Sunday, May 29, 2011

Glorious Counterrevolution

It's September of 2007. Though almost no one realizes it, the so-called Great Moderation is ending. The housing bubble has just peaked, a rolling financial conflagration has already started, and the US economy is descending into its steepest downturn since the 1930s.

And a well-known economist is saying:
One of the most striking facts about macropolicy is that we have progressed amazingly. ... In my opinion, better policy, particularly on the part of the Federal Reserve, is directly responsible for the low inflation and the virtual disappearance of the business cycle in the last 25 years. ..
The story of stabilization policy of the last quarter century is one of amazing success. We have seen the triumph of sensible ideas and have reaped the rewards in terms of macroeconomic performance. The costly wrong turn in ideas and macropolicy of the 1960s and 1970s has been righted and the future of stabilization looks bright.
Who is it?

Must be one of those smug right-wing Chicago types, right? Maybe Robert Lucas, whose claim that the “central problem of depression-prevention has been solved” was so widely mocked when the crisis broke out?

Nope. It's Christina Romer, soon to be Obama's top economist.

As Obama's CEA chair, by all accounts Romer led the pro-stimulus forces in the administration against the forces of austerity. Yet there she is, in Berkeley in 2007, speaking without irony of the "glorious counterrevolution" against Keynes in the 1980s:
The 1960s represented the beginning of a long dark period for macroeconomic policy.... [But] since 1985, inflation has been below 4% every single year and has averaged just 2.5%. Real short-run macroeconomic performance has been similarly splendid. … As someone who started her career saying there had not been a stabilization of the postwar economy, I now have to admit there most certainly has been – it just started in 1985, not 1947. ..
What stops this story from being a good morality play is that good hasn’t triumphed entirely. At the same time that we have seen a glorious counterrevolution in the ideas and conduct of short-run stabilization policy, we have seen a remarkable lack of progress in long-run fiscal policy. In this area, the legacy of 1960s beliefs is still very much with us and may threaten the long-run stability of the American economy. ... The revolutionary idea of the 1960s concerning long-run fiscal policy was that it was not important to balance the budget even over a period of several years. Rather, persistent budget deficits could actually be desirable because they would lower unemployment and move the economy toward a more desirable path for real output.
In other words, there is one flaw in the amazingly amazing progress in economic policy since the 1980s. It's not rising private debt, financial deregulation, or stagnant wages and soaring income inequality, none of which she mentions. It's that people need to worry more about the federal debt.

True, she admits, there's no concrete evidence for any economic costs to public indebtedness over its historic range.[1] But that shouldn't stop us worrying:
The consequences of persistent deficits may only be felt over a very long horizon. … It is also possible that the effects of persistent deficits are highly nonlinear. Perhaps over a wide range, deficits and the cumulative public debt really do have little impact on the economy. But, at some point, the debt burden reaches a level that threatens the confidence of investors. Such a meltdown and a sudden stop of lending would unquestionably have enormous real consequences.
Maybe. But ideas have consequences, too. For instance, Romer's argument here is the same argument, almost verbatim, that would be used by her opponents in the administration just a year and a half later, when she was pushing for a larger stimulus:
Romer’s analysis, deeply informed by her work on the Depression, suggested that the package should probably be more than $1.2 trillion. The memo to Obama, however, detailed only two packages: a five-hundred-and-fifty-billion-dollar stimulus and an eight-hundred-and-ninety-billion-dollar stimulus. Summers ... argued that the stimulus should not be used to fill the entire output gap; rather, it was “an insurance package against catastrophic failure.” ... He believed that filling the output gap through deficit spending was important, but that a package that was too large could potentially shift fears from the current crisis to the long-term budget deficit, which would have an unwelcome effect on the bond market. In the end, Summers made the case for the eight-hundred-and-ninety-billion-dollar option.
That's Ryan Lizza via Paul Krugman; in Krugman's version, Romer is the hero. But what he doesn't say is that the arguments being deployed against her here are ones she herself was making just a year or two earlier: Shortfalls in demand are less dangerous than policymakers think, but deficits are much more so; and thanks to nonlinearity you can't wait until there's some visible cost to deficit spending to curtail it.

Now, let's be fair: We'd all be better off if Romer had won her debate with Orszag and Summers. (And if Summers had then been remanded to a job in chicken manure management.) Still, it's important to remember how small is the gap between the wings of mainstream economics, despite the vitriol. 

In her Berkeley address, Romer says
The reason that I have talked in some detail about the economic beliefs that policymakers held in the 1950s is that I believe the policies they undertook and the economic outcomes derived largely from those beliefs.
I agree. In 2007, Christina Romer was using her podium to say that we don't need to worry about major recessions, that the greatest mistake in economic policy in recent decades was faith in fiscal policy, and that the most important intellectual task for macroeconomists is to convince policymakers of the dangers of budget deficits. Now, those same arguments are being used to tell us we should accept 9-10% unemployment as far as the eye can see. If we didn't want to end up here, we should have started somewhere else.



[1] Here is, literally, the entirety of her argument on the costs of higher deficits: "On the idea that persistent deficits don’t matter, I think there is widespread consensus that that is not true. There may be differences in our estimates of the size of the eventual effects, but most economists agree that deficits over decades unquestionably reduce national saving and have consequences for long-run standards of living.” No names, no cites, no data, no examples. Just, “most economists agree.”

Wednesday, May 25, 2011

Keynes Quote of the Day

From Britain's Industrial Future:
The notion that the only way to get enough effort out of the brain-worker is to offer him unfettered opportunities of making an unlimited fortune is as baseless as the companion idea that the only way of getting enough effort out of the manual worker is to hold over him the perpetual threat of starvation and misery for himself and those he loves. It has never been even supposed to be true, at all events in England, of the soldier, the statesman, the civil servant, the teacher, the scientist, the technical expert.
And to think this was the Orange Book of 1928! Times have changed.

They sure have. Then, it seemed like the move away from institutions based on material incentives to institutions based on intrinsic motivation was well underway, or at least realizable. While today -- perhaps in Britain even more than the US -- the tide is running strong the other way, with the good and great eager to get teachers and technicians, if not yet soldiers and statesmen, onto the unlimited-fortune/starvation-and-misery plan.

The context of the quote is interesting, too -- it's part of a larger argument for the "more or less comprehensive socialization of investment" Keynes would continue to argue for in the General Theory. Since managers of private firms already work for "a certain salary, plus the hope of promotion or bonus," nothing would change if their businesses were publicly owned: "The performance of functions by Public Concerns in place of privately owned Companies and Corporations would make but little difference to the ordinary man." If soi-disant hard Keynesians read more Keynes, they would find a much more radical vision there than countercyclical fiscal policy.


(via Jim Crotty's unpublished book on Keynes. Encouraging him to get that thing out is high up on my list of life goals. Britain's Industrial Future was officially written by a committee of Liberal grandees headed by Lloyd George. But this passage was written by Keynes, Crotty says, and he would know.)

Sunday, May 22, 2011

Think Global, Act Local, American Style

Via Christian P., the free-market solution to climate change:


Picture's from Vicksburg, Mississippi. The only thing that would make it better, is if there were a golf course in there.

Leaping Lizards

At a party last night, I ran into a biologist who studies lizards. So we got to talking, as you do, about bipedalism. The habit of running on two legs has arisen in several different lineages of lizards, but why did it evolve? Speed, energetic efficiency, heat loss, vision, or that all-purpose explanation sexual selection? or maybe, like us and the birds, they've got something better to do with their front limbs?


None of the above, says the biologist. Sure, there are bipedal lizards. But very likely, bipedalism in lizards did not evolve.

Wait, how's that?

Aerts et al., Bipedalism in Lizards:
The exact advantages of bipedal locomotion in lizards remain debated. Earlier claims that bipedalism would increase maximal running speed or would be energetically advantageous have been questioned. Here, we use ‘whole body’ mechanical modelling to provide an alternative solution to the riddle. The starting point is the intermittent running style combined with the need for a high manoeuvrability characterizing many small lizard species. Manoeuvrability benefits from a caudal [rearward] shift of the centre of mass of the body (body-COM), because forces to change the heading and to align the body to this new heading do not conflict with each other. The caudally situated body-COM, however, might result in a lift of the front part of the body when accelerating ... [leading to] observable distances passively covered bipedally as a consequence of the acceleration. In this way, no functional explanation of the phenomenon of lizard bipedalism is required and bipedalism can probably be considered non-adaptive in many cases.
In other words, if you, being a lizard, need to change direction quickly when you're running, it's better to have your center of mass situated in the back, near your pelvis. That makes it easier to swing the front of your body around when you turn. But a side effect of having your center of gravity toward your back end is that your front end tends to rise when you accelerate sharply, as, being a lizard, you often do. (You, being a person now, have experienced this if you've ridden a bike up a steep hill. Conversely, brake suddenly, the back end of the bike goes up.) Air resistance adds to this effect, as does the fact that one of the ways the center of gravity is moved backwards is an overdevelopment of the rear legs relative to the front ones. The result is that lizards evolved for junk in the trunk end up sometimes running on their rear legs, even if that was not selected for at all.

(The linked article is based on experiments with a mechanical model of a lizard. According to dude at the party, the same conclusions are suggested by observations of lizard bipedalism in nature.)

I'm writing about this partly just because it's cool (go science!) but also because it's a nice illustration of an aspect of evolution that's not widely understood, especially, perhaps, by some of its more aggressive proselytes. Darwinism is certainly correct, on some level: on the level that the appearance of design in an organism in no way implies the existence of a designer. But the statement that complex adaptive traits are the result of natural selection, while true, tells us much less than it seems to at first glance, because it's seldom obvious what constitutes a "trait"; even more seldom what universe of alternatives it was selected from. In this case, we, proud bipeds, see a lizard running on its hind legs and think, that's a trait; whereas, dancers and gymnasts perhaps aside, we're not much conscious of where our center of mass is. But what we see as a trait isn't necessarily what evolution sees; not everything in Borges' encyclopedia is selected on. Perhaps the majority of what we see as traits are, as in this case, spandrels.

Needless to say, this is especially true when the organisms are human beings and the alleged trait is something psychological, especially something relating to sex and gender roles. A true evolutionary explanation should provide both concrete evidence (not just a just-so story) for the selective advantage of the supposed trait, and an account of the specific developmental pathways through which it arises; at least it should have one of the two. But in many of the "evolutionary" stories that people get most excited about, both are entirely lacking. Certainly when it comes to higher brain functions, with the exception of vision, the only statement genuinely grounded in evolutionary biology is, "We don't know."

Wednesday, May 18, 2011

How Many Rooms Does a Man Need?

I'm generally a big fan of Rick Bookstaber. His posts have a depth and originality that's rare among economics blogs. But he goes seriously off the rails with this one, on commodity prices. In the long term, he argues, they are bound to fall, because a paradigm shift is underway:
with the increased focus on technology – where we spend more and more of our time on our cell phone, doing emails, watching DVDs and surfing the web – there is less of a difference between how the super rich and the reasonably well off spend their time hour by hour during their typical days. ... in the not-so-distant future the main items we will demand, beyond food, clothing and shelter, are “game systems”...

Our demand for housing and transportation, two of the biggest commodity hogs, will be lower. McMansions will be totally passe. It should already be dawning on people that most all of our non-sleeping hours at home are spent in the kitchen and its adjacent family room. Living rooms and dining rooms are relics. 
This is a classic example of what we might call Dow 36,000 syndrome, after the perfectly timed punchline to the tech bubble, which argued that stocks were no riskier than bonds and should be priced accordingly, people just hadn't realized it yet. The syndrome consists of coming up with a theory that implies people will behave quite differently than they do, and then, rather than concluding there must be something wrong with the theory, predicting that people will start behaving in accord with it any day now. There's no explanation for why people haven't followed the theory up til now, just the assurance that they're about to, just wait. Tomorrow, tomorrow, people will realize stocks should be priced like bonds. And they'll realize there's no reason to have a bigger house than you need for your daily routine.

I don't think so.

I happen to be sitting, as I type this, in a bedroom in John D. Rockefeller's old 40-room mansion in Pocantico.I don't know how much time he spent in most of those rooms ... or in the enormous coachhouse down the hill ... or in the "Orangerie, modeled after the original at Versailles" ... or in the guesthouse, the consumption value of which presumablydidn't much depend on the fact that it was initially exhibited at the Museum of Modern Art and then disassembled and shipped to the estate.

There may be a paradigm shift that leads to decreasing demand for commodities. I hope so; sooner or later, there needs to be. But Bookstaber, smart as he is, is being too much of an economist here. Anyone who thinks that the consumption of the rich (or of those in status competition with the rich) can be derived from some rational assessment of what a person needs, has not grokked what being rich is about.

Tuesday, May 10, 2011

Bond Market Vigilantes: Invisible or Inconceivable?

Brad DeLong is annoyed with people who are scared of invisible bond-market vigilantes. And he's right to be annoyed! It's extraordinarily silly -- or dishonest -- to claim that the confidence of bondholders constrains fiscal policy in the United States. As he puts it, "Any loss of confidence in the long-term fiscal stability of the United States of America" is an "economic thing that does not exist."

So he's right. But does he have the right to be right?

I'm going to say No. Because the error he is pointing to, is one that the economics he teaches gives no help in avoiding.

The graduate macroeconomics course at Berkeley uses David Romer's Advanced Macroeconomics, 3rd Edition. (The same text I used at UMass.) Here's what it says about government budget constraints:


What this means is that the present value of government spending across all future time must be less than or equal to the present value of taxation across all future time, minus the current value of government debt. This is pretty much the starting point for all mainstream discussions of government budgets. In Blanchard and Fischer, another widely-used graduate macro textbook, the entire discussion of government budgets is just the working-out of that same equation. (Except they make it an equality rather than an inequality.) If you've studied economics at a graduate level, this is what government budget constraint means to you.

But here's the thing: That kind of constraint has nothing to do with the kind of constraint DeLong's post is talking about.

The textbook constraint is based on the idea that government is setting tax and spending levels for all periods once and for all. There's no difference between past and future -- the equation is unchanged if you reverse the sign of the t terms (i.e. flip the past and future) and simultaneously reverse the sign of the interest rate. (In the special case where the interest rate is zero, you can put the periods in any order you like.) This approach isn't specific to government budget constraints, it's the way everything is approached in contemporary macroeconomics. The starting point of the Blanchard and Fischer book, like many macro textbooks, is the Ramsey  model of a household (central planner) allocating known production and consumption possibilities across an infinite time horizon. (The Romer book starts with the Solow growth model and derives it from the Ramsey model in chapter two.) Economic growth simply means that the parameters are such that the household, or planner, chooses a path of output with higher values in later periods than in earlier ones. Financial markets and aggregate demand aren't completely ignored, of course, but they're treated as details to be saved for the final chapters, not part of the main structure.

You may think that's a silly way to think about the economy (I may agree), but one important feature of these models is that the interest rate is not the cost of credit or finance; rather, it's the fixed marginal rate of substitution of spending or taxing between different periods. By contrast, that interest is the cost of money, not the cost of substitution between the future and the present, was maybe the most important single point in Keynes' General Theory. But it's completely missing from contemporary textbooks, even though it's only under this sense of interest that there's even the possibility of bond market vigilantism. When we are talking about the state of confidence in the bond market, we are talking about a finance constraint -- the cost of money -- not a budget constraint. But the whole logic of contemporary macroeconomics (intertemporal allocation of real goods as the fundamental structure, with finance coming in only as an afterthought) excludes the possibility of government financing constraints. At no point in either Romer or Blanchard and Fischer are they ever discussed.

You can't expect people to have a clear sense of when government financing constraints do and don't bind, if you teach them a theory in which they don't exist.



EDIT: Let me spell the argument out a little more. In conventional economics, time is just another dimension on which goods vary. Jam today, jam tomorrow, jam next week are treated just like strawberry jam, elderberry jam, ginger-zucchini jam, etc. Either way, you're choosing the highest-utility basket that lies within your budget constraint. An alternative point of view – Post Keynesian if you like – is that we can't make choices today about future periods. (Fundamental uncertainty is one way of motivating this, but not the only way.) The tradeoff facing us is not between jam today and jam tomorrow, but between jam today and money today. Money today presumably translates into jam tomorrow, but not on sufficiently definite terms that we can put it into the equations. (It's in this sense that a monetary theory and a theory of intertemporal optimization are strict alternatives.) Once you take this point of view, it's perfectly logical to think of the government budget constraint as a financing constraint, i.e. as the terms on which expenditure today trades off with net financial claims today. Which is to say, you're now in the discursive universe where things like bond markets exist. Again, yes, modern macro textbooks do eventually introduce bond markets -- but only after hundreds of pages of intertemporal optimization. If I wrote the textbooks, the first model wouldn't be of goods today vs. goods tomorrow, but goods today vs. money today. DeLong presumably disagrees. But in that world, macroeconomic policy discussions might annoy him less.