Saturday, November 30, 2013

Stephen Williamson on the ZLB: Interest Rates Need to Rise to Raise Inflation

     We've discussed before the divide between heterodox and mainstream economists and the fact that MS tend to dismiss anyone that fails to accept their conventions-DSGE modeling, microfoundations, etc. We can debate the legitimacy of this-I come down on the side of the heterodox guys mostly.

     Stephen Williamson has sure caused a lot of controversy with a post he wrote recently about the Zero Lower Bound and inflation. What's interesting here is that this is not a fight between the MS and HD schools but rather within the MS. Here we have how (MS) economists themselves react when one of their own goes off the reservation.  Williamson:

    "The situation in Europe is looking more stable, and the private sector is presumably finding new sources of private collateral, all of which reduces the liquidity premium on government debt. Further, we should expect this to continue, for example as the price of real estate and other assets rise. In general, if we think that inflation is being driven by the liquidity premium on government debt at the zero lower bound, then if the Fed keeps the interest rate on reserves where it is for an extended period of time, we should expect less inflation rather than more."

     "But that's not the way the Fed is thinking about the problem. What I hear coming out of the mouths of some Fed officials is that: (i) Things are bad in the labor market, and the Fed can do something about that; (ii) inflation is low. Thus, according to various Fed officials, the Fed can kill two birds with one stone, so it should: (a) keep doing QE; (ii) make it clear that it wants to keep the interest rate on reserves at 0.25% for a very long period of time."

     "What I hope the discussion above makes clear is that this is a trap for the Fed. There is not much that the Fed can do on its own about the short supply of liquid assets. They can get some action from QE, but the matter is mostly out of their hands, and more QE actually pushes the Fed further from its inflation goal. If the Fed actually wants more inflation, the nominal interest rate on reserves will have to go up. Of course that will lead to some short-term negative effects because of money nonneutralities."

     "The Fed is stuck. It is committed to a future path for policy, and going back on that policy would require that people at the top absorb some new ideas, and maybe eat some crow. Not likely to happen. The observation of continued low, or falling, inflation will only confirm the Fed's belief that it is not doing enough, not committed to doing that for a long enough time, or not being convincing enough."

    Certainly this is a pretty counter intuitive result-he has all kinds of math equations to get here at the top of the page. He has already garnered reproaches by Nick Rowe, Brad Delong,and then Paul Krugman. SW is famous-or infamous-for nothing so much as his one sided feud with Krugman and his constant razzing of him. He really seems to hold Krugman's criticisms of 'modern macro' back in 2009-of 'mistaking beauty for truth'-and routinely razzes him for supposedly letting his politics dictate his economics-many economists accuse Krugman of this. 

    In response to SW's post Nick Rowe says this:

    "My model can identify the edge of a bottomless ZLB cliff. To the north of the edge of that cliff, there can be an equilibrium rate of inflation. To the south of the edge of that cliff, there cannot be an equilibrium rate of inflation, because the cliff is bottomless. Therefore inflation will not go south of that edge. We will never observe a truck going south over the edge of a bottomless cliff, because that can't be an equilibrium, since it is bottomless."
   "That's not good enough, but it's the best I can do. That is my reaction on reading Steve Williamson's post."
    "I have no (obvious major) problems with Steve's formal model. It is in Steve's interpretation of that formal model where I have a very big problem. If Steve had said 'This model shows that the central bank should not target a rate of inflation south of XYZ, because if it did so the inflation rate would fall over the edge of a bottomless cliff' I would be OK with it. But instead Steve is saying 'This model shows why inflation will not in fact go south of XYZ, because there is no equilibrium inflation rate over the edge of a bottomless cliff'."
    "This is not an isolated example. This is very much the same problem I have had with some of the things Narayana Kocherlakota has said. Something somewhere went very deeply wrong with the way macroeconomics is done in some places. I do not know why it went wrong like that."
     "This is not about politics or ideology. Explaining everything in terms of politics or ideology is one of those witchcraft explanations that only ignorant people use, who practice witchcraft themselves, and so think everyone else is a witch. I am pretty sure I am more right-wing than Steve is. This is about how we do economics."
     I'm not totally sure I buy this claim of Nick's that economics is some pure realm where politics leaves no stain. One point that Simon Wren-Lewis got right is part of the problem with economists is that they like to think of what they do as something like physics. 
     "I think part of the problem with economics, which is very evident in the way it is taught, is how economists see themselves. (I think Alex Marsh describes this well.) The vision that I think many economists are attached to is that economics is like a physical science. So there is a body of knowledge, which has been accumulated over time in much the same way as the physical sciences have developed. This approach plays down the context in which that knowledge was developed - it may provide a bit of diversion in a lecture, but is not essential. There is certainly no need to worry about the methodology behind the way the discipline works."
     If we remember that economics is actually a social science it seems to me they wouldn't make this mistake. As it's a social science it's going to be messy. As to politics, again, the main thing that I've always noticed about SW is that he's obsessed with razzing Krugman and does it constantly. What's interesting though is that the story he tells here-the criticism that Rowe, Delong, and Krugman make is really about how he gets it-is less anti-Krugman than it is anti-Sumner. Let me be clear-this doesn't make it right. However, he's basically agreeing with Krugman-as well as post Keynesians-that the Fed is out of bullets. 
     That the Fed is 'trapped'-ie, a liquidity trap. While I don't buy that raising interest rates would raise inflation right now, it's certainly a very striking claim to make-QE is actually lowering inflation. It also would explain logically what is going on. 
      SW differs here from Krugman on explaining why inflation is still above zero-albeit very low. However, his disagreement on substance is even sharper with Sumner than with Krugman. He's differing with Krugman on why there is a liquidity trap. However, Sumner's whole argument for 4 years has been that there is no liquidity trap.    Krugman's criticism is mostly around the complaint that SW fails to give his result microfoundations.
    For the MS school this is quite a big criticism and SW will especially not enjoy getting it from Krugman. However, what do you say about SW's result if you dispute the need for MF
     P.S. Note that SW doesn't have this out as he most certainly does believe that you have to provide microfoundations so he'll have to explain why he's not guilty of this charge. 


Thursday, November 28, 2013

Randy Wray on Inflation Expectations as a Guide to Monetary Policy

     There are many reasons to be skeptical of Sumner's Market Monetarist idea of NGDPLT. What is the basis of the belief that the Fed can control NGDP either with or without trend? I think that a major reason MM has hit it so big is that its a very sexy idea-as it's very intuitive and all very intuitive ideas are sexy because they give us the sense of intellectual mastery.

    UPDATE: At least I'm consistent-I misspelled Wray's name throughout the piece-not Wrey as I had been writing. Actually now that I look at it I wasn't even consistent as I did spell it right once. It's corrected now.

    Milton Freidman's ideas were very intuitive as well-the money supply growth rule. Yet as Wray documented in his paper back in 1994 it was a total failure.

    The trouble is that velocity went haywire and the money supply ended up showing no correlation with inflation or NGDP during the 80s experiment. Wray's paper looked at what the Fed tried to replace the failed Monetarist experiment with-eventually it would be the Taylor Rule of course but at the time different indicators and targets were considered. Real interest rates were one. Another one was inflation expectations. Indeed, this is one indicator that Sumner always appeals to when making an argument-he looks at TIPs spreads. Yet what Wrey discovered in his research was that there is little correlation between inflation expectations and future inflation.

   For example, in 1980 inflation expectations for the next decade ran at 9 percent whereas actual inflation turned out to be half that. What this suggests and Wray's research confirmed is that inflation expectations are formed mostly by current inflation plus past inflation. Another case where the 'naive adaptive expectations view' seems to score a victory even if AE does allegedly assume people are stupid.

     My guess is that an NGDPLT Fed-ie, a Monetarism 2.0 Fed-will have just as many problems as the first Monetarist Fed of the 80s. The Fed lacks the power to control either inflation or NGDP. I'm sure if Sumner were to respond to this argument he'd come back with something like 'Well, gee, how then do you explain hyperinflation in Zimbabwe, moron who doesn't understand economics?!'

    One obvious answer is that this misconstrues hyperinflation which is not about a central bank engaging in too much Keynesian stimulus but rather political instability.

     I always give Sumner credit for his shrewdness. However, at the end of the day what he's selling is just old wine in new bottles. Appearances very much to the contrary- by design-  Sumner is not a Market Monetarist who happens also to be a Supply Sider in fiscal policy, he is a SSer in fiscal policy who happens to-perhaps correctly-calculate that MM is the best new bottle to sell the old SS wine.

    P.S. I notice Mr. Sumner hasn't posted much in the last 10 days. Grrrr! When is he going to write another post I can dismantle?! I need fresh meat! Think of me as the monetary version of Media Matters. David Brock listens to Rush Limbaugh so you don't have to, and I read Sumner so you don't have to.

    P.S.S. I'm sorry Mr. Sumner but mess with the bull you get the horns. That is all.

Simon Wren-Lewis, Mainstream Macro and 'Evolution not Revolution'

     He argues that the heterodox econ guys to summarily reject 'everything' in the mainstream and suggests this might be that young people find revolution more exciting than evolution. 

       "Take, for example, a recent post from Lars P Syll which caught my attention for obvious reasons.[1] He writes: “People like Hyman Minsky, Michal Kalecki, Sidney Weintraub, Johan Ã…kerman, Gunnar Myrdal, Paul Davidson, Fred Lee, Axel Leijonhufvud, Steve Keen – and yours truly - do not share any theory or models with Real Business Cycle theorists or “New Keynesians”". Any theory? Is everything in what has been called the new neoclassical synthesis a waste of time?"
      "I think this is a bit of an exaggeration. To pick just one example I read recently, Steve Keen in his Minsky model forthcoming in JEBO uses a Phillips curve, which I would say was the defining relationship in New Keynesian theory. His and the New Keynes Phillips Curve are not identical, and of course Keen’s is not microfounded, and they do somewhat different jobs, but still there seems to be some overlap between mainstream and heterodox there. This is hardly surprising. The Phillips curve started life as an empirical discovery. It is neither the invention of New Classical or New Keynesian thought, nor the fruit of heterodox ideas, and so can quite happily be shared."
      "What interests me is why the need for such wholesale rejection of the mainstream? I learnt one possible answer when young, which is the appeal of revolution rather than evolution. In Cambridge (UK) in the early 1970s, a significant group of the faculty called themselves Neo-Ricardians, and they too rejected neo-classical theory. Joan Robinson was an inspirational figure for this group, although the key influence was Piero Sraffa. They were strongly attracted to the ideas of the philosopher Thomas Kuhn, who talked about paradigm shifts in science. The mainstream was not going to evolve into something better: it was fundamentally flawed, and therefore had to be overthrown. Attractive stuff for undergraduates – too attractive in my case – but that particular paradigm shift never came."
       "A rejectionist strategy is of course unlikely to win friends within the mainstream. Even those quite critical of aspects of mainstream thought and teaching can be exasperated by the rejectionist attitude.  My own view is very similar to that expressed by Diane Coyle in her review of Steve Keen’s ‘Debunking Economics: The Naked Emperor Dethroned’: “I have a lot of sympathy with the details of Professor Keen’s project, but not its ultimate ambition. For in the end I think the Naked Emperor needs to be reclothed rather than dethroned.”

     A few thoughts. Whether or not we need 'revoluton or evolution' isn't always clear. Sometimes only time will tell. Unlearning Econ left a comment in this post-written back in the Summer of 2012:

     "I am not wedded to all of Keen’s criticisms of economic theory – he may well have taken some wrong turns. However, I don’t think they are necessary to dismantle neoclassical economics. Your ‘don’t throw the baby out with the bathwater’ attitude is fairly common, but I feel that neoclassical economics is flawed from the ground up. This essay identifies exactly what that ‘ground’ is, though offers only limited critique:

     Note: unfortunatley UL's link seems not to work. However, UL did say this in a recent post of his own:

    "T his is just a quick post to let people know that I am not ending the blog. However, readers might have noticed posting has slowed down a bit recently (4 and 3 posts in September and October respectively, versus 6 and 7 in July and August), and this is essentially just because I feel like I have less to say. The reason I started this blog was to get some sort of critical debate over the state of economics and learn (or unlearn, groan) about economics as a field – in other words, the kind of thing that you simply do not find on an economics degree. The blogosphere has definitely delivered in this area, but since I’ve now gotten what I set out to get, I feel I should focus more on other things."
     "I still have the same basic opinion as when I started the blog: neoclassical/mainstream economics (which exists, no matter what economists say!) is questionable in terms of relevance, coherence and methodology, and is not the only or best way to do ‘economics’, which itself cannot be thought of as an isolated, separate sphere. My opinions on some things have changed: I think some areas of neoclassical theory – as well as econometrics – are worthwhile, and that heterodox economists get some things wrong (the chief one being repeating the same criticisms over and over). My opinion is now less “neoclassical economics is nonsense!1!!” and more “the research program has reached its limitations and needs to be replaced and/or confined to specific spheres”.
     "However, I am also more optimistic about the discipline changing than I used to be. Real life discussions about the state of economics simply don’t have the same air of hostility as those on the internet – in my experience it’s not difficult to find mainstream economists who will tell you macroeconomics, undergraduate economics and ‘free market’ economics, as well as other areas, are generally garbage. The difficulty lies in trying to get them to think in any other way than the ‘individual agent faced with choices’, but su\ch alternative theories are being developed, and as awareness of them increases, economists will hopefully be able to see things in other ways."
     So is he more optimistic now that it can reform itself from the inside out? As to the idea of Kuhn and scientific revolutions, sometimes they are necessary. There was in the case of Copernicus and Galileo no way to simply split the difference with those who held to the Ptolemaic view of the Universe. 
     This seems to be the way a lot of certainly the MMTers see things. Yet is WL is arguing that real changes in economics only happens via evolution that's quite wrong-Keynes gave us the ultimate paradigm shift where things changed overnight. It's true that this time may be different-it's hard to imagine one book changing the entire world as it did in 1936. It may well be that we end up seeing important changes in an evolutionary way. 
     Yet I still can't feel that the divide between Neoclassical econ and it's critics is something of a zero sum game. At the end of the day you're either  Keynesian or a pre Keynesian and if you believe in NC that' means you believe in Say's Law that investment is fixed and so savings decides output and then we're stuck in the wold of today where policymakers have certainly acted as if they believe Say's Law. In this sense, what we have is a debate still as we've had since Keynes-it's Keynesian vs. pre Keynesian econ whereby we've had a 35 year counterrevolution. 
     P.S. To the extent that UL is optimistic it seems to be that he has access to what many of us bloggers don't. 

Simon Wren-Lewis on the Representative Agent in Action

     He claims that heterodox econ can't constructively engage with the mainstream and as an example asks how you can answer the question of what effect a short term increase in government spending will have on the behavior of individuals without the representative agent. He argues that the RA and EMH do have some uses but are not so good for other uses. 

       "My question was what the impact of a temporary increase in government spending, financed by taxes, would do to output in an open economy. It was not a trick question – I just happened to be thinking about a presentation on exactly this issue to policymakers, so it was on my mind. Now policymakers, in response to such a question, do not want long lectures on the sins of representative agents, rational expectations or whatever, and they certainly do not want to be told it is a bad question. They want some simple macro analysis."
      "So, what do consumers do if they are told that taxes are rising temporarily? First, do they take any notice of what they are told, or do they assume the tax increase is permanent? It really matters which. If the former, do they smooth the impact on consumption, as the representative agent intertemporal model (and other earlier models) suggests, which by the way means that the consumer sector goes into deficit."
      "If they do, output will tend to rise. How do traders in the FOREX market react? Do they try and work out if interest rates will rise, and if they do what are the results of this calculation? Do they say that in the past when output has increased the central bank has raised interest rates, or do they recognise that (as I assumed) we are at the zero lower bound and so no interest rate increase was likely?"
     "There are no obviously right answers to these questions, but I’m genuinely curious about how you would answer them without some appeal to representative agents. You could avoid rational expectations by assuming something simple like static expectations, but that would imply for consumers (after the initial surprise at taxes rising) the same thing as taxes rising permanently – until they were surprised by taxes falling again. And is the idea of consumption smoothing misguided, or just the idea that it results from optimisation?"

    I get it that policymakers don't want to be told it's a stupid question. Still my first response would be: why do we want it to be financed by taxes? In such an economy we'd be better off with a deficit financed spending increase. I don't know that I need any model to say this. One commentator took up WL's challenge. His style was as I agree is too common of heterodox guys a little overly polemical perhaps but I think he makes a good point. I'm not using his name as I have a hard time reading it I don't know what language he used for his name-Latin?

     "Your problem has relevance only for the world of representative agents."

      "It has no real solution because it is not defined properly even in the mainstream logic. Consumers and everybody else approach taxes as tax *rates* and not as amounts. Apart from ex post / ex ante problem of budget spending and taxing you can not claim that an increase of government spending has to be accompanied by an increase in tax *rates* to balance the budget. Your problem is over-assumed, it is missing critical information and therefore has no relevance for economic analysis in this world."

     "The only possible application of your representative agent problem and balanced increase of spending to the real world is if you increase government spending and then immediately tax the whole amount of it from the recipient. I just wonder why you spend your time and everybody else on such nonsensical "problems" ...

     WL retored:

     "A government can increase spending, and finance it by - say - not uprating tax allowances. No tax rate need change. Of course it will not get exact balance ex post, but that is not important. As the government says that it would like to increase demand without increasing debt, and this policy does just that, I think it deserves a little more respect than you give it."
     He responds

     "I give it full respect. But if people react to tax *rates* and there are no tax *rate* changes required to balance the budget, what is your argument then? Noone thinks of taxes in terms of volumes because taxes are predominantly relative. And budget result bounces up and down all the time and without any discretionary decisions on behalf of the government."

    "I also say that an assumption of balanced spending increase is without any basis in the real world. It does not happen and if it happens then it will be a pure luck/coincidence. It is impossible to balance the budget ex ante regardless of all political/economic desires. What does your question really want to ask? Why should anybody even bother with answer?"

    "Additionally, what does it mean to "increase taxes"? In this world tax codes are probably even thicker than legal codes. There is no such thing as "increase taxes". There are zillions of them with all loopholes and attached conditions. So which taxes will increase? And here it becomes a political/institutional issue and not an economic one. You can not assume such problems away. However if you approach them properly then you can not assume a representative agent. There are all types of non-linear re-distributional effects going on that any representative agent smell test fails in the first phase. You can surely increase granularity but every such gradual increase destroys your argument of representative agent. In the end you will have to admit that you simply have to rely on averaging certain cohorts due to information/computation limitations. However averaging and representative agent approaches are not even closely the same thing."

     "Again, his style is maybe a little overly combative-which NCers always use as an excuse not to respond to the arguments, it seems to me that he's on the right track. To put it more simply, even if you want to 'pay for it'-again, if I were advising anyone I'd discourage that-it may well not require tax rates to go up. It could just be 'paid for' by the stimulus leading to higher growth which increases revenues without having to raise taxes-this is what happened to huge WWII government military spending."

    P.S. As I can spell the commentator's name-as it seems he wrote in Sanskrit or something, here is a link to him. 


Simon Wren-Lewis on the History of Economic Thought

     After my critical post about Krugman and WL's defense of mainstream macro, I almost wondered if I was unfairl to them. I don't relish criticising Krugmnan .

   As regards WL, his views come across as considerably more nuanced if you read some of what he wrote further down the page in his recent defense. He does admit that mainstream macro has some real issues that need to be addressed soon. 

    "Having said all this, it would also be a mistake of equal magnitude to think that everything is just fine in the land of academic economics. I am struck about how economists, while at least partially defending their own particular field, are quite happy to express grave concern about what some of their colleagues in other fields do. I’ve noted Andy Haldane and Diane Coyle’s criticisms of DSGE modelling before, and you will find plenty of economists who can be very rude about their colleagues doing finance. More generally I suspect slightly less shrill versions of the sentiments expressed by the two Guardian columnists would attract considerable sympathy from lots of very sensible people who know quite a lot about economics."

    "Whether this should, or will, lead to any major upheaval in economic thinking – as suggested by Martin Wolf in this lecture for example – is a question for perhaps another post. What I want to focus on here is how the subject is taught, if only because that has a large influence on how the subject is perceived and how it develops. Both Guardian articles talk about student dissatisfaction (as expressed here for example), and there seems to be widespread support for the idea that economics teaching needs some fairly radical reform: see this recent meeting at the UK Treasury (which followed this) and Wendy Carlin’sarticle in the FT."

     "I think part of the problem with economics, which is very evident in the way it is taught, is how economists see themselves. (I think Alex Marsh describes this well.) The vision that I think many economists are attached to is that economics is like a physical science. So there is a body of knowledge, which has been accumulated over time in much the same way as the physical sciences have developed. This approach plays down the context in which that knowledge was developed - it may provide a bit of diversion in a lecture, but is not essential. There is certainly no need to worry about the methodology behind the way the discipline works."

     "An alternative and I now think better, vision would give more emphasis to how economics developed. Economic history would play a central role. Economic theory would be seen as responding to historical events and processes. For example placing Keynesian theory in the context of the Great Depression is clearly useful, given the events of the last five years. I think it is also important to recognise the links between economic theory and ideology. This is partly to understand why governments might not act on the wisdom of economists, but it also leads naturally to recognising that economists need to adapt to the social and political context in which they work. We should also be more honest that our wisdom might be influenced by ideology. Given the limits to experimental and econometric evidence, but with a very clear axiomatic structure, methodology is always going to be an important issue in economics."

     In this he would seem to be endearing himself to heterodox economists. Yet, here, he shows that he doesn't get it on the history of economics. 

     "Of course this alternative vision can be taken too far. I do not think it is helpful to teach the subject like a course in the history of economic thought. The insight gained from trying to understand what some past great economist actually said (or still worse, actually meant) is small. We do not necessarily need to know the details of every historical debate. In addition some important ideas in economics do not come from problems thrown up by major historical events or ideology: rational expectations is a clear example. We do try and integrate solutions to new problems into a coherent overall framework. I do not want to go back to teaching a schools of thought type of macro, because the mainstream is much more integrated."

     This is what Krugman says as well-that it doesn't matter what some great past economist actually meant. I don't get why that's so unimportant a detail. I guess that's why he doesn't think us heterodox guys can have a conversation with him. 

    So on balance I guess I wasn't unfair. WL certainly doesn't get it on the history of economic ideas. As I've said many times, one who does get it: the Market Monetarist David Glasner. He may be an MMer but he knows his history and has a very healthy respect for it. 

    As to the claim of Krugman that the textbooks were right-I think it depends what textbook you have in mind. It may well be that if the textbook you're talking about is Paul Samuelson's 1948 edition of The Foundations of Economics there's a lot of truth in that. However, even though Krugman and WL say that you have to have a nuanced reading of EMH, it seems clear that the reason they never saw the possibility of a housing bubble mattering is because they believed in the EMH.

   P.S. Yet I do think that WL is on the right track in his diagnosis of what dogs mainstream econ-that most economists like to think of economics as just like the physical sciences. It's a social science which is very different and which values and judgments do play an important part. 

Wednesday, November 27, 2013

Krugman and Simon Wren-Lewis in Defense of Mainstream Economists

      I'm a big fan of Krugman but I find his defense somewhat question begging-that somehow the failures are the failures of economists but the economic theory they believe in is wholly innocent. 

      "It is deeply unfair to blame textbook economics either for the crisis or for the poor response to the crisis. The mania for financial deregulation, for example, didn’t come out of standard economic analysis — in fact, it flew in the face of the canonical model of banking crises, Diamond-Dybvig, which suggested both a crucial role of government guarantees to prevent self-fulfilling panics and the need for regulation to control the moral hazard such guarantees would create. It’s true that few economists tracked the rise of shadow banking that bypassed the traditional safeguards — but that was a problem of vigilance, not bad theory."

     The trouble is which textbook does he have in mind? If it's Paul Samuelson's The Foundation of Economics maybe there's something to it. Still, I find it lacking as an explanation: if a theory is as sound as he believes it is then why do all practitioners of it get it so wrong? Why is it so easy to misunderstand this theory? In fact Krugman himself has at times admitted that even the IS-LM, 'old Keynesian' neoclassical synthesis was something of a tenuous consensus. Then as a 'kind of, sort of New Keynesian' he offers a 'sort of kind of, sort of' defense of EMT:

      "Efficient markets theory arguably deserves more blame for the failure of too many economists to recognize the housing bubble, but textbook economics always presented EMT as a baseline, not a revealed truth."
      Why does EMT also get so misconstrued? Krugman himself always admits that he never saw anything to worry about in terms of a housing bubble-is this not thanks to EMT?  Speaking of EMT, I wrote a few posts about this debate and Simon Wren-Lewis' defense of it a few weeks ago.  One trouble with EMT is that mainstream guys like WL always say it's being misused by why is it so conducive to being misused? I think the problem is that it's not so easy to clearly demarcate the difference between legitimate  and illegitimate uses of EMT.

   Wren-Lewis while another kinda, sorta NKer sounds rather like Sumner when he's forced to defend mainstream macro as a whole. He wonders if heterodox guys can even hold a conversation with mainstream economists.

     Here is his defense of mainstream-ie, Neoclassical-econ:

    "Mainstream (orthodox) economics is having a hard time in the pages of the Guardian. First Aditya Chakrabortty writes How do elites remain in charge? If the tale of the economists is any guide, by clearing out the opposition and then blocking their ears to reality. The result is the one we're all paying for.” Then Seumas Milne adds “Any other profession that had proved so spectacularly wrong and caused such devastation would surely be in disgrace.” In this post I want to say why such attacks are wide of the mark, but also say something about how these attacks gain traction, and why they suggest changing the way the subject is taught."

     "One frequent accusation, very evident in Milne’s piece, and often repeated by heterodox economists, is that mainstream economics and neoliberal ideas are inextricably linked. Of course economics is used to support neoliberalism. Yet I find mainstream economics full of ideas and analysis that permits a wide ranging and deep critique of these same positions. The idea that the two live and die together is just silly."

     Why is it silly? I mean it could be wrong but there's nothing that he said in this quote that makes it obviously wrong-only when you say something obviously wrong is what you say 'silly.' First of all, one would have to unpack what W.L. even means by 'neoliberal'-which already makes the answer non-obvious and so not silly. I do know that NC has been used to justify many bad ideas; here is an example of Noah Smith using it to export NL to Japan:

     W.L. also claims that orthodox econ makes it crystal clear that austerity is a bad idea in the middle of a deep recession. 

     "The absurdity of linking mainstream economics to all our current problems is also obvious if you think about austerity. As I never tire of saying, the proposition that austerity was a crazy thing to try in this recession is prominent in the pages of undergraduate and graduate textbooks. It is what mainstream economics, as practiced in central banks, tells us. Now I agree that it is a great shame that some influential economists sometimes seem to ignore or have forgotten what is in these textbooks, or put their own textbooks aside to provide support for particular political parties. However it remains the case that the most effective critic of austerity is using totally orthodox economics."

     One thing that makes me think that WL overstates the case is how strident he sounds hear-almost like Scott Sumner or something. The snide jibes at 'silly' and 'absurdity' suggest this is less a reasoned intellectual argument than just defensive name calling. He also complains about those who criticize the NCers for not predicting the crisis. 

     "Nearly all complaints about that mainstream start off with the economics profession’s failure to foresee the financial crisis. Again it’s important to make some fairly basic points. First economics is not just (or even mainly) about trying to forecast the future. The percentage of the profession that made this mistake is tiny. Another one of my favourite lines back from when I did forecasting is that macro forecasts are only slightly better than guesswork. We know that, both from past evidence and the models themselves. It is a difficult message to get across, because a very visible part of economics - making decisions about interest rates - necessarily involves forecasts, and the media loves simplistic messages, but institutions like central banks do their best to emphasise the uncertainty involved."

     He's right that econ is not just about predicting the future. However, one can't help but think that the reason the mainstream-and Krugman admits he's on this list-did so poorly is because they believed in EMH and this said that there couldn't be a bubble. At the end of the day Krugman and W.L. don't sound so different than Greenspan on this belief that bubbles don't happen or don't matter. 



Tuesday, November 26, 2013

Sumner vs. Krugman on California

     California is one of the favorite whipping boys of the conservatives and Sumner is hardly an exception. No wonder they hate California so much-Republicans have been decimated there and its got a repuation as a liberal state where at present the Dems wholly dominate. Here was Sumner the other day, flagellating the Golden State again:

    "I think it’s fair to say that modern American progressive thought is obsessed with two issues:

1.  The need to defeat GOP obstructionism, so that progressive reforms can be enacted.
2.  The need for higher income tax rates on the rich.

     "If this is the agenda then California is the ideal.  The GOP is dead and the Dems have dictatorial control.   They just raised their top rate to 13.3%, and they are determined to build a “high speed rail” line from LA to San Francisco.  (The scare quotes reflect the fact that the Chinese would laugh at the “high speed” claim.)
Today I saw a list of the best governed states in America.  California came in 50th out of 50.  In fairness, this ranking was based on 2012 figures, and doesn’t account for California’s recent success in producing a “balanced budget.”  (Scare quotes again—here’s why.)  But next recession their fiscal regime, which is more leveraged to stock market gains than the average hedge fund, will once again collapse like a house of cards.  They have America’s highest taxes on the rich and the following outcomes:

The Golden State was also among the worst states in the nation for educational attainment, health coverage, and unemployment.

     "Even worse, this policy failure occurred in a state that in many ways is extremely “lucky.”  California has some of the most delightful weather and beautiful scenery in the world.  It is very rich in oil resources. They are able to attract highly productive people to this environment despite high tax rates.  Imagine how California would be doing if they had Texas weather and scenery."

     "I sympathize with some of the complaints of modern progressives.  Yes, the filibuster is (was?) a bad idea. Yes, the modern GOP has regressed significantly from the Reagan era.  But I think the long period of conservative dominance, and then policy deadlock, has led many progressives to underestimate the difficulties of enacting a liberal vision in a polyglot society of 320 million people.  They have forgotten what caused the conservative resurgence in 1980.  It’s really, really hard to make a big and activist government work.  No one else has made an activist government work in a country so large. And based on the results from California and New York, it also seems difficult to implement in large states."

    California is considered the 'worst governed state' by Forbes Magazine and some Wall St. analysts who focus on debt levels and deficits and little else. Confirmation bias anyone? Here is Forbes:

     "California has the highest income taxes in the country, the highest gas taxes, the most regulations of any state and-surprise- the 4th highest unemployment rate.(which as every serious person knows is understated)."

      What 'every serious person' ought to know is that California was hit like few other states were by the housing bubble-along with Nevada.

       Here is Krugman on California, however, the contrast with Sumner makes one think of 'It was the best of times, it was the worst of times...'

      "Among the many vituperative reactions I had to yesterday’s column, one recurred a lot — namely, the assertion that California’s rising enrollment in Obamacare would bankrupt the state, which is already a fiscal basket case.

     Many of the vituperative reactions likely were Sumner readers who believe all his razzing. 

     "Guys, you do need to keep up a bit."

     "First of all, the Obamacare subsidies — both the credits for insurance purchased on the exchanges and the Medicaid expansion — are paid for by the federal government. In fact, implementing Obamacare is a major fiscal and economic boost to any state that does it, and states opting out of the Medicaid expansion are going to have significantly lower overall incomes and fewer jobs than if they had gone along. (My back of the envelope says around 1 percent of GDP, but I’m still working on that.)"
     "Beyond that, however, the California as fiscal basket case narrative is way, way out of date. Jerry Brown and the huge Democratic majority in the legislature have turned that situation completely around."
     "I know, it’s not supposed to be that way — and a lot of people will stick to their narrative, never mind the facts. But anyway, California is doing OK, both on health care and on budget policy."

      Here is the NYTimes article Krugman links to above:

     "California's finances are improving faster than expected and schools could receive billions in extra funds next year, according to the Legislature's budget advisors."

     "The state's budgetary condition is stronger than at any point in the past decade," a report released Wednesday says.

     "Higher-than-expected revenue, driven by the economic recovery and stock market gains, could pump more than $4 billion in unanticipated funds into schools and community colleges starting next summer, the report says.",0,4883962.story#ixzz2lorvQXrY

     So here is a state which certainly did not practice MM, hasn't done austerity-which means cutting taxes on the rich and raising them on everyone else-whether through higher taxes or lower spenidng it's effectively a tax hike-and is doing very well and has now been able to end its own sequester. 

    "In addition, the analysts say, the state is on track for multibillion-dollar surpluses over the next several years, a potential cushion against the expiration of Gov. Jerry Brown's temporary tax hikes in 2018.
     Good thing Alan Greenspan doesn't live in California huh? Or he'd be testifying that you have to get rid of that surplus in huge tax cuts for the rich or the surplus will do terrible things. He actually worried in 2001 that with so little debt the Fed would be hampered in doing monetary policy! 


What a Scott Sumner Economy Would Look Like

     Not to give away the ending too quickly, but my guess is it wouldn't look much different from what we've seen over the last 30 years. If you like the current status quo, you'll love Sumner's Market Monetarist world.

     First and foremost, my assumption is that a Sumner economy is also one run on supply side principles. I've had a number of arguments at The Money Illusion on this point-that part of MM is a belief in fiscal austerity. I've spoken with commentators at MI that seem to think that you don't necessarily have to believe in fiscal austerity to be a MMer. Yet I believe my good friend Morgan Warstler and he's pretty sure that the real virtue of NGDPLT is to devastate the 'unprodutive government sector.'

    I think that any flexibility is more illusionary than real. The idea of MM is to force us into a SS straitjacket. A Sumner economy-is a SS economy-is gong to be one with very low taxes for the rich, along with possibly higher taxes on the nonrich-Sumner calls for cutting the payroll tax for employers but not for employees

   and many more low wage jobs. Sumner is usually contemptuous when liberals complain that though many jobs have been created in say Germany-or the U.S. during the Bush years-they are mostly low wage service sector jobs. He argues that there's no reason for concern as with the drop in wages prices will get so low that this will equal out for workers with the increase in corporate profits enabling more innovation leading to even lower prices, in a virtuous circle.

   Such an economy will be demand constrained as even if employers increase profits through lower wages they sell less to these employees so it's at best a wash-in truth they may actually do worse.

   Again, to cite my friend Morgan-I honestly do like him as he's honest unlike Sumner-inflation is expected to be lower under the NGDPLT regime than the current Taylor inflation fighting regime. Will I at least concede that Sumner's society will have lower unemployment? I'm skeptical of that as well. For one thing the Fed hasn't demonstrated any ability to control either inflation or NGDP.

   For more on the weakness of the low wage model see here

   To recap: I begin with the assumption that MM and supply side econ (SS) are a package deal. If you buy his argument that only monetary policy has any right to deal with demand policy all this leaves for fiscal policy is supply side policy which means low taxes on the rich higher on everyone else, lax regulation, and a low wage economy were workers need to be subsidized via credit and wage subsidies-as Sumner indeed calls for. If NGDPLT were ever tried I suspect that it would be as least as big a disaster as the first Monetarist experiment of the 80s was-possibly more.

   The fiscal policy would be just old wine, new bottles-more Reaganism. If you love where we are now, then you'll want a second double helping of it.

    P.S. The very idea of SS theory is itself really just old wine, new bottles. It's just Say's Law repackaged where all saving is assumed to be future expenditure-by assuming a constant amount of output.

    SS is just microeconomics once again-that is to say pre Keynesian, ergo, MM-as is true of all Monetarism-is just a counterrevolution to return us to the pre-Keynesian era. Like all counterrevolutions no new ideas emerge, merely, old ones are repackaged.



Michael Lind on the Mirage of the Sensible Center

     If there is any one writer I've learned the most from regarding political philosophy it's Michael Lind-along with Garry Wills and Kevin Phillips. See bottom for more on the work of these three fine writers. 

      A decade ago Lind evoked the need to return to what he called the radical Center. The idea made sense to me-I get the idea of a kind of radical opposition to radicalism as it were. However, years later he offers some self-criticism.

    "The divisions within both parties over possible U.S. intervention in Syria mark a break from the recent pattern of partisan polarization in Washington over health care, taxes and other issues. Many political pundits will undoubtedly seize on the high-minded debate, one that is not following predictable partisan lines, as a model to emulate across a range of other issues. There’s a perennial yearning among Washington’s punditocracy, after all, to have politicians repudiate “the extremes of left and right” and search for common ground. There’s that old cliché that candidates for public office must “run toward the center” after pleasing the “extreme” constituencies in the base of the Democratic and Republican parties, and then govern from the center. Those who take this perspective often lament that many political leaders are stuck in primary mode, governing on behalf of their base."
     "This analysis assumes that there is some easily-identifiable center in American politics, and that both sensible policy positions and swing voters may be found there. But the more you look for this legendary center, the harder it is to find."
     "I plead guilty for having succumbed to the temptation of proposing a new public policy consensus that could win broad bipartisan support. In 2001, I co-authored with Ted Halstead The Radical Center. In the book, we argued: “‘Centrism’ itself has become something of a shallow mantra in recent American politics… We use the word radical — in keeping with its Latin derivation from “radix,” or “root” — to emphasize that we are interested not in tinkering at the margin of our inherited public, private, and communal institutions but rather in promoting, when necessary, a wholesale revamping of their component parts…” However, our attempt, somewhat similar to that of neoliberals, to provide the term “radical center” with fixed content in the form of a modernized and updated version of the mid-twentieth century New Deal settlement failed to take hold in popular usage."

     "If the political center means nothing more than the mathematical midpoint between the policy positions of Democrats and Republicans, then it is an abstract concept, like the center of gravity of the U.S. population, which has moved from Kent County, Maryland in 1790 to Texas County, Missouri, in 2010. This kind of notional “center” does not reflect any particular constituency or worldview. Its location on the political spectrum depends on the action of genuine movements. For example, as political scientists Jacob Hacker and others have documented, the Republican party has moved far to the right in the last generation, whereas Democratic positions on most issues have remained largely stable. If “the center” is the midpoint between the parties, then the center in 2013 must be well to the right of where it was in 1993, just to keep up with the radicalism of Tea Party conservatives."

      I think the trouble is that if the Center is nothing more than the midpoint between the parties-regardless of the content of each its meaningless. If one party engages in Holocaust Denial and the other didn't do we have to find the midpoint between the arguments? Yet this is how David Brooks' often seems to see it. It seems to me that the Center is not a fixed point but constantly evolving but never settled on. After all, what constitutes a 'Centrist' position varies very widely. The real trouble in American politics is that you have a sensible Centrist party already-the Democrats. Basically the Republicans keep moving further to the Right while the Dems stay in the same basic area-the Center. 

     Lind also has a very good piece out regarding low wages. This is a very good topic as many conservatives like Sumner just dont see why a low-wage society should bother anyone. Sumner would argue that if worst comes to worse simply give the poor a negative income tax rate and that the drop in wages also means employers can lower prices which on net leaves the poor just as well off. 

     What Lind points out that is that the effect of these offsets is hardly enough to make up for the drop in low wages. He makes the point that we now live in a 'low wage social contract' where there is acceptance that many people, perhaps most people will make a low wage. In fact 86% of Americans now work in the service sector which is mostly low wage jobs-with a few very high ones in the financial sector, et. al. So Sumner et. al. want to argue that a low wage economy and society are fine because they will be offset by low prices and the negative income tax. However, this Supply Side argument has not borne fruit. 

    The negative income tax would have to be a lot higher than it is to truly offset low wages. Sumner was very critical of a recent Swedish proposal to give married couples a subsidy of $67,000 each for 'juIt breathing.' Doing this though would cut into poverty. He doesn't like the idea of paying people for just existing. 

    The EITC in its current form however, is not enough. The idea of the low wage SC is basically Supply Side theory-you cut the wages of business, increasing its profits, enabling it to cut prices while with the help of low taxes on the rich, business is also able to achieve such a high level of innovation that this further lowers prices and raises productivity, etc. The problem is that whatever business gains in profits thanks to lower wages they lose in consumption thanks to a low wage economy. 

    The various tax credits are not enough either. One solution is to increase the   negative income tax greatly. This will run into political arguments. Ironically, while conservatives like Sumner and Friedman have pushed the negative income tax for years, recently, as Lind notes, you've had conservatives criticizing the idea that close to 50% of Americans don't pay-federal-income taxes, al Mitt Romney's 47% slur. Of course, this one sided look at things ignores all the taxes this '47%' pays in regressive payroll taxes as well as regressive state and sales taxes. 

   While conservatives have tempted liberals for years with the negative income tax, etc. we have other conservatives deriding things like the EITC and Child Tax Credit-as welfare, or handouts. The irony is that the Sumner-Friedman solution is for the govt to simply give money to low wage earners. The supposedly Left wing solution of the MMTers (Modern Monetary Theorists) calls for everyone who wants a job to be given a job. What is the more 'socialist' solution-having the government help those who cant find a job themselves?

    Similarly raising the minimum wage would seen to be preferable to a conservative than wage subsidies. In practice however, this has not been the case. Conservatives prefer to have lots of low wage workers who then receive a govt subsidy to simply raising the MW so that workers earn a livable wage without any government handout. 

   Sumner's ideal economy/society is coming into sharper relief. It's an economy with low wages, low prices, and presumably lower unemployment where the low wage economy is subsidized by the govt. This is very much a supply side utopia-ie, it's basically the society we've seen over the past 30 years since Reagan. If you love the current status quo then you'll love Sumner. 

   I've argued in the past that I think that Market Monetarism is necessarily about fiscal austerity. Sumner is a SSer himself and he's admitted to this. However, he allows some of a more liberal or Centrist cast of mind to believe that not everyone who follows the MM argument has to follow him on everything. 

    I disagree with this. I think that SS fiscal policy goes hand in hand with MM monetary policy. MM is a lot more overdetermined than it at first appears.

    UPDATE:    For more from Lind see here

     This last link is as close to a Bible of political philosophy as there is for me.

      Kevin Phillips wrote the manifesto for Republican domination interestingly enough-he gave breadth to the 'Southern Strategy' the GOP would employ successfully starting with Nixon in 1968 who Philips supported.

     However, he has long since left the reservation. He was already sour on the Reagan Revolution by 1979 before it even really started.

      His book Wealth and Democracy is everything a liberal could want. 

      I still look at Gary Wills' Confessions of a Conservative as about as good a theory of American politics as there is.