The Ambrosini Critique

Frankly, I’m confused by this Krugman post so after I’m done writing this, I’m going down to The Avid Reader to pick up Krugman’s latest book. I suspect he lays out this argument more fully there.

Delong reviewed the original version (written in the late 90s) and had this to say about Krugman’s policy advice:

The core of Krugman’s book is made up of analyses of the two greatest economic disasters of the 1990s: the lost decade of economic growth in Japan, and the waves of currency crises and depression that have rolled around the world … These are the parts of the book I love.

Krugman’s analysis of how the Japanese economy entered its present period of stagnation is lucid, clear, and accurate. The collapse of the financial bubble of the 1980s depressed consumption and investment spending…

The answer to what you should do in order to recover from such a state of depressed aggregate demand is “everything.” You should have the government run a substantial deficit … You should have the central bank push the interest rate it charges close to zero (to make it very easy and cheap to borrow money). And if that isn’t enough you should–as Krugman advocates–try to deliberately engineer moderate inflation. If demand is depressed because people think investing in corporations is too risky, change their minds by making the alternative to investment spending–hoarding your money in cash–risky too by having a share of its real puchasing power eaten away every year by inflation.

So far Japan has changed its fiscal policy to run big deficits (but, as any student of the Great Depression would suspect, they haven’t been big enough). Japan has lowered its short-term safe nominal interest rates to within kissing distance of zero. But these haven’t done enough good. And so Krugman thinks it is time for the deliberate engineering of inflation to extract Japan from what economists call its “liquidity trap.”

But at this point Krugman doesn’t have all the answers. For while the fact of regular, moderate inflation would certainly boost aggregate demand for products made in Japan, the expectation of inflation would cause an adverse shift in aggregate supply: firms and workers would demand higher prices and wages in anticipation of the inflation they expected would occur, and this increase in costs would diminish how much real production and employment would be generated by any particular level of aggregate demand.

Would the benefits on the demand side from the fact of regular moderate inflation outweigh the costs on the supply side of a general expectation that Japan is about to resort to deliberate inflationary finance? …

And there is another problem. Suppose that investors do not see the fact of inflation–suppose that Japan does not adopt inflationary finance–but that a drumbeat of advocates claiming that inflation is necessary causes firms and workers to mark up prices and wages. Then we have the supply-side costs but not the demand-side benefits, and so we are worse off than before. Something like this happened to the Popular Front government of Leon Blum in France in the late 1930s.

Thus senior officials of the U.S. government have a problem… Quiet whispers … will not … have much influence on what policy actually is. Loud shouts through public megaphones … run the risk of triggering adverse shifts in aggregate supply.

… “Keynesian” policies (like those advocated by Krugman) are most successful when they are enthusiastically adopted by were not generally anticipated, much less effective when they are both adopted but also anticipated, and positively destructive when they are anticipated but not actually adopted and implemented.

Delong’s worry about Krugman’s policy prescriptions is that expectation of inflationary policy will induce higher wages and thus depress supply. He’s guessing that in the case of Japan this effect would have been smaller than than the increase in demand. On net, his guess is that output would have risen under a Krugman policy regime.

So, assuming we take as given Krugman’s contentions that our present circumstances are very similar to Japan’s experiences in the early 90s, the salient questions are: how similar are Krugman’s policy prescriptions today to what he was advocating, and Delong was criticizing, for Japan? How salient are Delong’s criticisms? Did Japan follow Krugman’s advice and how did that work out for them?

UPDATE: I don’t see a discussion of wages or employment in Krugman’s book. He seems to be claiming in his post that deflation (along with sticky nominal wages), increased union power and minimum wage laws don’t increase real wages or at least they didn’t during the Depression. Why is he going on about nominal wages? Nominal wage supports don’t have cause unemployment, but they do when combined with deflationary monetary policy.

I’m missing something.

The Keynes chapter Krugman cites has a basic general equilibrium argument against the standard supply/demand story:

For the demand schedules for particular industries can only be constructed on some fixed assumption as to the nature of the demand and supply schedules of other industries and as to the amount of the aggregate effective demand. It is invalid, therefore, to transfer the argument to industry as a whole unless we also transfer our assumption that the aggregate effective demand is fixed. Yet this assumption reduces the argument to an ignoratio elenchi. For, whilst no one would wish to deny the proposition that a reduction in money-wages accompanied by the same aggregate effective demand as before will be associated with an increase in employment, the precise question at issue is whether the reduction in money-wages will or will not be accompanied by the same aggregate effective demand

Keynes spends the rest of the chapter arguing adjusting real wages (or keeping them stable) is easier/better/preferable for unstated reasons via monetary policy rather than “fixed money wage” policy… whatever the hell that would be.

In other words, I haven’t a clue as to why Krugman thought this chapter was relevant.

Did I mention I’m missing something?

BTW, Krugman’s book wasn’t nothing special. Its a decent rehash of recent mania/panic/crash history; it could have been a chapter or two in an updated version of Kindleberger’s book. I did learn Krugman thinks fiscal stimulus is a good idea right now. He doesn’t say why. I also learned he thinks the real problem with the financial crisis is in the shadow banking sector (banks without the columns and marble) and he thinks increased credit in the traditional banking sector is a sign businesses are leaving shadow banking. Somehow this means we need to bail out the shadow banks.

If you ask me, increased demand for traditional banking is a sign that the financial turmoil will have limited impact on the real economy, i.e. epsilon is small to use notsneaky’s notation. Yes, there is a 1930’s style bank run going down in the shadow banking sector, but unlike the 30’s we have a whole legit banking sector (not to mention the Fed’s direct participation in the commercial paper market) as backup.

As implied here :

Dear Global Economy, we thank thee for thy economies of scale, thy professional specialization, and thy international networks of trade under Ricardo’s Law of Comparative Advantage, without which we would all starve to death while trying to assemble the ingredients for such a dinner as this. Amen.

Gabriel summarizes the debate on fiscal stimulus and comes down on John Taylor’s side (good choice). Those checks we got in the mail from the Feds didn’t increase aggregate demand; while take home pay went up, consumption didn’t. People, on average, put that money in savings (e.g. paid down their credit card debt).

This conforms to standard economic theory, but not, by the way, our cherished models¹. People that win a lottery will tend to put most of their winnings in savings and only consume a small bit at a time because they know its a one time windfall. On the other hand, people who get a raise at work will tend to consume most of the additional pay because they expect the additional pay to be in each of their future pay checks. ²

These theoretical results depend on people having access to credit. Hypothetically, suppose you’re a poor student expecting to get a lavishly paid job when you go on the job market next year because you expect no Economic department budgets will be cut in the aftermath of the Great Depression 2.0. Let’s say. Anyway, you know you’re income will be much higher in the future and you’d like to spend some of that higher income today. There’s no reason for your future self to live high on the hog while your stuck in the present eating Top Raman. In other words, you’d like to borrow from your future self. Well, that’s not very likely because access to credit for poor students is limited.

Now, suppose the government sends you a check for $500. Even though this is a temporary increase in your income, contrary to that fancy economic theory above, you’re going to consume it all and not save any of it. You do this because you wanted to borrow money from you future self, but weren’t able to. You not saving is, in effect, you borrowing from your future self.

But darn us economist, here we are talking about efficiency again. What if government actors care about maximizing the consumption of the least well off? Sure their stated preferences, as evidenced by their reference to Keynsian stimulus in public statements, are for efficiency. But stated preferences and a smile buys you crappy happiness research. Instead the government may just care about those most hurt by recession and those most likely to be credit constrained and thus those more likely to increase their consumption after fiscal stimulus.

Does our Benovolent Dictator (with a mouse in his shirt pocket to make my title work) have maximin preferences? If his preferences reflect a typical individuals social preferences or the median voter’s typical social preferences, then my guess is yes.

1. Won’t anyone defend Keynesian fiscal stimulus? [↩]
2. Hey, what about Ricardian equivalence? In what sense aren’t all fiscal policies permanent ? Contra Taylor, “permanent” tax cuts without out spending cuts aren’t credible. [↩]

Now that many supporters of the war have had their mea culpas, its appropriate — given the annealing process that is the transformation of public opinion to written history — for the pendulum to swing back towards the pro-war camp. Eric Posner:

The sanctions regime, which began in 1990, destroyed Iraq’s economy (reducing GDP by as much as three quarters) and impoverished millions of Iraqis. Particular attention was given at the time to its effect on children. The contemporary critics of the sanctions pointed out that before the sanctions began, the child mortality rate was about 50 per 1000; during the sanctions, on one accounting the rate soared to about 128 per 1000 (click on "basic indicators" here). More conservative estimates were in the range of a doubling of child mortality. Using the more conservative estimate, at one million births per year, this works out to an annual difference of 50,000 children surviving to the age of 5 (for various qualifications, see here). Today, the child mortality rate is below the pre-sanctions figure, and so every year in excess of 50,000 more Iraqi children survive than during the sanctions. The data are hotly contested but the trends are unmistakable and will continue to strengthen if security improves. Meanwhile, violent deaths of civilians, while still far too high, are declining; a very cautious estimate of 500-800 per month, based on the most recent reports on the Iraq Body Count website, is much lower than the avoided deaths of children compared to the sanctions regime. A conservative estimate is that more than 40,000 Iraqis survive per year today than during the sanctions regime, and probably most of them children.  The tight correlation between GDP and child mortality across countries bolsters this conclusion.
Let’s suppose that the sanctions regime had continued for 10 years, from 2003 to 2013, and further that security flattens out—it doesn’t get worse, but it doesn’t get better. Under these assumptions, 400,000 Iraqi children would have died if the war had not occurred and the sanctions regime continued. Now, almost 100,000 Iraqis died during the war, and so one of the war’s benefits is that it saves the lives of 300,000 Iraqis (over 10 years).

Did I mention that I was against the war before I was for it and then abandoned the cause to only change my mind again?

Somebody please defend our cherished models from the likes of this:

The economy needs a boost to aggregate demand and since monetary policy isn’t working any more, fiscal policy has to step in. This is usually followed by drawing a graph with two or three curves on it.

I’m not going to do it, but somebody should.

These two posts presented themselves one after the other in my Google Reader stream this afternoon.

In the first link, Prof. Rodrik notes French President Sarkozy’s new plan to buy shares in French companies to protect them from “foreign predators”. On Prof. Rodrik’s planet this is a good idea because “the acquisition of controlling stakes in domestic companies by foreigners at fire-sale prices is an unnecessary transfer of wealth outwards”.

That Rodrik, so insightful. Such a maverick! Except what if all countries followed this policy? Given the earth’s economy is a closed system, there’s no transfer of wealth outwards off the planet. The only effect would be to have more of the economy concentrated in the hands of people that care next to nothing about efficiency (government), i.e. lower economic growth.

To coin a phrase, I’d call such policy “beggar thy neighbor”. But my concern is purely speculative and theoretical, right? Surely, there’s no cases in history where such policies were implemented before.

My first reaction to the headline to this post — “publishing economics harm science’s credibility” — was “you elitest ‘hard’ science bastards!”

My second reaction, “oh”.

From both the macro evidence and this body of micro–economic work, a large consensus—right or wrong—has emerged:
It holds that modern economies need to constantly reallocate resources, including labor, from old to new products, from bad to good firms. At the same time, workers value security and insurance against major adverse professional events, job loss in particular. While there is a trade-off between efficiency and insurance, the experience of the successful European countries suggests it need not be very steep. What is important in essence is to protect workers, not jobs

— From this neat summary of the experience with unemployment in Europe over the last several decades (and the changing intellectual story-telling that went with those trends)

Regarding intolerant religious people, Richard Heck writes:

Are we entirely sure that religious people do tend to be kinder and more compassionate than secular people? And are we sure of this, especially, when we do not set aside the notable exceptions [WA: e.g. homosexuals]?

I know its The Correct Thing To Say that religious people are intolerant and they are especially towards certain groups. This is the objective social fact of the matter and of course there’s the conclusive proof set out by that bumper sticker: hate isn’t a family value.

Having grown up in a place where the people are moderately religious¹ and then living most of my adult life amongst secular liberal types, my experience, though, is that the latter are relatively more intolerant especially when it comes to the former. At Berkeley, I was washed clean of all my conservative values which in retrospect weren’t any worse than those liberal values that replaced them. Just different.

I wonder if there’s any data on this? I prefer the “revealed preference” kind, though. Secular liberal types tend to put a premium on calling themselves tolerant thus biasing survey answers.

1. Five churches in a town of 1400 people. [↩]

I feel icky because I sense I’ve wondered into some age-worn ideological battle… but if you need more evidence Hoover was an interventionist, Prof. Caplan has it.

To be fair, and balanced, I should mention the obvious. Pointing out intervention in the economy sometimes leads in disaster isn’t to say all interventionist policies are bad. The calm, reasoned thing to do — something, perhaps, normal people would do — would be to pick a normative framework (e.g. efficiency) or two (e.g. economic depravity) and evaluate individual policies for their “goodness” along those dimensions. Did a given depression-era policy increase the number of unemployed? Did it encourage growth? How many people did it save from starving to death? Did it increase wages at the bottom of the distribution? What was the average “wage” for the working poor and the unemployed before and after the policy? From a macro perspective, were prices/wages more or less sticky during the 30’s? Does the relative success of money policy in other countries co-occur with more price-adjustment friendly policy (e.g. union busting)? Did redistributionist fiscal policy have the effect of neutralizing the distributional effects of monetary policy? What’s the implied weight depression-era policy makers had on policy meant to help alleviate economic depravity relative to efficiency improving policy? Maybe all that Woodford crap giving policy makers objective functions will actually have some use…