Inflation and unemployment revisited, or where is the deflation?

by  Tyler Cowen in

Ryan Avent has a good blog post, and an associated column, and a post from two days ago, related to an issue I have been discussing, namely if the negative AD shock is so primary and so terrible why have we seen so much price stability and even some mild inflation?  He covers so much ground it is hard to excerpt, so do read the whole thing, here is one summary bit:

The question is: if unemployment and disinflation typically go together, and if central banks effectively prevented disinflation, then why is there still so much unemployment?

I like what Ryan says but would stress some points which he does not relate.  Here you will find Krugman and Martin Wolf on the same topic, again many good points but I don’t think they are addressing the crux of the problem.

The key problem is not how to reconcile observed rates of unemployment and inflation (although that is an interesting issue), rather the key problem is how to reconcile observed rates of inflation with repeated claims made about the relative importance of negative AD shocks as the initial sin.  That’s the elephant in the room.

Again, wage stickiness might explain why “pressures for five percent deflation” might be translated into no more than “actual two percent deflation.”  It will not explain why deflationary pressures are translated into say “1.6% price inflation.”

My take would be this.  Let’s start with a simple AS-AD model and assume the AS and AD curves both shift back to the left.  It’s then easy to get a fall in output and employment without much if any deflationary pressures.

There is no need for “did they forget how to make ice cubes?” jokes or “was the Great Depression caused by soup kitchens?” kind of unperceptive remarks.  Two simple candidates for the AS shocks are increases in the risk premium and credit contraction; I would add TGS-related ideas as well.

For a bit more detail, consider a credit collapse, as we’ve been seeing for instance in Spain.  Due to a evaluation of expectations about the future of Spain and the security of euros in Spanish banks, credit dries up and some small and medium-sized businesses go under or cannot expand.  Sometimes the credit collapse is driven by deposit flight, other times by the need to recapitalize banks, other times by the greater riskiness of the real economy.  A credit collapse is both a negative AD shock and a negative AS shock together.

After all this, you can toss in inflation targeting, if need be, to help explain why so many countries are in the 0-2 percent inflation range.  But in any case the net deflationary pressures are not so strong in the first place.

Krugman, by the way, recently considered the view that both demand-side and supply-side forces might be at work, but his response is hardly an argument at all:

Oh, and one more thing: no, you can’t say “Well, there may be truth to both views”. Either the economy is supply-constrained or it’s demand-constrained. Of course even the most ardent demand-siders will admit that there are supply constraints in there somewhere, that if we had an economic boom we would, after some period of time, enter a regime where printing money is inflationary and government borrowing drive up interest rates. But not here, not now.

There is not much here, other than “Either the economy is supply-constrained or it’s demand-constrained.”  But that’s oddly non-marginalist.  The supply and demand sides interact like Marshallian scissors.  It’s not that one or the other has to be some kind of immoveable wall, or vertical curve, beyond which the other cannot budge.  A few seconds looking at shifts of AD and AS curves, as mentioned above, can establish this.

In sum, there is no big puzzle once we recognize that significant AD and AS shocks have been at work.

A short history of economics at U. Mass Amherst

by  Tyler Cowen in

From Dylan Matthews.  Here is an excerpt:

The tipping point, Wolff says, was the denial of tenure for Michael Best, a popular, left-leaning junior professor. “He had a lot of student support, and because it was the 1960s students were given to protest,” Wolff recalls. That, and unrelated personality tensions with the administration, inspired the mainstreamers to start leaving.

That created openings, which, in 1973, the administration started to fill in an extremely unorthodox way. They decided to hire a “radical package” of five professors: Wolff (then at the City College of New York), his frequent co-author and City College colleague Stephen Resnick, Harvard professor Samuel Bowles (who’d just been denied tenure at Harvard), Bowles’s Harvard colleague and frequent co-author Herbert Gintis, and Richard Edwards, a collaborator of Bowles and Gintis’s at Harvard and a newly minted PhD. All but Edwards got tenure on the spot.

…Under those five’s guidance, the department came to specialize in both Marxist economics and post-Keynesian economics, the latter of which presents itself as a truer successor to Keynes’s actual writings than mainstream Keynesians like Paul Samuelson. “When I got there, the department basically had three poles,” said Gerald Epstein, who arrived as a professor in 1987. “There was the postmodern Marxian group, which was Steve Resnick and Richard Wolff, and then there was a general radical economics group of Sam Bowles and Herb Gintis, and then a Keynesian/Marxian group. Jim Crotty was the leader of that group.” Suffice it to say, most mainstream departments have zero Marxists, period, let alone Keynesian/Marxist hybrids or postmodern Marxists.

Are wealth-motivated people less likely to help?

by  Tyler Cowen

According to one recent study, no:

A new study with business students at Loyola University challenges this narrative. In contrast to the 2008 paper, Michael Babula‘s study measured actual behaviour. The fifty students completed questionnaires about their religiosity and desire for wealth, then they headed, one at a time, across the building to give a short presentation, either about careers for economics students or about the relevance of the Good Samaritan parable to their future career.

Before they headed over to give their speech, half were told to hurry, time was short; the others were told there was no rush. Then, just before they reached the lecture room, a distressed, anxious stranger approached them. This person had just heard news that a relative had had an accident, but now their mobile phone had run out of battery and they had no change for a public pay-phone. The key test was whether and how much each student would offer to help the stranger in distress.

Seventy-eight per cent of the business students offered some kind of help to the stranger. Sixty-six per cent went so far as refusing to leave the stranger or giving him/her their mobile phone. The degree to which the students reported being wealth-driven was not associated with their levels of helping. Neither was their self-reported willingness to accept an illegal stock trading tip off. Being in a hurry also made no difference, neither did the content of the speech they were about to give. A factor that was linked with helping behaviour was “intrinsic religiosity” – that is, pursuing religion as an end in itself, not for the sake of status or other gain.

You will note this is a small sample and just a single experiment.

Michael Pollan’s *Cooked: A Natural History of Transformation*

by  Tyler Cowen in

Here is the bottom line:

The premise of this book is that cooking — defined broadly enough to take in the whole spectrum of techniques  people have devised for transforming the raw stuff of nature into nutritious and appealing things for us to eat and rink — is one of the most interesting and worthwhile things we do.

This is a highly thoughtful book, and I enjoyed the lengthy discussion of fermentation and fermented foods.  My favorite puzzle posed is the question of why fermented foods are so frequently matters of acquired taste across cultures.  Yet overall the book is missing a sharpness of argumentation or novelty of perspective which I look for in works of this kind.  You can order the book here.  Here is a useful Laura Miller review of the book.  Here is a NYT review.  Here is Mark Bittman coverage.  Here is an excerpt from the book.

Fiscal consolidation in earlier British history

by  Tyler Cowen in

Martin Wolf writes:

In 1816, the net public debt of the UK reached 240 per cent of gross domestic product. This was the fiscal legacy of 125 years of war against France. What economic disaster followed this crushing burden of debt? The industrial revolution.

There is more here, gated by the FT.  This is an excellent point but I will ask whether this is an argument for or against fiscal consolidation (without meaning to suggest that the British should raise taxes further or borrow less right now).  The industrial revolution is a tough act to pull off again.  By the way Martin reports:

Between 1815 and 1855, for example, debt interest accounted for close to half of all UK public spending.

The broader numbers are interesting too.  During the 19th century British consols generally yielded three to four percent.  By Wolf’s account British growth was about two percent for the first half of the 19th century.  So there was in fact some fiscal consolidation, because at those differential numbers growing out of the debt will not work.  Note for instance that during the 19th century Britain introduced or expanded some fundamentally new methods of taxation, such as the income tax.  In this sense the scope for “do it on the path toward larger government” fiscal consolidation was unprecedented and could not be replicated today.

What actually pulled Britain out of its debt problem was the Victorian growth spurt in the third quarter of the 19th century, which I consider part of the most revolutionary period of technological progress in all of human history.  Again, that may be hard to replicate.

There is good evidence that the British experienced crowding out of capital investment during their period of peak debt (pdf) and in that sense the burden was paid all along.  That situation is different today.

Your mileage on this one may differ, but in the 19th century Britain ran a regular balance of payments surplus.

There is also this (pdf):

Britain managed its huge national debt by relying on debt instruments (“consols” and similar bonds) that were perpetual yet callable. That meant that sudden spikes in interest rates, associated with wars or financial crashes, had limited impact on government solvency. Compare this to the danger that Italy and other European countries are facing, with the need to refinance over the next few months large fractions of their (much smaller) national debts. There was certainly a cost in terms of higher interest rates to British financial policy. But in retrospect one can argue that British authorities were wise to take that course, and that in general they were smarter than ours not to be deluded by the promises of liquid and rational markets, and were prepared for upheavals. For all the sophistication of our economic theory, our ancestors may have been more sophisticated than we are in truly understanding how the world works.

Very long-term debt is perhaps not such a bad idea today.

I do very much oppose the tax increases which have been chosen recently by the United Kingdom, and the switch in the content of public expenditure away from investment, and in that sense I agree fully with Wolf.  And of course today’s British debt/gdp ratio is not near 250%.  Nonetheless, when it comes to drawing conclusions about fiscal policy over the next ten to twenty years, the historical example of the 19th century can cut either way.

Are the empathetic dogs also the deceptive dogs?

by  Tyler Cowen in

That is one recent hypothesis which has come out of the “Dognition” program:

“One hypothesis has already emerged from Dognition’s users, Dr. Hare said. A surprising link turned up between empathy in dogs and deception. The dogs that are most bonded to their owners turn out to be most likely to observe their owner in order to steal food. “I would not have thought to test for that relationship at Duke, but with Dognition we can see it,” said Dr. Hare.”

The article is here, and I thank Vic Sarjoo for the pointer.

TED talks on innovation and automation

by  Tyler Cowen in

Here is Robert Gordon’s talk “The death of innovation, the end of growth.”

He stakes out the untenable position that economic growth is over (please do note that my TGS is relatively optimistic about the future).  To make one quick point in rebuttal, Gordon considers only national demographics.  Ask yourself a different question: circa 2013, are there more young global geniuses with a chance to make a difference, as compared say to 1969 or for that matter 1995?  People sometimes caricature my views as suggesting we have run out of new discoveries (the subtitle of my book should belie that), but that description actually seems to fit Gordon.

Erik Brynjolfsson has a contrasting talk, “The key to growth: The race with the machines.”  I mostly agree with Erik about the future (though not about the last forty or so years), but I worry about how he conflates “restructuring productivity” with the actual creation of new ideas as we attempt to measure them through total factor productivity.  I also don’t think that free goods much overturn the measured wage stagnation of recent times, infovores aside of course.

In any case both talks are very much worth a view, self-recommending as they say.

Toward a parallel market in Cypriot euros

by  Tyler Cowen in

Some people are trying to get this off the ground, although the legal issues appear to be murky:

Is your cash stuck in a Cypriot bank? Someone might be willing to take it off your hands.

Distressed-debt investors and brokers are circling Cyprus, the Mediterranean island that last month plunged its two main banks into an emergency restructuring and blocked thousands of depositors from touching all their money.

The idea: investors buy frozen bank deposits, at a discount. Depositors who need access to their money get a payoff immediately, instead of waiting months or years for the bank restructuring to be completed. Investors get a shot at a big payoff down the line.

The article is here, and hat tip goes to @RobinWigg.

Assorted links

by  Tyler Cowen

1. 6,297 Chinese restaurants and hungry for more.

2. Article on Chwe and Jane Austen.

3. There is no great stagnation (plastic finger tripods for eating messy foods), and is this the first time I have linked to The Onion?

4. Predictions by Eric Schmidt and Jared Cohen.  Tesla’s predictions for the 21st century.

5. On Hadji Murad.

6. Mankiw on Reinhart and Rogoff, and Ryan Avent on same, and now we are getting somewhere: “To me, the most interesting question is why it is so politically difficult to sustain appropriately accommodative monetary or fiscal policy.”  Most of the current discourse on that latter and all-important question is of low quality.

Subsistence economies and surplus economies

by  Tyler Cowen in

I am not sure this paper (pdf) is sound, and it is hardly in publishable form.  Still, it probably qualifies as the most interesting paper I have read this year to date.  It is by Lemin Wu, graduate student in economics at UC Berkeley, who appears to have links to Brad DeLong and Peter Lindert.  The title is “Millennia of Poverty: If Not Malthusian, Then Why?” and here is the abstract:

Living standards were constant for thousands of years before the industrial revolution. Malthus explained it this way: population grows faster when living standards rise; therefore, changes in technology alter the density of population but not the average welfare. This paper challenges Malthus’s explanation of the constancy and replaces it with the theory of group selection.

Malthusian theory is inadequate because it misses the fact that a dollar’s worth of diamonds contributes less to survival and reproduction than a dollar’s worth of grain. Grain is a subsistence commodity and a diamond is a surplus commodity. The Malthusian force anchors the average level of subsistence, but not that of surplus. If the surplus sector had grown faster than the subsistence sector, then living standards could have grown steadily before the industrial revolution, but they did not. The constancy of living standards thus implies that growth was balanced between subsistence and surplus, something Malthus did not explain.

To explain the balanced growth, I propose the theory of group selection. Selection of group characteristics, including culture and technology, goes on by migration and conquests. Since living standards rise with the ratio of surplus to subsistence, migrants and invaders usually move from places relatively rich in subsistence to those relatively rich in surplus. They spread the culture and technology of their subsistence-rich origin to the surplus-rich destination – the bias of migration favors the spread of subsistence over that of surplus. Even if surplus cultures and technologies would develop faster than subsistence ones in a local environment, the o setting biased migration balances the two sectors on a global scale. This explains the constancy of living standards.

My new theory reinterprets why living standards declined after the Agricultural Revolution and stagnated afterwards, how the Industrial Revolution happened and where the prosperity of Roman Empire and Song Dynasty came from.

I expect to hear more from Lemin Wu.

The paper is here (pdf), the slides to the paper are here, more pdf and 100 pp. at that.  I first saw this cited by @mattyglesias.

How good are schools in Guinea-Bisseau?

by  Tyler Cowen in

Not that good.  Here are some new results from Peter Boone, Ila Fazzio, Kameshwari Jandhyala, Chitra Jayanty, Gangadhar Jayanty, Simon Johnson, Vimala Ramachandrin, Filipa Silva, Zhaoguo Zhan:

We conducted a survey covering 20% of villages with 200-1000 population in rural Guinea-Bissau. We interviewed household heads, care-givers of children, and their teachers and schools. We analysed results from 9,947 children, aged 7-17, tested for literacy and numeracy competency. Only 27% of children were able to add two single digits, and just 19% were able to read and comprehend a simple word. Our unannounced school checks found 72% of enrolled children in grades 1-4 attending their schools, but the schools were poorly equipped. Teachers were present at 86% of schools visited. Despite surveying 351 schools, we found no examples of successful schools where children reached reasonable levels of literacy and numeracy for age. Our evidence suggests that interventions that raise school quality in these villages, rather than those which target enrollment, may be most important to generate very sharp improvements in children’s educational outcomes.

On the bright side here are some true chances for low-hanging fruit.