Keynes’s General Theory, chapter ten
The velocity of money can vary, aggregate demand matters, and the multiplier is real. Let's get those preliminaries out of the way. That all said, this is one of the least accurate chapters in Keynes's General Theory. To pull out one key quotation (pp.116-117, in section II):
It follows, therefore, that, if the consumption psychology of the community is such that they will choose to consume e.g., nine-tenths of an increment of income, then the multiplier is 10; and the total employment caused by (e.g.) increased public works will be ten times the primary employment provided by the public works themselves…
AARRRGGHH!
Empirically a typical estimate of a multiplier might be 1.3 or 1.4, not 10, not even in a deep slump. (Valerie Ramey points out that the key issue in estimating a multiplier is to determine when the fiscal innovation actually occurred; this is not easy.) One theoretical problem in generating a high multiplier is this. Say you have a debt-financed increase in government spending. You can get some dollars out of low-velocity pools into high-velocity pools on the first round of redistributing the spending flow. Do not expect complete crowding out and so nominal aggregate demand can increase, thus boosting output and employment. But the second and third round effects of the redistributed money are usually a wash and the boost to velocity dwindles. Why should it stay in a high-velocity sector of the economy?
It is common in the GT that Keynes confuses marginal and average effects and, for all of his explicit talk about average and marginal in this chapter, he is making one version of that error again. Rothbard and Hazlitt are not in general reliable critics of Keynes, but
they do have a good reductio (see chapter XI) on crude interpretations of the multiplier and that is what Keynes is serving up here. You can't just take a partial derivative of an accounting identity and call the result a causal relationship.
In addition to velocity/spending effects, there are also multiplier effects through real production. The most insightful analysis of supply-side multipliers comes from the work of W.H. Hutt.
The multiplier is a legitimate concept but often it is overestimated in its import. This chapter in Keynes is a step backwards from Richard Kahn, the father of the multiplier concept.
Here is one critique of Keynes on the multiplier.
Don't forget Alex's comments on fiscal policy and velocity.
The information architecture of Kindle 2.0
Chris F. Masse alerts me to this very interesting article. Excerpt:
Letting customers read a book's initial pages for free is a great
Kindle innovation and makes good use of the digital medium's ability to
dissolve the print requirement to bundle chapters. (Thus, this is a better-than-reality
feature.) The innovation will no doubt sell more books – particularly
for fiction, where people will want to see what happens next once
they're gripped by a story. In fact, for mystery novels, Amazon could
probably give away the first 90% for free and charge the entire fee
just for the last chapter.
The article is interesting throughout on a variety of Kindle-related topics. The author agrees with my basic claim that the Kindle favors plot-driven fiction over complex non-fiction or for that matter postmodern fiction. Referring back and forth across sections is a no-no, so goodbye Pale Fire.
Sentences to ponder
Andrew Sullivan writes:
And that’s why black men in DC are more affected by HIV now than black men in Rwanda.
Assorted links
1. Malaria and African economic development, via Chris Masse.
2. Lengthy profile of Larry Summers, from TNR, interesting and has new material.
3. Via Chug, markets in everything: topless coffee shop in Maine. And, via Matt, a topless doughnut shop, same state.
4. Update on Massachusetts health care; interesting throughout. Can they really do away with fee for service? ""Really controlling costs requires just stopping spending,” said Stuart H. Altman, a professor of health policy at Brandeis University." The Obama administration would be wise to keep those words in mind.
Patents versus Markets
Long ago Jack Hirshleifer pointed out that markets can reward innovative activity even in the absence of patents (H.'s point was actually that markets could over-reward such activity but the point was clear). If an inventor discovers a new source of energy that requires the use of palladium, for example, he can buy palladium futures, announce his discovery and wait for the price of palladium to increase. Of course, this only works if the discovery is credible so betting (contra Tyler) is an important way to test the credibility of a theory (e.g. here and here and of course Hanson's key paper Could Gambling Save Science).
All this is by way of introduction to a new paper in Science, Promoting Intellectual Discovery: Patents Versus Markets (press release here). Bossaerts et al. compare a patent system with a market reward system in an interesting experimental setting. The innovation is the solution to a combinatorial problem called the knapsack problem. In the knapsack problem there are Z items each with a certain value. You must choose which items to put into the knapsack in order to maximize it's value but each item also has a weight and you cannot go over a fixed weight which is set such that you can't carry all the items. The solution to a knapsack problem is not obvious since it's not always best to include the most valuable items. The authors argue that solving the knapsack problem is like combining ideas to create a new innovation. The authors, of course, know the optimal solution to each knapsack problem.
Rewards for creating the innovation are offered in two ways, in the patent method the first person to produce the optimal solution gets the entire reward. In the market system each participant is initially given an equal number of shares in each item. The item-shares trade on a market. After the markets close a $1 dividend is paid to each item-share if the item is in the optimal solution, other shares expire worthless. Thus, the price of the item-shares can be thought of as the probability that the item is in the optimal solution. (i.e. is palladium in the optimal solution to the energy problem? If so, it will have a high price.) Dividends are set such that the total reward is about the same in the two treatments. Proposed solutions were also collected in the market setting although the solutions per se were not the basis of any reward.
Important findings are that the problem was solved just as often in the market setting as in the patent setting. Indeed, in the market setting more people solved the problem on average. There are two possible explanations. First, the winner-take-all nature of the patent system may have deterred some of the weaker participants from exerting effort. Second, and more interesting, is that the prices in the market system did in fact incorporate information about the optimal solution – thus market prices may have given people hints about the optimal solution, much like seeing a partial solution to a jigsaw puzzle.
Problems are that the market system can work only if there are rents to be had from market prices. A new computer chip design, for example, won't change the price of silicon (although even here side-bets may be possible, the inventor knows the manufacturer to whom he sells the invention for example). Also, the price of an input, like palladium, can be influenced by many things other than the innovation so the market system will typically often involve more risk. Still this is an interesting experimental approach to a deep problem.
Thanks to Monique van Hoek for the pointer.
Do influential people develop more conventional opinions?
Following up on Robin's question I think the answer is yes, mostly. We are talking about the time series here, as people rise in influence. I see a few mechanisms:
1. People "sell out" to become more influential.
2. As people become more influential, they are less interested in offending their new status quo-oriented friends.
3. As people become more influential, their opinion of the status quo rises, because they see it rewarding them and thus meritorious.
4. The status quo is good at spotting interesting, unusual people who will evolve (sell out?) and elevating them to positions of influence.
5. Oddballs who are influential arrive first at where the status quo is later headed, and eventually they end up looking conventional.
6. Influential people are asked to write increasingly on general interest topics ("How to Be Nice to Dogs") and thus they find it harder to be truly unconventional. They cultivate skills of conventionality because that is what they are paid for or allowed to express.
Can you think of other mechanisms? Who are some test cases for these hypotheses?
BloggingFrozenHeads.TV with Robin Hanson
You'll find it here. Robin is awesome, as usual, and that is why I am grinning throughout. The topics are (among others):
 |
Tyler vs. Robin on the merits of cryonics (12:23)
Does fiction weaken your grasp of reality? (06:52)
Are economists evil? (12:10)
How to estimate the value of a person’s life (06:04)
Will prediction markets ever really take off? (08:06)
Has fame made Tyler boring? (02:27)
Addendum: Robin and his readers comment here.
Assorted links
1. Harlequin romances, a countercyclical asset?
2. By request: Tyrone on the crisis, here and here.
3. Has Portuguese drug decriminalization been a success? Possibly so.
4. Ten Chinese proposals for stimulating economic growth.
5. Life at GMU.
6. Steven Johnson on the future of the newspaper.
Answering the multi-request
AO has lots of questions:
What's the newest research and the current state of the literature on
school vouchers? Is there a good economics of education blog you
follow? You teach one part of the PhD I.O. sequence at GMU and have
given us your reading list, who teaches the other part and can we have
their reading list as well? Would decriminalization of drugs make us
worse off (by increasing the black market for drugs without allowing
the creation of legal markets) even though complete legalization would
make us better off? Are there other policies where marginal steps
towards the right direction make us worse off? Debate Nassim Taleb or
Dean Baker on bloggingheads.tv! More bloggingheads.tv with any
economists that you find large disagreement with!
In a nutshell: vouchers are better than the status quo but overrated by many market-oriented economists; evidence from Chile and Colombia and Sweden — the more systematic experiments — does show gains. In the U.S. the key question is how selectively or universally to apply vouchers; universal application creates a new middle-class entitlement and brings the federalization of education. In the old days I would read Joanne Jacobs on education. Alex teaches the other part of IO! Decriminalization for drugs keeps the rents from turning into profits for drug gangs; marginal steps in the right direction are usually all we have. Likely I am soon doing a Bloggingheads with Peter Singer; Brad DeLong and Arnold Kling are on the list as well.
What I’ve been reading
1. The Rape of Mesopotamia: Behind the Looting of the Iraq Museum, by Lawrence Rothfield. The definitive book on its topic.
2. Edward Skidelsky, Ernst Cassirer: The Last Philosopher of Culture. A very clear and readable book on a still underrated thinker.
3. The Euro: The Politics of the New Global Currency, by David Marsh. I can't say this book is fun to read, but it is the new go-to source on an increasingly up-for-grabs topic. It's at least as much about the EMS as about the Euro.
4. Richard Dowden, Africa: Altered States, Ordinary Miracles. Another mega-book on Africa, with mixed results. At least half of it is worth reading, and I learned a great deal (or at least I think I did) from the analysis of how Somalia is a relatively ethnically unified nation, by African standards at least.
5. Sarah Blaffer Hrdy, Mothers and Others: The Evolutionary Origins of Mutual Understanding. Does our cooperative nature come from our love of babies? Maybe my expectations were too high, but I found her earlier book more revelatory.
Markets in everything, and their advertisements
How Israel sells arms to India (YouTube).
I thank an anonymous (but loyal) reader for the pointer.
Betting your views, part II, Nouriel Roubini edition
John dePalma directs me to this article, excerpt:
…Just ask Nouriel Roubini
of New York University, who has a reputation as the most pessimistic
economist in academe. He deserves it. His most recent paper, published
last week, is entitled: "Can the Fed and Policy Makers Avoid a Systemic
Financial Meltdown? Most Likely Not." Nobody is more aware of the
gravity of the financial situation, and nobody has done more to point
out the risks of a systemic crisis. So how are Roubini's
own funds invested? They are 100 per cent in equities. In the long run
stocks do best and he is not yet close to retirement, so he keeps
putting more money into index funds each month. Fully aware of the
gravity of the financial situation, he is also aware of the futility of
trying to take action or to time the market. Those tempted to make the
investing equivalent of a goalkeeper's despairing dive should take note.
That's what I call taking mental accounting to an extreme.
Must you bet your views?
A reader asks:
How about some comments on the refusal by Krugman to bet some of his Nobel money against Mankiw?
Put aside Krugman and Mankiw and let's consider the issue in the abstract. Bryan Caplan believes that scholars should be ashamed if they do not publicly bet their views. In contrast I fear this requirement would become a tax upon ideas. How would you feel about an obligation (if only a moral one) for scholars and commentators to publicly reveal the content of their investment portfolios? Those portfolios are their real bets. Yet I still favor the privacy norm and I should note that Bryan never has (nor need he) revealed his portfolio to others at GMU, much less to the broader public.
Let's say that I, as a prolific blogger, express opinions on hundreds of economic policy topics, often involving either explicit or implicit predictions. Then say that hundreds of people wish to bet with me. Can I not simply turn them all down as a matter of policy and practicality?
If you're wondering, I practice "buy and hold and diversify," with no surprises in the portfolio and a conservative ratio of equity purchases. But those investment decisions don't necessarily reflect my views on any given day. I think it is intellectually legitimate (though perhaps not always prudent) to engage in mental accounting and separate those two spheres of my life. I change my mind lots of times, on many economic issues, but does that mean I have to become an active trader? I hope not and I'm not going to.
On long-run economic growth I'm still an optimist, though I am increasingly uncertain as to how much extant firms will capture those gains. On the short run issue at hand, I am fully with Mankiw, and Megan McArdle, in very much doubting the "rosy scenario" emanating from the Obama budget process.
Why do people assume that Jim Cramer is smart?
This was the first reader request:
Why do people assume that Jim Cramer is smart? More bluntly: why
does possession of a JD from Harvard Law School signal to people that
they should listen to you?
Surely an economist has some insights into this odd quirk of human nature.
Not everyone assumes that Jim Cramer is smart but in fact Jim Cramer is smart (though his advice is no smarter than that of a monkey's). Watch the early Jim Cramer and you will see (can anyone find a good YouTube link?). But take the smartest person you know and put him or her on TV for hours a week, for years, and see what happens. (See my book What Price Fame?.) Usually only very smart people get to experience such fates. Lots of screaming is an added bonus.
I'm not sure that the average person thinks so much of the typical Harvard Law graduate.
Megan McArdle had a good post on the Cramer dust-up with Jon Stewart.
The economics of prostitution pricing and prostitution bleg
From Allison Schrager, this was striking:
“I only charged $300 when I lived in San Francisco,” Andrea says.
Unlike most industries, escorts can charge higher prices when they are
in greater supply. This is because price is one of the few metrics sex suppliers
can use to convey quality. (In this way it is not unlike the hedge-fund
industry.) There are only about 30 VIPs in San Francisco, but nearly
100 in New York, so Andrea can charge more here. The customer
demographic is also wealthier, and a higher price deters customers from
bargaining, which is considered poor taste.
Alas, I cannot vouch for its accuracy. But in April I am participating in a NYC debate over the morality of prostitution, later to be broadcast on NPR. Notwithstanding my praise for Ross Douthat, I will be defending prostitution (with the Mayflower Madam on my side), against Catherine MacKinnon and others.
My bleg is this: other than Bernard Mandeville, what should I read to prepare? Any and all assistance is appreciated.