Here is a Krugman post on the question, here are earlier posts from Sumner and Yglesias. I will put my remarks under the fold…This topic is easiest to understand if you sub out the United States and sub in Greece. There is no AD boost that can (anytime soon, without a lot of extra growth kicking in), restore Greece to its previous output peak and its previously expected performance-to-come. Circa 2006, Greece was in an unsustainable position, if for no other reason the market didn’t understand the correct risk premium for Greece. Once the correct risk premium is applied, Greek output falls and furthermore numerous (related) bad events kick in and also a whole set of previous plans are shown to be unsustainable (and no this doesn’t have to be an Austrian argument!). The gap between Greece’s current path, and the path previously envisioned for Greece is thus:
a. part AD gap which can be fixed by AD policy
b. part a difference in risk premia, and for Greece the old risk premium, when the country borrowed at very low rates, was wrong and is gone more or less forever. The concomitant financial and fiscal stability is gone too.
c. part a difference in enthusiasm in supply, based on the differences between earlier expectations that “get rich quick” really does apply to Greece, and the current more pessimistic expectation that “get rich quick” is now unlikely, and thus “smaller-scale, scrabble-around projects just to make ends meet” are the order of the day. DeLong gets at some of this here.
Greece does have to rebuild a) — don’t get sucked into aggregate demand denialism! — but it also has to rebuild b) and c) and perhaps other factors too. This follows rather directly from — dare I breathe the words? — the synthetic real business cycle/neo Keynesian models which form the backbone of contemporary macroeconomics and which Krugman apparently still doesn’t wish to recognize. (To various commentators and other bloggers: when I write macro on this blog I usually take knowledge of these models for granted; if you don’t know those models that is fine, call me arcane, but it doesn’t mean I am the one who is wrong.) Krugman runs through a bunch of weak arguments and responses, and counters them well enough, but he doesn’t see or consider the baseline response that would follow from standard contemporary macro, with the possible exception of his brief parenthetical phrase about credit conditions.
Turning for a moment to broader points, the astute reader will note that in this framework the current sluggishness of recovery need not be evidence for Old Keynesianism. An ineffective response to fiscal policy does not per se have to mean we just didn’t do enough fiscal policy. And so on. Maybe yes, maybe no, but all of a sudden there is a lot more room for agnosticism about macroeconomics and more broadly there is more room for epistemic modesty.
Contra Tim Duy, you can hold this mixed view without wanting to see the Fed raise interest rates. Just avoid the AD denialism.
Krugman defines “potential GDP is a measure of how much the economy can produce” but keep in mind that this quite possibly won’t be a unique number. With what risk premium? With what enthusiasm of supply? See my Risk and Business Cycles for an extended discussion and also numerous citations.
It’s also worth noting that while gdp is a useful “we can all agree upon what to measure” kind of concept, its real meaning is conceptually fairly slippery and “potential gdp” is not likely to be better pinned down at its foundations. Let’s not reify that concept above and beyond what it is worth.
In any case, we can be agnostic about the size of the potential gdp gap with regard to the United States today and indeed my original post very carefully used a question mark in its title. But there is no incoherence to assert that part of the apparent gap is due to the real side. The new learning about America is not about the correct risk premium for our debt (not yet at least), but about our financial fragility, how well our politics responds to crises, some worrying long-term trends in the labor market, possible misreadings of the productivity numbers, and a few other real factors. It really is possible that previous investment plans were based on expectations of the real economy that were wrong and unsustainable and now have been (partially?) corrected, with negative growth penalties looking forward.
Stephen Williamson offers very detailed comment, noting also that the recession started well over four years ago, which gives plenty of time for nominal resets, and we’ve seen no downward cascading spiral, so maybe there is a non-AD problem with getting back on track at the preferred rate. He also eschews AD denialism. Today Krugman has a brief note along the lines that the views of his opponents on these questions are “even worse than your first impression” but that is best thought of as a) his occasional churlishness, and that b) his writings on this topic do not, at least not to date, reflect a very thorough knowledge of the relevant literature(s).
“He also eschews AD denialism. ”
As an AD atheist, I wish we would get more AD deniers.
“There is no AD boost that can (anytime soon, without a lot of extra growth kicking in), restore Greece to its previous output peak and its previously expected performance-to-come.”
Yes there is! If stimulus fails, try more stimulus!
Dress the 12,000 troops in Malta[1] in E.T. costumes and have them stage an alien invasion. It would be a cross between “Independence Day” and “The Mouse Who Roared”.
1: http://sfbayview.com/2012/cynthia-mckinney-12000-u-s-troops-bound-for-libya/
Over/under on posts the last sentence leads to?
should i again give this the more subtle reading ?
The CBO estimates show that about 50% of the current output from the trend of the Great Moderation is due to a productivity slowdown. While potential output never dropped, its growth has been well below 3 percent for some years now.
I do think much of the “potential output is low now” involving forward looking arguments that imply alot of counting your chickens before they hatch. In terms of what actually happens, there needs to be a good bit of increased consumption spending and reduced saving and investment for poor future expected yields to drive down potential output growth. Of course, that doesn’t mean that potential output 5 or 10 years old isn’t lower than the previous trend.
Is Krugman trolling or just angry and stupid?
Obviously, a fall in a class of asset prices (home prices in this case) will not lead to a drop in *output capacity*. But, no less obviously, it will lead to drop in valuation of said *output capacity*. Elaborating on how a bubble in home prices was “masking” a decrease in real output capacity is left as a exercise to the reader.
Krugman is angry and trolling. He thinks YOU are stupid.
It doesn’t matter if the “valuation of the output capacity drops” – what matters is that the actual flow what that capacity can produce (Real GDP) is unchanged.
To quote: “.. the actual flow that capacity can produce (Real GDP) is unchanged.”
In physical terms, yes. Right after the popping of housing bubble, the capacity to produce houses remained the same. What changed, is the capacity to make a profit making houses. And redirecting the productive factors form making houses to other purposes has costs.
So.. try again, Real GDP guy.
there is no such thing as a bubble
Ok, so Krugman says there is an AD gap, you say there is an AD gap and two other factors that lead to unemployment/slow growth. So why not fix the output gap? Then think about the other two.
Is there evidence that higher target inflation makes b and c harder/worse? Is there a reason that short term deficits make b and c worse?
Why not think about all of them?
The answer is that the solutions to a has no negative effect on b or c.
no, the NOMINAL RESETS that still need to happen are nominal debt contracts (esp mortgages). We are just now getting to the point where they are getting reset appropriately through short sales and foreclosures. getting to the point where the mortgage market is reset has been painfully slow. going foward, there has been no real decline in potential output.
There is an important distinction among “AD denialists” between those that favor AS shifts as explanation and those that think that AD/AS curves aren’t well-defined objects because of that whole general equilibrium thing. I think this is one of the most important disagreements between modern-macro/RBC types and econojournalist/PK/IS-LM types and is almost never discussed explicitly.
One of the great successes of the Woodford approach was convincing people that an AD curve was a real thing in his models even though it is clearly not.
Now what was it that I was hearing about long term unemployment and its impact on human capital?
I forgot to mention that while clicking links I was led to here which led me to think of the above:
http://andolfatto.blogspot.com/2010/12/deficient-demand-deflated-balloon.html
There are quite a few reason you might think potential output could be less coming out of this recession. But of course that doesn’t deny that there is deficient demand.
Cross reference with this: http://marginalrevolution.com/marginalrevolution/2012/02/human-capital.html
Maybe the idea is that the burst bubble reduces demand, and hence leads to lower production. But at that point you’re into a Keynesian world of deficient demand, and you should be talking about ways to close the gap, not accepting it as a fact of life.
I think this underlies the fundamental problem with AD arguments. If demand has fallen, it is not enough to say “We need more demand!” and have the gov’t try to conjure the “correct” amount with gov’t spending on… something or other. An economy is not made of the absolutely fungible dollars we attempt to measure it with, it is made of products and a trillion different competing conceptions of utility that change daily. Are we spending enough on NFL and porn? Not enough on housing? Who’s to say? Should we be spending more on education?
Attempts to actually questions like those have generally ended badly. For decades we attempted to have gov’t force the market to provide more housing and more education. We ended up with a burst housing bubble and a bloated education system that has actually become much less productive even as it becomes less affordable.
The correct answer is “we don’t know, and can’t.” The most practical answer is “let the collective wisdom of the markets try to figure it out on a day-to-day basis, with the full knowledge there will be failures, because that’s the best we can hope for.” The worst answer is “The gov’t should decide that.”
+1
I think this is giving up too easily. There are plenty of things, especially infrastructure, that we’ve under invested in as a nation for decades. There isn’t any real debate that we could use – another tunnel between New Jersey and New York or a better electric grid connecting the country. It’s just a matter of figuring out who is going to pay for it and how to make a decent profit in the process. We used to think the government could take the lead on some of these things. Now we wait for the private sector to take care of it until bridges literally collapse and there is no choice but to have government step in. Why?
The Port Authority of New York & New Jersey != the Private Sector.
Of course not, but they could have built the damn thing, even if it was a waste of money at least they would have a tunnel we’d be using for 100 years to show for it.
The one bridge that has collapsed did so during maintenance due to a design flaw, not because greedy private bridge companies didn’t spend enough money maintaining it.
The infrastructure problem is precisely that 90% of the effort is NOT “who is going to pay for it and how to make a decent profit” but rather “how do we comply with the thousands of regulations and will the gov’t allow it to be built at a profit.” Gov’t has been shutting shutting down coal plants and refineries, denying nuclear permits, disallowing the congestion pricing that could eliminate traffic problems, etc., even as it throws billions at high-speed rail boondoggles and gives $10K credits on electric cars that catch on fire and are probably a net negative for the environment anyway.
Tyler makes some good points but I’m afraid overall I have to call this one for Krugman
I disagree and score this round for Cowen.
Maybe Krugman will have better luck next time.
I had this round 9-9, with an automatic 1 point deduction for Cowen’s low blow. After 7 rounds, its now 67-65.
There are plenty of rounds left and Krugman has several matches going on at the same time.
He will probably get tired.
Not likely, you just can’t stop Krugman
I’ll tell you what’s a bubble: $40 to download Risk and Business Cycles on Kindle!
Where this argument makes sense is when the collapse of AD is sufficiently long, which it probably has been by now, that the reduction of real capital investment means that the capital stock is lower than it would have been without the bubble and its collapse, given that there may have been high investment during the bubble, although likely not of the most sustainable sort. So, it is an AD story that leads to an AS outcome.
Athens riots are bullish for Greek GDP growth : Paul Krugman
Okay … so, policy implications of all this … let’s see. On monetary policy, Cowen is to the “left” (expansionary side) of the status quo. Not explicit here, but clear from other posts.
On fiscal policy, Cowen would be willing to make austerity type moves regarding the long term entitlement crisis now, despite possible negative AD demand effects of such policies. That might help with b and c, and is necessary at some point anyway. But neither party seems very enthusiastic about such a move right now. Cowen also would oppose another stimulus package, contra Krugman, but again that’s not on the political radar anyway.
The “austerity” type moves that are really on the political table – not extending the payroll tax cut, a variety of cuts to non-entitlement spending … won’t have much real effect on the long term deficit, and hence likely not much effect on b and c. Cowen has been coy on those points, but I don’t really see how his theoretical framework sees much benefit from such spending cuts/tax increases.
So … on the real world of political choices regarding monetary and fiscal policy, is Cowen THAT far from Krugman, especially since he is not an AD denialist? They can argue all they want I guess about the necessity for current action on entitlements or another stimulus, but that seems angel on the head of a pin stuff given current political reality.
Am I wrong?
I do find it curious and frustrating that the Cowen can be so dismissive of Krugman’s good answers to “weak arguments and responses,” when those weak arguments represent current “conservative” orthodoxy, and are espoused (in the political arena, at least) by at least some Republican friendly economists.
++LarryM.
More generally, I’m beginning to get the distinct feeling that — and as an admitted non-economist who is learning the ropes, the jargon, the literature (slowly), and so on — there is a problem between Cowen and Krugman that is much beyond “signaling” (that is, the personalities involved in public display here). Let them stand as labels for public figures for the purposes of the following.
Paul (et al.) is rougly speaking aware of the arguments of those around him, but formulates a very persuasive argument at its core about what should be done at a macro level both in the relatively short term and also in the longer term. That is, he is clear that the best thing to do for human welfare both at home and therefore abroad as well is short term government stimulus in things that private investment isn’t really good for until after it’s apparent it’s needed: infrastructure investment for the “public good.” Bridges, roads, schools, hospitals, what have you.
Tyler (et al.) agrees with some of the larger portions of that assertion, but seems to a) disagree on details (how long? how much? when will it have an effect? for whom?) and b) spends a lot of time arguing about details of theory that complicate this larger vision. As I see it, it’s not that some of these thorny details do not have important implications, nor is it that they do not suggest that some of Paul (et al.)’s approaches will not misallocate or not be as aggregatively stimulating as (t)he(y) might think, but that it’s “just really hard to say that’s exactly right, although at a high level yes, Paul’s in the ballpark.”
In short, Tyler (et al.) seem to be providing the best possible counterattack to Paul (et al.) but as a collection of arguments they currently result in my mind to something like, “Well, we should wait because until we get the details settled, it could all go horribly wrong.” Philosophically, this is entirely reasonable. Politically and in the real day-to-day world, this doesn’t work — and that’s not an excuse to just dismiss it and move on, either. Very literally, we make decisions in both the small and large senses with incomplete information all the time — it’s what life is.
For example, “It’s also worth noting that while gdp is a useful “we can all agree upon what to measure” kind of concept, its real meaning is conceptually fairly slippery and “potential gdp” is not likely to be better pinned down at its foundations. Let’s not reify that concept above and beyond what it is worth.” is an entirely reasonable statement. But at the decision level, this is useless. It’s not about reification, but rather can we use it temporarily in some large sense to make a good decision (not PERFECT, but good).
Result: I am persuaded that if we did ONE thing, a good AD policy would be it. I am ALSO persuaded that it would miss the mark, generate externalities, fail in some respects to private investment, and so on. But those failures would have to be measured against the benefits that clearly **almost** all expect from the AD policy at the point of impact — things are only bad relative to the benefits, NOT absolutely. Never can the perfect be the enemy of the good.
That’s how I currently call it, and I mention it to provide Tyler and Alex some information about how the public argument is going with me, a professional and committed voter of the U.S. left who also believes that private enterprise is the critical driver of a balanced, healthy, and productive society with an important strain of individual freedom.
There certainly was an aggregate demand gap in the fall of 2008. I remember meeting a person who worked for a boat manufacturer who’s sales fell some 50%.
If there is currently an AD gap due to housing, it is because of a lot of money and resources used to build houses that will people will not use. The houses are either too big or too far away, etc. based on the prices they were sold for. Also, the general public lived above their means by using borrowed funds.
The core issue is whether or not large amounts of borrowing by the Federal government on projects with negative returns, i.e. poor investments, will make this country better off either in the short run or the long run. In the short run, it will make some people better off, while not having a large effect on the rest of the population. In the long run, it will make the majority of people worse off. The money will have to be paid back, and the current funds will have to be taken from money that would be invested in other areas. I have a friend who is a lawyer for the city of New York. He shows up to work late and leaves early and watches baseball on the internet most of the time. How much more money should he be paid to make his time a good investment? Is there a model to determine the effects of politically motivated investments provide more benefit to society than unbiased investments? Where are the effects of corruption?
I believe that one of the reasons for the last two bubbles has been an accumulation of wealth within the baby boom generation in preparation of retirement, when they will need that money to pay health care and living expenses. Why is the destruction of that wealth better for the United States in order to centralize power within the Federal government? In my opinion, this is where the money will come from to pay for stimulous through either higher taxes or inflation. It feels like the United States governement is on an acquisition spree with borrowed money like RJR Nebisco. It should be finding ways to improve the performance of their current operations to provide more value to the American people.
Now now, Robert P., your boat manufacturer was surely mistaken. Everybody knows that the 2008 decline was due to an outbreak of laziness by workers anticipating Obama raising taxes, which we all know he did with a vengeance. Look at that lazy lawyer friend of yours. This is the problem, everybody knows it, particularly all those lazy unemployed people.
The 2008 decline in the real economy was caused by banks cancelling revolving lines of credit in order to improve their capital adequacy. I will give you that a lot of money was pulled out of the stock market and into gold because of anticipation that the new administration would implement policies that would be detrimental to the economy.
As far as lazy unemployed people, economics are all about incentives, and when I was laid-off and working in Florida, I sat by pool and sunbathed until my unemployment and severence ran out before I was willing to move back to New York and take an inferior position.
I feel that Krugman as well as other political advocates over-simplify the economic cause and effects. For example, if one looks at the AD formula it looks really simple, and if we increase government demand, it can take the place of private demand and private investment. I believe that the world is a lot more complicated, and the AD formula is more an accounting description than a cause and effect relationship. To give an example of what I’m talking about, my Mom was a New York public school teacher, and the government had her fill out piles of paperwork in order to improve the education of the students. She believed that no-one read the paperwork. Through the use of the performance review process, my Mom was encouraged to not report problems in the class room and if there were disruptive children hampering the education of the entire class, to handle those children in the classroom without any outside knowledge or assistance. Should the process be improved or should more money be provided in salary, health benefits, or retirement benefits?
I don’t get that. No one argues that poor investments are poor investments. (That’s because they’re poor investments.) But you could have thousands of soylindras before you’d really start causing a problem. That is simply not an issue, if you really care about deficits, and debt. If you really care about deficits and debt, you’d encourage infrastructure needs to borrow money right now because we’ll currently pay back less money than we borrowed (or very close to it!)
So you could think that 1) there are no good public investments in infrastructure to be made (please, feel free to make that argument), or you could just be reacting to your other feelings — “It feels like the govt is on an acquisition spree…”. Really? Do you not know that the current federal government employment has been steadily dropping? Are you arguing against unfunded foreign wars? Are you saying that we shouldn’t be increasing our defense spending? Are you saying that we shouldn’t be trying to find ways to pay less for healthcare and cover more people?
It just sounds to me like the idea of “debt” makes you feel badly. If that’s the case, why do businesses take on debt in order to increase their future profits by prudent and intelligent investment? Or is it just government debt/deficits that you don’t like? It’s ok not to like them, of course. But if that were the case, then your comment would make more sense to me.
It is a level of leverage and ability to pay back the loans that is at issue. Was it wrong for the banks to over-leverage, while it is wrong for the government?
How confident are you that the government is going to invest in needed infrastructure vs politically connected projects? For example, Louisian built bridges to get to the casinos in Mississippi while not spending money of the dikes to protect New Orleans. Solyndra vs Keystone seems like an example of polictially connected investments instead of reasoned analysis.
Are you aware that the big banks have significantly reduced their lending to the private sector while at the same time significantly increased their lending to the government? I believe this is because lending to the government assists with capital adequancy while lending to the private sector does not. The question would be where would this leading provide for better results for the economy?
My response is that the U.S. economy is so big and deep that even in its currently limping state we are not close to any short term problems of paying back ANY loans at all. Nor are we in any danger of paying back medium or long term loans! We have lots of money flowing around the system (not nearly as much velocity as before, however), and the only question is whether we’re willing to tax some of that money to pay. In addition, we have our own currency, so we can permit some inflation to take care of any serious problem, or at least help us.
In fact, no one in the market currently believes that the U.S. will default on any loans at all. Treasuries are rock-solid at rates that leave investors paying us for the privilege of loaning us money. That this is partly because no one else — Norway, or Switzerland maybe — is playing the “trust in repayment” game very well, but being the strongest of a weaker crowd is still being the strongest.
As to the efficiency of investment: NO, they’re going to make a bunch of pointless mistakes and have small-scale corruption — just like private enterprise, but in a different way!!! I say “small scale”, because of all the big wasters of money in the U.S. government, the military and associated defense outlays by FAR dwarf any number of pointless bridges. The fact that you pay attention to a few bridges — sure, hundreds of millions gone, maybe over some years into the billions, for sure — but not to the tens of billions pumped into military projects each year that are totally failing leads me to suspect you are concerned about corruption in the infrastructure space but you don’t care about much, much larger (and therefore more important for budgetary reasons) corruption in military affaris. (To be quite honest, I think that those in the middle-right tend to simply ignore such stuff because they know they believe that you’ll lose some bucks here and there and it’s acceptable because it’s sooooooo important. that’s ideology, belief. Financially, crappy investment is crappy investment, and defense takes the cake.)
And yes, past the five-year period we must reign in health costs. That is CURRENT waste of huge proportions, and again since we were largely a structured-but-private market there, one imagines that somewhere on the right we would hear more about that corruption and misappropriation of wealth, but we do hear it really only in the libertarian world (here, for example). The standard Republican line is that, “we have the best health care in the world”, which according to comparative statistics is just false, even if there are several situations in which we excel.
My belief is that all human institutions are corrupt, but that what we need to do is identify how and where and why and reduce it to tolerable arenas and proportions. If you won’t agree to help fund any enterprise in government until it leaks NO money and makes NO investment mistakes, I trust you to support the same standard with private companies. if you don’t, then you’re not being persuasive at all.
That said, your last graph has some merit, for sure. Right now, the U.S. government bailed out the large banks, both here and abroad, and continues to provide them overnight loans at essentially free rates. The result is that we have a banking system that is *similar* at large scale to the zombie banks of the Japan. Right now incentives for big banks is not to lend to the private sector: whom do they trust? Not me for my house refinance: I have spotless credit and a great job and make a good chunk, but they still took three months to figure out that I’m an ok risk. Good god!
So their incentive is currently to take free money to finance more speculative enterprises and other government bets; the smaller scale private market is currently still “too risky” to waste their own money. That many of them would have gone belly up in the chaos of an un-backstopped economic collapse (which we did have to prevent!) is noticeably a part of the problem today. So the way I look at this is, OK, we HAD to stop the contagion, and NOW we’re left with these perverse incentives that we’ve created. Getting those banks off the breast milk is now going to be the problem there.
the economy itself may help here. We do seem to be recovering slowly now, and though we could do much better we can hope that if the world starts looking more “normal” that the Fed can start charging real overnight rates again, forcing banks to begin looking at real risks to make money…..
hard to know on this last point. Must avoid contagion; must wean big banks from Fed. That is a tough one.
Matt Yglesias makes an excellent point the other day when he pointed out that
All I can say is that I long for the old days (i.e., 3 years ago) when MarginalRevolution’s posts were not dictated by Paul Krugman. I am totally burned out by Tyler’s obsession with PK and can only hope that Alex will start posting more often.
It might even make sense if Krugman and Cowen were as opposed to each other as Krugman seems to think they are. When even Cowen can (by implication) refer to the arguments of Krugman’s other antagonists (people who in theory are ideologically simpatico to Cowen) as ” weak,” one wonders what all the fuss is about.
You are right, Ricardo and LarryM. What is the matter with Tyler even remotely giving the time of day to Krugman? He should be leading the charge against him on all fronts and in all ways, with the largest pitchfork in his hands out of the entire crowd of those charging to send PK to where he belongs! If he is not willing to do that, well, then he should stick to cheerleading libertarianism along with chess and ethnic foods in Washington and elsewhere, things we think he actually knows something about!
I think one problem is that the whole debate (at least as expressed in blogs and papers I’ve read on the web) takes too simple a view of capital, and of capacity. In particular, capital rots unless maintained, and if the demand for houses is a function of formation of households that can cover a mortgage, then home building cannot rise faster than mortgage worthy household formation for very long. For a while? Sure. But not for a long term.
So the housing bubble won’t be over until the pool of mortgage worthy (or house price saved) households rises to consume the housing stock. Don’t hold your breath.
Capital rotting is a big deal. Not just houses that have fallen into disrepair due to being vacant, but the capital that supports all sorts of production. So when demand (AD if you wish) goes away, capital stocks will on the whole decline – total capacity is like muscle mass – it’s costly to maintain, so if it’s not being used it will tend to decline.
Stimulating AD could be somewhat like exercise, but that won’t cure major imbalances by itself. (No amount of exercise will make you taller or me handsome.)
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