University with campuses in Prague, Warsaw and Budapest, a US-funded education center committed to critical thought and the study of democracy. Ironically, given recent developments, the CEU’s headquarters moved from Prague to Budapest when the Hungarian government of the time appeared more welcoming than the Czech.

Today it’s getting much darker in Eastern Europe:

That was then. The current Hungarian government, as Guy Verhofstadt wrote earlier this month, is probably the most illiberal and authoritarian in Europe, shutting down newspaperscorruptly capturing major facilities like water and energy, wrenching control of cultural and educational centers. Just like d’Souza, Barr and Trump Jr., the Hungarian government attacks Muslim migrants and Soros. During last spring’s election, when I was last in Hungary, you couldn’t turn without spotting the ruling Fidesz party advertisements, which featured crude photoshopped images of Soros personally cutting open the Hungarian border fences designed to keep out Muslim migrants. Like most authoritarian regimes, the Hungarian government inspires loyalty by stoking the fires of ethnic supremacy. Hungary, which spent centuries fighting the Ottoman Turks, has seen itself as Europe’s border with Islam since long before the current migrant crisis. The American alt-right laps up this talk of a clash of civilizations.

I know that some people think that it doesn’t matter if people lie about George Soros, if the President’s son calls him a Nazi collaborator.  All that matters (in their view) is corporate tax cuts.  In the short run it might seem like that is true, but in the long run you might say that honesty is all that matters.  A society built on lies will inevitably abandon liberalism.

Lies are a way of dehumanizing individuals like George Soros.  Once they are dehumanized, it’s much easier for troubled people to justify violence against them, or indeed against entire ethnic groups.  Hitler dehumanized the Jews through lies, and Mao dehumanized the rich through lies.  And that’s why for me there is only one overriding issue in the midterm elections.  Lies.  Yes, Hungary and Poland are still a long way from the 1930s, and America is further still, but I’d rather not experiment with how far this demagoguery can be pushed before causing major harm.  The risks are too great.

If there’s a recession, would it be Trump’s fault?

The short answer is “probably not”. But this requires making some careful distinctions:

1. It’s possible that Trump’s policies might become so reckless as to create a “real shock” that is large enough to cause a recession. Say a massive all-out global trade war. That seems very unlikely.

2. More likely, Trump’s policies might create a real shock large enough to complicate the implementation of effective monetary policy. Think of the way that the housing bust complicated things for the Fed in 2006-08. In this scenario, it would still be the Fed’s fault, but it would be bad trade polices combined with a flawed monetary regime that led to recession.

In this second case, I still think it would be very important not to blame Trump for the recession. We are never going to fix the problem of bad monetary policy until we stop misdiagnosing the problem. Today, 99% of economists continue to misdiagnose what went wrong in 2008, absolving the Fed of blame for an excessively tight monetary policy. To fix that, we need to start talking honestly about what causes most recessions—falling NGDP, not real shocks. And we also need to implement a regime that prevents real shocks from spilling over and causing bad monetary policy—which means NGDPLT.

3. It might be argued that Trump is to blame because he appointed the top officials at the Fed, and they made serious policy errors. To be honest, I would not blame the Dems for blaming Trump for any recession. After all, he’ll take undeserved credit for anything good that happens, so it’s only fair. Nonetheless, impartial observers who want to get at the truth should be careful before blaming Trump for any Fed screw-ups. If a demand-side recession did occur, would it be because Powell, Clarida, Quarles and the others were poor choices, or because the Fed’s entire operating system is flawed, and has been for decades? Obviously, the latter is much more likely.

Some people blame Bernanke for the Great Recession, but Greenspan’s public comments during this period suggest that the Fed would have done even worse if he had still been chair. As long as we focus on personalities we won’t solve the underlying problem, which is a flawed monetary regime.

Hopefully, the Fed has learned from the mistakes of 2008.  But we won’t know for sure until the next real shock comes along—the next crisis that requires the Fed to take aggressive steps to stabilize expected NGDP growth.

Those suffering from TDS may find this post to be dispiriting.  It would feel good to blame Trump for any recession.  Don’t worry, the voters will always blame the government for recessions, no matter what I say.

Some people who like Trump may be surprised that I take this view.  If so, it’s probably because your thinking is corrupted by politics and you assume that everyone is similarly corrupt.  Just as habitual thieves assume that everyone else would steal if they could get away with it.

I’ve been very clear all along that presidents have very little impact on the business cycle. Trump has done some useful tax changes, and lots of bad policies in areas such as trade, immigration, deficit spending, global warming, promoting an unstable financial system, etc.  But none of that has much impact on the business cycle—those are things that impact long run trend growth.  That’s how the President’s impact on the economy should be judged.

PS.  I’m not currently predicting a recession, as I don’t believe recessions can be forecasted.