Never send a Nazi to do an American Keynesian's Job

xkcd muses that it's not enough to have Nazis design our rockets: they only started working when Nazis actually built them too.

Some have similarly argued that Nazis provided the clearest Keynesian experiment in the 1930s. To a certain extent, this is obviously true. Just as we must admit that Nazi rocket technology was ahead of its time, so we must admit that they implemented certain Keynesian ideas when other Treasuries were still wringing their hands.

However, the character that dispairs at the end of the comic over Nazi rocket building acumen need not draw the same lesson from macroeconomic policy! By the forties we were doing Keynesianism too, without the nasty Nazi baggage. Indeed, as Brad Pitt's character noted in Inglourious Basterds - aggregate demand and killing those very Nazis was virtually identical: "our business is killing Nazis - and business is booming". Why anyone would consider saving Europe and East Asia from the wave of fascism washing over it a waste of resources (as some critics of the idea that WWII got us out of the depression suggest) is utterly beyond me. As far as I'm concerned, taking the cards we were dealt as given, it's some of the best money we ever spent. Hitler practiced economic policy that aided the German recovery. Roosevelt did it better, and defeated the Nazis to boot. Truman did it better, and made a huge human capital investment in prime age males and physical capital investment in Europe to boot. Eisenhower did it better, and gave us an interstate highway system to boot. Perhaps it was wise to pluck marginally attached Nazi party members for use at NASA. But don't send a Nazi to do an American Keynesian's job.

Shifts of curves vs. shifts along curves

Lots of people are rightly excited about concerted central bank action this morning. Scott Sumner notes that it lead to an immediate increase in interest rates. He then opines:

"With easier money we had a small rise in real interest rates, which mostly reflect expected real economic growth. Inflation expectations also rose. Of course this is all completely inconsistent with the Fed’s operating model; they think we need to lower long term rates. And it’s also completely inconsistent with the standard IS-LM model, as interpreted by Keynesians. But it’s completely consistent with the market monetarist version of IS-LM, as developed by Nick Rowe...

...Authors need to re-write the IS-LM model to show upward-sloping IS curves.

Market monetarism: Describing the world as it is, not as textbooks say it is."

Now I don't have a real problem with market monetarism, but this whole business of an upward sloping IS curve seems to make a mistake that you see intro students make a lot: confusing shifting curves with shifts along curves. Part of me is hesitant to make so simple a critique of guys like Scott Sumner and I suppose Nick Rowe (it's been a while since I've read the post on why he thinks the IS curve should be upward sloping), but since other intellectually formidable guys think it's nonsense, it's worth throwing this out there.

The IS curve is downward sloping because holding all else constant, a reduction in interest rates increases investment. Changing only interest rates, demand increases. But this is very different from interest rates changing as a result of a shift of the IS curve itself due to changes in demand that are unrelated to changes in interest rates. This bugs my students a lot - it takes a couple weeks to get used to the idea that "increasing demand" is an ambiguous statement. I press them - do you mean increasing quantity demanded or increasing the demand schedule? It all depends on what's causing the change - is it due to a change in price or a change in something else? One is a shift of the curve, one is a shift along the curve.

So what are we dealing with here? We have increasing interest rates. Why? Sumner himself says we have increasing interest rates because of growth expectations. Anticipated increases in future income shift the IS curve to the right. And if we can sum up the impact of this morning's policy announcement in one phrase it would be "anticipated increase in future income". We try to segment monetary policy into movements of the LM curve and fiscal policy into movements of the IS curve for obvious reasons, but when we're talking about changes in expected future income we have to be careful. There are two questions to ask:

1. Is demand changing because interest rates are lower? If the answer is "yes", then you are moving along the IS curve.

2. Is demand changing because something other than interest rates is making investors willing to invest more than before, given the same interest rate as before? If the answer is "yes", then you are shifting the IS curve itself.

It is quite plausible to have both. But saying "we observe demand increasing with interest rates" is not the same as saying "holding all else constant, an increase in interest rates increases demand".

We often see prices and demand both go up simultaneously in other markets - one need not throw out downward sloping demand curves over that.

Right? Tell me if I'm thinking about this the wrong way, please.

More on DeLong, Mises, and all that

Commenter "Patch" provides this passage from Human Action:

"It is beyond doubt that credit expansion is one of the primary issues of interventionism. Nevertheless the right place for the analysis of the problems involved is not in the theory of interventionism but in that of the pure market economy. For the problem we have to deal with is essentially the relation between the supply of money and the rate of interest, a problem of which the consequences of credit expansion are only a particular instance.

Everything that has been asserted with regard to the effects of any increase in the supply of money proper as far as this additional supply reaches the loan market at an early stage of its inflow into the market system. If the additional quantity of money increases the quantity of money offered for loans at a time when commodity prices and wage rates have not yet been completely adjusted to the change in the money relation, the effects are no different from those of a credit expansion. In analyzing the problem of credit expansion, catallactics completes the teachings of the theory of money and of interest.”

You can read it in context here.

I think this supports my premise to DeLong initially. Gold is given something of a free pass because it doesn't fluctuate all that much, and certainly not at political whim. If paper money increased at the same pace as the gold supply, you would not see Mises upset about paper money. The whole point (the whole reason why we like it) is that it is more flexible than the gold supply. The sweat of the gold miner's brow has little to do with the matter at hand (and I don't think DeLong ever seriously thought it did).

At Bob Murphy's blog, Danny Sanchez (of the Mises Institute) notes that this is how Rothbard read Mises too. In America's Great Depression, Rothbard writes:

"In his Human Action, Mises first investigated the laws of a free-market economy and then analyzed various forms of coercive intervention in the free market. He admits that he had considered relegating trade-cycle theory to the section on intervention, but then retained the discussion in the free market part of the volume. He did so because he believed that a boom–bust cycle could also be generated by an increase in gold money, provided that the gold entered the loan market before all its price-raising effects had been completed. The potential range of such cyclical effects in practice, of course, is severely limited: the gold supply is limited by the fortunes of gold mining, and only a fraction of new gold enters the loan market before influencing prices and wage rates.”

Another relevant point to emphasize here is that this whole discussion really highlights the reason why Austrians insist on talking about inflation in a way that nobody else talks about inflation. If this is how you think about the business cycle, it clearly matters whether we're talking about price increases or a money supply increase in general. If money "enters the loan market" you're clearly going to have some bidding up of prices as a result of increased borrowing, but the primary impact of the money supply inflation is going to be on the capital structure, not on prices and wage rates. And it's precisely that impact on the capital structure that presents the problem for Austrians.

A much longer discussion is available here.

I don't agree with all of Patch's criticism of DeLong. In my comment section, Patch accuses DeLong of selective quotation. Patch writes:

"Lets take a couple of more sentences from the page that you [DeLong] decided to cherry pick your quotes, okay?

"If gold production had been considerably greater than it actually was in recent years, then the drop in prices would have been moderated or perhaps even prevented from appearing. It would be wrong, however, to assume that the phenomenon of the crisis would not then have occurred."

Brad seems to have left out the sentence that comes right after his "proof", and right before the union quote. How convenient!"

Now this bothers me, because Patch himself is now cherry picking and cutting off his passage at convenient times. If you read the entire passage it's clear that DeLong still has caught Mises making a problematic claim. If you keep reading past where Patch stops, we have:

"It is true that there is a close connection between the quantity of gold produced and the formation of prices. Fortunately, this is no longer in dispute. If gold production had been considerably greater than it actually was in recent years, then the drop in prices would have been moderated or perhaps even prevented from appearing. It would be wrong, however, to assume that the phenomenon of the crisis would not then have occurred. The attempts of labor unions to drive wages up higher than they would have been on the unhampered market and the efforts of governments to alleviate the difficulties of various groups of producers have nothing to do with whether actual money prices are higher or lower."

Mises essentially says "don't think you're out of the woods yet - even if we're on gold the unions are still going to f*#% it up". He gives no indication that he thinks that "it would be wrong... to assume the phenomenon of the crisis would not then have occurred" because gold could cause the crisis. He says it's wrong because there are other causes outside of monetary causes. That's quite an omission on your part, Patch! He continues to discuss labor unions for another paragraph, and then he discusses another danger of being sanguine about how an increase in the gold supply would have moderated the crisis. He says that it "leads to the view that the crisis could be overcome by increasing the fiduciary media in circulation."

So my view is that DeLong has not cherry picked here and he has stumbled upon a genuine gold fetish on the part of Mises in this particular book. I am not convinced by Patch that DeLong has cherry picked because it seems clear to me that the one sentence DeLong picked out is truer to the entire passage than the two sentences that Patch picked out.

That having been said, my view is also that the passages from Human Action provided by Patch do show Mises telling a different story - and being more cautious about gold. That's fine by me - people can change their views over time. But clearly Brad has identified a problematic viewpoint from 1931, at the very least.

*****

In the same collection of essays that DeLong quotes from, an essay of Mises on The Stabilization of the Monetary Unit appears that was published in 1923. This is intriguing to me because Keynes's Tract on Monetary Reform was also published in 1923 and it was on essentially the same topic. Does anyone know if anyone has written a head-to-head comparison of the two, or looked into their comparative influences. Keynes was deeply involved in the German situation at this time too, which I'm sure influenced Mises's thought as well, which is why this comparison seems particularly interesting... I may have to finally add Mises to the reading list. He hasn't quite intrigued me enough up until now.

Occupy Libertarianism!

...a goal that is sometimes much harder than occupying Wall Street.

Peter Boettke offers a very thoughtful post about OWS and leaves it open to his readers. I have two comments at the very beginning.

One of the things that I would have hoped something like OWS would bring to light is that critics of libertarianism do not take libertarian arguments for granted about the (1.) robustness of libertarian polities, (2.) the idea that it is non-libertarianism that devolves into crony capitalism, (3.) the idea that libertarianism is the most advantageous social order for human liberty, or that (4.) non-libertarian social orders are in opposition to principles of emergent order.

Generally, non-libertarians don't think any of these things make much sense. It's why we're not libertarians after all! If we thought these things were true, we would be libertarians!

Nevertheless, as many non-libertarians know when you talk to a libertarian you often get treated like you:

1. Have never put much thought to institutional robustness
2. Do not place great importance on liberty
3. Do not think emergent orders have commendable qualities

Part of the reason why they treat us this way is that we don't always use the same language and buzzwords - so there's a certain amount of information that is lost in translation (you'll notice on this blog I explicitly try to use the language of libertarians when talking about these issues so that less is lost in translation - Bleeding Heart Libertarians could perhaps be said to use the opposite strategy to talk more effectively to the left).

Anyway, to a certain extent the post from Boettke is a little dispiriting for me - really the Chris Coyne video. I know that's Chris's view of things. And I have another view of things. But there's the sense from the video that feels like "these OWS people mean well but this goes over their head", which worries me. I don't think issues of institutional robustness have gone over Chris Coyne or Peter Boettke's head. I just think we disagree about those questions!!! But I get the impression from a lot of libertarians that they don't think it's just a matter of disagreement - they truly think critics of libertarianism don't comprehend the issue at hand.

That's discouraging - to a large extent I think we've failed to "occupy libertarianism".

I don't think all libertarians are like this - nobody in the comment section should go off on that tangent. Gene Callahan is one guy that actually agrees with me on a lot of things, but I think probably is still a "libertarian" - and where we disagree he knows it hasn't "gone over my head" - we just disagree. Same with Bob Murphy who I have developed a tremendous appreciation for. We disagree all the time, but I never get the sense from him that he thinks the fundamental issue is lost on me or has gone over my head (sometimes the whole disagreement is which issues we consider truly fundamental!). Not all libertarian are like this. Many just think their critics have failed to appreciate the real issue at hand. That needs to change.



I've found that an excellent litmus test for this is to talk about "libertarian social engineering". If you think this concern is completely nonsensical and are shocked to hear people talk about it, you really don't understand your critics and probably mistakenly think they are a lot more clueless than they actually are. Now, you can disagree with the charge of "libertarian social engineering" but still know why people like me worry a lot about it. That's fine. But if the very phrase makes you see a big flashing "does not compute" sign then you have some work to do.

A day which will live in infamy...

...the macro professor I TA for showed the first Keynes-Hayek rap in class today.

Oh well :)

In seriousness, though, I was surprised to hear her even raise the issue of the Austrian school halfway through the lecture - and I was glad she did. We finished our coverage of fiscal policy, and then she started talking about criticisms. She mentioned New Classical macro and then she said that the most prominent criticism today was from the Austrian school. Within a certain context (i.e. - as the most publicly/politically prominent criticism) this is probably correct.

She didn't get into anything too detailed, but she did talk about their views on interest rates and the housing bubble, and perspectives on the Fed and interest rate determination in the loanable funds market.

The feedback from the class on the video was telling. We've talked explicitly about Keynes and Keynesianism for two and a half lectures now - first with aggregate demand and supply, then with actual discussion of fiscal policy, and finishing up that discussion today - and she's discussed Keynes by name in each lecture. No real discussion of the Austrian school, but after the video she asked "who thinks Keynes won the debate" [two hands or so went up out of the whole lecture hall... I refrained to register my vote], then she asked "who thinks Hayek won" [a bunch of hands shoot up - although in fairness most of the 250 or so present abstained - probably a fifth raised their hands].

It just goes to show you, when you make a video where (1.) Keynes says he wants to steer the economy, (2.) Hayek says he wants you to be free, (3.) Keynes appears indifferent between waging wars and constructing public works, (4.) Keynes is acting like a jackass generally, and (5.) Keynes the jackass ends the video barfing in a toilet, then yes - undergraduates who have never read Hayek or Keynes will respond positively to Hayek but not Keynes.

And this is really the issue - that the video really doesn't help the students understand the actual disagreement between Keynes and Hayek. It is fun, yes. But it takes an important debate in economics and acts like it's a debate about ideology where one guy likes freedom and the market and the other guy likes government and control. And it should be no surprise at all that this is the message that the video conveys, since it is a message that is explicitly embraced by its creators, Russ Roberts and John Papola.

I have a macro review session tonight - I'll be going over the liquidity preference, the multiplier, crowding out, and automatic stabilizers - but it will be interesting to see if the students bring up the video.

As a side note, I had not noticed until today that Mike Munger is in the first video as well as the second.

Thomas Robert Malthus on how WWII got us out of the depression

"One of the most striking instances of the truth of this remark, and a further proof of a singular resemblance in the laws that regulate the increase of capital and of population, is to be found in the rapidity with which the loss of capital is recovered during a war which does not interrupt commerce. The loans to government convert capital into revenue, and increase demand at the same time that they at first diminish the means of supply. The necessary consequence must be an increase of profits. This naturally increases both the power and the reward of accumulation; and if only the same habits of saving prevail among the capitalists as before, the recovery of the lost stock must be rapid, just for the same kind of reason that a reovery of population is so rapid when, by some cause or other, it has been suddenly destroyed."

- Principles of Political Economy, Ch. VII Section III

A great insight from Karl Marx

"Adam Smith baulked at the logical conclsuion of his resolution of commodity value, and thus of the value of the annual social product, into wages and surplus-value, i.e. simply into revenue: the conclusion that the total annual product could then be entirely consume. It is never the original thinkers who draw the absurd conclusions. They rather leave this for the Says and the MacCullochs."

- Capital, Vol. 2, (pg. 466 in the Penguin edition)

That observation by Marx is also interesting considering what Keynes said about the intellectual history of Say's Law. He came down hard on Say and even Mill, but then said that those who followed them - particularly Marshall, Pigou, and Edgeworth - were too smart to put it as crudely as Say did. Still, their conclusions rely on Say's Law (whatever the hell that is - I'm not trying to minimize the arguments over the "law" itself - I'm just not interested in getting into that argument).

Assault of Thoughts - 11/28/2011

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

- Brad DeLong continues the discussion on Mises and gold, quoting me again. This one is quite good. He pointed out some Misesian contradictions before, but reconciled it with a cost of production theory of value. He never actually thought that's how Mises reconciled the contradiction - I think he simply thought Mises ignored it. But a lot of people (myself included) mistakenly figured Brad was saying Mises actually held a cost of production theory of value. This post is much better in that it identifies the contradiction and simply calls it a contradiction, without any hypothetical reconciliation. Hopefully some Austrians will take it up.

- And speaking of Brad DeLong on the history of economic thought, I had always figured he was exaggerating when he used to talk about Marx as a real business cycle theorist. I figured he must be cherry-picking or exaggerating. Nope - as usual Brad is dead-on. I've had my nose in Theories of Surplus Capital, Capital, and Grundrisse all weekend absorbing Marx on Say's Law, and that's pretty much his position. Granted - he starts with some very interesting discussion of the whole C-M-C' "metamorphsis of commodities" model that gets to sounding a lot like an explanation you'd hear out of Nick Rowe. But then he essentially says "this is all abstract - let's get more concrete" and makes a series of RBC arguments.

- A great old post by Arnold Kling on labor shortages.

- Heeding his warning, I am linking to this Nick Rowe post without comment... I do have a few thoughts, but now I'm nervous about sharing them. His footnote about "political economy" may be the most valuable point in the post for some readers.

- And Nick Rowe's post reminds me of a fortune cookie I got just this weekend: "The wise man learns more from the fool than the fool learns from the wise man". Probably right.

Karl Smith on the Keynes-Hayek Debates

"These were two of the most grotesque spectacles I have ever seen in my life."

It's all very good. That's more or less what I thought of the LSE one, so I never ended up even watching the Reuters one. It's roughly my reaction to the whole Keynes-Hayek rap too. These have mostly been thinly veiled political tropes dragged out and forced - like square pegs into round holes - into the mouths of Keynes and Hayek.

To a certain degree I'm exaggerating of course - you don't get the approval of Caldwell and Skidelsky for pure ideological tropes. But I think this accounts for a great deal of the modern Keynes vs. Hayek discussions, simply because people hate Keynes without knowing why and so they make up crap and attribute it to him - and others do the exact same thing with Hayek.

Malthus on depressions

"It is a contradiction in terms, to say that labour is redundant compared with capital, and that capital is at the same time redundant compared with labour:-- but it is no contradiction in terms to say that both labourers and capital may be redundant, compared with the means of employing them profitably"

- T.R. Malthus, Principles of Political Economy (2nd edition, 1836)



For my final history of thought essay, I'm doing some reading and thinking about Malthus, Marx, and Keynes and each man's refutation of Say's Law.

I like this a lot.

Here.

But "orthogonal" is even too strong. "Occasionally orthogonal" is probably better.

And is it any wonder that the people who veer towards only caring about one of these are also less concerned about constitutional democracy or decentralization of power? What's the use for an "ongoing process of negotiation" if you don't think there's anything to negotiate?

Assault of Thoughts - 11/26/2011

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

- This is a great post by David Friedman on the interest rate as the "price of money". One thing I would add that is along the lines of what he says is that you really have to think about what money is as a good. We usually say that it's a medium of exchange, a store of value, and a unit of account. So what is a loan? Well clearly if you take a loan you have access to money as a medium of exchange (which is useful because it's still a unit of account), but you don't have access to money as a store of value. Why? Because you have to give it back! It's not an asset to you, it's a liability. So what you're really trading for is the medium of exchange function of money - it's ability to be traded - it's liquidity. That's the source of the liquidity preference theory of the interest rate. Loans can be thought of as an unbundling of the medium of exchange and store of value functions of money. I think part of the discussion of liquidity preference at a time like this is confusing, though. When we talk about increases in liquidity preference during a depression, it's really the residual of a lot of other decisions. People don't want to spend because of uncertainty about their income levels and people don't want to invest because of uncertainty about demand (i.e. - low returns on that investment), so they save and keep their money relatively more liquid than they otherwise would.

- Is this post by Bob Murphy as strange to readers as it was to me? Krugman basically says "if everyone saves at once the economy can't grow as easily". Bob essentially responds "Krugman is wrong - after all if only one person saves and everyone else spends the economy can grow". Then Daniel basically responds to him "Right - but if everyone saves at once the economy can't grow as easily". Is there something I'm missing here? What is Bob talking about? He's just talking about something completely different from Krugman and thinking he's talking about the same thing, right?

- This post by David Henderson on Robin Wells also seemed strange to me (I've got some comments in it). Isn't discussion of minimum wages, the impact of regulation on investment, unions, etc. standard fare in intro economics classes? I know it is in ours at American University, and we're not exactly some arch-libertarian school! Henderson (and again David Friedman in the comments) acts like Wells is proposing a whitewashing of economics. Friedman writes "The obvious question is whether, when she teaches economics, she feels obliged to expose students to views that don't fit her own political position, since she seems to be suggesting that people who disagree with her have such an obligation." It's amazing to me that he raises that as the obvious question. I don't think there's a single economics intro course in the country that doesn't follow this basic pattern:

1. The market is efficient because of X, Y, Z

2. Government action distorts the market and makes it less efficient - standard examples include rent control, minimum wage, regulations, and granting monopoly privileges (I challenge someone to show me a freshman text that doesn't discuss all four of these) - all the stuff that Henderson raises in his post.

3. Final exam.

That's what an intro student gets. If you continue, you get a lot more context, caveats, uncertainties - the sort of stuff that Robin Wells is suggesting we emphasize more earlier on. I agree with her. I personally think that an intro student should learn the basic market efficiency and government distortions material - the standard intro presentation. But I agree with Wells that to the extent we can hint at the complexities of the situation we should. I don't understand what Henderson and Friedman are concerned about here. They act as if intro economics courses gloss over market efficiency and government distortion, when that's essentially what these courses are about.

A quick thought on OWS and the Tea Party

I think peoples' mistake in criticizing the Tea Party was in thinking they were somehow cheering on crony capitalists.

I think peoples' mistake in criticizing OWS is in acting like OWS is against capitalism.

I think the mistake of both the Tea Party and OWS is in acting antagonistically to the rest of the population - as if nobody outside the movement wants a free society or as if nobody outside the movement is frustrated with Wall Street. And I think both movements are lacking in concrete ideas.

Mmmmm - I love Thanksgiving

These are the tastey things we're bringing to Kate's dad's tonight:

1. Butternut squash and hazelnut salad (One of our favorite fall meals - we're substituting walnuts and walnut oil for the hazelnuts and hazelnut oil, just because we couldn't find hazelnuts - it's very good the original way too).

2. Pumpkin fondue... in a pumpkin! Have never made this before, but it sounds soooo good. Also going to be bringing this to my parents tomorrow.

Thanksgiving and Land Redistribution

One of the nice things about the internet is simply that word gets around - there's a lot of information to acquire, of course, but information acquisition is cheaper. So I assume most readers are well aware that in 1623 William Bradford ended a system of collective ownership of the corn production of Plymouth Colony, of course to the great benefit of Plymouth. If you're not aware of why collectivism doesn't work, you need to read this blog (and other economics blogs) more closely! If you're not aware of this particular Plymouth Colony episode, let me know in the comments and I can dig up a few old links.

Assuming that's all common knowledge, I wanted to highlight one very specific element of Bradford's privatization effort: the land redistribution. In his book Of Plymouth Colony he writes:

"At length, after much debate of things, the Governor (with the advice of the chiefest amongst them) gave way that they should set corn every man for his own particular, and in that regard trust to themselves; in all other things to go on in the general way as before. And so assigned to every family a parcel of land, according to the proportion of their number, for that end, only for present use (but made no division for inheritance) and ranged all boys and youth under some family."

It's hard to overstate the centrality of land policy for the early United States, and for classical liberals in general. While this blog is obviously pro-private property, one of the recurrent criticisms of private property as a social convention is its artificiality and tendency to reproduce inequality and past power structures. What's especially problematic is that people often treat private property as a natural state of affairs, and so while the problems associated with it are easily remedied, people can be resistant. For the most part, the classical liberals and our founders weren't resistant to the point that initial conditions matter crucially for the welfare implications of a system of private property, and in the 17th and 18th century "initial conditions" mostly meant land distribution.

Jefferson writes about this at length to Madison in 1785 during his eye-opening visit to France:

"The property of this country is absolutely concentered in a very few hands, having revenues of from half a million of guineas a year downwards. These employ the flower of the country as servants, some of them having as many as 200 domestics, not labouring. They employ also a great number of manufacturers, and tradesmen, and lastly the class of labouring husbandmen. But after all these comes the most numerous of all the classes, that is, the poor who cannot find work. I asked myself what could be the reason that so many should be permitted to beg who are willing to work, in a country where there is a very considerable proportion of uncultivated lands? These lands are kept idle mostly for the aske of game. It should seem then that it must be because of the enormous wealth of the proprietors which places them above attention to the increase of their revenues by permitting these lands to be laboured. I am conscious that an equal division of property is impracticable. But the consequences of this enormous inequality producing so much misery to the bulk of mankind, legislators cannot invent too many devices for subdividing property, only taking care to let their subdivisions go hand in hand with the natural affections of the human mind. The descent of property of every kind therefore to all the children, or to all the brothers and sisters, or other relations in equal degree is a politic measure, and a practicable one. Another means of silently lessening the inequality of property is to exempt all from taxation below a certain point, and to tax the higher portions of property in geometrical progression as they rise. Whenever there is in any country, uncultivated lands and unemployed poor, it is clear that the laws of property have been so far extended as to violate natural right. The earth is given as a common stock for man to labour and live on. If, for the encouragement of industry we allow it to be appropriated, we must take care that other employment be furnished to those excluded from the appropriation. If we do not the fundamental right to labour the earth returns to the unemployed. It is too soon yet in our country to say that every man who cannot find employment but who can find uncultivated land, shall be at liberty to cultivate it, paying a moderate rent. But it is not too soon to provide by every possible means that as few as possible shall be without a little portion of land. The small landholders are the most precious part of a state."

Adam Smith made the point about the problems with intergenerational transmission of inequality and private land holdings more bluntly:

"When great landed estates were a sort of principalities, entails might not be unreasonable. Like what are called the fundamental laws of some monarchies, they might frequently hinder the security of thousands from being endangered by the caprice or extravagance of one man. But in the present state of Europe, when small as well as great estates derive their security from the laws of their country, nothing can be more completely absurd. They are founded upon the most absurd of all suppositions, the supposition that every successive generation of men have not an equal right to the earth, and to all that it possesses; but that the property of the present generation should be restrained and regulated according to the fancy of those who died perhaps five hundred years ago." (Smith goes on to make similar observations as Jefferson about how unemployment follows from land concentration).

Thomas Paine put in his two cents too, of course, and suggested in Agrarian Justice that owners of land owed society a "ground-rent" for precisely the reasons that Smith and Jefferson highlight. Paine, then, moved the discussion into more modern versions of redistribution - specifically lump-sum payments organized by the community out of a progressive tax structure. This classical liberal principle of land redistribution and transfer payments has been applied through the whole westward movement of the American people, and subsequently in places like Latin America.

You also see this with shock therapy in the 1990s - when price liberalization proceeded before institution-building and redistribution, inequality was aggravated and market democracy didn't take. This is something that Joseph Stiglitz has pointed out repeatedly. The fleecing of the Russian populace by former Soviet factory managers is a well documented example of this.

And finally, in modern neoclassical economics, Arrow and Debreu's work has highlighted how crucially important these initial conditions are - this is the second fundamental welfare theorem, that any Pareto-efficient equilibrium is possible given an initial set of endowments. Kenneth Arrow was my history of thought professor's advisor, and he's told us in class that Arrow would make this point repeatedly - that if you really wanted to pursue social justice the key was in the adjustment of initial conditions, not in pretending you could reproduce market allocation.

It's important that this element of the Thanksgiving story - of Bradford's land redistribution - isn't lost. Equality was a critical issue for our founders, for classical liberals, and for economists in the liberal tradition up to the present day (such as Stiglitz and Arrow). Private property is an essential institution, but we have to always keep in mind that there's nothing natural about property - it's a human invention. Uncritically approving of all private property arrangements often leads people into the mistake of reifying old injustices.

The surest way to escalate violence at OWS events...

...not linking arms, but getting between shoppers and retailers on Black Friday (HT - Evan).

I'm sort of being funny, but not really actually. It sounds like they're talking about both occupying large retailers and boycotting them. Boycotting is fine, but if they get in peoples' way in the stores I wouldn't be surprised to hear about fights.

This was precious: "We're not anti-capitalist, we are anti-crapitalist" :)

We often go early-morning Black Friday shopping, but it sounds like I might not have to this year.

Gobble gobble

Let's give a warm F&OST welcome to Unlearningecon!

Welcome to the economics blogosphere. Unlearning Economics, the blog of commenter Unlearningecon, is now on my google blogroll, which means interesting posts are likely to make their way here. Five posts are up on the new blog so far. As you'll quickly learn, the blog takes a heterodox look at the discipline, and is very Keynes-friendly.

A thought from John Maynard Keynes

"The events of the coming year will not be shaped by the deliberate acts of statesmen, but by the hidden currents, flowing continually beneath the surface of political history, of which no one can predict the outcome. In one way only can we influence these hidden currents -by setting in motion those forces of instruction and imagination which change opinion. The assertion of truth, the unveiling of illusion, the dissipation of hate, the enlargement and instruction of men's hearts and minds, must be the means"

- John Maynard Keynes, 1919

Assault of Thoughts - 11/23/2011

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

- Mark Blaug, perhaps the best known historian of economic thought, passed away on the 18th (HT Tyler Cowen). This is a paper of his on how nobody does history of economic thought anymore. I've been lucky enough to have had a class offered in the subject both in undergrad and now in grad school, by two great professors who also have a deep interest in history of thought (Robert Blecker and Clyder Haulman). And of course readers know that this blog is practically a "history of Keynesian thought" a lot of the time.

- Speaking of this blog's work on Keynes - the moment I've been dreading has happened! One of my professors has become aware of the existence of F&OST! Not so terrifying as I imagined it - my math econ professor emailed to say my German preface post has been discussed favorably on an economic history listserv, and he offered some other literature. I can deal with one of the more intimidating professors we have reading what I think is one of my better posts :)

- Krugman and Thoma point us to Diamond and Saez offering a new rendition of Edgeworth's old argument for a progressive tax. This - I should add for people entranced by flat tax schemes - is pretty widely accepted by economists. Dan Klein of GMU accepts the logic of it (if not the policy... I'm not sure what his exact views on taxes are). Bob Murphy will give you counterarguments here (I should also note that most economists agree with Bob on interpersonal utility comparisons, but would not draw all the conclusions from that that he does).

- I got this book in the mail yesterday: Beyond Stock Stories and Folktales: African Americans' Paths to STEM [science, technology, engineering, and mathematics] Fields. I'll be reviewing it for the Journal of Negro Education once I get a break from classes this December. Part of my continuing effort to build a foundation (and a chunk of a CV) on science and engineering labor market research.

From Russ "I’m an anti-Keynesian because I want smaller government" Roberts

He writes in the comments of this post: "There is no scientific evidence that this [Keynesian policy] has been successful. The model they used to justify spending an extra $800 billion made an explicit prediction about the impact of that policy. It was off by 25%. That means that we are not in the realm of science."

No, no, no. How many times do we have to go through this?

We have two estimates in "the model they used" - first, a baseline unemployment forecast which was taken out of a forecasting model based on information they had available to them in very early January 2009 (three years ago now, people). Those forecasting models are very different from the models that make predictions about the impact of the policy. Forecasting models offer fancy versions of "what happens tomorrow is going to basically be like what happened yesterday". We do not have crystal balls, and forecasting models are never that great - particularly when everything is crashing down around you and no one is sure what's going on.

Then, in addition to that baseline, they had multiplier estimates adjusted by some kind of Okun's law rule which they basically just took and said "if our baseline forecast was X, then our forecast with stimulus is X times (1-Z)".

So the question is - what was wrong? The models producing the multiplier estimates or the models producing the unemployment forecasts? As I've noted here and to Russ numerous times, the multiplier models are very consistent in their results. We don't have a pinpointed multiplier like we have (or had?) pinpointed the speed of light, of course. But we're dealing with a parameter that changes depending on circumstance. Given what we know about multipliers, the results are very consistent and conform to predictions about how the multiplier should behave in different circumstances. Nevertheless, Russ continues to make these misleading claims that the range of multiplier estimates is enormous. And unfortunately, Russ has a much bigger platform for his assertions than I do.

As for forecasting, Russ might be interested in this from the CBO:

"Forecasters collectively have tended to make the largest errors during periods that included either turning points in the business cycle or significant shifts in the trend rate of growth of labor productivity. Large changes in oil prices—apart from their role in precipitating business cycles—also cause errors in forecasts of inflation. The difficulty of forecasting business-cycle turning points explains why most forecasters overestimated the economy’s future growth rate in the forecasts they made just before the two back-to-back recessions of the early 1980s. That pattern was repeated in the forecasts made just before the recessions that began in 1990, 2001, and late 2007."

Russ is looking at two estimates multiplied by each other - one of the multiplier, and one of forecasted unemployment - and he's acting as if he knows he can attribute the error to the first one. I call B.S. on that. Russ Roberts does not know that. Everything we know about fiscal multipliers from past research says they are high right now. Everything we know about forecasts during periods like this says they are bad. Certainly they are going to be bad in January 2009, when the crisis hadn't spread to the real economy yet and we had no idea precisely how the real economy would react.

In the comment section of a previous post I invited people who want to do guest posts to let me know. I would be especially interested if anyone wants to talk about multipliers and these naive accusations of "scientism" that get tossed around. It looks like things are likely to get worse for the world economy in the near future, and people who think this way are getting big exposure. The White House has pushed out its pro-stimulus economists and the worsening budget situation means that we need to be much smarter about how we do things. Let me know if you're interested.

Bingo

Also from that speech:

"When I was in the White House, I used to bristle when people would say I was a Keynesian economist. They acted as if I believed that fiscal stimulus mattered because of some theoretical book written in 1936, or because of what I was taught in graduate school. I used to say that I am not a Keynesian economist, I am an empirical economist. I believe what I do because of the empirical evidence."

Except (1.) I don't bristle because I find that old book and several other old books of his to be some of the most insightful books I've read, and (2.) most of my empirical work is elsewhere... but I'm on board with the sentiment.

This made me smile

Also from Christina Romer's speech:

"The Saturday morning we [she and her husband] sat down to run the first regressions was pretty stressful. But the result was that controlling for motivation [behind the tax cuts] mattered a lot. Our children still roll their eyes at the memory of two grown-ups jumping up and down in front of their computer screen yelling, “It worked! It worked!”

John Taylor: Empirical Macroeconomics is Easy!

Robert Barro and the Romers are so naive! They shouldn't have bothered to do all that work identifying their models... they could have just asked John Taylor and he would have told them you just need to control for oil prices!!!

Taylor's work has always struck me as strangely naive - essentially just looking at output or consumption and looking at policy and noting whether there was a change or not. I've always figured I had to be missing something. But apparently that's really about all there is to it - and when Christina Romer raise endogeneity concerns he just says "I controlled for oil prices".

The point, Dr. Taylor, is that stimulus is a function of certain variables (not oil prices so much) that also influence output, consumption, or whatever it is you happen to be looking at. The real concern is those omitted variables, and your safest bet is looking for exogenous variation in your fiscal policy variable, not trying to track down a bunch of controls.

Romer cites the best literature to get this point across: the returns to education literature. She also praises the work of labor economists who do this stuff. I learned econometrics from a labor economist, and it's paid off big time. I think all macroeconomists should.

Is Krugman too bullish on Europe???

He knows the situation a bazillion times better than I do, but this caught my attention:

"In fairness, Lehman’s bust called everything into question; everyone wondered whether there were 10, 20 Lehmans out there. We sort of know how many Italys there are."

But that wasn't the only problem with Lehman. It also did real damage to otherwise healthy firms. Yes, we know how many Italys are out there now. But how many more will look like Italy a couple weeks from now?

I would say that we've already priced an Italian failure in... but then again that's another thing they said about Lehman.

Scott Sumner has strange memories of the book 1984...

...because I always thought the real problem with 1984 society was the perpetual war, the one party state, and the prosecution of thoughtcrime.

Which isn't to say I disagree with Sumner about how unnerving modern surveillance is. It's also not to say that I think everything is perfect about modern society. It just seems to completely miss the forest for the trees to point to the surveillance state and write "1984 has arrived".

I'd personally rather live in a society that didn't have near-perfect surveillance. It just seems like a nicer place. But this seems like a very tough thing to draw the line on. The only difference between these cameras and a watchful beat cop is the efficiency with which they observe not what they're doing. As far as I know they don't have these cameras in private residences. Of course it's unsettling, but I find it less unsettling than an actual violation of rights in a less technologically advanced state.

Sentences of the day

Robert Skidelsky: "Politicians are masters at “passing the buck.” Everything good that happens reflects their exceptional talents and efforts; everything bad is caused by someone or something else."

DeLong and Mises, again

Brad continues to push on Mises and gold:

"But… but… but… If the cost of mining gold falls and we mine more gold and have more gold coins, the money stock has increased and we have the illusion of artificial (non-gold) wealth, which for von Mises ought indeed to distort market signals. Improved gold mining technology ought, for von Mises, to be as bad a thing as running a printing press.

But it very clearly isn't. I have found nothing anywhere in the Austrian corpus about the baneful effects of improvements in gold mining technology, and how they invariably lead to an Austrian boom-bust cycle--how a gold discovery distorts market signals and creates the illusion of artificial wealth just as any other monetary expansion does."

This is all quite true, and as I and a few others in his comment section noted, I probably should have just said "relatively stable measure" in the first place, because clearly gold is not a perfectly stable measure. In an email, Brad says:

"I know that von Mises explicitly holds a subjective utility theory of value [note well, all Austrians who have been accusing Brad of never reading a word of Mises]. But an immediate consequence of such a subjective utility theory is that a given quantity of money is equally good no matter where it comes from--it has the same subjective value, after all. And it seems very clear to me that for von Mises a given quantity of gold money is much better than that same quantity of paper money."

I disagree with that last sentence. If paper money increased at the same rate that the gold supply increased, I don't think you'd have nearly as much complaints about it from Mises.

But these paper/gold comparisons seem to be getting a little off track to me. I enjoy rubbernecking at the horrific train wreck that is gold-buggism as much as anyone, but the real concern seems to me to be the artificiality of money creation in general. I hope Brad can accept the argument that Bill Woolsey and I make, that gold was acceptable because its rate of increase was small and relatively unrelated to political meddling - and that if the rate of increase in the gold supply had been as rapid and manipulable as that of the paper money supply, Mises would have more concerns.

That having been said, I think the real question is "why does Mises consider an increase in the supply of money in response to a recession 'artificial', given that what we are responding to is an increase in the subjective valuation of liquid money - i.e., an increase in the demand for money?" That's the real question for Mises. And the answer, I think, is that he doesn't see an increase in the subjective valuation of liquid money as the cause of recessions. He sees the cause of recessions as a rearrangement of the capital structure after an "artificial" boom. If Keynesians really want to offer a critique of Mises in a language he understands, they would say "Mises is suggesting that in the face of changes in individual subjective valuations of money, the state, by fiat, ought to keep the money supply fixed." Because that's really what Mises and any Austrian who wants a gold standard (::cough::Ron Paul::cough::) is proposing.

An underdeveloped thought I'm going to catch a lot of flak for

I was thinking the other day that in a lot of ways it's very unusual that it's libertarians who have really promoted the idea of spontaneous order as it applies to the organization of human society. It's not completely unusual. Anyone who is going to promote these ideas is going to have to be pro-market, which libertarians obviously are. But there's a lot more non-libertarian pro-market economists out there who I think would have provided a more natural home for this work.

The reason why it's somewhat paradoxical coming from libertarians is for precisely the reasons we've been discussing in the comment thread of this post. Libertarianism is a political philosophy that forecloses many potential emergent orders in the non-market realm. Most pro-market economists who are non-libertarians have political philosophies that are much more amenable to ideas about spontaneous order. For the most part, we are constitutional democrats, right? We think that governments should be limited because we know about the incentive structures facing politicians and the distortions of government power. But we also know that you want to give the public a chance to shape their own laws, the way their society is organized, and you want to give the public the chance to experiment with that and change that and try new things over time. Most pro-market non-libertarian economists are of this view: constitutions are good and democracies are good, and there is no over-arching necessary political order that we pursue besides that. We all have our preferences for what we want the political order to look like, of course. But we don't take it as a philosophical necessity that the actual political order conform to that. The real important things are constitutionalism and democracy.

One would think that that is the environment where theorizing about spontaneous orders would flourish: an environment that is pro-market but also more democratic than libertarian. Libertarianism simply has too detailed plans about how the political order has to look: it's not spontaneous enough to be a natural home for spontaneous order.

So why did spontaneous order find a home among libertarians? I have a couple ideas.

- First I'm going to propose a "great man theory of history" - Hayek was simply a smart guy that got very interested in this stuff and wrote a lot of great stuff on it. Hayek was a libertarian, so it found a home among libertarians.

- Second, a lot of libertarian intellectuals were preoccupied with the socialist calculation debate at a time when non-libertarian pro-market economists were preoccupied with other research agendas. Ideas about spontaneous order were very relevant during this debate, so it found a natural home among libertarians - who were the most active in it.

- Third - again for historical reasons - a lot of libertarian economists were less concerned with developing predictive models, which made spontaneous order a more valid thing to talk about. If you're looking for predictive models, spontaneous order is going to interest you less - not because you think it's wrong but because it's hard to do anything predictive with it. Anyone who got excited about the Santa Fe Institute and that stuff found this out. One of the unfortunate outgrowths of this is that many libertarians have incorrectly concluded that modeling and appreciation of spontaneous order are mutually exclusive - which of course is ridiculous.

Anyway - if you think about it it's somewhat strange that a group of people with a very planned out view of what the political sphere should and shouldn't look like would have latched on to spontaneous order. But there you have it. The question is - in the future will the idea be claimed by non-libertarians? I think there's a broad enough appreciation of complexity that it will be - maybe not always with Hayek's language or with Hayek citations, but I think it is there already and it will only grow.

An observation on Economic Consequences of the Peace

I think Arnold Kling would find a lot to like in this book.

One of the threads you see in Keynes from the very beginning to the very end of his life is the idea that investment opportunities were plentiful in the late 19th century (for a variety of reasons) after being less plentiful in the early 19th, and that as we entered the 20th century a lot of the low hanging fruit was gone. Some people interpret this to be "stagnationist". I don't see how Keynes can be read that way, because I don't see anywhere where he says investment opportunities are gone for good (Economic Possibilities for our Grandchildren is often put forward in this regard - I think the argument there is slightly different, but that's a different issue). This is the foundation of a lot of Keynes's concerns about aggregate demand.

But what really comes out in Economic Consequences of the Peace is that a lot of the low hanging fruit is contingent on what Arnold calls "patterns of sustainable specialization and trade", and one of the biggest concerns that Keynes has about the Treaty is not just the injustice of it - but the total disturbance of these patterns, destroying any opportunity of restoring late 19th century growth levels.

Two other quick points:

- When you read Ricardo you are (or at least I was) amazed (1.) by how Malthusian he actually is, and (2.) by how much he actually did talk about population control as a reliable solution, and rejected increasing capital investment as viable. It's also surprising, reading Economic Consequences of the Peace, (1.) how Ricardian Keynes is on these points, and (2.) how Keynes - the alleged dedicated eugenicist - actually puts much less emphasis on population control as a solution and of course presses the investment option (he puts it in a way that anyone familiar with Malthus should recognize: "one geometrical ratio might cancel another"). Of course this weight towards increased investment - which Ricardo doubted - would only get more important for Keynes over the decades.

- Also - if you want a laugh- read Thorstein Veblen's review of Economic Consequences of the Peace. His argument - and I do not think I am being unfair here, but you can read it and judge - is (1.) Keynes is naive in his approach to the conferees because they actually didn't want to punish Germany at all, because (2.) the conferees wanted to build up a reactionary regime in Germany to oppose their real concern: Russian bolshevism. Keynes is presented throughout as a dunce for not realizing that the whole point of the treaty was not, in fact, to punish Germany but to help Germany and weaken the Soviets.

Two frustrating things at the Washington Post

One trivial, one more important.

1. Somewhat trivial, but still frustrating: The first line of this article on the new Mars mission that is hunting for life is "NASA’s most high-stakes, ambitious planetary mission in decades is scheduled to launch next week with a goal right out of science fiction: to learn whether Mars was, or ever could be, home to extraterrestrial life." Do these people even think before they put words to paper? What is "fictional" about this? We know tons about the spontaneous evolution of life on Earth. We know early Mars was a lot like early Earth. We look for life in all kinds of inhospitable places on this planet, and we certainly look for evidence of new types of earlier life because we know that this planet was able to support different kinds of life at different periods. Might science fiction use the possibility of extraterrestrial life to advance its plots? Sure. But it also uses romance and goal-fulfilling quests and even trade disputes to advance its plots. You wouldn't refer to a real-life trade dispute and say "that's right out of science fiction!" Why do this for the search for new life? It trivializes a very important effort. Some day we're going to find evidence of life outside of Earth somewhere. Hopefully it will be Mars and it will happen in the next decade. Mars is our best bet, after all, and if we don't find it there it might take a while longer. If we do find it there, I think it's going to dramatically change the way people think and talk about the universe. It's going to dawn on people how incomprehensibly small everything that we know and interact with on a daily basis is, how much more there is out there, and all the possibilities that that entails.

2. More important: William and Mary is considering ending in-state tuition levels as a result of declining state support. Ultimately the blame for this lies in Richmond, not Williamsburg, but its frustrating nevertheless. Strong public universities are an important advantage for Virginia, and an investment that the state government should take more seriously. I'm a third-generation Virginia public university graduate (along with my two sisters), and I would like to have the option to send my children to be a fourth generation. And this is something Kate and I have talked about too - staying in Virginia because of the schools. We like our options in D.C. anyway, but that has been a factor in long-term plans about whether to live here or Maryland, or whether to go somewhere else entirely. Once you make big public investments, you can coast on decisions in the past for a while, but if the state doesn't continue to invest in these institutions, some day we're going to lose a lot of the benefits.

More on the interstate/county comparisons and the multiplier

Brad DeLong linked to my earlier comment on the county-level multiplier estimates, arguing that what they provide is a good lower bound estimate. To a certain extent I agree with him. I would actually use this sort of argument a lot in project meetings at the Urban Institute. You are never going to completely rid yourself of endogeneity and bias, but what you really worry about is bias that overstates your conclusions. There were several instances where there were still estimation bias issues we couldn't deal with, but they biased the results towards a null result. I would always note that this wasn't a bad thing. We want to produce some insights, and if the only biases we have make those insights more conservative that can actually help convince people that there's something there.

So a lower bound estimate of 1.5 should help getting the point across that the fiscal multiplier is very real.

I am on board with that... mostly. Bias is still bad though, and you really need to try to think it through. What happens to these multiplier estimates when resources are fully employed? In that case, the results would be biased away from a null finding. Fiscal infusions draw resources away from comparison counties giving the impression of a larger multiplier when actually the fiscal infusion made no real contribution - and likely made the economy less efficient.

That worries me that we have underestimates during recessions and overestimates during normal times. Brad's point is a good one, it just makes me nervous.

*****

Andrew Bossie also has comments on the last post that are worth sharing. First, he writes:

"There is a level I agree with you to this. In which case, metropolitan areas are a good robustness check."

I'm not entirely sure of what he has in mind here - hopefully he can elaborate in the comments here. One robustness check (well, really just a different specification) that I was thinking of was using some sort of propensity score matching approach to match counties in completely different regions of the country to each other on the basis of pre-recessionary characteristics. That way you're looking at two areas (really, a big collection of pairs of areas) which are comparable, but which are not going to lose demand to each other. I'm not sure if this would really work, though. After all, a "low fiscal stimulus" area is likely to be near another high fiscal stimulus area, and its ex-post performance is going to be impacted by the fiscal infusion in that neighboring area - and that fiscal infusion is definitely going to be correlated with your treatment area. Ultimately, I have no idea how big these biases are - and that's part of the problem. And I wouldn't know how to go about estimating how big the bias is. I suppose one way to estimate it would simply be to compare it to something like Barro and Redlick's work: how do national multiplier estimates from military procurement compare to state and county-level multiplier estimates from military procurement? Does that sound like a good approach to people?

Andrew goes on:

"In the united states, particularly "historically speaking" loanable funds markets have been HIGHLY localized becuase of unit banking. Even in the new banking environment there are still something like 8000 local banks."

This, I think, is the wrong way of looking at it. Certainly there's wide variability in loanable funds markets, and I think I said this in my original post. The point is, the main impact that fiscal policy has on the loanable funds market would not vary across localities. That's quite different from saying there is no variation across localities. It's not that there's no observed variation - it's that there's no reason to expect the variation in these county-level markets to be correlated with the impact of national fiscal policy in the cross section.

These sorts of models difference out all the variation common to a single area over time, as well as the variation common to both areas. Indeed - that's why we like these sorts of models so much. They get rid of a lot of the heavy lifting when it comes to holding things constant. You'll still have variation between local loanable funds markets to work with, but that will not include the most important variation for macroeconomic considerations: variations at the national and international level.

Listening to and reading Christina Romer ranks among the smartest things anyone who is interested in economics could do

...which really is not that surprising since she got her undergraduate degree in economics at the College of William and Mary.

This is a recent talk she gave on estimating multipliers, and if you have ever caught yourself saying something like this hypothetical from her talk:

"If you press people for why they think this they will probably say something like, “It’s not rocket science—all you need are two good eyes to look around you. We spent all of this money and the economy is still terrible. It obviously didn’t work.”

Then you should really read the part that she writes next:

"Well, the theme of my talk this evening is that it is not that easy. Estimating the effects of fiscal policy may not be rocket science, but it is incredibly hard. The reason that it is hard is that fiscal actions are often taken in response to other things happening in the economy. Separating the impact of those other factors from the impact of the tax changes or spending decisions is very difficult. It requires many of the sophisticated techniques in the economist’s tool kit—along with a big dose of creativity, and plenty of plain old-fashioned hard work."

As well as the rest of it.

HT Brad DeLong

Karl Smith understands Hayek better than many Hayekians

This is a great statement by Karl Smith. The point really transcends Hayek, of course. After all, Hayek is often not the best source to go to if you want to give primacy to an evolutionary [dare I say yet again - pragmatist] understanding of the world over a logical foundationalist understanding of the world. His Austrian fellow-travelers are often far too caught up in deductionist conceits, and after all it was Hayek that Keynes was referring to with the "remorseless logician" line - and he had some cause for it. Hayek certainly matured into a more evolutionary understanding of our knowledge of the world and he left behind some of the most important applications of those ideas we have. Anyway - these are important insights where ever they come from. I picked up a lot of these ideas from Dewey and Rorty, and most importantly Keynes. But Smith is right to cite Hayek too - it's not a point that should be lost on libertarians (and before people go nuts in the comment section, it should go without saying that I know it's not lost on many libertarians and this is what attracts many libertarians to Hayek in particular - but you're not going to convince me for a second that the sort of thing Smith describes, this cult of reason, isn't out there - even among people who know Hayek and therefore should know better).

Anyway - I've talked long enough. Time to let Karl Smith talk:

"[C]ommon sense lies – as Hayek might have said – between instinct and reason. It has evolved over generations of folks dealing with each other.

And, importantly it does not depend on reason itself. People don’t have to have any understanding of why they believe what they believe for what they believe to be usefully true. That is, operating as if the world was this way informs you about the world.

A reasoned theory of the world should acknowledge this anchor. In some way our reasoning should accommodate common sense. Either as a special case, or as an approximation, or as a local maximum or something.

Otherwise, you have a hard time explaining why common sense has stood the test of time and cultural selection."

Regime uncertainty is a weak explanation of the current depression... but that is NOT an excuse to fail to take regime uncertainty seriously

And Keynes agreed -

"This means, unfortunately, not only that slumps and depressions are exaggerated in degree, but that economic prosperity is excessively dependent on a political and social atmosphere which is congenial to the average business man. If the fear of a Labour Government or a New Deal depresses enterprise, this need not be the result either of a reasonable calculation or of a plot with political intent; — it is the mere consequence of upsetting the delicate balance of spontaneous optimism. In estimating the prospects of investment, we must have regard, therefore, to the nerves and hysteria and even the digestions and reactions to the weather of those upon whose spontaneous activity it largely depends.

We should not conclude from this that everything depends on waves of irrational psychology. On the contrary, the state of long-term expectation is often steady, and, even when it is not, the other factors exert their compensating effects. We are merely reminding ourselves that human decisions affecting the future, whether personal or political or economic, cannot depend on strict mathematical expectation, since the basis for making such calculations does not exist; and that it is our innate urge to activity which makes the wheels go round, our rational selves choosing between the alternatives as best we are able, calculating where we can, but often falling back for our motive on whim or sentiment or chance."

- John Maynard Keynes, 1936 (Ch. 12, The General Theory of Employment, Interest, and Money)

Bob Murphy will love this post...

...because Paul Krugman is wrong and Scott Sumner's zealous dedication to whatever he's talking about at the moment (in this case, that Krugman is wrong) leads him to overstate his case.

First - Krugman is wrong to say that sub-national cross-sectional studies are good for estimating multipliers. I've explained this several times before in critiques of papers producing multipliers that I "like" and "don't like". There are a couple major reasons why this sort of estimation strategy is a bad one:

(1.) Demand spillover means that any impact on demand in one unit is going to raise demand in other units. It's not just interstate commerce either, particularly since Krugman is looking at county-level data here. Once you get to that level, labor markets matter a lot too. My wife and I live in Arlington County, Virginia, but we both work in Washington D.C..

(2.) One of the most important impacts of fiscal stimulus is what it does in the loanable funds market. This market is national (international, actually), so it's going to be a wash in county-level comparisons. Remember - when you're comparing changes at the level of a geographic sub-unit, you are estimating effects off of the variation between those sub-units. The interest rate may vary between those sub-units, but not as a result of anything going on with fiscal policy.

Scott Sumner doesn't lay out this case against Krugman exactly - he just throws around "fallacy of composition" and "correlation is not causation" - but even in his criticism of Krugman I think he goes too far. The paper which Krugman cites that produces the 1.5 multiplier he's interested in actually is a fairly appropriate use of geographic sub-units in my opinion. The question that Nakamura and Steinsson ask is "what is the impact of fiscal policy for geographic sub-units within a monetary union" (presumably with Europe in mind). If that's what you're interested in, then county-level comparisons are a great idea because you want to difference out the impact of monetary policy and the impact of fiscal policy on the loanable funds market. The only criticism I can think of is that they use military procurement - which is a federal expenditure - so they can't capture the impact on the public finances of geographical sub-units (which may be relevant). Aside from that, this is a very appropriate use of county-level comparisons. That does not mean that Krugman is right to praise the method in general. It's certainly no good for measuring the effects of ARRA - as some have tried to do.

I also think Sumner is way too strong in criticizing the Sufi and Mian study that Krugman introduces in the first place, which isn't even meant to estimate multipliers. Sumner argues that if tight money caused the problem in the first place, housing sector indebtedness is a spurious cause. That's a little much. Look, there's disagreement over whether tight money is the primary cause of financial troubles, or whether financial troubles caused the tight money. This county-level analysis by Sufi and Mian can't answer that chicken-and-egg question. But it can verify the importance of balance sheets as one link in the chain, so I think Sumner needs to back down on this one. Unless Krugman claims "tight money is definitely not the problem here", he doesn't seem to have said anything out of line with respect to the Sufi and Mian study. Krugman is quite sympathetic to the idea that tight money causes recessions, I think.

What readers need to be careful of, though, is assuming that geographical sub-unit analysis is a panacea for multiplier estimation - it's not.

What passes for evidence in the internet age

- The 1920-1921 depression demonstrates Keynesians are wrong.
- Keynesians thought there would be a post-war depression.
- Keynes's German preface lauded the Nazis.
- Keynesianism is consumptionism.
- Mises was pro-fascist (there are a lot of things I find reprehensible about that passage in Liberalism, but one thing I don't think is that it suggests he was pro-fascist).

That doesn't exhaust it - it's just a few that interest me. And I added Mises at the end to demonstrate all the Keynes stuff is because that's what interests me - not because I'm trying to put forward a sob story where we're the embattled ones.

Granted, it's not a problem with the internet - it's a problem with how people have interacted with the internet at the dawn of the information age. After all, I could not have produced my counter-arguments to these or promoted them so efficiently on this blog and elsewhere without the internet.

Money Chemistry

An interesting Slate video on the chemical properties of different elements and why gold has been used as money.

I found the part about radioactive elements interesting. They had two reasons for rejecting them:
1. Health risk, and
2. Radioactive decay - as they say "your money would disappear!"

Now, to a Slate columnist those sound like bad things. But to an economist worried about liquidity preference, that would be a feature, not a bug! Who would want to hold on to money if it depreciated rapidly and posed a health risk?

Silvio Gesell enters the nuclear age!

Assault of Thoughts - 11/17/2011

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

- One little pet peeve that has come up recently: people who, when speaking of the demand curve facing all firms in a market for a single product, call it "aggregate demand" instead of "market demand".

- Sometimes I just don't understand how other bloggers' minds works. Thankfully, probably the two blogging minds I understand least blog together (easier to contain my puzzlement that way). The most recent zinger was this post from Don Boudreaux where he presents the most common argument for constitutional limits to democratic governance - the argument that I accept for constitutionalism, and the argument that has allowed constitutionalism to sweep the free world - and he asserts that that argument is "seldom identified" as a reason "for restricting the role and scope of government". Really Don? Really? I'm filing this under "inventing an opposition out of thin air just so you can argue with them".

- LK makes an interesting point discussing this Skidelsky interview. Everybody ought to know by now that the 1930s in both Britain and the U.S. amounted to blind groping towards something like Keynesianism. Understandable, of course. Keynes didn't even have a full grasp on Keynesianism until 1936, and these things take time to digest. As we know, his ideas became very popular very quickly, and were eventually used in policy making more deliberately. LK notes that the first time Keynesians really had the reins of policy was during WWII, and their task then wasn't to increase aggregate demand, but to tamp it down and control inflation. When I was looking through the Keynesian predictions for the post-war period I saw this a lot too. They stated regularly how important it would be to keep hold of inflation now that we're out of the depression. One new policy tool that was often cited in this regard was Social Security (forced savings). Hayek said that Keynes was worried his followers might turn into inflationists. I wonder if this is just another of Hayek's many tall tales. If you think about the Keynesian scene in the 1940s, there really doesn't seem to be much reason to think they'd turn into a bunch of inflationists. There was inflation then, of course. But then again - it's not cheap to kill fascists. I don't know how attributable that is to Keynesianism, particularly when the administration hired the Keynesians to keep all that in check.

- Brad DeLong takes Paul Krugman to task for yelling at David Glasner. I agree strongly. Take a look at the update in Glasner's post - he links to F&OST. I made the same connection to the liquidity trap that Krugman did (before Krugman did), without treating Glasner like an enemy (which he's clearly not). [UPDATE: After all, if Brad DeLong has to tell you you're being too harsh to someone on the internet, you know you have a problem! :) ]

- Speaking of people who link to F&OST.

Self-interest is a powerful thing

Amidst all the turmoil in Europe, lots of catty back and forth between Mises.org and Brad DeLong yesterday, police crack-downs, and the general nastiness of the last couple years, this was the blog post that I read yesterday that bothered me the most. Bryan Caplan was just talking about how he got his job at GMU and the very real risk that he would have gotten a much less satisfying job.

Self-interest - not greed, but self-interest - is an incredibly powerful motivation. I'm several years out from jumping into the job market, and it still worries me a lot. Like Bryan, I have a few reassurances. I've got great connections at The Urban Institute, and I'd love to go back there or a place like that, and I'm pretty sure they'd have me. The non-advocacy think tanks are high on my list, and I think their hiring is a little less aggravating than academia (which I'm also interested in - and I'm entirely open to a public policy department rather than an economics department). I'm not as well position as Bryan was when he was on the market to jump into academia. But on the plus side I'm probably more willing to work for government - depending on the job (like Bryan I'm simply not interested in government jobs where I'd have to act against my conscience - but there's a wide range of good research and data-oriented government work).

Anyway, it's years off and I think I have good prospects for certain jobs and I'm laying the best groundwork I can. But isn't that funny that of all that I read yesterday, that post "got to me" the most?

UPDATE: And as the third commenter down on Bryan's post pointed out - notice the importance of non-wage factors in Bryan's discussion of the job market. Above a basic living standard, I think it's mostly right that other factors take a lot of precedence. If nothing else, there are incredibly important compensating wage differentials associated with whether people can drag themselves out of bed every day to do the work.

A comment I left on Brad DeLong's post which may be of interest...

"For what it's worth, I think Hayek has a more useful set of ideas on the business cycle than Mises anyway. Keynes even made basically the point in Ch. 16 of the GT that Hayek does in Prices and Production - that a lower interest rate will make production processes longer (and also more capital intensive - but the elongation is the main point). Hayek's business cycle theory hinges on the fixed [and specific] nature of those investments in longer production processes. That guarantees that adjustment is not costless. I'm not that familiar with Mises, but I don't think he has that mechanism that Hayek does.

My concern with all the Austrian work is that while it may be a very interesting description of what happens to what they call the "time structure of production" in response to the interest rate, there's no obvious reason to tie that to the business cycle. Their story is "during the boom interest rates are artificially low, and during the bust they go back to their natural rate". In a loanable funds world, that makes sense. But in a liquidity preference world, the story is "interest rates are too high for full employment". In a liquidity preference world where those interest rates are kept too high by a zero lower bound, you of course have even more trouble.

So the whole Hayekian story is predicated on the assumption that we move below Wicksell's natural rate during the boom, and return to it in the bust. Our best understanding of macroeconomics (from Hicks et al.) says that we're at Wicksell's natural rate during periods of full employment, and are above it during the bust.

In other words, the Hayekian mechanism should produce a capital structure that is just right during the boom and too short during the bust - exactly the opposite of their normal story.

So while all the fluctuations of the "temporal structure of capital" are quite interesting to me, I don't think they offer much in the way of a business cycle theory."

Since the STEM workforce stuff this morning made me think of and listen to it...

...a nice Willie Nelson cover of "The Scientist"

Brad DeLong issues a challenge to Austrians

"I would like to hear an alternative theory as to where this mammoth #economictheoryfail [i.e., Mises's theory of the business cycle] comes from--other than the theory that it comes from enslavement to a naïve cost-of-production theory of value, according to which gold-backed money's value is in some sense "real" because of the resource cost of mining, while fiat money's value is in some sense "fake" and thus bound to cause trouble [Brad's guess]."

As most of you know, my macroeconomics is generally in agreement with Brad's. But my interpretation of Mises is somewhat different from his. Mises, following Menger, clearly doesn't have a cost of production theory of value. It's really much simpler than that. It's not that gold mining is more genuine because you have to work at it. It's simply that gold represents a fixed measure of value. And for Mises, not only is that acceptable - it's preferable. Otherwise, adjustments of the money supply create the illusion of artificial wealth, which for Mises would distort market signals.

*****

This is all fine as far as it goes. Brad DeLong doesn't want to distort market signals, after all - and neither do I. We are market-friendly guys. The problem is that in a world where people demand money for its liquidity, the interest rate is going to be influenced by the amount of whatever thing we artificially ascribe the qualities of "money" to. The amount of loanable funds available for investment are going to be determined by this interest rate, and the level of investment is going to be determined when entrepreneurs compare their probable rates of return to this interest rate. This means that the amount of money out in the world may be at such a level that there will be too few loanable funds available for investment (or, the same thing, too much kept liquid) to be consistent with full employment.

Ultimately all money is artificial -or to put it better - all money is a social construction. There is nothing intrinsic or natural about the stuff. It is perhaps the quintessential social construction. Mises is concerned about an artificial distortion of market signals, and that's a reasonable concern under certain circumstances. But I'm also concerned about an artificial underutilization of factors of production, which is only occurring because there are not enough little green pieces of paper with dead white men on them circulating. If we were to compare competing artificial distortions here, it seems to me resource underutilization is the one we're most at risk of suffering from.

That makes me a market monetarist/quasi-monetarist.

What makes me a Keynesian is that I actually think one of the major problems we're facing is that the act of saving and the act of investing are done by separate people, and that while people may want to provide a lot of loanable funds right now, investors don't have work to be done that earns a worthwhile rate of return. To a large extent, this is a vicious cycle. There's nothing to invest in because demand is weak. But demand is weak because there is not enough to invest in. Even if this equilibrates - even if income gets ground down through the paradox of thrift to the point that the loanable funds market clears, there's still no reason to expect that it will clear at a full employment level.

I do know of one consumer of loanable funds that has a lot of worthwhile stuff it can do. This economic agent is not reliant on the profit motive, so its ability to do useful things is not constrained by weak prospective demand. This economic agent knows that a school provides value, that scientific advances provide value, that infrastructure provides value - despite current constraints on other utility-maximizers' ability-to-pay and willingness-to-pay.

The profit-maximizers say "if nobody wants to buy from me then the profit-maximizing choice is to sit on something with a zero rate of return than invest in something with a negative rate of return". Only a non-profit-maximizing agent can say "I don't measure benefit by the excess of revenue over costs, and this money is cheap right now - I have things to do with it".

*****

Now I think I have homework to get back to.