Category: Economics
Circa 1961, or, the more things change…
At the August FOMC meeting, Young reported on a lengthy discussion at OECD of West Germany's persistent surplus. The economic solution required either German inflation, additional revaluation of the mark, or deflation elsewhere. The German delegation rejected inflation and revaluation…
That is from Allan Meltzer's History of the Federal Reserve, volume 2, book 1, 1951-1969.
Krugman on Cowen and Germany
Let's consider Krugman's three main points:
1. This was not an effort at fiscal stimulus; it was a supply policy, not a demand policy. The German government wasn’t trying to pump up demand — it was trying to rebuild East German infrastructure to raise the region’s productivity.
2. The West German economy was not suffering from high unemployment — on the contrary, it was running hot, and the Bundesbank feared inflation.
3. The zero lower bound was not a concern. In fact, the Bundesbank was in the process of raising rates to head off inflation risks — the discount rate went from 4 percent in early 1989 to 8.75 percent in the summer of 1992. In part, this rate rise was a deliberate effort to choke off the additional demand created by spending on East Germany, to such an extent that the German mix of deficit spending and tight money is widely blamed for the European exchange rate crises of 1992-1993.
On #1, policymakers may intend all kinds of results, including a new skat table for Onkel Mathias and bananas for Brandenburg. The scenario nonetheless saw a big boost in debt, spending, and aggregate demand, and in a setting with unemployed resources. That makes it one test case, even if the primary motive was the unification of Germany and not stimulus per se.
On #2, you willl find data on German unemployment rates here, for each half of the country and consolidated. In the West there is unemployment before unification, a big boost in employment during the first two years of unification, and then much higher unemployment.
Let's track those rates, starting in 1989: 7.9, 7.2, 6.2, 6.4, 8.0, 9.0, 9.1 (1995), 9.9, 10.8, 10.3, etc.
You can read those numbers two ways. First, stimulus worked until they lost heart, or "it boosts the economy in the short run but it postpones adjustment problems and in the medium run you end up with a poor and sluggish private sector job market." I was making the simpler historical-explanatory point that, no matter how you slice and dice the data, the poor outcome in absolute terms explains why the Germans are not so impressed by ideas of debt, spending and aggregate demand. And if stimulus proponents keep on losing heart at the critical moments, the citizenry is still right to be skeptical.
The real story requires a look at the tottering East German labor market as well. At the immediate moment of unification, unemployment/underemployment for the consolidated Germany are higher than the above numbers behind the link indicate; read for instance these comments and also here.
The strongest criticism of the example is not one that Krugman considers. If you had access to a more finely calibrated employment index, reflecting the gross underemployment of DDR workers, with continually collapsing jobs, there is at least some chance the true data series might show more effectiveness for fiscal policy than the published data, or the West German mood at the time, would indicate.
#3, like #1, is a distraction. The zero bound might — in some frameworks — make fiscal policy necessary rather than monetary policy. But the zero bound is not required to drive the main arguments that fiscal policy is effective with unemployed resources. So historical examples with a non-zero bound and ineffective fiscal policy do count against fiscal policy.
As an aside, you can find some RBC and cash constraint models where fiscal policy is more effective at the zero bound, but a) I think these papers are deeply flawed, b) the liquidity constraints in those models do much of the work and those constraints held anyway for parts of East Germany, and c) Krugman and others are advocating fiscal policy for a wide variety of economies, not all of which are at the zero bound, even if they have constrained monetary policy for other reasons, such as Ireland.
On #3, Krugman is correct that the Bundesbank actions hurt the German economy (though keep in mind, at the time of tightening in 1992 the rate of German price inflation was five percent and it stayed at 4.4 percent the year after). This implies that tight monetary and loose fiscal policy, taken together, won't work. I endorse that conclusion. It also shows that the monetary authority moves last, which is exactly the point made by fiscal policy critics such as Scott Sumner. Stressing that point does no favors to the argument for fiscal expansion, quite the contrary. Krugman is eager to slap down the historical example but he is losing track of the broader principle he cites to do so.
Overall the pro-ramp-up-the-spending fiscal policy advocates are keener to produce examples which don't count than examples which do count. The positive arsenal is pretty weak, consisting mainly of World War II, an experience which cannot be repeated or replicated.
Krugman also directs his attention at a secondary point in the argument, taking up a single paragraph in the column. He doesn't touch the main point: Germany cut off fiscal stimulus early and focused on the real economy and they're doing fine. Even if you think this prosperity is at the expense of others (and I don't), the pro-ramp-up-the-spending-stimulus view suggests that Germany itself should be ailing, yet it isn't. Here are further good comments on that topic.
On the main point of the column, you can find some good criticisms from Ryan Avent, though I would stress it is exports not stimulus that led the German recovery and that Germany is not obviously due for a spill.
Zero marginal product workers
Matt Yglesias suggests the notion is implausible, but I am surprised to read those words. Keep in mind, we have had a recovery in output, but not in employment. That means a smaller number of laborers are working, but we are producing as much as before. As a simple first cut, how should we measure the marginal product of those now laid-off workers? I would start with the number zero. If a restored level of output wouldn't count as evidence for the zero marginal product hypothesis, what would? If I ran a business, fired ten people, and output didn't go down, might I start by asking whether those people produced anything useful?
It is true that the ceteris are not paribus, But the observed changes if anything favor the hypothesis of zero marginal product. There has been no major technological breakthrough in the meantime. If anything, there has been bad monetary policy and a dose of regulatory uncertainty. And yet again we can produce just as much without those workers. Think of "labor hoarding" yet without…the hoarding.
You might cite oligopoly models and argue that the workers can produce something, but firms won't hire them because they don't want to expand output, due to lack of demand. That doesn't seem to explain that output has recovered and that profits are high. And since there is plenty of corporate cash, it is hard to claim that liquidity constraints are preventing the reemployment of those workers.
There is another striking fact about the recession, namely that unemployment is quite low for highly educated workers but about sixteen percent for the less educated workers with no high school degree. (When it comes to income groups, the lowest decile has an unemployment rate of over thirty percent, while it is three percent for the highest decile; I'm not sure of the time horizon for that income measure.) This is consistent with the zero marginal product hypothesis, and yet few analysts ask whether their preferred explanation for unemployment addresses this pattern.
Garett Jones suggests that many unemployed workers are potentially productive, but that businesses do not, at this moment, want to invest in future productive improvements. The workers only appear to have zero marginal product, because their marginal product lies in future returns not current returns. I see this hypothesis as part of the picture, although I am not sure it explains why current unemployment is so much higher among the unskilled. Is unskilled labor the fundamental capability-builder for the future? I'm not so sure.
It's also interesting to look at the composition of the long-term unemployed (not the same as the composition of all the unemployed, of course). Older workers with a college education are quite stuck, conditional on their being unemployed. And in this group, more education predicts a longer spell of unemployment. Is this ongoing "recalculation," optimal search theory, or is the roulette wheel simply coming up zero each time it is spun for these workers? Maybe a bit of each. If you want, call some of it age discrimination and relabel the idea "perceived zero marginal product."
In general, which hypotheses predict lots more short-term unemployment among the less educated, but among the long-term unemployed, a disproportionately high degree of older, more educated people? This stylized fact seems to point toward search and recalculation ideas, with some zero marginal products tossed in. Do aggregate demand theories yield that same data-matching prediction? I don't see it, at least not without being paired with a theory of concomitant real shocks.
Nothing in the zero marginal product hypothesis requires that these marginal products be zero forever. As the entire economy expands more rapidly (when will that happen?), the value of even a low quality worker can quickly become much higher. If you are opening up a new building, suddenly you really need that extra janitor and he is indeed more productive at the new margin.
Some people identify the zero marginal product hypothesis with the "hopeless dregs of the earth" description, but the two are not necessarily the same. Complementarity, combined with some fixed initial factors, can yield zero or near-zero marginal products of labor. (You'll see the phrase "excess capacity" used in this context, though that matches the oligopoly hypothesis more closely.) The "dregs of the earth" view is pessimistic, but the complementarity version of the zero marginal product idea can be quite optimistic, predicting a very rapid recovery in the labor market, once the interactions turn positive.
The "dregs" and the "complementarities" views also have different policy recommendations. The dregs view implies either hopelessness or a lot of fundamental retraining or ongoing assistance, while the complementarity view leads one to ask how we might mobilize positive complementarities (rather than leaving orphaned factors of production) more quickly. Perhaps there are some fixed factors, such as managerial oversight, and entrepreneurs do not want to strain those fixed factors too hard. How can we make such fixed factors more replicable or more flexible?
Addendum: Arnold Kling comments.
What Germany knows about debt
Here is my latest NYT column, excerpt:
Far from embracing this social democratic model, American Keynesians have criticized it for relying too heavily on exports and not enough on spending and debt. Yet it is not just the decline in the euro‘s value that supports the German resurgence.
Most of the other euro-zone economies are not having comparable success because they did not make the appropriate investments and reforms. Moreover, the euro is still stronger than its average value since 2001, which suggests that the recent German success is not attributable only to a falling currency.
In any case, the Germans are exporting much quality machinery and engineering (not just glitzy autos), which can help other nations recover. It is an odd state of affairs when the relatively productive nations are asked to change successful policies because of an economic downturn.
I would add a few points:
1. I am not sure why the American left so near-unanimously lines up behind Keynesian recommendations these days. (Jeff Sachs is an exception in this regard.) There are other social democratic models for running a government, including that of Germany, and yet a kind of American "can do" spirit pervades our approach to fiscal policy, for better or worse. Commentators make various criticisms of Paul Krugman, but putting the normative aside I find it striking what an American thinker he is, including in his book The Conscience of a Liberal. Someone should write a nice (and non-normative) essay on this point, putting Krugman in proper historical context.
2. You sometimes hear it said: "Not every nation can run a surplus," or "Can every nation export its way to recovery?" Reword the latter question as "Can every indiviidual trade his way to a higher level of income?" and try answering it again. Productivity-driven exporting really does matter, whether for the individual or the nation. It stabilizes the entire global economy,
3. There really is a supply-side multipler, and a sustainble one at that.
4. The phrase "fiscal austerity" can be misleading. Contrary to the second paragraph here, even most of the "austerity advocates" think that the major economies should be running massive fiscal deficits at this point. (And Germany had a short experiment with a more aggressive stimulus during the immediate aftermath of the crisis.) They just don't think it works for those deficits to run even higher.
5. The EU is an even less likely candidate for a liquidity trap than is the United States. That said, how to distribute and implement additional money supply increases would be a serious political problem for the EU. Simply buying up low-quality government bonds would work fine in economic terms, but worsen problems of moral hazard, perceived fairness, and so on. This problem should receive more attention.
Markets in Everything: A Puzzle
“Shared social responsibility” as a path to greater profit?
At a theme park, Gneezy conducted a massive study of over 113,000 people who had to choose whether to buy a photo of themselves on a roller coaster. They were given one of four pricing plans. Under the basic one, when they were asked to pay a flat fee of $12.95 for the photo, only 0.5% of them did so.
When they could pay what they wanted, sales skyrocketed and 8.4% took a photo, almost 17 times more than before. But on average, the tight-fisted customers paid a measly $0.92 for the photo, which barely covered the cost of printing and actively selling one. That’s not the best business model – the company proves itself to be generous, it’s products sell like (free) hot-cakes, but its profit margins take a big hit. You could argue that Radiohead experienced the same thing – their album was a hit but customers paid relatively little for it.
When Gneezy told customers that half of the $12.95 price tag would go to charity, only 0.57% riders bought a photo – a pathetic increase over the standard price plan. This is akin to the practices of “corporate social responsibility” that many companies practice, where they try to demonstrate a sense of social consciousness. But financially, this approach had minimal benefits. It led to more sales, but once you take away the amount given to charity, the sound of hollow coffers came ringing out. You see the same thing on eBay. If people say that 10% of their earnings go to charity, their items only sell for around 2% more.
But when customers could pay what they wanted in the knowledge that half of that would go to charity, sales and profits went through the roof. Around 4.5% of the customers asked for a photo (up 9 times from the standard price plan), and on average, each one paid $5.33 for the privilege. Even after taking away the charitable donations, that still left Gneezy with a decent profit.
The full article is here and I thank Michelle Dawson for the pointer.
*Jimmy Stewart is dead*
So says Larry Kotlikoff, in his new book, entitled Jimmy Stewart is Dead: Ending the World's Ongoing Financial Plague with Limited Purpose Banking. It's lively and polemic, and suddenly it lurches into a proposal to reform financial intermediation:
Under limited purposes banking the banks are themselves simply financial intermediaries, while their mutual funds represents mini-banks, if you like, all of which are subject to 100 percent capital requirements.
Explained another way, you hold liquid securities directly and cut out the middleman of the lending bank. It's like expanding the idea of a checkable money market mutual fund to cover the retail banking sector. Here is his short Op-Ed on the idea, here is a Business Week article, and here are numerous endorsements for the book. See also Bob Litan on "narrow banking."
I used to advocate a version of this idea myself, but I no longer think it is a good reform proposal, for a few reasons:
1. There aren't enough safe, liquid assets to cover the stock of bank deposits. There would be even fewer safe, liquid assets if fiscal conservatives had their way. And we've now learned that the commercial paper market can seize up and shut down and AAA securities aren't always so safe.
2. Holding T-Bills eliminates the need for the bank intermediary and the resulting problems of moral hazard. But remember — these ends are achieved only by lending that money to the government. What's the old saying?: out of the frying pan, into the fire…
3. A lot of what current banks do would be replicated by non-bank commercial lenders and the risk of the banking sector would be transferred somewhere else. Ideally, these non-bank lenders would engage in greater "maturity-matching," but if banks will exploit the moral hazard problem won't these lenders exploit it too? The financial crisis very much changed my mind on this question. Can't such lenders, to policymakers, appear "too big to fail" in the same way that standard banks do? Are General Motors, AIG, and GE Credit really the path to future financial sector safety? Maybe there is room for improvement, by using more commercial lending, but it is murky and I no longer see a clear gain in this regard.
Here, by the way, is a Bert Ely critique.
The world’s largest database of job openings for economists
It is here and the bottom line is this:
Starting from today, walras.org and VoxEU.org have joined forces to form the largest global database of job openings for PhD economists. Any job posted on walras.org is automatically also posted on VoxEU’s new job market database, which can be accessed by clicking here.
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The speed of labor market adjustment
Ezra Klein reports:
Notice that adding new jobs at a rate of 200,000 a month would take us 150 months — or 12.5 years — to get back to normalcy. So far, only April has seen more than 200,000 in non-census jobs growth — and even then, just barely.
This in my view is a puzzle for all theories of labor market adjustment. Why does it take so long? This isn't one of those West European scenarios where, due to benefits, being unemployed is permanently somewhat attractive alternative for some subset of the work force. Nor is the United States a country where employers cannot fire recalcitrant workers.
If monetary velocity fell by eleven percent, is it the view of the Keynesians that the required nominal wage adjustment takes so many years? Hysteresis means that unemployment gets "baked in" to some extent, but if anything you might expect that to speed up shorter-term adjustment in the work force, to avoid such a fate.
Does the required "recalculation" take so long? I find myself coming back to the view that many previously employed workers simply have a current marginal product pretty close to zero.
Addendum: Arnold Kling comments.
Excludability depends on technology
Eric Crampton alerts me to the following idea:
Design student Fabian Brunsing has devised a fiendish device that makes pay toilets seem positively munificent: Dubbed “Pay & Sit: The Private Bench,” it consists of a bench covered with retractable metal spikes and a coin slot. If you want to sit down on the bench without an array of spikes jamming you in the keister, you’ve got to pay €0.50 (about 70 cents US).
As seen below, this causes the spikes to retract so you can sit on the bench, and also activates a timer. Shortly before the timer expires, you’re warned by a buzzer to get up; then, the spikes shoot back up. Beware!
Of course actual privatized benches, as you might find them in a shopping mall, do not usually embed this device.
Is Creativity Declining?
Nobody would argue that Torrance’s tasks, which have become the gold standard in creativity assessment, measure creativity perfectly. What’s shocking is how incredibly well Torrance’s creativity index predicted those kids’ creative accomplishments as adults. Those who came up with more good ideas on Torrance’s tasks grew up to be entrepreneurs, inventors, college presidents, authors, doctors, diplomats, and software developers. The correlation to lifetime creative accomplishment was more than three times stronger for childhood creativity than childhood IQ.
Like intelligence tests, Torrance’s test–a 90-minute series of discrete tasks, administered by a psychologist–has been taken by millions worldwide in 50 languages. Yet there is one crucial difference between IQ and CQ scores. With intelligence, there is a phenomenon called the Flynn effect–each generation, scores go up about 10 points. Enriched environments are making kids smarter. With creativity, a reverse trend has just been identified and is being reported for the first time here: American creativity scores are falling.
From Newsweek. I am not at all convinced that creativity is on the decline. The study cited seems to be unpublished and there isn't much on the author's website which is a little, well, too creative for my tastes. Nevertheless, the Torrance test and its correlation with lifetime creative is interesting and a good reminder of what IQ tests do not reveal. I also liked this bit:
When faculty of a major Chinese university asked Plucker to identify trends in American education, he described our focus on standardized curriculum, rote memorization, and nationalized testing. “After my answer was translated, they just started laughing out loud,” Plucker says. “They said, ‘You’re racing toward our old model. But we’re racing toward your model, as fast as we can.’ “
How should we define money? (warning: this post is pure semantics)
E. Barandiaran writes in the comments:
Tyler, I hope that tomorrow (7/14) you read this comment about Arnold Kling's challenge to BC: define money that meets two requirements. Please tell AK that his two requirements were the same that Milton F. argued for the QT of M to make sense –but as anyone familiar with the history of Milton's version knows, he failed miserably. I'm still waiting your definition of money.
Arnold Kling writes:
So my challenge for Bryan (and for the rest of the profession, because I am the one who is out on a limb on this) is to come up with a definition of money that satisfies two criteria. First, your monetary aggregate is correlated with nominal GDP in a reliable way (with "reliable" including that if you were to target it, the relationship would not fall apart). Second, the Fed controls that monetary aggregate reasonably closely.
No definition of money fits Arnold's challenge (though Bryan argues for the monetary base) and I'm not going to offer a single definition of money, period. I see money first as a medium of account and then as an option on purchasing goods and services. As an option, "money" is more like "credit cards" than many economists might find comfortable, but so be it. No single number very well summarizes the quantity or outstanding value of the money supply, properly understood to include the option value of lines of credit but also the option value of currency and bank reserves. (Bill Barnett promotes "divisia indices," which I view as a nice try to a hard-to-solve problem.)
That said, a large, exogenous shift in the money supply will raise the general level of prices. There is overwhelming evidence for that proposition (check out my macro Principles text with Alex, for one good chart, or visit Zimbabwe). If some mix of currency, bank reserves, and useful lines of credit go up, prices will go up too, in very rough proportion, no matter what the exact measure of the money supply should be.
A lot of the better criticisms of the quantity theory play off of whether "money" is exogenous in the first place. Many of the points of these critics are well-taken, but still a properly specified exogenous boost in the money supply will bring the traditional quantity theory result. You just don't have to see that exogenous shift as the only relevant scenario for all real world monetary economics.
I see this post as "a lot of words." I'm not saying much, I am just trying to limit how much other people's words confuse you.
On the quantity theory, I recommend reading and studying Arthur Marget's A Theory of Prices, especially volume II. Marget was a penetrating thinker who understood his chosen topics better than anyone else and who was very good at pulling out the deep truths in apparently simple propositions. I think of him as the Scott Sumner of his day, minus a blog.
Gender Parity in Schooling Around the World
The world has reached gender parity in schooling and in a few years we will see a schooling ratio in favor of women. Using UNESCO statistics (more detail here) on school life expectancy, the average country has a parity level of 1.01 in favor of women or, weighting by population, .991. In other words, at current rates women can be expected to get the same number of years of education as men, as a world average.
Equal life expectancy of schooling on a world level does not mean that all is well – basically we have a relatively small number of countries in which women get much less education than men and a large number of countries in which women get somewhat more education than men. On the vertical axis in the figure below (click to enlarge) is total life expectancy in school and on the horizontal axis the ratio of female to male life expectancy in school. The figure tells us a number of interesting things. First, the largest imbalances are against women and these tend to occur in countries with a low level of total education. South Korea is an interesting outlier.
Second, in India parity is below 1 and in China it is above 1. In India female school life expectancy increased by a huge 2.5 years between 2000 and 2007 and the parity ratio increased from .77 to .9 so we can expect the (weighted) world parity level to easily tip over 1 in the next few years (if it has not done so already). The graph suggests that a ratio around 1.09 is the "norm" towards which countries are trending with development.
Interestingly, some of the Muslim countries, such as Pakistan and Afghanistan (no data for 2007-2008 but in 2004 the parity ratio was less than 0.5), are below parity but Qatar and Iran have some of the highest ratios in the world, both above US levels.
Are we relying too much on behavioral economics?
George Loewenstein and Peter Ubel say yes. Often there is no nudge-based free lunch and we need a straightforward relative price shift:
Behavioral economics should complement, not substitute for, more substantive economic interventions. If traditional economics suggests that we should have a larger price difference between sugar-free and sugared drinks, behavioral economics could suggest whether consumers would respond better to a subsidy on unsweetened drinks or a tax on sugary drinks.
But that’s the most it can do. For all of its insights, behavioral economics alone is not a viable alternative to the kinds of far-reaching policies we need to tackle our nation’s challenges.
There is much more here, hat tip to Mark Thoma. Loewenstein, of course, is one of the pioneers of…behavioral economics. (If you're wondering, I don't agree with a number of their examples, but I do agree with their overall point.)
*Vietnam: Rising Dragon*
It might seem strange, given the system's surveillance and security networks, but the Communist Party is wary of high-profile law enforcement campaigns. Failure would be worse than embarrassing for a party which is supposed to represent the people's will. Such campaigns are only ever risked at times and in ways which demonstrate the Party's continuing hold on power.
That is from Bill Hayton's new book — Vietnam: Rising Dragon — which I found informative and insightful on virtually every page. Recommended.