This is an excellent way of putting it, Ryan

I never thought of putting it this way before! When we economists veer into normative claims, its natural to talk about each other in the same way that we talk about the normative values of others: namely, in terms of preferences.

Ryan Murphy discusses the same Boettke/Smith piece that I criticized yesterday and puts their views in preference relation terms: "The fundamental problem for me is what I would call their lexicographic preferences for Public Choice arguments over other issues."

Well said! Lexicographic preferences make sense if we're talking about a subsistence diet or a small hut for shelter. It doesn't necessarily make sense when we're talking about policy tradeoffs.

That still doesn't exhaust my concerns with Boettke's approach to talking about robust political economy. One of my biggest concerns is that he bases his whole argument on the assumption that the people he's arguing against idealize central bankers or politicians - when in reality nobody idealizes central bankers and politicians. Just because we think they have a role to play doesn't mean we think they're angels. I'm firmly a Madisonian on this: if your preferred institutions rely on men being angels, you need to look for other institutions.

Keynes on the incentives of banks in a depression

And as Brad DeLong often points out, any insightful points you make about economics have more often than not already been made (and made more eloquently) by John Maynard Keynes. This is from the beginning of The Consequences to the Banks of a Collapse in Money Values (1931), a piece that I've actually been wanting to have a reason to share on here (he talks about 1921 in here, which is another reason why I like it). I think it speaks to the points about the incentives of banks under free banking that I made in the prior post.

"A year ago it was the failure of agriculture, mining, manufactures, and transport to make normal profits, and the unemployment and waste of productive resources ensuing on this, which was the leading feature of the economic situation. To-day, in many parts of the world, it is the serious embarrassment of the banks which is the cause of our gravest concern. The shattering German crisis of July 1931, which took the world more by surprise than it should, was in its essence a banking crisis, though precipitated, no doubt, by political events and political fears. That the top-heavy position, which ultimately crumbled to the ground, should have been built up at all, was, in my judgement, a sin against the principles of sound banking. One watched its erection with amazement and terror. But the fact which was primarily responsible for bringing it down was a factor for which the individual bankers were not responsible and which very few people foresaw—namely, the enormous change in the value of gold money and consequently in the burden of indebtedness which debtors, in all countries adhering to the gold standard, had contracted to pay in terms of gold.

Let us begin at the beginning of the argument. There is a multitude of real assets in the world which constitute our capital wealth—buildings, stocks of commodities, goods in course of manufacture and of transport, and so forth. The nominal owners of these assets, however, have not infrequently borrowed money in order to become possessed of them. To a corresponding extent the actual owners of wealth have claims, not on real assets, but on money. A considerable part of this "financing" takes place through the banking system, which interposes its guarantee between its depositors who lend it money, and its borrowing customers to whom it loans money wherewith to finance the purchase of real assets. The interposition of this veil of money between the real asset and the wealth owner is a specially marked characteristic of the modern world. Partly as a result of the increasing confidence felt in recent years in the leading banking systems, the practice has grown to formidable dimensions. The bank-deposits of all kinds in the United States, for example, stand in round figures at $50,000,000,000; those of Great Britain at £2,000,000,000. In addition to this there is the great mass of bonded and mortgage indebtedness held by individuals.

All this is familiar enough in general terms. We are also familiar with the idea that a change in the value of money can gravely upset the relative positions of those who possess claims to money and those who owe money. For, of course, a fall in prices, which is the same thing as a rise in the value of claims on money, means that real wealth is transferred from the debtor in favour of the creditor, so that a larger proportion of the real asset is represented by the claims of the depositor, and a smaller proportion belongs to the nominal owner of the asset who has borrowed in order to buy it. This, we all know, is one of the reasons why changes in prices are upsetting.

But it is not to this familiar feature of falling prices that I wish to invite attention. It is to a further development which we can ordinarily afford to neglect but which leaps to importance when the change in the value of money is very large—when it exceeds a more or less determinate amount.

Modest fluctuations in the value of money, such as those which we have frequently experienced in the past, do not vitally concern the banks which have interposed their guarantee between the depositor and the debtor. For the banks allow beforehand for some measure of fluctuation in the value both of particular assets and of real assets in general, by requiring from the borrower what is conveniently called a "margin." That is to say, they will only lend him money up to a certain proportion of the value of the asset which is the "security" offered by the borrower to the lender. Experience has led to the fixing of conventional percentages for the "margin" as being reasonably safe in all ordinary circumstances. The amount will, of course, vary in different cases within wide limits. But for marketable assets a "margin" of 20 per cent to 30 per cent is conventionally considered as adequate, and a "margin" of as much as 50 per cent as highly conservative. Thus provided the amount of the downward change in the money value of assets is well within these conventional figures, the direct interest of the banks is not excessive;—they owe money to their depositors on one side of their balance-sheet and are owed it on the other, and it is no vital concern of theirs just what the money is worth. But consider what happens when the downward change in the money value of assets within a brief period of time exceeds the amount of the conventional "margin" over a large part of the assets against which money has been borrowed. The horrible possibilities to the banks are immediately obvious. Fortunately, this is a very rare, indeed a unique event. For it had never occurred in the modern history of the world prior to the year 1931. There have been large upward movements in the money value of assets in those countries where inflation has proceeded to great lengths. But this, however disastrous in other ways, did nothing to jeopardise the position of the banks; for it increased the amount of their "margins." There was a large downward movement in the slump of 1921, but that was from an exceptionally high level of values which had ruled for only a few months or weeks, so that only a small proportion of the banks' loans had been based on such values and these values had not lasted long enough to be trusted. Never before has there been such a world-wide collapse over almost the whole field of the money values of real assets as we have experienced in the last two years. And, finally, during the last few months—so recently that the bankers themselves have, as yet, scarcely appreciated it—it has come to exceed in very many cases the amount of the conventional "margins." In the language of the market the "margins" have run off. The exact details of this are not likely to come to the notice of the outsider until some special event—perhaps some almost accidental event—occurs which brings the situation to a dangerous head. For, so long as a bank is in a position to wait quietly for better times and to ignore meanwhile the fact that the security against many of its loans is no longer as good as it was when the loans were first made, nothing appears on the surface and there is no cause for panic. Nevertheless, even at this stage the underlying position is likely to have a very adverse effect on new business. For the banks, being aware that many of their advances are in fact "frozen" and involve a larger latent risk than they would voluntarily carry, become particularly anxious that the remainder of their assets should be as liquid and as free from risk as it is possible to make them. This reacts in all sorts of silent and unobserved ways on new enterprise. For it means that the banks are less willing than they would normally be to finance any project which may involve a lock-up of their resources."

To say that banks are less willing to lock up their resources is equivalent to saying that banks have liquidity preference too.

An advantage of central bankers - maybe even their one saving grace - is that central bankers do not have any liquidity preference to speak of.

Lee Kelly on Money and Free Banking

Lee, a guy who used to comment on here a lot, has a guest post at Lars Christensen's blog. It's definitely worth the read. The beginning goes over the standard story on excess money demand and general gluts, and talks a little about trends in barter and alternative monies.

Then he gets into the alternative of free banking. Now what I still don't understand about free banking is why people think it would solve the problem better than central banking. These discussions always seem to get through the problems with central banking - which I think we all know like the back of our hand by now - and then it moves to free banking as an alternative, but it always seems to wrap up before we really explore free banking! I don't blame Lee for this - he was under no obligation to satisfy my curiosity! But maybe I could get readers here to build my faith in free banking a little.

What you want is a more elastic money supply. I might even go as far as saying that what you want is a perfectly elastic money supply because it's absurd to economize on resource consumption just to get more of the medium of exchange. We should economize on resource consumption because we make tradeoffs with other scarce resources! Why economize on real goods just to make tradeoffs with green pieces of paper that don't earn a return? I'm not sure if that's right - maybe we don't want a perfectly elastic money. But we want a more elastic money supply for all the traditional reasons we've always wanted it: because an excess demand for money is completely pointless and for many people quite painful.

So what I would think free bankers would want to demonstrate to skeptics like me is that free banking offers a more stable and more elastic money supply. Is there any reason to think this?

Why do we demand money? While Lee is right that excess demand for money results in general gluts, it can also be caused by general gluts (yes, you read that right). Remember when people talk about a general equilibrium in the context of a general glut, they're usually thinking of a point in time. But a lot of the sales at that point in time are contingent on expectations about the future. All investment is contingent on expectations. And of course, a lot of consumption is too. We smooth consumption over time, and if we are concerned about our income stream in the future we're going to cut some consumption today. General swings in expectations about the future can result in an excess demand for money (which can of course further generalize the glut, through the more traditional mechanism that Lee outlines).

We know how central banking reacts to this, and the answer is "as well as the central bankers react". The incentives of the central bankers are often OK - particularly here in the U.S. where we have a dual mandate. The biggest problems come from things like knowledge problems, reaction times, etc.

The fact that knowledge problems are a potential issue in central banking is what (understandably) piques many peoples' interest in free banking. But what is a banker's incentive under free banking? If asset values are falling because of a general depression of expectations about future economic performance, it seems to me that banks are not going to be making money readily available, they're going to be worrying about their own solvency. And that's the critical difference: central bankers don't worry about solvency or profits, but free bankers do. For that reason I just can't get my head around why people think free bankers would do better in a crisis situation.

There are a couple pieces of evidence. First is the relative absence of systems of free banking. I get some predictable push-back when I talk about this (to anticipate one form of push-back - yes I know about the good old days in Scotland), and obviously its not proof of anything. But it is indicative, I think. If free banking were really that much better you would think it would be naturally selected into more widespread existence.

But you can also just look at the behavior of banks under central banking. As the Fed discovered in the 1930s, and as they're discovering today, bankers don't always do the socially optimal thing. The money that the Fed actually has control over has been much more responsive than broader monetary aggregates that banks have control over:



Obviously this isn't competing monies exactly, but I'd be interested in someone explaining to me why the same fears and conservatism on the part of banks wouldn't stymie the generation of new money in a system of free banking. That's my concern. It's not - as Boettke and Smith suggest - an idealization of central bankers thats holding me back. It's that I don't understand why free banking would provide more elastic money, and I don't feel like anyone has explained to me why I should expect it to.

Another pet peeve I thought I'd share

...because I feel like it's been a while since I've shared a pet peeve.

So I'm sitting here getting some work done with the TV on, and some car insurance commercial comes on.

I hate car insurance commercials. Why? Because they're either consistently bad at interpreting data or they're good at it and are being deliberately dishonest - and I don't like either of those things.

So on this one they talk about how the average person who switched from Allstate to this company "saved an average of $547". Argh - nails on a chalkboard. I'll let readers take a shot at why this bothers me before I answer.

UPDATE: So the problem here is a substantial selection bias. They always say that $X are saved by "switching" to their company. Often they'll go as far as this ad and even say $X are saved by switching to their company from a specific other company. That's all well and good, but the problem is you only switch companies if you get a better deal! There is no indication of how your expected savings will compare to this. Let's say insurance companies assessed everyone exactly the same premium on average, but there was some random variation across insurance companies for any given person. So no insurance company gives a "better deal" than any other insurance company. Now let's say you initially buy insurance after some kind of limited search process. In the future, you may switch. Because there's some randomness to it, there may be another company out there that would actually give you a better deal than you initially got. But the point is you'll only switch if they give you a better deal. So any insurance companies that assess their quality on the basis of the savings of switchers are always going to be able to tell you they can save you a bunch of money!

Different coverage is offered by different companies, etc. - and that complicates reasons for switching. But for me at least, insurance company advertisements are basically giant flashing billboards for selection bias. Enjoy the geckos and laugh at Flo, but forget whatever numbers they spew at you. Don't believe anything about any "savings" until you actually shop around for it yourself.

Unlearningecon on marginalism and the labor market

I am predisposed to foam at the mouth in disagreement with this post. Three things have prevented me so far - (1.) reading and responding to Henderson and Gochenour, (2.) lots of homework, test taking, midterm grading, and proposal writing, and (3.) not having a clue why Unlearningecon would write something like this "the Division of Labour (DoL) means that it is often impossible to separate the produce of one worker from that of his colleagues."

I feel uncomfortable responding to a point that seems so wrong I wonder if I'm mistunderstanding.

(1.) and (2.) are out of the way for now. I'm not sure how to deal with (3.).

The Lucas Critique is a theory/empirics interface point, not a theoretical point

We're into the second week discussing monetary policy in macro, and the Lucas Critique came up last night - so I wanted to share some brief thoughts.

One of the things that bothers me is the way some people use the Lucas Critique as a bat to swing at Old Keynesian theoretical orientations. A good example is Williamson's recent criticism of the DeLong-Summers paper as "lazy" and a "piece of trash" and the authors plus Krugman as "arrogant loud-mouths" (ye who swoon over Krugman's rudeness and expect me to take you seriously - I eagerly await your posts criticizing Williamson and would be happy to repost them here). I don't think this is entirely appropriate (and to be honest I think Krugman could have been a little more specific when he talked about "decadent Lucasian doctrine" that dominates journals).

The Lucas Critique, in my mind, pointed out that lots of structural models can produce the same reduced form model. The moral of the story is you can't take an empirical relationship and infer a structural model from it. You have to do more work to support your argument.

This, in my mind, is very different from saying that all non-structural models are rubbish. Ever since Lucas, there's been a lot of work on microfoundations, and there's been a lot of empirical work trying to get at price formation and that sort of thing. And a lot of people have converged on a New Keynesian Phillips Curve that is A-OK with the Lucas Critique. We also have microfounded IS-LMs that seem to make good sense.

Given that leg-work, I don't see anything wrong with going back to an aggregate model and using it to talk about policy or teach students. Any questions about the structural model can be referred to the literature.

The point is, it's almost a historical accident that Lucas butted heads with neoclassical Keynesianism. That just happened to be the sort of economics people did at the time that this sharp guy named Lucas came along. There's nothing inherent in Keynesianism that is averse to thinking more deeply about structural parameters and models.

So in that sense, we should be careful not to mistake the Lucas Critique as a critique of the actual positions of the Old Keynesians. Instead, it was a critique of the way that the Old Keynesians defended their positions. The New Old Keynesians are fully on board with the Lucas Critique, the leg-work has been done (although it certainly ought to continue), and we now have aggregate models we talk about casually that come with implicit microfounded justifications. I think people ignore the implicit defense at their peril.

Some links on money

- First, Unlearningecon critiques exogenous money theories. As is often the case, I think he's right on a lot of points, but overstates the argument against the mainstream. I've always thought about the money multiplier as an upper bound determinant of the money supply, and I've always thought that's what everybody thought. Money supply is endogenously determined the actual interests of banks. It seems to me you can still have exogenous policy levers in an endogenous system, though.

- Recently I've criticized Scott Sumner for missing the point on fiscal policy and unnecessarily turning friends into enemies. He doesn't seem to get that the New Old Keynesian point is that in a liquidity trap, when monetary policy works largely through expectations, fiscal policy helps monetary policy become more effective than it otherwise would be (this is the old Krugman argument). Noah Smith makes a similar point here, arguing that simple counter-cyclical fiscal policy that dampens AD swings can reduce the cost of monetary policy.

- Lars Christensen cites a new paper by Boettke and Smith on robust political economy. As regular readers know, I think institutional robustness is very important, but I also think a lot of the discussions of institutional robustness have been pretty weak. One of the interesting things to me is that people who talk about robustness often claim that their opponents are idealizing an institution, when they really aren't! When there's not an appreciation of that point you have people like Mark Pennington advocating libertarianism as a solution to the unjustified idealization of people unable to really answer questions from people like me who reject libertarianism precisely because I don't think men are angels. For people like us, the issue has never been whether the Fed can be made to do "the right thing". Of course it can't. No human institution can. We have reams of historical evidence suggesting that it can't. What we say is that (1.) if the Fed or the fiscal authority for that matter were to move in X direction things would be better than worse, and (2.) removing fiscal and monetary authority to do X is unambiguously worse - half-assed is better than full retreat. You might model the fiscal or monetary authority "doing the right thing" to demonstrate point (1.), but this hardly suggests you think they will do the right thing. Again, I'd point back to Krugman (1998) which I'm really glad I read again the other week, given the flurry of discussion on monetary and fiscal stabilization recently. His whole point is to outline a policy that could be beneficial when the Fed isn't run by angels or supermen. Until the "robustness" crowd recognizes that this is what we're saying, I don't see how far these arguments can get. We know men are not angels. We never said they were. What we're saying is that half-assed pursuit of an optimal policy by non-angels will yield better results than abdication of policy-making altogether by non-angels. That doesn't mean there aren't smart institutional reforms. In the political arena, we decentralize, democratize, and constitutionally restrain precisely because these things help when you deal with non-angels. In the monetary arena, similar reforms will also help. But none of the answers that we've given (to my knowledge - correct me if I'm wrong) rely on men being angels. That would obviously be a non-starter, which is precisely why nobody assumes it.

A note to economics students...

...if one of your mid-term questions begins with the sentence "Dr. E is an environmentalist and a critic of economics. On the Charlie Rose Show he attacks an economics text as follows", there is an extremely high probability that your professor is going to expect you to disagree with whatever follows.

You are better off saying you disagree and just throwing random vocabulary from class together than you are defending whatever follows.

You are, of course, best off knowing why the hypothetical character is wrong.

Regardless of whether you go for the better option or the best option - don't expect to get anywhere by saying the guy is right.

Karl Marx would be proud

I'm finding that when I write text for macro after writing up the model itself, I write "kapital" instead of "capital".

My understanding is that the German is the origin of that notation, after all.

Henderson and Gochenour on Presidential Greatness

David Henderson and Zac Gochenour have a new paper on the assessment of presidential "greatness" by historians. David discusses it here, and sociologist Fabio Rojas discusses it here. Zac if you have a blog and I'm missing your discussion, let me know. Since two of my favorite things to think about are American history and interpreting empirical work, I thought I'd discuss this.

Their conclusions are highly counter-intuitive (to me at least - I'm guessing many readers won't find them counter-intuitive). To use Rojas's phrase "presidents who kill people are popular". Henderson and Gochenour don't put it quite like that, but their view is very similar. They write: "Our data analysis suggests that wars in which a large percentage of the U.S. population is killed will, all other things equal, cause historians to judge as great a president on whose watch those wars occurred." They are not shy about making this a causal story. To me, this doesn't pass the smell test. All other things equal, we like presidents less when they have a lot of blood on their hands. Which of course raises the question of whether "all other things" really are equal here.

1. Military Deaths Per Capita

One of the nice things about the paper is that all the data is provided in an appendix, so you can reproduce their results and try out a few things (the formatting makes it a little hard to copy - if you want a Stata version of the data, my do-file, or my log file - since I'm not going to clutter this post with output - just email me). Their results seem to be robust to different specifications of military deaths per capita (MDPC, their explanatory variable of interest), which is always appealing. I was a little leery of a simple rank, so I did a natural log of the raw numbers and that gave me similar results. I'm going to use log MDPC going forward because it's easier for me to interpret.

The assignment of MDPC was a little troubling to me. Now, they do come out and admit that they were somewhat arbitrary in assigning MDPC when discussing the fact that they attributed all of the Revolutionary War deaths to Washington, even though that war happened years before his presidency. This decision was especially confusing to me because they do have a "war hero" variable in the regression already, which is presumably the whole reason why the Revolutionary War was significant for Washington. He was not a Lincoln or a Wilson that decided to send us to war. He simply served in a prominent position during that war. But that's what the "war hero" variable is for. This isn't a minor issue, of course. Washington happens to be the second highest ranked president and the Revolutionary War is very high on the MDPC scale. So deciding whether to treat Washington like other generals in exactly his position (Eisenhower, Grant, Jackson) or treating him uniquely can really swing the results. Making the decision in a way that makes your result stronger - if that is the only general you treated that way - is of course going to raise eyebrows.

But there's one more MDPC choice that bothered me, and that's Lincoln/Buchanan. Buchanan stood out in their scatterplot as one of the lowest ranked presidents, and the reason for Buchanan's consistently low ranking is unambiguous. I'll pass the mic to Wikipedia for this one, but anyone familiar with American history knows why: "However, his [Buchanan's] inability to impose peace on sharply divided partisans on the brink of the Civil War has led to his consistent ranking by historians as one of the worst Presidents." So here we have a guy that we regularly rank low in the scale of presidents because we lay the Civil War at his feet, and yet Civil War deaths get attributed to Lincoln who, most Americans would agree, did the right thing in a tough and inevitable situation. This seems odd to me. If we think the carnage of the Civil War matters in the ranking of presidents (and almost certainly it does) shouldn't the guy that we think holds a lot of blame for not solving the sectional strife before war have some of those deaths attributed to him?

If you reassign Washington's logged MDPC to zero and you set Buchanan's logged MDPC equal to Lincoln's (so I'm not even removing the deaths from Lincoln's count), the logged MDPC variable (which I've switched out for their ranked MDPC variable because I like variables I can interpret) goes from being significant and positive (i.e. - more death is associated with a higher presidential rank) to small and insignificant (no empirical relation).

2. Causality, endogeneity, or spurious finding?

I think the two decisions I made above are less arbitrary than the decisions made by Henderson and Gochenour, but let's say you disagree with me and we just keep their significant relationship between MDPC and rank. I'm still not sure this means what they're implying it means. A "great" president in my mind is going to be a president that does the right thing in a tough time when the stakes are really high. You could have lots of potentially great presidents out there, but of course if they never have the opportunity to do great things their presidency won't be "great". Now, when the stakes are high people are of course willing to pay a high cost, including going to their death. When the fate of the Union is at stake, when the enslavement of millions is at stake, when the freedom of Europe from fascism is at stake, when a nation or armed group attacks us unprovoked, etc. - we usually think it's appropriate to risk life to address the situation. So the very situations which are high-stakes enough for presidents to make great decisions are also situations where you're likely to see a lot of battle deaths - not because we think death is a great thing, but precisely because the stakes are so high.

This interpretation - which I think makes the most sense - suggests that the relationship between MDPC and presidential greatness is largely spurious, rather than being causal as the authors suggest.

Another interpretation is that they have the causality reversed. We consider presidents great if they step into great conflicts and make the best of a bad situation. Nobody likes the fact that we had a Civil War, but we think Lincoln did the right thing in it. Nobody likes the fact that we had a Revolution. It would have been nice if we just parted amicably with Britain. But Washington (and Jefferson and Adams for that matter) had the right approach to a bad situation, and we recognize that. The same goes for WWII and even WWI. Roosevelt didn't ask Hitler to invade Western Europe and threaten the future of Western civilization. Wilson didn't ask for that powder-keg to go off, nor did he invite Germany to attack our civilian vessels. But given the bad situation, these presidents responded appropriately.

If this is the right interpretation (and I think this interpretation makes sense too), then Henderson and Gochenour have an endogeneity problem. It's analogous to simple regressions of GDP on fiscal stimulus. If you just do a simple regression (like they do here) with no attempt to identify your model, you're going to get a negative relationship between fiscal stimulus and GDP. Why? Because we only do fiscal stimulus when the economy is bad! These presidents only make tough decisions when they are handed a rotten situation!

We can argue about whether WWI was a war of choice for Wilson, or whether German submarines firing on American ships and revealed plans to invade the country from the south provided a good reason to declare war on a country that was already ravaging our allies. If plans to invade you and actual attacks on your ship aren't cause for war, I'm not personally sure what is.

But the point is, I think both of these explanations - for spuriousness and bias due to endogeneity - make a lot more sense than the idea that we like presidents that preside over lots of war deaths. You would think with such a counter-intuitive conclusion Henderson and Gochenour would provide some explanation of why they think people love war death so much. I'm not sure what an explanation would be.

3. Other variables

I ran some other variables that I thought you all might be interested in. First, what struck me about the high-ranking presidents is that the reason why I thought we loved Lincoln and Washington so much is because they expanded the scope of liberty for the American people. Washington was instrumental in freeing America from the British, and Lincoln was instrumental in freeing millions of enslaved black Americans. If you had to pick one reason why we like those two, "liberty" would be that reason, right? Since Johnson played a major role in expanding civil rights for blacks in the 20th century too, I added a dummy variable for Washington, Lincoln, and Johnson called "liberty". When you add that to the regression with my revised (insignificant) logged MDPC variable, "liberty" is barely insignificant at the 10% level (worth reporting I think - since we only have 40 observations!). When you drop the log MDPC variable, "liberty" is significant at the 10% level and is associated with a 147 point increase in the C-Span ranking.

Then I thought about why we like the other guys, and the reasons are quite similar to why we like Lincoln and Washington. We like Franklin Roosevelt and Wilson, for example, because they advocated and fought for liberty abroad. Reagan is also associated with the end of the Cold War, so I added those three to Lincoln, Washington, and Johnson for a "liberty, broad" variable. This one was not significant.

I also tried a dummy variable for whether the president was a "founding father" (I identified that as Washington, John Adams, Jefferson, and Madison). I was surprised that wasn't significant. I also added a dummy for whether the president was a Virginian. Unfortunately, that doesn't matter either.

4. You can't measure a singularity with a regression

In my third section where I was adding other variables, I was really trying to think about what it is we look for in a president. We like presidents that are instrumental in freeing people who weren't previously free, for example. But when you think about the determinants of presidential greatness, you very quickly get into very specific reasons. Why do we like Johnson despite Vietnam? Civil Rights. Why do we not like Nixon despite ending Vietnam and a fair amount of other good policies? Watergate and general creepiness. Why do we like FDR besides WWII? The New Deal. Why do we like Jefferson? We could list things like the Louisiana Purchase, but really its because Jefferson crystallized the American idea - and he did it throughout his life, not just (and perhaps not even primarily) through his presidency. If we really want to measure why we like certain presidents and why we don't like others, the exercise would degenerate into a cross-section with forty fixed effects. Needless to say, that's a non-starter.

Crude Austrians, macroeconomics, and complexity

A blogger over at Corrente, a blog that sometimes covers MMT stuff, they criticize crude Austrian objections to macroeconomics and aggregation (often hilariously paired with Garrison's own aggregate models [this is a knock on the crude Austrians that can't see the irony, not Garrison]).

The post raises some important points about complexity theory. This is another thing about the crude Austrians I've found absolutely unfathomable. In the same breath that they criticize aggregated analysis, they claim to appreciate complexity and emergent order.

If there is ONE CONCLUSION of complexity theory, it's that complex aggregates composed of many interacting parts can exhibit stable behavioral patterns that are not immediately obvious from looking at the interaction of the parts. And this isn't exactly a new point in economics either - this is Mandeville/Smith stuff. And yet somehow the people who pay so much lip service to complexity are often the same ones that critize thinking about aggregates.

Holy Guacamole - how did I let this slip through the cracks!!!

A very important paper by Summers and DeLong on fiscal policy in a severely depressed economy. I even knew it was coming - just a crazy week.

This, along with Krugman's prescient 1998 paper on Japan, are going to be two crucial pillars of the "New Old Keynesianism". Let's hope that awful name doesn't stick, but this crisis is going to make a big impact on thinking about the macroeconomy, just like the 1930s and the 1970s did, and this is going to be the narrative that you're going to need to be familiar with.

Field choice: gender economics?

A little while back I mentioned American University's program in gender analysis in economics. Part of that is the potential for PhDs to do their field work in gender economics. I never even considered it before, until now.

The course schedule is pretty thin for fall semester - I'm taking Econometrics II and Macro Political Economy (required for the macro track that I'm on), but there weren't a lot of other options. I couldn't take the advanced macro theory class yet. There were some development and international classes but I'm not particularly interested in that for field work. And labor economics isn't offered. The one tempting field course is monetary economics, but then I looked closer at the microeconomics of gender course, and it looks pretty interesting. It's basically another labor class - female labor supply, household bargaining, unpaid work, etc. These are all critical topics for a labor economist.

As interesting as monetary economics is, I'm never going to be a hotshot macroeconomist. It's always going to be interesting to me, but I really have to think about what my actual career will be, and I'm going to be a labor economist of some variety (and that's interesting to me too, of course!). I'm wondering if I should just do field work in labor and gender economics (we choose two fields - my primary will still be labor), and still do the macro theory track (we choose one of three theory tracks - macro, micro, or hetrerodox).

Any thoughts? Is that too "out there"? I initially just figured it would not have much currency in the discipline, but when I look at the content of the courses it's actually really critical material to familiarize myself with.

The other nice thing about it for the fall is that it meets right after my econometrics course, which means (because we'll hopefully have this Sloan money so I don't have to TA) I'd be trekking up to AU for two days rather than four.

Scott Sumner: An obstacle to sufficiently expansionary monetary policy?

The man is conjuring up enemies again. In this post, Sumner writes: "I believe that “liquidity-trap Keynesianism” is one of the major causes of the Great Recession—it contributed greatly to the monetary policy passivity. It’s been an abject failure." and "In my view the major battle going forward in mainstream macro will be between those who favor monetary policy rules as a demand-side stabilization tool, and those who favor fiscal stimulus. On the fringes you’ll have the MMTers, the Austrians, the RBC-types, etc. But they’ll never have much influence, because they don’t offer (stabilization) policy advice that is taken seriously in the halls of government."

It used to just be frustrating that Sumner seemed completely incapable of distinguishing enemies from (more or less) friends, and to watch his Krugman complex which rivaled that of many Austrians. But it's really getting worrisome to me.

If the fight was really between market monetarists and Keynesians, and if it wasn't the Austrians and RBC types that had some kind of control over the policy debate (if for no other reason than that they sound more "reasonable" to politicians afraid of money and debt), we would have substantially more monetary easing throughout this crisis. Sumner acts as if there is someone out there proposing fiscal stimulus as an alternative to monetary policy. If there is, I have yet to come across that person. Acting like monetary easing is a fringe position the way the market monetarists do might even be hurting the cause of getting it accepted as the right view. So why is this happening? The more I hear this out of Sumner the more I worry that it's about scientific priority and promoting NGDP targeting as the framework for thinking about it. If you say "ya, Brad and Paul are in agreement with me on the Fed, they just think there's a stronger case than I do for fiscal policy", you aren't doing much for the Scott Sumner brand. I hope that's not what it is, but I'm increasingly worried it might be.

Krugman's position - and as far as I know DeLong is there with him on this - is that:

1. In a liquidity trap, the traditional interest rate mechanism for increasing growth through monetary policy is gone, but

2a. Through a credible commitment to being irresponsible, monetary policy will still work, although,

2b. Credible commitment to being irresponsible is hard for the monetary authority to do for the simple reason that all their pre-Fed work has been dedicated to convincing people that their policy responses are not going to be sustained indefinitely.

3. Fiscal policy that trickles out is unlikely to do much and will hurt the long-term debt position, but large fiscal policy can shock the system to the point where traditional monetary policy (that does not rely so exclusively on expectations) gets traction again.

This means big monetary expansion coordinated with big fiscal expansion. You can find this spelled out in plain English in his Japan paper. He takes Koo to task in 2010 for suggesting that monetary policy is useless and he points out that to the extent that we have a strong monetary response we need less of a fiscal response. He cheers on people who reject Fed passivity. He reiterated in 2011 that he supports both monetary and fiscal expansion, and he supports fiscal expansion precisely because of how tough credible monetary commitments are (Sumner acts like these issues are trivial - who turned out to be right?).

But Scott Sumner doesn't seem to even get what Krugman is saying. In this post Sumner just can't seem to get his head around the fact that Krugman is not saying "monetary policy can't work", he's saying "monetary policy's effectiveness in a liquidity trap is almost entirely dependent on expectations of future monetary policy".

Then at the end of that post, Sumner suggests Krugman used to be a pure-monetary-policy guy in 1998, and now is opposed to it! I STRONGLY encourage you guys to read the 1998 paper on Japan. He's an advocated of a paired fiscal/monetary policy approach then just as he is now, and for exactly the same reasons. He doesn't talk about fiscal policy until later in the paper... maybe Sumner only read the beginning and skimmed the rest. But he is supporting the same position now as he was then:

The efficacy of monetary policy in a liquidity trap his highly contingent on expectations, and strong fiscal policy can jolt the economy into a position where monetary policy is less contingent on expectations to be effective.

Guest Post 2: Blue Aurora on Econophysics

This is Blue Aurora's second installment. It's worth pointing out that his first post elicited some other commentary in the blogosphere. Gene has a humorous treatment of uppity physicists here. Jonathan goes into some Austrian critiques of economics as a predictive science, and the relevance of this point for econophysics . Regular readers know I agree on this point - that I like to think of economics primarily as an explanatory science, just like any study of a complex system.

There was some comment section discussion of statistical distributions that I was unfortunately not able to participate in. I think the point that a lot of people who criticize assumptions of normal distributions miss is that a lot of what they're talking about are assumptions about normally distributed parameter estimators. As far as I am aware, we can assume these estimators are normally distributed - they are random variables themselves, after all. That's a very different proposition from assuming that whatever distribution these parameters contribute to are normally distributed. An estimator for a mean is going to be normally distributed regardless of whether the distribution that generated that mean is normally distributed or not. Anyway - on to Blue Aurora

*****

MOVE OVER, MANKIW, KRUGMAN, AND BERNANKE

Why do I list this cast of economics characters? Because whatever your strand of economic thought, be it Austrian, Feminist, Old Institutionalist, New Institutionalist, Market Monetarist, Neoliberal, Post-Keynesian—do call yourself what you like—but the bottom line’s the same: There’s a new show in town, and it’s dangerous.

Picture, if you will, the orthodox citadel under assault by a bunch of physicists armed with a concentration in statistical mechanics (not to mention a knack for “non-stationary increments”) and Mandelbrot’s fractal geometry. Robert Lucas attempts to draw out his eponymous Critique. It proves futile, as the econophysicists point out that Lucas had erred in his conclusion from a “scientific standpoint” (see page 224 of “Dynamics of Markets: The New Financial Economics” by Joseph L. McCauley). Bernanke doesn’t take long to bow thereafter. Why hasn’t this scenario happened yet? Two simple reasons—the lack of widespread knowledge, and the fact that the econophysics project hasn’t grown that strong just yet.

So far as I have been able to tell, the econoblogosphere hasn’t commented extensively on the so-called “econophysicists”. This is in spite of the fact there is a dedicated blog on econophysics at an econophysics forum, econophysicists who are based at respectable institutions (for example, Jean-Philippe Bouchaud teaches at École Polytechnique), and even the occasional media mention in the movement’s fifteen years—for instance, in a 2005 article on The New York Times and in the Sept/Oct 2009 issue of Adbusters. Okay, there’s Cosma Shalizi’s little rant at Three Toed Sloth, the Gallegati-Keen-Lux-Ormerod “Worrying Trends” paper in Physica A, and Jean-Philippe Bouchaud’s article in Nature. Leading econophysicists Imre Kondor and Rosario N. Mantegna have received grants from the Institute for New Economic Thinking. The Austrian School-sympathizing scholar of quantitative finance, Nassim Nicholas Taleb, has referred to leading econophysicists Dr. Didier Sornette and Dr. Jean-Philippe Bouchaud, in his popular works. Of course, with the instrument that is the World Wide Web, in due course the econophysics project will receive more attention—but for the moment, they have not.

Here and there, they have been referred to on the blogosphere—see the March 3, 2011 entry on online blogger Lord Keynes’s website, “Social Democracy for the 21st Century: A Post Keynesian Perspective”, for instance, and Robert Vienneau’s July 13, 2006 entry. I’ve also encountered some comments on the forum of the Ludwig von Mises Institute. Why is the commentary so dispersed and not so frequent, despite the World Wide Web? A culture clash between the econophysics project and the economics profession is one reason. So would the youthfulness of the econophysics project (only being fifteen years old!), the fact that the natural sciences and social sciences have been interacting for the past two centuries aside—Jan Tinbergen studied physics at the undergraduate level, and so did Paul Samuelson, but there is something different from these previous translations of phenomena in the natural sciences into the social sciences. I figured there was something different to them once I read the article referenced in the bibliography of a post written by Lord Keynes of Social Democracy for the 21st Century.

Lord Keynes refers to a July 2009 article published in Elsevier-owned “Physica A: Statistical Mechanics and its Applications” called “Economic Uncertainty and Econophysics”, written by one Christophe Schinckus. Three renowned economists that touched upon uncertainty covered in the subject of the article were none other than John Maynard Keynes, Friedrich A. Hayek, and Frank H. Knight. Schinckus claims in his article abstract: “By presenting econophysics as a Knightian method, and a complementary approach to a Hayekian framework, this paper shows that econophysics can be methodologically justified from an economic point of view.” I strongly feel that the econoblogosphere needs to discuss this issue in much greater frequency.

Thus far, it has been rather dispersed and all over the place. However, in my quest to learn how my fellow bloggers would make of econophysics, I prodded around and linked to the econophysics forum. One blogger had an initial reaction that indicated some amusement and flippancy: “What does economics have to do with physics? Sounds like a revival of Comte.”

Not taking it seriously initially, I then linked to Jean-Philippe Bouchaud’s article in Nature. He
proclaimed that “In short, [Bouchaud] doesn’t know what he’s talking about.” Then he cited “The Epistemological Problem in Economics”, an essay by Ludwig von Mises, to counter Jean-Philippe Bouchaud’s essay. I countered that the econophysicists have listened to outside criticism referring to the Gallegati-Keen-Lux-Ormerod paper) and have made an impact on finance. As of this writing Jean-Philippe Bouchaud is still the editor-in-chief of the journal Quantitative Finance. Dr. Bouchaud’s methods have set a precedent. Future financiers will have to listen—and
following the example of the econophysics project, adopt an empirically-based approach that rejects a priori theorizing, but stand up in the face of a financial crisis.

It was at this point In the following interactions I had with him, the Austrian School disciple, Jonathan Finegold Catalan, pointed to the “lack of controlled experiments” that “distinguishes physics from economics”. But there is a lack of controlled experiments in astrophysics and geophysics, and they are considered empirical sciences! Observation, as Catalan should know, is a part of the scientific method. Going by Catalan’s logic, astrophysics and geophysics would be unscientific. What makes econophysics scientific? The techniques of the econophysics project have yielded solid results. While predictive power is obviously secondary to explanatory power, what Dr. Bouchaud, Dr. Stanley, and their colleagues have been doing seem to hold up! The techniques of statistical mechanics are designed to analyze and describe non-linear, random processes. Human decision-making processes are non-linear and non-additive, as demonstrated
by the works of cognitive psychologists and countless other scholars. The techniques of statistical mechanics so far, hold up. The explanatory power of the econophysics project may well prove more fruitful than current methods. But enough with the turf wars over method. I suspect that economists could use an even bigger toolbox if they are to avoid being completely falsified by the
econophysics project.

Heterodox economists Mauro Gallegati, Steve Keen, Thomas Lux, and Paul Ormerod are a few economists who have engaged the econophysics project. All four of them have published in Physica A. But engagement of the econophysics project doesn’t have to begin at the fringe (see the special issue in the Journal of Economic Dynamics and Control mentioned above). John Sutton, a scholar at the London School of Economics and Political Science, is one of the few orthodox economists aware of the econophysics literature. So there is still time for the economics
profession to cooperate with the econophysics project and ultimately, learn. Unless of course, Dr. McCauley and Dr. Bouchaud have their way, Brad DeLong and Scott Sumner wouldn’t be debating estimates about the multiplier effect anymore. There wouldn’t be debates between the New Classicists and the New Keynesians. Instead, according to the world of Dr. McCauley and Dr. Bouchaud, both Sumner and DeLong shall be relegated to the role of Ptolemaic astronomer. Dr. McCauley accuses Keynesianism and Monetarism of becoming “ideologies”.) And it seems that the econophysicists—with their Mandelbrotian-Osbornian-statistical mechanical analysis—have the tools to potentially falsify virtually all of economics. One way to deal with this problem would be to take all of the Great Moderation Consensus to aggressively critique and attack the econophysics project. But I feel that reaching out to the econophysics project en masse will have a far more positive effect, and prevent economics from being falsified completely.

For somewhere beneath the acerbic stance taken by the more outspoken econophysicists like Dr. Bouchaud and Dr. McCauley, there just might be a point lying somewhere from which a new economics can evolve.

Strawmen are not very good sparring partners

I've been fascinated by some of the responses to my recent post on Caplan and education. Some of them are general comments, not directed at me. I'd still say they're strawmen of some sort because I don't think you see many people at all in the "economics of education" community saying them. But several commenters seem seriously confused about my point.

Caplan argues that the value of college education is substantially overstated, and that a lot of what we think of as the returns to education is signaling. I'm not aware of anyone that rejects the signaling model - they just might not think it's as important as Bryan does. And my point was this: Caplan suggests that a lot of education has no bearing on jobs, and that what a degree does is signal intelligence, conformity, conscientiousness, etc. We can add professionalism, self-motivation, forming and defending arguments, etc. My point is just that the curriculum that Caplan suggests has nothing to do with jobs provides or strongly reinforces these traits. I took one English class in college. The substance of the course has had no bearing on my career and it's not going to have any bearing on my career. But I did have to write a lot and form arguments in the class. Who cares if those arguments were about Hawthorne, Melville, and Faulkner? The point is I was writing a lot more in that class than in any economics class I took and I got a lot out of it. Yes, degrees signal skills. But they also provide skills, and simply asking "does this English class contribute to his job as an economist?" seems to me to be a terrible way of assessing whether college courses provide job skills.

The whole college experience provides skills too.

So my point is simply (1.) Caplan is not very convincing on course content, and (2.) he's taking the signaling model - which is unambiguously true in my opinion - too far. I think the signaling model primarily tells us why you see a lot more people getting four years of college education than three years. If it was simply a human capital story, you wouldn't see a big discontinuity at four years. But we do, because degrees as signals matter.

Somehow, a lot of people seemed to think that I was saying you can only get these skills through college. Of course not. Saying "X, therefore Y" in no way implies "Z, therefore not Y". Come on - you guys can do better than that.

Working right out of school or vocational/technical education can absolutely provide this as well (along with a lot of job-relevant skills that aren't taught in college). Why do you think I always share apprenticeship stuff on here and talk about Bob Lerman's research on it?

Here's my view of the economics of American education in a nutshell: The biggest problem we have with the distribution of human capital investment in the educational system is that it is bifurcated, and that has a big impact on the economic prospects of students. There are a lot of people that drop out or get sub-standard high school education, and there are a lot of people that go to college, but we have a gap in the formal provision mid-level skills (some of this is filled in on the job, of course). The biggest problem I see for higher educated workers is a demand-side problem, particularly for very highly educated workers. Jonathan Catalan provides a great summary of the argument for caring about demand-side rather than supply-side issues here.

At the lower end, though, I think we have supply-side problems in addition to any demand-side problems. We simply don't produce enough workers with vocational skills in this country. There are some positive trends. You see more career and technical education than you used to, the "college for all" mantra is slowly chipping away, and community college attendance is growing. These are all very good trends, but there's a lot left to be done. I think community college is especially important because of its versatility. It can provide mid-level skills that are closely connected to the skills the labor market is demanding, but it also provids an entry point to four year college for those students who decide that's right for them. So it's flexible in that sense. Career and technical education is important because it usually happens at the high school level, and it's very good at keeping students from dropping out and providing skills that are marketable. Finally, apprenticeship is important because it can take up drop outs later in their lives, and it provides earnings while making a human capital investment.

UPDATE: Oh - also worth mentioning - by mid-April Hal Salzman (Rutgers), Lindsay Lowell (Georgetown) and I are going to submit a proposal to the Sloan Foundation that's related to this - it should support one of my dissertation essays. There are several components, but the title of the proposal is "Science and Engineering Pathways in a Loosely Coupled System", with "loosely couple" referring to this Caplan point (and it's a point a lot of people make) about how people don't do work in their degree fields. We have specific focus on S&E people. My chunk of it is going to be looking at wage expectations and wage responsiveness of early career scientists and engineers. It's going to be a basic occupational choice approach, with somewhat more flexible specification of wage expectations than you often see to try to estimate discount factors that people use. I think it's also unique in that it's going to try to get at not just (for example) "life sciences occupation vs. non-life sciencs occupation wage differentials", but "life science major in a life sciences occupation vs. life sciences major in a non-life sciences occupation wage differentials" which is presumably the more relevant story. There's not a lot of data on both majors and occupations out there, so you don't see this as much - but the two most recent years of the ACS (and I assume future years too) does have this, which is great. The only crappy thing is that 2009/2010 is a horrible study period for doing a labor market analysis, but we'll see how it works out.

Why am I skeptical of this Karl Smith post?

Here. Don't cheat and look at the comment.

House listing picture FAIL

Seeing a bunch tomorrow... not seeing this one.

We are just animals

And as I've said ad nauseum, that doesn't mean we aren't wonderfully unique animals (cough-Gene-cough), nor does it mean we have warrant to be offensive and dismiss social norms (cough-Noah-cough). What it does mean is that we can understand why we are the way we are by realizing that we are just highly evolved animals.

And one of the great things that we animals do is better ourselves through social behavior. Human beings are both particularly adept at constructing functional social systems, and the possessors of traits (abstract thought, language) that make us particularly likely to have functional social systems inadvertantly emerge. And of course there's no strict dividing line between the two.

Anyway - social behavior is an animal thing. You need individual agency to really make the collective action that we call "social behavior" both possible and meaningful. Here are some fun videos of this characteristically animal thing we call "social behavior":

Classical liberalism and libertarianism are absolutely not synonymous

But of course, they are related, as all viewpoints in the liberal tradition have a close relation to classical liberalism.

It's a point we used to discuss on here a lot, although not as much recently. Matt Zwolinski has a great post up on Milton Friedman's liberalism (contrasting it with libertarians) that highlights this point. This is not a matter of changing views over time, it's worth emphasizing - the precursors of modern libertarians were contemporaries of Friedman, after all.

Bryan Caplan's new book

He has an outline here. I've been tangentially interested in the rational voter stuff, but I should probably actually pick this one up and read it more carefully. I agree marginally on some of this stuff, but have hesitations. One of the things that's bothered me about the way Caplan blogs about education is that he often treats human capital theories and signaling theories as an either/or issue. This outline seems more nuanced, which is nice.

The point I strongly agree with here is chapter 8. I think that's more because we've underinvested that and the way we do education here has resulted in some serious bifurcation in the skills distribution.

One of the things I wonder about his emphasis on signaling is that a lot of the things that are being signaled are actually traits you probably pick up in college. College helps turn dependent kids into independent adults, and it's those qualities that make an independent adult that play a large role in signaling. I'm not saying that's the only way to impart those skills, I'm just saying I wouldn't make such a strong case against formal education as Bryan does.

Two good posts on thinking about macroeconomics

- First, Gene has a good post at Think Markets on a general theory of social cycles. Somehow a long comment of mine on it got lost, but in a nutshell what I like about this is that I can't think of a single business cycle theory that can't be incorporated into the theory of social cycles that Gene discusses here, which is a simple process relating equilibrium, displacement, and adjustment. This is a good thing. Too many people have tendency to think that a good business cycle theory is THE theory of the business cycle. This is a bad way to approach a phenomenon that obviously could, and almost certainly does have lots of different causes. You are less likely to make that mistake if you take Gene's approach and start the conversation by talking about cars merging into the left lane (see the post), and then move into talking about the business cycle. That sensitizes you to the fact that this is a general phenomenon. Of course this still leaves lots of room for debate. I can still think the most relevant problems are demand-side distortions and you may think the most relevant problems are policy (or fractional reserve) distortions of the interest rate. But we can argue about that as an empirical matter of relative importance and still recognize that a variety of causes are quite plausible.

- Second, Noah Smith argues that the macro wars are still on, although they've transitioned. This is an insightful take on the role of economics blogging and New Old Keynesianism in the current crisis. I find the discussion of DSGE models interesting. A lot of people dismiss this as "if the model can explain anything it doesn't really explain anything at all", but I'm not sure it's quite right. What it says, I think, is that the DSGE "model" isn't really a model at all so much as a framework for thinking about things - common language or paradigm. That's fine. It's actually a good thing that we can use a common language to talk about different answers to the same question. I have different thoughts than some people on this "predicting the crisis" point. The most important contribution of experts isn't seeing into crystal balls. Sure there are warning signs, but a lot of people were pointing to those warning signs. Aside from that, prediction is dicey. We don't expect that of evolutionary biologists - we should not expect that of economists. What we do turn to experts for is explanations of the world around us. And that is an area where many economists have failed, and where I think Krugman has had great success. Noah focuses on reactions to the crisis, and I think that fits in naturally with explanations of the crisis. That's the real value-added from expertise in complex systems: explanation, not prediction.

Thinking about markets

What would the average person think if you said "I don't know why what I pay for gas in a month has been going up consistently for the last several months - I fill up my tank as often as I always have, so why am I paying more!"

The average person - I hope - would give you a blank stare of disbelief. Gas is sold on a market, after all! Price changes affect how much you pay, even if you're using the same physical amount of gas as you always have.

But then, gas prices are posted prominently on big billboards so everyone knows that the price moves around. It's amazing how rapidly intuition about markets disappears when we don't have that information in our faces. Maybe this is atypical, but I was shocked by a conversation I overheard at a restaurant last night in the booth behind us to the point that I almost turned around and interrupted the conversation (to Kate's relief, I didn't). This guy was talking about his electricity bill and how it had increased a lot since last month. "It's not like we've been leaving the TV on or doing anything different", he said. Someone was screwing him, he concluded. But maybe even if you didn't do anything different, other people did! Maybe our unusually warm last couple weeks lead a lot of people to turn off the heat and switch on the AC. Maybe electricity demand always increases as we transition from winter into summer. If prices per kilowatt were posted as prominently as gas prices, perhaps this conversation wouldn't have happened - but it is surprising to me that these sorts of points can be lost on people.

One interesting thing I learned recently about electricity pricing (at least in some areas) is that your pricing is a function not just of your electricity use, but also your peak use in a month. I hadn't realized that. So I guess that means dry your laundry at night when all your other lights and appliances are off to get a lower bill.

This all reminded me of a good post by David Henderson yesterday on confused thinking about quantity sold and the demand schedules. I've found that this is one of the toughest things to get students to really assimilate: the difference between a movement of the demand curve and a movement along the demand curve. They have no problem drawing it all out on a graph - that's fine. What I've found they have trouble with is (1.) taking a verbal explanation, like this article that Henderson cites, and translating it into a supply and demand graph, but even more so they have trouble with (2.) explaining what they've graphed in a way that distinguishes quantity demanded from the demand schedule and quantity supplied from the supply schedule.

Why make public investments in science?

I have my answer. Actually I have several answers, but it usually comes back to an externality-based argument.

One that I don't focus on too much is spin-off technologies (although these are special types of externalities themselves). Yet for some reason spin-offs can seem like the definitive justification for public investment in science by non-economist public science enthusiasts.

I think this is unfortunate and someday I'd like to articulate for a general audience why spin-off technology is not the strongest justification for public science available.

Investing in science education

I'm in the camp that is skeptical of emphasizing supply-side policies in the science and engineering labor market. I am - as in my macro (although that is coincidental) - a demand-side guy.

But here's one really good reason to invest more in science and engineering education... you get more superheros:

What's new with me?

The last couple days have been pretty crazy, but now that I have a brief period to catch my breath (before a mid-term next week) I wanted to share a couple exciting new developments:

1. First, Kate and I got pre-approved for a mortgage this weekend, which we are very excited about. We're meeting with a realtor tonight and hopefully by this summer we'll be home owners! We plan on staying in the area, but probably a little further out... it's pretty pricey in Arlington proper and my plan to get fabulously wealthy by working for a non-profit and then leaving that job to go to grad school is not panning out how I was hoping it would.

2. I recently submitted an application for Mathematica's summer fellowship program. The fellowship is for independent research on racial disparities. Previous groups of fellows come from a mix of social science degrees. I'm proposing an evaluation of NSF's HBCU undergraduate grant program. Mathematica is a big player in the policy evaluation world, and a lot of previous work has been more big picture question researchy, and less evlauation-oriented, so I'm hoping this catches their eye. Plus science and engineering education always seems to be a topic that piques peoples' interest.

3. I'm working some today on my application to the Sloan Foundation for a multi-year research grant with my co-author on the engineering chapters. This is exciting because if we get it, it will (1.) replace my teaching assistantship at AU (which is really nice, despite how fun teaching can be), and (2.) support my dissertation research. My section of the proposal is going to be on wage expectations and the occupational choices of early career scientists and engineers. The broader proposal is going to look at the transition from school to the labor market for science and engineering majors, and specifically explore the relationship between major choice and career choice).

4. My paper on Newton and Keynes was nearing the point of cleaning up and sending in at the end of spring break... until I came across some Royal Society material suggesting there was a lot more activity from Keynes in 1942 than I had initially realized. So it's closer, but that needs some more work.

So lots of interesting stuff over spring break, but now it's back to reality. We'll see how these things move forward, or whether they'll have to be put on the back-burner until May.

Guest Post: Blue Aurora on Econophysics

Frequent commenter Blue Aurora asked to do a guest post on "econophysics". It's a relatively new research agenda that I don't know too much about, but which has long interested Blue Aurora. Here is the first of two posts on the subject - feel free to ask him more about it in the comment section:

*******

Econophysics, a portmanteau term coined by Boston University physicist H. Eugene Stanley in 1995, is the application of statistical mechanics to economics and finance. Just what is this statistical mechanics, you wonder?

Statistical mechanics, a sub-field of physics, is a mixture of combinatorics and probability theory applied to thermodynamic systems of composed of a large number of particles, and through that, the capacity to make predictions on said systems. (Although statistical mechanics is better described as “probabilistic mechanics”, the “statistical” prefix remains entrenched in the scientific literature.) Are you confused by that sentence? Here’s a simpler way of putting it – it’s the study of particles interacting with other particles in a thermodynamic system composed of said particles. The particles are the microscopic constituents of a larger macroscopic system like say, a steam-powered locomotive engine in operation. No, this does not mean that econophysics treats agents in the same manner that neoclassical economics does (i.e., the representative agent). Distance is a factor in the interaction of such particles, and human agents are affected by distance. Statistical mechanics screens through the noise and enables one to make predictions of what shall happen to the particles, making it a superior approach than standard economic theory.

What follows from this approach? Firstly, it follows from this approach that one is able to study a system in a non-linear fashion. Secondly, in econophysics, it also entails the rejection of Subjective Expected Utility, which even behavioral economics follows as “prescriptive rationality” (see Christophe Schinckus’s 2011 article on the neo-positivist argument for econophysics for reference). Thirdly, before being applied to economics and finance in the late 20th century in the form of “econophysics”, statistical mechanics has been applied to systems biology, fluids, granular and soft matter, evolutionary systems, and network analysis, to name a few examples gathered off the website of Physica A: Statistical Mechanics and Its Applications. When applied to economics and finance however, it allows for the analysis of a non-equilibrium system changing over time. An excellent application of statistical mechanics to economics would be Raymond Hawkins’s paper on the lending sociodynamics of Hyman P. Minsky’s “Financial Instability Hypothesis”, which uses an equation from statistical physics to describe the stages leading to the infamous “Minsky moment”. How is the Financial Instability Hypothesis formalized by statistical mechanics? It is formalized by the use of a Fokker-Planck equation.

Of course, not all of the insights of econophysics is original. The theoretical foundation of econophysics comes largely from their highly empirical and positivistic methodology, and ultimately avoids a priori theorizing—something standard economic theory has been accused of for far too long.

Building on the work of the late mathematician Benoit B. Mandelbrot and the physicist M.F.M. Osborne, the econophysics project is nascent, but already has made an impact in finance and economics, with the Journal of Economic Dynamics and Control even devoting a special issue to the application of statistical mechanics to the aforementioned fields. How successful are their criticisms and their own research? Well, judging from their publications in their flagship outlet, Physica A: Statistical Mechanics and Its Applications, it seems that the techniques used, for the most part, are fairly solid. But they also remain largely unused by the economics profession.

Multi-fractal systems, derived from Benoit B. Mandelbrot’s research itself (the econophysicists have adopted Mandelbrot’s use of the Hurst exponent), also appear to be largely absent in the economics literature, but is covered often in the publications of econophysicists. The same would apply to detrended fluctuation analysis. But the most devastating critique by the econophysics project that follows from Benoit B. Mandelbrot’s analysis would be the “mild risk” of the standard normal distribution versus the “wild risk” of the Cauchy distribution.

The “Reagan-Thatcher-Friedman” world, as Joseph L. McCauley puts it in the second edition of his Dynamics of Markets (2009), can only deal with “mild risk”. However, in the real world, it seems that the “wild risk” of the Cauchy distribution serves as a far more accurate device in modeling financial reality. The Cauchy distribution appears to explain the highly-repetitive behavior of booms and busts in financial history, whereas standard economic theory appears to only allow for such events as having a likelihood of one in twenty million cases. This is simply unacceptable.

Benoit B. Mandelbrot’s research proves that the financial time series data for a fifty-year period is overwhelmingly dependent and discontinuous. In other words, prices are volatile with a propensity to spike, and prices have memories of sorts. Mandelbrot’s research program, having been absorbed into the econophysics project, serves as a lethal weapon for the more vocally critical econophysicists—namely one Joseph L. McCauley. At the opposite end, we have the aforementioned H. Eugene Stanley, who is more receptive with ordinary economists. I learned of H. Eugene Stanley’s less hostile approach from this video.

Though Stanley is still critical of mainstream economics and finance, he is still receptive to cooperating with mainstream economists. This is better than Joseph L. McCauley, who wants not only to raze the neoclassical bastion to the ground, but also plans to falsify just about every other school of economic thought. Armed with the research programs of Benoit B. Mandelbrot and M.F.M. Osborne, and a concentration in statistical physics, these guys just might have what it takes to falsify mainstream economic theory and more. The economics profession better be on the look-out, and take econophysics—which is more than just, to use McCauley’s words, “agent-based models, fat tails, and scaling”—seriously.

Two great points from stickman

Here.

I'll put the first point in my own words: My skepticism of you increases exponentially with the number occasions on which you choose to buck consensus. Stickman is commenting at first on the popularity of weird diets among libertarians, but he goes on to note Lew Rockwell's promotion of a variety of kooky ideas. This looks really bad, and I feel this way about climate skeptics a lot. OK, skepticism is a good impulse - I'm not going to dismiss you as crazy just because you reject this scientific consensus... but if you reject the climatologists' consensus, and then you also reject the monetary macro consensus (let's generously allow that reasonable people can disagree on fiscal policy), and then you also reject empirical research in favor of a priorism, and it looks very bad. Add creationism to the mix and I wonder why we're even talking. But it doesn't stop with scientific consensus. Often these are the people who hem and haw about the Civil Rights Act, who think FDR was a fascist, and who think that the Progressive movement was the worst thing that ever happened to America. These sorts of people aren't interested in getting to the bottom of things so much as bucking consensus whenever and wherever they come across it.

It should come across as very odd to people that climate change skepticism is almost exclusively a preoccupation of the right. This is not to say everyone on the right rejects climate change - it's to say that if you reject climate change you are almost certainly on the right. What is happening in the Earth's atmosphere should not be correlated at all with political views, and yet it's highly correlated. That alone - leaving all the climate science itself to one side - should lead people to steeply discount climate change skepticism. In other words, if climate change skepticism were evenly distributed across the political spectrum, I would probably take it a lot more seriously than I do.

*****

The second point that stickman makes is one I've made on here many times before: Selgin, Lastrapes, and White (2010) is very good history, but very bad policy evaluation. Stickman points out that they acknowledge at the outset of the paper that they lack a counter-factual and they're simply doing history. That's true - but then one wonders why they conclude with this:

"(Available research does not support the view that the Federal Reserve System has lived up to its original promise. Early in its career, it presided over both the most severe inflation and the most severe (demand-induced) deflations in post-Civil War U.S. history. Since then, it has tended to err on the side of inflation, allowing the purchasing power of the U.S. dollar to deteriorate considerably. That deterioration has not been compensated for, to any substantial degree, by enhanced stability of real output... Finally,the Fed cannot be credited with having reduced the frequency of banking panics orwith having wielded its last-resort lending powers responsibly."

The bolded lines are not the sort of statements that are made about historical research - they are statements made about evaluation research. And that's certainly the way this paper is promoted. And while Selgin, Lastrapes, and White may have reeled in their fans at some point, I'm not aware of any case where they have said "oh no - you misunderstand - you can't take this to be an evaluation of the Federal Resere - it can't accomplish that".

A good rough-and-ready test is to just think about all the ups and downs that they cite and ask "did similar things happen in economies that did not change their central banking system in 1914?" The answer is "yes!". If you look up banking panics on Wikipedia and look at their list for the 19th century, you see it flip flopping between panics originating in England and the United States. 1819 - U.S., 1825 - Britain, 1837 - U.S., 1847 - Britain. Britain had a central bank long before the 19th century so it offers a good opportunity to hold institutions constant here. It seems like banking panics in the 19th century were just something that happened in credit-based industrializing economies. Flash forward into the early 20th century and you see the same thing - the elephant in the room in the post-Fed record, the Great Depression, happened in Britain and the U.S.. If we treat this like a difference-in-differences test, a cursory look at the evidence suggests that the pre-post work done in Selgin, Lastrapes, and White is probably going to be a very misleading way to infer anything at all about Fed policy. Stickman's right - the introduction seems to say that. I just wish the title, the conclusion, and the promotion said it as well!

Does this Washington politician deserve this defense?

Mattheus von Guttenberg defends career politician Ron Paul thusly:

"Paul doesn't highlight it often (because he is not speaking to a crowd of students or postdocs trained in economics) but the whole point of talking about the erosion of the monetary unit is to emphasize the non-neutrality of money in the short run.

But of course, money is neutral in the long run. Who cares if the money unit is 50% of what it used to be if your paycheck is 200% what it used to be? I understand that point, Daniel. But Paul is trying to bring attention to the interim process. In the short run, money is most certainly not neutral and large influxes of it benefit specific people and organizations at the expense of other people and organizations."

Do you all think this is justified? My first thought was that accepting the short-run non-neutrality of money is pretty coincident with advocacy of expansive monetary policy. That's sort of where it all starts. But I suppose that's not strictly necessary, so we can let that one go.

Still, I think Mattheus is wrong. If you know money is neutral in the long run, you don't go around spouting as your main argument against the Fed that the dollar has lost 95% of its value since 1913 (or whatever the number is). If you actually know that non-neutrality is a short-run issue, what Ron Paul goes around saying is precisely what you wouldn't want to say if you thought most people don't understand short-run non-neutrality.

If you understood economics, but were worried other people didn't, what you would do is talk about real wage trends and trends in the real value of fixed incomes and the minimum wage. That's a short-run non-neutrality point.

Caplan on Kleiner and Licensing

Bryan Caplan links to a relatively new working paper by Kleiner and Krueger on occupational licensing. Studies show that it is associated with a 15% wage premium. What Bryan is interested in here is that licensing doesn't seem to inflate the returns to education very much (often getting a license requires a college degree). Bryan is surprised... I'm not sure we should be that surprised. Bryan is a skeptic about how useful degrees really are, but of course if you think they are useful, then this isn't an artificial inflation of the returns to education at all, and it's probably a pro forma requirement for formal training that people working in this line of work would have pursued anyway.

Morris Kleiner - a nationally known expert on licensing and the co-author of this paper - is one of the chapter authors for the engineering book I'm contributing to (his chapter will also be on the licensing of engineers). He's a very nice, down to earth guy. I shared a cab with him from NBER back to the airport, and he had lots of interesting thoughts to share on what academic life was like.

I think Kleiner and Caplan are generally right about these sorts of supply restrictions, but we need to be careful. There are real principal-agent problems and information asymmetry problems in professions that use licensing, which a reasonable licensing standard could actually help with. You can't just point to the 15% wage premium and chalk it up to protectionism. A chunk of that may be genuine productivity gains. Licensing like this emerges naturally from self-policing by different professional groups. Of course it can be overdone, but we shouldn't just instinctively turn up out nose at it. You've got to be careful with that sort of libertarian social engineering instinct, or you'll wreck some good emergent order!

Where I think licensing probably does the most damage is in lower skill occupations that really aren't plagued with principal-agent problems, and don't need the self-policing. Those can be real barriers to employment for low skill workers. Matt Yglesias used to post on this a lot - he was good at bringing attention to this problem.

Another great observer of American social problems highlighted the risks to low income workers posed by licensing as far back as the sixties (when licensing was less common). Does anyone know who he was?

Don't let Thomas Sowell know Thomas Sowell said that!

I am ceaselessly amazed by Ron Paul, as you all know. The guy acts like the antithesis of the Washington politician, and yet he personifies the Washington politician. And since he (1.) so regularly makes a big deal about the fact that he's the antithesis of the Washington politician, and (2.) so regulalry demonstrates what an adept politician he is, I am more often than not laughing at the cognitive dissonance of it all whenever I see Ron Paul saying something.

Similarly, I have a very high likelihood of finding amusement in the things that Thomas Sowell says. It's not what he says so much as the fact that he's saying it. Similar to Ron Paul, Thomas Sowell is very well known for his critique of intellectuals who make claims about society. That's all well and good - he even has some good points in the critique. But I just can't bring myself to take Sowell completely seriously when he puts on his public intellectual hat, precisely because he is so widely identified as an anti-public-intellectual. It would be like seeing Bryan Caplan at a voter registration drive.

So, on cue, I got a chuckle out of Sowell's firm pronouncements on the Fed (HT - Ryan Murphy).

Don't tell Thomas Sowell that Thomas Sowell said that! He'll have some stern words for him! I can picture it now:

- You're not really known as a monetary economist, so talking about this stuff is really outside of your area of expertise.

- You may not like the Fed, but you really aren't going to be held accountable for pronouncements like this - you don't have anything on the line.

- "Cancer", really? That's nice 'verbal virtuosity', which as Sowell points out can be appealing to people - but it's not really helpful analysis.

- Sowell, of course, is contributiing to the climate of mistrust around Bernanke and the Fed.

The only point in the (I'm assuming COMPLETELY authoritative) Wikipedia review of Intellectuals and Society that he didn't hit in this three minute fifty one second video was making it personal (although he seemed to have a personal attachment to Arthur Burns... so perhaps that one is worth exploring more).

A lot of this is just meant to be in fun - the point of Intellectuals and Society was a good point. Unfortunately, it's often people who complain the loudest about the misbehavior of others that are successful in taking the spotlight off themselves.

Stanley Fish, Limbaugh, and Maher

David Henderson points out a pretty disturbing op-ed from Stanley Fish on why we should differentiate Maher from Limbaugh that basically amounts to "Maher is a good guy, Limbaugh is a bad guy, so the double standard serves the cause of the good".

The op-ed was especially offensive to read because there was no need to invoke anything like that to differentiate Maher from Limbaugh. The way I've viewed it is that there are some offensive things we can say that are generic insults, and then there are specific commentaries on behaviors. Limbaugh was identifying women who (1.) use contraception and (2.) are sexually active and (3.) are open about it and (4.) think it's a worthwhile policy discussion to have as being "sluts" or "prostitutes" because they do those things. That's considered beyond the pale because he's passing judgement on these things that most of us think reasonable modern women should feel perfectly comfortable doing.

Bill Maher isn't really commenting on behavior. He just doesn't like Sarah Palin and is grabbing for a mean word to throw at her. It's not exactly nice, but it's a different goal altogether than Limbaugh's.

I wish there was a good conservative counterpart to Maher, but there really isn't that I can think of. Maybe it's best to use an apolitical counterpart like Louis CK. He has a foul mouth and he uses all those insults. But like Maher (and unlike Limbaugh) Louis CK is not vilifying reasonable behavior: he's just lobbing insults.

There's a good reason to be angry at Limbaugh and not Maher, but Fish did not reach for the good reason.

OK, talking in the last post about how we busted out of Africa and kicked ass after nearly going extinct reminded me of this...