Why I Love Scott Sumner

I love his long post on my paper. But much more than that, I love that he’s willing to write a post denying scientific realism by way of arguing for abolishing the concept of price inflation.

That said, I wish Scott would give up in his Rortyian antirealism, which is false. It may also help to point out that, however entertaining and stimulating Rorty is to read (I am a fan in this regard), he is among the worst possible guides to questions about realism, truth, and knowledge.  As an alternative pragmatism, I would recommend Susan Haack’s. I’d espcially recommend to Scott chapter nine of her Evidence and Inquiry, “Vulgar Pragmatism: An Unedifying Prospect,” which gives it to Rorty good and hard. I’d also recommend Michael Devitt’s Realism and Truth or his review essay on “Scientific Realism” from the Oxford Handbook of Contemporary Philosophy, embedded below.

That said, I think Scott is largely right that the usefulness of a deflator is a function of what you want to use it for. But it’s wrong to say there’s no fact of the matter about the average rate of price inflation, though it may be true that is not a very useful fact. I think the fact of “neurodiversity,” as Tyler Cowen calls it in his delightful book, pushes us toward the conclusion that each person faces her own personal rate of inflation. Perhaps increasingly so. One implication is that a single rate calculated on price changes in a single “typical” consumption bundle isn’t very informative. This necessarily overlooks the very real distributive consequences of new products or quality improvements which affects some people immensely while affecting others not at all. (For a stark intuition-priming case, think of the value to Alf of a new medical innovation that saves his life but was unavailable a month prior at any pirce. Now think of the value of the same innovation to Betty who suddenly dies when a safe lands on her head.) There are CPI-(U-RS, etc.) “real wages” and then there are really real wages, which rise fastest for people who get the most out of new products and quality improvements, or from new innovations in retail that push down prices (Wal-Mart) or that reduce the costs of matching buyers and sellers in secondary markets (Craiglist’s or Ebay). Calculating the average change in really real wages for a group of individuals may be intractable in principle or (as I suspect) it may be a mere technological problem. In any case, the more diverse the preferences and consumption patterns of the group one is averaging over, the less meaningful the application of a single deflator.

I’d like to see more interest in exploring personal inflation rates and individual level changes in really, real wages. It seems to me that a combination of credit and debit cards records together with consumption-focused experience sampling ought to be able to make a good start.

Michael Devitt. Scientific Realism

Economic Expertise and Moral Mathematics

Ryan Avent, following up on Ezra’s post on the policy prestige of economists in general and benefit/cost analysis in particular, writes:

[I]f we can’t use cost-benefit, how do we make these decisions? How in hell do we figure out which trade-offs are sound ones and which are damaging to society on net? To the economist, and indeed to many policymakers, eliminating cost-benefit analysis is like depriving them of language — how can you discuss the problem without it?

In fact, we really have no other way of wrestling with these issues. One can argue by moral imperative — that we don’t have the right to impose serious costs on others — but we still must determine how much compensation or preventative action those others are owed, and from where the resources to pay or take action should be drawn. These questions involve trade-offs, which must be weighed in some fashion, and so again we find ourselves turning to economists.

Why do we turn to economists again?

I agree that it is impossible to think intelligently about policy without some minimum of economic literacy. But the economist has no competence whatsoever to tell us, say, the appropriate discount rate to apply to future costs and benefits, to take one important example. I’ve heard philosophical arguments to the effect that the discount rate for future welfare should be zero and that the discount rate should approach infinity as we consider the welfare of furture beings with whom there is no possibility of reciprocity. The funny thing is that I think people get the implications of discount rates wrong, and that both zero and infinity point to more or less maximizing growth. A zero discount rate plus a basic grasp of the relationship between technology and growth plus a reasonable projection of the current trend of technological progress implies an obligation to maximize economic growth rates with no concern whatsoever to avoid the incidence of future externalities of current activity. This is an economic argument, but it is also something rather more. Likewise, an infinite discount rate implies that we should do the best we can for our children and grandchildren, and leave it to our grandchildren to worry about their grandchildren. If we’re doing something now that might hurt people none of us will coexist with 100 years, then so what?

Of course, neither of these arguments will convince Ryan or Ezra. I’m sure we disagree both about the discount rate, which is not itself an economic question, and about the implications of the discount rate, which is only a partially economic question. And I think it gets even worse: economists have almost no competence whatsoever in telling us what counts as a cost or a benefit. That’s pretty important, isn’t it?

So why do we give so much weight to the opinions of economists?

How the Promise of Future Subsidies Can Freeze Markets

I think Casey Mulligan nails it:

The [Chicago city] council has debated mandating hybrid purchases. But the rumor among taxi drivers is that in addition, or perhaps instead, the city or other government agency will eventually subsidize the purchase of a hybrid.

Drivers have decided that they should not purchase a Prius or other hybrid until the subsidy arrived. Buying one now would mean over-paying.

Regardless of whether it is realistic to expect Chicago to someday subsidize purchases of hybrid taxis, the fact is that some cab drivers are considering the possibility. If taxi drivers consider future subsidies in their industry, then so must bank executives.

Last fall the public learned that banks were not selling many of their legacy mortgages and mortgage-backed securities, despite the impression that ownership of the assets were hindering the banks’ lending. A variety of theories have been put forward to explain this failure, and to suggest what the government might do to fix it.

But the lack of trade in mortgage-backed securities may have something in common with the lack of trade in hybrid Chicago taxicabs. The secondary market for legacy mortgages may have stagnated largely because of the (ultimately correct) anticipation of a huge government subsidy.

Taleb's Ten Principles

To prevent future crashes. I think most of these are pretty good. Explanations for each principle in Taleb’s FT piece

1. What is fragile should break early while it is still small.

2. No socialisation of losses and privatisation of gains.

3. People who were driving a school bus blindfolded (and crashed it) should never be given a new bus.

4. Do not let someone making an “incentive” bonus manage a nuclear plant – or your financial risks.

5. Counter-balance complexity with simplicity.

6. Do not give children sticks of dynamite, even if they come with a warning 

7. Only Ponzi schemes should depend on confidence. Governments should never need to “restore confidence”.

8. Do not give an addict more drugs if he has withdrawal pains.

9. Citizens should not depend on financial assets or fallible “expert” advice for their retirement.

10. Make an omelette with the broken eggs.

Galbraith: Listen to Galbraith or the Economy Gets It!

James K. Galbraith’s Washington Monthly piece “No Return to Normal” is a mix of the completely sensible (propping up bad banks is a recipe for further looting by insiders and more stupid risk-taking) and a totally crazy conviction that modern states are economically magical institutions. That is, it is a James K. Galbraith piece. Here is some crazy:

Apart from cash—protected by deposit insurance and now desperately being conserved—the American middle class finds today that its major source of wealth is the implicit value of Social Security and Medicare—illiquid and intangible but real and inalienable in a way that home and equity values are not. And so it will remain, as long as future benefits are not cut.

Yes, 401(k)s are down, and Galbraith’s thesis seems to be that they always will be unless… guess what? But, okay, suppose he’s right and there is no recovery if we fail to embrace James K. Galbraithianism. In what crazy world does the economy both (a) fail to recover and (b) the government make good on already completely infeasible entitlement commitments? And how bizarre is it to say in the space of two sentences that a source of wealth is “real and inalienable” just as long as benefits are not cut through the democratic process — which of course they can be and probably must be if Galbraith is right about the likelihood of a no-recovery future. If voters can lose some portion of future government transfers by voting for politicians who vote them away, then those transfers are obviously alienable. (The courts clearly say there is no legal right whatsoever to these transfers.) And alienable future transfers from the government that are conditional on political will and economic feasibility are about as “real” as my future lovechild with Gisele Bundchen. Does anyone have an interpretation of Galbraith’s passage that makes sense?

He later goes on to claim, amazingly, that increasing spending on Social Security is “an economic recovery ace in the hole.” So the best I can do is guess that Galbraith is incoherently shuffling back and forth from a scenario in which we don’t use his “ace in the hole” (investments and home values worthless forever!) and one in which we do (Social Security checks good as gold.) But that’s hardly fair, is it? 

A main theme of Galbraith’s article is that things are so bad that mainstream economics can be of no assistance, so you’ve got to go heterodox. But he says nothing to clarify why, if we must abandon the consensus views of professional economics, one should prefer Galbraithianism over other departures from othodoxy. He seems to infer his own views from the alleged failure of standard views. It is rather gentle to note that that doesn’t follow. For example:

In short, if we are in a true collapse of finance, our models will not serve. It is then appropriate to reach back, past the postwar years, to the experience of the Great Depression. And this can only be done by qualitative and historical analysis. Our modern numerical models just don’t capture the key feature of that crisis—which is, precisely, the collapse of the financial system.

I largely agree about the inapplicability of many models, but it’s not at all obvious that the experience of the Great Depression is more rather than less applicable than those models. The Depression was a long time ago. The economy was a lot different then. If one is going to do “qualitative and historical analysis” then it seems that recent collpases in the financial systems of other countries are rather more germane. Why not look at those instead of reaching back “past the postwar years”? Because there’s some ineffable but essential Americanness to the American economy? Galbraith actually seems to think so, which is why one must look away from the examples of Argentina and Indonesia! This seems arbitrary and I don’t get it. Of course, if we go back to the Great Depression, we just become mired in competing “qualitative and historical” analyses, which in reality tends to sound a lot like “Must destroy Amity Shlaes!!!” And that’s obviously a lot more intellectually rigorous and helpful than stupid mainstream economists with their stupid mainstream models.

Can Obama Lead the U.S. Out of Recession?

Russ Roberts rightly says “no,” and also strikes the right note of professional modesty:

So it’s a time for humility rather than hubris in my profession. Obama’s economic team, for all its brain power and good intentions, is in uncharted territory. There’s no recipe or manual or roadmap for getting the economy back on track. No one is quite sure how to correct imbalances in financial markets and the housing market. And no one knows how to create confidence, the biggest element lacking in the current economic climate.

No man or woman runs the economy. No man or woman or team of people can possibly plan the evolution of the economy in the coming months. America will come out of the recession but the time and pace are unknown. Obama can help. But he can just as easily slow down any recovery. Some part of the current mess we’re in is the result of erratic government policy that has added to the uncertainty facing consumer, investors, and entrepreneurs.

I certainly don’t mind aggregate demand economics as long as folks realize the limits of the stuff. I take it that one of the main lessons of living macro is that a stable framework of well-wrought rules tends to do better in the long run than periodic attempts to trick folks with the government’s amazing money-printing and money rearranging powers. I think this sort of thing would get through to people better if it were possible to to communciate the economy’s strategic micro-foundations: an economy is a massive, immensely complex coordination game. Maybe we’d like to think that there are Big Chiefs with scalpels and tweezers for fingers, but the fact is Big Chiefs have hams for hands. If the economy is a glassed-in ant colony and a recession is a confusion of non-connecting tunnels then “corrective” government intervention is banging the glass with a fat fist, like Fonzie banging a Jukebox. Barack Obama may be one cool cat, but the government ain’t no Fonzie. Mostly you get disoriented ants.

John Cochrane on Keynesianism

I’m not sure how to link soley to John Cochrane’s contribution to the Delong v. Zingales Economist.com debate, so I’ll just reprint it here:

Nobody is Keynesian now, really. Keynes distrusted investment and did not think about growth. Now, we all understand that growth, fuelled by higher productivity, is the key to prosperity. Keynes and his followers famously did not understand inflation, leading to the stagflation of the 1970s. We now understand the links between money and inflation, and the natural rate of unemployment below which inflation will rise. A few months before his death in 1946 Keynes declared:1 “I find myself more and more relying for a solution of our problems on the invisible hand [of the market] which I tried to eject from economics twenty years ago.” His ejection attempt failed. We all now understand the inescapable need for markets and price signals, and the sclerosis induced by high marginal tax rates, especially on investment. Keynes recommended that Britain pay for the second world war with taxes. We now understand that it is best to finance wars by borrowing, so as to spread the disincentive effects of taxes more broadly over time.

Really, the only remaining Keynesian question is a resurrection of fiscal stimulus, the idea that governments should borrow trillions of dollars and spend them quickly to address our current economic problems. We professional economists  are certainly not all in favour. For example, several hundred economists quickly signed the CATO Institute’s letter2opposing fiscal stimulus. 

Why not? Most of all, modern economics gives very little reason to believe that fiscal stimulus will do much to raise output or lower unemployment. How can borrowing money from A and giving it to B do anything? Every dollar that B spends is a dollar that A does not spend.3 The basic Keynesian analysis of this question is simply wrong. Professional economists abandoned it 30 years ago when Bob Lucas, Tom Sargent and Ed Prescott pointed out its logical inconsistencies. It has not appeared in graduate programmes or professional journals since. Policy simulations from Keynesian models disappeared as well, and even authors who call themselves Keynesian authors do not believe explicit models enough to use them. New Keynesian economics produces an interesting analysis of monetary policy focused on interest rate rules, not a resurrection of fiscal stimulus. 

Our situation is remarkable. Imagine that an august group of Nobel-prize-winning scientists and government advisers on climate change were to say: “Yes, global warming has been all the rage for 30 years, but all these whippersnappers with their fancy computer models, satellite measurements and stacks of publications in unintelligible academic journals have lost touch with the real world. We still believe the world is headed for an ice age, just as we were taught as undergraduates back in the 1960s.” Who would seem out of touch in that debate? Yet this is exactly where we stand with fiscal stimulus. 

Robert Barro’s Ricardian equivalence theorem was one nail in the coffin. This theorem says that stimulus cannot work because people know their taxes must rise in the future. Now, one can argue with that result. Perhaps more people ignore the fact that taxes will go up than overestimate those tax increases. But once enlightened, we cannot ignore this central question. We cannot return to mechanically adding up today’s consumption, investment and export demands, and prescribe the government demand necessary to attain some desired level of output. Every economist now knows that to get stimulus to work, at a minimum, government must fool people into forgetting about future taxes, an issue Keynes and Keynesians never thought of. It also raises the fascinating question of why our Keynesian government is so loudly announcing large and distortionary tax increases if it wants stimulus to work.
 
There is little empirical evidence to suggest that stimulus will work either. Empirical work without a plausible mechanism is always suspect, and work here suffers desperately from the correlation problem. Quack medicine seems to work, because people take it when they are sick. We do know three things. First, countries that borrow a lot and spend a lot do not grow quickly. Second, we have had credit crunches periodically for centuries, and most have passed quickly without stimulus. Whether the long duration of the great depression was caused or helped by stimulus is still hotly debated. Third, many crises have been precipitated by too much government borrowing. 

Neither fiscal stimulus nor conventional monetary policy (exchanging government debt for more cash) diagnoses or addresses the central problem: frozen credit markets. Policy needs first of all to focus on the credit crunch. Rebuilding credit markets does not lend itself to quick fixes that sound sexy in a short op-ed or a speech, but that is the problem, so that is what we should focus on fixing. 

The government can also help by not causing more harm. The credit markets are partly paralysed by the fear of what great plan will come next. Why buy bank stock knowing that the next rescue plan will surely wipe you out, and all the legal rights that defend the value of your investment could easily be trampled on? And the government needs to keep its fiscal powder dry. When the crisis passes, our governments will have to try to soak up vast quantities of debt without causing inflation. The more debt there is, the harder that will be.

Of course we are not all Keynesians now. Economics is, or at least tries to be, a science, not a religion. Economic understanding does not lie in a return to eternal verities written down in long , convoluted old books, or in the wisdom of fondly remembered sages, whether Keynes, Friedman or even Smith himself. Economics is a live and active discipline, and it is no disrespect to Keynes to say that we have learned a lot in 70 years. Let us stop talking about labels and appealing to long dead authorities. Let us instead apply the best of modern economics to talk about what has a chance of working in the present situation and why. 

Here is some Keynesian wisdom I think we should accept. 

“The difficulty lies, not in the new ideas, but in escaping the old ones, which ramify, for those brought up as most of us have been, into every corner of our minds.”

“How can I accept the doctrine, which sets up as its bible, above and beyond criticism, an obsolete textbook which I know not only to be scientifically erroneous but without interest or application to the modern world?”

“Practical men, who believe themselves to be quite exempt from any intellectual influences, are usually the slaves of some defunct economist.”

I think Cochrane is right about bizarre denialist flavor of the recent vogue for undead Keynesianism and — about  most other stuff, too. But I’d also like to see him acknowledge the limits of post-Lucas macro modeling as well. I think the lesson for the economics profession is now pretty clear. Macroeconomics that is useful for policymaking needs to (1) include a lot more political economy and (2) work from more empirically-grounded behavioral assumptions. That is to say, it would be nice to see more top-flight economists like Cochrane acknowledging that macro policy is politics and that people act like people. I suppose doing this would make the math seem impossible, but nobody ever said science was easy.

Christina Romer's Six Lessons

David Frum’s new column for The Week nicely lays out what the chair of the White House Council of Economic Advisors really thinks of the administration’s economic policy: 

Invited by a reporter Monday to criticize President Obama’s economic plans, the chair of the White House Council of Economic Advisers, Christina Romer, naturally brushed the question aside. “You want me to tell you what’s wrong with the fiscal stimulus package?” she said. “SO not going to do that!” 
 
Too late! As it happens, the lecture Romer had just finished delivering at the Brookings Institute on Monday afternoon was criticism enough. 
 
An expert on the Great Depression, Romer organized her lecture around six lessons distilled from the era. The administration she serves seems to be disregarding every one of them. 

Read the rest for the lessons.

"This House Believes We Are All Keynesians Now"

Brad DeLong and Luigi Zingales debate it at Economist.com

DeLong’s opening statement too effectively arrays a huge amount of intellectual firepower against him. If he could persuasively cut this team of giants down to size, it would be a killer opening. But his response to the challenge he erects seems to amount to the contention that this squad of bona fide geniuses are really benighted halfwits guilty of an elementary error. That’s pretty hard to swallow. Meanwhile, Zingales handily hops over the bar he sets for himself. I liked Zingales’ analogy:

[E]ven the third interpretation of the house statement—that we should follow Keynesian prescriptions to combat the current economic crisis [the interpretation DeLong wants to defend]—is false. I am not disputing the idea that some government intervention can alleviate the current economic conditions, I am disputing that a Keynesian economic policy can do it. With a current-account deficit that in 2008 was $614 billion, a budget deficit that was $455 billion and military expenditures of $731 billion, it is hard to argue that the government is not stimulating demand sufficiently. The current crisis is not a demand crisis, it is a trust crisis. Bad corporate governance coupled with bad government policies has destroyed the financial sector, scaring investors and freezing lending. It is as if a nuclear bomb had destroyed all roads in America and we claimed that to alleviate the economic impact of such an event we should invest in banks. It is possible that eventually the effect will trickle down. But if the problem is the roads, you want to rebuild roads, not subsidise the financial sector. And if the problem is the financial sector, you want to fix this and not build roads.

So far, DeLong is getting crushed in the voting, though he’s working the audience hard in the reader comments. Is that allowed? 

Also, here is Brad debating Michele Boldrin. I haven’t listened yet.