Month: December 2008

Hail Garett Jones!

From the comments, Garett Jones writes:

Here’s a simple neoclassical explanation for the high G (government purchases)–>Low Y (GDP) relationship: 

More high-paying government jobs–>
More people waiting in line for those good jobs–>
Less private-sector employment. 

Queuing for good Davis-Bacon jobs is what creates the problem. 

It’s a new twist on the Cole and Ohanian story of high wages worsening the Depression, and Quadrini and Trigari told it in the Scandinavian Journal of Economics as well as here

There is more at the first link.  I am pleased to report that I have the honor of sharing a corridor with Garett Jones.

Advertising markets in everything

Tom Farber gives a lot of tests. He’s a calculus teacher, after all. So when administrators at Rancho Bernardo, his
suburban San Diego high school, announced the district was cutting
spending on supplies by nearly a third, Farber had a problem…

"Tough times call for tough actions," he says.
So he started selling ads on his test papers: $10 for a quiz, $20 for a
chapter test, $30 for a semester final.

San Diego magazine and The San Diego Union-Tribune
featured his plan just before Thanksgiving, and Farber came home from a
few days out of town to 75 e-mail requests for ads. So far, he has
collected $350. His semester final is sold out.

Here is the story and I thank Hunter Amor Williams for the pointer.

Writing to Peter Singer about Down syndrome

I liked this Michael Bérubé post; here is an excerpt:

…in the 1920s we were told that people with Down syndrome were incapable of learning to speak; in the 1970s, we were told that people with Down syndrome were incapable of learning how to read.  OK, so now the rationale for seeing these people as somewhat less than human is their likely comprehension of Woody Allen films.  Twenty years from now we’ll be hearing “sure, they get Woody Allen, but only his early comedies–they completely fail to appreciate the breakthrough of Interiors.”  Surely you understand my sense that the goalposts are being moved around here in a rather arbitrary fashion…

You’re looking for things people with Down syndrome can’t do, and I’m looking for things they can.  We each have our reasons, of course.  But I don’t accept the premise that cognitive capacity is a useful criterion for reading some people out of the human community, any more than you would accept the premise that we should grant rights to animals on the basis of whether humans think they do or don’t taste good with barbeque sauce.

Greg Mankiw writes my post for me

He quotes Blanchard and Perrotti, neither of whom is a follower of Milton Friedman:

find that both increases in taxes and increases in government spending
have a strong negative effect on private investment spending. This
effect is consistent with a neoclassical model with distortionary
taxes, but more difficult to reconcile with Keynesian theory: while
agnostic about the sign, Keynesian theory predicts opposite effects of
tax and spending increases on private investment. This does not appear
to be the case.

There is much more here and do read the whole thing.  The bottom line is that the evidence for the Keynesian effects of fiscal policy is far from overwhelming.  Keynesian results cannot be ruled out but we simply don’t understand the short-run dynamics of cycles very well.  So why should we be so convinced it is time to spend $1 trillion or more? 

Addendum: On this post comments seem to be working.  Sorry again for the troubles.

Changes in money wages

And what Keynes had to say then is as valid as ever: under
depression-type conditions, with short-term interest rates near zero,
there’s no reason to think that lower wages for all workers – as opposed to lower wages for a particular group of workers – would lead to higher employment.

Suppose that wages across the US economy had been, say, 20 percent
lower than they actually were. You might be tempted to say that this
would make hiring workers more attractive. But to a first
approximation, prices would also have been 20 percent lower – so the
real wage would not have been reduced. So how would lower wages lead to
higher demand for labor?

Well, the real money supply would have been larger – but the normal
channel through which this might increase demand, lower interest rates,
was blocked by the zero lower bound. Yes, there would have been a
slight Pigou effect: real private sector wealth would have been higher,
because cash under the mattress (or wherever) was worth more. But on
the other hand, real debt burdens would also have been higher, probably
exerting a contractionary effect. Overall, there’s no good reason to
think that lower wages would have helped raise employment.

That is Paul Krugman and also here.  That is correct but note the argument requires lower wages for all workers, exactly as Krugman states.  He does not go through a change in wages for only some workers and indeed that scenario is very different and not necessarily Keynesian.  When unemployment is present, lower wages for some workers can stimulate renewed employment and — depending on elasticities — possibly greater purchasing power as well or at least not proportionally diminished purchasing power.  (Each worker earns less but there are more workers employed.)  There won't in general be much of a deflation.  The hiring of some workers can also lead to an upward spiral in production, employment, and again purchasing power, as outlined by W.H. Hutt in his books on Keynes. 

Krugman and others wish to argue that the New Deal years were ones of recovery; that is fine but it increases the chance that the Hutt scenario and not the Keynes scenario would apply at that time.

The simplest version of the Keynesian argument on money wages also relies on labor as the primary source of marginal cost (true in many but not all sectors) and lack of market power for retail prices, among other assumptions about market structure.  Yet another scenario is that some nominal wages fall and entrepreneurs (with some market power) invest more in response and hold retail prices relatively steady.

I believe Keynes's "falling nominal wages-falling prices-constant real wages-constant unemployment" scenario does hold for some of the 1929-1932 period and indeed I have argued as such in print.  But once we get into the Roosevelt era, we have government propping up some wages above market-clearing levels and thus higher than necessary unemployment.  Note that the Roosevelt policies applied only to some workers and by no means to all or even most workers, which again suggests the Hutt analysis is more relevant than the Krugman/Keynes analysis.

Krugman asks why Keynes's point, presented in 1936, is not more widely recognized today.  But the limitations of Keynes's argument — including its reliance upon particular assumptions about cost and market structure — were pointed out by Jacob Viner in…1937 (see pp.161-162 JSTOR). 

Viner, I might add, was hardly a laissez-faire denialist.  He favored an active government response to the depression, and he admits Keynes's results can hold but needn't hold.  He is the one who stakes out the sophisticated middle ground, not Keynes.  So we're still trying to catch up to 1937, not 1936.

Addendum: It turns out I am blogging chapter 19 of the General Theory; I am looking forward to our forthcoming book club too much!

The Next Crisis

It’s not just Social Security and Medicare which are underfunded.  State governments have vastly underfunded public pensions.  Here is the abstract to a new NBER paper, The Intergenerational Transfer of Public Pension Promises by Novy-Marx and Rauh. 

The value of pension promises already made by US state governments will
grow to approximately $7.9 trillion in 15 years. We study investment
strategies of state pension plans and estimate the distribution of
future funding outcomes. We conservatively predict a 50% chance of
aggregate underfunding greater than $750 billion and a 25% chance of at
least $1.75 trillion (in 2005 dollars). Adjusting for risk, the true
intergenerational transfer is substantially larger. Insuring both
taxpayers against funding deficits and plan participants against
benefit reductions would cost almost $2 trillion today, even though
governments portray state pensions as almost fully funded

Interpreting the Monetary Base Under the New Monetary Regime

The monetary regime has changed and, as a result, many people are misinterpreting the recent increase in the monetary base.  Paul Krugman, for example, posts the picture Benbase_2at right.  His interpretation is that the tremendous increase in the base shows that the Fed is trying to expand the money supply like crazy but nothing is happening, i.e. a massive liquidity trap.  (Krugman is not alone in this interpretation, see e.g. this post by Bob Higgs).  Thus, Krugman concludes, Friedman was wrong both about monetary history and monetary theory. 

Krugman’s interpretation, however, neglects the fact that the monetary regime changed when the Fed began to pay interest on reserves.  Previously, holding reserves was costly to banks so they held as few as possible.  Since Oct 9, 2008, however, the Fed has paid interest on reserves so there is no longer an opportunity cost to holding reserves.  The jump in reserves occurred primarily at this time and is entirely under the Fed’s control.  The jump in reserves does not represent a massive attempt to increase the broader money supply.

Here’s a bit more background.  When no interest was paid on reserves banks tried to hold as few as possible.  But during the day the banks needed reserves – of which there were only $40 billion or so – to fund trillions of dollars worth of intraday payments.  As
a result, there was typically a daily shortage of reserves which the Fed made up for by extending hundreds of billions of dollars worth of daylight credit.  Thus, in essence, the banks used to inhale credit during the day – puffing up like a bullfrog – only to exhale at night.  (But note that our stats on the monetary base only measured the bullfrog at night.) 

Today, the banks are no longer in bullfrog mode.  The Fed is paying interest on reserves and they are paying at a rate which is high enough so that the banks have plenty of reserves on hand during the day and they keep those reserves at night.  Thus, all that has really happened – as far as the monetary base statistic is concerned – is that we have replaced daylight credit with excess reserves held around the clock.  The change does not represent a massive injection of liquidity and the increase in reserves should not be interpreted as evidence of a liquidity trap.

Addendum: (For the truly wonkish.)  If you want more, see my earlier post on excess reserves, posts by Jim Hamilton, and David Altig, and especially two very useful Fed articles, Keister, Martin, and McAndrews (n.b. the last section) and Ennis and Weinberg.