Category: Economics
Stating the obvious
"We have very few good examples to guide us," said William G. Gale, a senior fellow at the Brookings Institution, the liberal-leaning research organization. "I don't know of any convincing evidence that what has been proposed is going to be enough."
Here is the article, from today's NYT. I would reword this slightly, so as to indicate that progrram size alone does not guarantee success. In fact the larger the stimulus becomes, the fewer good examples we have to guide us. Aggregate demand macroeconomics does add a great deal of value to our understanding of the economy, but as in all macroeconomic theories the limits to our knowledge are quite severe.
Homeownership should not be subsidized
Home ownership policy of the Bush and Clinton administrations was, in
essence, an attempt to pay low-income people to make a risky investment
that they would otherwise rationally avoid. I cannot understand why
anyone would think that such a policy would be sensible. In some cases,
these people will do well and enjoy the upside of their investment, but
in other cases they will do poorly, with the result that they will be
worse off than ever.
That's Eric Posner. You'll note that Henry Paulson has been calling for the mortgage agencies to be resurrected as "public utilities" of some sort. I don't understand this path. There is a very good (modern) liberal case against more home ownership: behavioral economics is true, people overestimate their prospects, poor people shouldn't take too much risk, and the natural market tendency is too much home ownership, not too little. That's without taking environmental issues into account.
Here is a recent Richmond Fed article, skeptical of the idea of homeownership subsidies.
Obama at GMU
President-Elect Obama just spoke at GMU. I was fortunate to have an invite. He had a number of good lines including as good a one-line explanation and justification for Keynesian economics as you will find:
Only government can break the cycle that is crippling
our economy, where a lack of spending leads to lost jobs, which leads
to even less spending, where an inability to lend and borrow stops
growth and leads to even less credit.
He emphasized that jobs would be created in the private sector and saved in the public sector. Nicely put.
His goal is "not to create a slew of new government programs, but a foundation for long-term economic growth." Very good.
In terms of long-term investment, I was pleased to see him mention the smart grid in particular, an idea I pushed as recently as today.
Overall, my view is that the Obama fiscal stimulus plan is evolving in a sensible direction. As promised, he is a pragmatist who is listening to a wide variety of well-qualified, centrist economists.
A substantial fraction of the fiscal stimulus is tax cuts, a substantial fraction is preventing state and local funding from plummeting, a modest but reasonable fraction is on maintenance and improvements of old infrastructure (projects that are mostly already on the books), and a modest (but increasing over time) fraction is on longer term projects which are likely to pay off in future returns.
At present, I see very little in the way of Keynesian pyramid building. Nor do I see an attempt to grab the revolutionary moment by the horns and push the U.S. in a new direction. Thus, thankfully, No New Deal. There is plenty of uncertainty in the economy but it’s not regime uncertainty.
Addendum: Do note that I am
evaluating Obama relative to what we can expect given the situation and
our current politics and also relative to say the New Deal.
The Smart Grid and the Fiscal Stimulus
Earlier I pointed out that a) regulatory problems have prevented investment in the smart grid and b) subsidies to wind power in some states have driven prices to negative levels (yes, people are being paid to consume power). These two problems are closely related.
The states control whether transmission lines get built but states with a lot of wind energy don’t have an incentive to build transmission lines to move the power out. In effect, states with a lot of wind energy are preventing exports which lowers their own internal price of electricity but raises everyone else’s price and reduces the use of wind power.
A new article in Technology Review makes the point.
One effect of these regulatory moves was that companies had less incentive to invest in the grid than in new power plants, and no one had a clear responsibility for expanding the transmission infrastructure. At the same time, the more open market meant that producers began trying to sell power to regions farther away, placing new burdens on existing connections between networks. The result has been a national transmission shortage….
[Many states have a lot of wind potential]…But the existing transmission system doesn’t have the capacity to get that much electricity to the parts of the country that need it. In many of the states in the [wind] region, there’s no particular urgency to move things along, since each has all the power it needs. So most of the applications for grid connections are simply waiting in line, some stymied by the lack of infrastructure and others by bureaucratic and regulatory delays.
Hat tip to Andrew Samwick who writes:
The federal government is the entity that can resolve that failure, by taking the lead and making those expansions itself. It can recoup its costs by levying a fee on subsequent power consumed through the grid. I hope the fact that we need this investment isn’t a reason for it to be excluded from plans for fiscal stimulus.
Fly by the minute
Taking a cue from the cellphone industry, an upstart South African
airline is selling flights by the minute and allowing customers to buy
tickets and book flights via text message.Airtime Airlines takes to
the sky later this month, offering three flights a day from its base in
Durban to Johannesburg, Cape Town and Port Elizabeth. Passengers
purchase minutes much like they would for a prepaid cell phone and
redeem them for a ticket. Fees are assessed according to the length of
the flight – say, 75 minutes for the run from Durban to Johannesburg –
and could save as much as half of what competing airlines charge.
Here is the article. It’s not yet clear whether they have managed to lease planes, but here is another part of the business plan:
The cost for Airtime minutes can fluctuate, presumably according to
promotions and market factors, so topping off
becomes an exercise comparable to fuel hedging. Buy a big block of
minutes when you think they’re at their cheapest and you look smart,
unless the price drops again the next day. Then again, it might go up.
The price recently rose from 3 Rand to 5 Rand, meaning the cost of a
round-trip flight from Durban to Cape Town climbed from about 750 Rand
($81) to 1,250 Rand (about $134). Still that’s cheaper than the $200 it
would cost on South African Airlines.
But can you sell minutes short? I thank Christopher Balding for the pointer.
Cancer and Statistical Illusion
The cover of this month’s Wired promises "The Truth About Cancer" but the article inside is a tissue of misleading statistics and faulty logic. The article begins with fancy graphics telling us "If we find cancer early, 90 percent survive" but "If we find cancer late, 10 percent survive." And this:
Find the disease early "and the odds of survival approach 90 percent…This reality would seem to make a plain case for shifting resources toward patients with a 90 percent, rather than a 10 or 20 percent, chance of survival."
Thus, the opening block of text commands, "Scientists should stop trying to cure cancer and start focusing on finding it early. It’s the smart way to cheat death."
The fallacy in all of this is painfully easy to spot. If we measure survival, which these studies do, with a 5 or 10 year survival rate then obviously people whose cancers are detected early will survival longer than people whose cancers are detected late.
The key question is whether people who are treated early survive longer than people whose cancers are detected early but who are not treated. In Thomas Goetz’s long article there is not a single piece of evidence which demonstrates that this is true. Indeed, quite the opposite. About 9 pages into the article, after the jump, we find this about CT scans for lung cancer:
As with the Action Project, these studies found that, yes, CT scans detected a huge number of early cancers–10 times as many as they would expect to find without scanning. In that regard, the scans did their job as a screening test. And as expected, the number of surgeries based on those diagnoses jumped. But when Bach looked at the resulting mortality rates, he found essentially no difference between those who received a CT scan and those who had not. Despite the additional surgeries, just as many people were dying as before.
Nowhere does the author mentions that this finding invalidates just about everything he has told us in the first eight pages.
Addendum 1 : Do note that I have nothing against early detection and I am not claiming that it never works. My problem is with misleading statistical analysis.
Addendum 2: Careful readers will note that this is an almost perfect example of the economicitis fallacy that I blogged about late last year.
Words I wrote yesterday about fiscal policy
The argument for fiscal stimulus is simply that it will stop things from getting worse by preventing further collapses in aggregate demand. That may be true but fiscal stimulus won’t drive recovery. Recovery requires that zombie banks behave like real banks, that risk premia are properly priced, and that the economy undergoes its sectoral shifts toward whatever will replace construction and finance and debt-driven consumption. Fiscal policy won’t do much toward these ends and in fact a temporarily successful stimulus might hinder these long-run adjustments.
Here is a very good piece from Hal Varian on fiscal stimulus.
Economists v. Historians on the New Deal and the Great Depression
Writing at The Beacon Jonathan Bean nicely reminds us of Robert Whaples survey of economists and historians on questions in economic history. Among the questions that Whaples asked members of the Economic History Association to express agreement or disagreement on was the following:
Taken as a whole, government policies of the New Deal served to lengthen and deepen the Great Depression.
About half of the economists agreed (or agreed with some provisos) that the New Deal lengthened and deepened the Great Depression. Thus this point of view among economic historians is basically mainstream. Among historians there was much less agreement with the statement, although a significant minority, 27%, agreed, mostly with some provisos.
How did the tax cut get so big?
Yes, 40 percent of the Obama stimulus package will be a tax cut. It’s already a talking point that "the Democrats have lost their nerve" but the reality is not so devious. Obama wishes to deliver on his pledge to cut taxes (always electorally popular) and upon close inspection the economic team probably hasn’t found a lot of first-year stimulus spending it likes. That leads to this obvious policy conclusion and of course it is very good news. No, I do not think these tax cuts will drive recovery but a) less money will be wasted, and b) it shows that the Obama team is willing to flinch and be realistic, not just as a final compromise but indeed as an opening gambit.
The best way to think about fiscal policy is to judge, in advance, what is actually likely to come out of the process. The alternative approach is to recommend policy based on one’s personal sense of what should be done and then to blame all the forces which stop that from happening. (Rarely do these people stop to ask whether their political views are robust to the presence of significant opposition.) A lot of people on the left are disappointed, but in my view what is coming out of the process is, so far, above average.
Ed Glaeser’s words of wisdom
While the mechanics of a payroll tax cut are simple, spending hundreds
of billions wisely on infrastructure is hard. Currently, the federal
government spends about $40 billion a year in transportation, and
another $20 billion on other forms of infrastructure. There is a case
for significantly increasing this amount. Our roads do need repairing,
and it makes sense to invest more in a downturn when unemployment is
high. But even doubling the current federal infrastructure expenditure,
a vast increase, would represent only 8 percent of a $750 billion
package.
Here is much more, on the mark throughout. Here is related material by Mark Thoma and Paul Krugman. Here is a related post by Alex.
Addendum: Obama now is calling for $300 billion in tax cuts as part of the stimulus plan, roughly forty percent of the total.
John Taylor on the Fed’s “industrial policy”
"What you are looking at now is really being determined by other
considerations. How much should we buy of mortgage-backed securities?
How much should we loan to foreign central banks? This is really more
like an industrial policy," he said…"If you have a situation where the Fed is borrowing to invest in all
these sectors it seems to me you have a huge governance issue…that
demands a lot of thought," Taylor said.Taylor said the U.S. Congress has a legitimate right to demand a say
in who the Fed lends money to. The outcome would be "radical reform"
that would risk monetary policy independence, he said.
Here is the full article.
Famous economists’ famous errors
Bob T., a loyal MR reader, asks the following:
10 (or more) most famous mistakes in economics.
Viner on costs and Feldstein on Social Security come to mind. Malthus? Not
talking about old vs. new economics, but simple analytical errors and bad
predictions.
That’s a good start. What else might be listed? Just to circumvent various hobby horses in the comments section, let’s avoid Marx and Marxists, Keynes, and the last twenty years.
1. Kenneth Arrow confusing risk subdivision and risk multiplication, in arguing that government should use a riskless rate of discount.
2. The Cambridge, Mass. economists having to admit, finally, that capital reswitching could be quite a general phenomenon (though is it, really?)
3. Ricardo’s prediction that most of national output would end up going to the landlords.
4. Paul Samuelson praising the economic performance of Soviet central planning in his Principles text.
5. 93 percent of all proclamations made about the demand for money in macroeconomics.
6. The more exaggerated claims about the Laffer Curve.
7. Various claims that the Fed should have let the money supply fall during the Great Depression.
8. Jevons’s claim that England (or was it the world?) would soon run out of coal.
9. Welfare analysis done in overlapping generations models (the standard welfare theorems do not generally hold in such models).
And dare I offer up a controversial pick:?
10. Those who think that the difference between "capital" and "ideas" in a Solow growth model is actually well-defined.
What else can you think of?
How to keep away inflation in the future
Larry, a loyal MR reader, asks:
When the US government borrows and prints so much money in the coming
few years, how is the country going to keep massive inflation away?
Borrows and prints are different here. The borrowed money is no inflationary threat, if the U.S. government is willing to raise taxes to pay it off.
As for the newly created reserves, in theory the Fed can suck them out of the banking system at will (and/or change the rate of interest paid on reserves, to influence demand to hold). But will it hit the right timing in practice? Let’s say the economy miraculously recovered tomorrow. Banks would be very eager to make more loans than they are doing now and the broader monetary aggregates would go up rapidly. However the broader aggregates take many months to influence the price level, so in the meantime the Fed would sell assets from its balance sheet and take reserves out of the economy. These are uncharted waters and the trial and error factor likely will be significant.
It is the lags which give the Fed some chance to react but the lags also mean that the Fed will never quite know if it is proceeding at the right pace. And will the contractionary open market operations be conducted with all the non-standard assets currently on the Fed’s balance sheet?
As I said, uncharted waters.
I give it a reasonable chance that we, in due time, have a secondary recession, resulting mainly from the Fed deflating at too rapid a pace as the economy recovers.
Intelligent agent modeling
I am more optimistic about intelligent agent modeling than is Tyler. For one we already have an important, convincing, and Nobel-bestowed variant of intelligent agent modeling, namely experimental economics. Experimental economics uses one particular type of intelligent agent, the type based on…genetic algorithms. True, the intelligent agents used in I-A models are typically not as sophisticated as the agents used in experimental economics but they are rapidly improving. (Moreover, such agents are already important economic actors in their own right in limited areas, e.g. portfolio insurance, and they will continue to become more important as time continues.)
I see bringing experimental economics and I-A modeling closer as an important goal with potentially very large payoffs. Here, for example, is my model for a ground-breaking paper.
1) Experiment
2) I-A replication of experiment (parameterization)
3) I-A simulation under new conditions
4) Experiment under the same conditions as 3 demonstrating accuracy of simulation
5) I-A simulation under conditions that cannot be tested using experiments.
Now that would be a great paper. I-A agent modeling is already very useful for modeling contagion, peer effects, and highly non-linear environments. It will become even more useful when combined with experimental economics in a way that demonstrates the equivalence of the two types of intelligent agents.
Should the government peg the S&P 500?
The very well known macroeconomist Roger Farmer says yes:
It is time for a greatly increased role for monetary policy through
direct intervention of central banks in world stock markets to prevent
bubbles and crashes. Central banks control interest rates by buying and
selling securities on the open market.A logical extension of this idea is to pick an indexed basket of
securities: one candidate in the US might be the S&P 500, and to
control its price by buying and selling blocks of shares on the open
market.
That is from the FT. Though he says he is warming to the idea, to my ear Mark Thoma sounds skeptical as am I. Public choice considerations aside, if the Dow is valued at 7000 in market opinion and the Treasury (Fed?) is propping it up at 8500, a lot of people will sell shares into the hands of the government. How much are the shares worth then? How hard will the government try to break the shorts who speculate on lower prices? Will this work any better than currency pegs? What are the implications for pursuing other monetary targets, such as the rate of inflation? If the peg succeeds who would hold other, riskier assets?
Some people might even say that the "Greenspan put" was part of what got us into this hole in the first place.
Farmer is working on a book How the Economy Works and How to Fix it When it Doesn’t.