Me and the Jigsaw Puzzle at Project Syndicate (and apparently I'm an economist, too!)

Brad DeLong has a new Project Syndicate article talking about the sluggish labor market recovery. It draws a lot from previous blog posts of his, and one thing that he draws from those blog posts is a mention of yours truly:

"As the economist Dan Kuehn likes to say, a recession is like somebody knocking your jigsaw puzzle, disturbing the pieces, and turning some of them over. When the Fed ends a liquidity squeeze, it turns the pieces right side up. So it is easy to reassemble the puzzle. Now, however, there is no one to turn the pieces right side up, so things are much harder to correct." [emphasis mine]

I have to credit Steve Horwitz, of course, who initially talked about the jigsaw puzzle analogy for thinking about the recession. I think he did a good job talking about the Austrian approach using this analogy, but a pretty ham-fisted job carrying it over to Keynesianism. My response on how Keynesians see the complex interactions that make up the economy, and how to talk about this with the jigsaw puzzle analogy here and here.

The summary is this: Keynesians see recessions as being caused by interest rates that are too high as a result of liquidity preference and deficient demand. The multiplier process aggravates this because negative demand shocks translate into negative income shocks, which cuts into effective demand down to a new equilibrium point. But the driver of all this is discoordination caused by interest rates that are too high. Keynesians think the market works - it does efficiently allocate goods and services. But if you give it bad signals, it's going to disrupt the price mechanism. The interest rate is that disrupted price signal in a downturn. Given good price signals, entrepreneurs can fit the puzzle pieces together. But with the bad signal that the interest rate is giving firms, many of the puzzle pieces entrepreneurs would normally spend their time fitting together aren't even viable or taken into consideration. The problem, in other words, is not that entrepreneurs can't fit the puzzle pieces together but that certain low marginal efficiency of capital investments aren't even considered when the interest rate is distorted.

As you might expect, this perspective makes it challenging to talk to people who want to pretend that Keynesianism is a claim that the price mechanism does not work, that entrepreneurs can't be relied upon, etc.

Curves shift - it's not a big deal

This morning I was complaining about people who got excitable about John Taylor's nice graph of unemployment vs. investment percent of GDP. Not really all that surprising, I said.

Now, it seems people are going from "wow it's remarkable" to "it's meaningless".

Specifically, Justin Wolfers shares this graphic going back to 1948:

And concludes it is "decidedly unimpressive". This is the wrong way to look at this sort of data. Relations in economies are not stable. They shift over time. Technology changes. Preferences change. What you should see in this graphic is about four curves like the one John Taylor first showed laid on top of each other, each shifted a little because of some fundamental change in the economy. We see it with the Beveridge Curve. We see it with the Phillips Curve. Every time these curves shift people want to call the time-of-death on a very solid underlying phenomenon. That's bad economics. Taylor's original graphic was fine - what was a little questionable was Taylor's interpretation of it. We know employment is highly correlated with GDP. We know investment moves a lot and consumption doesn't over the business cycle. We should expect unemployment to be highly correlated with investment.

If it moves over time, who cares? Curves shift. All this means is that any business cycle theory worth its salt has to answer the questions (1.) why does investment change, and (2.) why don't we stay on the production possibilities frontier - why isn't the reduction in investment matched by an increase in consumption?

Richard Cantillon says...

...that lots of things influence the interest rate, including the money market (although he cautions people not to make the mistake of thinking it exclusively drives rates), the loanable funds market, risk premia, etc.

It took the remorseless logicians of the 19th and 20th centuries to dream up the idea that the interest rate could be simply explained in only one market.

Mattheus and I have talked some about the interest rate in another commment thread, and one link that I pointed him to that I think does a good job explaining why the interest rate is such a weird price is this one from Brad DeLong.

Assault of Thoughts - 3/30/2011

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

-David Beckworth on the three monetary systems operating during the Civil War.

-Roger Farmer talks more about a new paper of his that Stephen Williamson discussed recently. I find Farmer to be one of the most interesting modern Keynesians. He's very much in the style of this George Evans video that Thoma shared earlier, which relies on expectations in a multiple equilibrium environment. Plus Farmer pays attention to gross flows and labor market dynamics. He's definitely a guy I want to spend more time reading in grad school.

-Greg Mankiw and Mark Thoma call this figure "striking". Is it really? I'm not so sure. We know unemployment tracks output, we know shifts in output are primarily driven by investment volatility. I would be surprised if we didn't have this strong of a relationship.

-Matt Yglesias discusses a new survey on why women leave engineering careers. This is of interest to me given the NBER work that I'll be turning to soon. The paper is primarily about the sufficiency and responsiveness of labor supply, but of course to talk about that intelligently we have to address labor demand questions - you can't say if supply is sufficient or responsive if you don't talk about who labor is being supplied to. One of the points we cover is "replacement demand" for engineers, and we focus on two sources of replacement demand: the retirement of older cohorts and people with engineering degrees not retiring, but leaving the field. So this sort of work is especially interersting to me.

-Bad economics of the mini-war in Libya. I was bothered by two things in this post - see if you can identify them.

Quick link

I've been pretty busy drafting a report on title insurance... it's getting to the somewhat embarassing point of actually being fascinating to me - I'm enjoying writing it. Part of that is that I don't usually get to write much at work (I normally do the data work) so writing a forty page paper on a pretty obscure real estate cost is a nice change of pace. Part of it, I'm sure, is Stockholm Syndrome.

Either way, the point is it has kept me from blogging in the mornings and probably will for a little while longer. However, I've just come across something to keep things going! Paul Krugman grappling with Friedrich Hayek. That one should keep the blogosphere bitching for a while -it usually does. In fairness to Hayek, he was talking about Britain - I'm not sure if their data looks similar to our trends during this period or not. I imagine it does, though. I might be blogging more soon, or it might stay quiet for a while longer if I can keep my writing momentum and start drafting major sections of the NBER chapter.

A good post on ethical realism and intuitionism

From Tyler Cowen. I agree with most of the points he makes here. I think of morality in objective terms, but I think other people who do that often run into the hubristic trap that Cowen identifies here: assuming that because there is some objective standard for morality you can make what often amount to subjective declarations. Morality ultimately deals with social relations - morals are largely relational. As far as I can tell, there is little you can do with or to yourself that I would readily think of as "immoral" or "moral". Social relations are complicated, which makes the sort of quick ethical deductions that a lot of people make more tenuous than they first appear.

- Is it ethical for me to put another person in a cage and keep them there by force for the rest of their life?

- Is it ethical for me to put another person in a cage and keep them there by force for the rest of their life if that person was a sadistic murderer and rapist?

- Is it ethical for a group of people to put another person in a cage and keep them there by force for the rest of their life if that person was a sadistic murderer and rapist?

- Is it ethical for a group of people to follow a predetermined set of widely agreed upon principles to determine whether a person deserves to be put in a cage and kept there by force for the rest of their life if that person was a sadistic murderer and rapist?

Everyone would answer "no" to the first question and "yes" to the last question. Depending on peoples' taste for vigilante justice, there will be a mix of responses to the second and third question. The action is fundamentally identical in each of these cases, but context matters tremendously for ethical claims. But what sort of context matters?

1. Who is doing the action.

2. Who the action is being done to.

3. Precipitating events.

4. Proceedure.

5. Whether multiple people engage in the action or not.

6. Whether the group of people is simply acting, or deliberating.

7. Whether the groups' deliberation itself is ethically conducted (I'm sure there was substantial deliberation in the Nazi high command, but deliberation alone means little).

Notice especially how point 3. and 7. introduce some recursivity as well, which further complicates the identification of what is a "moral" course of action in a particular case. This is really where intuition and tradition come in. Neither are perfect guides, but their point is to guide action when naive objectivism poses real risks. It is easy to be an unalloyed objectivist when the moral question is "torturing babies", which Cowen offers. It's much harder for the sorts of questions we deal with every day.

A lot of moral questions also revolve around "rights". If you are a moral objectivist (like me) and have a natural rights philosophy (unlike me), you find yourself in a relatively convenient circumstance. The raw materials of arbitrating many moral claims - peoples' rights - are ethically unambiguous to you, so deriving conclusions from them is also unambiguous. Clearly, if rights are socially constructed and mutliple constellations of rights can all be morally valid, determining the ethics of a given question becomes - not subjective - but harder.

The points that Cowen ends on are especially good:

"I find that my combination of views is fairly rare. People who believe that ethics is objective and intuitive are often quite keen to make a lot of detailed pronouncements about the content of those ethics. The agnostics tend to be relativists or subjectivists. It seems to me that people are first choosing a mood or attitude, and then finding the disparate views which match to that mood and, to themselves, justifying those views by the mood. I call this the “fallacy of mood affiliation,” and it is one of the most underreported fallacies in human reasoning. (In the context of economic growth debates, the underlying mood is often “optimism” or “pessimism” per se and then a bunch of ought-to-be-independent views fall out from the chosen mood.)

...We somehow need to come to terms with two propositions at the same time:

1. We need to think more rather than less ethically.

2. The content of ethical philosophy tells us less, in reliable terms, than most people would like to believe."

Consumer-centrism unnecessarily confuses people

Yes, I'm beating the old "people inappropriately only think of consumers when they think in Keynesian terms" again.

Tyler Cowen suggests that there's something different about what we're seeing because firms are making record profits but not hiring. It's not the first time Cowen has written about this. This has been pointed out in the past as some puzzle for demand based theories.

It doesn't seem all that puzzling to me. Firms have liquidity preferences too. When people earn cash and sit on it, my first thought isn't "wow, maybe we need to think about other things besides demand-based theories". I'm willing to entertain other theories, but this strikes me as confirmation of the fundamental point of demand-based theories.

Three retirements of note

- Thomas Hoenig, of the FOMC, announced he is retiring by October. This is a very good thing. Hoenig has been a major obstacle to responsible monetary policy. He's been consistently overruled, but I would not be surprised if he has impacted the scale of the interventions that have taken place. He better not decide to change his mind down the road and seek the position again. I hear Congressional standards are very high nowadays. Some Nobel laureates aren't even considered qualified.

- Alan Merton, George Mason University's president, has announced that he will be retiring in 2012. Some of you may not realize, but Merton was a very entrepreneurial president of George Mason. He took it from being a sort of Northern Virginia local college to one that was well known in the state. As I understand it, that entrepreneurial spirit also played a big role in shaping Mason's economics department, which I'm sure all readers are familiar with. The growth strategy for GMU econ has been to fill niches. Their Austrian economists are the most well known, but they also do a lot of work in public choice theory and experimental economics. Some have suggested that more traditional fields have suffered in the department as a result, and of course there are suggestions (not entirely without merit) that the department is quite political and ideological, but the strategy has made them very productive and a force to be reckoned with in certain fields. Two Nobel laureates in an economics department ranked 133rd is not something you see every day. George Mason was not for me. I didn't even apply there, although I applied to most other programs in the area. I think after Merton the question for them is going to be the same question I know they've struggled with before: are they going to leverage their specializations or are they going to become a highly politicized ghetto? I have high hopes for the former outcome but like any entrepreneurial venture there is some risk to this strategy.

- And to round it off, I might as well note that my thesis advisor and mentor for William and Mary's economics department, Clyde Haulman, is retiring after this year. Prof. Haulman is an interesting guy. I first had him in my history of economic thought class, so he was the guy that introduced me to all the older economists I talk about here. If I recall, we ended at Keynes. I worked as a research assistant of his on a study of minority owned firms in Williamsburg, and as I had said he supervised my thesis. He did a lot of work on economic history, particularly in the early republican period in Virginia (he recently published a book on the Panic of 1819 in Virginia). Interestingly enough, he is also the mayor of Williamsburg (he was vice-mayor when I was there). A good guy and a great professor.

I think Yglesias is Wrong

He writes:

"Atrios says “All the various cuts that our horrible new Republican governors are trying to implement aren’t just going to make the residents of their states suffer, they’re also going to work against the macroeconomy.”

I don’t really think that’s true. Federal spending cuts shrink the federal budget deficit and constitute a negative shock to aggregate demand. States have to balance their budgets, so the alternative to a lower level of spending would be a higher level of taxes. In AD terms, it’s basically going to be a wash either way. Its the failure of congress to enact some kind of state/local bailout appropriation that’s forcing the anti-stimulative state level stuff."

First, states don't have to balance their budgets, they choose to. One of the best things that could happen for both federalism and macroeconomic policy would be for the states to abandon that old shibboleth the way the federal government did eighty years ago. If they did, we'd see more robust states rights and a more stable macroeconomy.

But even setting that point aside, I still think Yglesias is wrong here. Issuing more government bonds helps get us from Keynes's economy to Hicks's economy. Keynes said liquidity preference (Brad DeLong would say highly-secure-financial-asset-preference) kept interest rates too high. Investment was depressed because the interest rate (the cost of capital) don't coincide with equilibrium in the loanable funds market. Running deficits and accomodative monetary policy pushes interest rates down and gets you to Hicks's economy. Hicks talked about an economy where the interest rate did coincide with equilibrium in the loanable funds market, but there was still slack in output.

How do we take care of that? Deficit spending, as Yglesias points out. "Shifting the IS curve". Also committing to inflation which will lower interest rates further and errode savings which will get people stuff less in their matresses. But these investment effects operate on the economy through the multiplier, and you can increase the multiplier by increasing the marginal propensity to consume. State-level spending will still do this regardless of how it finances it. Higher MPC means a higher multiplier for the private investment, deficit spending, and monetary policy going on.

UPDATE: waterzooi comments that he's not sure I'm right when I say that states don't have to balance their budgets, because most have balanced budget requirements. Allow me to clarify: states don't have to have balanced budgets - they choose to impose that constraint on themselves. There's nothing forcing them to constitutionally require themselves to balance their budgets. There was a time when this was not a constitutional requirement for most states, and many states did incur public debt. Many ran into trouble with that, which lead to a wave of these constitutional amendments. But they don't have to have those amendments and in my opinion they should probably be scrapped. I don't know the details, but even these constitutional requirements give some leeway, depending on how the books are kept on certain capital investments.

Telecom, Early Republic Style

This was a very interesting post by Matt Yglesias. He writes:

"Here’s another slice of What Hath God Wrought:

The United States Post Office constituted the lifeblood of the communication system, and it was an agency of the federal government. The Constitution explicitly bestowed upon Congress the power “to establish post offices and post roads.” Delivering the mail was by far the largest activity of the federal government. The postal service of the 1820s employed more people than the peacetime armed forces and more than all the rest of the civilian bureaucracy put together. Indeed, the U.S. Post Office was one of the largest and most geographically far-flung organizations in the world at the time. Between 1815 and 1830, the number of post offices grew from three thousand to eight thousand, most of them located in tiny villages and managed by part-time postmasters. This increase came about in response to thousands of petitions to Congress from small communities demanding post offices. Since mail was not delivered to homes and had to be picked up at the post office, it was a matter of concern that the office not be too distant. Authorities in the United States were far more accommodating in providing post offices to rural and remote areas than their counterparts in Western Europe, where the postal systems served only communities large enough to generate a profitable revenue. In 1831, the French visitor Alexis de Tocqueville called the American Post Office a “great link between minds” that penetrated into “the heart of the wilderness”; in 1832, the German political theorist Francis Lieber called it “one of the most effective elements of civilization.”

A reminder that when big government is made to work well, the gains are gigantic. Nowadays it seems to me that publicly owned and operated post offices are basically anachronistic, but this was a crucial public service in geographically expanding and overwhelmingly rural country at a time when letters in the mail represented state of the art communications technology. And the underlying idea of the USPS, that the government should be facilitating the creation of high-quality communication, remains true today. That’s why the question of the AT&T/TMobile merger seems so important. The fact that the Computer & Communications Industry Association (Google, Microsoft, EBay, Yahoo, Facebook) is vehemently opposed to the deal strikes me as a credible indication that letting it go through would be a mistake."

People today have a view of the founders that I think would have shocked the founders themselves. We look back and we don't see a very active federal government, and of course there's a reason for that. The founders placed a premium on limited government. That has been the quintessential American tradition. But a lot of people take that tradition and turn it into a case for sterilizing self-government and democracy where it could be the most productive, and it's this tendency that I think would be most shocking to the founders - particularly the Jeffersonians. In a lot of ways, the government was on the cutting edge and the post office is one example. Jefferson also pushed for state-sponsorship of a truly modern post-secondary education institution. Prize funds and bounties were common for industrial innovations. The early republic only looks libertarian today because the Post Office seems so quaint, so we write it off. We don't see it as the major intervention that it was. The Post Office is also a good example because we probably really don't need public mail delivery anymore. It's an example of how these things change over time. Space exploration is the same way. We are past the point where NASA needs to dominate space exploration. At one time NASA did need to do that, but now it's not clear it does. Once we establish colonies on Mars, it's not clear that we'll need any space agency at all (until that time, there are major externalities associated with colonization that I think really require a public agency).

I also think we gravely misread the founders because of our constitutional history. There was a major fight in the early republic over how far the general welfare clause extended. There wasn't substantial disagreement at all over whether the Congress should take on public works projects or internal improvements. There was only a disagreement over the legal niceties. Here, the Jeffersonians argued that the Constitution needed to be revised to include it. This is not a surprising argument and it should not be confused with a lack of enthusiasm on the part of the Jeffersonians. Jefferson, after all, was under the impression not only that the Constitution would be revised frequently but that it would be scrapped and rewritten many times over. Things didn't work out that way, of course. The preponderance of opinion went with a reading of the general welfare clause that took the words "general welfare" to include things like internal improvements. This wasn't some great betrayal of '76. All agreed that was a provision for the general welfare. But it's given an odd impression of creeping interventionism and some sly abandonment of what was fundamentally Jeffersonian. I really don't think it was. If Jefferson knew in advance that our Constitution worked so well and that we wouldn't scrap it and rewrite it on a regular basis, I don't see any great obstacle to him accepting what became the dominant reading of the general welfare clause. What he expected to achieve through regular democratic revision has been achieved through an understanding of the constitution itself as a democratic document giving Congress discretionary authority to provide for the general welfare. Jefferson's primary concern was that this power be held democratically and not tyrannically. His concern with the federalists was their enthrallment to stockjobbers and bankers - that they would wield power undemocratically. His solution was to keep the construction of our understanding of federal power democratic. In other words, Jefferson said what he said about the Constitution with Hamilton and Morris in mind. If he knew Jackson was just around the corner, I think he would have reacted differently. Does this make sense? And if Jefferson won and we had a regularly, democratically revised Constitution perhaps there would have been no need for Jackson.

Either way, the little dance that the Constitution and policy did in the 1810s-1840s or so has given the impression that there were a lot of libertarians running around in the early republic. I simply don't think that was the case.

Consumer-centrism in thinking about the economy

You all know complaints I've made before about how people over-emphasize consumption behavior when talking about Keynesianism. It's an odd tendency since Keynes talked about the propensity to consume as some sort of psychological law that he didn't really attempt to derive or explain.

This post by Mark Thoma is interesting and forces people out of that box a little. He presents some leg-work by Rebecca Wilder tracking the extent of corporate savings. Usually the paradox of thrift gets talked about as a consumption-savings trade-off, but it's firms that are really sitting on the cash and it's investment that really takes the hit in recessions. The paradox of thrift itself is another area where people can have a confused approach to Keynesianism. To quote the Roberts-Papola rap, people think "savings is destruction - that's the paradox of thrift". Actually, that's not the paradox of thrift at all. Savings is not destructive at all. What's destructive is an excess of savings over investment. It's not clear why this would happen with consumer saving unless there was a large increase in the consumer saving rate. When firms save (i.e. - try to stay more liquid), though, investment is far more constrained from growing.

Impeached or ruled unconstitutional? What does one do here?

On facebook earlier this morning I favorably linked to a suggestion from Kucinich that Obama's invasion of Libya was an impeachable offense. At this point, though, I'm starting to get a little unclear on what impeachment entails. I was always under the impression that being impeached did not require removal from office, but since posting this I've read that if you are convicted of impeachment charges you are removed from office. The Constitution only says "Judgment in Cases of Impeachment shall not extend further than to removal from Office", suggesting to me that an impeached president may not even be removed from office, but on Wikipedia it says "If any officer is convicted on impeachment, he or she is immediately removed from office". I am apparently missing some legalese here. Why does the Constitution say you can't do more than remove someone from office, but the interpretation seem to say you can't do more or less than remove them from office?

This makes me reconsider my initial support for the idea of impeaching Obama.

Let's be clear here - what is Obama guilty of? He is guilty of waging war without Congress OKing it. That's a Constitutional requirement and he is unequivocally guilty of violating the Constitution on this point in my mind. But we've had many cases in the past where the courts rule against the President on the constitutionality of the President's actions. So why do we throw someone out of office over some infractions but simply overrule them on other infractions?

And what is right in this case?

I'm not especially supportive of this action in Libya, but we're clearly not going in there in a way that flaunts international law, we clearly aren't going in there for a lie (everyone is clear on exactly what Gadaffi is doing... this isn't yellow-cakegate all over again), and we're probably not strengthening al Qaeda's hands by doing this. This is probably not a good thing to jump into, but it's not a grave crime against humanity either. It's entirely plausible Obama could have gotten Congressional approval, but the problem is he didn't seek it out. Should he be thrown out of office for that? It seems like something that just needs to be overruled and ended until Congress gives it a stamp of approval. I'm not sure what his means, though. The Tom Woods school of thought says nullify the hell out of anything that violates the Constitution. This seems silly to me. I thought impeachment was the solution, but now I'm not so sure. Throwing a president out of office for every violation of the Cosntitution seems just as silly to me. I'd prefer we just overrule him.

Anyone know the law around this or have opinions on the right way to go about it?

More Andolfatto on Paul

David Andolfatto - who previously received so much criticism for pointing out that a particular Congressmen didn't know much about monetary economics - has a sequel post outlining how that Congressmen doesn't know much about monetary policy. It's very polite and clear, and hopefully shouldn't garner quite the same reaction from the crowd that swoons over the word "pinhead" but is happy to hurl around terms like "statist" and "fascist".

A lingering question... is "pinhead" more or less appropriate than "joker"? I just want to make sure I know when it's OK to "speak truth to power" and when it's not OK.

The pragmatist's response to the inevitable flailing of philosophy

"I'm sorry, but we can't send a search-and-rescue team into Plato's Cave"

A question about Mars, economies, and sciences

Jonathan Catalan points to a recent Hugo Chavez musing that capitalism might have killed off the Martians. So here's a question...

...social scientists and especially economists study the behavior of humans under conditions of scarcity. Entomologists study the behavior of bugs in their harsh environments. Herpetologists study the behavior of amphibians and reptiles. Primatologists study the behavior of primates, and how they react to the constraints of their environment.

If we make contact with an alien species on par with human beings in terms of their intellectual and social capacity, who will study their behavior under conditions of scarcity and constraint? Will the people who study them be considered biologists or social scientists? Who is better equipped to study them? What is really the dividing line between biologists who study animal behavior and social science, except the species under study?

Economics and Biology Again

A couple biology blogs picked up an old post by Russ Roberts on how economics is like biology (here, here, and especially here, by Mike). As I've said many times, I agree that the biology analogy is apt, but I think Russ largely butchers it for many of the reasons pointed out in the last link.

Russ writes: "But we would never ask of biologists what the public and media ask of economists. We do not expect a biologist to forecast how many squirrels will be alive in ten years if we increase the number of trees in the United States by 20%. A biologist would laugh at you. But that is what people ask of economists all the time."

Mike responds: "Erm, no. Actually, ecologists not only answer those types of questions for regulatory purposes all the time (e.g., forestry biologists, fisheries biologists, pest control, crop management), but they routinely answer much more difficult questions, such as how does a temperature increase combined with less rainfall affect pine populations due to a change in bark beetle populations. Biologists have been running simulations (which are different from models) for a very long time."

Mike is exactly right, and I made this point to Russ initially. A lot of people that are down on economics as a science don't really understand what they're talking about when they talk about the complexity of an economic system. Complexity doesn't mean that you aren't able to predict the behavior of something, it simply means that there are certain dynamics that can emerge unpredictably. You can think of it like the classic difference between risk and uncertainty in the economic system. Certain events can have probability distributions fitted to them, but you have to allow for fundamentally uncertain process, and ultimately that prevents you from projecting too far into the future. But you can simulate things and you can forecast. You just have to know what processes are subject to the fundamental complexity of the system and what aren't. Biologists can predict what will happen when an ecosystem that is understood experiences a shock. Biologists cannot predict what animals will have evolved 10,000 years from now. Economists can predict growth paths for the economy. Economists cannot predict what specific firms will still be successful in 100 years.

The post then gets into a discussion of natural selection and the role of natural history in biology. His point is simply that both disciplines deal with historical contingency and rely on theory to be both confirmed by history, but also to reconstruct historical narratives. This section is all good.

Finally, I have to take issue with a point that this post ends on. Mike writes: "But where Roberts goes off the rails is his statement that economists try to predict specifics and that's impossible to do. I personally wouldn't blame an economist who didn't get the timing exactly right on the collapse of Big Shitpile. But what was disturbing was that very few economists--or at least those that interacted with the public--were saying that the combination of rapidly rising housing prices, high personal debt and stagnating wages were a disaster waiting to happen."

I have two contradictory responses to this. You may choose one.

1. I think more people noted the housing bubble was a bubble than for some reason people generally admit. I heard it referred to as a "bubble" around the Urban Institute long before it popped. Everyone has their lists of their buddies who saw it coming. The housing bubble was not that much of a surprise to anyone, I don't think. What was a surprise was what it did to the rest of the economy, which was largely based on the what the finance industry had done with the mortgages. People were sounding the alarms about the debt build-up too - lots of mainstream people. But the debt loses some of its cogency when you don't know how liable everyone was to movements in sub-prime mortgages. That was the real surprise, but I don't think it says anything about economics as a science that we aren't privy to the portfolios of major banks.

2. And as Scott Sumner and others have pointed out - there's no good way to point out a bubble when you're in one. If there was, you probably wouldn't have bubbles. It's one thing to say "gee, house prices look overvalued". It's another thing to say what that overvaluation means, and it's yet another thing to say what implications it has for the economy.

*****

The question of science boils down to this - what method do economists use to chase after useful knowledge? Well, we have an iterative deductive/inductive process where theory is tested against data and the tests inform new theory construction. Replication of results is required to convince the community of economists of a claim. Good economists don't let their normative judgements influence their conclusions. We deal with complex systems and we deal with the interactions of a specific mammal, so it's not surprising we are similar in character to biology. If someone studied the same sort of thing in another species they would actually be called a biologist, after all.

Price Coordination, Structural Adjustments, and Keynesian Downturns

Brad DeLong mentioned my extension of Steve Horwitz's puzzle analogy again. He writes:

"As Dan Kuehn likes to say, a recession is like somebody knocking your jigsaw puzzle, disturbing the pieces and turning some of them over. When the Federal Reserve ends a liquidity squeeze it turns the pieces right-side-up--and so it is easy to reassemble the puzzle. But right now there is nobody to turn the pieces right-side-up--and so things are much harder.

Pursuing this analogy further, I claim that things are even worse. As long as aggregate demand remains low, we cannot even tell when pieces are right-side-up. New investments, lines of business, and worker-firm matches that would be highly productive and profitable if capacity utilization and unemployment were at their normal levels are unprofitable now. We do need not just demand recovery but structural adjustment. But the market cannot do demand recovery rapidly by itself. And it cannot do structural adjustment at all until demand recovery is well under way."

This is the right way to approach economics, rather than a style that you often see that says that one pet theory is not just correct, but the only correct theory. I obviously don't need to be convinced that we're facing demand problems... what I'm a little confused about is precisely what structural problems we're facing that Brad refers to. Certainly there's the issue with housing. That strikes me as a bubble that popped and we're going to need some reassignment of resources previously dedicated to that. Is that all we're talking about here? Or is there something deeper? The one thing that comes to mind is the computer. Is there large scale technological unemployment associated with skill-biased technological change that we need to adjust to? That seems plausible, I guess. Is that what he's refering to or does he have something else in mind?

The important point, though, is that Keynesianism is all about problems with the price mechanism. The nice, tight, Walrasian system is actually over-identified which interferes with price signals sent to investors especially. You can think of it as an "interest rate wedge" similar to the "tax wedge" that is standard fare in undergraduate economics. I don't know if anyone has talked about it in this way before, but it seems like a useful way of doing it for people who seem to think Keynesians ignore price coordination. When these prices are distorted at the very least a demand problem is introduced - demand is insufficient to fully employ resources because there is excess demand for liquidity (or high quality assets, or whatever else you want to talk about... DeLong is always good at listing a few relevant margins) that would re-equilibrate if the Walrasian system were just-identified but doesn't need to re-equilibrate if it is over-identified (hence the stable underemployment result)*. But this price distortion also prevents any other adjustments that need to take place from taking place - including structural adjustments. If interest rates are artificially higher than the equilibrium rate, you're going to have a stable Keynesian obstacle to structural adjustments just like you have to any other investment. As Brad said initially, ""structural adjustment" takes place when unemployment is low, not when unemployment is high".

In a way, you can think of traditional macroeconomic policy getting us from Keynes (where the interest rate is higher than the MEC) to Hicks (where the interest rate is equal to the MEC), but DeLong is saying that even when we're at Hicks's solution you still need full employment for prices in the goods and services market to be able to coordinate again and respond to structural adjustments. Does that seem like a reasonable way of talking about it?


* - One way to think of why this is true is that slack in a just-identified system is arbitrageable while slack in an over-identified system is not arbitrageable.

Comment reminder

Blogger can be moody and capricious. Just a reminder that you can just let me know if it eats one of your comments. It's just marked it as spam, and I can rescue it.

We don't moderate comments on here for the most part - I think I've only removed comments twice for being inappropriate. And if that happens there will be no mystery about it - I'll let you know I've done it.

Catalan on an Internal Review of Economics

Jonathan writes:

"I think it’s time to ignore the role of the state [the role that politics has in the views economists hold], if it has any, and instead focus on introspection. It would be worthwhile to have some kind of organization activity, where the foundations of different theories are revisited, and where the science recovers some of its backbone (which, to me, is the coordination process). Without this type of internal review, it seems to me that economics will continue to grow in multiple directions, without any common basis, and the science will proceed down this road of disorganization and inaccuracy.

The differences in theory are real, not politically driven. Whatever arguments there are on the policy level, they stem from these differences in theory. It’s worthless to assess the political environment, and ignore the theory — if you’re looking to “fix” the profession, pointing fingers is not the way to do it."

The review itself doesn't seem entirely necessary to me because I think I diagnose the problem differently. The problem with economics is not that we have multiple theories, it's that we've convinced ourselves that these theories are mutually exclusive. In the Austrian school, changes in the interest rate change the capital structure, which changes how resources are used. In Keynesianism, changes in the interest rate drive a wedge between the cost of capital and the returns on capital, which changes how resources are used. RBC theory posits real shocks that influence resource use. Minsky suggests that behavioral instability in financial markets introduces cyclical behavior. None of these ideas are mutually exclusive. What makes them mutually exclusive - what makes them appear "disorganized" to Jonathan - is that we've convinced ourselves that you can only agree with one of them. This is what bugs Russ Roberts so much too - he thinks disagreement is a sign that we are not scientific. Instead, I think it's a sign that we are just contentious people who disagree when we don't have to.

What economics does need to do is become more like biology. We are dealing with a very complex system where lots of forces are acting simultaneously. Our disagreements are not like those of Lamrack and Darwin, where we disagree on the fundamental processes involved. Austrians may talk about it slightly differently than the rest of us, but we all agree on subjectivism, marginalism, price coordination, and market efficiency. That's what makes economics what it is, just like evolution by natural selection makes evolutionary biology what it is. We are well past the fundamental disagreements. Our disagreements are more of the punctuated equilibrium vs. gradualism sort. We share a common foundation, but there are major disagreements in the way that that foundation is understood to unfold. We have a complex subject, just as evolutionary biologists do. It would be nice to resolve these sorts of disagreements conclusively. One day we presumably will and one position will be banished. But for the time being, the disagreement persists. Most of our disagreements are even more minor than that. For example, while our theories of interest rate determination represent a big disagreement (albeit with a common core of what we agree on), either a loanable funds, liquidity preference, or hybrid theory of the interest rate can accommodate Austrian theorizing about the capital structure. Austrians may find it hard to convince people that it is important, but that's OK. Nobody is obligated to consider something important just because another economist thinks it is. People have to be convinced!

Not a shining moment for Peter Boettke

Don Boudreaux links to this paper presented by Peter Boettke.

This gets to the heart of the criticism he provides of Keynes, which he calls "bad economics":

"But there are good reasons why economists forced these theories into the underworld of economic opinion. They reflected bad economic analysis. What I mean by that is that they implicitly assume away scarcity and believe the fundamental problem of modern society is poverty amidst plenty, and they explicitly deny both actor rationality and the coordinating role of prices, and the function prices serve in guiding decisions and the feedback and discipline provided by profit and loss. If you postulate a world of post scarcity, then neither the coordinating role of the price system, nor the incentives of the property rights structure, is critical; and if you don’t allow the individuals that populate your economy to learn from market signals, and you don’t allow those signals to actually work, then of course the economy will not work!"

There was a time when good criticisms were raised against Keynesianism (or what Keynesianism turned into), and real advances were made. This piece by Boettke is so poorly thought through, though, it becomes hard to know how to respond in a productive way. We assume away scarcity? Since when? Boettke provides no reference at all to what he could be referring to and I have no idea. We "explicitly deny" actor rationality? No - rational behavior was at the heart of all the economics I ever learned. Even the behavioralist work that challenged some assumptions of rationality did it by pointing out a deeper rationality to human behavior (sometimes based in evolutionary imperatives, etc.). Nobody I know - no Keynesian - ever "explicitly denied" rationality. He also says we "explicitly deny" the coordinating role of prices, which is even more unbelievable. The whole Keynesian system revolves around a distortion of a price - the interest rate - which leads to economic downturns. Price coordination is the bedrock of Keynesianism (as it is of all good economics), and it's what Keynesians count on to efficiently allocate labor, capital, and money. It's poor price signals that cause all the problems in the Keynesian understanding of the world. How could Boettke suggest we "explicitly deny" price coordination? It's hard to tell because he never cites anyone or explains how he came to this conclusion.

I guess what's most frustrating is that on most occasions Boettke seems like a reasonable and intelligent guy that's worth engaging. Then you read something like this and just think "my God - what's the point of even talking to him - he could care less about thinking through these issues, and he's happy to substitute whatever he wants to for what people actually think". If someone were to ask me to explain Keynesianism it would literally be impossible without the concept of rationality, trade-offs, and price coordination. Without those things, Keynesianism not only doesn't make sense - you just wouldn't have the vocabulary to discuss it at all. It's not clear to me, then, why Boettke takes this approach. What value does he see in inventing disagreements with Keynesianism? What is the point of inventing a boogeyman? If we don't disagree on the coordinating role of prices why tell your colleagues and most of all your students that we do? I really don't understand his motivation here. Boettke is lionized as a guy that cares a lot about his students, but that's not going to adequately prepare them to go into the world and talk about economics. They're going to approach a Keynesian and accuse them of "explicitly denying" rationality and price coordination, and then the Keynesian is going to say "actually, those ideas are central to our thought, so instead let's discuss X, Y, and Z where we do disagree" and these students are going to be completely unprepared to talk about anything other than the caricature that Boettke is providing. I spend a lot of time on here walking through pretty elementary points about why price coordination is so important in the Keynesian system, why no Keynesian is proposing central planning, what the conditions are for market efficiency, etc. I'm willing to tackle foolish points like "you guys don't care about price coordination". A lot of people won't be willing. If you say things like what I quoted from Boettke, above, a lot of people will just assume you've excused yourself from the argument that reasonable and informed people are having.

Anyway - very disappointing.

The new Review of Austrian Economics is out

The last article is open access.

A Symposium on Pluralism and Austrian Economics

Examining social processes with agent-based models
Chad W. Seagren

Illustrating the importance of Austrian business cycle theory: A reply to Murphy, Barnett, and Block; A call for quantitative study
Andrew T. Young

Why should Austrian economists be pluralists?
Robert F. Garnett

Against representative agent methodology
Roger Koppl

Pluralism and heterodoxy in economic methodology
Randall G. Holcombe

Cultivating constructive discourse over economics and public policy
Peter Boettke

Specialists and citizens all: A reply to Boettke, Koppl, and Holcombe
Robert F. Garnett

Review of Russell Hardin, How do you know? The economics of ordinary knowledge
Princeton University Press, 2009, 240 pages
Samuli Leppälä

Open Access: A critical review of against intellectual monopoly
John Kennedy

Assault of Thoughts - 3/I suppose it's technically the 20th/2011

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

- Bravo. Very good to see this sort of thing. A bipartisan supermajority of Senators calling on the president to tackle tax and entitlement reform. One of the nice things about this sort of initiative is that even if they are overly conservative in their approach, a tax and entitlement reform is not going to pose the sort of threat to those struggling through a depression that, say, a cut to the non-military discretionary budget (i.e. - the portion of the budget that goes to working families) would pose. Even if they cut deeper than necessary, it's the sort of thing that unfolds over many years. And it's the sort of thing that really needs to be done. The fact that right now we need larger deficits does not change the fact that we face a very real long-term debt problem.

- This does not seem like a wise way to fight an increase in liquidity preference.

- This is perhaps the best post I've seen so far on the most recent back-and-forth over whether economics is a science or not. If it's not, fine - just count biology, geology, meteorology (and Sumner argues even physics) out too. It seems most meaningful to me to say that economics is a science because we chase useful knowleddge the same way all the other sciences chase useful knowledge. If you want to provide another definition for it, then be my guest. Go right ahead. In the mean time, I have some science to go do.

- Matt Yglesias tackles the constitutional justification for federal provision of infrastructure. He makes things more complicated than they need to be. He works his way through the commerce clause, dismisses it, and then brings up an unnecessarily obscure clause: "I would have said that the power “[t]o establish Post Offices and Post Roads” implies a generic grant of authority to do transportation." You don't need to read any farther than the first clause of Article 1 Section 8 - the Congress can appropriate money to provide for the General Welfare. The constitutional quibbles of Jefferson himself on this point amounted to no more than that he felt the need to obtain the permission of the states the roads and canals were passing through first. Nobody ever questioned this application of this clause until decades after the Constitution was ratified. To some 21st century eyes that may seem like it's close enough to be "originalism", but to me if someone takes decades to register a complaint I'm not buying that this is a legitimate originalist interpretation of the Constitution. If I were around back then I'd be in Gallatin's corner.

Always good to get criticism from both sides

So I was at this talk this morning at Georgetown on high-skill immigration, hoping to get some insights for the NBER chapter that I am now finally drafting.

I didn't entirely agree with the speaker, but it was good - I took more issue with his policy conclusions than his actual findings.

Anyway, I made a pretty standard argument about how it's much harder to claim that immigration hurts American workers than he asserted. After the talk, a guy from the Economic Policy Institute came up to me and accused me of wanting to "immiserate the country"! That threw me off guard a little (since, of course, I have no interest at all in immiserating the country), so I didn't respond as well as I would have liked to. I plan on sending him a more coherent email.

Anyway - it was reassuring. When I get attacked from the right and the left I feel more reassured that ideological imperatives aren't driving what I'm saying (although surely they play a role for all of us).

They should have a video of the talk - I'll post it when it comes up.

Assault of Thoughts - 3/18/2011

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

- First, a jigsaw puzzle roundup. Steve Horwitz started things the other day by using a jigsaw puzzle metaphor to explain the difference between Austrians and Keynesians. Don Boudreaux concurred. I let them keep their description of themselves but corrected some misunderstandings of the Keynesian claim. Brad DeLong linked to me. I clarified what I thought the heart of the problem was - people read things like ditch-digging and assume Keynes was talking about make-work projects, when really his point was closer to Friedman's helicopter drop. Jonathan Catalan likes the metaphor if we keep in mind that it's oversimplified, and calls attention to Hutt's view on idle resources (which is often presented as an alternative to Keynes, but it strikes me as being different... more complementary than supplementary). Samuel Wonacott responds here. I was also fascinated to see the Joint Economic Committee Republicans' blog pick up Steve Horwitz and Don Boudreaux on this - and a Mercatus Center link. It's always interesting to see Austrians claim how hot and heavy Washington is for Keynesians and how they're shut out. Republican Congressmen are posting their stuff. Wouldn't it be great if Paul Krugman and Brad DeLong were on the White House blogroll? Ya - that's not happening. And while Hayek's portrait is up in at least two Congressional offices, I doubt Keynes is up in anyone's. Interesting to see that. Did I miss anyone's?

- Evan blogs about how theologians grapple with history

- Robert Vienneau blogs about Card and Krueger's work on the minimum wage and recent evidence.

- Scott Kuhagen updates us on Cucinelli's assault on Mr. Jefferson's University.

- Many people have pointed to Will Wilkinson's summary of the literature on the economics of disasters. I did a search on this literature too shortly after the earthquake, when all the broken window fallacy slandering was going on, and I came up with a lot of the cites that Wilkinson provides. Much of these are publicly available - it's worth a look. This is an empirical question, guys. It's not a morality play. It doesn't seem like we're likely to see any silver lining from this, but the logic of a silver lining from disasters is not crazy - you just have to be careful in how you talk about it and what precisely it is that you're claiming.

Two points on reason

First, I was thinking about Hume on the experience of "miracles" the other day and how his point ought to be generalizable. This is the crux of his criticism in Of Miracles:

"The plain consequence is (and it is a general maxim worthy of our attention), “That no testimony is sufficient to establish a miracle, unless the testimony be of such a kind, that its falsehood would be more miraculous, than the fact, which it endeavours to establish: And even in that case there is a mutual destruction of arguments, and the superior only gives us an assurance suitable to that degree of force, which remains, after deducting the inferior.” When any one tells me, that he saw a dead man restored to life, I immediately consider with myself, whether it be more probable, that this person should either deceive or be deceived, or that the fact, which he relates, should really have happened. I weigh the one miracle against the other; and according to the superiority, which I discover, I pronounce my decision, and always reject the greater miracle. If the falsehood of his testimony would be more miraculous, than the event which he relates; then, and not till then, can he pretend to command my belief or opinion."

It seems to me that this has applications beyond experiential evidence to logical evidence as well. Often logical evidence is put on a pedestal - particularly in some of the circles that I engage with on this blog. Frequently it is assumed that the critic must find a flaw in the argument - that the burden of proof is on them. To make matters more challenging "the argument" is usually nothing more than a premise, a conclusion, and a citation of Mises, which doesn't give the critic of the conclusion much to work with. I would never deny the burden of proof placed on the critic (usually I'm simply not interested in crafting a disproof), I just wonder to what extent it is uniquely borne by the critic. This is where Hume comes in. Hume's critique of those who have claimed to see the miraculous is that they should ask themselves "is it more likely that what I see is correct, or is it more likely that I am deceiving myself?". I think this sort of self-interrogation should be done more, particularly by heterodox rationalists who derive conclusions that are apparently lost on lots of other intelligent people. I am no logician and I have never read Mises and I am not motivated to disprove Mises because I'm not all that swayed by the imperatives of a purely a prioristic science in the first place. In other words, my criticism is not a very good test to put your ideas to if you do take the imperatives of a purely a prioristic science seriously. But in the absence of a disproof, I think those who are tempted to take Mises and others as indisputable should take Hume to heart - what is more likely, that the failure to see a disproof implies the absence of a disproof, or that there is a disproof and your own logical faculties simply fail you? In other words - knowledge is not innocent until proven guilty. Knowledge is always probabilistic. And the content of the knowledge itself is not the only factor in play - your ability to scrutinize and digest that content is also a factor.

*****

Chris Perridas - an H.P. Lovecraft blogger - points us to a piece about Lovecraft by Erik Davis that I think has some interesting things to say about Lovecraft and reason. One of the things that is often noted as being unique in Lovecraft is that his horrors and monsters are not supernatural at all. In that sense, Lovecraft was not a part of the Romantic tradition. Indeed he identified himself with the Critical Realists of the early twentieth century. What's different about Lovecraft's monsters is that they are not presented as a suspension of reality or a flight into fantasy - they are presented as a reality we simply weren't aware of. Davis writes:

"For Lovecraft, it is not the sleep of reason that breeds monsters, but reason with its eyes agog. By fusing cutting-edge science with archaic material, Lovecraft creates a twisted materialism in which scientific “progress” returns us to the atavistic abyss, and hard-nosed research revives the factual basis of forgotten and discarded myths."

Insanity is a potent theme in Lovecraft, but the insanity comes as a result of the reality of the monsters. Monsters aren't a function of insanity; insanity is a function of the monsters.

Brad DeLong, Ditch-Digging, and Helicopters

Brad DeLong graciously linked to my post extending/critiquing Steve Horwitz's jigsaw puzzle metaphor for the difference between Austrians and Keynesians, which I felt relied on critiquing a parody of Keynesianism.

It's fitting that Brad linked to it because I think he's one of the best guys out there for explaining that Keynesianism is not about the government being the spender of last resort - it's about the government acting to eliminate distortions in the interest rate. These distortions arise from the fact that the interest rate is really one price for (at least) two goods: credit (or loanable funds) and cash (or liquidity). For those of you that remember your linear algebra, this is the same as saying that we have more equations than we have unknowns. We have four equations (demand for loanable funds, supply of loanable funds, demand for cash, supply of cash) but only three unknowns (quantity of loanable funds, quantity of cash, and the interest rate). We call systems like this "over-identified", which means somewhere there is going to be slack. Keynes was ambiguous about where the slack would come up. Hicks forced the slack to express itself in output by making a model where both the loanable funds market and the cash market had to clear. Wherever you fall (and I'm personally agnostic between Keynes and Hicks), the point is it's this price distortion that causes all the trouble, and Keynesianism is about fixing broken interest rates.

For some reason, this message does not get across to people and Keynesianism instead gets treated like it's saying "Y=C+I+G so if you increase G you have to increase Y". This view reads Keynes writing about burying bank notes and digging ditches and assumes he's talking about make-work projects. This view reads Brad DeLong saying that anything that adds to the deficit passes the cost-benefit test and thinks he's saying we just need to add more demand and pump up G. This completely misses the point. Keynesian ditch-digging is not a make-work argument. Keynesian ditch-digging is a helicopter drop, not a make-work program. The first helicopter flew in June, 1936* - only a few months after Keynes published the General Theory. It's a shame, because if Keynes had come up with Friedman's "helicopter drop" analogy rather than a ditch-digging analogy it probably would have lead to a lot less confusion.

If you want to cling to a loanable funds theory of the interest rate, by all means do your best at defending that view. It's going to insure that you happily and naively live in an abstract world of full employment and supply creating its own demand. Good luck with that one. But if you choose to engage Keynesianism, make sure you take the time to understand the argument. It's not about make-work, and it's not about replacing what the private sector used to do. It's about correcting price distortions that are inherent in monetary economies.

* - In Nazi Germany, which is why the helicopter picture in the top-left has a swastika on it... I don't just randomly post Nazi military images on my blog - it ain't my fault they figured the helicopter out first.

A St. Patrick's Day Classic

I believe we've posted this here in the past, but it's always good:

Cause for hope

Arnold Kling has bothered me in the past for his wild ideas of what progressivism is, but there is cause for hope as well. For example, in this post he talks about reducing the payroll tax and replacing it with a carbon tax, making Social Security less regressive, and shining a spot light on tax expenditures as having a "whiff of liberaltarianism". These are ideas that I hear all the time in the circles I'm a part of in the Democratic-leaning policy analysis community. This stuff that Kling is apparently positive about is standard fare. It's encouraging to see a "whiff of center-left thinking" on such a prominent libertarian blog!

If a bill was introduced tomorrow to cut the payroll tax and replace it with a carbon tax, it would not be the left that would be standing in its way. If Congress got serious about really accounting for the money that gets funnelled out through tax expenditures, it would not be the left that would throw up roadblocks.

Stimulus and jigsaw puzzles

Steve Horwitz has a post arguing that the metaphor of a jigsaw puzzle illustrates the difference between the Keynesian and the Austrian perspective. It's long, but this portion gets the essential points out:

"In a series of newspaper columns last year, Don Boudreaux compared the economy to a giant jigsaw puzzle with billions of pieces that can fit together in numerous combinations only a small number of which produce a meaningful pattern or picture. We learn which combos work because they “beep” every time we get one “right” and those beeps give us pleasure. I like that metaphor and I want to make use of it to talk about Austrians, Keynesians and stimulus spending.

Imagine that we do what Don describes and start constructing this jigsaw puzzle, but rather than the beeps reflecting combinations that create meaningful patterns, imagine that the beep mechanism is suffering from a computer virus that leads it to commit both Type I and Type II errors. The result is that we end up creating a puzzle that sees no meaningful image emerge (whether one characterizes the pattern as “out there” or emergent isn’t essential to my point). Suppose further that we eventually use up all of the pieces and discover we have wasted our time because there is no meaningful picture to be found.

What happens next? For one thing, we have to spend some time pulling the puzzle apart as what we’ve created produced no meaningful picture. Then we’d want to fix the bug in the beeping mechanism. And then we’d want to get back to the task of building a puzzle that did create a meaningful pattern. Of course this extension of Boudreaux’s metaphor is designed to mimic the Austrian theory of the business cycle, though somewhat imperfectly.

Now suppose we are in the process of dismantling the old puzzle. Suppose further that as we pull pieces apart, we have to wait for a beep to inform us that doing so was a good “pulling apart.” Once we know we have correctly dismantled, we can try to “re-fit” those pieces into the puzzle. As we engage in this process, there will be a bunch of pieces that are sitting around waiting to be “re-fit” into the puzzle, ideally generating a true beep and helping create a meaningful picture when re-fit correctly. Of course if we’ve really fixed the beep mechanism, these “pieces in waiting” will grow at first as we do more dismantling than reconstructing, then shrink as those reverse.

So while the Austrian puzzle observers nod approvingly as the dismantling and reconstruction continues slowly but effective onward as puzzle makers learn from the beeps, along comes their friend the Keynesian. The Keynesian bemoans the fact that there are so many puzzle pieces sitting “in waiting.” He says “wouldn’t things be better if we just starting putting those pieces into the puzzle in any old way? Even if we don’t get a meaningful pattern, at least we’d use up all the pieces. After all, isn’t that how you know you’ve reached the goal of a finished puzzle?”

The Austrians respond by saying “No, the point isn’t to just use all the pieces. That’s easy to do, but it’s not the challenge of this kind of jigsaw puzzle. The challenge here is to produce a meaningful pattern without having a picture on the box, and which might not require all of the pieces to be used, because the meaningfulness of that pattern derives from the way in which the organization of the pieces matches what puzzle demanders want in a picture even though they cannot articulate it ahead of time.”

Now it’s true that puzzle pieces are not human beings, but the underlying contrast of visions here seems to me to capture the debate. The argument for stimulus spending by Keynesians amounts to saying we need to activate idle resources either without thinking about whether the puzzle pieces actually fit together or, more subtly, not thinking about, or not caring about, whether they produce a meaningful pattern. The point is just to make sure they are being “used.”"

It's always interesting to hear what people think you think - for example, that Keynesians don't care or worry or realize that market activity is characterized by complex, extended specialized exchange relationships. I don't think this analogy quite works because it only really seems to address the crude Keynesian "lean against the wind" sort of argument that says "I and C are low so we have to increase G to make up the difference". "Lean against the wind" as a simple decision rule isn't the worst thing in the world, so it usually gets by without too much criticism. Better that people think in those terms than that they embrace austerity. But it really misses the primary point.

Keynesians argue that the price distortion occurs in the bust, not the boom. Interest rates are too high, and the Austrians are embracing this distortion of the price mechanism as normal. When you hear Keynesians talk about stimulus, they don't usually talk about how it gives people jobs directly (although if you can do that on worthwhile projects like building roads and schools of course that's nice). When Brad DeLong talks about stimulus, for example, he always refers to its benefit as being the provision of high quality assets for which there is an excess demand. The point is to eliminate the price distortion in the interest rate, so that investors can once again engage in specialization and exchange.

A better analogy for Keynesianism (if we stick to the jigsaw puzzle), is that some shock occurs - someone bumps into the table where you're working on the puzzle - turning a bunch of your pieces upside down. The information that investors were using to make decisions is distorted because you no longer have the picture on the front of the puzzle piece to use to make decisions about the use of that puzzle piece. Whereas previously all puzzle pieces were available for utilization, the shock distorted information such that many of the puzzle pieces aren't viable for use. What does one normally do in this situation? Well, you start to correct the distortion! You start turning over puzzle pieces so that the people working on the puzzle can now viably use all of the puzzle pieces that are available. To Keynesians, the Austrians look like they are embracing a price distortion and insisting that the people working on the puzzle continue to use the pieces that have been turned upside down. The Austrians insist that those working on the puzzle will figure out what goes where, even if they no longer have the picture on the front of the piece to look at (information from undistorted prices). Keynesians are simply responding "why don't we turn the piece over and then keep working on the puzzle?", and find it incredible that this idea seems so foreign to people.

A note on testing theories and a question to Austrians on their predictions

The Note
So a while back I expressed interest in a much more rigorous empirical investigation of the elongation of the capital structure, using input-output tables produced by the Bureau of Economic Analysis. I think Austrian arguments about the elongation of the capital structure make good sense, and I think it would be nice to confirm that in the data. I thought of a major problem with the interpretation of this sort of results recently associated with the question of identifying a "natural" or equilibrium interest rate, and therefore a "natural" capital structure. Austrians say that interest rates during the boom are too low, distorting the capital structure and setting malinvestments up for the bust. After the bust, interest rates return to "normal" and the capital structure becomes less elongated (shedding jobs in the process). Keynesians suggest that interest rates during the boom are largely fine, and we have busts when shocks make interest rates too high. You can see the fundamental disagreement between the two arguments, but the data should look the same. I think an analysis of the capital structure of the sort that I talk about in the link would still be interesting. It would be good to know more about how substantial the shifts in the capital structure are. But assuming they are significant, what would the Austrian model predict? Long capital structure in the boom, shorter in the bust. What would the Keynesian model predict? Precisely the same thing - long capital structure in the boom, shorter in the bust. The only difference is in what is considered natural. Keynesians will say the boom was natural. Austrians will say the bust was. Looking deeper into the capital structure is not going to be able to arbitrate that one.

The Question
The question I had for Austrian readers is how they explain interest rate behavior in light of deficits and monetary expansion, which Krugman talks about here. I know there was some related discussion about inflation several months back. Many Austrians had predicted runaway inflation and had to eat their words when it didn't materialize. More circumspect Austrians criticized them for making those predictions in the first place, noting the role of interest on reserves and other factors that would have prevented runaway inflation. So the inflation question seems to have been settled amongst Austrians, but I'm not aware of the Austrian story on why massive deficits and lots of money printing hasn't raised interest rates. Keynesians have a very clear answer - we're in a liquidity trap. Or more generally speaking, interest rates clear two markets - the credit market and the money market - and its possible for disequilibrium to persist in one while equilibrium persists in another. I'm not quite sure how Austrians account for this. Can they account for it? How? Just curious and figured someone might have insight.

Over a year ago - how did I miss this?

Matt Stone and Trey Parker are Keynesians - I will hear no dissent on this one.

Maybe they're libertarians or maybe they're not. They've been reluctant to be very declarative on this. All that seems clear to me from what they've said is that they don't like the right or the left. That's fair enough, and a lot of people think that means they're libertarian. I'm a little skeptical of that as a guy that's frustrated with the right and the left and not a libertarian. But fair enough. If they are libertarians, they are Keynesian libertarians.

The mockery of classical thinking is throughout (including of the idea that interest rates were kept too low in the boom), but the good stuff starts at 13:20.

Stan gives us a critique of the politicians
Kyle gives us Keynes

More on libertarian social engineering and rationalism

Autofyrsto links to an old post of mine on libertarian social engineering, where I make the argument that libertarians are the biggest viable social engineers in America today (I'm assuming - safely, I think - that state socialism is off the table). Strict libertarianism takes a blueprint for the organization of society that it has derived rationally from a few essential principles and seeks to impose that blueprint on society. They don't see it as an imposition, of course, because they see it as a reaction to other impositions. But their perception is largely irrelevant. The strict sort of libertarians (rather than "libertarians on the margin", like Greg Mankiw) pursue radical change on the basis of very little experimentation or experience. That's not inherently good or bad, but it's something to be cautious about.

Autofyrsto primarily takes issue with what he perceives to be my assault on reason and rationalism. He starts by making an issue out of the point in the David Brooks article I link where Brooks notes that Edmund Burke was "horrified" that "individuals would use abstract reason to sweep away arrangements that had stood the test of time". Atuofyrsto goes on to protest when in the blog post I link to Greg Mankiw admits that he "recoil[s] at more radical libertarian positions". Autofrysto writes that "If steam comes out of the libertarians’ ears, it is only at the frustration of arguing with people who openly and proudly muzzle the voice of reason so that they may continue to believe, at our expense, whatever makes them comfortable." Muzzle the voice of reason? This is an odd interpretation of what Brooks, Mankiw, and I were doing. We aren't unreasonable or unrational people, after all. It would be strange for us "openly and proudly muzzle the voice of reason". All we're suggesting is that human society is complex and a single person or a group of people can't map out a blueprint for it. Reason is a tool of the mind to be used, not abused. Autofyrsto seems to be arguing that the admonition not to abuse reason is an attempt to muzzle it. I disagree.

Autofrysto then goes on to cite a favorite of this blog, Thomas Paine:

"To argue with a man who has renounced the use and authority of reason, and whose philosophy consists in holding humanity in contempt, is like administering medicine to the dead, or endeavoring to convert an atheist by scripture. Enjoy, sir, your insensibility of feeling and reflecting. It is the prerogative of animals. And no man will envy you these honors, in which a savage only can be your rival and a bear your master."

Again, no one here is renouncing the use and authority of reason. Quite the contrary. I am renouncing the unreasonable application of reason. I am renouncing the fetishism of reason. I am upholding the idea that man's reason is a great asset but renouncing the idea that it is capable of forseeing and planning all things. I'm advocating common sense, in other words, which makes the rebuke with Paine a little laughable. Autofrysto ends with this point, which I can agree with him whole-heartedly on:

"We should carefully scrutinize the so-called “wisdom of the ages” in light of reason, and abandon it when it fails that scrutiny. I don’t even know how to explain why. It seems so self-evident."

It's official!

I'm an economics doctoral candidate at American University, and I'll start there at the end of August. I'll be the very grateful recipient of a merit-based assistantship that I'll be able to keep for four years. I'm planning on doing the macroeconomics track, with field work in labor economics and monetary economics. Right now I'm interested in doing dissertation work on gross worker flows and the wage adjustment process, but of course that's a little while off at this point.

Assault of Thoughts - 3/14/2011

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

- In 1993, Michael Kremer published a famous paper demonstrating that technological development increased with the size of a population, confirming some important characteristics of endogenous growth models and demonstrating that they do a great job explaining economic growth in the long sweep of human history. Gary Gunnels shares a New York Times article that describes much the same process in a more cooperative human pre-history than a lot of people expected. This line especially jumped out at me and reminded me of Kremer, with its explicit population/technology connection:

"Knowledge can in fact be lost by hunter-gatherers if a social network gets too small. One group of the Ache people of Paraguay, cut off from its home territory, had lost use of fire when first contacted. Tasmanians apparently forgot various fishing techniques after rising sea levels broke their contact with the Australian mainland 10,000 years ago."


- There's a lot of broken window fallacy talk going on in response to the Japanese earthquake, and I'd encourage people to approach with caution. A lot of what's been written is just ideologues using the tragedy of others as an opportunity to say horrible things about people they disagree with, and enlisting good thinkers like Bastiat to do their dirty work. I have a bunch of posts on how to think about the broken window fallacy here that people can review if they're interested. I don't feel like getting into specifics on this particular instance - it just turns my stomach to see how some people have been using this as an opportunity to slander others. If anyone knows any empirical studies of the impact of disasters on output/employment I'd be interested in knowing about that work.


- We had a great time in Richmond. The John Marshall House was interesting, and we had a knowledgeable and engaging guide for that. We saw the state capital and the governor's mansion. The White House of the Confederacy was kind of ugly, but it had a nice back porch. The Museum of the Confederacy was very well done. A re-enactor on hand demonstrated a lot of daily life in the army, and all the exhibits were interesting. They have an impressive collection of the effects of all the major Confederate officers, including a lot of Lee's possessions. We did not end up getting over to the Poe museum, but I had been there before. If anyone's in Richmond I recommend the Penny Lane Pub on Franklin Street. We also went to Legend Brewery, although that was more disappointing. On the way out we drove down Monument Avenue - I'm very glad we took that detour. They have some great statues of J.E.B. Stuart, Robert E. Lee, Stonewall Jackson, Jefferson Davis, Matthew Maury, and Arthur Ashe. The whole avenue is lined with some really beautiful houses as well - it reminded me of the garden district in New Orleans.

On the way out we stopped by James River Cellars, which had a lot of great wines to offer. They were all pretty dry until you got to the desert wines which seemed to overcompensate for the other offerings. We picked up a 2007 Meritage (like a Bordeaux), which was a good year in Virginia and the last year they made the Meritage. We also got a Chardonnay. The man that did our tasting was a history teacher - we were telling him about the trip and he had an interesting perspective. He said "The war started in April of 1861 and it ended in April of 1865. A lot of people down here need to remember that". I was surprised he said it - certain tasters might not have taken it as well, but I thought it was nice to hear. I've never read all that much about or engaged the Civil War for much this reason. I don't want to dump on Lee or Jackson or the Confederacy in general. I don't want to make them out to be monsters the way a lot of people do. At the same time, the deep South made a very dumb decision and it pulled a lot of the upper South with it in that decision. They lost. It's long over. I kind of like this idea of putting it to rest. But you can't really get into Civil War history with that perspective very easily. All sides are too invested. If I ever substantially got into reading and writing about Civil War history the way I do with the interwar period or the early republic, I think I'd like to stick to the facts and just not even mention causes or motivations. I'm not sure if that's possible, though.

Here is a picture of the Lee Monument on Monument Avenue being unveiled in 1890:

Tip of the iceberg

This sort of headline is never good to see: "Number of the Week: Companies' Cash Hoard Grows".

But this is only the tip of the iceberg. Keynes writes:

"The concept of Hoarding may be regarded as a first approximation to the concept of Liquidity-preference. Indeed if we were to substitute “propensity to hoard” for “hoarding”, it would come to substantially the same thing. But if we mean by “hoarding” an actual increase in cash-holding, it is an incomplete idea — and seriously misleading if it causes us to think of “hoarding” and “not-hoarding” as simple alternatives. For the decision to hoard is not taken absolutely or without regard to the advantages offered for parting with liquidity; — it results from a balancing of advantages, and we have, therefore, to know what lies in the other scale. Moreover it is impossible for the actual amount of hoarding to change as a result of decisions on the part of the public, so long as we mean by “hoarding” the actual holding of cash. For the amount of hoarding must be equal to the quantity of money (or — on some definitions — to the quantity of money minus what is required to satisfy the transactions-motive); and the quantity of money is not determined by the public. All that the propensity of the public towards hoarding can achieve is to determine the rate of interest at which the aggregate desire to hoard becomes equal to the available cash. The habit of overlooking the relation of the rate of interest to hoarding may be a part of the explanation why interest has been usually regarded as the reward of not-spending, whereas in fact it is, the reward of not-hoarding."

Liquidity preference is not just matress stuffing. This behavior exists in the context of a market, which means there's not always a quantity effect - there can be a price effect that isn't even picked up in this cash hoarding data. It's also a marginal effect that happens across a whole suite of assets. Highly illiquid assets are dumped in favor of moderately illiquid assets. But looking at cash on hand is a good indicator of the direction in which it's headed.