A New Fallacy

I'm coining a new fallacy in discussions of economics and politics: the Central Government Fallacy. Committed by those who forget that we live in a federal republic, and in so doing make fallacious claims about policy. People are very prone to committing the Central Government Fallacy when talking about macroeconomic policy.

How significant is the Central Government Fallacy for today's public discourse? Very significant. If you're one of those people that thinks the United States is engaging in Keynesian macroeconomic policy, then you haven't been paying attention.

There's been a lot of talk about Keynesianism lately - and that's good. And there are a lot of policymakers that have been taking Keynes seriously lately - and that's also good. But if you think we've been practicing Keynesianism, you're quite simply wrong. How would I characterize our policy response to the economic crisis? Tepid monetarism. That works tolerably well in most circumstances, but not when nominal interest rates are at record lows, inflation is low, and demand is weak.

Of Austrians and Integrals

So I was looking through Ludwig von Mises's Human Action online this morning for something specific, and I stumbled across a section title that gave me great hope that I had misplaced my criticism of the Austrian School's bizarrre aversion to mathematical economics.

The section title was:

"The Integration of Catallactic Functions"

Alas, "integration of functions" did not end up meaning what for a brief instant I had hoped it meant. I should have known better - I just have integration on the brain. On Tuesday I take my partial differential equations final. It's funny - you'd think a subject called "differential equations" would have more differentiation. If I remember my ordinary differential equations from a couple years back, that did have a lot of differentiation. PDE, however, is just a ton of integration. Bah.

It's times like this that I regret being a mere mortal - for as Albert Einstein reminds us: "God does not care about our mathematical difficulties. He integrates empirically".

Despite the difficulties in integrating functions that are introduced by my blatant lack of divinity, at least I have a Y-chromosome:

...or perhaps I missed the point of the comic :)

Russ Roberts and Joe Stiglitz on the Crisis

Russ Roberts, an economist at George Mason University, recently finished an essay on the incentive structures that caused the financial crisis, which he's been working on for several months now. While I don't agree with Roberts's policy recommendations, I think he presents a very good and clear way of thinking about financial regulation. It's a typology that I've also heard Joe Stiglitz use (he comes to different conclusions), so I thought it was worth sharing with you. This is my spin on what these two men have said, of course - it's extremely general. Please take it as a policy typology and not a policy position.

We can simplify and think of two possible types of policy for finance: "regulating the upside" and "insuring the downside". Of course many policy options fall into these categories, and it's a lot more complicated - but this is their basic framework. "Regulating the upside" is far dicier an endeavor and a lot more falls under that umbrella. Restrictions on interstate banking, capital requirements, disclosure requirements, distinctions between commercial and investment banking, and regulation of specific products like derivatives all fall under this category. So I want to make clear that just because Stiglitz (and I) advocate "regulating the upside", that doesn't mean that everyone in this camp supports all the same policies. It's just a good way of thinking about our options. "Insuring the downside" is somewhat easier to think about. This includes things like deposit insurance (FDIC), arguably the Fed discount window's "lender of last resort" function, post hoc bailouts (and, as Roberts emphasizes, the presumption of post hoc bailouts), and even the "Greenspan Put". So with these two policy types, we can think of four basic options: (1.) don't regulate or insure, (2.) regulate, but don't insure, (3.) insure but don't regulate, and (4.) regulate and insure.

Both Roberts and Stiglitz have argued that one of the major causes of this crisis was that we insured against losses for financial institutions in a variety of ways, leading them to take dangerous risks. Roberts would have us eliminate these insurance measures so to reduce excess risk taking. Stiglitz would keep the insurance measures but regulate the activities of financial institutions more stringently. They each made their case to the Joint Economic Committee in December, which you can watch here.

What's interesting and nice is that there is such broad agreement that a disproportionate emphasis on insuring losses is dangerous. But there are reasonable critiques of the other options as well. Roberts's solution of removing is rejected by almost all economists, and for good reason. Policies like deposit insurance were put in place in the first place because excessive losses tend to exacerbate crises. Roberts is right that when someone covers your losses you will take more risks than you otherwise would. But he cheerfully ignores or glosses over the fact that when you risk suffering large losses from the mistakes of others or systemic downturns, that dampens investment activity and encourages people to take too few risks.

Stiglitz argues, contra Roberts, that the solution isn't to unlearn all of the lessons about the importance of insuring certain downside risks. His point is that you insure, but then you regulate the excessive behavior that a few will take, knowing that their losses are insured. This avoids the biggest dangers of an erratic credit cycle that Stiglitz suggests (and I agree) would happen with Roberts's plan. The danger, of course, is that there are a lot of regulations of the upside that we could conceive of, and not all of them are good. Government employees and private employees are made of the same stuff, and both make mistakes. Excessive regulation can dampen economic growth.

And of course there's also a lot of common ground. Debt is privileged over equity in the tax code, and I think fixing that would have broad appeal for both camps. "Too big to fail" distorts the idea of loss insurance, substituting ad hoc corporate welfare. Insurance is about covering expected losses - "too big to fail" is about "it's easier to ask forgiveness than permission". Both sides want to take measures to guarantee that the implicit bailout is no longer implicit.

Ultimately, though, Stiglitz and Roberts come to wholly opposite conclusions from roughly the same initial critique of our current regulatory apparatus. The common ground only goes so far, but I think it's interesting that they're working from the same basic typology. The choice between Roberts and Stiglitz ultimately boils down to a question of the volatility of the market vs. the heavy handedness of government. Both are quite real concerns, and we do ourselves a disservice by ignoring either one of them. While I personally fall in Joe Stiglitz's lower-right hand quadrant of the typology I've presented, I definitely have my differences with him, as I certainly do with Roberts as well. Generally speaking, I worry that Roberts doesn't pay adequate attention to the market failures that I described, and Stiglitz doesn't pay adequate attention to the potential government failures.

Before closing, I'd like to provide a link and a disclaimer. First, I want to refer people back to my post on Hyman Minsky (which now has some very insightful comments from F&OST guest, Sebastian). My basic critique of Roberts is that he misses the Minsky insight of financial fragility. Indeed, to the extent he recognizes this sort of fragility, he lauds it as a virtue. In many cases it is a virtue. There is absolutely no doubt that failure is functional - that destruction is creative. The market is successful precisely because firms and individuals fail. That's not where Roberts disagrees with economists like Stiglitz (although Roberts would probably like you to think that's where the disagreement lies!). The point of disagreement isn't the necessity of letting people fail. The point of the disagreement is that Stiglitz sees both functional and unfunctional kinds of failure, whereas Roberts rarely mentions the type of destruction and failure that isn't functional or creative.

My disclaimer is that I haven't read Roberts's new essay yet. However, he's been working on it for a while, and I've read and extensively commented on numerous blog posts from Roberts on the issue and even on this essay while it was in its formative stages. I also did listen to his entire December testimony. So take this more as general thoughts on Russ Roberts's position, rather than on this essay in particular.

Will the real "epistemic closure" please stand up?

There has been considerable discussion in the blogosphere about the "epistemic closure" of modern American conservatism. It seems to have started with Julian Sanchez, who expressed concerns about AEI's treatment of David Frum (an issue that has been disconcerting for me as well, as a think tank employee myself). Douthat, Yglesias, McArdle, Friedersdorf, and many others responded to Sanchez's thoughts. Another major engagement has involved Manzi and Levin at The National Review, over a piece that Levin wrote on climate change. Bruce Bartlett has shared his own, very well known experience in the conservative movement. Ezra Klein adds some interesting (if limited) empirical evidence (I share his criticism of the method - but as he suggests, something similar could be expanded upon). There's certainly a lot that I've missed, but each of these links will lead you to other links - so you should be able to catch up (I haven't read through it all in detail - I've been putting my free time into studying for a final this week).

Anyway, through all of these really great thoughts, I think the meaning of the initial "epistemic closure" concern has been lost. I count at least three versions of "epistemic closure" available to us - two of which are being addressed in this ongoing debate, and a third that I think is especially interesting to think about.

Version 1 (Wrong and Uninteresting): "Epistemic Closure" as shorthand for various and sundry bitching about conservatism
One of my biggest concerns, however, has been that this whole debate has degenerated into complaining about conservatism, rather than providing a clear critique of conservatism. For Bruce Bartlett, conservatism's alleged epistemic closure amounts to: "They don’t think there are any new ideas of particular interest to them. Their philosophy is fully formed. The only question is how best to implement conservative ideas in the political debate". His concern seems to be the increasing activism of conservatism, and the rigidity of their value system. Others have talked about the "conservative cocoon" phenomenon, where conservatives (allegedly) have restricted interactions with those who don't share their views (in a similar vein, a friend from college shared this this interesting research with me on the closedness of the conservative blogosphere). Douthat focuses on the point of whether there are internal debates in conservatism, a question that is especially salient in light of the Frum Affair. But none of these address the more fundamental point of epistemic closure that was originally raised.

Bartlett's concern about activism and values is beside the initial point. Marxists, for example (at least the early Marxists) were unalloyed activists with a completely closed value system, but they were very thorough in thinking through epistemological questions. As for the "cocoon", the phrase "the ivory tower" is definitive of the cocooning of a group of thinkers - and yet no one accuses the academy of having an underdeveloped approach to epistemology. Douthat's concern with internal debate also has nothing to do with epistemic closure. There is no debate to speak of that 2+2=4 or that the Earth revolves around the Sun. Does that mean it is supported by a suspect epistemology? As I say, I haven't read all of this in great detail, but a lot of the debate seems to simply be a random assortment of complaints about conservatism, with the fancy phrase "epistemic closure" thrown in as a catch-all.

Version 2 (Wrong and Interesting): "Epistemic Closure" and the way that conservatives know what they "know"
Beneath the surface of these random complaints, there is real concern with and discussion of what Julian Sanchez initially meant by "epistemic closure" - namely, how conservatives derive knowledge about the issues that they pontificate on. Sanchez argues that accuracy of the knowledge inputs for the conservative movement are increasingly unimportant. Conspiracy theories, birth certificate skepticism, and crazy Beckesque guilt-by-association chalkboard flow charts have (so the argument goes) become sufficient factual fodder on which conservatives build their arguments.

The Manzi-Levin debate on the National Review is worth looking at as an example (well, at least Manzi's initial post is an example) of a genuine discussion of epistemological questions. Climate change is one issue where I think conservatives are pretty clearly ignoring the evidence to defend what is essentially an ideological position. Other issues, such as financial regulation, health reform, and fiscal stimulus are more dubious issues. I think it's hard to make a blanket statement that conservatives "ignore the evidence" more than liberals. Often they're taking the same evidence and simply applying a different set of values to it. Regardless, it's a fruitful question to ask - and there are a lot of conservatives, particularly in Washington, that do seem to be assuming their own conclusions rather than carefully reviewing the evidence.

Version 3 (Right and Very Interesting): The "Epistemic Closure" of Julian Sanchez's undergraduate subconscious
The New York Times reports Sanchez's confession that "he probably fished “epistemic closure” out of his subconscious from an undergraduate course in philosophy". Indeed he did. Sanchez used "epistemic closure" to describe the problem of "epistemological closed-mindedness", but "epistemic closure" is also a technical term in philosophy, which I only stumbled across recently while preparing for this blog post. The short definition of "epistemic closure" is:

"The principle that, where P and Q are propositions, if we know that P, and know that P logically entails Q, we know that Q"

In other words, "closure" refers to a closed system of knowledge, not closed-mindedness. I think it's fine that Sanchez didn't use "epistemic closure" in this technical sense, but it's interesting to think about the implications of this definition. The idea of "epistemic closure" is often closely associated with skepticism, because of the very real possibility that your knowledge of your initial statement (P), somehow (implicitly) presupposes the later statement (Q). The example given in this longer treatment of epistemic closure is:

"the proposition I have a driver’s license issued by the state of North Carolina entails that North Carolina is not a mere figment of my imagination"

The skeptical position would point out that your ability to make the initial statement presupposes the truth of the second statement. It's not exactly what Sanchez had in mind (and I should point out that I think what he did have in mind, while not exactly "epistemic closure", was also very interesting), but this does relate to a problem that I'm personally concerned about: the problem of deductively extended logical systems of thought. Theoretically, deductive logic is a fantastic source of knowledge. But it relies on two fundamental pillars: the accuracy of its axioms and presuppositions, and the validity of its deductions. The skeptical objection to arguments based on "epistemic closure" are very similar to my (perhaps less formalized) reservations about deductive logic and a disproportionate emphasis on rationality and reason in general.

Logical formality can amplify the errors of bad initial assumptions, while providing the veneer of incontrovertibility. As logical systems get increasingly extended, making broader and broader claims, the initial errors (which may have been negligible) can easily multiply into substantial errors. As Nikola Tesla once said: "Today's scientists have substituted mathematics for experiments, and they wander off through equation after equation, and eventually build a structure which has no relation to reality". In economics, I think the Austrian School and Real Business Cycle School are both excellent examples of Tesla's scientists who have "wandered off", confident in their deductive systems that bear no relation to reality. At least Real Business Cycle theorists will do empirical work to check up on things. The Austrian School explicitly refuses to do this check up.

I suppose I've wandered quite far from the point of conservative "epistemic closure" over the course of this etymological exercise. Are conservatives more likely to "wander off" with deductive arguments built from fallacious assumptions? Quite possibly. I think that's an open question.

A Specter is Haunting Europe...

Lots of smart people are getting very worried about Europe.

Nick Rowe is contemplating the withered shell of the Eurozone that may be left after all this is over.

Paul Krugman is bracing for "the mother of all bank runs"

and Ken Rogoff, the former IMF chief economist, said that it is unlikely that the sovereign bailouts would end with Greece.

And all these pronouncements of course feed into expectations, which makes the bad news even worse. We aren't out of the woods yet.

Baby's First Cubicle

Two Marcusian insights in one toy:

"To the extent to which the machine becomes itself a system of mechanical tools and relations and thus extends far beyond the individual work process, it asserts its larger domination by reducing the "professional autonomy" of the laborer and integrating him with other professions which suffer and direct the technical ensemble."

and

"The people recognize themselves in their commodities; they find their soul in their automobile, hi-fi set, split-level home, kitchen equipment."


Although we should be careful not to get too worked up about this sort of thing. Remember, Marcuse also said: "Not every problem someone has with his girlfriend is necessarily due to the capitalist mode of production."

What to expect from alien contact

In his Discovery Channel series, Stephen Hawking recently made two important statements about alien life: (1.) that it almost certainly exists, and (2.) that trying to contact it would be extremely dangerous. His point is simple - that alien life in all likelihood would see the Earth as a source of resources, and would come here to destroy us and take what they need.

Despite the clear thinking that Stephen Hawking has done in the past on the place of humans in the universe, I think his point here is problematic. Drezner raises a number of concerns with Hawking's point as well - many of which revolve around strategic considerations. But I think he even misses another important point.

We shouldn't discount the prospect that alien life will have evolved cooperative, friendly, rational, altruistic tendencies and a robust sense of universal rights - perhaps even property rights. And just as a considerably more advanced alien society can be expected to have stronger biological and technological faculties than humans, we should expect them to have more advanced social faculties. Daniel Dennett highlights the fact that while life evolving on other planets will of course be considerably different from life on Earth, there are many "good tricks" that evolution will "discover" again and again. He gives the example of eyesight (for organisms evolving in a transparent atmosphere) as a feature that is so advantageous it is almost certain to evolve elsewhere. Other things, like a base-ten number system - are considerably less likely to evolve again and again because in all likelihood it emerged solely as a function of our ten fingers.

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I would guess that cooperation, trust, and the recognition of some collection of universal rights are memes that would almost certainly evolve in an advanced species. Daniel Dennett reviews Dawkins's theory of memes here, and specifically points out the role that memes can play in overriding the underlying impulse to thrive and reproduce* (which itself is probably an evolved meme, or at least an evolved cocktail of hormones). Dennett focuses on destructive memes - like Wahhibism - but he also mentions more constructive memes, like the idea of memes itself! One of the most obvious "successful memes" is the ability to trust others, to cooperate, to exchange, and to recognize these things called "rights" which have no substantive or tangible basis but are nevertheless extremely important in human society. A great deal of research has suggested that it was precisely this ability of humans to trust each other and engage in mutually beneficial exchange (which is impossible without an understanding of property rights) that allowed them to dominate the Neanderthals (who did not have trade networks). Of course, this highlights the fact that cooperation and violent competition are not necessarily mutually exclusive. Yet in the last hundred years humans have worked to make the two mutually exclusive.

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Why wouldn't we expect aliens to evolve that ability to trust, cooperate, exchange, and recognize rights? It seems like one of those "good tricks" that evolution will discover again and again. Certainly any civilization advanced enough to reach and destroy the Earth probably depended on some version of property rights and exchange to get to its advanced state.

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Obviously, none of this is certain. We don't have a lot of evidence to draw from. Some form of trust and exchange seems quite essential to successful evolution: trust and exchange to the exclusion of violence and domination seems much less important and far more tenuous, based on the experience of our own society. But I think there's reason to be optimistic. As Adam Smith said, "the division of labor is limited by the extent of the market". Because trade, exchange, and cooperation are networked-based activities, they become more beneficial as the network grows. This is why I think there is an underlying tendency towards a global economy and a global government: and this tendency is implicit in the nature of trust, exchange, and cooperation. If it is implicit, then a unified planet operating on the basis of trust, cooperation, and exchange shouldn't be all that inconceivable. None of this is to say that a Spartan meme wouldn't also be evolutionarily fit. We seem to have demonstrated by experience that a Spartan meme completely devoid of out-group cooperation and trust is not evolutionarily fit - but who knows? I think Hawking is jumping the gun to just assume that aliens would be dangerous. They could be dangerous, but there's also good reason to believe that if they're more advanced than us, we may very well be the trigger-happy, belligerent ones.

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*Dennett's characterization of the impulse to thrive and reproduce is somewhat problematic and at odds with another Dawkins idea - the idea of the "selfish gene". Ultimately, it is selection at the genetic level that drives evolution, not at the level of the organism. Many organisms themselves have evolved the tendency not to reproduce because it facilitates the reproduction of their genetic code through other close relatives. Dennett glosses over his point here, but I don't think it changes the argument substantively.

Assault of Thoughts - 4/26/2010

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

- The private space industry took a step forward this month when Dulles-based Orbital Sciences bought General Dynamics' spacecraft development and manufacturing division. I think this is good for two reasons. First, we've known since Smith's Wealth of Nations that "the division of labor is limited by the extent of the market". The emergence of dedicated spacecraft manufacturing companies is a sign that the extent of the spacecraft manufacturing market is expected to broaden. It's also a good sign that space will not necessarily be utilized, explored, and eventually settled by defense contractors like General Dynamics.

- How many NABE firm surveys is it going to take to realize that hiring has been primarily limited by aggregate demand expectations, and not by taxes or regulatory uncertainty or the alleged generosity of the safety net? I really don't see what's so hard about this.

- The financial reform bill is moving through Congress, and I'm wondering how many people actually know what's in it. I haven't had the opportunity to follow this debate as closely as the health reform debate - and I felt like a lot of Americans had misconceptions about what was in the health reform bill (which was relatively easier to understand). How many know what is in this one? And yet how many people think we should just do nothing with this bill? This is a pretty good argument for representative government - but it simultaneously highlights the problems of any government solution.

- Paul Krugman talks about epistemic closure in macroeconomics. I don't know how to take this, really. It certainly sounds plausible - I'm not sure whether it's true or not. It reminds me of some awkward conversations I've had with my supervisor at work. We were talking about my plans for PhD programs, and she suggested I shoot high and that one of the places I apply should be Chicago (she went to Chicago for her masters' in public policy). Not only is that a ridiculously long shot, I had trouble explaining to her that while I'm sure I'd get a great education there I'm just not sure how balanced it would be. I think my brother Evan (a current PhD student in Chicago's Divinity School) is savvy enough to get the point without being offended, but I'm not sure this is on other people's radar. At a place like Harvard, you know you'll get a balanced position. You've got Greg Mankiw on the one hand and Robert Barro on the other. You're going to hear both sides of the issue. Maybe you would at Chicago too, I just couldn't say with as much certainty.

- I've had a decent opportunity to study this weekend because Kate has been watching Sex and the City, which doesn't always hold my attention. However, it did remind me of something I stumbled across this week that would have fit in perfectly with the show: a detailed review of John Maynard Keynes's sex diaries. I knew that Keynes had a promiscuous streak of homosexual encounters in his early years at Cambridge, but I had always thought these were more anecdotal. It turns out, he actually kept meticulous records on it. The earlier diary names names, including many men from the Bloomsbury Group. The later diary is a coded time series of encounters.

- My paper on the 1920-21 depression on SSRN. As soon as my PDE class is over next week I'm going to revisit this with gusto and then submit. Any thoughts are appreciated.

- Barro and Lee have an updated version of their global education dataset available now at NBER. It's a fairly interesting endeavor - I first came into contact with it in econometrics a couple years ago.

- Inside Higher Ed reviews the AEA's new sub-journal proceedure. I'm curious what other people think of this. My impression has been that the four sub-journals aren't as prestiguous as other journals in the field. In other words - they're not really a runner up to the AER. But then again, I haven't published in any journals yet, so I'm not necessarily the best person to ask.

Minsky as the Glue of an Austrian-Keynesian Synthesis?

Washington is buzzing about financial reform, and so Hyman Minsky has been on the table (well, the 19th Annual Minsky Conference helped with that too). Minsky was a Keynesian economist (usually classified as "post-Keynesian" because of his hostility to the neoclassical synthesis) that taught at Brown, Berkley, and the Washington University in St. Louis. His primary contribution was the idea of "financial fragility" - the fundamental instability of financial markets. He attributed this fragility to the division of borrowers into three groups: hedge borrowers (who can pay off principal and interest out of the cash flow from their investments), speculative borrowers (who can pay off the interest of the debt out of cash flow but must roll over the debt), and Ponzi borrowers (who can only pay off the debt from capital gains, not cash flow). Credit grows the economy, and as the economy grows more Ponzi borrowers are attracted to the market (they see asset values appreciating, which is essential to their strategy for paying debt). If asset values stop appreciating, Ponzi borrowers default and credit is restricted for hedge and speculative borrowers. If the shock is large enough, the Ponzi borrowers can bring down the system. It's a familair sort of story - it sounds a lot like animal spirits, accelerator-multiplier stories, and lots of other Keynesian dynamics. This one just depends on asset values and debt financing strategies.

And I had always associated it with Keynesians until this morning when I saw a post by Arnold Kling (a libertarian economist blogging at Econlog) that seemed to be suggesting that Krugman (in a post lauding Minsky, no less) positioned himself against Minsky. I think Kling's concern was that Krugman suggested that regulation might help fix the "financial fragility" problem. It's an odd thing for Kling to juxtapose with Minsky, since Minsky thought essentially the same thing!

But it did make me think about Minsky's relationship with more libertarian economists. There's actually quite a bit of common ground with Austrian credit cycles. Frank Shostak blogged on Minsky at the Mises Institute blog in 2007. His response was typical of Austrian answers to this sort of question - he argued that Minsky "described" the crisis but did not provide an explanation for why it started. What Shostak really means, of course, is that Minsky didn't provide the explanation that Shostak wanted him to provide. Minsky's system works on its own. Simple intertemporal choice theory gives us the reason for why debt financing emerges. Once you have debt financing, all you need is borrowers with different motivations and repayment strategies (Minsky's hedge, speculative, and Ponzi borrowers), and the system runs on its own: boom and bust, boom and bust. Debt and agent heterogeneity is all it takes. I'm not sure why Shostak can't see this, but regardless - he wanted Minsky to say that central banking was the source of the crisis, which Minsky did not say.

I'm starting to stray outside of territory that I'm familiar with, but it seems to me that a more Rothbardian take on the credit cycle is much more easily reconciled with Minsky. Rothbard recognized that it was the credit system itself, and not central banking in particular (although he of course had major critiques of central banking too) that introduced the business cycle. Rothbard of course took this more or less reasonable concern and went off the deep end with it. He alternatively advocated full reserve banking (!!!!!), and free banking (where banks would issue their own currency, and there would be no bank regulation or central banking). I can't imagine the cognitive dissonance that came with advocating both of those courses of action - one of the most restrictive forms of bank regulation one could think of on the one hand, and complete deregulation on the other. But they do seem to come from a common source for Rothbard: the acknowledgement of a fundamental cyclicality of the credit market.

So can Minsky - with his Keynesian explanation of credit cycles - offer an opportunity for the Austrian-Keynesian synthesis that I've written about in previous posts? My previous thinking on the issue has focused on: (1.) general framing: the shared concern about uncertainty, decentralized knowledge, and time, and (2.) the macroeconomy: a "Garrison-Modigiliani" synthesis of sorts.

But Minsky may offer another point of connection. I've previously remarked that Brad DeLong offers an important olive branch when he highlights the relevance of Austrian theory to pre-Depression business cycles. Of course, Austrian economists are often the type of people that simply don't know how to take a compliment. Because DeLong also critiqued a few of their points, they've generally interpreted his olive branch as a hostile attack! But Minsky goes beyond what Brad DeLong has conceded, and offers the possibility that Austrian (or at least Rothbardian) ideas on the credit cycle may be relevant after the Depression as well as before.

I think there's a lot that needs to be reevaluated before any of this happens - not the least of which being the Austrian's central bank fetish. That, of course, is a problem. Many Austrians think that their critique of central banking is what Austrian economics is. I actually disagree, and I think that's really selling the Austrian school short. The value added from Austrian economics, in my opinion, is the combination of the credit cycle with the temporalized capital structure, and the dynamics that that introduces. Their views on central banking, epistemology, and methodology (not to mention their views on Keynesianism) hinder the Austrian project.

I know this is still all very general, just like my last post on this sort of synthesis. I don't know what to say except for (1.) I have more specific ideas in my head that I am more hesistant to post explicitly, and (2.) I do intend to write them up at some point - but perhaps in the somewhat more distant future.

In closing, I found several interesting Minsky links:

- First, the Levy Economics Institute at Bard College is ground zero for Minskyesque economics today, and it offers a lot of interesting post-Keynesian perspectives.

- They have recently made Minsky's papers available online

- The New Yorker has an interesting piece on Minsky here.

- The Economist describes the proceedings of the Minsky conference (including a lot of what Krugman had to say) here.

- The Economist also describes the Fed's (probably somewhat self-serving) advocacy of Minsky here.

Solidarity

The creators of South Park recently joined the ranks of many other artists whose lives were threatened by Muslim fundamentalists dedicated to the proposition that other human beings who don't share their values or who offend their sensibilities don't deserve to draw breath. The motivations behind Muslim rage and frustration are varied and complex. I would even submit that some of these motivations may be justified. Muslim societies across the world have borne considerable pain and suffering over the last several decades - much of it entirely unprovoked. But none of this justifies threats to artists and satirists working to enlighten, enrich, and entertain us.

To add insult to injury, Comedy Central censored the episode that Trey Parker and Matt Stone submitted. This isn't a first amendment issue, of course. Comedy Central had every right to do what it did. But in my opinion, they tarnished themselves by abandoning Trey and Matt, who have worked tirelessly to deconstruct shibboleths and taboos. You may not enjoy the show, but to a certain extent you have to respect the satirical mission.

Militant fundamentalist Islam is more than a security threat. It is a step backwards in human evolution - a regress to a time before modernism and humanism - as is every militant fundamentalism. Perhaps the only difference between Islamic militant fundamentalism and other varieties is that its toxic combination of revealed truth, liberal textual appeals to violence, and an explicitly global sense of its own jurisdiction imbues the movement with a unique animation and activism. Nationally based militant fundamentalisms (such as national fascist movements), or militant fundamentalisms based on other epistemologies than revealed truth (such as international Communism) are certainly disturbing, but in many ways they are less disconcerting. More reasonable epistemologies can be reasoned with or disproven. More limited jurisdictional claims can be isolated or even simply appeased. Militant fundamentalist Islam is a different beast that is only further complicated by the fact that there most definitely is (and we can never forget this) a considerably more widespread non-militant, non-fundamentalist Islam.

I can only speak for myself, not Evan - but I want to offer this post in solidarity with South Park and all the other artists, film makers, and writers that have faced or even suffered death at the hands of these people.

South Park

The Danish Cartoonists

Theo Van Gogh

Salman Rushdie

And an intriguing response suggestion.

Of Miracles

Who has taken the time to read their Hume?:

A.) The Insane Clown Posse

B.) Christopher Hitchens

Here's a tougher quiz. Who is more entertaining and offensive to the tender, mild-mannered mainstream:

A.) The Insane Clown Posse

B.) Christopher Hitchens

Libertarian Paternalism Exchange

Cato Unbound has an interesting exchange up between Glen Whitman and Richard Thaler. I get the same impression from Whitman that I mentioned in this morning's post on "pendulum science" and the tendancy to attribute some starkly opposing position to someone you happen to be disagreeing with at the time. That's really bad practice, in my opinion. As Paul Krugman recently wrote: even though we may disagree, it does not follow that we are mirror images of each other. Just because you are especially attached to the free market (or in this case anti-paternalism) doesn't mean that everybody that you don't completely agree with isn't also attached to the free market and anti-paternalism. I haven't followed libertarian paternalism in detail, so I'm not saying that I side with Thaler over Whitman, but he had some good points. I know a lot of people that could take this point of his to heart:

"Finally, it is of course true that I cannot control how my ideas are used, either by those who advocate similar but more intrusive policies, nor by those like Whitman who criticize them by mischaracterizing them. When we say that we only want to help people make better choices as judged by themselves, we mean it. Really. And it is frustrating to constantly have to respond to those who criticize something we do not say or believe."

Pigou and Coase: Progress, or just a Pendulum?

We like to think that science advances somehow. Maybe it creeps along as theories are falsified in turn. Maybe the internal contradictions of one way of thinking reach a crescendo and there is a sharp "paradigm shift" in thought. Or maybe two opposing ideas find a way of taking the best of both worlds, and synthesize into a better alternative. Some people can make a lot of fuss about which of these models of scientific progress is the right one - I think it's quite clear that we progress in all three ways, depending on the circumstances.

Nevertheless, I sometimes feel like social sciences especially have a pendulum model of non-progress. People go back and forth between two distinct camps and there's no real growth in knowledge. On balance, I don't think that is social science's dynamic, of course. On balance I do think it progresses. But the frequency with which it behaves like a pendulum is unfortunate.

I got the sense of the pendulum of economics recently when I began to read this paper by Roger Backhouse and Steven Medema on "government failure" in the Cambridge, Chicago, and Virginia schools of thought. I found it through the GMU Workshop in Philosophy, Politics, and Economics webpage, which I was interested in exploring after reading this recent post by Peter Boettke on PPE programs across the country (a very good development, in my mind).

The paper presents a history of "welfare economics". First, let me present my perspective on that history - which is somewhat of an outsider's perspective, but a decently informed one, I think:

1776-1912: Classical and very early neoclassical economists outlined for the world why the division of labor and free exchange maximized human welfare. They weren't anarchists - they saw a role for the state, but at the time the important point was to show the ways in which state intervention hurt people. So most of the effort was put into demonstrating the welfare-maximizing properties of the market. Arguments for the role the state should play stayed relatively ad hoc simply because that wasn't the point of the endeavor.

1912: Arthur Cecil Pigou (in my opinion, by far the most stereotypically British name a mother and father have ever conspired to anoint their offspring with) writes Wealth and Welfare, which systematizes how we think about human welfare, reaffirms earlier views on the welfare maximizing properties of markets, and introduces the essential insight welfare maximization crucially depends on whether all the costs and benefits of a transaction are borne by the parties to the transaction. If not all the costs are felt by the parties to the transaction, too much of that transaction will transpire (why not produce and trade more of it if you're not bearing all the costs?). If not all the benefits are felt by the parties to the transaction, too little of that transaction will transpire for the same reason. In other words, my view of Pigou's most important contribution was that he put the right to enjoy the benefits of property (one of several traditional elements of a "property right") front and center in the question of the welfare maximizing properties of a market.

post-1912: After Pigou, Ronald Coase made the further innovation of introducing transaction costs. Coase reemphasized Pigou's point that full property rights guaranteed welfare maximization (remember for Pigou the problems arose when there was something wrong with the property rights). But he also highlighted the fact that in theory there's no reason why property rights can't be complete. So why are they incomplete in practice? Coase's solution was that we incur transaction costs when we define property rights or trade rights to property with others. We can think of transaction costs as the costs of trading or drawing up contracts. Coase got a lot of mileage out of transaction costs, including his theory of the firm.

That has always been my understanding of "welfare economics", at least up to Coase, and I've always been a fan of both Pigou and Coase. They seem like two sides of the same coin to me. Externalities (ie - Pigou) form a huge part of my thinking now, especially with respect to the strange but compelling idea of the social contract, and I cited Coase liberally in my senior thesis. They're both great, and quite complementary (at least I've always thought so). Some people juxtapose them more starkly, which is what this paper by Backhouse and Medema has done (although I'm not all the way through it). For them, it's not a question of these innovations of internalized and externalized costs, property rights, and transaction costs - ie, the real meat of welfare economics. For them it's a question of "market failure" vs. "government failure". Pigou is put up as this guy that thought markets failed and trusted government to fix them when they did. Coase and Buchanan supposedly provide a counterpoint to this "naive" position and say that governments can fail.

This doesn't really seem like progress to me - it seems like "pendulum science" that ignores the most essential points of Pigou and Coase. Yes, Pigou saw externalities and realized that if you simply internalized the costs and benefits - if you fixed the property rights - the market would maximize welfare. So he made a case that sometimes the government can do that. But where in the world did people get the idea that Pigou thought governments couldn't fail? Pigou's whole point was the welfare-maximizing properties of the market, after all! In his Industrial Fluctuations he repeatedly criticized government interventions as being counter-productive. He is (unfairly) held up by Keynes as being the poster-boy of neoclassical distrust of government. Where do Backhouse and Medema get this idea that Pigou was naive about "government failure" and down on markets? I suppose that's just derived from the quite simple point that a "Pigovian tax" could potentially internalize costs (for me, this falls under "obvious insight derived from his earlier ideas" not "ignorant of the prospect of government failure"). Backhouse and Medema (and a lot of others, I'm afraid) see the progress of welfare economics as a fight between "pro-government" and "pro-market" forces. That seems to considerably impoverish the real contributions of Pigou and Coase, and promote this idea of science as a pendulum - as a war of the titans - rather than as a developmental endeavor. Even if you put a lot of emphasis on Kuhnian "paradigm shifts" in science, presumably those paradigm shifts improve the way we think about things (despite their haphazard nature). Kuhn never said we oscillate back and forth between two essentially ideological positions.

This is a recurring beef I have with a lot of libertarian-leaning economists. Why do they do this or think like this so often? They tend to refer to themselves as "free market economists", implicitly suggesting that others are not free market economists or are somehow pro-government to the exclusion of being pro-market. My impression has always been that aside from the rare Marxist (who has a pretty tenuous claim to being an "economist" to begin with), economists are almost by definition "free market economists". These libertarian-leaning economists imagine this massive pendulum swinging between "pro-market" and "pro-government, but (1.) the "pro-market" and "pro-government" identities are almost always straw-men (Pigou by any measure is a "pro-market" economist), and (2.) the market/government issue distracts from the most important advances: the importance of property rights to welfare maximization (Pigou) and the importance of transaction costs (Coase). Those are the important things in welfare economics. Why are we getting involved in this food-fight that's almost completely beside the point? Let's drop this illusion of pendulum science and do progressive science instead. That's what Pigou and Coase always put their effort into.

Mustspeak

The idea of "Newspeak" - a sanitized, simplified, politicized version of English - is one of the most enduring legacies of George Orwell's fiction. Newspeak was deliberately designed to regulate human interaction and obscure dangerous ideas. "Freedom is Slavery" is the most famous example. But for Orwell, Newspeak was far more insiduous than this sort of linguistic obscurantism. In a description of Newspeak in 1984, he writes:

"By 2050—earlier, probably—all real knowledge of Oldspeak will have disappeared. The whole literature of the past will have been destroyed. Chaucer, Shakespeare, Milton, Byron—they'll exist only in Newspeak versions, not merely changed into something different, but actually contradictory of what they used to be. Even the literature of the Party will change. Even the slogans will change. How could you have a slogan like "freedom is slavery" when the concept of freedom has been abolished? The whole climate of thought will be different. In fact there will be no thought, as we understand it now. Orthodoxy means not thinking—not needing to think. Orthodoxy is unconsciousness."

That was the real terror of Newspeak; not that it was a tool of deception, but that it was a tool of destruction and devaluation. It didn't simply hide truth - it destroyed truths.

That is Orwell's Newspeak, and commentators are always on the look out for it. Branding your opponent as a "Big Brother" or "Orwellian", or identifying something they say as "Newspeak" is always a winning rhetorical strategy (well... at least a winning punditry strategy). But something interesting I saw today on the BBC website highlighted actual political manipulation of language and made me think that perhaps instead of Newspeak, Orwell should have offered us "Mustspeak". Newspeak's ability to frame contradictory ideas as consistent, and its blighting of the English language certainly makes for good fiction, but Mustspeak - a form of political language that compels people to action - is probably more pervasive in real life than Newspeak will ever end up being.

BBC created a "word cloud" of British political party platforms from 1945 to the present. The regularity of the appearance of the word "must" really struck me. Politicians certainly try to hide the truth, don't get me wrong. But in a free society that can be a challenging task. Sometimes what's more effective is for politicians to try compel people to action, before they have time to reflect on the truth. In a society with a free press, a strong education system, and a literate populace there's only so much truth you can hide. But what you can do is manufacture a sense of urgency or duty that blunts or retards critical thought.

So by all means, keep looking for Newspeak ("new" came up in the word clouds a lot as well). But be on the look out for the less publicized examples of Mustspeak. And if you ever read about Mustspeak in a dystopian novel, just remember: you heard it here first.

Histories of the Self

In his other blog, Clavi non Defixi, Evan has an interesting post on work by Jan Goldstein, a history professor he is taking a course with at the University of Chicago. He provides selections from, and thoughts on, her book The Post-Revolutionary Self: politics and psyche in France, 1750-1850. Evan's post emphasizes Goldstein's sharp distinction between Cartesian and Lockean understandings of the self - a distinction that is minimized in other treatments of the subject. As a theologian, Evan also seems to be thinking about how this attempt to provide a sharper contrast between Descartes, Locke, and the post-revolutionary thinkers attempting a return to Cartesian selfhood can be used to broaden theological work on the self, which primarily engages Augustine's treatment of the issue, and the Augustinian precedent in later Western work on the subject.

However, as I click through Evan's links, I get the impression that Goldstein herself offers a far more institutional and historical perspective on the post-revolutionary concept of selfhood, which honestly interests me more. Goldstein argues that the post-revolutionary quasi-resurrection of Descartes served as a sort of prop for the new regime. This is the blurb for the book:

"In the wake of the French Revolution, as attempts to restore political stability to France repeatedly failed, a group of concerned intellectuals identified a likely culprit: the prevalent sensationalist psychology, and especially the flimsy and fragmented self it produced. They proposed a vast, state-run pedagogical project to replace sensationalism with a new psychology that showcased an indivisible and actively willing self, or moi. As conceived and executed by Victor Cousin, a derivative philosopher but an academic entrepreneur of genius, this long-lived project singled out the male bourgeoisie for training in selfhood. Granting everyone a self in principle, Cousin and his disciples deemed workers and women incapable of the introspective finesse necessary to appropriate that self in practice.

Beginning with a fresh consideration of the place of sensationalism in the Old Regime and the French Revolution, Jan Goldstein traces a post-Revolutionary politics of selfhood that reserved the Cousinian moi for the educated elite, outraged Catholics and consigned socially marginal groups to the ministrations of phrenology. Situating the Cousinian moi between the fragmented selves of eighteenth-century sensationalism and twentieth-century Freudianism, Goldstein suggests that the resolutely unitary self of the nineteenth century was only an interlude tailored to the needs of the post-Revolutionary bourgeois order."

My guess is that like me many readers will find this description of Goldstein's work as a historical project more interesting. But please click through and read Evan's post - it's a good read that focuses more on the substance of the understandings of the self, rather than the function that they served.

Funny Heidegger Video

Evan shared this video with me last night: "Have You Read 'Sein und Zeit'?".

Funny on two levels - because of my interest in the relevance of time for the social contract, and the general importance of time as a major factor in incomplete contracts and economic dynamics in general, I've decided I should know more of what the hell Heidegger meant by "the existential and ontological constitution of the totality of Dasein is grounded in temporality". And not just Heidegger, but anyone that has good thinking on how we experience time. Of course, I've been as frustrated in this effort as the brown rabbit in the video.

On another level, I think just about anyone can relate to this no matter what you're reading. You know there's always something that you could read to provide greater context, but you have so much other substantive stuff to read that good contextual or foundational reading is a challenge. I feel this way about the Austrian school too (more as my context than as my foundation... I do a pretty decent job going back and reading the works that are foundational to my thinking). When I get a chance, I do sincerely want to read Pure Theory of Capital and Time and Money. But don't bust my balls about reading any von Mises or Rothbard (at least reading them cover to cover) - it ain't happening till I'm old, well read in my own stuff, and have some free time on my hands!

Past Fallacious Fallacies on F&OST

This morning, I described the "aggregation fallacy" as a "fallacious fallacy" - something that a lot of people wrongly point to as a fallacy. I think I'll try to highlight a couple more of these cases over the next couple weeks, mostly from economics.

In the meantime, since we've gotten a lot more readers lately, I wanted to highlight two past posts on fallacies on this blog that I thought were both pretty fun.

The first is a post by Evan on a fallacy that he enjoyed coining: the fallacy of gravity as a mechanism of consciousness. As Evan suggests, it probably already has a name, but it's more fun to give it a new name that enables you to reference Wile E. Coyote. The post is very good.

I also have one on the fallacy of teleological thinking when we talk about evolution and the environment.

Fallacious Fallacies and the Great Recession

Aggregate Demand and the Great Recession
On April 17th, the chair of Obama's Council of Economic Advisors chairwoman (and W&M alum) Christina Romer set off a firestorm in the economics blogosphere with a relatively benign rendering of mainstream economics through the medium of a shout out to 1990s political culture. Namely, that: "it's the aggregate demand, stupid". Romer's case is that aggregate demand is driving unemployment as opposed to unemployment insurance. The Economist provides a general overview of the question, while a paper prepared for a Brookings panel and a San Francisco Fed paper provide some empirical structure to the debate.

Bloggers have lined up on either side. Menzie Chinn, Michael Derby (WSJ), Mark Thoma (here and here), and Brad DeLong take Romer's side. Arnold Kling and Megan McArdle are opposed to her position. Tyler Cowen and Bryan Caplan are also opposed, but their posts go down this strange rabbit hole of nominal wage rigidities, which is very unusual because (1.) Romer never mentions nominal wage rigidities, and (2.) nominal wage rigidities have exactly zero to do with aggregate demand deficiencies, although some economists are fond of referencing them.

Fallacious Fallacies
Some of the more interesting posts on the issue get into alleged fallacies committed by the pro-Romer aggregate demand crowd. I'm going to call these "fallacious fallacies", because they miss the mark by a fair margin, they threaten clear thinking, but you hear them a lot because human beings (particularly bloggers) love to play "gotcha". So I'm gonna call "gotcha" on the "gotcha" guys. The fallacious fallacy in question is the "aggregation fallacy". While most economists content themselves with the fact that aggregate demand is real and job search intensity (which is lowered by generous UI benefits) is real, and we have to arbitrate between their relative importance, some economists flatly reject the validity of aggregating anything. Robert Higgs recently listed the "aggregation fallacy" first in his list of six alleged fallacies. The argument is that by aggregating a variable like income into a variable like GDP, or an individual price into an aggregate like the CPI, complex processes at a lower level of aggregation are glossed over. This critique can come in several varieties, but it's disconcerting for me that it is ever expressed in the all-encompassing way that Higgs presents it. Peter Boettke recently brought this aggregation debate into Romer's aggregate demand debate. In his comment section, after some debate on the question, Peter writes that he is "unpersuaded that aggregate concepts do much of anything to improve our understanding of an economic system".

The problem, as I see it, with this common "fallacious fallacy" is that it takes a kernel of truth and explodes it completely out of proportion, to the detriment of clear thinking. Of course haphazard aggregative thinking can lead to erroneous conclusions. But we already have a name for that: the ecological fallacy. Ecological fallacies are committed when you infer things about individuals based on the behavior of aggregates. That's an entirely valid thing to look out for, and it's something that macroeconomists who do trade in aggregates obviously have to take special care to watch out for. But Boettke and others, by taking the risk of committing an ecological fallacy to the extreme, themselves are at grave risk of a fallacy of composition. I would argue that the rejection of the paradox of thrift, the rejection of the prospect of a "general glut", or the rejection of the possibility of a wage-price spiral are all such fallacies of composition. If I were to commit a "fallacious fallacy" of my own, I would say that Boettke and others are committing a "disaggregation fallacy" (but I won't, because I have no methodological hang-ups about micro-data, which I personally use far more often than macro data).

Why do these fallacies persist? I'm not quite sure. A couple weeks ago I would have attributed it to the insularity of the Austrian school. Like Darwin's finches, eccentricities around something as mundane as an aggregate serve a function in the Austrian school (it's an easy to understand whipping boy for Keynesianism that is accessible to new initiates) that would not have evolved outside of that niche but can persist in that particular insular environment. Since transitioning from a few less illuminating Austrian blogs to more illuminating Austrian blogs, though, I have a much harder time making this argument. Then what is it? Why do smart guys with good things to say like Peter Boettke insist on peddling "fallacious fallacies" like the "aggregation fallacy"? Why is it so hard to see that there are two very real fallacies - the ecological fallacy and the fallacy of composition - that do apply in certain instances, but that you can't simply assume apply in all instances? I'm not sure - any ideas? I can't imagine how these people justify the co-existence of psychology and sociology, or organic chemistry and biology.

Quick Conclusion on UI, AD, and the GR

I want to point out that the empirical work I link to above shows that extended UI benefits have marginally increased unemployment (by 0.4 percentage points). We obviously don't have the data or the identification strategy to get an especially rigorous estimate, but that one seems to hold water with the Fed and the NBER. This suggests that Romer is right that UI benefits aren't a huge component of the story. But it also suggests that the economists who argue that the aggregate demand impact of the UI program in particular is a net positive are wrong. The argument goes that if you give unemployed workers more spending power it boosts aggregate demand, which helps the economy. A negative net impact of UI extensions - even a small negative impact - suggestst that any AD effect is swamped by the incentive effects. In other words, tentative, preliminary empirical evidence suggests that we're getting to the point where UI extensions may be justifiable on a humanitarian basis, but are getting harder and harder to justify on a stimulus basis. That does not mean that UI is keeping us in quasi-depressionary conditions. That doesn't even mean we shouldn't extend UI. And it certainly doesn't mean what Jerry O'Driscoll seemed to be implying: that you can't simultaneously say that AD and UI are important determinants of the unemployment rate, but that AD is more important than UI right now (as opposed to, say, the late 1990s when UI might have been a more important factor). What it means is we need to be careful about how we justify UI extensions, and seriously consider cutting off the extensions.

This has been fun. Future "fallacious fallacies" I might tackle are the Broken Window Fallacy, the accounting-identity-as-behavioral-law fallacy and reductio ad absurdum. Each of these, like the "fallacy of aggregation" has a kernel of truth that is habitually blown way out of proportion by zealous "gotcha" bloggers.

Lexington and Concord

Kate and I have a quite small, but growing, collection of nice (or at least meaningful) art. One of the less nice, but more meaningful pieces that I like a lot is a simple painting on a wood panel of Captain John Parker, of the Lexington militia, that used to belong to my grandparents. He stands at attention at one side of the bedroom door (on the other side is Daniel Morgan, the captain of a Virginia rifle company).

Concord Hymn
Ralph Waldo Emerson

By the rude bridge that arched the flood,
Their flag to April’s breeze unfurled,
Here once the embattled farmers stood,
And fired the shot heard round the world.

The foe long since in silence slept;
Alike the conqueror silent sleeps;
And Time the ruined bridge has swept
Down the dark stream which seaward creeps.

On this green bank, by this soft stream,
We set to-day a votive stone;
That memory may their deed redeem,
When, like our sires, our sons are gone.

Spirit, that made those heroes dare,
To die, and leave their children free,
Bid Time and Nature gently spare
The shaft we raise to them and thee.

My Working Paper on the 1920-21 Depression

President Harding's Conference on Unemployment, 1921

I'm very new to scholarly publishing, so I'm not quite sure about the etiquette of posting drafts online. I know journals demand original work, but enough working papers are floating around out there I assume that simply means unpublished work (more experienced scholars, please tell me if I'm making a mistake here!). Assuming it's fine, I wanted to share a paper I've been working on for several months now, called "A Critique of the Austrian School Interpretation of the 1920-21 Depression". The relatively unknown 1920-21 depression has gotten considerable attention in certain circles recently as an alleged successful test-case for non-interventionism. In this piece, I specifically engage a series of three shorter articles by Thomas Woods, Jim Powell, and Robert Murphy that make the non-interventionist argument. I think many readers will be familiar with these works, particularly that of Thomas Woods, which has been well publicized on Youtube. This topic has been covered extensively in the blogosphere (I know Brad DeLong, David Henderson, and Steve Horwitz have all blogged on it).

My conclusion is that fiscal intervention was indeed inappropriate in the 1920-21 downturn, and that markets were perfectly capable of self-adjustment, but that monetary policy was far more effective and commendable than just about any of the critics - Austrian or otherwise - give it credit for. Thomas Woods shockingly calls the Fed's actions "hardly noticeable," which for quite a while made me wonder whether he and I were discussing the same depression. In addition to these fundamentally historical points, I also make the analytic point that Keynesian policy recommendations aren't discredited at all by the 1920-21 downturn, and that Woods (2009), Powell (2009), and Murphy (2009) only argue that it is discredited because they misunderstand or ignore Keynes's ideas on (1.) nominal wage adjustments, (2.) the interest rate, and (3.) deflation. I hope I successfully make the point that Woodrow Wilson, Warren Harding, and Benjamin Strong did a commendable job in the post-war period, but that this episode isn't an appropriate test for falsifying Keynesianism.

If you have any comments, I'd very much appreciate them.

Benjamin Strong,

Governor of the New York Federal Reserve

Charlottesville Musings

My wife Kate and I are leaving for Charlottesville this morning for the weekend to celebrate our dating anniversary and replenish our wine cellar. I had a couple Charlottesville related thoughts I wanted to share.

Jefferson and the Social Contract
One of the ideas I struggle with a lot is the social contract. In a lot of obvious ways, it's a very poorly thought out idea. Put simply, a social contract is a contract that in all likelihood many of the parties never consent to. Hence, it's not really a "contract" at all. It's not a new critique, but it's a nagging one, and it's a critique that inevitably leads to the conclusion that state authority itself is illegitimate. Nevertheless, all of us tacitly accept the social contract in practice, even if it's very common to reject it in theory. Even some of the most vocal critics of the idea do this. Libertarians most readily furnish the criticism I outlined, and yet it's rare to find a libertarian that doesn't think that a minimalist role for government is appropriate: enforcing contracts, providing national defense, etc. I'm not personally clear on why the social contract "works" in these situations, but not in other situations. Why is it legitimate to cite Rousseau's fallacies and the problems with the social contract when we're talking about health reform but not when we're talking about the recognition of contracts? The only position consistent with this (valid) critique of the social contract is anarchism. The rest of us are simply getting by on various versions of inconsistency.

I was recently reading Jefferson's 1813 letter to John Wayles Eppes (here's the Charlottesville connection), originally for the purposes of revisiting Jefferson's thoughts on banking. However, what I was struck by was his opening thoughts on the legitimacy of public debt. This is where he makes his famous suggestion for 19 year limits on constitutions and debt contracts. He acknowledges and attempts to circumvent the problems with the idea of the social contract in an interesting way:

"...But what limits, it will be asked, does this prescribe to their powers? What is to hinder them from creating a perpetual debt? The laws of nature, I answer. The earth belongs to the living, not to the dead. The will and the power of man expire with his life, by nature's law. Some societies give it an artificial continuance, for the encouragement of industry; some refuse it, as our aboriginal neighbors, whom we call barbarians. The generations of men may be considered as bodies or corporations. Each generation has the usufruct of the earth during the period of its continuance. When it ceases to exist, the usufruct passes on to the succeeding generation, free and unincumbered, and so on, successively, from one generation to another forever. We may consider each generation as a distinct nation, with a right, by the will of its majority, to bind themselves, but none to bind the succeeding generation, more than the inhabitants of another country."

One thing that leaps out at you is that Jefferson finds nothing wrong with the fundamental logic of the social contract, which isn't necessarily surprising. Groups of men are considered "as bodies or corporations" and "a distinct nation". What Jefferson has a problem with isn't the homogenization of the citizens into the state, but the perpetuation of that institution over time. In other words, the most disconcerting tyranny is the tyranny of the past over the future, and not of the present majority against the present minority. This is especially notable because he is writing it in 1813, very late in his life. In the heyday of the American Revolution and (for Jefferson) the French Revolution, the radicals were not particularly nervous about democracy. Many anti-federalists and Republicans were quite comfortable with the idea of a popular unicameral legislature (ie, the House of Representatives without the Senate). It was only after the excesses of the French Revolution and the waxing power of the Federalists that suspicion of democracy thoroughly took hold. And yet as late as 1813, long after these developments and long before the inauguration of Jacksonian democracy, Jefferson is not concerned at all with the traditional objection to the social contract - he is concerned with the question of time.

The problem of time has come into my own thinking about the social contract, but in a very different way. Jefferson sees the "usufruct of the earth" as passing from one generation to the next unhindered. He is specifically thinking in contractual and property-rights terms here when he addresses the ability of man to derive profit from the earth. The ability to exclusively enjoy the proceeds of an object is the defining characteristic of "property". This is where I split with Jefferson. It was common in the early 19th century to view land as a passive factor of production to be exploited. We know now, of course, that (1.) land is hardly the only or even the most important factor of production (most economic models don't even include land as a factor of production anymore), and (2.) to the extent that it is one, it certainly isn't inherited unhindered. The fact is, we impose on future generations - very often for the better, but sometimes for the worse.

I've come around to thinking about the social contract as a solution to a severely incomplete inter-generational contract. Imagine a situation where all past, present, and future generations could come together and write contracts. Inter-generational transfers could be worked out. Future generations could pay past generations to make certain investments. Past generations would be forced to compensate future generations for damages made. This is the "optimal" market solution. The problem, of course, is that in the long run we are all dead. We can't make these sorts of contracts. We can't even make contracts with our future selves, much less with future generations. Such is the tyranny of unidirectional time. Among other things, this leads to sub-optimally high private discount rates and high interest rates in general (Keynes's fundamental insight). But it also means that we are imposing on future generations (and we have been imposed upon by past generations) because we make decisions for them that they can't be a party to. Jefferson sees this problem and concludes that the solution is to ensure that our decisions aren't binding on the future. I think this is good; sunsetting is always healthy in government. But I don't think it gets at the more fundamental problem that Jefferson only begins to broach. In my mind, the government's interest in de-temporalized society, it's ability to think in terms of the long-run, the fact that it seems to naturally eschew high private discount rates, instead operating on the basis of low social discount rates, suggests that the government and the social contract has an important role to play in getting closer to an optimal nexus of inter-generational contracts; something that private contracting has no hope of achieving.

Slavery and History

Of course Jefferson doesn't only leave a legacy of enlightened self-government and liberty. He is also a part of the legacy of slavery. Virginia's slave society has been in the news a lot lately with Governor McDonnell's ham-fisted declaration of Confederate History Month, and it's something that I've written about here. I want to mention it briefly again here, because the legacy of slavery also has a lot to do with inter-generational contracts, and the imposition of past generations on future generations. An MIT economist writes of a similar process in Peru, where she found that colonial labor practices have an enormous impact on current poverty rates in different regions of the country. This is an example of what has been called "path dependence", and it's a process that is as relevant to American chattel slavery as it is to Peruvian miners.

The District of Columbia celebrated Emancipation Day yesterday (April 16th), the day in 1862 when Lincoln emancipated the city's 3,100 slaves in anticipation of the 1863 Emancipation Proclamation. Despite the festive atmosphere, slavery still shapes race relations, poverty, unemployment, and incarceration in America today. We act like this is old news, that it happened 150 years ago. But what we forget is that what happened 150 years ago powerfully shaped what happened 149 years ago. And what happened 149 years ago was an enormous determinant of what happened 148 years ago, and so on down to the present day. In one of the best books I've read on the subject, Durable Inequality, Charles Tilly describes the process by which inequalities are not necessarily dissipated, but can also be reinforced over time. Christopher Hitchens makes a similar argument when it comes to reparations for slavery (I've never been convinced by this position until listening to this short piece by Hitchens). Thinking about these issues is always hard. My earlier post (linked above) in which I criticize McDonnell's announcement is nevertheless peppered with hedging, caveats, and apologetics for the Confederacy. So I understand how tough it is to negotiate these questions. That's really the heart of the problem: it's very hard to determine what a just relation between past, present and future generations is when past generations are dead, when future generations haven't been born, and when the present generation is rife with externalities, imperfect property rights regimes, and incomplete contracting. It's very hard to think about, but we still need to think about how our contracting behavior is embedded in the expanse of time.

The Virginia School of Political Economy

Of course, there are obstacles to this too. In many ways government has a much longer time horizon than private interests, but at other times it has a much shorter horizon, stretching only to the next election cycle. This is a nice segue into another Charlottesville legacy: The Virginia School of Political Economy. The founder of this school of thought is generally recognized to be Nobel laureate James Buchanan, currently of George Mason University. Buchanan was once the chairman of the University of Virginia's department of economics. He moved from there to Virginia Tech, and then on to George Mason University. All of these schools now have strong public choice theory programs.

As I understand it, there are two main research areas in this school of thought: the analysis of constitutions, and the analysis of rent-seeking behavior. I've only read the constitutional literature casually, but enough to be impressed by it and influenced by it. Buchanan's work on constitutions really provides an analytic structure to what I think is a very fundamental understanding of constitutions shared by many Americans. As I often say on here, "I really should read more of this," because it's good stuff. I've been less impressed with the work of these economists on rent-seeking, not because I dispute their insights so much as I dispute their emphasis. Government introduces the prospect for rent-seeking and rent-seeking is bad. Government officials are as self-interested as any private actor. I'm not impressed with these sorts of points because they strike me as being so obvious. Nobody has really laid out the "constitutional phase" in the detail that Buchanan has. But how many people have made the rent-seeking observations that Tullock has? Lot's - we've known about it for centuries. It strikes me as emphasizing the most obvious points and neglecting the most interesting points.