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August 25, 2011

Latest Posts from Economist's View

Latest Posts from Economist's View

Glasner: Barro on Keynesian Economics vs. Regular Economics

Posted: 25 Aug 2011 02:34 AM PDT

"I am sure that Professor Barro, very, very clever fellow that he is, will clear all this up":

Barro on Keynesian Economics vs. Regular Economics, by David Glasner: Readers ... may have guessed by now that I am not a fan of The Wall Street Journal editorial page. ... But I have to admit that even I was not quite prepared for Robert Barro's offering in today's Journal. You don't have to be a Keynesian economist – and I have never counted myself as one – to find Barro's piece, well, let's just say, strange....

Barro ... draws the contrast ... between Keynesian economics and regular economics. Regular economics is the economics of scarcity and tradeoffs in which there is no such thing as a free lunch, in which to get something you have to give up something else. Keynesian economics on the other hand is the economics of the multiplier in which government spending not only doesn't come at the expense of private sector spending, amazingly it increases private sector spending. Barro throws up his hands in astonishment:

If [the Keynesian multiplier were] valid, this result would be truly miraculous. The recipients of food stamps get, say, $1 billion but they are not the only ones who benefit. Another $1 billion appears that can make the rest of society better off. Unlike the trade-off in regular economics, that extra $1 billion is the ultimate free lunch.

Quickly composing himself, Barro continues:

How can it be right? Where was the market failure that allowed the government to improve things just by borrowing money and giving it to people? Keynes in his "General Theory" (1936), was not so good at explaining why this worked, and subsequent generations of Keynesian economists (including my own youthful efforts) have not been more successful.

Nice rhetorical touch, that bit of faux self-deprecation, referring to his own fruitless youthful efforts. But the real message is: "I'm older and wiser now, so trust me, the multiplier is a scam."

But wait a second. What does Barro mean by his query: "Where was the market failure that allowed the government to improve things just by borrowing money and giving it to people?" Where is the market failure? Hello. Real GDP is at least 10% below its long-run growth trend, the unemployment rate has been hovering between 9 and 10% for over two years, and Professor Barro can't identify any market failure? Or does Professor Barro, like many real-business cycle theorists (say, Charles Plosser, for instance?), believe that fluctuations in output and employment are optimal adjustments to productivity shocks involving intertemporal substitution of leisure for labor during periods of relatively low productivity?

Perhaps that is what Barro thinks now,... but about two and a half years ago, writing another op-ed piece for the Journal, Barro had a slightly different take on what is going on during a depression.

[A] simple Keynesian macroeconomic model implicitly assumes that the government is better than the private market at marshalling idle resources to produce useful stuff. Unemployed labor and capital can be utilized at essentially zero social cost, but the private market is somehow unable to figure any of this out. In other words, there is something wrong with the price system.

John Maynard Keynes thought that the problem lay with wages and prices that were stuck at excessive levels. But this problem could be readily fixed by expansionary monetary policy, enough of which will mean that wages and prices do not have to fall.

So in January 2009, Barro was at least willing to entertain the possibility that some kind of obstacle to necessary price and wage reductions might be responsible for the failure of markets to generate a spontaneous recovery from a recession, so that a sufficient monetary expansion could provide a cure for this problem by making wage-and-price reductions unnecessary. But ... it would be interesting to know if he thinks that monetary expansion ... is not somehow inconsistent with his conception of regular economics. I mean you print up worthless pieces of paper and, poof, all of a sudden all that output that private markets couldn't produce gets produced, and all those workers that private markets couldn't employ get employed. In Professor Barro's own words, How can that be right? ...

Well,... if restoring full employment by printing money does not contradict regular economics, I have trouble seeing why restoring full employment by borrowing and government spending does contradict regular economics. But I am sure that Professor Barro, very, very clever fellow that he is, will clear all this up for us in due course...

[In a part I left out, he explains the similarity between the two types of policy in more detail.]

The Nobel Laureates Meetings at Lindau

Posted: 25 Aug 2011 02:25 AM PDT

Today's conference line-up:

09:00 - 09:30 Prof. Dr. Myron S. Scholes Economic Sciences Quantitative Finance and the Intermediation Process 
09:30 - 10:00 Prof. Dr. William F. Sharpe Economic Sciences Post-Retirement Economics 
10:00 - 10:30 Prof. Dr. Sir James A. Mirrlees Economic Sciences Poverty, Inequality, and Food 
10:30 - 11:00 Coffee Break
11:00 - 11:30 Dr. John F. Nash Jr. Economic Sciences Ideal Money and the Motivation of Savings and Thrift 
11:30 - 12:00 Prof. Dr. Edward C. Prescott Economic Sciences The Current State of Aggregate Economics 
12:00 - 12:30 Prof. Dr. Robert J. Aumann Economic Sciences Challenging Nash Equilibrium: Rational Expectation in Games 
12:30 - 13:00 Prof. Dr. Robert A. Mundell Economic Sciences Currency Wars, Euro-Mania and the Price of Gold 
13:00 - 15:00 Lunch Break
15:00 - 16:30 Panel "Behavioural Economics": George A. Akerlof, Robert J. Aumann, Eric S. Maskin, Daniel L. McFadden, Edmund S. Phelps, Reinhard Selten (Chair: Martin Wolf, Financial Times)
17:00 - 18:30 Afternoon Discussions with Laureates Aumann, Mirrlees, Mundell, Nash Jr., Prescott, Scholes and Sharpe (for Laureates and Young Economists only)
20:00 - 22:00 Dinner at various restaurants

Update: So far, today has been a series of lectures (see above). The first two were about finance – math and all – but no talk at all about the financial crisis. It's as though no questions at all were raised about these models by recent events in financial markets. From the perspective of the students who are here, I think it would have been much more valuable for Scholes and Sharpe to explain where the research agenda in this area ought to be headed. What are the major questions that need to be answered?


The talk I'm waiting for is Prescott's discussion of the current state of macro models. I'm guessing it will be mostly a love fest, but he does say that "I will discuss deviations from theories that need resolution as well as the successes," so perhaps I'll be pleasantly surprised. 

Not Learning from the Past

Posted: 25 Aug 2011 02:07 AM PDT

The Frum Forum notes that many economists are now assigning a high probability to a double-dip, and adds:

If a double dip does come, it will be the inaction in the face of warnings that it was on the way which future generations will be most baffled by.

One quibble, calling it a policy of inaction is too kind. There has been action, but the wrong kind:

At this point the entire advanced world is doing exactly what basic macroeconomics says it shouldn't be doing: slashing spending in the face of high unemployment, slow growth, and a liquidity trap. It's a global 1937. And if the result is another recession, the witch-doctors will just demand more bleeding.

It's hard to believe we're doing this again.

No Evidence That Government Housing Policy Caused the Crisis

Posted: 25 Aug 2011 01:17 AM PDT

This shouldn't be news -- the idea that the CRA or GSEs caused the crisis doesn't hold up against the evidence. But people still believe the myth, so it doesn't hurt to have one more paper showing that there is "little evidence to support the view that either the CRA or the GSE goals caused excessive or less prudent lending than otherwise would have taken place. ... In fact, the evidence suggests that loan outcomes may have been marginally better in tracts that were served by more CRA-covered lenders":

The Subprime Crisis: Is Government Housing Policy to Blame?, by Robert B. Avery and Kenneth P. Brevoort, Working paper, FRB: Abstract: A growing literature suggests that housing policy, embodied by the Community Reinvestment Act (CRA) and the affordable housing goals of the government sponsored enterprises, may have caused the subprime crisis. The conclusions drawn in this literature, for the most part, have been based on associations between aggregated national trends. In this paper we examine more directly whether these programs were associated with worse outcomes in the mortgage market, including delinquency rates and measures of loan quality. We rely on two empirical approaches. In the first approach, which focuses on the CRA, we conjecture that historical legacies create significant variations in the lenders that serve otherwise comparable neighborhoods. Because not all lenders are subject to the CRA, this creates a quasi-natural experiment of the CRA's effect. We test this conjecture by examining whether neighborhoods that have been disproportionally served by CRA-covered institutions historically experienced worse outcomes. The second approach takes advantage of the fact that both the CRA and GSE goals rely on clearly defined geographic areas to determine which loans are favored by the regulations. Using a regression discontinuity approach, our tests compare the marginal areas just above and below the thresholds that define eligibility, where any effect of the CRA or GSE goals should be clearest. We find little evidence that either the CRA or the GSE goals played a significant role in the subprime crisis. Our lender tests indicate that areas disproportionately served by lenders covered by the CRA experienced lower delinquency rates and less risky lending. Similarly, the threshold tests show no evidence that either program had a significantly negative effect on outcomes.

Warren Samuels on the "Invisible Hand"

Posted: 25 Aug 2011 01:08 AM PDT

Gavin Kennedy has been trying to extinguish the invisible hand myth for some time now:

Warren Samuels on the "Invisible Hand," Adam Smith's Lost Legacy: More good news on Warren Samuels new book in the publisher's blurb, posted in the Coordinating Problem Blog (here):

The post, "Warren Samuels (1933-2011)", is by Peter Boettke of George Mason University, Fairfax, Virginia, and the academic home of my friendly sparing partner on the "invisible hand", Daniel Klein.

Regular readers will see immediately why I am so excited to read an outline of its main theme and one of its concluding assertions: that 'no such thing as an invisible hand exists'. Yes, it was a metaphor.

This conclusion is from a most highly respected source in the history of economic thought.

The scholarly profession will sit up and note what Warren Samuels says, even if it has not responded positively yet to the six-year campaign of Lost Legacy to alert it to the errors of the modern myths about Adam Smith's use of the invisible hand metaphor.

"Erasing the Invisible Hand" (Cambridge, 2011) is described by the publisher as follows:

This book examines the use, principally in economics, of the concept of the invisible hand, centering on Adam Smith. It interprets the concept as ideology, knowledge and a linguistic phenomenon. It shows how the principal Chicago School interpretation misperceives and distorts what Smith believed on the economic role of government. The essays further show how Smith was silent as to his intended meaning, using the term to set minds at rest; how the claim that the invisible hand is the foundational concept of economics is repudiated by numerous leading economic theorists; that several dozen identities given the invisible hand renders the term ambiguous and inconclusive; that no such thing as an invisible hand exists; and that calling something an invisible hand adds nothing to knowledge. Finally, the essays show that the leading doctrines purporting to claim an invisible hand for the case for capitalism cannot invoke the term but that other non-normative invisible hand processes are still useful tools."

Review copies are circulating - but none has come this way.

"Rules-based Keynesian Policy?"

Posted: 25 Aug 2011 12:42 AM PDT

Is John Taylor anti-Keynesian?:

Rules-based Keynesian Policy?, Twenty Cent Paradigms: John Taylor, who is one of the most prominent academic critics of administration and Fed policy over the past several years, grapples with the label "anti-Keynesian" that was pinned on him by The Economist. He writes:

In a follow-up to the Economist article, David Altig, with basic agreement from Paul Krugman, argued that it was a misnomer because I developed and used macro models (now commonly called New Keynesian) with price and wage rigidities in which the government purchases multiplier is positive (though usually less than one), or because the Taylor rule includes real variables in addition to the inflation rate. In my view, rigidities exist in the real world and to describe accurately how the world works you need to incorporate such rigidities in your models, which of course Keynes emphasized. But you also need to include forward-looking expectations, incentives, and growth effects—which Keynes usually ignored.

In my view the essence of the Keynesian approach to macro policy is the use by government officials of discretionary countercyclical actions and interventions to prevent or mitigate recessions or to speed up recoveries. Since I have long been critical of the use of discretionary policy in this way, I think the Economist is correct so say that I am anti-Keynesian in this sense of the word. Indeed, the models that I have built support the use of policy rules, such as the Taylor rule for monetary policy or the automatic stabilizers for fiscal policy, which are the polar opposite of Keynesian discretion. As a practical prescription for improving the economy, the empirical evidence is clear in my view that discretionary Keynesian policy does not work and the experience of the past three years confirms this view.

"Keynesian" means different things to different people - at its broadest, it means accepting that there are frictions in the economy which mean that aggregate demand matters and policy can have real effects. This is in contrast to the pure classical view, in which Say's law holds, demand is irrelevant, and output depends on technology and preferences. In the version of Keynesian economics in our undergraduate textbooks - the IS-LM/AS-AD framework - the frictions are nominal rigidities and the Keynesian model deals with "short run" fluctuations around a "long run" equilibrium determined by the classical model. In this setting, both monetary and fiscal policy matter (by shifting the LM and IS curves, respectively), though early Keynesians emphasized fiscal policy and "monetarists" (most prominently Milton Friedman), gave primacy to monetary policy. The version of Keynesian economics in our graduate textbooks and academic journals - "New Keynesian" - combines dynamic optimization with sticky prices, and explicitly addresses the lack of "forward looking expectations" in the traditional textbook version. Furthermore, some argue that both the IS-LM and New Keynesian incarnations really miss the point and gloss over more fundamental irrationality and instability Keynes saw in the capitalist system.

As Taylor describes his views of the economy (and from what I know of his academic work), it seems consistent with mainstream New Keynesian economics (though his version has been less favorable to fiscal policy than some others). His criticism of recent fiscal and monetary policy grows out of another longstanding conundrum in macroeconomics, "rules versus discretion." He is not claiming that countercyclical fiscal and monetary policy are fundamentally impossible, which is what I would say is the true "anti-Keynesian" view. Rather, he is arguing that discretionary policy may do more harm than good, and policy should be based on stable, predictable rules.

A primary argument for rules is that discretionary "fine tuning" is impractical based on "long and variable" lags associated with (i) recognizing the state of the state of the economy, (ii) designing and implementing a policy and the (iii) the policy's impact reaching the economy. Often lurking behind this argument is a political philosophy that is skeptical of government (no coincidence that Milton Friedman was the most famous proponent of rules - Brad DeLong recently argued this is how he resolved the contradiction between an economics that said monetary policy can be effective with a libertarian political philosophy).

Taylor is careful to say that he opposes "discretionary Keynesian policy" - I think "anti-discretion" might be a better characterization of his critique than "anti-Keynesian." Of course, that only matters if it is possible to be "anti-discretion" without being "anti-Keynesian." I think it is.

I don't share the political philosophy, but the experience of the last several years has underscored the practical difficulties of discretionary policy. The early-2009 Obama administration with large congressional majority is about as close to government by center-left mainstream Keynesian technocrats as the American political system is likely to ever give us. In retrospect, it is clear they misjudged the scope and duration of the downturn and were not able make adjustments as that became apparent.

Monday morning quarterbacking in April, I suggested that the stimulus should have been designed in a "state-contingent" fashion to remain in place until the recovery reached certain benchmarks. It is a small step from there to a "rules based" countercyclical fiscal policy - policies like aid to state governments, extended unemployment benefits, payroll tax cuts and even increased infrastructure spending could be designed to kick in and ramp down automatically based on the state of the economy (e.g., with triggers based on the unemployment rate). To me, that's very "Keynesian", but also "rules-based", and its easy to imagine that might have worked better than the actual policies that were put in place.

links for 2011-08-24

Posted: 24 Aug 2011 10:04 PM PDT

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