Happy Halloween!

Here's a classic:

This Halloween should be fun - we moved this summer and are in an apartment complex with lots more kids than in the last one - so we should have trick-or-treaters. I plan on watching Tim Burton's Sleepy Hollow, which I've always loved for the atmosphere.

- My supervisor from GWU shares this link explaining taxes to children using Halloween. Pretty funny - even covers lock-box myths and Social Security taxes.

- This also reminds me of another sign I saw at the rally: "Burn Witches, not Korans"

- David Henderson reflects on the over-sensitivity to safety and Halloween. Of course I agree with him on this, but I have to say - part of the fun of Halloween was flaunting parental safety measures - staying out later than we were supposed to, wandering much farther than we were supposed to. Not that that's a reason for being absurd about the night's festivities, but from a kid's perspective the "rules were meant to be broken" attitude enhanced things.

- Here are some old links of mine: Poe on economics and Lovecraft on the nature of human fear.

And speaking of Poe, here's one of my favorite renditions of The Raven (by Christopher Walken):

A Good Krugman Post

It's here. Here's an excerpt:

"The background to the world economic crisis is that we went through an extended period of rising debt. Now, one person’s liability is another person’s asset, so rising debt made the world as a whole neither richer nor poorer. It did, however, leave the borrowers increasingly leveraged. And then came the Minsky moment; suddenly, investors were no longer willing to roll over, let alone increase, the debts of highly leveraged players. So these players are being forced to pay down debt.

The process of paying down debt, however, must obey two rules:

1. Those who pay down debt must do so by spending less than their income.
2. For the world as a whole, spending equals income.

It follows that

3. Those who are not being forced to pay down debt must spend more than their income.

But here’s the problem: there’s no good mechanism in place to induce those who can spend more to do so. Low interest rates do encourage spending; but given the size of the debt shock, even zero rates are nowhere near low enough.

So since the world economy can’t raise the bridge, it is lowering the water: without sufficient spending from those who can, the only way to make the accounting identities hold is for incomes to decline"

One of the biggest problems for professional economists and laymen alike is to understand how accounting identities are appropriately or inappropriately used. This is the right way to use it. Accounting identities have to hold, simply by definition. That doesn't tell you what will happen of course. What happens depends on what the elements of an accounting identity do because of exogenous forces. Note that here Krugman is not saying "Y=C+I+G so if we increase G it will increase Y". He's saying these identities have to hold, so income is going to be set depending on the decisions people make regarding demand, savings, etc. Income has to equal spending and savings has to equal investment - but what levels these come in at are determined by behavioral responses.

The Rally to Restore Sanity and/or Fear

I was at the rally yesterday and it was a lot of fun - it was enormous, as I'm sure most people know. I've heard two estimates - 215,000 and 250,000, which sounds about right to me. I'm personally wondering if that takes into account how packed the crowd was. When people were interviewed at the Beck rally, interviewers were easily weaving their way through the crowds. At least in my section of the rally, we were packed shoulder to shoulder. I couldn't see a thing the whole time, but I could hear it most of the time. I went in with a friend from Pittsburgh - Kate and another friend of ours stayed home and watched it on TV. I'll have to do that this week - I heard there was some pretty funny stuff going on on-stage.

The signs were all pretty funny. CBS has a sign review here, and Alex Tabbarok has one here. The majority of them were on the theme of staying calm and being civil with others. Lots of "I disagree with you but I'm pretty sure you're not Hitler". I saw a "we may disagree on a lot but I'm sure we agree on some things - do you like toast?". I saw a fair amount of political signs - mostly against Fox News and Glenn Beck. A fair amount against the Tea Party too. Very much in the vein of "I'm not a socialist/I'm patriotic too" - very few hostile to Fox or the Tea Party for anything other than the crap they shoveled on us (i.e. - I didn't personally see any signs accusing them of racism or anything). There were signs refering to Fox News as liars... hard to disagree with that one. Not a lot of partisanship aside from that. People may take issue with this, but you know what - Fox News and the Tea Party are injecting precisely the kind of extremism this rally was intended to combat. I don't see a problem with calling them out on it as long as we don't veer into other things like accusations of racism.

There were, of course, a lot of Halloween costumes there. I saw lots of zombies, one of whom was carrying one of my favorite signs: "What do we want?: Brains! When do we want them?: Brains!".

Best sign of the whole event... "Gee, this orgy is getting off to a slow start".

One other thing worth remarking on - I was surprised at the range of people there. It was an ethnically and geographically diverse crowd - that wasn't surprising. But the age range was. Lot's of senior citizens there, lots of parents with young children. That was pretty cool to see. And of course there were lots of twenty-somethings which wasn't as surprising.

1920-21 Depression Article is on Online First at the Review of Austrian Economics!

You can find it here. It's gated, but if you subscribe you can read it. I'm not sure how long it takes articles to migrate from "Online First" to the journal itself. Yay! Working with the Review of Austrian Economics has been a very good experience - I'm grateful to Steve Horwitz for encouraging me to submit here.

Lovecraft on Autumn

What you say of the fascination of autumn is very true - and I have always felt it despite the menace of physical discomfort it brings. I love an abnormally hot October, when I can wander around through the prismatic landscape and imbibe the spell of the ancient harvest season without shivering. There is malancholy in it, but the accompanying beauty and sense of adventurous expectancy are so great as to make that quality forgivable. It is a season of almost weird retrospective, when one seizes on the unchanged objects and processes of nature - or of anciently ordered life - and half-imagines that the past which they typify is still present. The woods, the fields, the hillside orchards laden with fruit, the fields of sheaved corn, the old stone walls overgrown with flaming vine, the farmyards heaped with brilliant pumpkins and other garnerings of the year, the acrid odour of smoke, the distant notes of horn and hound across the stubbled fields and dying meadows - all these things have a potent magic for one who has known the old days and the simple folkways of an immemorial culture not yet urbanised.


H.P. Lovecraft, Sept. 2, 1931, letter to August Derleth

"Prices and Production" Reading Group

Jonathan Catalan is organizing one and I'll be participating in it. The book, where Hayek outlines his version of what has come to be called Austrian Business Cycle Theory, is organized as a set of four lectures. We'll be reading a lecture a week or so, and Jonathan will kick off the discussion with a blog post. He invites other bloggers to post on it as well and cross link, which I'll likely be doing. I think this is a great format and if this is successful it should not be the last of these.

The Mises Institute provides the book for free here. The first lecture starts on page 221.

Feel free to join in - maybe leave a post on Jonathan's blog to let him know and thank him for organizing this.

Dueling Nobelists on Quantitative Easing

The Wall Street Journal reports that Christopher Pissarides, recipient of the Nobel Prize, has expressed doubts that quantitative easing will help the labor market at all.

If you just looked at the headline you might say "well Pissarides just thinks it's all a matching problem so no wonder he's skeptical of pro-active aggregate demand policy". That's actually not his argument at all, and he raises the same point that I have in my skepticism over monetary policy. Pissarides says: "Quantitative easing is not going to do anything for employment because there is already lots of liquidity". He doesn't come out and say "liquidity trap", but what he says is certainly consistent with it - we're pushing on a string with monetary policy.

Ed Phelps, the 2006 Nobel recipient, disagrees. He says "The U.S. should be allowed to let the dollar weaken as ultimately everyone benefits, the U.S. thanks to exports, while all the others then benefit from the innovation that results from this... Innovation will get going only if exports get going, and that’s the only way to get employment going."

I'm no monetary economist (yet), and I know even less about the international implications of monetary policy. Phelps seems to be relying a lot on exports here, but I'm not sure exports are our biggest problem. Because we're in the very special case of a liquidity trap, I've been skeptical about how big an impact monetary policy can really have, so in that sense I sympathize with Pissarides. I see some advantages, though:

1. Any prospect of creating any inflation helps insofar as sticky wages and debt burdens present a problem.

2. Phelps may overemphasize exports, but weakening the dollar to boost exports can't hurt. Will it be enough? I'm more doubtful about that.

3. Even though there won't be much action on short-term rates, quantitative easing is still likely to effect long-term rates which should do something for investment. Keynes points to this effect on long-term interest rates in his "second place" policy recommendation in his open letter to Roosevelt (the first recommendation is fiscal policy).

So, I'm with Phelps insofar as I think we oughta do it, but I'm with Pissarides insofar as I don't expect miracles. Like I said, though - I'm no expert on QE and I'm curious what others think.

The Supply (In)elasticity of Graduate Labor

Perhaps an imposing title for some readers, but bear with me - it seems like it's been blaring in my face from all directions lately.

The research I presented with Hal Salzman at NBER the other week was a broad overview chapter on trends in the supply of engineers. The work has been veering towards a very specific labor supply problem, namely the inelasticity of labor supply. For non-economist readers, that means that the supply of engineers is not responsive to price changes in the way that we usually think goods and services are. Think of a supply and demand model where the supply curve is vertical. The result is that when demand for engineers increases, their wages increase but you don't get many more engineers. One of the reasons for this, of course, is that it takes time to train an engineer (so supply doesn't adjust over night) and guys like me can't just jump into the field to take advantage of the higher wages. But some, like Romer (2001), have suggested that the problem goes much deeper than an adjustment lag, and that graduate institutions aren't set up to be responsive to market signals. Our chapter has been steadily veering towards this research question: how do engineering programs respond to market demand? Yesterday Hal also passed on this article on the responsiveness of programs, which reports on this paper presented at the AEA meeting in January. It's not just a problem with the engineers, though.

Theology and the Humanities
Evan has a great post up on graduate programs in theology, where he critiques a review of these schools by R.R. Reno. Many issues come up in Evan's discussion (in fact most of it is on the dominance and relevance of "schools of thought" in theology departments, which is very interesting), but one of them is simply that students are often taking stabs in the dark when they apply to these schools. Economics graduate schools have a complex ranking and tier system that is fairly transparent and broadly embraced, but my impression is that theology departments (and many other disciplines) really don't have this. Reno, to be fair, makes an attempt to remedy this by reviewing the major departments, and Evan does his part by responding to Reno. I'm guessing neither of them see schools strictly as a labor supply institution, but from a labor market perspective the opacity is troubling. Some of this is a problem with the institution itself, and some of it is an information asymmetry problem plaguing applicants. This video has been making the rounds, and illustrates perfectly this problem of information asymmetry (or, as the kiddies call it, "optimism").

I've heard these issues from the humanities for a long time from Evan. It sounds rough. Unlike economics or engineering, there isn't a robust private market for graduate-level humanities students. We could say that the cultural maintenance work that humanities scholars do is a massive positive externality.

UPDATE: A theology student friend of Evan's links to a cartoon that gets at the heart of the issue and asks "Could God make a degree so useless that even he couldn't get a real job with it?"

Law
Another article that has been making the rounds on precisely this problem is this Slate piece suggesting that too many lawyers are supplied. The demand for lawyers has fallen dramatically, but supply is not being as responsive. Kling talks about the article here and Andrew Sullivan talks about it here. I imagine this is more of an adjustment lag than a long-run issue. Law school takes less time and is very expensive (for the student) relative to PhDs that are often covered by financial aid or grants. In addition, law students are intimately connected to the labor market through their summer internships.

Economics and the Social Sciences
And then, of course, there's the labor supply process that I'm currently trying to jump into. As I said above, I think economics is uniquely transparent in its rankings and in how explicit it is about what it takes to get in and what you can do with the degree when you leave. A lot of the reason for this is that while a large share of economics PhDs (I've heard half I think - is that right?) go into academia, it's not a purely academic degree in the way that humanities degree can be. I think the same issue with managing expectations during the application process applies, though. Anyone that's applied to an economics program knows that there are two kinds of advice you get from people: (1.) the encouraging, excited advice, and (2.) the tough-love advice that all but tells you it's not worth it if you don't go to a top tier school. I recently got the second version from a colleague at work. It's well intentioned and I'm glad people get this advice, but not exactly the kind that I needed at the time that I received it. You all know what schools I'm applying to - I think it's a nice range, with some very well ranked programs in the mix. I think all of them are OK for a non-academic job in the D.C. area, which seems like the most likely course for me (although I'm warming up to academia). But this raises exactly the same issue of supply elasticity. Even given the transparency of a lot of the economics PhD application experience, a lot of applicants still need to be told that for an academic position you're in trouble without a top-tier school.

A user-generated video about political science similar to the one above presents another asymmetry that manifests itself as a supply inelasticity - namely, that social scientists are incentivized to do research that isn't useful for the real world. George Mason professors make this case a lot, although others would argue that their department suffers from exactly the same problem:

Does anybody else have interesting anecodes/links/information on the elasticity of graduate labor supply? At this point I have a personal, bibliographical (my chapter), and scholarly interest in the issue and would love to hear thoughts.

- Romer, Paul. 2001. "Should the Government Subsidize Supply or Demand in the Market for Engineers?" Innovation Policy and the Economy, vol. 1.

Assault of Thoughts - 8/28/2010

"Words ought to be a little wild, for they are the assault of thoughts on the unthinking" - JMK

- First, Krugman and Keynes were featured on the Colbert Report on Tuesday (at about 1:25). Colbert points to Krugman's lesser known New York Times feature, "Krugman's Kidz Korner". I believe that shot of Keynes is taken from a picture from the Bretton Woods Conference - it looks quite similar, at least.

- It's been a little while since I've been mentioned by name in a Cafe Hayek post, but here Don writes "Daniel Kuehn will not like my latest column in the Pittsburgh Tribune-Review, in which I criticize modern macroeconomists’ – and, particularly, Keynesians’ – naive aggregates." It's kind of a funny article. Basically he says economists can't make predictions like other scientists. I agree that economists have weaker predictive powers, but no weaker than, say, a biologist. I don't know why Austrians are so obsessed with the physics/astronomy metaphor. There are other memes crammed in the article as well - in simpler words, he essentially makes the case that I often do on here, that "accounting identities aren't behavioral laws". I'm not sure what he expects me to disagree with there. The comments on Don's post act as if this is some kind of mystery to Keynesians - again, I'm not sure why. He ends on a pretty flimsy critique of aggregates, when what I really think he ought to be doing is critiquing the misuse of aggregates.

- This summer Kate and I visited Vint Hill Winery, where customers could design their own barrel of wine. It seemed like an interesting (if expensive) way to get involved in the winemaking process. A London entrepreneur is trying to do the same thing remotely - letting people design wine over the internet, and implementing the winemaking it robotically. She's running into some legal roadblocks right now. It seems to take away a lot of the point of winemaking, but even if you just look at it as "made to order wine", it's a pretty cool idea (HT Tyler Cowen).

Stephen Colbert, Destroyer of Economies

Stephen Colbert, as most of you know, is terrible for the economy. He's best known for the demand shock he introduces. He calls rallies for "keeping fear alive", which is bad news whether you're a Higgsian or a Keynesian. Some economists insist most uncertainty and fear comes from the government, others suggest the bulk of it comes from demand conditions, but Colbert doesn't discriminate - in his world, you have everything to be afraid of.

As if aggregate demand hasn't caused enough problems for us in the last couple years, Colbert is now introducing a clear aggregate supply shock, reducing Greg Mankiw's incentive to work. What's more, this obviously reintroduces the prospect of inflation problems. Stephen Colbert is not only driving us into a deeper depression - he's raising the specter of stagflation.

A few links

I feel like I've been out for a while, but I'm slowly starting to recover from this weekend. Last week at work we were finishing up a large report for the Treasury Department, literally right up to the minute I was leaving for Boston, and then yesterday I took the GREs. I ended up getting a 790 on math and a 700 on verbal which is an improvement on both counts and will be competitive - so now I'm starting to decompress from all that... so how about a blog post?

- First, Mark Thoma points to a Kauffman survey of economics bloggers on various topics. The survey is interesting - it's important to scroll down to the bottom to see the politics and affiliations of the people surveyed. Obviously not necessarily representative, but it's interesting.

- Second, Jonathan Catalan writes about the "Impossibility of Complete Economic Erudition", and considers how long it would take him to really familiarize himself with Keynesianism, relating this to the Murphy-Krugman debate. This problem has bothered me a lot in the past as well. I guess I'd say a few things - first, I think the degree of erudition needs to be higher for a full blown debate than for, say a debate on a blog or a journal article. Nobody is coming to this blog to see an expert talk about ABCT. They are coming to see someone somewhat familiar with ABCT talk about it, and then see other commenters who are more familiar with it discuss it. In a journal article you have time to do the leg-work for your research, and ultimately you have reviewers to address any issues, and if there are still problems people can write replies. But in a debate people come to see experts grapple with the issues, and you need to know the issues you're talking about. I should note I think Jonathan has a pretty decent understanding of Keynesianism. He doesn't play the crude Keynesianism card the way Robert Murphy often does, and when he does it's easy to address in a civil way - just like he addresses it when I play the crude Austrian card. That's fine - and we can blog and write fairly successfully. But I don't think either of us would be in a position to debate each other on these issues. And as Jonathan alludes to, he's still learning ABCT and I'm certainly still learning Keynesianism. My grasp of old-school Keynesianism, which I usually pitch here, is still amateurish. I'm even less familiar with the newer material. But that's life - life is the time between the cradle and the grave that you get to spend figuring this world out.

- Evan shared this research with my from the University of Chicago, which suggested that future offenses cause more intense feelings than similar past offenses. The effect applied to good deeds as well. This is interesting from the perspective of the economics of time. Usually we think of discounting future occurrences - and people who think like me think we discount the future way too much, in a sub-optimal way (probably an evolutionary hold-over from when survival was a more day to day proposition for the species). But we don't think of past occurrences that much because we can't turn back the clock. Of course, I've referenced Jefferson and Paine's writing on here before with respect to the tyranny of the past. They were both worried about constitutions and congresses that could bind future generations. Of course, this research suggests that future generations might not mind all that much - which might help explain the persistence of a social contract pushed through in Philadelphia well over 200 years ago.

My experience in Boston and at the NBER conference

...was incredible. This was the sort of event that made me realize I've made more or less the right career/life choices.

I got into Boston on Thursday and spent most of the morning finishing off my slides in a coffee shop. From there I walked down Boston Common and then down Boylston Street and up Washington Street with the eventual goal of Brattle Book Shop, which was established in 1825. The book shop has an expansive outdoor section of lower priced books and a great collection inside as well. I decided to limit myself to late 19th and early 20th century history and economics to beef up that section of my library and not go crazy with purchases. I ended up getting a first edition of Norman Pollack's The Populist Response to Industrial America and a copy of Coin's Financial School, edited by Richard Hofstadter and including an essay in the front by Hofstadter on "Coin's Financial School and the Mind of 'Coin' Harvey". Both of these books will be useful for a project I'm doing this fall, writing five entries for an Encyclopedia of American Populism, which I got hooked up with through the H-Net announcements board this summer. This was after submitting my 1920-21 depression paper, when I felt the need to move on to something else and build my knowledge and credentials with turn of the century history. I'm writing relatively short entries for "the quantity theory of money", "the National Monetary Commission", "the International Monetary Conference", "Coin's Financial School", and "technological unemployment". The Hofstadter edition of Coin's Financial School is obviously for that entry, and Pollack's book is going to be great help in my entry on technological unemployment (which was not initially intended for the volume, but I convinced the editors to add).

Moving on from the populism books, I also got a first edition of William Beveridge's Full Employment in a Free Society. There was an interesting note at the front of the book (this was published in 1945): "A Wartime Book: This complete edition is produced in full compliance with the government's regulations for conserving paper and other essential materials". Whatever they did to comply in the production of the book, it's in great condition. William Beveridge is of course famous for the Beveridge Report and the Beveridge Curve, and this book that I got is a great example of an early exposition of Keynesianism. Finally, I got Herbert Hoover as Secretary of Commerce 1921-1928: Studies in the New Era of Thought and Practice. It's a collection of conference papers - one covers the 1920-21 depression itself, while others cover other episodes in his time as secretary.

OK, now that I've taken two full paragraphs talking about my books it's probably time to move on. After the bookshop I headed north, intending to look at Paul Revere's house, the Old North Church, and Copp's Hill Burying Ground (a setting, not to mention inspiration for a lot of Lovecraft stories). I didn't get that far because it started to rain. I ducked into a nearby burying ground, though - at King's Chapel just above Boston Common. This is Boston's oldest, and it was mentioned by Hawthorne in The Scarlet Letter (and allegedly an adulteress's grave was a source of inspiration for him). I saw the grave of John Winthrop, the first governor, and William Dawes Jr., who helped alert residents of Lexington and Concord that the British were coming. There were many large, old trees in this cemetery which, with my umbrella, kept my laptop, clothes, new books, and books my mother-in-law sent with me to take to my wife's uncle dry. I was pretty weighed down and could have run to some other store, but it was a nice scene - a cemetery quickly emptied of tourists when the rain began, with brooding storm clouds and crisp autumn air. I stayed under the tree until the rain stopped, and then went on to my hotel.

That afternoon I blogged on the Murphy-Krugman debate (I'm still unenthused), polished my slides a little more, and then headed out to Harvard Square to have dinner with the conferees at The Sandrines, a nice French bistro near Harvard. This was a great experience - I met Richard Freeman, a very gregarious and funny guy, as well as all the authors of the other chapters. The one guy I knew - my co-author - was late, so I was forced to get to know some people, including Sue Helper at Case Western Reserve University, Cathy Weinberger at UC Santa Barbara, and Erling Barth at the University of Oslo. Talking with all of them before and during dinner really made me reconsider the prospect of an academic career - I've leaned more towards the private sector and the government for many years now. But these guys were really able to spend a lot of time delving into their research and taking the time to do the job right and investigate a problem until it was solved. At the Urban Institute we're often under a lot of tough time constraints, and sometimes we don't get to into the nitty-gritty of the research in the way that I heard these guys talking about. There are liabilities to the academic approach as well, of course, but I think it would nice to let research unfold at its own pace.

The conference itself went well. I ended up presenting a lot of our work. The atmosphere was informal and collegial, with lots of discussion and suggestions. This wasn't a normal conference environment where the goal was to pick apart the presenter's case. We had an interest in being constructive, as well as sharing ideas because ultimately we're all going into a single volume and we want there to be some coherence between the chapters. So I thought our presentation went well, it was well received, and I was treated as an equal by everyone else (all professors). They would pull me aside in the hall during coffee breaks to talk more about it, etc. A great experience all around.

We went to the Harvard Business School for a lunch seminar. Three papers were presented on non-compete agreements in high-tech firms. Essentially many firms have workers agree that if/when they leave the firm they won't work in the same industry for a year or two afterwards. Some states - most notably California - have made such agreements illegal as a restraint of trade. The effect has been a steady brain drain of innovative workers from states that allow non-competes (the vast majority of states) to places like California.

I met up with Kate's uncle, who works at Harvard Law School, and went back to his place in Brookline Friday night. I probably got more sleep there than I have all week, and headed off in the morning back to Washington. A great trip over all. My opinion of NBER and Harvard has risen considerably, as has my disposition towards academic economics. Now the task will be to find time this fall to finish off this chapter for the May conference. It's going to be very busy at work. We shall see!

Murphy v. Krugman: The Blind Debating the Blind

So Bob Murphy has thrown down the gauntlet. He's challenging Krugman to a debate, at the Mises Institute, with Ezra Klein as the moderator, on Austrian Business Cycle Theory and Keynesian theory.

You'd think I'd be thrilled, right? I've got a big interest in both. I drone on about a synthesis or at least a reconciliation at the same time that I reserve some pretty serious criticisms for a lot of the Austrian school. I have no shame in saying that Krugman is one of the best living economists. Should I be promoting this?

Honestly, I can't muster much enthusiasm at all for this.

First, the basics:

1. Paul Krugman, sharp as he is, has demonstrated that he only knows superficially what ABCT entails - for the most part, he's ignorant of it.

2. Bob Murphy, despite his substantial Austrian credentials, has shown that he also only understands Keynesianism very superficially. To a large degree, he's fairly ignorant of the Keynesian argument.

Why would I be interested in seeing these two debate at all?

In this challenge, Murphy notes that Krugman will eventually feel pressured into debating if they keep the requests up. Really? At the Mises Institute of all places? He would feel compelled to debate there? They savage him every other day on there. He's been called a liar and lacking a conscience, blatantly dishonest, and a political operative. Keynesians are said to want "perpetual war for perpetual prosperity" and are "essentially Marxian". Liberals are accused of hating private charity, being fascists. All of these came up with a quick search, and all of this is in the text of the Mises post itself. There's even worse vitriol in the comment section, and obviously if I invested time in more searching I could find more ("Krugman" turns up over 27,000 hits on the Mises blog, after all - almost ten time the number of hits you get on the New York Times website, where Krugman writes a column!). Why would anyone in their right mind want to speak at such a hostile, unprofessional venue? There are a few good guys at the Mises Institute, but aside from them it's mostly absurdities - and very nasty absurdities at that.

So they take this hostility, and they turn it into a crusade of sorts. Robert Murphy refers to "younger anti-Keynesians", as if the whole point is to be against Keynes rather than... say... to learn truth about the economy. Jeff Tucker similarly invests deep significance to this - calling it "the great debate of our time". Really? This is "the great debate of our time"? Mises Institute regular Gary North has something he calls "the Keynes Project", again devoted not to seeking truth but winning an epic battle between Keynesians and Austrians.

This attitude is bizarre. As I said in an earlier post, this whole Mises Institute gang has a clash-of-the-titans approach to economics. They don't see other economsits as colleagues. They see them as enemies. And that fosters a deeply unprofessional website environment where commenters come in and say far worse things.

Which leads me again to ask - even if I did think Krugman and Murphy were the best people to debate this issue, why would Krugman ever agree? I wouldn't. Ten or twenty years from now, when I'm a hot shot economist (and because I'm sure I'll still be engaging the Austrian school in some capacity), I don't think I'd ever accept a speaking invitation from the Mises Institute. NYU? GMU? St. Louis? Sure. Those Austrian-friendly schools would be fine. But not the Mises Institue.

Technological Unemployment at The Economist

I can't help slipping in one more post before flying out this morning... here's a discussion of technological unemployment at The Economist (HT Brad DeLong).

Robert Murphy on the Austrian School and Keynesianism

So I've been meaning to write about this new post by Robert Murphy that "puts the Austrian business cycle theory to the test". I wanted to share a few thoughts and get people's reactions.

The post is a decent catalog of some of the problems with Krugman's take on things, a good start for explaining the congruence of the crisis with ABCT, but a very bad attempt to draw conclusions from that.

1. First, Murphy is right to point out indices of decline rather than absolute declines (which Krugman does). Construction has seen a higher rate of job loss than manufacturing, which is of courses consistent with ABCT.

2. Murphy notes that Austrians opposed a suite of government actions. He writes: "Now say what he will about the Austrian economists, surely Dr. Krugman will concede that they opposed the above actions, and that they would have predicted at any time that these policies would lead to economic stagnation". It's true that they opposed these actions, but then again Krugman said many were inadequate or just plain wrong too. It's worth probing what each side predicted the effect would be. Krugman (and I for that matter) suggested we would have continued deflation and low interest rates. Not all, but a sizable portion of Austrians predicted inflation and high interest rates. This makes sense - both of those results are easily derived from Keynesian and Austrian approaches, respectively. So Krugman and the Austrians were both right here - but who was right for the right reasons? Generally speaking, I'd say Krugman.

3. Robert Murphy is being entirely disingenuous when he writes this: "In contrast to the Austrian story, what does the Keynesian view predict? Well, if a recession is really just about a general drop in aggregate demand, then we shouldn't see any particular relationship among individual sectors, and how they respond both in magnitude and across time. If you reread Krugman's commentary on his chart, that's exactly what he himself says the Keynesian story means." What can spark a demand shock? Lots of things, of course - but one major cause is a popped bubble that leaves people with a lot less income and wealth than they previously had. Murphy abstracts away from the bubble completely and acts like this is all a question of the capital structure and roundaboutness. You can't remove the housing crash from this narrative - that was the aggregate demand shock which brought the rest of the economy down. The question shouldn't be "how do Keynesians account for the construction employment" - that's obvious - there was a housing crash after some standard bubble psychology and bad policy. The question should be "how do Austrians account for the breadth of unemployment". Clearly the basic rebalancing of the capital structure can't explain this. You need some story about malinvestments as overinvestments or overproduction in addition to the standard malinvestment story. The case can be made, but the onus doesn't seem to be on the Keynesians.

4. So where do we end up with Murphy? Well he's using the same fallacious logic that I had to correct from him with my 1920-21 depression paper. Is this downturn consistent in some important respects with ABCT? Sure. Of course it is. My feeling is that that is because ABCT is a logical and accurate theory of a real macroeconomic process. So of course you're going to see it in the real world. Does that mean the Keynesian explanation is wrong or not also consistent? Of course it doesn't. These are not mutually exclusive processes that we're describing here, and the theories that you're promoting are only mutually exclusive because you have defined them as such. You don't just assume that oil embargoes can't cause recessions because you've attached the "Keynesian" or "Austrian" label to your lapel, do you? No - because the supply shock of an oil embargo isn't inconsistent with additional demand shocks or capital structure adjustments. Robert Murphy lives in a Manichean world, not a scientific world. He wants economic theories to engage in a battle of the titans. This was how it was with his explanation of the 1920-21 downturn too. For Murphy, if ABCT fit the facts (he didn't make that much of a case that it did - he barely talked at all about the capital structure), then Keynesianism couldn't fit the facts. Part of this was simply because he grossly misunderstood Keynesianism, but a lot was also because he couldn't accept the fact that under some circumstances Keynesianism and ABCT predict much the same thing.

So long story short, I think Murphy makes some decent points and a good beginning of a case for ABCT, but draws some very bad conclusions from it.

The New York Times on Keynes and Democrats

The New York Times reports that Democrats are at odds over the relevance of Keynes (HT Kate and waterzooi), despite overwhelming support among what the article calls "liberal economists" (I'm not sure why they think it's just liberal economists). This isn't especially surprising. First, the "Keynesian resurgence" is relatively new anyway. No one should be shocked that the dedication of some was fleeting. But we also have to remember that Keynesianism isn't really all that politically popular:

Politician: "I want to run even larger deficits than Obama has and I could even stand for some public employment programs, and I want to maintain those ::mummblemummble:: tax cuts"

Reporter: "Excuse me sir - I didn't catch that last part"

Politician: "I want to maintain those ::mummbleBushmummble:: tax cuts"

Reporter: "What?"

Politician: "The Bush tax cuts"

Ya - that's a winning electoral strategy. Voters just love budget deficits and George Bush. Think about this - how would the average voter react to that? Some people act like Keynesianism is tailor-made for politicians and winning elections. This is absurd. You know what wins elections?: "Balance the budget! Get Washington off my back! Muslims attacked us!". Come on - of course politicians are retreating from Keynesianism. News flash - this has been going on for two years and the politicians were never entirely on board in the first place. So it's an interesting trend to note, but it's not surprising at all from public choice theory perspective.

The near future in the life of your host

Blogging will be light for at least the next week - there are some exciting things coming up.

First, on Thursday morning I'm off to Cambridge, Massachusetts to present preliminary findings from an analysis of trends in the supply of new engineers to the labor market from the mid-1980s today. The conference is organized by Richard Freeman and Hal Salzman (my co-author) at the NBER's Science and Engineering Workforce Project. We're coming up with some really interesting stuff. One of the things I like about our analysis is that we're taking a very close look at the reaction of engineering programs to the increased demand for engineers. Lot's of people have modeled the labor market for engineers, and lots of people have looked at graduation trends from engineering programs - but we look at the growth, development, and composition of these programs over time as well, which I think is somewhat more unique. I'm hopefully going to get to present these results at the Urban Institute later this year as well - the chapter will be finished in May 2011, and the book (NBER and U. Chicago Press) will come out some time in 2012 I believe.

The conference participants are also going to attend a seminar at one of Harvard's Science-Based Business Initiative Seminars. Not sure what the topic will be, but that looks interesting.

I'm thrilled to be a part of this, and I'm very excited to meet Richard Freeman - a very well known labor economist at Harvard. Here's a clip of Freeman speaking about his research:

And this is Richard Freeman's Jefferson lecture at Berkley in 2008. He emphasizes Jefferson's views on inequality:

One of the things I like a lot that comes out strongly in both of these talks (towards the end of both of these talks) is what Freeman calls "progressive federalism". It's largely the same point I've made on here on several occasions.

That conference is Thursday and Friday. I'll be back Saturday and studying for two days straight for my second shot at the GRE Monday morning. Shooting for an 800, of course - but we shall see. Something very much in the "safe zone" at least. I'll be pushing forward with applications after that. One of the things I'll be applying for is an NSF Graduate Research Fellowship, which involves a much more detailed description of my proposed research - so I may be blogging more about that as I sketch it out.

Assault of Thoughts - 10/19/2010

"Words ought to be a little wild, for they are the assault of thoughts on the unthinking" - JMK

- The Navy hunts for the sunken Bonhomme Richard, John Paul Jones's Revolutionary War ship.

- Arnold Kling on Robert Hall on quantitative easing.

- I rolled my eyes when I started reading this post about a geneticist and a physicist writing an article about what evolution has to say about economic recovery. Needless to say, economists have been applying evolutionary ideas for decades, and I didn't have much faith that these guys could just jump into the field and have something especially useful to say any more than I could jump into genetics and make a decent point. It actually sounds quite good, though. I've heard the point before (from Santa Fe Institute people), as well as from Krugman and some other trade theorists:

“By treating the world trade network as an evolving system, theory predicts the trade network is more sensitive to evolutionary shocks and recovers more slowly from them now than it did 40 years ago, due to structural changes in the world trade network induced by globalization,” the authors state.

The concept of modularity, which in biology refers to a structure that is part of a larger system but can function on its own, is key to their findings. In evolutionary theory increased modularity leads to more complexity, and a greater ability to withstand shocks. But globalization has decreased modularity in world trade and led to a more homogeneous structure, leading to deeper recessions and longer recoveries.

The blog also notes an IMF paper that has said essentially the same thing - I'm sure the references in there have other examples.

- Michael Hirschorn has an article on the role that the internet plays in political objectivity - the echo chamber effect, essentially. People read things that confirm their priors and essentially feel at liberty to make up their own facts.

- Evan points me to a post by theologian he follows, Adam Kotsko, on the notion of "affordability". The comment section gets into some post-Keynesian/MMT talk about the illusion of affordability as well. It's of the "if you can afford a massive military you can afford to fund the humanities" variety. I have a comment in the comments section noting that the narrative isn't quite that clean. While the military does make up a large share of the budget, the affordability "crisis" is a medium to long-term crisis, and the major culprit is Medicare, not the military. Still - always good to see other bloggers thinking about this. Kotsko will occasionally try his hand at some economics posting.

Sullivan on Oakeshott, Hayek, and Popper

Sullivan notes a New York Times article on uncertainty in economics and Jim Manzi's reaction to it. I've just skimmed it, but it seems to cover the same points I've made countless times on here about how hard it is to prove anything in macroeconomics and how hard it is to untangle causality. Then Sullivan writes:

"It is extremely hard to maintain awareness of our own ignorance when trying to make real-world decisions. The article ends with a quote by currently-fashionable behavioral economist Dan Ariely: "If you have a simple problem, you can offer a simple solution. But the economy is a hugely complex problem. So we either simplify the problem and offer a solution, or embrace the complexity and do nothing."

But there is an unconsidered alternative that permits us to constantly recognize our ignorance, yet not be paralyzed: The Open Society. This is the whole point (in my view) of the institutions of representative democracy, limited, law-bound government, and free markets.

We are back to Oakeshott, Hayek and Popper, aren't we?"

My concern with this is that this "alternative" - The Open Society - incorporates both of the options that Ariely lists. "simplify and do something" and "embrace complexity and don't do anything" are both possible under the Open Society. So is "simplify and don't do anything" (I'd argue this is the Tea Party/GOP approach) and "embrace complexity and do something" (my personal approach).

I suppose I just find this interesting from a "uses of Hayek in society"/"who claims the complexity mantle and why" angle. But this really doesn't seem to help matters at all. Where does the movement for fiscal and monetary stimulus come from if not the Open Society? Where does the Tea Party come from if not the Open Society? I think there are some points that the Tea Party makes that threaten American republicanism and constitutionalism, but generally speaking not so much that they can be considered outside of the Open Society.

I alluded to this earlier when I reacted to the way Peter Boettke framed public choice theory: I think a lot of people are making a least common denominator argument and building it up to be some major refutation.

Boettke on the laureates

Peter Boettke has another good post up on the search and matching literature. There are some reasonable sentiments here, he connects the literature to Alchian which I think is fine. It's worth a read. Sometimes, though, I get the impression that a lot of Boettke's insights are based on the narrative that left-leaning economists magically forget simple things like governments screw things up or that markets are efficient. He dreams up these narratives and then builds a case for the importance of the Austrian school and public choice theory on the grounds that they're essential to bring ideas of market efficiency or the risks introduced by governments back to mainstream economics.

I think there's something fundamentally wrong with this sort of mission statement for the Austrian school or public choice theory. The fact is, left-leaning and mainstream economists haven't abandoned the idea of market efficiency*. They never abandoned the idea that politicians don't know how to run an economy. These insights were never lost. If you try to build an Austrian revival on preaching these points, you're not going to be very well received because the reaction will be "(1.) we know that, so (2.) you seem to be trying to feed us libertarianism by clothing it in points of agreement that we already know."

That's not to say the Austrian school and public choice theory don't have something important to offer. The mainstream knows that prices serve a coordinating function in society. They haven't really done much with the fact that the capital structure itself is a function of time and therefore determined by the interest rate. That's what Austrian economics can add. Don't tell us what we already know about market efficiency. It's both condescending and redundant. Public choice theory can teach the mainstream about distinctions between constitutional and political stages of public decision making. That's not widely thought about, but it's hugely important (particularly in a place like the United States). That's what public choice theorists can add. Don't tell us what we already know about political inefficiency. And for God's sake don't act like Buchanan's Cost and Choice was the first time anyone thought about opportunity cost! When you do that, not only do you sound condescending - you also sound ignorant of the literature.

My feeling is this. Any economist that doesn't embrace the idea that markets can screw up and are not the best of all possible worlds comes across (to me at least) as naive and a little immature. Any economist that doesn't embrace the idea that governments can screw up and are not the best of all possible worlds also comes across as naive and immature. And anyone that acts like either of those very obvious facts implies that:

(1.) the market is somehow bad or not an essential social institution, or
(2.) that the government is somehow bad or not an essential social institution

Seems to me, at least on first impression, to be guided by ideology rather than objectivity.

*Unless, of course, by "left-leaning economists" you mean actual Marxists. There are a few important examples of such people, but I think it's foolish to leverage those examples into some sort of representation of left leaning economists. Oskar Lange is an important guy, he played a big role in some mid-century debates... but he's no stand-in for your average left-leaning economist. The man is a Marxist and that's a different situation entirely. I'm talking about the community of classical liberal economists - they have not abandoned any of these points or insights.

Assault of Thoughts - 10/17/2010, Hitler Edition

"Words ought to be a little wild, for they are the assault of thoughts on the unthinking" - JMK

- The Economist has a review of Timothy Snyder's Bloodlands: Europe Between Hitler and Stalin, which documents the ways in which Stalin and Hitler enabled each others' tyrannies, and the ways in which we have forgotten the crimes of both men in Eastern Europe. In 1937, Bertrand Russell wrote that: "homicidal lunatics were well employed in killing each other, but... sensible men would keep out of their way while they were doing it", and I think this is how we tend to view the second world war's eastern front. What that obscures, of course, is the innocents caught in the middle.

- The New York Times reports on a controversial new exhibit on Hitler in Germany. I can understand the German sensitivity to this, but I think the educational goals are laudable. Andrew Sullivan reacts to the exhibit here.

- It turns out that producing fraudulent propaganda was not below the Nazis (shocking, I know). One particular instance recently revealed as a fake is a famous picture that was alleged to show Hitler at a rally in 1914, showcasing the leader's German patriotism. Recent analysis suggests it was doctored.

- I don't mean to ignite any political firestorm with this one - I just thought it was interesting. Apparently, in the 1930s Twentieth Century Fox helped produce film propaganda for the Nazis. I just think it's an interesting piece of history that says nothing about the modern corporation... less scrupulous people that like to make use of flow charts on chalkboards could probably draw a different conclusion, if they were so inclined.

- I recently acquired a copy of Joachim Fest's authoritative biography, Hitler. Not sure if I'll get a chance to read it any time soon, though.

- Twice in the last week or two I've come across references to the foreword to the German edition of Keynes's General Theory and the alleged connection with the Nazis. It's horribly bad analysis to draw that parallel. So in the interest of dispelling it, here's an old post of mine about the foreword. Reading it again, I think the prose is a little rougher than it ought to be. I think I ought to expand on this in the future.

Benoit Mandelbrot, 1924-2010

Benoit Mandelbrot has passed away (HT - Tyler Cowen). Best known for the iconic Mandelbrot set and his work on fractal geometry, he also had a lot to say about the complexity and fragility of financial markets, and the importance of large rare events ("fat tails") in these markets. A lot of people I engage with learned to appreciate complex systems and the economy from Hayek. I first learned to appreciate them from Mandelbrot, Soros (Alchemy of Finance - contra Fox News, Soros doesn't just spend his time wrecking foreign currencies and funding liberals... he's written several good books too and bankrolled democratic movements in Eastern Europe), the Santa Fe Institute, etc.. I'm not deeply familiar with this literature (Soros is the only one I've ever read at any length) - but Mandelbrot/Soros/Santa Fe got me on to Krugman and what he's written about emergent processes (this was my introduction to Krugman, in fact).

I think this chain of influence is a large part of the reason why I find Hayek so much more useful and interesting than Mises. Anyway, there are many roads to complexity and emergent behavior (it would seem to contradict complexity theory if there weren't, wouldn't it?) and I always find it interesting that some people seem to think the Austrian path is the only way there. Sorry - that was something of a tangent, I know. This is Mandelbrot on the Efficient Market Hypothesis - the heart of his argument is at 7:15:

Don't make any loud sounds around the Mises Institute...

OK so a little while ago I blogged on how fricken paranoid people over at the Mises Institute were. You had a great New York Times article covering the influence of Hayek and Bastiat and they managed to be insulted by it. They just knew there had to be some sort of nefarious motive behind the Times article. The author was a known liberal, and the thinking was that that liberalism had to spill over into what she was writing. There was no way that a liberal could be dispassionately interested in reporting on the influences on the Tea Party. And they even admitted that you had to "read between the lines" (i.e. - make shit up) to get this.

So they're back at it. First is Jeff Tucker responding to Ben Bernanke's speech. In any other economics blog you could have woken up this morning to lots of good commentary about the economics of Bernanke's speech. Jeff pulls out one passage where Bernanke highlights the simple point that inflation is a function of both (1.) the money supply and (2.) expectations - he takes the point about expectations and he says that Bernanke is saying "If inflation goes wild, it is your fault for not trusting the Fed". Persecution complex, just like before. Something is seriously wrong with the way Jeff Tucker sees the world.

The next one is J. Grayson Lilburne who writes a long post disputing a year and a half old anonymous Youtube video criticizing the Austrian school. Lilburne makes some good points - the video was a little sloppy on some claims. The thrust of the video, though, is fine and similar to points I've made on here. But the point is it's an anonymous Youtube video that's pretty old as Youtube videos come. How defensive do you have to be to see that and think "I need to go and write a response to this thing!"? If I wrote an extended critique of every poorly reasoned video disputation of Keynesianism it would (1.) be all I write about on here, and (2.) probably crash the Mises.org server from all the searching I'd be doing on their video library.

Paranoia and hypersensitivity is not a healthy quality to have in a community of scholars. There are days I wish the Mises Institute would just convert into a publishing house and leave it at that. And I've thought of saying this out loud for a while but have withheld - I really think Jonathan Finegold Catalan's considerable talents are wasted on the Mises Institute. I understand it's a great venue to get started at. God knows breaking into publishing is tough for young scholars. But I think Jonathan would be better off getting out of the Mises echo chamber. Or at least submit things to the QJAE if you submit there.

Speaking of publishing in Austrian venues, I got the official word last weekend that my article on the 1920-21 depression was accepted for publication in the Review of Austrian Economics (it had been in an R&R holding pattern for a while). They're typesetting and all that right now - very exciting stuff.

Xenophon on Rights

Xenophon left a comment on this post that I think is worth pulling up for discussion. He writes (with his typical absolutist flair and reductionist approach to all historical figures named in a post):

"It is not true that individuals possess a prescriptive ‘natural liberty’ in their economic activities."

This sort of thinking is exactly what is wrong with modern liberalism/progressivism/socialism (they are largely the same thing). No wonder Dewey was such an early fan of Stalin.

The notion that one does not have a right to make a living is so stupid that it is difficult to muster the words to describe its stupidity, yet Dewey stands there and writes such. Worse is of course that Dewey's idea invites the sort rent seeking that harm the folks he presumably wishes to aid the most."

Anyone have any thoughts? My thought is that Xenophon makes the mistake of confusing "no natural rights" with "no rights" as if natural rights were the only rights that could ever exist. Your mistake, Xenophon, is in assuming that your foundation for rights is the only foundation that has been put forward. Neither Keynes nor Dewey nor I have said that the concept of rights is vacuous - only that the concept of natural rights is. There's quite a big difference. If you advocate natural rights I would be wrong to claim you don't believe rights exist - I would have to recognize that you simply understand their origin differently than I do.

I was actually reading James H. Nichols Jr.'s essay on "Pragmatism and the Constitution" in Allan Bloom's edited volume Confronting the Constitution: The Challenge to Locke, Montesquieu, Jefferson, and the Federalists from Utilitarianism, Historicism, Marxism, Freudianism, Pragmatism, Existensialism... (that was too good a sub-title not to write out in full), and with Xenophon's comment this passage from that essay seems worth citing:

"In contrast with this early liberal conception of the natural individual apart from society, Dewey argues that - apart from certain biological structures - the individual does not have much that charcterizes him: "the actual 'laws' of human nature are laws of individuals in association, not of mythical beings apart from association." Accordingly, the idea of opposition between individuals and society is "wholly unjustified". The older idea of the individual as something given is a misleading abstraction; in fact, "social arrangements, laws, insitutions... are means of creating individuals". (emphasis mine)

I'm not finished with the essay yet - it's interesting so far. Needless to say this stark opposition the author and editor want to pose between the founders and pragmatism is a little contrived (I imagine the Marxism chapter is a lot less contrived... and I have no idea how "Freudians" are related to the Constitution). I'm by no means well read when it comes to Dewewy - I just like what I have read. If anyone has good reading suggestions on that, let me know.

Christopher Hitchens on electoral politics

Excellent as usual. Here's an excerpt:

I could introduce you to dozens of enthusiastic and intelligent people, highly aware of "the issues" and very well-informed on all questions from human rights to world trade to counterinsurgency, to none of whom it would occur to subject themselves to what passes for the political "arena." They are willing to give up potentially more lucrative careers in order to work on important questions and expand the limits of what is currently thinkable politically, but the great honor and distinction of serving their country in the legislature is only offered to them at a price that is now way too steep.

Consider: What normal person would consider risking their career and their family life in order to undergo the incessant barrage of intrusive questioning about every aspect of their lives since well before college? To face the constant pettifogging and chatter of Facebook and Twitter and have to boast of how many false friends they had made in a weird cyberland? And if only that was the least of it. Then comes the treadmill of fundraising and the unending tyranny of the opinion polls, which many media systems now use as a substitute for news and as a means of creating stories rather than reporting them. And, even if it "works," most of your time in Washington would be spent raising the dough to hang on to your job. No wonder that the best lack all conviction.

My family has lived in Arlington, Virginia - just about as close to D.C. as you can get without living in it - for five generations, and there hasn't been the slightest inclination among anyone in my family tree to get into electoral politics or even to work on Capitol Hill, with one exception - my great grandad ran for and won a spot on Arlington County School Board a couple times (he helped integrate Arlington County schools in the 1950s, and for those efforts the state legislature in Richmond revoked the right of Arlingtonians to elect their own School Board - so needless to say, no electoral politics after that). When you live this close to the sausage factory you don't really want any part of that.

Boettke on complexity and order in economics

Peter Boettke always has an intriguing way of looking at economics. Here he presents a 2x2 matrix to classify economic perspectives:

"The rows reflect the problem situation we are find ourselves in (simple or complex), the columns reflect the outcome of our interactions (order or disorder). Neoclassical economics is found in the simple/order cell; Keynesian and market failure theory is found in the complex/disorder cell; Marxism and critics of economics are found in the simple/disorder cell. What does that leave? The complex/order cell and that is the intellectual home of the Classical economists such as Smith-Say, the Austrian school from Menger to Mises to Kirzner, and the New Institutional school of Alchian, Buchanan, Coase, Demsetz, North, Olson, Ostrom, Smith, Tullock and Williamson, etc."

To him I'm sure this makes a lot of sense, but it sounded a little odd to me. It seems to me that the only thing putting Keynesian and market failure theorists into the complex/disorder cell is the fact that they don't have a "best of all possible worlds" view of the economy. But is the economy an ordered array of human action for them? Absolutely it is! I wrote in the comment section that where I could see Austrians and Keynesians in different cells is if the matrix was a simplicity/optimality matrix. But in a simplicity/order matrix it seems like Austrians and Keynesians should both be in the complex/order cell.

I would have thought the Nobel prize would have sealed this point. What is search and matching theory if not a market process theory?

I have more thoughts in the comment section of Boettke's post.

Of Streetlamps and Macroeconomics

Mark Thoma and Angus positively review Ricardo Caballero's new paper (previously covered by Peter Boettke) which argues that:

"the current core of macroeconomics—by which I mainly mean the so-called dynamic stochastic general equilibrium approach—has become so mesmerized with its own internal logic that it has begun to confuse the precision it has achieved about its own world with the precision that it has about the real one. This is dangerous for both methodological and policy reasons. On the methodology front, macroeconomic research has been in “fine-tuning” mode within the local-maximum of the dynamic stochastic general equilibrium world, when we should be in “broad-exploration” mode. We are too far from absolute truth to be so specialized and to make the kind of confident quantitative claims that often emerge from the core. On the policy front, this confused precision creates the illusion that a minor adjustment in the standard policy framework will prevent future crises, and by doing so it leaves us overly exposed to the new and unexpected."


It's an intriguing and a cutting criticism, but I'm at something of a loss for how to react to it. Of course, a major part of why I'm at a loss is that I don't really have that much experience with DSGE models. I suppose some of what I did in my macro class for my master's degree could be considered DSGE - but even after that I didn't do anything with it. How familiar is Thoma, Angus, or Boettke with these models when they chime in? I don't know.

I would caution a few things. First, some people are going to be tempted to read this and take it and throw out all "mainstream" theory in favor of a heterodox approach that doesn't emphasize mathematics. The thing is, a lot of the Keynesian "mainstream" that has been expressed in this crisis isn't the kind of economics that Caballero is talking about. He's talking about the RBC and New Keynesian models of the 70s, 80s, and 90s - not the Old Keynesian stuff you see ressurected on the blogs. That doesn't mean the Old Keynesian stuff is up to the task, but it's not what Caballero is talking about here and it's important to realize that.

Second, a lot of what Cabellero describes as the "periphery" of macroeconomics is exactly what the loudest Keynesians now are saying is important and have been saying is important. Caballero writest his of the "periphery":

"To be fair to our field, an enormous amount of work at the intersection of macroeconomics and corporate finance has been chasing many of the issues that played a central role during the current crisis, including liquidity evaporation, collateral shortages, bubbles, crises, panics, fire sales, risk-shifting, contagion, and the like. However, much of this literature belongs to the periphery of macroeconomics rather than to its core. Is the solution then to replace the current core for the periphery? I am tempted—but I think this would address only some of our problems."

This has "Nick Rowe", "Paul Krugman", "Peter Diamond", etc. written all over it. A year ago, Krugman identified this same periphery and pointed out how many people were working on it, arguing that (1.) these are not trivial people, but (2.) they could still be more accepted by the core. None of this is to say that Caballero is wrong - it's only to say that you need to be careful who you try to bludgeon with this point. Some people (I'm not going to name names) have a tendency to lump the entire mainstream together, consider them all hopeless, and then embrace a heterodox position that really isn't up to the task of dealing adequately with any of this.

Third, I'm not sure Caballero is right at all that policymakers are neck-deep in this DSGE, street-lamp macro world. There was recently a flurry of controversy over some remarks made by former Fed governor Larry Meyer. That's discussed here, here, here and here. Essentially, Meyer argues (contra Caballero) that policy makers don't use the fancy new models and they are not "mesmerized with their internal logic". Meyer comes out against those models and asserts that the Fed doesn't usually play those games. I don't really know what goes on in the guts of the macroeconomic policy making apparatus, so I can't say. I do know the classic Fed models are old-school Keynesianism - Klein and Modigliani type stuff. I can't imagine there aren't guys running newer RBC and DSGE stuff there too, but I'll have to take Meyer's word on the general emphasis.

This whole discussion I think probably isn't that productive. A lot of the people weighing in and parroting the reactions probably know next to nothing about DSGE models. They probably also know very little about how government economists do their work. They're also probably not very familiar with the "periphery" literature, and so make the mistake of going for a heterodox economics that is a complete non-sequitor to Caballero's point.

Still, he does have a point and it's worth delving deeper. Just be careful.

Something is very wrong here - please help: Boudreaux, Krugman, and government spending

Don Boudreaux has a post up claiming that real federal spending is positioned to increase by 40% over the 2007-2010 period. He's using inflation-adjusted OMB data (I'm not sure how they adjust for inflation). He argues that federal rose 29% between 2007 and 2009.

He cites Jim Agresti who found that government spending increased by 27% between 2007 and 2009 (apparently Agresit uses nominal BEA government current receipt and expenditure tables).

This is not the kind of growth in government spending I've been tracking with the BEA data (and I don't really follow OMB data), so I checked out the tables I normally go to - the NIPA real (chained 2005 dollar) GDP components tables. I grabbed a mix of quarterly and annual numbers for federal, state and local, and total government spending as well as GDP, and produced these:

These are in billions of 2005 dollars, which is why the levels might look a little off. State and local spending makes up considerably more than federal spending. The quarterly stats are annualized and seasonally adjusted - I'm not sure exactly what that entails, but it means we don't have to worry about comparing across quarterly and annual data (they do have different endpoints though - my annual data ends in the fourth quarter of 2009 and my quarterly data ends in the second quarter of 2010).

So I have a 6.5% increase in total government spending which of course is a weighted average of robust growth at the federal level and shrinkage at the larger state and local level.

What is going on here? I haven't had my second cup of coffee yet so maybe I'm mixing something up. Am I wrong or is Boudreaux and Agresti wrong (their numbers don't even seem to add up with each other, granted)? Why are these numbers so different - shouldn't BEA and OMB be close? I'm also concerned that budgeting practices for OMB make it not exactly what we want to look at - and that the NIPA tables are better. Is it that Agresti adjusts for inflation wrong?

If Krugman is right and government hasn't been up to the task (as I suspect he is), then this is a dangerous claim to be passing around. If Boudreaux is right and it's been "Government's Gone Wild", then that has major implications for what we think of fiscal policy. Can anyone help account for the divergences?

My BEA data is from table 1.1.6. Agresti's seems to be from 3.1. His are nominal dollars. If someone wants to look at 3.9.6, which has the real dollars that would be useful. If anyone wants to look into this more, run more numbers, and write something up I'd be happy to host a guest post sorting all this out - just let me know in the comment section.

Assault of Thoughts - 10/13/2010 "Looking to the future" edition

"Words ought to be a little wild, for they are the assault of thoughts on the unthinking" - JMK

- Paul Krugman is finally having his paper "The Theory of Interstellar Trade" published. No details on when or where. The abstract:

"This paper extends interplanetary trade theory to an interstellar setting. It is chiefly concerned with the following question: how should interest charges on goods in transit be computed when the goods travel at close to the speed of light? This is a problem because the time taken in transit will appear less to an observer traveling with the goods than to a stationary observer. A solution is derived from economic theory, and two useless but true theorems are proved."

- The AHA blog announces a new exhibit at the National Building Museum I saw advertised on the metro that looks interesting. It's called "Building Tomorrow: America's World Fairs of the 1930s". It looks at the impact of six world fairs held during the depression years, and how they conceived of the future, particularly with respect to architecture and design.

- Mises.org republishes a 1979 Libertarian Review article by Murray Rothbard criticizing what he called the "space cadet" contingent among the libertarians. These were the guys that saw a sci-fi libertarian utopia in our future, although Rothbard contends their dedication to libertarianism was weak. This reminds me - does anyone know a good book on utopians - particularly social/economic utopians of the last century and a half or so? I know Cohn, although he covers slightly different material. This, like many things, is a perspective that has interested me a lot more since reading Lovecraft's letters and essays.

- The Long Now blog looks at what the constellations will look like in 50,000 years.

The Blogosphere on the Nobel Prize

As I told my wife last night, I have been very, very pleased with the Nobel winners this year. Although I've done almost no actual work in this field yet (one unpublished conference paper and I'm writing another economic history paper right now using similar ideas), the search and matching approach to labor markets is sort of what I've tied myself to in my personal statement for graduate school. As all the links have suggested, economists have celebrated these guys for years. But this prize cements these ideas as being of more permanent importance. I also think it's pretty cool that I mentioned the prospect of these guys winning on this blog when I didn't see them on anyone else's short list.

So what has the blogosphere said over the last 24 hours? Actually it seems like it's said much less than it did after the 2008 Krugman prize or the 2009 Ostrom and Williamson prize.

Tyler Cowen has by far the most comprehensive coverage I've seen. He has an overview here, a discussion of Diamond here, Mortensen here, and Pissarides here. This is an excellent review by Cowen. He writes:

"This is a prize for the importance of economic heterogeneity and the importance of second-order effects. The cited labor market imperfections cannot be cured by reflating nominal demand, although that policy may be desirable for other reasons. Mortensen and Pissarides have an explicitly Schumpeterian approach and their work represents one version of a "recalculation" argument. (Peter Diamond in contrast does not draw out that aspect of the problem and I think of the three as each a quite different kind of economist.) You can think of Mortensen and Pissarides as providing one reason why private recalculation takes longer than is socially optimal and how this might be fixed. Their work shows how cyclical and structural phenomena operate together and must be analyzed together. In the last twenty years their work on labor markets has been much more influential, and rightly so, than traditional Keynesian approaches. Furthermore their work has dissolved the entire characterization of "Keynes vs. whomever" as out of date. Their work has much influenced my blogging on the recent employment crisis."

Like clock-work, Arnold Kling connects the winners to his recalculation story. I was actually surprised this post didn't go up sooner. I think that's basically right, but that it's much, much more than that. There are differences too, though. Kling's version is usually expressed as an industrial restructuring story - people need to move from one industry to another as the economy changes. Mortensen and Pissarides (and I suppose Diamond - I am less familiar with him) don't really require wholesale restructuring. Even in an economy with a static industrial composition, their search and matching frictions still apply.

Paul Krugman notes the prize winners have specific predictions about the behavior of job creation and job destruction when there is an when there isn't an aggregate demand problem - and what we're seeing now indicates an aggregate demand problem.

Mark Thoma reflects here, Stephen Williamson here, Ed Glaeser here, and Edmund Andrews here.

Let me know if there are any other good discussions of the new laureates!

In the next day or two I hope to get a response from my boss about an idea I pitched about writing a short fact sheet providing an easily accessible explanation of Diamond, Mortensen, and Pissarides's work and connecting these search and matching ideas to the research done at the Urban Institute. A lot of the work we do was either initially inspired by this research or is very relevant to it. So this seemed like a good hook to repackage and promote some of the stuff we've published in the last two years or so and explain this relatively technical literature to the public and to policymakers. I'll let you know if they give the go ahead on that.