Horwitz and DeLong on policy in our depression

Steve Horwitz has an interesting discussion at the Adam Smith Institute on policy in this depression and specifically why "Krugman is wrong". If you are not familiar with Austrian macroeconomics it's an excellent summary. But of course, he also critiques the Keynesian response, and these portions are less strong in my view. I have two nit-picky concerns that nevertheless get to more fundamental issues - one that I'll address and one that I'll let Brad DeLong's recent post address.

Nit #1: "Stimulus failed"

Steve spends a lot of time talking about the failure of the stimulus package - not just the failure to get us out of the depression (many of us said at the time it wasn't up to that task), but the failure to do any good at all. I'm most troubled that he used the Romer-Bernstein graph to make the point. There are two reasons to show it:

1. To argue that forecasters in December 2008 did not get it right, or
2. To defend forecasters in December 2008 as presenting a viable counterfactual.

It's hard to say exactly where Steve falls because he doesn't frame it like I just did, but in the talk he seems to support the first option, and yet he also presents it as being bad news for stimulus. This seems like an extremely misleading thing to do. If you accept the first option, the only answer an economist really has any business providing on what it says for the stimulus is "we can't know exactly without a counter-factual, but we can rely on past evidence - but this graph that I am showing you understates the positive impact of the stimulus because of the poor forecast".

I could be misreading him and he could be arguing just for #2, but I don't think he's doing that. I think #1 is far more defensible myself. The problem is that Steve seems to want to have his cake and eat it too: he wants the premise from #1 but the conclusions from #2. It's not just him of course. You see this a lot. I don't understand it. Steve understands the problems around inference from non-experimental data, so why does he promote the graph as demonstrating the failure of the stimulus?

This has bigger consequences, and this is why this nit is important. In a world where "are you better off than you were four years ago" is perceived as a sensible question for evaluating a candidate, people who understand counterfactuals and inference from non-experimental data (like Steve Horwitz) ought to be clarifying this sort of thing to the public, not confusing them on what this graph means.

Nit #2: Krugman and people like him don't understand that interest rates coordinate intertemporal choice

I was surprised the first time I heard him say this, but then he revisited it several times. Does anyone honestly believe Krugman and people who agree with Krugman don't understand that the interest rate is a price signal?

A lot of people think this is what the argument is over - the market process. I disagree strongly. If you want a good example of a Keynesian understanding the interest rate as a price signal and raising other quite different concerns, I suggest you read Brad DeLong's Platonic dialogue today. The Hayek/Mises stuff is subtext until Sokrates jumps in farther down, but if you're at all familiar with the Austrian argument you should see it much earlier. This is a critical point in the exchange, from the perspective of the discussion with the Austrians (yes I know this critical "point" is like half the dialogue):

"Hypatia: A second worry is that because of tight fiscal-loose money the real rate of interest is not doing its job of signaling the true optimal first-best shadow price of intertemporal choices. It is making the price of investment too low.

Glaukon: Thus a tight fiscal-loose money economy would seem to be one that invests too much and that weights the composition of its investment too heavily toward long duration assets.

Hypatia: Yes. The price at which savers lend and at which investors borrow and choose investment projects is false. False prices produce transfer rectangles--in this case, a transfer from savers to investors--as well as excess purchases of the investment goods whose market price is less than their social resource cost.

...

Glaukon: But can you elucidate to me the harm from purchasing investment goods whose private purchase is profitable just because the interest rate is below the first-best optimal intertemporal tradeoff shadow price?

Hypatia: I don't think I understand: price is below shadow cost; purchases are too high; Harberger triangle; deadweight loss.

Glaukon: Let me see if I can say where I am having my problem: I understand pollution externalities--we undertake too much polluting activity because we do not factor the harm of pollution into the market price and so there is a deadweight loss Harberger triangle composed of the harm rectangle imposed on society as a whole offset by the triangle that is the benefit to private polluters minus the private cost.

Sokrates: That is completely correct, Glaukon.

Glaukon: But in the case of over-easy monetary policy I do not see this. I the benefit triangle to investors--they get to make investments that are privately profitable. I see the transfer rectangle. But where is the harm, exactly?

Tiresias: I believe that the harm must somehow arise out of the fact that consumers are non-Ricardian.

Klio: Non-Ricardian?

Tiresias: Yes, if consumers are Ricardian, then if taxes are too high they simply borrow to pay their extra taxes. Consumption and investment stay what they would be at first-best fiscal policy. There is no aggregate demand shortfall for easy money to correct."

My paraphrase of Brad's response to the Austrians is that yes, ultra-expansionary monetary policy, if we were to adopt it, would move us below the natural rate, and that will throw investment and consumption off balance and produce elongated capital structures like you're worried about. But it's critical to recognize that that is a cost associated with government spending that is below trend in a non-Ricardian world and of credit market problems. Loosening monetary policy is the best alternative to the fiscal and credit market problem. Another way of putting it is the old saying that "it takes a lot of Harberger triangles to fill an Okun's gap".

Yesterday he presented a somewhat different argument, which I am more amenable to: that we are actually above the natural rate right now, which is why the Wicksellian perspective calls for monetary expansion. There is no false signal being sent. In fact, if I were to put my Hayekian hat on I would be worrying that firms are getting the wrong signals to invest too little and to have production processes that are too short because we are above the natural rate.

How to square Brad's post yesterday with his post today? I'm assuming the monetary policies he's discussing today are genuinely "ultra-loose" in the sense that White meant it - below the natural rate - in order to compensate for the failure of fiscal policy makers.

So there are two responses to the Austrians:

1. You're right but those are costs that we incur because we're in second-best territory. If your argument is that first-best is better than second-best we agree. But these Harberger triangles still don't outweight the Okun gap.

2. You are right about the response of entrepreneurs to the interest rate but wrong that we are below the natural rate right now: all signs suggest we are above it.

Both are appropriate, but I think #1 is unnecessarily deferential to the Austrian assumptions about the natural rate.

Anyway, one thing is clear: Brad DeLong understands that interest rates are signals that coordinate intertemporal decisions.

Today's reading list

- Frances Wooley, "Getting the Better of Becker" (1996)

- Marrianne Ferber, "A Feminist Critique of the Neoclassical Family" (2003)

- Barbara Bergmann, "Becker's Theory of the Family: Preposterous Conclusions" (1995)

From the horse's mouth

Jonathan has a long discussion on Hayek and capital theory, which I think is very good, but I want to clarify (perhaps unnecessarily) one point about my earlier post. I've been reading some of Pure Theory of Capital, but it's not like this has introduced me to the Ricardo Effect and I've concluded myself that because Hayek highlighted the Ricardo Effect, Hayek thought consumption and investment move in opposite directions. What I was struck by the other day was that he just comes out and says it, without even any reference to the Ricardo Effect (I assume that is what he has in mind, but maybe not):

Starting on page 47:

"In the following list of propositions the first of each pair is intended to represent the traditional or "Anglo-American" point of view, while the second gives the contrasting "Austrian" view on the same problem:

...


9A. The deamnd for capital goods is asumed to vary in the same direction as the demand for consumers' goods but in an exaggerated degree.

9B. The demand for capital goods is assumed to vary in the opposite diretion from the demand for consumers' goods."

Certain modern Austrians will go nuts if you have the audacity to agree with Hayek on this point. They'll tell you you don't understand Austrian economics. I just want to clarify that it's not just me extrapolating business cycle theory from a book that wasn't primarily about businss cycle theory.

Some observations on discussing politics with non-politicians that feel there are important issues at stake

So here's a little observation for how political discussions on the non-politician blogosphere end up in, my view.

In the diagram below, DK is me, BM is Bob Murphy, GM is Greg Mankiw, MR is Mitt Romney, RP is Ron Paul, and BO is Barack Obama. There's no reason to choose Bob or Greg except that they are convenient examples of people who seem to feel for Paul and Romney about what I feel for Obama.

I think DK is the truth point. I really have no other choice. I can attach a certain degree of certainty to my views, but I have no choice but to believe they are true. Why would you hold a view you believe is wrong? So everyone gets assessed relative to the truth point as I see it.

On average, non-politicians are closer in on the truth point than politicians.

Barack Obama is off the truth point. Clearly. He's a politician. But most importantly he's not me. There are only a couple people approaching being as close to the truth point as me and it's certainly not going to be a guy that thinks spending all year grubbing for votes is a good use of his time.

The thing to remember is that everyone is in my position. Bob also thinks non-politicians - people who sit around and think about this stuff rather than manipulate to gain office - have a better grasp on things than politicians too. But for him Ron Paul is pretty good as politicians go. But still not great.

Same with Greg Mankiw and Mitt Romney.

The problem is that Bob Murphy sees me defending a politician when he knows that politicians are far from the truth point, particularly that one. I'm defending Obama because I see him as approximating the truth, but that seems implausible to Bob Murphy, who has his own truth point. I'm sure most of this is subconscious, because Bob probably knows that I think Obama approximates the truth imperfectly. But subconsciously that seems so implausible that Bob has to wonder: does Daniel not see that politicians, as a group, are on average way off the truth point? He wonders if I miss this fundamental point. He wonders if my thinking has been obscured by ideology or partisanship.

And I - subconsciously - wonder that about him too.

And let's face it, we all sometimes wonder that about Greg.

I think this sort of process generates a lot of second guessing and motive questioning than is optimal.

What's more is that I'm not sure that the situation necessarily improves as the DK, GM, and BM points move closer together unless there are some really eccentric politicians in the mix.

Two things I find interesting about Hayek on business cycles

1. His model was considerably more highly aggregated than that of, say, Lawrence Klein's "Old Keynesian" models.

2. The guy seems to agree that one difference between Austrians and "Anglo-Americans" is that Austrians do not think consumption and investment demand move in the same direction over the business cycle. Mises disagreed with this. I know a lot of modern Austrians will foam at the mouth if you suggest this. But I don't think many people appreciate that Hayek thought this (at least as of 1941). They find it much easier to accuse their accusers of being idiots.

A monetary policy offset does not mean that the impact of fiscal policy on output is zero. A monetary policy offset means that you have shitty central bankers.

That's all.

Woodford, Jackson Hole, and all that

There's lots that has been written on it. I just want to make one clarifying point:

NGDP level targeting is a policy goal with an implicit policy rule. It makes sense in a lot of theoretical frameworks, specifically monetarist and Keynesian frameworks. I am still completely confused at how some Austrians seem to think it makes sense in an Austrian framework but I'll take their word for it. It's a goal and an implicit policy rule - we can have a big tent on that.

So how did Woodford come to that policy rule? I haven't read his paper, but from what I gather it came via an argument that was essentially Krugman's Japan argument. A Keynesian argument that is "New Keynesian" insofar as it relies on expectations of future demand (although we all know this is only "New Keynesian" in a formal modeling sense - the Old Keynesians were as well aware of all this as the New Keynesians, their formal models simply hadn't caught up with their thinking).

Boudreaux: a duck in a barrel, I know, but easy targets can make good illustrations

The other day I bemoaned the fact that some people who appreciate the allocative efficiencies of free action in markets seem to miss the allocative efficiencies of free action in government because the organizing logic is a little different. To me, there's an obvious institutional division of labor that the classical liberals easily identified but that is being ignored by a lot (not all) modern libertarians. A good example of a modern libertarian not being able to think about free government the same way they think about free markets is provided in this post by Don Boudreaux. It's about as sensible as the critiques of the market you hear from the OWS crowd.

He writes:

"Former CDC official William Dietz – criticizing George Will’s criticism of the nanny-state’s quest to dictate our diets in ever-greater detail – observes that “Many neighborhoods have abundant fast-food restaurants and lack supermarkets….  Individuals can’t be expected to make healthy choices if there are no healthy choices available” (Letters, Sept. 1).

True.  But this fact doesn’t mean that George Will is wrong to counsel skepticism of government.  Quite the contrary.

Just this past Tuesday you properly criticized the use of zoning regulations to prevent the opening of a Wal-Mart in D.C. (“Expedite zoning appeal so Wal-Mart can start construction in the District,” Aug. 28).  So here we have a case of the market attempting to expand people’s food choices, only to be obstructed in that effort by the very agency – government – that Mr. Dietz calls upon to assist the market in expanding people’s food choices."

OK, now consider my taste for Virginia wines. Not every store carries them - often you get to choose from California, Argentina, Chile, Australia, and New Zealand (interestingly, it's not too hard to walk into a store with no Old World wines, but that doesn't bother me as much). Now would it make sense to me to say what Don said here about government? Would it make sense for me to scoff at the ability of the market to provide for peoples' wine preferences because of the clear evidence of an instance where it didn't provide for my preferences?

No, of course not. That would completely misunderstand the organizing logic of the market. For one thing, there are stores that do provide Virginia wines in response to consumer demand, and I know who does and doesn't and who has more and less variety of it. Moreover, prices convey information to sellers in the market, so my demand for Virginia wine from this stores competitor will influence the choices of the store that did not carry Virginia wine.

There is an organizing logic of the market that we know is efficient (given a reasonable definition of "efficient", of which we have a few), and it would be ignorant of me to berate the market simply because of an observed case where I don't get what I want.

The same goes for free government, and yet Don is making an exactly analogous argument here. OK, governments don't always do what we want (surprise!!!). There is an organizing logic for free governments though, where votes and petitions to representatives communicate information about our demands. We have a legal system in place that arbitrates violation of our rights by government just as surely as if a private actor violated our rights. And we also decentralize power so that all of these mechanisms work more smoothly.

There are obvious pitfalls of government, so why have government at all? Well this gets back to the classical liberal division of labor between the market and the state that I was talking about. The market is very good at providing private needs, and the state is better at providing collective needs.

And look around you. What does the government provide? It almost exclusively provides goods characterized by externalities. That's no accident. The one exception is consumption programs that exist for egalitarian reasons, but (1.) Jefferson, Paine, and others talked about and thought about inequality in externality terms - and I think this is the right way to look at it, and (2.) many of our current egalitarian policies were set up with macroeconomic externalities in mind (Social Security and unemployment insurance were discussed in terms of consumption smoothing, and still are in many cases). Anyway, if you don't like thinking about it in those terms, you might take a capabilities approach, as discussed in the last post. These are all clearly ways of thinking about state action that are firmly in the liberal tradition.

There's no real defense of the sort of the arguments that Don is making, which are really akin to OWS and some of the more thoughtless leftist protesters out there.

Menger on the State

Isaac Marmolejo, who runs the always interesting Radical Subjectivist blog, shared some links on the last thread about Carl Menger's views on the state (here and here). The first is one Menger and the state generally, with some well deserved swipes at Hoppe, and the second is about the role of the state in the development of money specifically. Isaac quotes a passage on roads and schools, but let me quote something (from his lectures to Crown Prince Rudolf of Austria) just before that I think provides Menger's basic framework. It's actually potentially more expansive than most classical liberals of the liberal/moderate persuasion on the American political spectrum (at least in this passage - perhaps he more specifically defines it elsewhere):

"Government thus has to intervene in economic life for the benefit of all not only to redress grievances, but also to establish enterprises that promote economic efforts but, because of their size, are beyond the means of individuals and even private corporations.

These are not paternalistic measures to restrain the citizens' activities; on the contrary, they furnish the means for promoting such activities; furthermore, they are of some importance for those great ends of the whole state that make it appear civilized and cultured."

He then goes on to talk about roads and their importance for the "general welfare".

So we have a general welfare justification. We have what could be called a "necessary and proper" justification, because Menger sees activities as being acceptable if they support the larger purpose of the state. There's something like Sen and Nussbaum's capabilities approach when he talks about furnishing citizens with the means for their activities. But most notably, the whole first paragraph justifies state action simply as a matter of scale economies.

There was a little bit of a scuffle over whether these passages could really be taken as Menger's views. I'll let Isaac handle that one here. As for whether he's a socialist or not (Joseph Fetz's contention), I don't think there's anything contradictory if the founder of the Austrian school was a socialist, but I doubt that's the case. Certainly Fetz hasn't exerte any effort to convince any of us that Menger thought the state should own or substantially control the means of production of society. Let's not dumb down socialism, people.

Democracy, Markets, and Classical Liberalism

One thing you notice from time to time - and particularly in "you didn't build that" exegeses - is that people who have been (rightly) convinced of the efficiency of voluntary market exchange as an organizing logic for society have a very hard time accepting other voluntary logics that don't work quite as smoothly as market exchange. That seems like a shame to me.

We shouldn't jump straight to government. Let's keep it in the private sector - you see this even with skepticism about charities sometimes. Sometimes people who (rightly) appreciate market exchange will make the critique that although charity is voluntary and private, the fact that the needs of the recipient aren't explicitly taken into account hurt the case for charity. This will often lead people to consider aid to Africa hopeless, or scold you for giving a homeless person food instead of just giving them money (which is more comfortable for someone that's thoroughly ingrained Kaldor-Hicks into their ethical sensibilities). One can go further than that: see Bryan Caplan on the deserving poor, Ayn Rand on altruism, and Malthus on charity.

When you get into government it's often no longer just a cataloguing of the differences between market order and government, it can be an outright denial that "government" and "voluntary" should even be used in the same sentence. And that's really what I have a problem with. I'm not one that promotes socializing everything. I know the limits of political allocation and the problems with majoritarianism. That's not in dispute. My concern comes in when people using government to solve their problems and constitutional democracy aren't even considered voluntary versions of an admittedly problematic organizing logic.

In the market, we choose voluntarily as individuals. In a democracy we choose voluntarily as a community. There are costs and benefits to each. The communitarian nature of democracy prevents democracy from being good at supplying private needs. The individual nature of the market prevents the market from being good at supplying collective needs. This seems to offer a liberal solution that - in practice - will always be a contested one, but which nevertheless is characterized by a relatively straightforward division of labor between the public and the private sphere. The fact that the contours of this division of labor will be contested can be ameliorated by democracy itself, federalism, constitutionally limited government, and free movement and speech. This is the classical liberal position and the position of the American founders.

Unfortunately there are a lot of people today who couldn't write that about government but who nevertheless claim the classical liberal mantle.