The problem with Economists

We have an incomprehensible, to most, outside-in view of the world. David Friedman says something correct but incomprehensible:

Climate aside, we do not live in a static world—consider the changes that have occurred over the past century. The shifts we can expect to occur due to technological progress alone, even without allowing for political and demograpic shifts, are much larger than the shifts required to deal with climate change on the scale I am discussing.

A few months back I was debating a petroleum engineer about peak oil. It occurred to me that if petroleum engineers didn’t get excited about hard problems in energy production, maybe those hard problems wouldn’t get solved. This, I think, is the problem with the assumption of exogenous technology and this is the problem with economists giving policy advice.

Wishful thinking as economic analysis?

Prof. Delong:

The American economy appears to be nearing the end of contraction. That’s good news, particularly when one considers that only about 10% of the funds authorised in this year’s stimulus bill has been spent; the plan is only beginning to ramp up and outlays will peak in 2010. We should expect that injection to provide the economy with a nice boost at a critical time.

On the other hand, state budget policies are sharply contractionary at this point. Despite allocations of federal aid to states, services are being cut, state employees are being laid off, and taxes are being raised in order to balance the budgets of local governments constitutionally unable to run deficits. It’s not at all clear that the federal stimulus will entirely compensate for state-level fiscal tightening, which means that American fiscal policy could, on net, be contractionary.

Easy money is doing its part, of course, but the bottom line is that the fiscal boost many are expecting may not actually materialise. This will end up causing a lot of human suffering, and it may make for a long and shallow recovery—or worse, a tipping back into contraction.

Nobody thinks that it’s time to go back in the water yet. And we do need a bigger stimulus.

I can’t find the economics here. The economy is “nearing the end of contraction”, people are suffering now and fiscal policy is contractionary now. So… we need stimulus (from the current package and a new bigger one) next year and beyond?

I know what’s going on here. Delong, an uber-smart guy, has done analysis showing how this makes sense. The problem, like “beat the market” investment strategies, is if he tells people his analysis, that’ll make it unworkable.

Professor, honestly, I won’t tell anyone if you let me in on the secret!

Are there “good” governments?

I’m actually with Will Wilkinson when he talks up “liberaltarianism” and I support a reasonable social safety net. I’m one of those people that thinks rising GDP indicates increasing interdependence, that that is a good thing and that self-sufficiency is the road to poverty. Today Wilkinson suggests a reason why liberaltarianism might be a non-starter:

[I]t’s easiest to get people to face up to tax increases if they don’t have the sense that they’re paying more just so the special interests of the winning coalition can get more.

Isn’t the conditional phrase an empirical fact about governments?

This reminds me of my dad and the Church. Even after all us kids grew up and he stopped going to church, he gave money to them every week. The Church does a lot of good things for people — disaster relief, poor assistance, etc — but a couple years ago my dad stopped giving. His primary reason: he thought his money was primary going to paying off molested children; it wasn’t going to help poor people. He didn’t want to subsidize corruption.

I don’t want to subsidize corruption either.

Why not reduce Black poverty instead?

I’m what you might call a political newb so this might be an obvious question: why is Obama talking about redistributionist policies like credit cards and health care when the real problem in America, on this front at least, is Black poverty? What political costs would he pay that outweigh the large benefits of fixing this problem? Wouldn’t these costs would be relatively small for him? Or is it not about politics at all…is the problem just intractable?

Being an economist, I just assume redistributionist policy is easy. Maybe I’m wrong.

(h/t DarwinCatholic)

Research in fiscal policy: A cross section

In the latest NEP-MAC, there’s 12 papers on fiscal policy out of 64.

This paper finds significant crowding out effects. This one claims, “discretionary fiscal policy is more timely than conventional wisdom would suggest.” Those two are data papers, but this theory paper explores the implications of imperfect competition in the goods market and concludes despite this deviation from neo-classical nirvana, its hard for policy makers to improve welfare with fiscal policy.

“If the Fed is God, …”

Many (most… all…) claims about money policy contain some predicate, explicit or not, that the money authority actually can have real effects (e.g. Hamilton, “If you think that the Federal Reserve is responsible for more than 15-20% of the variation in the CPI, …”). This seems to be a pretty important assumption. Why don’t I know if its been tested or not?

I guess one way its tested is to produce models that don’t have money policy but explain big chunks of the data. Is this what RBC was all about? Does a current strand of the literature continue this line of research?

The Great Depression was a test of this assumption, but I want more than narrative evidence (i.e. more than one data point).

Current History

This long Sumner post is well worth it. My favorite part is all of it but bloggy customs require an excerpt:

The intuition is that if the Fed always targets the forecast, and if Fed forecasts are pretty close to the consensus private sector forecast, and if the Fed never targets an NGDP growth path which is expected to generate a recession, and if recessions are avoidable right up to the moment they begin, then recessions will never be predicted by the consensus forecast. It may seem implausible that recessions are avoidable right up to the last minute, but recall that the recession that began in December 2007 saw positive real GDP growth in the first two quarters of 2008. A highly expansionary monetary policy in mid-2008 might well have prevented a downturn in the second half, and the first half of 2008 might not have been retrospectively labeled a recession. Recessions are not just downturns, they are prolonged downturns, and hence are preventable even after they have started.


Despite that fact that we teach our students out of textbooks that suggest the zero lower bound doesn’t prevent highly effective monetary stimulus, and despite the many foolproof escapes from a liquidity trap put forward by Bennett McCallum, Lars Svensson, and even Ben Bernanke himself, there never in fact was any kind of consensus that the zero bound did not inhibit monetary stimulus. The profession as a whole is just as afraid of a liquidity trap as was Keynes, maybe even more so.

The argument is that policy makers had it all figured out, resulting in the the 20 beautiful years of the Great Moderation, but lost faith when interest rates hit zero.

By screaming about liquidity traps, Paul Krugman caused the recession!

Individual psychology != mass psychology

I haven’t been following the bail-out debate between Krugman and Delong, there are dissertations to write. Jonah Lehrer claims to summarize the disagreement. Krugman thinks toxic assets really aren’t worth that much and Delong thinks investors are risk averse en masse. Lehrer adds:

I think one way to evaluate these dueling positions is to look at how people generate perceptions of risk. Investors have concluded that these toxic assets are simply too risky to invest in, at least without large infusions of government money. How rational are these perceptions of risk? Are investors wary of buying toxic assets because they have good evidence that the toxic assets are virtually worthless? Or are they wary of these investments because they’re irrationally scared?

He then goes on to cite some evidence from psychology that people can mis-perceive risks.

The problem is “investors” aren’t a person. “Investors” don’t have a psychology, they have psychologies. There’s no telling how those psychologies aggregate. For example, all it takes is one big non-Delongian investor to fix the supposed high risk-aversion of “investors”. This big, risk loving investor would buy up all the toxic assets because he’d know they’re a steal.

The fact that no such investor has materialized is support for Krugman’s point of view. These are crappy assets.

Delong’s response is most likely something about the government (i.e. the U.S. federal government) being the only investor big enough to ride out the wave of pessimism. To which I say, really? There’s no big buy and hold institutional investors? There’s no sovereign wealth funds? All the PE funds have suddenly lost their long horizons? There’s no other big governments?

Is Delong going to invest in these assets? He has tenure and he’s far away from retirement.