Month: December 2008

He answers them here, on a short (and fun) video.  They’re tough questions.

Addendum: The whole Krugman interview is here.  And Mark Thoma indexes further questions.

I read his comment (JSTOR) on Richard Cooper’s paper on capital controls.  Tarullo is very willing to countenance the notion, in a way that might appeal to Dani Rodrik.  He even considers the notion that perhaps such controls should be permanent for some countries.

Here is some of his policy work, mostly centrist Democrat it seems.  Here is his testimony on reforming the IMF and World Bank.  He wants to make the Bank smaller, hire fewer academic economists, devote more attention to project evaluation, and (good luck) restructure the dysfunctional role of the Bank’s governing board.  He wants to give greater IMF quotas to the rising economic powers such as China.

He just wrote a whole book picking apart Basel II; here is a summary of his conclusions.  They make sense but somehow they don’t read as if he is getting to the heart of the matter.  When he writes he is reluctant to generalize.  The Basel work is probably one reason why Obama nominated him for the Board of Governors.  He is much more a "regulation guy" than a "monetary policy" guy.  That suggests he won’t challenge Bernanke on monetary policy.  Overall it is another sign that Obama is committed to making high-IQ, high experience, high quality economic nominations.

He teaches law at Georgetown.  He is currently working on a book on international banking regulation; basic biographical information is here.  He won’t get to finish the book.

I believe that most current advocates of a huge fiscal stimulus have two major arguments in mind.  The first is that "when resources are unemployed, in principle government spending can put them back to work, times are dire so we need this."  The second is the Galbraithian point that public sector expenditure has been starved for a long time so in principle there are plenty of good ways to spend money through government.  In the predominant mental model on this topic, it is believed either of these arguments suffices to justify a large fiscal stimulus.  In the debates I sometimes find that when one claim is criticized there is a mental switch back to the other.

Don’t let those switches distract you.  My point is simple: it is very hard to find examples of successful fiscal stimulus driving an economic recovery.  Ever.  This should be a sobering fact.  The New Deal doesn’t count because fiscal policy wasn’t very expansionary then.  American participation in World War II doesn’t count.  Nazi Germany during the 1930s doesn’t count.  (Read Matt Yglesias’s response; the point however is that maybe Hitler couldn’t have easily spent the money on something else in a rapid and effective fashion; if he could have they why can’t we find more examples of a fiscal-policy lead recovery elsewhere?).  I’ll cover Japan in the 1990s and other examples soon.

Don’t be mesmerized by a static, aggregated AD-AS diagram into thinking surely it must be easy.  Whether the government can target unemployed resources effectively, and deliver the right stimulus in time, is a major question and so far the evidence isn’t so convincing.  Keep in mind there are good reasons why truly major fiscal stimulus hasn’t been tried very often.

Here’s Free Exchange on the research behind fiscal policy.  They write:

Today, Mr Cowen links
to a(nother) piece of macro research on stimulus multipliers that finds
in favour of tax cuts before declaring that "the science isn’t there",
to support deficit spending as stimulus.

The point is not that I think tax cuts are much better than government spending as stimulus; I don’t.  The NBER piece I cited considers the possibility that tax cuts bring a multiplier of as large as five.  I say no way.  The point is not to argue for tax cuts.  The point is to note that this is the best research that the highly reputable NBER can come up with on the topic.  What does that say about prevailing standards of evidence and proof in the area as a whole?  It means they are very weak and that we know very little.  This is not "the evil and corrupt WSJ Op-Ed page," this is the NBER and the researchers have done as good a job as others on this topic or maybe better.  And what they have produced still isn’t very believable.

The bottom line is this: we are being asked to believe that a big, trillion or even multi-trillion fiscal stimulus can boost the current macroeconomy.  If you look at history, there isn’t good reason to believe that.  Any single example, such as the Nazis, can be knocked down for lack of relevance or lack of correspondence to current conditions.  Fair enough.  But the burden of proof isn’t on the skeptics.  It’s up to the advocates of the trillion dollar expenditure to come up with the convincing examples of a fiscal-led recovery.  Right now we’re mostly at "It wasn’t really tried."  And then a mental retreat back into the notion that surely good public sector project opportunities are out there.

So what you have is the possibility of faith — or lack thereof — that our government will spend this money well.

And that is under "emergency" conditions, with great haste ("use it or lose it"), with a Congress eager to flex its muscle, and with more or less one-party rule.

For me, that’s not enough.

Yesterday, my newspaper was delivered with a stamped envelope for sending tips to the delivery person. I put a tip in the envelope. Feeling extra generous, I did not include my address. Explain. Shouldn’t all tips be this way? Discuss.

Is the financial crisis — which is rapidly becoming the "real economy" crisis — somehow the "dual" of the socialist calculation problem? 

A’la Hayek, say the price of copper goes up.  Markets will make many adjustments and the proper adjustments usually cannot be foreseen by a central planner.  Nonetheless there is some iterative process by which those adjustments get made and, I am sad to say, our understanding of that process involves a good deal of hand waving.  It’s fine to talk about entrepreneurship but the net effect need not be equilibrating.  The relationship between local adjustment, where we have decent Marshallian theories, and global adjustment, about which we know little, remains tricky.

General equilibrium stability theory used to assume gross substitutability to derive the convergence to a new equilibrium but in fact convergence did not usually come easily in the models.  (I take gross substitutability as meaning that a decline in the price
of one good will, on the whole, lead to increased expenditures on other
goods, but here are some alternate specifications.)  Most of the time we hope that the proper local adjustments get made and the whole pinwheel turns and mutates in the proper directions over time. 

Are there conditions, however rare, under which market adjustment and convergence does not occur?  If a few of the vertices get stuck, can it become impossible for the economy to fulfill its mutating pinwheel program of change and adaptation?

Today, banking, finance, and construction all need to shrink and indeed they are shrinking.  Given the centrality of lending and project evaluation, is a sufficiently healthy banking sector needed for the pinwheel to properly turn?  Must investors abandon their quest for liquidity to bring their information to bear on market prices?

Paul Davidson, the Post Keynesian, used to stress that gross substitutability should not be taken for granted.  Was he on to something?

The kind of equilibrium stability theory that obsessed Franklin Fisher was written off as irrelevant some time ago.  Maybe people will start looking at it again.

Here’s a great metaphor from Paul Krugman’s The Return of Depression Economics:

A microphone in an auditorium always generates a feedback loop: sounds picked up by the microphone are amplified by the loudspeakers; the output from the speakers is itself picked up by the microphone; and so on.  But as long as the room isn’t too echoey and the gain isn’t too high, this is a "damped" process and poses no problem.  Turn the dial a little too far to the right, however, and the process becomes explosive; any little sound is picked up, amplified, picked up again, and suddenly there is an earsplitting screech.  What matters in another words, is not just the qualitative fact of feedback, but its quantitative strength.

Aside from the obvious parallels – feedback, the crash as an ear-splitting screech, the way everyone is always surprised – this metaphor has something else going for it.  It doesn’t make a lot of sense to look for the X,Y,Z "causes" of the crash because when feedback is present X,Y,Z may not be a problem even though X,Y,Z + epsilon creates a disaster.

Tyrone barely knows enough technical macroeconomics to bark out an opinion, much less defend it or specify coherent policies.  Nonetheless he suggested that I pass the following along to Ben Bernanke:

It seems there is not enough lending.  People would lend more if interest rates were higher or at least I think I learned that in Econ 101.  So let’s raise interest rates.  I’ve also heard we have banks buying T-Bills and the Fed and government buying claims to real businesses.  Can that be true?  Isn’t that backwards?  If they aren’t working properly, why not just recall all the T-Bills? (Didn’t General Motors do something like this once?  It seemed to work out for them.)  Then the banks would have to invest somewhere.  Give a bonus to any bank that does something real.  Let the others rot.  (Tyrone then called up Trudie, who told him: "Have the Fed announce it will go massively short in the T-Bill futures market, sometime in the near future and without further warning.  That would scare people out of government assets.")

What about that guy who set up the phony investment company?  Can the Treasury make a new one of those, only bigger?  He took money away from people and gave it to charities and the needy and the arts and higher education.  That sounds like stimulus so why are we sending him to jail?  Wasn’t he ahead of the curve?

Why don’t we increase the tax deduction for donations to any charity which manages to expand its spending on overhead or is the word infrastructure?  For every dollar given, let the donor deduct more than a dollar from taxes.  That’ll get the money out of the banks of those rich people and into the hands of real Americans.  Still, it’s not as good as the phony guy who’s been doing this for twenty years.  I guess we’re all trying to catch up to him.  It seems he had help from his family but Bernanke does not.  Makes all the difference.

Tyrone tells me, by the way, that soon he will try his hand at a restaurant review.  It can’t be any worse than this.

Or should I have called this post "zero nominal rates of interest"?

The JSTOR link is here.  In 1969 Tsiang wrote that if the Fed pays interest on reserves, or nominal interest rates in loan markets approach zero, money (if you can still call it that) dominates all investment assets.  The only equilibrium involves the government holding all of the economy’s real capital.  In other words, Milton Friedman’s old recipe for an optimum quantity of money can never be realized in anything resembling a decentralized economy.

Here is Jeff Hummel’s post on paying interest on reserves.  Here is today’s headline on the Fed and the federal funds rate.  Note that for Chiang, either zero nominal interest rates or interest on reserves was enough to cause the problem; did he imagine we might someday have both?

Help!