Raghu Rajan polarizes with his essay

Greg Mankiw calls it wise, John Cochrane likes it, David Brooks likes it, and I liked it, but other people are upset or less impressed.  Karl Smith flips out.  Adam Ozimek points out one misunderstanding of the piece, not the only one I might add.  The essay itself is here.

Ezra Klein argues that Rajan should not have presented long-term vs. short-term thinking as either/or (for more on the “false choices” view, read here).  To be sure, some policies such as immigration reform help both the short and long-term problems.  Still, any given dollar must be spent somehow and “the stimulus model” and “the long-term investment model” are indeed competing visions for the allocation of resources.  Think of it as having to choose a rate of discount for evaluating expenditures.  I say choose the low discount rate, which of course still may justify those forms of stimulus with long-term payoffs.  Ezra also notes that long-term investments may require short-term sweeteners to pass, but I see that as an illustration of Rajan’s point, namely that we are not very interested in the long run for its own sake.

Once the problem is presented in sufficiently precise microeconomic language, we can see where the real choice has to be made, namely at the level of the discount rate.

Rajan wants to spend money as an investment model would suggest.  There is an “investment drought,” including from our government, and the growth-inducing parts of discretionary spending are coming under increasing pressure.  AD stimulus is/would be less effective with each passing day.  Raghu’s case on this point is strong, maybe you don’t agree but I don’t see that the critics have grasped it with sufficient depth.

In the past, in other contexts, Karl Smith and Matt Yglesias have defended “muddle through” and short-term thinking in policy.  I see the public choice literature — both theoretically and empirically — as suggesting political discount rates to be far too high.  Climate change is Exhibit A, but other examples are numerous.

Krugman is upset at Rajan, but where to begin?  He misunderstands Rajan on structural unemployment, for a start see Adam’s post of correction listed above.  (In general Krugman has written and rewritten more or less the same post against structural unemployment at least a dozen times without responding to, or even presenting, a strong version of the argument.  It’s an intellectual Turing test fail, and maybe I’ll cover this some other time.)

From Krugman, there is more:

Most important, as Karl Smith says, is the fact that Rajan’s injunction that we focus on long-run growth isn’t responsible — it’s deeply feckless. The truth is that we don’t know much about promoting long-run growth, whereas we know a lot about promoting short-run recovery — which is a very different problem. In practice, stroking your chin and talking about the long run is mainly an excuse for doing nothing.

I would find it more useful if Krugman simply stated his preferred discount rate, and whether he wishes to count highly uncertain results for nothing (I don’t think so).

In any case, Krugman gets it backwards.  Any Martian visiting the economics blogosphere, or for that matter Krugman’s blog, could tell you that most of micro is a more or less manageable topic, whereas macro induces economists to start thinking of each other as idiots and fools.

More substantively, we know a fair amount about promoting growth, for instance read Alex’s The Innovation Renaissance, much of which has been endorsed by left-wing thinkers too.  Read the new Acemoglu and Robinson book.  Even Robin Wells thinks we know how to promote long-run growth.

One might try to draw a distinction between “once and for all” changes in output and permanent boosts to the rate of economic growth, a’la Solow.  In this context, that won’t wash, even if it is otherwise a defensible distinction (debatable).  If we could get many “one time” gains today, for five or ten years running, that would be excellent and would boost growth and create jobs, whether or not we would be boosting the rate of innovation twenty years out.  Krugman in other contexts argues for such gains all the time and with great vehemence and certainty, not with the faux temporary agnosticism exhibited above.

Finally, Rajan is a case for testing Krugman’s oft-stated view that we should listen most seriously to those who have made good predictions in the past.  Rajan was probably the best, more accurate, most serious, most detailed, and most non-Chicken Little predictor of the financial crisis.  You might think that means he gets listened to today, or given the benefit of the doubt on interpretation, but apparently not.


Raghuram Rajan is primarily a finance and banking economist. A very good one at that. Most finance types are very Fischer Blackian in their thought process - money matters so long as liquidity is in a crunch, once the liquidity crisis is averted, the economy is viewed as essentially forward looking and non-monetary. They are able to spot asset price and financial structure misalignments, but sometimes tend to overstate its centrality as compared to, say, wage-setting and labour dynamics, or the behaviour of consumption wrt interest rates, etc. This explains why he accurately predicted the crisis but is not convinced of aggregate demand management. If you read Rajan's work on, say, capital controls, he sounds positively 'Keynesian' - in the sense that he espouses almost every notion of 'aggregate management' (capital controls are not all bad, FDI>FII, a currency crisis is not the time to push for greater capital account convertibility etc.) that a Keynesian would espouse, transcribed to the field of capital flows rather than aggregate demand. Yet on aggregate demand he is not convinced, and when he formulates his finance-view of the economy into the economics-view language of aggregate demand and unemployment, he just re-hashes the usual buzzwords of structural, long run vs short run, inefficient government spending which end up fracturing along political fault lines. It irritates people because he wasn't talking about bloated healthcare in 2008, when healthcare was still bloated. It's not an incorrect argument, but it irritates people. Long run arguments irritate people because they were as true 3 years ago as now, and using them to show that aggregate demand management does not work post a crisis is a bit disingenuous.

The other subtle point that many people miss is that an argument along the lines of 'we were not as wealthy as we thought we were' is primarily a finance view of the world. You cannot fully grasp it until you commit yourself (atleast partially) to the view that capital is not factories and buildings, but present value of expected future cash flows. When these expectations are re-evaluated, a number of sensible projects become unviable, some operas do not get their funding rolled over, spending is cut back, and we see a 'real shock' in the midst of a nominal crisis. This 'wealth effect' is Rajan's implicit mental model (and yours as well) but he does not make it clear, preferring to talk in language of structural etc. which is irritating to many people.

"until you commit yourself (atleast partially) to the view that capital is not factories and buildings, but present value of expected future cash flows."

I thought everyone had already committed to that?

Anyway, very nice comment. The question is why does this constant process of failures and creative destruction building and undermining economic moats marginally every day become systemic and catastrophic? Why do a suddenly large percentage of people get their expectations wrong? It could be money, it could be animal spirits, it could be solar cycles, it could just be inertia, or it could be the fact that a small group attempt to manage finance expectations through the mechanism of the interest rates that quantify future expectations. What would Occam's razor suggest as the first to be falsified?

Thanks! When it comes to the macroeconomics of capital, many people, especially those who speak the language of aggregate demand, are instinctively committed to the 'capital = factories + building' view. Witness the entire debate around Jim Bullard's speech, with Yglesias, Smith, Krugman, Sumner etc. all expressing disbelief that the 'productive capacity' of the economy could possibly disappear overnight. This is nothing but a corollary of the buildings + factories view.

On your question around what theory of expectations of the business cycle is the best (or worst), I don't know. Disequilibrium Keynesian theories (ala Leijonhufvud, Minsky) sound most plausible. But perhaps the bigger question is, why does business cycle stabilization matter so much, esp. in developed economies. What really happens if GDP declines by 2% p.a for 3 years? What about all the wealth that already exists - doesn't that act as a buffer for these bad times? What about the already existing social safety nets - isn't this precisely the scenario that they're built for?

The logic of increasing spending and increasing production in a slowdown is not as compelling as it is presumed to be, especially for advanced economies that already have a lot of wealth.

I must say that your first post was a very good one and it summed the issue up very nicely. Except that whole "present value of future cashflow" part. I mean it was also Krugman who said something along the lines - OK, we now know that a lot of capital build in noughts is crap. Like McMansions built in the middle of nowhere. People are poorer then they tought. So far so good. However the key difference is that while Krugman does not see any logic between "we are poorer than we thought" to "therefore I have to stay at home and unemployed".

Rajan basically preaches austrian view of the economy: western nations finally realized that they have misaligned capital structure due to long neglected structural deficits (they "reaised" that present value of future cashflow is low". We need to completely realign our capital and production in order to survive. This takes time and comes at a price unemployment. Krugman says - fine, this story can be true, we heard it a lot since 2008. Now Mr. Rajan, please show what exactly is this "new capital" that we need to realign our economy into. Because all I see is decline all over the board. Not only in construction, but in manufacturing, services - and yes, even in government.

Sumner has quite different story: around 2008 all western nations experienced a sharp decline in nominal GDP (demand) due to a shock. Unlike other occasions - like 2001 depression - this time central banks and governments not only proved ineffective in preventing it, they actually make it worse by focusing on banking sector instead of broader economy. Economy is largely about expectations. Markets now calculate that future NGDP is going to remain low, which depresses NGDP now. Or in other word, markets either realized that central banks and governments will retain passively tightened monetary policy or they sense that instead of rule based and predictable CB and governments are becoming more discretionary - which adds uncertainity. Be it as it might - either knowing that there is going to be a tight monetary policy in foreseeable futire, or uncertainity of not knowing if CB will change its currently tight monetary policy - it effectively depresses their expected future cash flow from capital. That in turn makes current capital less profitable and it makes many project not worth initiating. They are just waiting it out. Of course, some very brave, lucky and skilled people may undertake "structural" changes that will make them beat current very bad odds. But overall, the effect is depressing. It is as Keynes said:

"For if effective demand is deficient, not only is the public scandal of wasted resources intolerable, but the individual enterpriser who seeks to bring these resources into action is operating with the odds loaded against him. The game of hazard which he plays is furnished with many zeros, so that the players as a whole will lose if they have the energy and hope to deal all the cards Hitherto the increment of the world's wealth has fallen short of the aggregate of positive individual savings; and the difference has been made up by the losses of those whose courage and initiative have not been supplemented by exceptional skill or unusual good fortune. But if effective demand is adequate, average skill and average good fortune will be enough."

But you don't need to accept the ABC to say that capital has been misallocated/ mispriced. You don't need to accept anything about negative correlations between sectors or between C&I or between whatever. There is decline across the board, sure - that's the income effect right there, that's Keynes. I don't think Rajan disagrees with that. People just differ on how much of the decline is pushing sensible things out of the feasibility window and how much of it is desirable, in some sense. They differ on how many workers were ZMP, on how many economic decision-makers were swimming naked in the high tide. Therefore they differ on how much of the income effect should we really fight with all our might. That's where Rajan disagrees with Krugman/ Summers.

Why should a re-evaluation of future opportunities cause unemployment? Well what was that employment based on, in the first place? An evaluation of future opportunities! In fact there is evidence that employment is actually less sensitive to most exogenous shocks than it should be. Witness Fay & Medoff, 1985, who are quoted most approvingly by Summers himself in his criticism of RBC

"Jon Fay and James Medoff (1985) surveyed some 170
firms on their response to downturns in the demand for their output. The questions asked were
phrased to make clear that it was exogenous downturns in their output that were being inquired about. Fay and
Medoff (l985, p. 653) summarize their results by stating that "the
evidence indicates that a sizeable portion of the swings in productivity over the business cycle
is. in fact, the result of firms' decisions to hold labor in excess of regular production
requirements and to hoard labor." According to their data, the typical plant in the U.S.
manufacturing sector paid for 8 percent more blue­ collar hours than were needed for regular
production work during the trough quarter of its most recent down­ turn. After taking account of
the amount of other worthwhile work that was completed by blue-collar employees during the trough
quarter, 4 percent of the blue-collar hours paid for were hoarded. Similar con­clusions have been reached in every other examination of microeconomic data on productivity that ram aware of. "

It seems that only when a 'big' shock hits post a 'big' misallocation of resources that people start becoming really 'rational' about these decisions - mortgages are defaulted upon, workers are fired, opera houses stop receiving their funding, etc. But is that necessarily to be fought through a stimulation of consumer and business spending?

I don't necessarily endorse Rajan's positive recommendations, by the way, except to note that it is probably consensus now that healthcare, education and finance are all bloated in the US.

"There is decline across the board, sure – that’s the income effect right there, that’s Keynes. I don’t think Rajan disagrees with that" - actually I think that Rajan disagrees with that - at least in his essay. Let me recap what he says there:

"In fact, today’s economic troubles are not simply the result of inadequate demand but the result, equally, of a distorted supply side"
"The Federal Reserve abetted these shortsighted policies. In 2001, in response to the dot-com bust, the Fed cut short-term interest rates to the bone. .... which created jobs, especially
for the unskilled .... Many construction workers have lost their jobs and are now in deeper trouble than before, having also borrowed to buy unaffordable houses"

How I read it is basically an Austrian story. Rajan rejects monetary stimulus because he fears it will create somehow unsustainbable growth and that it will feed another bubble. Please find me any article where he describes insufficient demand as at least part of the current downturn story.

As for labor hoarding - this does not help your cause. It actually makes it even worse. It basically means that there is not only unemployment/low employment in US, but that unusually high part of the workforce is just hoarded and unproductive. That basically means that per-worker productivity could have been rising quite fast which would meant that the economy could absorb even large part of nominal stimulus without any negative push of inflation. Because firms would first use their hoarded labor capacity and only after that they would start actually hiring new employees.

"To be sure, some policies such as immigration reform help both the short and long-term problems"

Too bad we didn't have intelligent immigration reform during all the years when Tyler was extolling the wonders of shanty towns and cheap chalupas, back before he discovered that one of the three causes of his Great Stagnation was the country doesn't have anymore "smart, uneducated kids.") Obviously, due in sizable measure to immigration policy, it has an abundance of uneducated kids, just not smart ones.

Assuming that a sizable portion of the non-immigrant kids turned out smart and educated, shouldn't that be cause for some happiness?

Why is it "too bad" that the immigrant kids turned out to be not smart; that ought to give the native kids a relative advantage? A win-win?

define advantage. in jobs? sure, if you're a bell curve right sider. in affordable livability? eh, not so much. it never ceases to amaze how quickly otherwise bright economics-minded rational people 1) conveniently forget about the concept of negative externalities and 2) think that the only thing genetically passed on among humans is skin color and hair texture.

I should have said 'supposedly sensible' instead of 'sensible' in the 2nd paragraph above.

"Read the new Acemoglu and Robinson book."

Have you actually read it? It's comically unfalsifiable: anything bad in history is due to "extractive" government and anything good is due to "inclusive" government.

Quoting from Rajan's essay:

"Relative to incomes, cotton shirts and canned peaches have never been cheaper."

I was wondering if this is really true. Does anyone know how much cotton shirts cost, say, in the 50's or 60's?

Today, I'm guessing $40 is a rough estimate of the median cotton shirt sold? If so that'd be about 1.5% of median personal monthly income?

You think $40 is the median price for cotton shirts? Who are you Jack Donaghy? Lucille Bluth?

I am Google Shopping.

Anyways, what's your estimate?

It is kind of frightening just how hard it is to answer your simple question. Amazon says it is somewhere between $1 and $400 for a cotton shirt...

The answer is the lowest. The rest are positional goods.

By that logic the median American car is a Kia?

Probably not even a used Kia would be comparable to the average 1950s auto in terms of functionality, efficiency, safety, durability etc.

T-shirts, otoh, have a relatively small functional variance.

Well considering "cotton shirt" is vague. My initial estimate would have been 5 dollars or so, with "T-shirts" in mind. Since we're actually talking button ups, it's somewhere around $10 to $15. People buy a lot from Wal-Mart, Old Navy, and the like. $40 would stretch the upper bound where most Americans shop for clothes.


Spending as a percentage of income has dropped drastically on both food and clothing.

Canned peaches in 1960: $0.29
Canned peaches in 2012: $1.29

Don't know about shirts, but here's peaches.

Del Monte Peaches: 29c a can: http://pix.cs.olemiss.edu/econ/1960s.html
Del Monte Peaches: $1.29 a can: http://www.bigapplegrocer.net/scripts/Del-Monte--%C2%A0Peaches---Yellow-Cling-Slices-in-Heavy-Syrup---85-oz-can~product~19745.htm
Ratio: 4.3:1

Nominal GDP PPP: 2,881
Nominal GDP PPP: 48,337
Ratio: 16.8:1


Although, I suspect using median individual income instead of GDP-per-capita will make the ratios not so divergent. I think GDP-growth-per-capita has outpaced incomes but not sure of the exact 1960:2012 ratio.

Nice shout-out to Bryan Caplan and his "intellectual Turing test." ;)

Prof. Cowen writes, "Any Martian visiting the economics blogosphere, or for that matter Krugman’s blog, could tell you that most of micro is a more or less manageable topic, whereas macro induces economists to start thinking of each other as idiots and fools."

In response to this claim, here is Rajan himself: "None of this will be easy, of course. Consider how hard it is to improve the match between skills and jobs." Another: "Government programs aimed at skill building have a checkered history. Even government attempts to help students finance their educations have not always worked."

Rajan proposes a few policies: "information" and "counseling" for students about the costs of different programs versus their likely career prospects, subsidies to companies who hire young workers, subsidies and/or some sort of mandatory or tax-sheltered private account for continuing job training and child care for older workers, and tax reform.

It does not seem to me that any of these proposals -- whatever their value to increasing long-term growth -- will cost that much. It also isn't clear they will work. Accordingly, there doesn't appear to be a basis for the dilemma Rajan states at the end: "They can act as if all is well except that their consumers are in a funk and so what John Maynard Keynes called “animal spirits” must be revived through stimulus measures. Or they can treat the crisis as a wake-up call and move to fix all that has been papered over in the last few decades and thus put themselves in a better position to take advantage of coming opportunities."

Why not both?

Rajan explains

Since the growth before the crisis was distorted in fundamental ways, it is hard to imagine that governments could restore demand quickly— or that doing so would be enough to get the global economy back on track. The status quo ante is not a good place to return to because bloated finance, residential construction, and government sectors need to shrink, and workers need to move to more productive work. The way out of the crisis cannot be still more borrowing and spending, especially if the spending does not build lasting assets that will help future generations pay off the debts that they will be saddled with. Instead, the best short term policy response is to focus on long-term sustainable growth.
Fiscal austerity is not painless and will probably subtract from
growth in the short run. It would be far better to phase reforms in over time, yet it is precisely because governments did not act in good times that they are forced to do so, and quickly, in bad times.

If you have a headache, why not shoot yourself in the foot and take an aspirin? Well, because one of those solutions makes things worse.

He says "it is hard to imagine" how fiscal stimulus can work. That's fine but lack of imagination is not an argument, even for a smart guy like Rajan.

Instead, we should be guided by the empirical evidence on what fiscal stimulus has done around the world: as in this or this for instance. If debate would focus more on the evidence and less on "it's hard to imagine", that would be a big improvement in discourse. For instance, your claim that stimulus in the United States would "make things worse" lacks any sort of empirical foundation.

Our nation borrows half its budget and gives it directly to consumers.

I have no idea what people are talking about.

Don't you see? The government could borrow all of its budget and give it freely to anyone who asks, and we'd somehow still either be facing a "demand shortfall" or a mysterious lack of "NGDP" (which looks exactly like spending, but also possesses the magic power of economic stimulus).

Circular reasoning produces circular solutions.

What I liked about Rajan was his claim that it was the industrial policies the last 20 years that caused the problems.

Maybe not industrial policies but other ones that caused the financial crisis.

Am in Ireland currently.

When we walked past the Irish bank regulator, our guide asked us to lower our voices, saying

"Lower you voices. The bank regulator has been asleep for 20 years, and we wouldn't want to wake him up."

Great post. The crux of the matter really is about the short and long term tradeoffs. Krugman's attempts at sweeping that discussion under the rug are rather lame. And yes, the bond market didn't respond as dramatically as some predicted - but all that says is the tradeoff is real. If it did, there wouldn't be as much of a tradeoff. Public debt is a huge problem and there is no guarantee that we won't have other crises in the future that "require" desperate measures. The world is messed up - Europe of course, but also China (most worryingly) and India are looking shaky. We can't pretend that the current crisis is the last crisis we will have and after this is dealt with, it will be smooth sailing.

would not defend Krugman, his position is very questionable but

More substantively, we know a fair amount about promoting growth, for instance read Alex’s The Innovation Renaissance, much of which has been endorsed by left-wing thinkers too. Read the new Acemoglu and Robinson book. Even Robin Wells thinks we know how to promote long-run growth.

is all Tyler at his 'best'

http://charleskenny.blogs.com/weblog/2009/06/the-success-of-development.html ( a link which Tyler provided himself)

somehow they do not know well the recipes to long term growth too.

And if to ask question if a pop book by Alex answers posed questions - the answer is no.

So selling a provocative book of his friend is a good deed, but i cannot see how it makes an argument? is just selling all the things Tyler personally likes is now a case for strong argument?

and finally Acemoglu-Robinson book. Not only they failed to consider IQ ( OK some hate the concept ), but they failed to examine counter argument to their consept. See for example http://www.amazon.com/Printing-Revolution-Early-Modern-Europe/dp/0521447704 - this is a strong case when a technology preceded many institutional changes. There are many other faults with the tone and the content of Acemogly-Robinson work ( it is really strange why such a poor work is still popular - did not economist like to read about printing press changed a world, but maybe about paper http://www.amazon.com/Paper-Before-Print-History-Islamic/dp/0300089554 ? )
maybe the better theory would be some interplay of institutions and technology ( and this is plausible view ) it just makes things too difficult for simple theories of Acemoglu-Robinson ( when they spare themselves from any understanding of how technology works and develops )

so assaulting Krugman with salesman argument is somewhat which does not look as academic discussion

I'm pretty sure the point wasn't just to sell books, but rather that economists of all stripes, embarrassingly including Krugman's wife and editor/rage multiplier, say that they know what will encourage long run growth.

"Krugman’s wife and editor/rage multiplier"


So... if I'm reading Krugman correctly, if we can't see the benefit of a policy in the short term, and the long-term benefits are uncertain, then we ought not enact the policy? How... shortsighted. Of course we weight potential long-term benefits (and liabilities) against more certain short-term effects, but that's what macro is... We make long-term policy on principle, which is why Rajan's post was criticized by some for being too ideological and ephemeral.

All long-term benefits are uncertain.

There's an old saying in my family: The very best time to plant a tree is twenty years ago. The second best time? Right now.

For all the Krugman bashing on this site, if you were an investor and based your investment decisions on the Chicago School crowd over the last 30 years, you'd have a lot less money than if you went with the Krugman crowd. These endless, silly semantic games over what Krugman believes are ridiculous.

I am sorry, is this a discussion about investment banking returns? I must have missed that. Also, did you miss the part where Rajan predicted the crisis?

Enron investors probably disagree.

General Motors investors also disagree.

We also disagree

There is absolutely no reason that I can think of that US government could not fight short run demand shortfall, while simultaneously engaging in structural reforms designed to boost long run productivity. In fact, some of them are complementary. For example, not firing a bunch of teachers is going to address both. Or here is one even better: offer graduates in the top 10% of their class teaching jobs that pay 150 grand a year with the caveat that they have to teach for 5 years or return part of the money. You get a boost in short run demand while improving the quality of the teaching pool.

I just don't understand the false choices. Oh, and just because Rajan forecasted 2008 crisis does not in any way mean he can forecast other things just as well. A broken clock is right twice a day

Teachers are magic.

Indeed. And lack of teachers is dark magic

"Still, any given dollar must be spent somehow and “the stimulus model” and “the long-term investment model” are indeed competing visions for the allocation of resources."

Unless, you know, the Federal Reserve prints more dollars.

I just don't understand why they are competing visions rather than complementary visions

Dollars are resources.

A lot of structural changes don't involve spending, but changing the regulatory structure. Some spending is both good for short term and long term. Makes sense, no ?

To a first approximation they aren't scarce resources, unless we run out of ink and paper.

We might run out of trust.

In the Carboniferous Epoch we were promised abundance for all,
By robbing selected Peter to pay for collective Paul;
But, though we had plenty of money, there was nothing our money could buy,
And the Gods of the Copybook Headings said: "If you don't work you die."

" AD stimulus is/would be less effective with each passing day. Raghu’s case on this point is strong, maybe you don’t agree but I don’t see that the critics have grasped it with sufficient depth."

The first sentence above appears to encourage further AD support (along with whatever else is a good idea to do, including long-run policies). However, when read in combination with the second sentence, it changes a lot in meaning. By endorsing Rajan, who wants to do zero additional AD support, It starts to look like you might be arguing for zero additional AD support. I fear that I am misunderstanding, making a direction vs. destination error. It would help me understand your macroeconomic policy views if you could clarify what role you think short-term AD support should have going forward. I understand it to be somewhere in between "We should do some AD support, but the likes of Krugman are making a mistake by focusing solely on that," and "The time for AD support has passed; Rajan is correct that we should not do any AD support at this point."

Exactly. Please Tyler, enlighten us.

Isn't part of the debate that short run AD types want to gloss over the long run effects (especially the partisan ones) of some of the spending? The right fears that a lot of the stimulus is being spent in ways that may or may not solve AD problems but certainly tilt the structure of the economy in a social democratic/euro socialist direction.

If Krugman thinks the short run AD is so important, why doesn't he propose stimulus measures designed to please the republican Right as a compromise? Instead he sneers. So it means even Mr. AD first wants AD in ways that don't favor his enemies in the long run. Given that environment, some on the right may prefer a stalemate on short run AD if the tradeoff for the long run doesn't serve them well.

I see what you are saying but it doesn't seem to be the case. I think the right opposes BOTH fighting the AD and making long run investments, as long as any of this involves additional government spending that is not part of defense.

For example, does the right support tripling the basic research budget? I don't think so

The left on the other hand, is not really opposed to deregulation where it makes sense. Look at the biggest deregulators of the last 12 years ( hint: Larry Summers )

In the wake of Solyndra/BeaconPower/LightSquared/etc, it's not hard to understand why anyone would be skeptical of gov't "investments." Nor might we expect tripling the basic research budget to produce much economically useful insight -- instead we tend to get more politically-driven junk science like global warming studies that are used as a cudgel by lobbyists to reduce private economic activity.

Long-term investments would be things that improve productivity and create better incentives -- school vouchers, college tuition reform, more sensible regulation, lawsuit reform, SS disability reform, etc.

Lately, we're getting regulations that every pool have a handicap access elevator built into it, that arsenic levels be lowered below natural harmless levels, that small businesses file thousands of 1099s, and that coal plants stop producing nonpollutants.

TallDave: being skeptical of a concept based on 4 hand picked examples is silly. I can pick 4 hand picked examples of private investments being money losers, clearly we would not conclude that private investment is bad based on those 4. Nobody is arguing for government investments ONLY, we are not talking about Soviet Union here.

Fannie Mae / Freddie Mac. At least there is a limit to private investment money

The "etc." implied sundry other examples exist.

Private investors generally lose their own money, not money that was seized from someone else and then distributed by politicians and bureaucrats. No private investor would have funded Solyndra at the point the gov't did, but Obama had already called them the "true engine of economic growth" and they had people calling the WH, so they got funded, in a crooked illegal deal that let politically-connected Solyndra investors walk away with money ahead of taxpayers, no less. Incentives matter.

Oh, we're not talking about outlawing private investment? That's a relief!

Already in Rajan's 2nd sentence he shows that he cannot distinguish between budget constrained household and not budget constrained nations when he proclaims that "Households and countries are not spending because they can’t borrow the funds to do so".

Every country with it's own money can generate as much of it as it wants at will. Look at Japan today. The UK. Look at Israel in the 1960s and 70s. Israel had some 180% debt to GDP, Japan has 220%, and they have and had no trouble to keep the money flowing. Why should they? If "markets" don't want the debt, the central bank can, does and did step in.

Only the Euro countries have robbed themselves of this macro policy route. We need to set up a EU treasury that raises money and doles it out to the states like the US treasury does. We could have full employment in an instant if we only wanted to.

Of course, where to put the money is another question. But "productive work" should be easily found. We could invest 100s of billions into ailing infrastructure and research facilites. 99,999% of possible inventions have not been invented yet.

Fiat currency is not a bottomless well. Just ask Zimbabwe.

Japan will have to deal with this soon. http://www.reuters.com/article/2012/02/17/us-japan-debt-idUSTRE81G0IZ20120217

Infrastructure spending also doesn't always go well:

Nor does gov't do VC very well, as Solyndra demonstrated.

Contrary to popular belief of some, Solyndra represented about 0% of the stimulus bill. Zimbabwe? Really? And the stimulus bill wasn't 'shovel ready projects'. Nearly half the bill was tax cuts, another good chunck was direct income support (food stamps, extended unemployment etc.) A bit of it was topping off spending accounts on things like highway construction/repair and yea in that very limited area you may run into some problems finding good 'shovel ready projects'. And most of stimulus isn't even labelled stimulus by a special law. Someone who lost their job stops paying income tax, that's stimulus. Someone who incurrs a loss on their portfolio and write sit off against other income is stimulus. Someone opting to collect Social Security early because they just don't have the energy to deal with the current impossible job market is stimulus but no special law was passed calling it that.

I notice that a lot of the criticism of AD policies here has nothing to do with AD policies in the real world. It's like someone remembers seeing a picture of a construction dude digging a road in their economics textbook and says 'ahhh that's stimulus'. No it's not stimulus anymore than a photo of a man in a 3-piece suit talking urgently on his cell phone while his secretary takes notes is 'business'. Both are *illustrations* which make for a nice mental picture but if you insist on making too much of them they will start telling you less and less about the real world.

Contrary to popular belief of some, Solyndra represented about 0% of the stimulus bill.

It also represented 100% of the following Obama claim: "Companies like Solyndra will always be the true engine of economic growth." You know, the whole "investment" pitch.

That the government spent so much money losing a billion here and there doesn't really matter does not fill me with confidence. But okay, here's your chance: tell me what amazing things the gov't did accomplish. Wow me.

Someone who lost their job stops paying income tax, that’s stimulus

As opposed to what? Requiring them to continue paying tax on income they don't have?

It also represented 100% of the following Obama claim: “Companies like Solyndra will always be the true engine of economic growth.” You know, the whole “investment” pitch.

Confirming my assertion that your argument is about illustrations rather than substance.

As opposed to what? Requiring them to continue paying tax on income they don’t have?

Well if you lose your job you do still have to pay property tax on yor home. You still have to pay sales tax on the things you have to buy. Numerous taxes do have to be paid without any regard to your income status.

So yes if you had a law that said your property tax bill would be cut in half if you became unemployed for more than a month, that would be stimulus. The thing about income tax is that the tax cut is 'automatic' in that sense. See 'automatic stablizers'

That the government spent so much money losing a billion here and there doesn’t really matter does not fill me with confidence.

This, though, is simply accounting. Nothing was actually spent on Solyndra because the economy was not and is not at full employment. 'Crowd out' is only an issue when the economy is using all its resources, then the gov't tipping the scales for one company means that capital must be taken from some other company to fund it.

That's correct, there was no substance to Solyndra. So, why did they get a crooked deal that ilegally put politically-connected investors ahead of taxpayers?

The point is that no one is suggesting income tax be levied in the absence of income, or even that it's possible. There is no policy there, so that isn't a policy of "stimulus" that's just reality.

This, though, is simply accounting. Nothing was actually spent on Solyndra because the economy was not and is not at full employment. ‘

Oh dear God.

Of course leaving millions people unemployed has structural impacts on the potential growth rate of the economy, with the diminishment of skills, work habits, and social connections. And having a large lumpen proletariat who have dropped out of the labor force does pose social problems. Perhapse we should adopt the Harry Lime solution.

"....You know, I never feel comfortable on these sort of things. Victims? Don't be melodramatic. Look down there. Tell me. Would you really feel any pity if one of those dots stopped moving forever? If I offered you twenty thousand pounds for every dot that stopped, would you really, old man, tell me to keep my money, or would you calculate how many dots you could afford to spare? Free of income tax, old man. Free of income tax - the only way you can save money nowadays..."

This post and links were most helpful for me, as I was having trouble understanding why exactly I was backing Rajan in the first place, despite his problematic points, and you nailed it. The fact that people are uncomfortable with talk about the long term when the short term matters so much - that explains a lot. Off and on for three years I have hammered away at Karl's blog about (potential) long term solutions in spite of his take on 'in the long run we are all dead'. I don't want that to be taken so literally, even though it is true!

I do not understand. There are long-term and there are short-term problems. Then there may be short-term problems that can very well turn into a long-term problems. Ok, now some practical examples. There is a long-term problem of healthcare and social security implicit debt. There is a short term problem with unemployment. And then there is a possibility that if we leave unemployment unattended, then there will be huge issues due to hysteresis effect, people losing their skills turning it into a real - structural long term issue.

Krugman says - let's do both. But first let's solve the short-term problem before it gets out of hand. Then we have another 20 or so years to find out what to do with healthcare and social security. Rajan and Cowen seems to completely ignore any short term problems. He basically says - imagine that we do not have any short-term issues. How would we tackle our long-term issues like healthcare and social security and indebtness? Slashing budgets. So now that I intentionally omitted any short-term issues and used the word "structural" enough times, this is what you should take out of my article - we need to worry about healthcare and budgets now. And if someone like Karl Smith or Krugman goes shrill I can still accuse them of attacking straw man. Neat.

Sorry, but I don't buy it.

But as Rajan points out, the short-term solutions tend to create ever worsening long-term problems, until you end up like the PIIGS.

And that is why Krugman tagged him as one of the "Do-nothing Caucus". The problem is, that all supposedly negative effects of these short-term solutions turned not to be true. Like soaring interest rates. So as I see it, supply-siders have hard time arguing against short-term solutions as presented by some New Keynesians or Market Monetarists. So they turn back to fairy tales - like explaining the depression using Austrian Business Cycle vocabulary and to prevent being seen as complete shrills they salt it with serious looking buzzwords like "long-term sustainability" or "structural reforms". But if you decompose what they actually say about depression, if you filter out these long-term-growth supposed serious "truths", the only thing that stares at you is just unsound theories backed up by pure wishes without any serious data.

That is why Rajan repeats the same "facts" about government regulation (Freddie & Fannie) being behind the housing bubble or fed keeping interest rates "to the bone". He simply does not interact with any criticism by the other side - like analysis of F&F portfolio or claims that low interest rates do not express the stance of monetary policy. He repeats the same refuted arguments over and over again as if they are universally accepted truths.

The problem is, that all supposedly negative effects of these short-term solutions turned not to be true. Like soaring interest rates.

See Greece.

like analysis of F&F portfolio

You might want to re-examine that assumption -- F&F lied about their portfolio holdings, and did not admit their true holdings until the SEC charged them with securities fraud over the lack of disclosure


I support NGDPLT which is the main point I disagree with the essay. However in terms of housing I support modular building components that have technology built into them, which people can readily take apart and resell. People who don't have much money seriously need those options. That's where I have especially sounded like a broken record over at Modeled Behavior when they posted about housing. Plus I believe human capital and knowledge need to be understood differently in terms of wealth. At the very least I felt comfortable expressing those sentiments in a fairly liberal atmosphere. I believe money can solve our problems in terms of physical resources and capital, just not human resources which need new social structures, at local levels, to tackle healthcare and social security issues in the long run.


The fact that people are uncomfortable with talk about the long term when the short term matters so much – that explains a lot

See I think there's the opposite problem here, Rajan is a little too comfortable talking about the long term. It's classical intellectual hubris. Spend hundreds of megabytes presuming to 'solve' all the economies problems over the next 100 years with sophisticated plans and proposals none of which will be implemented and whose ultimate purpose is to simply show everyone how smart the speaker is by spawning now a slew of new jobs but new side debates and discussions for the chattering class to compete for name recognition. Amazingly Krugman's stance is much more modest and much more trusting of the market.

Let AD expand to full employment and the market will decide which sectors workers have to move into and which workers have to move out of. If there are structural issues such as regulations preventing a specially promising sector from expanding to its full potential, it will be much easier to spot and mount a case for addressing. This, of course, leaves people like Rajen out in the cold. Whose he to say, for example, that there's too many people employed building houses and not enough writing apps for ipads? In 2020 if the market wants more ipad apps it will get people to that market, if it wants to have homes with excellent cabinatry in the kitchens it will get people that market instead and Mr. Rajen's thoughts on the matter count not a bit more than yours or mine.

You are right in that it is practically impossible to roll back thousands upon thosands of regulations that now stand in the way of 'circles of sustainability', or settings in which people can actually meet mutual obligations with one another voluntarily. That's why I advocate small city or town sized experiments in which people are able to utilize inexpensive living options so that they have sufficient time to work towards egalitarian solutions for the knowledge based work that everyone wants to take part in, especially as they age and physical labor becomes more difficult. In terms of knowledge based work most needed, everyone gets to partake so that they can do the work without being overloaded by it, such as the post just made here about doctors having to work extremely long hours, and grad students being expected not to have families so as to keep their jobs.

You are right in that it is practically impossible to roll back thousands upon thosands of regulations that now stand in the way of ‘circles of sustainability’, or settings in which people can actually meet mutual obligations with one another voluntarily.

See statements like this make me suspect that Rajan partisans aren't really playing the game here. They are pretending to be talking about macro-economics when in fact they are trying to do what Obama was accused of doing, using a crises as an opportunity. We get it...

You want various regulations scrapped. This guy wants the min. wage abolished. This other guy would like to see school vouchers. You over there want laws to limit labor union power. This guy wants more nuclear plants and blames the EPA for there not being more. She wants oil drilling off the coast of Florida.

This all, though, has nothing to do with the recession. All the stuff you want to carp about was around before 2008 as much as it is now. We had labor unions when the unemployment rate was only 5%. We also had regulations and min. wage laws and public schools and teachers' unions. We had all of that and the world was able to work. So ok we get it, you have a wish list of things you'd like to see but what does that have to do with the depression? Nothing which is why none of the arguments presented by the so-called 'Very Serious People' ever seem to be able to stand up to any scrutiny.

And before you try it, please don't try pulling out the 'well pre-2008 was a mystical bubble so that's why we had 5% unemployment even though we didn't adopt universal school vouchers/oil drilling/min. wage abolishment/union busting laws/etc....' card.

I was already living in my own recession - I have not had a regular job since 2003, at which time I tried as best I could to hang on to both self employment and working for others. Please try to see this situation through the eyes of the marginalized who do not want their world to fall apart around them. As a bookseller, I was worried fifteen years ago that we would lose a lot of knowledge if we did not validate the knowledge and possibilities that each human being actually has. For the past nine years I have tried my best to make sure that does not happen.

I know this is a little bit hopeless, since the different tribes can't even agree on the common facts that are before us (is the current crisis in Europe the result of excessive Government spending in the periphery or is the clearly forseeable result of a monetary union without a Fiscal union by nations with very different levels of productivity economic resources?) but here goes. Tyler states Rajan should be taken seriously because he predicted the coming crisi? Well then, should not Dean Baker, James Galbraith, Steve Keen, and John Quiggin be taken seriously since they to clearly and in depth predicted the crisis, and counter Rajan, believe that he resulting slump is clearly the result of collapse in demand as debtors (private and public) stop spending so as to liquidate their debts, but their creditors do not increase their spending as the seek the safety of cash and cash like instruments (such as U.S. Treasuries and German Bund notes)? http://www.cepr.net/index.php/publications/reports/the-run-up-in-home-prices-is-it-real-or-is-it-another-bubble/; http://paecon.net/PAEReview/issue46/Baker46.pdf; and http://www.guardian.co.uk/commentisfree/cifamerica/2011/dec/19/obama-stimulus-failure-dean-baker; and http://www.google.com/url?q=http://www.aeaweb.org/aea/2011conference/program/retrieve.php%3Fpdfid%3D185&sa=U&ei=gIuqT9n3FIas0AGRxKWFBQ&ved=0CDIQFjAJ&usg=AFQjCNFdMBd8lJAopMkOQh52YTJr3fZ_4w

I start reading Rajan's piece and can hardly make through the first paragraph where I see him making statements that not based on data, on the actual facts of the Irish or Spainish case for instance (where their Governments passively stood by while private lenders and developers borrowed cheap from Germany, the Netherlands, and France to build and buy houses at bubble prices that created massive bad private debts and wasted investment that then became Government liabilities to help out those same German, Dutch, and French lenders - Government policy of a sort I guess, but the Government policy of doing nothing (until the bailout) that libertarians claim they want.) Instead I see a lot of the same AEI and Cato meme spinning that it makes his whole argument suspect in my view. Also, I see a lot of "just so" argument. For instance his claim that "dergulation in the 1980s" in the U.S. created a "productivity" increase. First, as far as I can understand, productivity increases or decreases are still pretty mysterious things as far as I can read. Second, the big result of the 1980s "deregulation" was the Savings and Loan debacle. Trucking and railroad deregulation appeared to have had net positive results (although truck drivers make so little income it is hard to attract new drivers, perhaps the one job field where the there is evidence of shortage), long term consequences of airline deregulation are increasingly debatable.

In the end, the empirical fact that Tyler like Raj's story while Krugman does not, is evidence that it is essentially another tribal argument and chant on behalf fo the freshwater tribe against the saltwater tribe.

It was a very good essay, perhaps more so when you consider it in light of yesterday's graph showing gov't spending hasn't fallen much. His points on the effects of easy credit in the periphery are especially interesting.

I would add the tax effects of incentives to move income from corporate to personal in the 1980s seem to explain a lot of the spreading out of the top of the income distribution.

why no mention of scott sumner? He hates Rajan's piece too.

Again, Tyler's hackish link to Veronique Rugy's hackish chart is another example feeding chum to the libertarians who come to this site for ammunition and stories that confirm "that it is all the damn fault fo the moochers and parasites" who failed to forsee 5 years ago that there was no future in carpentry and plumbing as suggested by Duncan Black. For the actual charts of austerity, see the Economist (that know bastion of Socialism (Not). http://www.economist.com/blogs/freeexchange/2012/05/euro-crisis-0

Also, the "deficits" both in the U.S. and Europe are principally the result of the Great Recession and slow growth, which decrease revenue, while increasing claims on income transfer payments for unemployment (during the Depression, much to his consternation and despite his austerity in 1930-32, caused Herbert Hoover to run deficits. Which FDR used to great political effect 1932, but then fortunately put on hold for a while once he got into office. Unfortunately, he still didn't like having a deficit, so started retrenchmen tin 1936-37, which held caused the relapse of the '37-38 recession). Hence most Keynsians predicted austerity would not lead smaller deficits, but instead could lead to higher deficits as economies contracted.

Yes, if you remove the context of 2002-2009, and then throw in some projections, it looks like there's some really serious spending cuts. In truth, all they've done is cut back to 2007 levels of spending.

The deficits in the U.S. are primarily the result of spending increases.


Note that revenue is still near historic highs as a proportion of the economy.


Karl Smith has explicitly promoted "muddle through" short-term thinking on climate change, so that's not much of a response to him.

Best part of Tyler's post: "One might try to draw a distinction between “once and for all” changes in output and permanent boosts to the rate of economic growth, a’la Solow. In this context, that won’t wash, even if it is otherwise a defensible distinction (debatable). If we could get many “one time” gains today, for five or ten years running, that would be excellent and would boost growth and create jobs, whether or not we would be boosting the rate of innovation twenty years out. {And how Krugman has argued for this last point}"

Excellent. Think about this: we are not at the optimal production possibilities frontier and/or Pareto-Optimal envelope, meaning that "one time" gains are still important for the USA, even aside from the Solow "only technological innovation matters" growth model. Bravo!

Copyright problems aside, as this is "Fair Use" in a scholarly blog where by definition no money is at stake so no lawsuit, I have read all blogs save Krugman's and summarized the views below, with excerpts, to save you, dear reader, the trouble. You're welcome!

Brookes: "The diverse people in this camp — and I’m one of them — believe the core problems are structural, not cyclical. The recession grew out of and exposed long-term flaws in the economy. Fixing these structural problems should be the order of the day, not papering over them with more debt. Make no mistake, the old economic and welfare state model is unsustainable. The cyclicalists want to preserve the status quo, but structural change is coming. " YES BUT BROOKES IGNORES THAT SHORT-TERM AGG. DEMAND (AD) IS DOWN, NOT DUE TO STRUCTURAL ISSUES, WHICH TAKE A LONG TIME TO HAPPEN. SIMPLY PUT--LONG TERM DECLINE IS MEASURED IN DECADES, AS IT HAS SINCE PRODUCTIVITY BEGAN TO FALL IN THE G7 SINCE THE EARLY 1970S. BY CONTRAST, LACK OF AD IS MEASURED IN MONTHS, LIKE THE MONTHS OF SEPT/OCT 2008. SO KEYNES IS RIGHT--WE ARE IN THE SHORT TERM NOW.

Karl Smith: "Is there an area in which our policy initiatives have more consistently failed than in producing long term sustainable growth? Do we even have a consensus on how long term growth got started in the first place? Do we have a solid story to explain growth differentials today? YES, THE SOLOW MODEL. WE NEED MORE BASIC R&D INCENTIVES FOR INNOVATION. NEXT!

Adam Ozimek: "The misunderstanding this generated is unsurprising: it’s worded confusingly. And who knows, maybe I’m the one reading him wrong. In any case, there much else wrong with his piece that, most importantly the incorrect assumption that we can either do long-term reforms or worry about short-term problems. We can do both. Why not, for instance, identify solutions that attack long-term and short-term problems. What magical policy could simultanously address our short-term housing sector weakness (including an oversupply of housing, low house prices keeping homeowners underwater, and a lack of normal construction sector contribution to recovery), long-term demographic problem driven by an aging society, a medium and long-run debt-to-GDP problem, and a shortage of skilled labor? A huge increase in skilled immigration." SPOT ON ADAM! NOTHING MORE TO ADD, YOU NAILED IT. BRING IN THE *SKILLED* IMMIGRANTS AND EVEN KRUGMAN WILL AGREE THAT THEY WILL IMPROVE US GDP (AT THE POSSIBLE EXPENSE OF THEIR HOME COUNTRY)

(BETTER THAN) Ezra Klein (AND SECONDED BY Felix Salmon): "Tyler Cowen is much taken with Raghuram Rajan’s essay arguing that “the West can’t borrow and spend its way to recovery.” I’m not as impressed. Here’s the core idea:

The industrial countries have a choice. They can act as if all is well except that their consumers are in a funk and so what John Maynard Keynes called “animal spirits” must be revived through stimulus measures. Or they can treat the crisis as a wake-up call and move to fix all that has been papered over in the last few decades and thus put themselves in a better position to take advantage of coming opportunities.

I call this “false choice policymaking.” We can focus on the long-term or we can focus on the short-term. Rajan never explains why we have to choose one or the other. What if he had written this paragraph instead?

The industrial countries have a clear path forward. What John Maynard Keynes called “animal spirits” must be revived through stimulus measures. And the crisis must be used as a wake-up call to fix all that has been papered over in the last few decades and thus put themselves in a better position to take advantage of coming opportunities.

Is there anything wrong with that paragraph? Is there a logical flaw in it? A technical mistake? Is there some reason to believe that we can’t have both a larger payroll tax cut now and more emphasis on Race to the Top reforms? Or that rebuilding our infrastructure means we can’t reform our tax code?

Of course not. Rajan has built a straw man here. No one supports stimulus but opposes long-term measures to enhance our competitiveness. The real position he’s arguing with is that “the West should borrow and spend its way to recovery while making the long-term reforms necessary for growth.” "


The problem is that what statists call "long-term measures to enhance our competitiveness," i.e. clean energy, high-speed rail, etc., others believe to be merely wasteful gov't spending, while what free-marketers believe to be ""long-term measures to enhance our competitiveness," i.e. school vouchers, deregulation, lower taxes, less welfare spending, are believed by statists to be misguided if not morally wrong.

From a free marketer perspective, you cannot both increase gov't spending and enhance our long-term competitiveness -- these two things are in direct conflict.

+1 TallDave, I'm a fan of yours, but you gotta give credit to Uncle Sam for penicillin (it was not patented, and only after a massive government R&D project to commercialize it was it made in quantity). And Teflon. Don't forget Teflon.

Apparently mass production was the result of related research into corn liquor.


I'm not sure we should assume things invented in war or defense spending would not have been invented absent war, or not at the cost of other innovations. It seems like a "that-which-is-not-seen" problem.



Tyler, I agree with you on the discount rate. But...

The question is not about how we will use our resources, but that we have resources we're not using, and we are losing them everyday. It does not matter how much we lose, if we still have unused resources, we should use them. It's optimum on the short term and on the long term.

When we are using all our resources we can think about what we'll do with them.

Unless you are talking about the political cost of solving the short term versus the political cost of solving the long term. But you are not, because you did not. But even if you see thing from that angle, you have to consider that using our resources to prevent them from disapearing is optimum on the long term.

I'd like to introduce a new type of 'Godwin-law': every discussion about macro-economics eventually turns into an explanation that Krugman has it all backwards. I would like to call it the 'Krugman-law'.

Why can't we leave the poor man alone?

Here's a legit link wit no paywall:


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