Paul Krugman: The Chutzpah Caucus

When will we ever learn?:

The Chutzpah Caucus, by Paul Krugman, Commentary, NY Times: At this point the economic case for austerity ... has collapsed. ... Yet calls for a reversal of the destructive turn toward austerity are still having a hard time getting through. Partly that reflects ... widespread, deep-seated cynicism about the ability of democratic governments, once engaged in stimulus, to change course in the future.

So now seems like a good time to point out that this cynicism, which sounds realistic and worldly-wise, is actually sheer fantasy. Ending stimulus has never been a problem — in fact, the historical record shows that it almost always ends too soon. ...

Still, even if you don’t believe that stimulus is forever, Keynesian economics says not just that you should run deficits in bad times, but that you should pay down debt in good times. And it’s silly to imagine that this will happen, right?

Wrong. The key measure you want to look at is the ratio of debt to G.D.P... And if you look at United States history since World War II, you find that of the 10 presidents who preceded Barack Obama, seven left office with a debt ratio lower than when they came in. Who were the three exceptions? Ronald Reagan and the two George Bushes. So debt increases that didn’t arise either from war or from extraordinary financial crisis are entirely associated with hard-line conservative governments.

And there’s a reason for that association: U.S. conservatives have long followed a strategy of “starving the beast,” slashing taxes so as to deprive the government of the revenue it needs to pay for popular programs.

The funny thing is that right now these same hard-line conservatives declare that we must not run deficits in times of economic crisis. Why? Because, they say, politicians won’t do the right thing and pay down the debt in good times. And who are these irresponsible politicians they’re talking about? Why, themselves.

To me, it sounds like a fiscal version of the classic definition of chutzpah — namely, killing your parents, then demanding sympathy because you’re an orphan. Here we have conservatives telling us that we must tighten our belts despite mass unemployment, because otherwise future conservatives will keep running deficits once times improve.

Put this way, of course, it sounds silly. But it isn’t; it’s tragic. The disastrous turn toward austerity has destroyed millions of jobs and ruined many lives. And it’s time for a U-turn.

Links for 05-06-2013

• Tax Reform: As Usual, We’re Going About it All Wrong - Jared Bernstein
• Lessons can be learned from Reinhart-Rogoff error - Larry Summers
• Reinhart and Rogoff, in Context - Economic Principals
• Don’t blame Reinhart and Rogoff - FT.com
• Employers lack confidence, not skilled labor - Robert J. Samuelson
• Finance and growth in China and India - Vox EU
• George Osborne’s Fear of Ghosts - Paul Krugman
• How Social Networks Drive Black Unemployment - NYT
• Tyler Cowen: More Money for Drug Companies - Dean Baker
• Naive Fiscal Cynicism - Paul Krugman
• Wait No More David Beckworth - Robert's Stochastic thoughts
• The Seen and Unseen: Structural Budget Deficits Edition - David Beckworth

'Talk about Softened Austerity at the Eurozone Level is Pure Nonsense'

A self-described "Gloomy European Economist" argues that the key to recovery in Europe is boosting aggregate demand, but "No expansion of eurozone aggregate demand can happen without a reversal of policies in Germany." Unfortunately, "there is no sign that core countries like Germany will finally let their domestic demand expand":

It Ain’t Over ’til It’s Over: Austerity partisans had a couple of rough weeks, with highlights such as  the Reinhart and Rogoff blunder, and Mr Barroso’s acknowledgement that the European periphery suffers from austerity fatigue. In spite of the media trumpeting it all over the place, and proclaiming the end of the austerity war, it is hard to believe that eurozone austerity will be softened. Sure, peripheral countries will obtain some (much needed) breathing space. But this is neither a necessary nor a sufficient condition for a significant policy reversal in the EMU. The problem is that there is no sign that core countries like Germany will finally let their domestic demand expand. And yet, this is what is needed. ...

We are not going to see the pre-crisis level of activity for at least 2 or 3 years... Domestic demand is down almost 6%, mostly because of investment (-19.1%). It makes no sense claiming otherwise: this is a Keynesian (sorry for the bad word; should I rate this post R?) aggregate demand deficiency crisis. ... As a sidenote, the dramatic decrease of investment makes one wonder what will be left of the EMU capacity to produce, once aggregate demand resumes. The only two engines of growth, today are public consumption (!) and exports, both at around +4% with respect to the pre-crisis peak ; they compensate, unfortunately only partially, for the dramatic drop in domestic private demand. Further reducing government spending, as will most probably keep happening, will lay the burden of recovery only on the external component. It is worth repeating that this small-country-syndrome, in the second largest economic bloc of the world, can only spell disaster. It is impossible to conceive a long-term reliance of our prosperity on demand coming from the rest of the world, as proponents of the “Berlin view” would like us to believe.

It seems very hard not to read from this figure that the EMU needs to seriously boost domestic demand, if it wants to break free from the recessionary spiral that is afflicting it since 2008. And once this is agreed, then it becomes clear why this talk about softened austerity at the eurozone level is pure nonsense. The eurozone is compressing public expenditure, while the private sector, downbeat or financially constrained, keeps expenditure stagnant. Countries that can afford it (hint: their longest river is called Rhein…) should increase their domestic demand. Not because they need to save those sinners in the periphery, but because of their size. No expansion of eurozone aggregate demand can happen without a reversal of policies in Germany.

Whether rebalancing will happen through higher wages (much needed), or increased public spending, is not for me to say. But unless Germany accepts to act as the locomotive of European growth and increases its domestic demand, giving one extra year for budget consolidation to Greece, Spain or Italy, will not end austerity. It ain’t over…

'Does Immigration Hurt Support for the Welfare State?'

Does immigration undermine support for social insurance programs?:

Does immigration hurt support for the welfare state?, by Dan Hopkins: ... there is a ... concern about immigration ... that you are more likely to hear from the European left than the American right: that immigration undermines the social welfare state by making voters less supportive of public spending. ...

The striking thing about the United States, though, is that increasing ethnic and racial diversity hasn’t dampened our public investments.

We can study this by looking at U.S. cities. American municipalities vary markedly in their ethnic and racial demographics, and they routinely make decisions about how to allocate scarce dollars. But when we examine cities’ spending patterns in recent decades, we see that growing diversity has done little to change public good provision. Your public library is likely to have seen cutbacks, but it’s probably not because of your neighbors’ backgrounds. ...

He goes onto provide evidence that a 1999 paper by Alberto Alesina, Reza Baqir, and William Easterly that came to the opposite conclusion had causality backwards. Correcting for this, he finds that "Among the 1,000 largest U.S. cities, those that rapidly diversified saw the same changes in their spending on those categories as did cities that did not diversify."

Links for 05-05-2013

• Psychohistorical Origins of Niall Ferguson's Bizarre Remarks - Brad DeLong
• More than "When the Storm Is Long Past the Ocean Is Flat" - Brad DeLong
• Blowing In The Wind: Is Global Warming Over? - EconoSpeak
• R&D and benchmark revisions of GDP - Econbrowser
• The Gods Themselves Contend In Vain - Paul Krugman
• Blanchard on Fiscal Policy - mainly macro
• Mayday in Slovenia - unsettling economics
• Replication (2006) - Fernando Martel García
• Punishment Severity & Criminal Activity - Owen Zidar
• Granger Causality Testing Done Properly - Dave Giles
• I disagree with Noah Smith and Mark Thoma - Robert's Stochastic thoughts
• Complete Crowding-Out or Near Identities: Cato Silliness - EconoSpeak
• Childless Keynesians And The Future They Made - Modeled Behavior
• Congressional influence as a determinant of subprime lending - Vox EU
• Demography: Twentieth Century Economic History - Brad DeLong
• Talkin’ Taxes at Milken Global Conference - Jared Bernstein

Cowen: To Fight Pandemics, Reward Research

Tyler Cowen:

To Fight Pandemics, Reward Research, by Tyler Cowen, Commentary, NY Times: That frightening word “pandemic” is back in the news. A strain of avian influenza has infected people in China... The outbreak raises renewed questions about how to prepare for possible risks...

Our current health care policies are not optimal for dealing with pandemics. The central problem is that these policies neglect ... “public goods”: items and services that benefit many people and can’t easily be withheld from those who don’t pay for them directly.

Protection against communicable diseases is a core example of a public good, as is basic scientific research... Without government financing for such public goods, the capacity wouldn’t be there if a new pandemic produced a surge in demand. This would amount to an institutional failure.

The government could also take another, more unusual step: it could promise to pay lucrative prices for the patents on drugs and vaccines that prove useful in dealing with pandemics. ...

Over all, the American government seems to be turning its back on its traditional role of producing and investing in national public goods. ... Focusing government on the production of public goods may sound like a trivial issue... But, in fact, we have been failing at it, and the consequences could be serious indeed.

[This extract probably doesn't emphasize the idea in the second to last paragraph above -- offering prizes for ideas that prove useful in dealing with pandemics -- as much as Tyler would prefer.]

'Keynes, Keynesians, the Long Run, and Fiscal Policy'

Paul Krugman on how to tell when someone is "pretending to be an authority on economics":

Keynes, Keynesians, the Long Run, and Fiscal Policy: One dead giveaway that someone pretending to be an authority on economics is in fact faking it is misuse of the famous Keynes line about the long run. Here’s the actual quote:

But this long run is a misleading guide to current affairs. In the long run we are all dead. Economists set themselves too easy, too useless a task if in tempestuous seasons they can only tell us that when the storm is long past the ocean is flat again.

As I’ve written before, Keynes’s point here is that economic models are incomplete, suspect, and not much use if they can’t explain what happens year to year, but can only tell you where things will supposedly end up after a lot of time has passed. It’s an appeal for better analysis, not for ignoring the future; and anyone who tries to make it into some kind of moral indictment of Keynesian thought has forfeited any right to be taken seriously. ...

I thought the target of these remarks had forfeited any right to be taken seriously long ago (except, of course and unfortunately, by Very Serious People). [Krugman goes on to tackle several other topics.]

'Microfounded Social Welfare Functions'

This is very wonkish, but it's also very important. The issue is whether DSGE models used for policy analysis can properly capture the relative costs of deviations of inflation and output from target. Simon Wren-Lewis argues -- and I very much agree -- that the standard models are not a very good guide to policy because they vastly overstate the cost of inflation relative to the cost of output (and employment) fluctuations (see the original for the full argument and links to source material):

Microfounded Social Welfare Functions, by Simon Wren-Lewis: More on Beauty and Truth for economists

... Woodford’s derivation of social welfare functions from representative agent’s utility ... can tell us some things that are interesting. But can it provide us with a realistic (as opposed to model consistent) social welfare function that should guide many monetary and fiscal policy decisions? Absolutely not. As I noted in that recent post, these derived social welfare functions typically tell you that deviations of inflation from target are much more important than output gaps - ten or twenty times more important. If this was really the case, and given the uncertainties surrounding measurement of the output gap, it would be tempting to make central banks pure (not flexible) inflation targeters - what Mervyn King calls inflation nutters.

Where does this result come from? ... Many DSGE models use sticky prices and not sticky wages, so labour markets clear. They tend, partly as a result, to assume labour supply is elastic. Gaps between the marginal product of labor and the marginal rate of substitution between consumption and leisure become small. Canzoneri and coauthors show here how sticky wages and more inelastic labour supply will increase the cost of output fluctuations... Canzoneri et al argue that labour supply inelasticity is more consistent with micro evidence.

Just as important, I would suggest, is heterogeneity. The labour supply of many agents is largely unaffected by recessions, while others lose their jobs and become unemployed. Now this will matter in ways that models in principle can quantify. Large losses for a few are more costly than the same aggregate loss equally spread. Yet I believe even this would not come near to describing the unhappiness the unemployed actually feel (see Chris Dillow here). For many there is a psychological/social cost to unemployment that our standard models just do not capture. Other evidence tends to corroborate this happiness data.

So there are two general points here. First, simplifications made to ensure DSGE analysis remains tractable tend to diminish the importance of output gap fluctuations. Second, the simple microfoundations we use are not very good at capturing how people feel about being unemployed. What this implies is that conclusions about inflation/output trade-offs, or the cost of business cycles, derived from microfounded social welfare functions in DSGE models will be highly suspect, and almost certainly biased.

Now I do not want to use this as a stick to beat up DSGE models, because often there is a simple and straightforward solution. Just recalculate any results using an alternative social welfare function where the cost of output gaps is equal to the cost of inflation. For many questions addressed by these models results will be robust, which is worth knowing. If they are not, that is worth knowing too. So its a virtually costless thing to do, with clear benefits.

Yet it is rarely done. I suspect the reason why is that a referee would say ‘but that ad hoc (aka more realistic) social welfare function is inconsistent with the rest of your model. Your complete model becomes internally inconsistent, and therefore no longer properly microfounded.’ This is so wrong. It is modelling what we can microfound, rather than modelling what we can see. Let me quote Caballero...

“[This suggests a discipline that] has become so mesmerized with its own internal logic that it has begun to confuse the precision it has achieved about its own world with the precision that it has about the real one.”

As I have argued before (post here, article here), those using microfoundations should be pragmatic about the need to sometimes depart from those microfoundations when there are clear reasons for doing so. (For an example of this pragmatic approach to social welfare functions in the context of US monetary policy, see this paper by Chen, Kirsanova and Leith.) The microfoundation purist position is a snake charmer, and has to be faced down.

[1] Lucas, R. E., 2003, Macroeconomic Priorities, American Economic Review 93(1): 1-14.

Links for 05-04-2013

• Fiscal consolidation: At what speed? - Olivier Blanchard, Daniel Leigh
• Where Have All the Jobs Gone? - Jared Bernstein
• Update: The Future's so Bright ... - Calculated Risk
• This Week In Statistical Silliness - Edge of the American West
• Three things all serious people know are true - Irish Economy
• ‘The Human Cost of Climate Change’ by Andrew Guzman - WP
• Playing Whack-a-Mole With Expansionary Austerity - Paul Krugman
• Four changes to trade rules to facilitate climate change action - Vox EU
• Monetary Policy's Jurassic Park Problem at the Zero Bound - Rortybomb
• Low-income students can get into selective colleges - WP
• The Case for Precaution: Plan Bee - EconoSpeak
• Humorists At The European Commission - Paul Krugman
• The Old vs. the Young - Economix
• Mark Thoma on "Replication" - Dave Giles
• Building a Better Jobs Calculator - macroblog
• Fed eyes enhanced capital requirements - FT.com
• When Can Regression Coefficients Change Sign? - Dave Giles
• When Will the Adjusted R-Squared Increase? - Dave Giles
• Evaluating Progress in Regulatory Reform - FRB Speeches - Tarullo
• Wright Brothers Flight Legacy Hits New Turbulence - National Geographic
• Broader Unemployment Rate Ticks Up - WSJ
• Urban futures - UnderstandingSociety
• Lessons on Fiscal Policy Since the Recession - Economix
• Varieties of Academic Temptation - Paul Krugman
• Not swooning, not soaring - Free exchange
• Government Spending Cuts Contribute to Slower Growth - NYT

Romer and Stiglitz on the State of Macroeconomics

Two essays on the state of macroeconomics:

First, David Romer argues our recent troubles are an extreme version of an ongoing problem:

... As I will describe, my reading of the evidence is that the events of the past few years are not an aberration, but just the most extreme manifestation of a broader pattern. And the relatively modest changes of the type discussed at the conference, and that in some cases policymakers are putting into place, are helpful but unlikely to be enough to prevent future financial shocks from inflicting large economic harms.

Thus, I believe we should be asking whether there are deeper reforms that might have a large effect on the size of the shocks emanating from the financial sector, or on the ability of the economy to withstand those shocks. But there has been relatively little serious consideration of ideas for such reforms, not just at this conference but in the broader academic and policy communities. ...

He goes on to describe some changes he'd like to see, for example:

I was disappointed to see little consideration of much larger financial reforms. Let me give four examples of possible types of larger reforms:

• There were occasional mentions of very large capital requirements. For example, Allan Meltzer noted that at one time 25 percent capital for was common for banks. Should we be moving to such a system?
• Amir Sufi and Adair Turner talked about the features of debt contracts that make them inherently prone to instability. Should we be working aggressively to promote more indexation of debt contracts, more equity-like contracts, and so on?
• We can see the costs that the modern financial system has imposed on the real economy. It is not immediately clear that the benefits of the financial innovations of recent decades have been on a scale that warrants those costs. Thus, might a much simpler, 1960s- or 1970s-style financial system be better than what we have now?
• The fact that shocks emanating from the financial system sometimes impose large costs on the rest of the economy implies that there are negative externalities to some types of financial activities or financial structures, which suggests the possibility of Pigovian taxes.

So, should there be substantial taxes on certain aspects of the financial system? If so, what should be taxed – debt, leverage, size, other indicators of systemic risk, a combination, or something else altogether?

Larger-scale solutions on the macroeconomic side ...

After a long discussion, he concludes with:

After five years of catastrophic macroeconomic performance, “first steps and early lessons” – to quote the conference title – is not what we should be aiming for. Rather, we should be looking for solutions to the ongoing current crisis and strong measures to minimize the chances of anything similar happening again. I worry that the reforms we are focusing on are too small to do that, and that what is needed is a more fundamental rethinking of the design of our financial system and of our frameworks for macroeconomic policy.

Second, Joe Stiglitz:

In analyzing the most recent financial crisis, we can benefit somewhat from the misfortune of recent decades. The approximately 100 crises that have occurred during the last 30 years—as liberalization policies became dominant—have given us a wealth of experience and mountains of data. If we look over a 150 year period, we have an even richer data set.

With a century and half of clear, detailed information on crisis after crisis, the burning question is not How did this happen? but How did we ignore that long history, and think that we had solved the problems with the business cycle Believing that we had made big economic fluctuations a thing of the past took a remarkable amount of hubris....

In his lengthy essay, he goes on to discuss:

Markets are not stable, efficient, or self-correcting

• The models that focused on exogenous shocks simply misled us—the majority of the really big shocks come from within the economy.
• Economies are not self-correcting.

More than deleveraging, more than a balance sheet crisis: the need for structural transformation

• The fact that things have often gone badly in the aftermath of a financial crisis doesn’t mean they must go badly.

Reforms that are, at best, half-way measures

• The reforms undertaken so far have only tinkered at the edges.
• The crisis has brought home the importance of financial regulation for macroeconomic stability.

Deficiencies in reforms and in modeling

• The importance of credit
  • A focus on the provision of credit has neither been at the center of policy discourse nor of the standard macro-models.
  • There is also a lack of understanding of different kinds of finance.
• Stability
• Distribution

Policy Frameworks

• Flawed models not only lead to flawed policies, but also to flawed policy frameworks.
• Should monetary policy focus just on short term interest rates?
• Price versus quantitative interventions
• Tinbergen

Stiglitz ends with:

Take this chance to revolutionize flawed models

It should be clear that we could have done much more to prevent this crisis and to mitigate its effects. It should be clear too that we can do much more to prevent the next one. Still, through this conference and others like it, we are at least beginning to clearly identify the really big market failures, the big macroeconomic externalities, and the best policy interventions for achieving high growth, greater stability, and a better distribution of income.

To succeed, we must constantly remind ourselves that markets on their own are not going to solve these problems, and neither will a single intervention like short-term interest rates. Those facts have been proven time and again over the last century and a half.

And as daunting as the economic problems we now face are, acknowledging this will allow us to take advantage of the one big opportunity this period of economic trauma has afforded: namely, the chance to revolutionize our flawed models, and perhaps even exit from an interminable cycle of crises.

Baker and Duy on the Jobs Report

Dean Baker on the jobs report:

Economy Adds 165,000 Jobs in April, Unemployment Drops to 7.5 Percent: Recent job reports show there is zero evidence that the prolonged period of high unemployment has anything to do with the workforce’s lack of skills.

The April jobs numbers came in somewhat better than expected with the Labor Department reporting 165,000 new jobs. Job growth for the prior two months was revised up by 114,000, bringing average job growth for the last three months to 212,000. The unemployment rate edged downward to 7.5 percent, the lowest level since December of 2008.

While the total jobs number was somewhat better than the consensus prediction, the composition was disturbing. More than a fifth of the added jobs (34,600) were in employment services. Restaurant employment accounted for 38,000 jobs and the retail sector added 29,300. These three sectors accounted for more than half of April job growth. Health care added 19,000 jobs, a bit less than its 25,000 average over the last year.

In addition to the unbalanced nature of the job growth, there was 0.2 hour decline in the length of the average workweek. This led to 0.4 percentage point drop in the index of average weekly hours, equaling the largest declines since the recovery began.

The job losers were led by the government sector, with the federal government shedding 8,000 jobs, 3,500 of which were in the Postal Service. State and local governments lost 3,000 jobs, bringing their job loss over the last year to 224,000. Construction shed 6,000 jobs, all in the non-residential sector. This reflects less public building as reported in the March construction data. Manufacturing employment was flat in April for the second consecutive month. There is clearly little momentum in this sector right now. ...

The unemployment duration measures all fell in April, largely reversing increases from the prior two months. The share of long-term unemployed fell by 2.2 percentage points to 37.4 percent, the lowest number since October of 2009. It is important to remember that the reduction in the maximum duration of unemployment benefits has likely played a role in this decline since many unemployed workers give up looking for jobs when benefits expire.

One disturbing item in the household data was a 1.0 percentage point drop in the share of unemployment due to voluntary quits. This is the sharpest fall since February of 2009 and could be an indication of less confidence in the job market.

One issue worth emphasizing from this and past reports is that there is zero evidence that the prolonged period of high unemployment is due to a lack of skills of the workforce. This is known because there are no major areas of the economy in which we see the standard signs of a shortage of skilled workers: rising wages, increasing hours, and large numbers of vacancies. However at an even more basic level, the rise in unemployment rates has been roughly proportionate across education levels.

In fact, the unemployment rate has gone up slightly more for college grads relative to its pre-recession level than for people without high school degrees. ...

This report is consistent with the weak growth we have seen since the end of the stimulus. It will be surprising if the unemployment rate does not rise by the end of the year.

Tim Duy:

Quick Employment Thoughts: Running to meeting in a few minutes, but have some quick thoughts on the employment numbers:

Don't Get Fooled Again.  San Franscisco Fed President John WIlliams discounted the last employment report, and he was right to do so. The underlying economy continues to grind along at a slow and steady pace; it doesn't pay to get pulled into becoming overly optimistic or pessimistic about what the latest numbers. The twelve month moving average is remarkably steady:

Summer Tapering Back On The Table.  The recent data flow suggested that plans to begin tapering QE this summer with a year-end target for ending the program. And the inclusion of the "may increase or decrease" clause in the last statement seemed to imply that the recognized the shift in the tone of the data. But the Fed did not alter its economic outlook at the latest FOMC meeting. The combination suggests that the Fed would delay plans to end QE if the data faltered, that such a plan was not a sure thing. But this data suggests that their forecast was more correct than not, which then gives them room to follow the plan that appeared to be coalescing as the last meeting. In short, over the last six months, nfp growth has been 208k a month in spite of the sequester. This can certainly be interpreted as stronger and sustainable improvement.

Bottom Line: The employment report does not alter the Fed's forecast, but provides renew confidence in that forecast. Which could bring a summer tapering of QE back into play.

Paul Krugman: Not Enough Inflation

Inflation is the wrong thing to worry about:

Not Enough Inflation, by Paul Krugman, Commentary, NY Times: Ever since the financial crisis struck, and the Federal Reserve began “printing money” in an attempt to contain the damage, there have been dire warnings about inflation...

And now, sure enough, the Fed really is worried about inflation. You see, it’s getting too low. ...

It’s not hard to see where inflation fears were coming from. In its efforts to prop up the economy, the Fed has bought more than $2 trillion of stuff — private debts, housing agency debts, government bonds. It has paid for these purchases by crediting funds to the reserves of private banks, which isn’t exactly printing money, but is close enough for government work. Here comes hyperinflation!

Or, actually, not. From the beginning, it ... should have been obvious that the financial crisis had plunged us into a “liquidity trap”... Economists who had studied such traps ... knew that some of the usual rules of economics are in abeyance as long as the trap lasts. Budget deficits, for example, don’t drive up interest rates; printing money isn’t inflationary; slashing government spending has really destructive effects on incomes and employment.

The usual suspects dismissed all this analysis; it was “liquidity claptrap,” declared Alan Reynolds of the Cato Institute. But ... the liquidity trappers seem to have been right, after all. ...

So all those inflation fears were wrong..., at this point, inflation — at barely above 1 percent by the Fed’s favored measure — is dangerously low. ...

So why is inflation falling? The answer is the economy’s persistent weakness, which keeps workers from bargaining for higher wages and forces many businesses to cut prices. And if you think about it,,,, you realize that this is a vicious circle, in which a weak economy leads to too-low inflation, which perpetuates the economy’s weakness.

And this brings us to a broader point: the utter folly of not acting to boost the economy, now.

Whenever anyone talks about the need for more stimulus, monetary and fiscal, to reduce unemployment, the response from people who imagine themselves wise is always that we should focus on the long run, not on short-run fixes. The truth, however, is that ... by letting short-run economic problems fester we’re setting ourselves up for a long-run, perhaps permanent, pattern of economic failure.

The point is that we are failing miserably in responding to our economic challenge — and we will be paying for that failure for many years to come.

Links for 05-03-2013

• More services means longer recoveries - The Berkeley Blog
• Comment on Reinhart and Rogoff's FT article - Jonathan Portes
• Government Spending Cuts Contribute to Slower Growth - NYT
• All About Spherically Distributed Regression Errors - Dave Giles
• Stolen from Brad's Comment Thread - Robert's Stochastic thoughts
• Me not working hard? - Antonio Fatas
• Nominal GDP Targeting is Left, Right? - Jeff Frankel
• The rise of economics as engineering - INET
• Good Old R-Squared! - Dave Giles
• Measuring the 'reach for yield' - Vox EU
• Subsidies push farmers to buy “Cadillac” crop insurance - Radio Iowa
• April Employment Report Preview - A Dash of Insight
• Self-defeating austerity shocks - Vox EU
• The third lever of macroeconomics - Free exchange
• The Vampire Theory of Inflation - Uneasy Money
• The Origins of Great Economists' Worldview - Matthew Kahn
• Oregon Medicaid Frakt Carroll and Drum - Robert's Stochastic thoughts
• Can And Should The Fed Battle Bubbles? - EconoSpeak
• Fire Insurance Is Worthless! - Paul Krugman
• Those Ultra-Keynesians at the NRO WSJ Oped Pages - EconoSpeak
• Winning the intellectual debate on austerity while losing the policy debate - EPI
• Larry Summers and Glenn Hubbard Square Off on Our Economic Future - NYT
• Monetary stimulus vs financial stability is a false trade-off - Nick Rowe
• Should the Unemployed Move to North Dakota? - Tim Taylor
• Trend and Nonlinear Cyclical Employment Dynamics - Econbrowser
• The Case for Megabanks Fails - Economix
• More Straw - Paul Krugman

Sachs: Banking Abuses ‘Can’t Get More in Your Face’

Jeff Sachs is interviewed by Paul Vigna of the WSJ's MoneyBeat:

Jeffrey Sachs: Banking Abuses ‘Can’t Get More in Your Face’, by Paul Vigna: ....When I really started to ... keep track of the number of lawsuits, and the number of settlements, and it’s amazing actually how many there are, of course. Libor, Abacus, other financial fraud scandals, money laundering, insider trading. The list is actually extraordinary. The frequency of new cases, new settlements, new SEC charges, is stunning. ...

Why the lack of prosecution?

The legal defenses are very powerful, the lobbying is very powerful, the government in general is completely squeezed even if it would like to regulate. But we also have a revolving door of senior regulatory officials, congressional staff, congressmen and senators. Everyone’s in on this. ...

What will it take to change the system?

I think that the public is utterly disgusted, of course, and that is a major start. There’s going to be a massive backlash..., what one does feel is that the extent of abuse, the stench of it, is reaching such a high level that we’re not in an equilibrium, political or social, right now. This is explosive stuff (scandals like Abacus and insider trading). It’s unbelievable. So far it hasn’t stopped the practice, but it can’t get more in your face than this actually.

I think in the end the question will be ... whether a political movement not based on mega-donations can win political control. I believe that it can actually. Some movement like the populist movement or the progressive era of the past is going to rise and say ‘we don’t need contributions, we’re not taking them, and if you the American people want a way out of this that doesn’t involve politicians bought for big money, we’re the ones.”

But short of that I don’t see a way out. ...

'Economics Needs Replication'

Via Eric Weiner at INET, and continuing a recent discussion, this is Jan Höffler and Thomas Kneib on replication in economics:

Economics Needs Replication, by INET Grantees Jan Höffler and Thomas Kneib: The recent debate about the reproducibility of the results published by Carmen Reinhart and Kenneth Rogoff offers a showcase for the importance of replication in empirical economics.

Replication is basically the independent repetition of scientific analyses by other scientists... The principle is well accepted in the natural sciences. However, it is far less common in empirical economics, even though non-reproducible research can barely be considered a contribution to the consolidated body of scientific knowledge. ...

In the narrow sense, replicability means that the raw data for an analysis can be accessed, that the transformation from the raw data to the final data set is well documented, and that software code is available for producing the final data set and the empirical results. Basically, this comes down to a question of data and code availability, but nonetheless it is a necessary prerequisite for replication. A successful replication would then indicate that all of the material has been provided and that the same results were obtained when redoing the analysis.

In the wider sense, a replication could go much further by challenging previous analyses via changing the data sources (such as changing countries, switching time periods, or using different surveys), altering the statistical or econometric model, or questioning the interpretational conclusions drawn from the analysis. Here, the scientific debate really starts, since this type of replication isn’t concerned with simply redoing exactly the same analysis as the original study. Rather, the goal is to rethink the entire analysis, from data collection and operationalization to the interpretation of results and robustness checks.

Unfortunately, very few journals in economics have mandatory online archives for data and code and/or strict rules for ensuring replicability. Moreover, the incentive for making your own research reproducible, and for reproducing research done by others, is low.

In this respect, there are several interesting lessons to be learned by the Reinhart/Rogoff case.

One is that the impact of replication can actually be quite high, especially when replicating papers that have been influential... Still, it is important to remember that replications that question earlier results are not the only ones that are of value. It is also helpful to know if a specific study could be replicated...

Another important lesson is that involving students in replications can significantly change attitudes towards replication. For students, a replication is a perfect opportunity to perform their own analyses based on an already available paper. They get to learn how experienced scientists tackle applied-research questions and they also learn that the consolidated body of scientific knowledge is constantly changing as it is questioned and transferred to new contexts.

Finally, it is very important for the raw data to be made available so that every step up to the final results of a study can be replicated. ...

In recent years, we have been teaching replication to students at all levels (ranging from undergraduates to Ph.D. candidates) and have set up a large global network to support the idea of replication by students. ...

As a part of our INET project on empirical replication, we therefore are collecting and sharing a large dataset of empirical studies. These studies are all potential candidates for replication that meet the minimal requirements for replicability. Information on these studies, as well as additional information about already published replications, is available in a wiki shared with collaborators who join our teaching initiative. Moreover, we will soon provide via the same wiki website additional resources to support teaching replication seminars. We also started a working paper series on replication so that replication papers can be published as reports and provide a forum for discussing replicability as another part of the wiki website.

We welcome you to join our efforts... You can find more information and contact us here and here.

One place where replication occurs regularly is assignments in graduate classes. I routinely ask students to replicate papers as part of their coursework. Even if they don't find explicit errors (and most of the time they don't), it almost always raises good questions about the research (why this choice, this model, what if you relax this assumption, there's a better way to do this,here's the next question to ask, etc., etc.). So replication doers occur routinely in economics, and it is very valuable, but it is not a formal part of the profession the way it should be, and much of the replication is done by people (students) who generally assume that if they can't replicate something, it is probably their error. We have a lot of work to do on the replication front, and I want to encourage efforts like this.

Global Financial Regulation

In case this is of interest:

Global Financial Regulation
Speakers:

• James Barth, Senior Finance Fellow, Milken Institute; Lowder Eminent Scholar in Finance, Auburn University
• Bob Corker, U.S. Senator
• Carey Lathrop, Managing Director and Head of Global Credit Markets, Citi
• Kevin Lynch, Vice Chairman, BMO Financial Group
• Thomas Perrelli, Partner, Jenner & Block; Former Associate U.S. Attorney General

Moderator: Jaret Seiberg, Managing Director and Senior Policy Analyst, Guggenheim Partners

As countries implement new regulations in response to the global financial crisis, will safer and sounder markets be the result? Or just more burdens and costs? What impact can we expect on financial institutions, lending, the flow of capital around the world and, eventually, the global economy? Has the too-big-to-fail problem been solved, or should the giants simply be broken up? Is there a place for a global financial regulator? And what should be done about the shadow banking system - the institutions that wield influence but go largely unregulated? Our panel will delve into whether there are more effective ways to oversee financial markets than current methods.

How Medicaid Affects Adult Health

Following up on Brad DeLong's theme today, more on the Oregon Medicaid experiment (and whether expansion of Medicaid is a good idea -- DeLong has a more cautionary but ultimately positive take on the results -- Krugman comments here):

How Medicaid affects adult health, MIT News: Enrollment in Medicaid helps lower-income Americans overcome depression, get proper treatment for diabetes, and avoid catastrophic medical bills, but does not appear to reduce the prevalence of diabetes, high blood pressure and high cholesterol, according to a new study with a unique approach to analyzing one of America’s major health-insurance programs.

The study, a randomized evaluation comparing health outcomes among more than 12,000 people in Oregon, employs the same research approach as a clinical trial, but applies it in a way that provides a window into the health outcomes of poor Americans who have been given the opportunity to get health insurance.

“What we found was that Medicaid significantly increased the probability of being diagnosed with diabetes, and being on diabetes medication,” says Amy Finkelstein, the Ford Professor of Economics at MIT and, along with Katherine Baicker of Harvard University’s School of Public Health, the principal investigator for the study. “We find decreases in rates of depression, and we continue to find reduced financial hardship. However, we were unable to detect a decline in the incidence of diabetes, high blood pressure, or high cholesterol.”

A paper based on the study, “The Oregon Experiment — Medicaid’s Effects on Clinical Outcomes,” is being published today in the New England Journal of Medicine.

The findings bear on the expansion of the federal government’s Affordable Care Act (ACA), currently being phased in across the nation. The ACA provides funding for states to expand Medicaid coverage to low-income adults who are currently not part of the program.

Winning the lottery

The researchers analyzed the impact that Medicaid had on people over a two-year span. Among other things, they found about a 30 percent decline in the rate of depression among people on Medicaid; an increase in people being diagnosed with, and treated for, diabetes; and increases in doctor visits, use of preventative care, and prescription drugs. They also found that Medicaid reduced, by about 80 percent, the chance of a person having catastrophic out-of-pocket medical expenses, defined as spending 30 percent of one’s annual income on health care.

“That’s important, because from an economics point of view, the purpose of health insurance is to … protect you financially,” Finkelstein says.

The researchers did not find any change in three other health measures: blood pressure, cholesterol, or a blood test for diabetes. But the data does provide important indicators about the ways newly-insured people are using medical services.

“There was a big increase in the use of preventative medicine,” says Baicker, noting that Medicaid increased the use of services such as mammograms and cholesterol screening, as well as increasing doctor's office visits and prescription drugs.

Other health researchers say these findings correspond with a developing picture of how increased medical care addresses different kinds of problems over different spans of time.

“I would expect a more immediate impact when it comes to measures of mental health and emotional well-being, including depression,” says Thomas McDade, an anthropologist at Northwestern University and director of its Laboratory of Human Biology Research, who studies public-health issues. “Things like risk for cardiovascular disease, your lipid concentrations, your blood pressure, these are things that are really established over a lifetime of exposure to diet, physical activity, and psychosocial environment, so we don’t expect them to move as quickly.”

The study uses data from a unique program the state of Oregon founded in 2008, after officials realized they had Medicaid funds for about 10,000 additional uninsured residents. The state created a lottery system to fill those 10,000 slots; about 90,000 residents applied.

That lottery thus generated a group of residents gaining Medicaid coverage who were otherwise similar to the applicants still lacking coverage. Using this divide, the researchers compared to a control group of 6,387 people who signed up for the lottery and were selected to 5,842 people who applied for Medicaid but were not selected to enroll.

“We recognized the lottery as a literally once-in-a-lifetime opportunity to bring the rigors of a randomized controlled trial, which is the gold standard in medical and scientific research, to one of the most pressing social policy questions of our day, namely, the consequences of covering the uninsured,” Finkelstein says.

Or as Baicker puts it, “We would never accept a medical trial that didn’t have a control group.”

In particular, this kind of study, by matching two like groups of people, eliminates one longstanding problem in studying health insurance: that people in worse health may seek out health insurance more often than those in good health do, thus making it appear, at a glance, that having health insurance does not help improve medical outcomes.

“The whole tension with studying the effects of insurance is, you have to wonder why some people have insurance and other people don’t, and whether those reasons could be related to the outcomes you’re studying,” Finkelstein explains, “like the possibility that people who are sicker seek out insurance more. So you can get perverse results [on the surface], indicating that health insurance makes you sicker, not because it actually does, but because of the kinds of people who are seeking it out.”

As McDade also notes, “It’s a true experiment, and these kinds of opportunities do not come along very often.” ...

Links for 05-02-2013

• Rethinking Macroeconomic Policy - iMFdirect
• The core CPI-PCE inflation gap - FT Alphaville
• The Trouble with Low Inflation - Jared Bernstein
• Finite Sample Properties of GMM - Dave Giles
• Estimating an Euler Equation Using GMM - Dave Giles
• Treasury and MBS Markets as QE Continues - Carola Binder
• When does +2.2% = -0.1%? er, never? - Environmental Economics
• How Long Will You Be Willing to Tweet for Free? - Justin Fox
• Speaking of Getting It Wrong - Paul Krugman
• The lost generation - Free exchange
• Austerity is not the only answer to debt - Reinhart and Rogoff
• Any Examples of Thoughtful Public-Spirited Republicans? - Brad DeLong
• Six Ways to Separate Lies From Statistics - Bloomberg
• Skilled work - UnderstandingSociety
• Quandaries for Macroeconomic Policy - Tim Taylor
• Not Everything Is Political - Paul Krugman
• Is a Higher Borrowing Trajectory Warranted or Not? - Brad DeLong
• GOP bill prevents government from collecting economic data - Dylan Mathews
• I Debated Alan Reynolds on Fiscal Policy... - Brad DeLong
• Bubbles - Crooked Timber

Fed Watch: FOMC Leaves Policy Unchanged

Tim Duy:

FOMC Leaves Policy Unchanged, by Tim Duy: The FOMC concluded their two-day meeting by holding policy constant, as expected. The assessment of the economy was largely unchanged. From March:

Information received since the Federal Open Market Committee met in January suggests a return to moderate economic growth following a pause late last year. Labor market conditions have shown signs of improvement in recent months but the unemployment rate remains elevated. Household spending and business fixed investment advanced, and the housing sector has strengthened further, but fiscal policy has become somewhat more restrictive. Inflation has been running somewhat below the Committee's longer-run objective, apart from temporary variations that largely reflect fluctuations in energy prices. Longer-term inflation expectations have remained stable.

Now:

Information received since the Federal Open Market Committee met in March suggests that economic activity has been expanding at a moderate pace. Labor market conditions have shown some improvement in recent months, on balance, but the unemployment rate remains elevated. Household spending and business fixed investment advanced, and the housing sector has strengthened further, but fiscal policy is restraining economic growth. Inflation has been running somewhat below the Committee's longer-run objective, apart from temporary variations that largely reflect fluctuations in energy prices. Longer-term inflation expectations have remained stable.

Notably, recent data has had little impact on the Fed's economic outlook. This includes the last employment report as well. The inclusion of the term "on balance" was clearly intended to downplay the March numbers.

My interpretation is that the Fed is attempting to move away from being pulled this way and that by the monthly fluctuations of the data and instead focus on the underlying trend; presumably, it is that trend that should be guiding policy decisions. Of course, one could argue that that underlying trend should induce them to additional action, but that is neither here nor there at this point. From their perspective, policy is appropriate given that trend. The Fed also strengthened its language on fiscal policy, but again the damage so far is not sufficient to change the course of policy. Or, probably more accurately, the damage is not so great that the Fed is willing to let Congress hit the ball into their court.

The other significant change came latter in the statement. From March:

The Committee will closely monitor incoming information on economic and financial developments in coming months. The Committee will continue its purchases of Treasury and agency mortgage-backed securities, and employ its other policy tools as appropriate, until the outlook for the labor market has improved substantially in a context of price stability. In determining the size, pace, and composition of its asset purchases, the Committee will continue to take appropriate account of the likely efficacy and costs of such purchases as well as the extent of progress toward its economic objectives.

Now:

The Committee will closely monitor incoming information on economic and financial developments in coming months. The Committee will continue its purchases of Treasury and agency mortgage-backed securities, and employ its other policy tools as appropriate, until the outlook for the labor market has improved substantially in a context of price stability. The Committee is prepared to increase or reduce the pace of its purchases to maintain appropriate policy accommodation as the outlook for the labor market or inflation changes. In determining the size, pace, and composition of its asset purchases, the Committee will continue to take appropriate account of the likely efficacy and costs of such purchases as well as the extent of progress toward its economic objectives.

In the wake of the last meeting, comments from some Fed presidents as well as the minutes themselves seemed to imply that further expansion of the large scale asset purchase program was out of the question. Instead, it seemed the focus had firmly shifted to ending QE as soon as possible, with the end of this year as a goal. With this language shift, the FOMC pulls back on this direction, and instead makes it clear than an expansion of the program is still possible. And possible not only due to a changing employment outlook, but also due to a deteriorating inflation picture.

But isn't the inflation picture already deteriorating? Yes, the latest numbers suggest a worsening disinflation trend. The Fed, however, probably has not adjusted their forecast; they probably do not expect that substantially lower inflation is likely given that inflation expectations remain anchored and economic activity is not deteriorating. In such an environment, they likely are not all that concerned that inflation is running somewhat below target.

Moreover, the Fed has that cost-benefit analysis thing working in the background, and likely believes that any more than $85 billion a month is not likely to have large, positive marginal benefits. Not enough to justify expanding policy further for any small changes to the forecast.

Bottom Line: The urge to taper off quantitative easing has lessened since the last meeting. That pushes the beginning of the end back to the later back of the year. The door is open to additional stimulus as well, but I suspect that it would have to be driven by the employment side of the mandate. Clear evidence of a deflationary threat is likely necessary to drive action on the other side of the mandate; such a threat seems unlikely in an expanding economy.

What Comes Next for the Fed?

I have a few comments at MoneyWatch on the Fed's decision to keep policy unchanged:

What comes next for the Fed?

'Everyone Has the Same Chance at the AER, Right?'

Publication in our best journals is based on factors other than merit, "author prestige also comes into play":

Everyone has the same chance at the AER, right?, by John Whitehead: Wrong:

We spoke with Virginia economics professor William R. Johnson, who edited the edition of the Review in which the [Reinhart and Rogoff] paper first appeared.
This annual edition, "Papers and Proceedings," differs from all others in that the papers come out of presentations made at the yearly meeting of the American Economic Association, he said.
The papers are personally selected by the AEA's president-elect, in consultation with a  committee.
As a result of these unusual circumstances, Johnson said, the editing of "Proceeding" papers is less rigorous.
"Normal peer review doesn't happen for these papers in the way of other issues of the AER." ...
But author prestige also comes into play, Johnson said, adding that that was true for all AER papers, not just the ones that appear in "Proceedings."

We all knew this but it is a little surprisingly to see its admission. [via www.businessinsider.com]

It was awhile ago, but I once discovered an error in a paper in the AER (the author used the level of the price level rather than the log). When I pointed out the error, the author -- who is very well known (and now the Fed chair) -- wrote a letter to the editor of the AER arguing that it didn't materially affect the results, and subsequently our note pointing out the error was rejected (much like Reinhart and Rogoff argue that their results are not materially affected by their error, but I think the error mattered as it weakens the case in the Bernanke and Blinder paper, but even if it doesn't wrong results should be corrected -- the results cannot be replicated based on the information in the paper). The prestigious author won out over lowly me, and to this day there is a wrong result in a table in a influential paper in the debate over how to conduct monetary policy. The only place I know of where the error is noted is in a footnote to a (relatively obscure) paper of mine (along with Jo Anna Gray). The footnote says:

Table 1 of Bernanke and Blinder [1992 ] reports marginal significance levels for the federal funds rate that are dramatically higher than those for M2. There are numerous differences between our studies, most of which are inconsequential. However, this discrepancy in results is due to a computational error in the Bernanke and Blinder study. While the error significantly affects some of the F-statistics reported by Bernanke and Blinder, it has little effect on the corresponding variance decompositions reported in the paper. We thank Ben Bernanke for providing assistance that allowed us to confirm and correct the error

Again, whether or not is materially affects the results is debatable. The F-statistics changed quite a bit, the IRFs less so, but in any case results containing computational errors should be corrected, especially in papers as influential as this one turned out to be. (Update: This also shows that the profession cares very little about making it easy to replicate results.)

We will never be a science so long as this crap persists.

Fed Watch: What About Inflation?

Tim Duy:

What About Inflation?, by Tim Duy: I find Binyamin Applelbaum's Fed preview to be rather depressing and distressing. Applelbaum begins with a solid insight - reducing the unemployment rate is not the same as maximizing employment:

The Federal Reserve is making modest progress in its push to reduce the unemployment rate. But that is not the jobs goal Congress actually established for the Fed. The central bank is supposed to be maximizing employment. And on that front, it is not making progress.

Applelbaum points to the employment to population ratio as evidence that the Fed is falling short of the mandate. But are Fed officials ready to do more? No:

There is little sign, however, that Fed officials are considering an expansion of their four-year-old stimulus campaign as the Fed’s policy-making committee prepares to convene Tuesday and Wednesday in Washington.

Applelbaum notes that the recent flow of data has forced monetary policymakers to back away from talk of ending large scale assets purchases. But among the reasons to avoid expansion of the program we find this:

Another reason the Fed is not embracing new measures is that it already has tied the duration of low interest rates to the unemployment rate. The Fed said in December that it intended to hold interest rates near zero at least as long as the unemployment rate remained above 6.5 percent, provided that inflation remained under control. The theory is that the economy will get as much stimulus as it needs.

But what if the inflation rate is persistently below the target? Or, worse, trending lower? Clearly then the economy is not getting the stimulus it needs. If we are missing on both targets, then the economy needs more stimulus. And while we can debate the efficacy of monetary policy in influencing the pace of employment growth, surely monetary policy can influence the inflation rate. Correct?

The distressing part of this article is that it reads as if the Fed has given up not only on its ability to influence the pace of employment growth, but also on its ability to influence the inflation rate. Or, possibly worse, that the Fed is simply no longer concerned with the inflation rate now that the obvious threat of deflation has passed. This again feeds suspicion that the Fed's 2 percent target is really an upper bound.

Bottom Line: The Fed is supposed to have a dual mandate. Dual, as in two. Maximum employment and price stability. One would think that failing at the latter would be at least as important as failing at the former. Perhaps we are learning that the Evan's rule is flawed - it should not be about only conditions before which the Fed considers removing stimulus, but also conditions by which the Fed deliberately considers adding additional stimulus. A two-side Evan's rule is needed.

Links for 05-01-2013

• Leading Macroeconomist Leaves Central Bank - mainly macro
• China Manufacturing Weakens - WSJ
• What the ECB can and cannot do to heal the eurozone - Gavyn Davies
• Fiscal forecasts: Governments vs independent agencies - Vox EU
• The Republican War on Social Science - Slate Magazine
• Some Official Data Come With Standard Errors! - Dave Giles
• There is No Debt Crisis In Europe - Macro and Other Market Musings
• Fed weighs tighter cap on bank leverage - FT.com
• The study behind 'uncertainty' is worse... - Ezra Klein
• Why the Fed probably won’t expand QE on Wednesday - Neil Irwin
• Confidence Intervals for Impulse Response Functions - Dave Giles
• The war on science takes a turn - Steve Benen
• Looking for Inflation? It Vanished - WSJ
• The Myth of the Manufacturing ‘Renaissance’ - WSJ
• Can You Say “Bubble”? - The Baseline Scenario
• Is antimatter anti-gravity? - EurekAlert
• Does antimatter fall up or down? - EurekAlert
• Which way for the ECB? - Bruegel Blog
• The Beatings Must Continue - Paul Krugman
• The missing workers - Economic Policy Institute
• Wealth Inequality and Political Inequality - Economix
• The mother of invention - Interfluidity
• Taylor on monetary policy - John Cochrane
• The Costs and Benefits of QE - Jared Bernstein
• The Economics Knowledge of High Schoolers - Tim Taylor
• Is it Crazy to Think We Can Eradicate Poverty? - NYT