Category Archives: Public Policy

Managing Expectations Better

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Expectations matter. A lot. Stable institutions in a context of trust are necessary for liberal prosperity. In this sense, the work of government is to manage expectations–to maintain a stable strategic framework within which plans can be formed and cooperative action successfully coordinated over the long term. That is why, for instance, I think quickly restoring a legal and administrative framework for functioning financial markets ought to be among the government’s chief priorities.

Yet I’m extremely suspicious of what strike me as intellectually contentious, ad hoc interventions into the economy aimed at expectation management. Countercyclical economic mood-control initiatives seem to me inconsistent with the maintenance of a general framework of stable rules — that is, they don’t take the importance of expectations seriously enough — while also smacking of illiberal state propaganda. It’s hard to draw a principled distinction between framework and ad hoc rules, but I think it’s intuitive enough. Steady, predictable expansion of the money supply seems like the good kind of expectation management, while fool-in-the-shower money supply management seems like the bad kind. Likewise, automatic stabilizers, such as the predictable increases in welfare and unemployment transfers during recessions, strike me as greatly preferable to freestyle panic-mode stimulus legislation.

I understand that on some theories, a spell of poor economic performance cannot be expected to end without government assistance, and the failure to open the monetary spigot and induce spending through tax cuts and government spending is to invite disaster. OK. Suppose we’re all convinced by those theories. (I’m not, but suppose.) Wouldn’t we be naive to ignore the opportunistic nature of democratic politics and to therefore fail to grasp how Keynesian theory plus economic decline will tend to invite a pork bonanza rather than timely, targeted, and temporary stimulus policy? Doesn’t taking both politics and the seriousness of recessions seriously suggest rigging policy in advance to include more automatic stabilizers? Why not have it as standing policy to halve payroll taxes, or increase TANF payments a certain percentage, or what have you, whenever the NBER gets around to calling a recession? If you insist on infrastructure, why not plan out, far in advance, some well-considered but non-urgent infrastructure projects that can be switched on immediately upon the onset of a downturn?

Wouldn’t this be better expectation management? People about to hit recession would know in advance what’s going to happen, instead of being made to wait on the outcome of the unpredictable, volatile and often self-undermining political wrangling of opportunistic panic.

The objections I anticipate to auto-stimulus are (1) it can’t work without the element of surprise and (2) that each recession is an unrepeatable precious snowflake that requires special initiatives targeted to its unique circumstances. About (1), why think the political process will reliably deliver the right surprise? About (2) the TARP stuff does seem like that. But so far, I don’t see anything in Obama’s bill that seems unique to the times. It’s just a train wreck of haphazardly considered tax cuts and spending.

Macroeconomics as Mind Control

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It just goes on and on, this talk of confidence, animal spirits, and what not. It now seems pretty plainly true that the thrust of prescriptive macroeconomics is propaganda. That’s why, in this post, I wasn’t even joking when I asked whether anyone had empirical evidence for the poor economic effects of state-sponsored propaganda, or whether we’ve just given up on it because we think it’s wrong.

Anyway, Robin Hanson, picking up on the macro-as-mind-control meme writes:

The consensus among macro-economists seems to be that people can in fact be fooled by such stimuli, but as Tyler indicates, it is not clear which policies most fool us.  In particular, the more public attention we give to the stimuli, the less they might work.  We might make people realize that they need to compensate via saving, and the more we scare folks into thinking we need huge stimuli, the more we might scare them away from normal economic activity levels.

So should we stop explaining macro-economics during this crisis, and stop saying how desperately we need stimuli? 

The answer, of course, is that no one knows–especially not the macroeconomists!

Will Ambrosini is annoyed by all the macro bashing, and says that one can see that modern macro is successful, if one knows about the best new stuff. But when asked in comments what advice he’d give the president, Will says:

I’d have him give speeches about positive prospects for growth (”your company will turn the corner! your wages will go up!”); I’d have him talk about how this recession is a short term bump in the road. No more talk about how shitty things are (without, of course, denying the statistics… I assume Obama’s a better rhetorician than I am). Pessimism feeds on itself so to the extent the president controls expectations, he should try to improve them. Even though I don’t think the President has that much control over expectations, I think Obama’s rhetoric of transformation is more useful than his rhetoric of crisis.

I’d advise him that any actions he takes should reinforce his positive message.

Well, why not try this?

Or this:

Or this:

Somebody please tell me why anyone thinks Larry Summers is better at mass mind-control than Scarlett Johansson?

This Is What I Am Talking About

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The New York-based blogger for The Economist‘s Free Exchange replies to my lament by arguing that economists do have a theory of the psychology of coordinated expectation. They do, sort of. But they don’t have the kind of theory that I have in mind. Harvard’s Gregory Mankiw admits as much when he blogs:

Yale’s Bob Shiller argues that confidence is the key to getting the economy back on track.

I think a lot of economists would agree with that. The question is what would make people more confident. Bob thinks that confidence would rise if the government borrowed more and spent more. Other economists think that confidence would rise if the government committed itself to, say, lower taxes on capital income. The sad truth is that we economists don’t know very much about what drives the animal spirits of economic participants. Until we figure it out, it is best to be suspicious of any policy whose benefits are supposed to work through the amorphous channel of “confidence.” [emphasis added]

In what macro textbook can one find references to empirical psychological work on confidence? On individual-level variability in confidence, on the conditions under which the confidence of various personality types is affected by economic variables, on the relationship between changes in condfidence and changes in economic behavior, on the social “infectiousness” of changes in confidence, etc.

I have a lot of respect for Shiller, but Mankiw is right. Shiller doesn’t have any real evidential basis for claims about what policies will induce confidence. And neither does anyone else.

More Macropsychoeconomics

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I certainly do not reject the idea that coordinated, population-wide changes in beliefs and/or preferences have macroeconomic effects. I think herd psychology and fool-in-the-shower-style updates of expectations about lifetime income can and do have big macroeconomic effects. In fact, I think we are seeing some of this now. But booms and busts are not only about aggregate demand and animal spirits. Nor are they only about government-induced capital misallocation. I’d like to see somebody with the wherewithal to explain how policy-led misallocation interacts with herdy consumer and investor psychology. Then I’d have a reason to really believe someone who says we merely need to wait and let all the malinvestment shake out, or someone who says we merely need to prop up the confidence of consumers and creditors.

It seems likely that there are in fact a lot of bad bets that need to get squared and that the herd could use some prozac. But what dose? How much is too much; how much leads to just the sort of systemic malinvestment that leads the herd to panic again? This is the sort of thing I feel like no one really knows anything about, though I am more than eager to be shown the secret science.

Daron Acemoglu’s VoxEU op-ed reminds me of another piece of macropsychoeconomics I’d like to know a hell of lot more about: backlash threat:

Decisive action on the crisis is necessary; not just soften the blow of the recession but also to avoid a backlash that could be deeply harmful to long-run growth. A deep and long recession raises the risk that consumers and policymakers start believing that free markets are responsible for the economic ills of today. If so, we could see a move away from the market economy. The pendulum could swing too far, bypassing properly-regulated free markets, towards heavy government involvement that could threaten future growth prospects of the global economy.

A comprehensive stimulus plan, even with all of its imperfections, is probably the best way of fighting these dangers. Nevertheless, the details of the stimulus plan should be designed so as to cause minimal disruption to the process of reallocation and innovation. Sacrificing growth out of our fear of the present would be as severe a mistake as inaction. The risk that the belief in the capitalist system may collapse should not be dismissed.

OK. I find the backlash hypothesis totally plausible. The idea here is that (1) good economic institutions require sufficient cultural support, (2) the “do nothing” response will erode cultural support and thereby threaten future economic performance, so (3) we should do something that prevents backlash, but nothing that screws up the very institutions we’re trying to preserve by not doing nothing.

So what’s the actual evidence for (2)? Acemoglu notes that populist, anti-market backlash is a big problem in developing economies, and I agree with him. But surely places with durable, high-quality economic institutions already have a lot of both elite and popular buy-in, which should limit the magnitude of any  backlash. If the point of “doing something” is really institution-preserving political theater (like Acemoglu, I’m an institutionalist, and think this does count as “economic policy”), then how much theater do we need? What is the minimum that will suffice to keep the pitchforks in the barn? Over the medium- and long-term how much can upgrades in economic literacy do to reduce backlash threat? Obviously, institution-preserving political theater creates a political opportunity to screw up economic policy, or Acemoglu wouldn’t be warning us against it. So maybe good long-term economic policy involves prioritizing economics education as a prophylactic against future backlash.

Tax Cut Stimulus: Better Economics, Wiser Politics

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Bruce Bartlett offers an excellent overview of the stimulus debate in Forbes, and in my opinion draws the right policy conclusion:

I think the critics of an activist fiscal policy are forgetting the essential role of monetary policy as it relates to fiscal policy. As Keynes was very clear about, the whole point of fiscal stimulus is to mobilize monetary policy and inject liquidity into the economy. This is necessary when nominal interest rates get very low, as they are now, because Fed policy becomes impotent. Keynes called this a liquidity trap, and I think there is strong evidence that we are in one right now.

The problem is that fiscal stimulus needs to be injected right now to counter the liquidity trap. If that were the case, I think we might well get a very high multiplier effect this year. But if much of the stimulus doesn’t come online until next year, when we are likely to be past the worst of the slowdown, then crowding out will greatly diminish the effectiveness of the stimulus, just as the critics argue. According to the Congressional Budget Office, only a fraction of proposed infrastructure spending can be spent before October of next year; the bulk would come long after.

Thus the argument really boils down to a question of timing. In the short run, the case for stimulus is overwhelming. But in the longer run, we can’t enrich ourselves by borrowing and printing money. That just causes inflation.

The trick is to front-load the stimulus as much as possible while putting in place policies that will tighten both fiscal and monetary policy next year. As terrible as our economic crisis is right now, we don’t want to repeat the errors of the past and set off a new round of stagflation.

For this reason, I think there is a better case for stimulating the economy through tax policy than has been made. Congress can change incentives instantly by, for example, saying that new investments in machinery and equipment made after today would qualify for a 10% Investment Tax Credit, and this measure would be in effect only for investments largely completed this year. Businesses will start placing orders tomorrow. By contrast, it will take many months before spending on public works begins to flow through the economy, and it is very hard to stop it when the economy turns around.

Stimulus based on private investment also has the added virtue of establishing a foundation for future growth, whereas consumption spending does not. As economist Hal Varian of the University of California at Berkeley recently put it, “Private investment is what makes possible future increases in production and consumption. Investment tax credits or other subsidies for private sector investment are not as politically appealing as tax cuts for consumers or increases in government expenditure. But if private investment doesn’t increase, where will the extra consumption come from in the future?”

Some may reply that infrastructure stimulus spending does provide a foundation for future growth. But the point is that the timing for infrastructure spending is wrong to work as stimulus. I’m eager to have a debate over whether certain putative public goods are public goods, over whether they are underfunded, over what tax-funded infrastructure is most needed and most conducive to future growth. But this is actually a pretty irresponsible time to have this debate. A government with superpowers that could with laser precision identify immediately those places where economic resources are underutilized and somehow approve a bunch of projects that bring those (and only those) resources online and get those projects started now without undue corruption, waste, etc. might have a chance to stimulate with an infrastructure surge, but that’s not a possible government, so it’s bad policy. If there are stimulus options that can be well-timed, that do not all-but-guarantee a decade of clusterfuck contracting scandals, that can be easily reversed, and that encourage the development of the real economy, then what is the possible objection?

Crowding Out

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If you think markets tend to work better than government in giving people what they want and need, then you’ll worry about government spending crowding out private spending. If you think government works better than markets in giving people what they want and need, then you’ll want government spending to crowd out private spending. I agree with Arnold Kling that maybe this helps explain why positions on the stimulus debate break so cleanly (and damningly for the scientific pretensions of macroeconomics) along partisan lines. Here’s Arnold:

On the stimulus proposal, the division is almost entirely left-right. I cannot think of a single economist on the Left who is skeptical, and I cannot think of a single economist on the Right who is a supporter.

I think that the left-right polarization reflects the fact that the stimulus is ideologically loaded. If nothing else, it shifts large amounts of power and decision-making authority toward government technocrats. If you’re a neo-Galbraithian, that is a good thing. For example, Mark Thoma writes, 

Tax cuts won’t build schools, or any other public good.

John Kenneth Galbraith was always complaining that the public sector was starved. He viewed entrepreneurialism as a myth. It comes down to a choice between technocratic planning in large firms or technocratic planning in government, and he preferred the latter.

On the other hand, if you’re a Hayekian, the shift in power is appalling.

Well, I am appalled. But also confused, since I didn’t think that most mainstream economists who also happen to be Democrats were “neo-Galbraithians.” Arnold says there is pretty much no evidence that neo-Galbraithian policy is good for a recession. As far as I know, there’s pretty much no evidence that neo-Galbraithian policy is good for the economy generally. But what mainstream economists who are also loyal Democrats actually says that it is? That’s what’s confusing to me. My sense was that there was a pretty solid non-partisan professional consensus against neo-Galbraithianism. So how come the stimulus debate is shaping up as if mainstream Democratic economists do want the public sector to crowd out the private sector? What gives?

The War of the Economists

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A bit more on the public relations quandary the economics profession ought to be in, if it isn’t already…

When I see Delong more or less indiscriminately trashing everyone at Chicago, or Krugman trashing Barro, etc., what doesn’t arise in my mind is a sense that some of these guys really know what they’re talking about while some of them are idiots. What arises in my mind is the strong suspicion that economic theory, as it is practiced and taught at the world’s leading institutions, is so far from consensus on certain fundamental questions that it is basically useless for adjudicating many profoundly important debates about economic policy. One implication of this is that it is wrong to extend to economists who advise policymakers, or become policymakes themselves, the respect we rightly extend to the practitioners of mature sciences. There is a reason extremely smart economists are out there playing reputation games instead of trying to settle the matter by doing better science. The reason is that, on the questions that are provoking intramural trashtalk, there is no science.  

Sadly, there is no one better to listen to.

Are Economists Completely Clueless?

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The following is a frustrated rant. React accordingly.

I am slowly reaching the conclusion that the current debate over fiscal stimulus — like prior debates over monetary stimulus, and the causes of the financial crisis — has exposed the cluelessness of (many? most?) professional economists and ought to be considered an embarrassment to the profession.

In the debate over economic stimulus, I hear many otherwise brilliant people making a lot of baseless conjectures about mass psychology — about consumer and creditor “fear” and “uncertainty,” and what to do about it. But, as far as I can tell, none of them has even a rudimentary theory about the causes of micro-fear or how it scales up to aggregate consumer demand or aggregrate credit supply, etc. So I feel like I’m hearing a lot of smart people talking out of their asses about a subject they’ve never actually studied –the psychology of coordinated expectations — and pretending it is “economics,” a subject with much greater rhetorical prestige and political power than amateur psychology. 

For example, if individuals’ decisions about consumption, savings, and debt are rooted in beliefs about their future incomes — a view I think most economists share — then it would seem that an economy-wide decline in personal consumption would indicate that a lot of individuals have more or less simultaneously revised their expectations about their future economic prospects. As far as I can tell no one has a theory of the events that predict revisions in an individual’s estimates of her lifetime income, much less a theory of how the perception of events predicts the magnitude of these revisions. Nor have I encountered a story about how these revisions become coordinated and scale to the macro-level. 

Nevertheless, I hear economists saying things about how easy money is needed to soothe investor worries, about how a surge of government spending is needed to quell consumer anxieties, about how the government’s “doing nothing” would cause people to panic and make everything worse, and so on. Do any of them have any idea what they are talking about when they say these things? I’m afraid they don’t. And, frankly, I think they should be ashamed of themselves.

If booms or recessions are really based in coordinated psychological changes, then why should we think that monetary or fiscal policy is the most relevant policy lever? If the thoughts and feelings of the population are the issue, then maybe the real problem is that the mass media are unduly scaring people. Wouldn’t it follow, then, that good economic policy would have at least as much to do with controlling the media as controlling the money supply? If the problem with handing Maria Bartiromo a script of state-mandated talking points is that it wouldn’t work, how do we know that?

It would be pretty interesting if it turned out that manipulating the money supply is what an efficient state turns to when it can’t more directly manipulate “animal spirits” through propaganda. If the problem with turning the entire media into a servant of state macroeconomic engineering is not that it wouldn’t work, but that it’s repulsively illiberal, then we ought to face up to it. Maybe we focus so much on certain not-very-effective policy instruments because those are the ones we consider within the state’s legitimate power. We think it’s okay that the state attempt to manipulate our thoughts and feeling by printing money, nationalizing banks, and building highly-publicized public works, but we don’t think it’s okay to do it by intervening in the media in the way the state very much did do during the Great Depression and WWII.

Alright, but then why do we think we can draw policy lessons from those earlier periods when, for moral reasons, we’ve taken some of our state’s formerly favorite tools of economic policy — outright propaganda and control over media — off the table? If you think we’ve taken these tools off the table for practical reasons, who was it that showed us that they don’t work?   

Maybe I’m being unfair here. I hope someone will explain to me how it is that economists, and by extension the American state, isn’t just winging it.


Kevin Murphy is Right

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Megan McArdle points us to this fascinating panel at the U of Chicago devoted to evaluating Obama’s stimulus plan. Kevin Murphy’s remarks  (between 17:20 and 31:37 in the video) wonderfully elucidate the terms of the debate, and helps me better grasp exactly why the stimulus is sure to be a bust. If you agree with Murphy, as I do, that the efficiency of government spending is generally low, that the value of activating currently idle resources is low (the “multiplier”), and that the deadweight loss from the future tax increases required to finance the stimulus spending is high, then the whole thing looks like a pretty sure loser.

If America Was a Rational Technocracy

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If we’re gonna throw mountains of taxpayer dough at the recession, in a desperate attempt to do something, it would at least be nice to learn from it. We’re wasting a ton of money, and smart people know it. But some stimulus ideas are better than others. We just don’t know with much certainty which ones those are. That’s why I like Len Burman’s unrealistic idea of running experiments:

The ideal “experiment” would assign different “treatments” to different states. States that begin with A-E: tax credits, F-K: infrastructure, and so on. We could even have a control group that would get nothing. Sorry, Wyoming.

OK, that’s not going to happen. 

Burman goes on to suggest giving grants to the states, letting them do whatever they want with it, but then very carefully gathering data about what happens when they do whatever they decide to do. The reason this is a relatively great idea is that it assumes that a lot of fiscal stimulus will fail, and that we don’t know what we’re doing. But policy that is remarkable for the honesty of its assumptions doesn’t tend to be extremely popular.

Postmaterialism and Cohen's Maxim

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It is a commonplace on the left that “programs for the poor are poor programs,” the second ‘poor’ meaning “poorly funded.” Call this “Cohen’s Maxim” after Wilbur Cohen, a chief architect of Social Security. Cohen’s Maxim is likely true when wealth transfer programs targeted to the poor are very unpopular relative to “social insurance” that is heavily marketed as “universal.” Yet if the idea is to secure a certain level of benefits for the genuinely needy, the universal social insurance scheme (which will waste a lot of money by taking it from the middle and upper classes and then giving most of it back to them later) will tend to be much more expensive than the targeted transfer scheme. Other things equal, one should prefer the means-tested program, since it frees up resources that can be used to (a) make the targeted benefits larger, (b) sent back to taxpayers while leaving the poor no worse off, or (c) spent on other desirable social programs. The only reason to prefer the social insurance scheme (if the point is to help the poor) is if there will otherwise be insufficient political support to keep benefits for the poor at a decent level.

Under what conditions would we expect Cohen’s Maxim to be true? Conditions under which the middle and upper classes tend to resist financing welfare transfers. They might resist for ideological reasons, in which case Cohen’s Maxim will rise and fall with trends in ideology. But they might also resist for reasons of perceived economic self-interested, which in turn might to some degree drive trends in ideology. What if past a certain threshold in income and wealth, voters became more concerned with questions of fairness and justice and less concerned with their own perceived economic interest? That’s Ronald Inglehart’s “postmaterialism” thesis in a nutshell, and it appears to be well-supported by evidence. We may be seeing it in the move of wealthy voters toward the Democratic Party. Obama’s win over McCain among the wealthiest voters might be because he promised to tax them more and spread the wealth around. 

Suppose this trend continues and, as the median income rises, an ever larger portion of voters above the median comes to prioritize social justice over tax rates. Under those conditions, why think Cohen’s Maxim would hold? 

By the way, I’ve always rejected Cohen’s Maxim. Unemployment benefits are targeted, but generous and popular. My favorite argument against making Social Security into a means-tested program is that benefits would likely to be too generous, generating serious moral hazard while being unjust to boot. The core of this argument is the disproportionate heft of retirees as a voting bloc, and the relative unity of their interests. Forced intrapersonal transfers are preferable, my argument goes, to exploitative, class-based (younger to older) interpersonal transfers. But if economic growth makes us ever less fixated on our narrow our economic interest in the voting booth, this argument could break down, too.

So could postmaterialization someday put us in a position where it becomes feasible to get rid of elaborate schemes like social security and medicare–and even the personal account alternatives to these–and go with the most direct, efficient, and transparent safety net policy? Provide government assistance to people who fall beneath a certain minimum of resources. Otherwise, don’t. 

Related: Here’s my colleague Jagadeesh Gokhale smacking down some bad arguments for the Social Security status quo.

Breathtaking Capital Destruction

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I missed this excellent Lynne Kiesling post in my roundup. Lynne, who has forgotten more about regulation than I will ever learn, cites these “extremely disturbing facts” from David Yermack’s excellent WSJ piece:

  • GM and Ford are two companies that made the most money-losing investments in the 1980s; between them they “destroyed $110 billion in capital” in the decade, according to an analysis from the careful and renowned economist Michael Jensen.
  • Over the most recent decade, “the capital destruction by GM has been breathtaking,” $182 billion, and Yermack estimates that the aggregate capital investment in GM and Ford since 1980 has let to a net reduction in capital of $465 billion.
  • This is what I find particularly disturbing: with that $465 billion, “GM and Ford could have closed their own facilities and acquired all of the shares of Honda, Toyota, Nissan, and Volkswagen.”
  • “When a company makes money-losing investments, the cost falls upon all of society.” This observation means that we have already reduced our future economic well-being by $465 billion by his calculations, due to the persistence of these firms and their poor business decisions.

This is what I’m talking about. There is a reason firms like this need to go out of business: human welfare.

What about Felix Salmon’s argument that in the current credit environment, regular bankruptcy won’t work out, and so the government should put up some money to help finance the reallocation of GM’s assets? Sure. The important thing to me isn’t that the government does nothing, but that it doesn’t unustly and irrationally throw fresh wads of taxpayer money at the world champions of “capital destruction.” Felix links approvingly to Ryan Avent’s suggestion:

If Congress can pass a special, tailor-made rescue bill for the automakers, then certainly it can also pass a special, tailor-made bankruptcy bill for them.

This, too, would be a carnival for egregious favor-seeking, but if existing bankruptcy law is insufficient in the current climate (and I don’t feel like I know that, but it’s certainly plausible),  then this may make the most sense. The important thing to me is that capital and productive assets find their way to their most productive uses, and in a way that sustains a general structure of institutions that facilitates efficiency and welfare improvements in a stable way over the long run.

More Yglesian Sense

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Matt thinks it would be wonderful if Jonathan Cohn and Clay Risen were to get their ponies, but nevertheless refuses to replace sound principles of political economy with ponyology:

I hope I’m wrong about this. But I’m pessimistic. The mere fact that it would be desirableto do something to keep everyone who depends on the car industry for a living that simultaneously restores the domestic car firms’ economic viability and serves environmental policy goals doesn’t make it possible. Generally the reason we try not to have the government running businesses is that promoting public goals and maximizing profits require you to do different things. We normally try to advance policy goals by establishing a framework of taxes and regulations so that firms pursuing their interests will be compatible with the public interest. But if GM is going to be a welfare agency, it’s hard to also expect it to be a viable company that will rapidly get off the federal teat.

True.