How many times have you heard the following argument in the last two years?
Tax cuts/helicopter drops of cash/whatever won't stimulate demand. People are too nervous to spend. Whatever you give them, they'll just save it.
The problem with this claim, like the analogous argument about reserves, is that it never considers the savers' motives. Why are they saving in the first place? Once again, there are two theories:
Theory #1: People just don't have anything they want to buy. They're satiated, so no matter how much extra income they get, they'll just sit on it.
Theory #2: People want a buffer. They aren't comfortable with their current asset cushion, so they're saving in order to return to their comfort zone.
Theory #1 is wholely implausible. There's tons of stuff that people still covet. The truth, then, lies in Theory #2: People will start spending again once they feel like they've got enough breathing room.
So what? Well, if you believe in Theory #2, tax cuts/helicopter drops of cash/whatever do much more to stimulate demand than they appear. Even if they don't persuade anyone to actually spend more, they move people closer to their financial comfort zone. And once they reach that zone, they'll start spending again! Even seemingly ineffective efforts to boost demand reduce the time we'll have to wait before demand begins to rise.
If your goal is to stimulate demand, then, the right implication to draw from the "They'll just save it" mantra isn't fatalism. Instead, you should ask yourself, "By how much do their savings need to rise before they will start spending again?" - and ramp up your tax cut/helicopter drop/whatever accordingly.
I'm well-aware that stimulating demand isn't everything, and has its own dangers. My point is that a plausible account of savers' motives shows that, contrary to many, purely demand-based problems have been and remain easy to solve.
What the Blinder-Zandi paper does is explore the properties of a macroeconometric model. The economics profession abandoned those models thirty years ago, so the tool they are using is like a fossil, frozen in time. Of course, there have been many tweaks over the years, but my guess is that if I had access to the full model I would feel like I was returning to what I first worked on when I worked for Blinder thirty-five years ago.
The model assumes a Keynesian world, in which labor is a variable factor of production that responds to incremental increases in aggregate demand. That might be an excellent assumption for 1910, when 73 percent of the work force was blue-collar. By 2000, 73 percent of the work force was white-collar. See Wyatt and Hecker. In today's Garett Jones economy, labor acts more like a fixed factor. Blinder and Zandi do not know this (they may know it, but I doubt that it is incorporated into the model). So they do not know about jobless recoveries, breakdowns in Okun's Law, the high ratio of permanent job losses to temporary layoffs, etc. Instead, at best they are living in 1970, with some add factors thrown in to get the model to track recent data.
They do not know about lots of new research into labor dynamics, which shows that the rates of job creation and destruction are enormous relative to the net gains or losses in employment. See Davis, Faberman, and Haltiwanger. Again, Blinder and Zandi may know about this research, but I can almost guarantee you that their model does not.
If macroeconometrics were a viable paradigm, we would have seen major efforts to try to bring this sort of model up to date from its 1975 time warp. However, for reasons I have documented, the profession has decided that this macroeconometric project was a blind alley. Nobody bothered to bring these models up to date, because that would be like trying to bring astrology up to date.
While ghost-writing for the Conservative Missionary and the Libertarian Missionary, I found myself reflecting on the principles of good debating. I realize that debating can just be a sophistical exercise. But it doesn't have to be. In fact, it has obvious truth-seeking advantages over the straightforward lecture format. For starters, debaters usually have a knowledgeable opponent to keep them honest. Even better, debate gives people a chance to put the other side "on the stand" - to publicly ask them the tough questions people normally evade, then say, "Yes or no, Mr. Such-and-such?"
In any case, here are my candidate principles of good debating. They're not primarily about winning, but about deserving to win. But I do think that they are crowd-pleasing as well as truth-seeking.
Principle #1: Strive to address people who don't already agree with you. Realistically, you'll at best change the minds of the undecided. But the best way to sway the undecided is to reach out to your most intransigent opponents.
Principle #2: Talk to your opponent like he's your best friend, even if he does the opposite. Not only are ad hominem arguments invalid, but they send the signal that you lack better arguments. You'll also think harder and more creatively about your position once you spurn invective.
Principle #3: Split your time between talking to your audience and talking to your opponent. The optimal balance might not be 50/50 exactly, but you should spend a goodly amount of time both appealing directly to your opponent, and pointing out his blind spots.
Principle #4: If you're uncomfortable publicly defending aspects of your position, reconsider your position. In extremely oppressive societies, keeping your thoughts to yourself is common sense. But in modernity's largely open societies, your discomfort says more about the quality of your beliefs than the unfairness of the world.
Any others?
Alan Blinder and Mark Zandi used Zandi's econometric model as the basis for a claim that the stimulus and the TARP worked. Thirty-five years ago, I was Blinder's research assistant, doing these sorts of simulations on the Fed-MIT-Penn model for the Congressional Budget Office. I think they are still done the same way. See lecture 13. Here are some of the things that Blinder had to tell his new research assistant to do.
1. Make sure that there were channels in the model for credit market conditions to affect consumption and investment.
2. Correct the model's past forecast errors, so that it would track the actual behavior of the economy over the past two years exactly. With the appropriate "add factors" or correction factors, the model then produces a "baseline scenario" that matches history and then projects out to the future. For the future, a judgment call has to be made as to how rapidly the add factors should decay. That is mostly a matter of aesthetics.
3. Simulate the model without the fiscal stimulus. This will result in the model's standard multiplier analysis.
4. Make up an alternative path for what you think would have happened in credit markets without TARP and other extraordinary measures. For example, you might assume that mortgage interest rates would have been one percentage point higher than they actually were.
5. Simulate the model with this alternative scenario for credit market conditions.
6. (4) and (5) together create a fictional scenario of how the economy would have performed had the government not taken steps to fight the crisis. According to the model, this fictional scenario would have been horrid, with unemployment around 15 percent.
Some comments:
i) Blinder and Zandi do not spell out the details of step 1 or step 4. Thus, I have no idea how to evaluate their approach to estimating the impact of financial measures.
ii) Other than the add factors, and any ad hoc adjustments that were made in step 1, every result in the paper would have been found by simulating the model three years ago. There is no new evidence being brought to bear. What Blinder and Zandi are reporting is the Keynesian theory that was built into the model.
iii) They report model multipliers to two decimal places, e.g. 1.61 for extending unemployment insurance benefits. They do not provide confidence intervals or any other estimate of reliability.
iv) the paper has not been published in a peer-reviewed journal. The theoretical and statistical properties of the model probably would not be considered acceptable in modern practice. Even if those issues were overlooked, the intensity of the political rhetoric combined with the opacity of the exercise would cause difficulties for most editors of academic journals.
I do not think we will ever know what would have happened to the economy without the fiscal stimulus and the large monetary interventions. My guess is that the overwhelming majority of economists would agree that we will never know the answers to those questions. However, in the competition for public attention, Blinder and Zandi have two advantages. First, they support a narrative in which government experts did the right thing, which is comforting to government experts and all who believe in them. Second, at a tactical level, their use of an esoteric computer model along with those two decimals of precision, they intimidate journalists and other laymen.
I know that they think this is for a good cause. They really believe that the stimulus and TARP were good policies that got a bad rap. But in my view that does not justify this unseemly exercise in propaganda dressed up as research.
I'm going on vacation Thursday morning here. I'll be there until August 15. Sometime tomorrow and for a four-hour layover in Denver on Thursday, I'll pre-program some posts on things I've been thinking about. I'll also go on line from time to time while I'm there, although that's not easy. What that means is that I won't be nearly as active a responder to people who comment on my posts.
I've gone to Minaki for at least some time every summer of my life since 1951, except for about five years in the 1970s, 1980s, and 1990s. My grandfather built the cottage in 1921 or 1922 and the major improvements were electricity (1958) and running water (2000.) It's partly because of that that I appreciate modern technology. After having hauled literally thousands of buckets of water, I love running water.
Paul Romer is always interesting, and especially in this podcast with Paul Kedrosky. In the last quarter of the interview, the discussion turns to badly-performing cities, and Romer speculates that we need a workout procedure that would allow a city government to move into completely different hands. As with troubled banks, one could argue that we need a more effective resolution authority for troubled governments.
Possibly related: Tyler Cowen on privatizing local government.
The above title should have been the title of my previous post. The title I gave it, "Mark Thoma Doesn't Get It," was unnecessarily provocative, as one of my co-bloggers has pointed out. I know the myth of male power, and part of it is that we men are not supposed to have feelings. We do have feelings. I think, based on his reaction in a subsequent post, that I hurt Mark Thoma's feelings. I didn't mean to. It was thoughtless of me to think that with that title, I wouldn't upset him. What I really meant to do is talk about the following:
When people advocate government intervention, they rarely, maybe never, tell us how the incentives will be set up so that government will do the right thing. Think about how asymmetric the argument is. Incentives in the private sector are such that someone will do something in his interest that hurts others in society, but he doesn't take account of that hurt in his decision. Or, someone could take action that would benefit others a great deal but it isn't in his interest to take the action. Notice the use of reasoning about incentives to show why the market fails. Therefore, continues the argument, we should have government intervene.
Did you catch the non sequitur? The argument proceeds at first using standard economic tools. We show that the incentives are such that the private actors make the decision that leads to sub-optimal results. Then we (not really we, but many of us) conclude that government should step in. But there's no analysis of government incentives. Why would government do the right thing? That's the unjoined debate. The late George Stigler once said it's like a judge at a beauty contest seeing just the first contestant and then awarding the prize to the second contestant.
I wasn't naive enough, as Mark Thoma suggests in his response, to think that he has "unqualified support for regulation." Also, he has been critical of specific regulations. One of the things that makes his blog interesting is his eclectism. I was just saying that although I read his blog a fair bit, I've never seen him, when he advocates a regulation or a government program, explain why he thinks the incentives will be set up so that it works. I had hoped to get him to address this. It would still be nice if he would.
Addendum: One of the commenters on my post said the discussion shouldn't proceed without mentioning Coase and Demsetz. I'm a fan of both men, and indeed, it was Demsetz who got me into economics, as I lay out in Chapter Two of my book, The Joy of Freedom: An Economist's Odyssey. Of course, I had Demsetz's nirvana fallacy in mind when I wrote this. But I'll often use ideas without naming the person I got them from.
I mean, nothing says "have a nice day" like an issue brief from the Congressional Budget Office on the prospects for a U.S. sovereign debt crisis. On the potential for inflating away the problem, the brief says,
On balance, the increase in tax revenues resulting from higher inflation would be more than offset by higher payments for benefit programs and higher interest payments as the outstanding debt rolled over and ongoing deficits required the issuance of more debt.
Read the whole issue brief. There is no way that excerpts can do it justice.
Eric Falkenstein offers a theory of financial manias.
Sometimes, the investors (dupes) think a certain set of key characteristics are sufficient statistics of a quality investment because historically they were. Mimic investors seize upon these key characteristics that will allow them to garner funds from the duped investors. The mimic entrepreneurs then have a classic option value, which however low in expected value to the investor, has positive value to the entrepreneur. The mimicry itself may involve conscious fraud, or it may be more benign...The mimicking entrepreneurs are really symptomatic of investing based on insufficient information that is thought sufficient.
Falkenstein's point is that the signaling is endogenous. When a particular signal works well for good intermediaries (ones that make a legitimate profit by choosing investments wisely), there is an incentive for bad intermediaries (who choose investments less wisely) to mimic the signals provided by good intermediaries.
Falkenstein claims that there is no equilibrium in which good intermediaries are well received and bad intermediaries are not. When times are good, the incentives are great for bad intermediaries to develop the ability to mimic good intermediaries. Only when there is a crash do the bad intermediaries get exposed and wiped out. Right after a crash, people distrust all sorts of signals, including those that had been used by good intermediaries. So after a crash, even good intermediaries have difficulty establishing credibility. By the time they come up with credible signals, bad intermediaries are ready to mimic those signals.
Government as Deux Ex Machina
Almost all economists recognize that there are some market failures that must be corrected by government intervention, the disagreement is over their prevalence. Some economists see widespread and costly market failures, and that government can intervene effectively to overcome them.
Notice a category missing? The category includes me. It's economists who do "see widespread and costly market failures" but don't see how "government can intervene effectively to overcome them." The debate between advocates of government intervention like Mark and critics like me is still unjoined--by Mark. What he has not shown us and, more upsetting, what so few advocates of government intervention even try to show us, is how a government regulator will have the right incentive to do the right thing. Will the government regulator be fired if he screws up? Not typically. Will he get a huge bonus if he does something right? Not typically. And how, with a centralized information system, will he get the information needed to make a good decision, something I wrote about in the context of dealing with terrorism? I don't read Thoma as much as Arnold does, but I read him a fair bit and I've never seen him deal with these issues. Have you?
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