Three or four mistakes?

Brad DeLong discusses whether the Fed erred in the early 2000s by keeping interest rates too low, thus creating the housing bubble and the catastrophe we are currently experiencing. He concludes that it did not - that interest rates in the early 2000s were in fact higher than the natural rate and low interest rates were therefore justified to keep the economy from experiencing a devastating deflation.

As it happens, Bob Barbera and I have written a few papers on just this question. We criticize the standard practice of measuring the gap between the actual rate and the natural rate of interest by comparing the real federal funds rate or the real interest rate on say 10 year treasuries to long-run averages of those quantities. The interest rates that matter for the economy are risky rates such as the yield on Baa corporate bonds. Monetary policy should be measured according to where something like the Baa bond is relative to its long-run average.

The graph below shows how policymakers might be misled by looking at the real fed funds or Treasury rate rather than the Baa bond rate. In the graph, the blue line is the real federal funds rate (fed funds rate minus previous 12 months PCE inflation) relative to its average over 1970-2009; the red line is the analogous figure for the 10-year Treasury rate; and the green line is the analogous figure for the Baa bond yield.

As the economy slipped into recession in 2001, the Fed reduced the federal funds rate dramatically. By early 2003 the real federal funds rate was more than three percentage points below its normal value (which you could take as a very crude estimate of the "natural" fed funds rate). The real Treasury rate was also more than a percentage point below its "natural" rate. By either of these measures policy was very stimulative, so why was growth so sluggish? The answer is that the real Baa rate was still close to its normal (neutral, natural) level; policy was not in fact very stimulative, once you took account of the risk premium on corporate bonds. (The risk premium was high during this period because of the fallout from the Enron and related scandals, 9/11, the wars in Iraq and Afghanistan, and the recession.) The correct policy response was to lower interest rates further, but the Fed's ability to do this was limited by the fact that it was already very close to the zero bound on the nominal federal funds rate.

Recovery began in late 2003 when the real Baa rate fell into expansionary territory. By 2004 it was clear by all measures that policy was very stimulative, and the Fed began to raise the federal funds rate. It's repeated increases in the federal funds rate, however, were not aggressive enough to push the Baa rate up. The overly expansionary monetary policy in this period added fuel to the fire of the housing bubble that was already underway.

By mid-2006 one could argue that the federal funds rate was about at its neutral level, so that monetary policy was appropriate. The real Baa rate, however tells a different story: it was still over a percentage point below its neutral level, fueling excessive growth and speculation.



The Fed would have done better, Bob and I argue, had it paid attention to what was happening with the Baa rate - in particular, the spread between the Baa rate and 10-year Treasuries. This is shown in the graph below. In 2006-07 the Baa-Treasury spread (blue line) was considerably below its long-run average of two percent and even further below the moving average line in red. As Hyman Minsky argued long ago, excessively low risk premia are characteristic of the "ponzi finance" phase of the business cycle that precedes the crash. Bob and I argue that the correct policy strategy is to adjust the nominal federal funds rate one-for-one with the credit spread; had the Fed followed this policy it would have raised the federal funds rate by a further 50 to 100 basis points in 2006. (Note: the graph also suggests that monetary policy should have been tighter in late 2007 and early 2008, which would clearly have been disastrous. This is due largely to the spike in inflation that occured in that period, which reduces the real Baa rate as I've measured it. If you ignore the spike in inflation, monetary policy looks close to neutral in late 2007-early 2008.)



So I think the Fed's mistake occurred in the period 2004-06 when it neglected to raise the federal funds rate sufficiently to offset the shrinking risk premium on corporate bonds. Having said that, however, I have to acknowledge that in 2004 I criticized the Fed for raising interest rates when the economy had not yet recovered from the recession. In fact, I had a brief discussion with Paul Krugman at a conference in September 2004 in which he expressed puzzlement at the Fed's apparently aggressive actions. Smart people (I'm referring to Krugman here, not me) would not necessarily have avoided Greenspan's mistake.

The price of progress

The Waxman-Markey bill has been criticized from a number of quarters for giving permits away rather than auctioning them and also for awarding offsets for projects that would have been undertaken anyway. (See e.g. the post by Ted Gayer referenced in the previous post). The bill, in other words, involves large arbitrary redistributions of wealth that do nothing to advance the cause for which the legislation is intended.

This is a valid criticism of the bill. It should be noted, however, that is a problem that occurs naturally in just about every piece of legislation you can think of whose objective is to provide incentives for people to change their behavior. It is almost unavoidable, or at least unavoided in previous cases.

Take the Bush tax cut of 2003 for example. Formally called the "Jobs and Growth Tax Relief and Reconciliation Act of 2003," the legislation reduced the top marginal tax rate for interest, and dividend income from 38% to 15% and for capital gains income from 20% to 15%. The idea was to increase the incentive for people to buy stocks and real assets, thereby stimulating investment. At the same time, however, the legislation by necessity produced a large windfall gain to anyone who happened to own stocks, bonds, or real assets at the time the legislation passed. That is, though it was intended to reward new investment, the bill also retroactively rewarded past investment, which does nothing to benefit the economy in the present.

So large windfall transfers occur routinely with most legislation involving tax cuts or subsidies. And in fact the Waxman-Markey bill does go further in trying to limit these kinds of subsidies than is usually done (by auctioning off some of the permits and by attempting to count only new carbon-reducing initiatives as valid offsets). The windfall transfers have to be accepted as the price of progress. For the most part they are temporary: five, ten years down the road all carbon reduction measures are "new" worthy of being showered with incentives. Hopefully the permit grants to polluting industries will be temporary as well, though I don't know what the legislation says about this exactly.

Cap and Trade

Passing legislation to control greenhouse gas emissions is and is going to be very difficult. How do you get the public to swallow significant increases in energy costs? How do you get Congress to overcome opposition to the bill from a multitude of powerful corporate lobbies and stick to its guns when the inevitable faux-populist backlash hits?

If you're Barack Obama, Nancy Pelosi, Edward Markey, Henry Waxman, and a few other legislative leaders, you roll up your sleeves and cobble together a highly imperfect bill that makes the compromises with special interests that are necessary to assure passage of the bill while not (hopefully) detracting from its overall effectiveness. It's ugly, but progress is made.

If you are the Bush Administration and the Republican leaders of the House and Senate in recent years, you bury your head in the sand, pretend the problem doesn't exist, and stand ready to demagogue any serious attempts at resolving the problem of global warming.

And if you're Greg Mankiw, who believes that global warming is a problem, supports a carbon tax to solve the problem, but served as economic spokesman for the Bush Administration and still apparently has a toolshed full of political axes to grind against Democrats in the White House and Congress? In that case, apparently, you stand on the sidelines and snipe at the people who are actually trying to solve the problem. You criticize them for passing an imperfect rather than a perfect bill, trying hard to forget your (modest) role in stymying progress in the past.

Hence Mankiw's latest post on cap-and-trade, headlined "The Ugly Cap-and-Trade Bill." The post is just a link to two articles critical of the legislation just passed by the House. Both point out real weaknesses in the legislation. The article by Alan Viard criticizes the bill because most of the emissions permits are given away rather than auctioned. No argument there - auctioning makes a lot more sense, giving away the permits is just a payoff to corporate interests so they won't stand in the way of passage. But this is the price, apparently, that has to be paid for passage, and we're all better off paying the price. And as Viard points out, the payoff does not affect the incentives facing the polluting firms so it doesn't reduce the effectiveness of the bill. By contrast, imagine the kind of horsetrading that would accompany Mankiw's preferred solution, the carbon tax. In this case, the easiest type of deal to make would be various exemptions from the tax (farmers don't pay! certain corporations hiring so many workers producing certain types of products in particular Congressional districts don't pay!). These payoffs would affect incentives and therefore would reduce the effectiveness of the bill.

The other article Mankiw links to, by Ted Gayer, likewise makes reasonable criticisms of the way the bill handles carbon offsets. But these are details that can be ironed out in the future. The important thing is that we are now on the way to adopting a framework to finally reducing carbon emissions. It's ugly, there are problems, but it's a real step forward. People who genuinely care about global warming need to hop aboard this real, existing steam locomotive and stop waiting for the perfect, shiny TGV that's never going to come.

George Will: liberals are unfairly ignoring flawed academic studies critical of their agenda

In yesterday's Washington Post (via RealClearPolitics), George Will criticizes the Obama Administration in particular and Democrats and liberals in general for failing to acknowledge research showing that investment in green energy technology costs jobs. It's a curious argument: he argues that the proponents of green technology investments should take the research he cites (a study by Spanish economist Gabriel Calzada) seriously even if it is wrong and ideologically motivated:

It is true that Calzada has come to conclusions that he, as a libertarian, finds ideologically congenial. And his study was supported by a like-minded U.S. think tank (the Institute for Energy Research, for which this columnist has given a paid speech). Still, it is notable that, rather than try to refute his report, many Spanish critics have impugned his patriotism for faulting something for which Spain has been praised by Obama and others...

What matters most, however, is not that reports such as Calzada's and the Republicans' are right in every particular... Still, one can be agnostic about both reports while being dismayed by the frequency with which such findings are ignored simply because they question policies that are so invested with righteousness that methodical economic reasoning about their costs and benefits seems unimportant.

Very strange. I would think that a requirement for an argument to be taken seriously is that it be logically sound and not obviously self-serving. But then what do I know, I'm not a public intellectual of the standing of George Will.

For the record, Calazada's study does seem to be an honest attempt at measuring the effects of spending on solar technology in Spain on job creation. Its major and fatal weakness is its analysis of how spending on solar "crowds out" private sector job creation. The macroeconomics is just plain wrong.

Calazada's argument is:

- The Spanish government spends 28.7 billion euros on solar power subsidies to create 50,200 jobs, or 571,138 euros per job. In the private sector, on average, each job "costs" 259,143 euros.
- So if the government creates one job in solar power, it takes 571,138 from the private sector; this money would have employed 571,138/259,143 = 2.2 workers, so there's a net loss of 1.2 jobs per new job created in solar.

There are all sorts of things wrong with this analysis from a standard textbook macroeconomic perspective.

- We are in a recession, in which there are a lot of unused resources (unemployed workers, idle factories, etc.). In this environment, when the government employs someone in the solar industry or in any other industry, there is no need for employment to fall in other sectors to "pay for" these additional jobs. The new jobs in solar can be filled by the previously unemployed. Of course there may be bottlenecks due to a shortage of workers with particular skills, but the general message is that the author's estimate is going to vastly overstate the extent of "crowding out" of private employment.

- On average over long periods of time a capitalist economy operates at full employment; that is, all workers who want to work are able to find a job. If you're a neoclassical economist like the author of the study (and George Will's sympathies would be here as well), full employment is arrived at naturally through the magic of markets; if you're a Keynesian, full employment is achieved by the adroit use of monetary and fiscal policy. Either way (in the basic framework used by macroeconomists), no policy intervention is capable of changing the overall level of employment in the long run. If investment in solar energy reduces demand for labor the effect is to reduce wages, not employment. I'm not sure if Obama has ever claimed that investment in green technology would increase employment in the long run (as opposed to stimulating the economy during the recession or providing "good jobs" that pay high wages), but if he has, he's guilty of the same logical error.

- I would wager that a big part of the reason that solar jobs are more expensive than average jobs is that solar power is a relatively capital intensive sector of the economy. You could theoretically apply the author's analysis to show that all sorts of private sector investments destroy jobs. For example, airline manufacturing, biotechnology, pharmaceuticals, and software engineering are all relatively capital intensive industries. So if someone decides to invest in one of those sectors, it's going to cost jobs - better (according to the implicit argument in the report) to invest our money in street sweeping, textile manufacturing, chicken processing, and other labor-intensive industries. But no self-respecting neoclassical economist would make that argument.

- In fact, according to neoclassical economic theory, investments in capital intensive sectors of the economy make the economy as a whole better off because wages in those sectors are higher than those in labor-intensive sectors. A complicated set of adjustments involving changes in the average level of wages, the relative price of skilled versus unskilled labor, relative prices of capital-intensive goods versus labor-intensive goods, and so on will result in full employment with higher wages, a larger capital stock, and higher GDP overall.

- The above analysis is true if the solar power industry truly has higher productivity than the rest of the economy. If, in the case of Spain and what is proposed for the US, resources are directed into solar power by government subsidies, then there may indeed be a net cost. The cost comes about because we're switching to a higher-cost source of energy (I won't address the issue of mismanagement of the program, which is obviously an issue that policymakers need to be aware of). But for those who want the government to do something about global warming, this is a given. The fundamental problem is that the market price of carbon-based fuels is too low, does not reflect the "externalities" of oil production and consumption - global warming, the need to spend gobs of money defending oil supplies in the middle east, etc. The low price of oil today reflects an implicit subsidy in the value of these externalities. Subsidizing solar power and raising the price of carbon fuels essentially replaces one subsidy with another. Standard neoclassical theory says we're better off having done this, assuming we've correctly priced the externalities, even though measured incomes will be lower.

Will's contention that proponents of green technology investment and other measures to fight global warming ignore research on their costs is wrong - it's the bad and self-serving arguments like those Will cites that are systematically ignored. Economic analysis by the Congressional Budget Office has played an important role in formulating the legislation now percolating in Congress. Case in point: the CBO report I cite in a blog post from a few days ago.

Apparently Ted Turner's father was not a fan of liberal arts education

Here's a letter Ted Turner's father wrote to him upon learning that his son wanted to be a Classics major at Brown University. It must be read in its entirety.

The Senate's health plan

Paul Krugman is p.o.'d about press coverage of the Congressional Budget Office's estimates of the cost of the Senate (HELP) health plan.

Both Igor Volsky and Ezra Klein catch major media organizations picking up completely false GOP talking points, and completely misrepresenting the CBO “scoring” that created so much consternation last week. Neither of the plans CBO studied contains a public option — yet people who got their news from allegedly reputable TV shows were led to believe that the CBO results were devastating news for advocates of a public option.

The failure of the media to report accurately on the CBO study is remarkable (I almost said astonishing, but nothing astonishes me anymore). It's not as if this is some technical detail that only an expert would have caught (though even then, you'd hope that some of these media analysts would be experts in the field they're analyzing or consult with experts before running their mouths about the topic). The CBO study is quite explicit about what elements of the plan it's looking at. Starting on page 1:

It is important to note, however, that those figures do not represent a formal or complete cost estimate for the draft legislation, for reasons outlined below...

Then again on page 2:

Important Caveats Regarding This Preliminary Analysis
There are several reasons why the preliminary analysis that is provided in this letter and its attachments does not constitute a comprehensive cost estimate for the Affordable Health Choices Act... [there follows some gobbledygook]

Then the explicit statement on page 8:

The proposal does not include a “public plan” that would be offered in the exchanges, nor does it contain provisions that would require employers to offer health insurance benefits or impose a fee or tax on them if they did not offer insurance coverage to their workers.

How could any educated person miss these caveats? Unless they didn't actually read the report...

The cost of Cap'n Trade

The Congressional Budget Office estimates the net costs of the American Clean Energy and Security Act of 2009, the legislation pending in the House that would institute a cap-and-trade system for greenhouse gas emissions. Opponents of the bill are concerned about the costs to the economy and to average Joes. The CBO reports (all figures are in 2010 dollars):

On that basis, the Congressional Budget Office (CBO) estimates that the net annual economywide cost of the cap-and-trade program in 2020 would be $22 billion—or about $175 per household. That figure includes the cost of restructuring the production and use of energy and of payments made to foreign entities under the program, but it does not include the economic benefits and other benefits of the reduction in GHG emissions and the associated slowing of climate change. CBO could not determine the incidence of certain pieces (including both costs and benefits) that represent, on net, about 8 percent of the total. For the remaining portion of the net cost, households in the lowest income quintile would see an average net benefit of about $40 in 2020, while households in the highest income quintile would see a net cost of $245. Added costs for households in the second lowest quintile would be about $40 that year; in the middle quintile, about $235; and in the fourth quintile, about $340. Overall net costs would average 0.2 percent of households’ after-tax income.

Richard Nixon: the gift that keeps on giving

The NY Times plucks a gem from the latest released tapes, right after the Roe v. Wade decision:

“There are times when an abortion is necessary. I know that. When you have a black and a white,” he told an aide, before adding, “Or a rape.”

I think even in 1973 that was a pretty retrograde attitude towards race-mixing.

Scariest graph of 2009

Paul Krugman keeps updating this graph, and it never gets less scary.

Healthcare spending and subprime lending

I've always had a hard time understanding the economics of our health care system. We know there's a ton of waste in the system, but where does it come from: is it because consumers don't have the incentive to look at sticker prices? insurance companies cherry-pick their customers? doctors run too many tests to cover themselves from malpractice suits? government subsidizes gold-plated insurance policies? pharmaceutical companies exploit their monopoly power and buy off Congressmen who stand in their way?

Atul Gawande's article in the New Yorker and a more technical piece on the Health Affairs blog by Amitabh Chandra have persuaded me that a big part of the problem in health care is the same problem that led to the subprime mess: rampant, uncontrolled pursuit of profit on the part of the product providers (alliteration unintended). Gawande asks why health care costs in McAllen, Texas are so much higher than in the demographically similar region of El Paso and finds that the reason is that doctors in McAllen have adopted an entrepreneurial model where the goal is to earn as many fees as possible by subjecting patients to (arguably) unnecessary procedures. Where hospitals focus on the health of patients rather than doctors' incomes - places like the Mayo Clinic in Minneapolis and hospitals in Grand Junction, Colorado - costs are much, much lower.

To the extent that this argument is correct - and it doesn't mean that there aren't other factors driving costs up as well - the problem in health care sounds an awful lot like the problems in subprime lending and investment banking. Start with a lightly regulated market with lots of distortions caused by problems of asymmetric information and government taxes and subsidies. Add a dose of the good ol' American can-do entrepreneurial ethos. Plop in uninformed, easily manipulated consumers, and presto - you've got yourself an explosion in irresponsible spending. And if the analogy is correct, the solution (or a big part of the solution) to the health care spending problem is the same as the solution to the subprime lending problem: lots of heavy-handed regulation. Chandra concludes with:

The key Dartmouth message is that regardless of whether the association between spending and outcomes is positive, flat, or negative, there are plenty of providers who’re able to deliver high-quality care without being high-cost suppliers. Reform efforts should focus on encouraging these organizations, which are accountable for all of my care, to replicate...

Congress needs to encourage Minneapolis-type care to emerge in Miami, while curtailing the incentives for Minneapolis to morph into McAllen. This involves doing much more than offering piecemeal adjustments to the reimbursement system. It requires rewarding the creation and expansion of already existing delivery systems that have the right incentives to check costs while delivering quality. It requires competition between these delivery systems for patients and their premiums. It requires that Congress and the president have the courage to fight the beneficiaries of the status quo, who have already begun to launch a bitter fear-campaign against attempts to implement accountability and value.

In terms of the health care reform debate now occurring in Congress, it would appear that whether there is a public insurance option or not is beside the point. We can have health care reform on the Swiss model - a private insurance system subject to tight regulation.

The parable of Jesus and Ford

From The Treatyist.

Rising bond yields is a sign that US policy is working

Martin Wolf makes many of the same points I made in an earlier post. I agree wholeheartedly with myself!

Fix the rating agencies!

There's much to like in Obama's financial regulation reform plan, but one glaring omission is that it does nothing to change the system under which rating agencies get paid by the companies whose bonds are being rated. Here's the story.

The broader issue is that in addition to regulating the behavior of financial institutions, reform needs to be focused on changing the incentives these institutions have. Obama's proposals on executive pay - empower a regulator to review pay packages to make sure they don't provide incentives to engage in overly risky behavior - seem to be an example of how to do this right. Failure to reform the rating agencies sets up a situation where the regulators are saying "be cautious" while the incentive structure is saying "full steam ahead." That's a system that won't work.

Sounds like a plan!

David Brooks in today's NY Times. I don't quite know what Brooks' point is here (does he think Obama is a fraud or a genius?). But for my money, if this is truly Obama's strategy he's the second coming of FDR.

Al Jazeera suspects fraud in Iranian election

From Al Jazeera English

Ahmadinejad had apparently taken the northwestern city of Tabriz with some ease.

Tabriz is the heart of East Azerbaijan, and Azeris are among the tightest ethnic groups in the country, unfailingly voting along ethnic lines.

In the 2005 presidential election, Mohsen Mehralizadeh was a largely unknown and wholly unsuccessful candidate. He came in seventh and last, and yet he still won the Azeri vote in the Azerbaijani provinces. Mir Hossein Mousavi is an Azeri from Tabriz.

Elsewhere, Mehdi Karroubi failed to take his home state of Lorestan; in Khuzestan, Mohsen Rezai, a local scion, was expecting at least two million votes. His total for the entire country has failed to breach one million.

And with each updated count, Ahmadinjad's lead did not waver from a very stable range of 66-69 per cent, irrespective of which districts were reporting.

After 3am [22:30 GMT], the interior ministry went quiet for the night. Out on the streets, some groups of youths were driving the streets in celebration. But not 69 per cent of them.

More on rising interest rates

Brad DeLong links to some articles on the problem of rising interest rates on US government bonds, coming out in favor of a benign interpretation. As discussed in the post below, I think the key piece of evidence that the rise in rates is not a sign of a fall in confidence about the solvency of the US government or inflationary pressures is that German, UK, and other rates have been rising at the same time. Yield curves around the world are all steep. Furthermore, Paul Krugman notes that overall US borrowing - government + private sector - has not risen much if at all in the last year or so.

On the other hand over at the WSJ Arthur Laffer is so worried about the inflationary consequences of all this spending and money creation that he is calling for a $1 trillion reduction in the monetary base and dramatic cuts in spending to cut the budget deficit. This following a piece by John Bolton saying it wouldn't be so bad if Israel bombed Iran. Thank God those people don't have their hands on the steering wheel anymore.

This is quite odd...

http://www.neave.com/television/

Ferguson v. Krugman

Niall Ferguson and Paul Krugman have been spatting about the recent runup in US government bond yields.



Ferguson (paraphrased version): The rise in bond yields signifies concerns about inflation in the US due to the Obama Administration's irresponsible fiscal policy decisions. Interest rates will continue to rise as long as financial markets fear a US default (explicit or implicit through inflation).

Krugman (paraphrased version): That's silly. We're in the middle of the biggest recession since the Great Depression. In recessions there is a surplus of savings that keeps interest rates down. Bond yields aren't particularly high now and won't get much higher until the economy begins to recover.


Krugman is taking a disappointing shortcut here. His is an argument about the average level of interest rates (however you define that). It is certainly possible for the government bond yield to rise even in a recession if concerns about our government's solvency drive investors away from US bonds and toward something else. But what could that something else be?

How about interest rates on bonds issued by governments that haven't taken the "irresponsible" measures that the Obama Administration has? If Ferguson is right, we should expect yields on these bonds to be falling as investors buy them up and raise their prices. But as shown in the graph below, since late February (i.e. after the stimulus package was passed and the CBO put out some scary budget updates) German, UK, French, and Canadian bond rates have increased at roughly the same pace as those of the US government. The big difference in the graph is that US rates were unnaturally low in January - this has to be due to US government bonds' functioning as a "safe harbor" during the financial crisis.


If we compare current yields on 10 year bonds to get a measure of expected inflation differentials or movements in exchange rates, we'd have to conclude that roughly speaking, financial markets are anticipating no greater a rate of inflation in the US than in these other countries, and no major depreciation of the dollar against these currencies.




But Ferguson has to be right at some level - if US bond rates are rising, where is the excess savings going? What are investors buying if not government bonds in the US, Germany, etc.? Apparently they are buying risky assets such as corporate bonds. Here's what's happened to corporate bond rates this year:





This can only be interpreted as good news for the economy. The increase in credit spreads in the fall was a strong signal of looming recession - likewise a decline in credit spreads is a sign of a coming recovery. It should be noted, however, that we're not yet where we should be. In normal times we should expect BAA rates to be about 2 percentage points higher than 10-year government bond rates. Based on recent history, as (if?) the economy recovers over the next six months I think we can expect the 10-year rate to rise another 50-100 basis points and the BAA rate to fall another 100-150 basis points.

WSJ attacks shoddy economics, gullible press

It takes some chutzpah coming from a newspaper that features articles by Arthur Laffer on its front page, but here's what the WSJ has to say about the Obama Administration's claims to have "created or saved" 150,000 jobs since passage of the stimulus bill:

Of course, the inability to measure Mr. Obama's jobs formula is part of its attraction. Never mind that no one -- not the Labor Department, not the Treasury, not the Bureau of Labor Statistics -- actually measures "jobs saved." As the New York Times delicately reports, Mr. Obama's jobs claims are "based on macroeconomic estimates, not an actual counting of jobs." Nice work if you can get away with it.

And get away with it he has. However dubious it may be as an economic measure, as a political formula "save or create" allows the president to invoke numbers that convey an illusion of precision. Harvard economist and former Bush economic adviser Greg Mankiw calls it a "non-measurable metric." And on his blog, he acknowledges the political attraction...

Now, something's wrong when the president invokes a formula that makes it impossible for him to be wrong and it goes largely unchallenged. It's true that almost any government spending will create some jobs and save others. But as Milton Friedman once pointed out, that doesn't tell you much: The government, after all, can create jobs by hiring people to dig holes and fill them in.

If the "saved or created" formula looks brilliant, it's only because Mr. Obama and his team are not being called on their claims. And don't expect much to change. So long as the news continues to repeat the administration's line that the stimulus has already "saved or created" 150,000 jobs over a time period when the U.S. economy suffered an overall job loss 10 times that number, the White House would be insane to give up a formula that allows them to spin job losses into jobs saved.

The WSJ quotes former Bush Administration officials who say they never would have gotten away with such nonsense. But I think Obama is getting the benefit of the doubt here because he hasn't established a track record of lying to the press and the public.

On the main issue, though, Mankiw et al. are of course right. It's impossible to tell whether any action taken by the Obama Administration or the Federal Reserve in recent months has "saved or created" jobs, or how many. That's because we can't run the counterfactual experiment: same recession with no stimulus, or same recession with no exotic Fed lending facilities. The same problem occurs in other contexts. Did the Iraq war or the Bush Administration's "enhanced interrogation" program make the U.S. safer? Did Bush's 2001 or 2003 tax cuts create jobs? How could we possibly know, since we can't run history over again without these particular interventions.

So what do you do? Do you say you have no idea whether your programs worked, or do you make a reasoned argument? If I were the Obama Administration I'd make a reasoned argument, and if I were the news media I'd report skeptically on it.

As a side note, Milton Friedman was not the one who said that government can provide jobs by paying people to dig holes. That was John Maynard Keynes. And his point was not that government jobs were not productive - his point was that while he hoped that during depressions government would spend money on productive things, even spending money on wholely unproductive things would stimulate the economy.

This explains quite a bit

Brad DeLong and Paul Krugman have been struck slack-jaw by the way that otherwise brilliant economists of the Chicago school seem to have forgotten everything useful about macroeconomics.

From an interview with Robert Lucas in Snowdon, Vane and Wynarczyk, "A Modern Guide to Macroeconomics," 1994:

Q: David Laidler has recently drawn attention to what he described as "the appallingly low standards of historical scholarship amongst economists." Is it important for an economist to be a competent historian?

A: No. it is important that some economists be competent historians, just as it is important that some economists be competent mathematicians, competent socioligists, and so on. But there is neither a need nor a possibility for everyone to be good at everything. Like Stephen Dedalus, none of us will ever be more than a shy guest at the feast of the world's culture.

Q: How do you view Keynes as a macroeconomist?

A: I suppose Keynes, via Hicks, Modigliani and Samuelson, was the founder of macroeconomics, so one has to view him as a leading figure in the field!

Q: Should students of macroeconomics still read the General Theory?

A: No.

I don't find the principled and thoughtful justification for doing nothing about global warming very persuasive

Greg Mankiw says he was disappointed that the Bush Administration didn't do more about global warming, but at least their reasons for doing nothing were "principled and thoughtful." Keith Hennessey puts the best face on the Bush Administration's non-policy. First he says that he accepts the possibility that global warming poses a serious threat to the planet:

Given this uncertainty, I believe there is a small but non-trivial risk that there will be severe climate change over the next century or two. And so I am willing to consider significant and effective policy actions to slow the growth of greenhouse gas emissions to reduce that risk. I do not, however, believe that risk is so great or so certain that we must immediately commit to drastic changes in our economy, or that we must ignore the costs of those policy actions.

He believes the cost of a carbon tax or cap-and-trade system would be high. The biggest cost, he thinks, is a global trade war brought on by the imposition of a tax on Chinese imports to force them to reduce carbon emissions.

I believe there are cures that are worse than the disease. An import tariff would be protectionist... In the context of a global climate change negotiation in which different countries are establishing different domestic carbon prices, and in which two of the world’s largest economies (China and India) refuse to do the same, it is easy to see how a carbon import tariff by the U.S. could set off a global trade war, with potentially devastating effects on the world economy.

Hennessey finds unacceptable policies that would cost 1/2-1 percent of GDP:

We are not talking about small numbers here. China thinks developed countries should contribute 1/2 – 1 percent of GDP to help poorer countries cut their emissions, and the economic effects of domestic carbon prices are measured in the same orders of magnitude. When you’re measuring things in percent of GDP, you’re shooting with real bullets. I oppose imposing such a tariff, threatening one, or even floating the idea as Dr. Krugman has done.

Therefore, Hennessey proposes that rather than attempt to set a high price for carbon emissions, government instead promote research and development into new technologies.

Therefore, I conclude the best policy is for the U.S. not to impose a domestic carbon price in the near future. To the extent policymakers believe severe climate change is a risk that should be addressed, I instead recommend they focus on pushing carbon-reducing technology R&D, and reducing tariffs and other trade barriers to the exchange of such technologies... I would be comfortable with the U.S. contributing taxpayer funds to a joint international R&D effort, if it were an alternative to a domestic carbon price, and as long as U.S. firms maintained their property rights to such research.

This argument is really extraordinarily weak. Hennessey is terrified of a trade war (to the point where he counsels economists like Paul Krugman not even to float the idea of a tariff on Chinese goods). By contrast, he seems not too concerned about the possible harms to the earth's climate (and our life on the planet) due to global warming. Sensibly, he acknowledges the possibility of, say, Manhattan being buried under a hundred feet of water, but somehow manages to expunge the thought from his mind. "Protectionism," however - that's a scary proposition!

He argues that imposing a tariff on Chinese goods would spark a global trade war that would devastate the world economy. That seems very unlikely: the Chinese would retaliate, but they have too much at stake in world trade to take actions that would impose extremely high costs. It is far more likely that a tariff would result in a period of tense negotiations and ultimately a solution that would keep global trade going. And I know of no evidence that a "trade war," in isolation, has ever caused a global recession. Whether Smoot-Hawley actually had dramatic consequences in the 1930s is an open question, but there's no doubt that the world economy was going to have a Great Depression with or without those tariffs. The last time the U.S. imposed trade restrictions on a large Asian economy for whom exports were the central component of its growth strategy was the 1980s, when we imposed "voluntary" export quotas on Japanese automobiles. I don't remember any Great Depression in Reagan's second term.

For a former official in a Republican administration, Hennessey is strangely optimistic about government's ability to discover the technologies that will solve the problem of global warming. I think when you ask the government to pick winning technologies you get things like the ethanol subsidy and the 2005 energy bill. New technologies are absolutely going to be the key to reducing carbon emissions. But the best way to stimulate the discovery of these new technologies is to make carbon expensive and let the private sector make the investments in R&D. R&D is not a substitute for a carbon pricing policy - a carbon pricing policy is a necessary precondition for a sufficient scale of R&D.

If I were a conservative who thought that there was a real chance of catastrophic climate change occurring in the next century as a result of global warming, but was concerned about the economic consequences of higher carbon prices, I would pass legislation phasing in carbon taxes over a long period (a decade, say). I would create some flexibility in the phase-in schedule that would allow taxes to be raised or lowered as new information came in about the likelihood of severe climate change or to account for the business cycle (say, delay the imposition of higher taxes during a recession). I would offset the taxes in a creative way that would lessen the burden of the taxes to businesses. Imagine, for example, that the Bush Administration had paired a phase-in of a carbon tax with a phase-out of the corporate tax. That would have been an interesting political debate.

I believe that the Bush Administration's failure to take action against global warming had nothing to do with principle and thought. My money is on greed and ignorance.

Captcha!

Google makes me type in the letters I see in a "captcha" image in order to verify that I am a human being and not a robot. Apparently I am a robot - I went through about five captchas before giving up and resetting my password. Are you a human or a robot? See if you can decipher these captchas:

We call it "independent study"

Matt Yglesias calls Stuart Taylor and Michael Goldfarb's search for evidence that Sonia Sotomayor lived a life of exhorbitant privilege "Ahab-esque". It's quite a show:

In October 1974, Princeton allowed Sotomayor and two other students to initiate a seminar, for full credit and with the university's blessings, on the Puerto Rican experience and its relation to contemporary America.

I went to Princeton but somehow I never got to teach my own class, or grade my own work. One wonders how Sotomayor judged her work in that class, and whether the grade helped or hindered her efforts to graduate with honors.

Here at Gettysburg College we call that "independent study." Usually our best, brightest, most creative students take advantage of the opportunity.

I think this is meant to be reassuring

From the NY Times story on GM's bankruptcy:

“We don’t think that after this next $30 billion, they will need more money,” one senior administration official said.

Summer beach reading

James Hamilton, "Causes and Consequences of the Oil Shock of 2007-08," NBER Working Paper No. 15002:

This paper explores similarities and differences between the run-up of oil prices in 2007-08 and earlier
oil price shocks, looking at what caused the price increase and what effects it had on the economy.
Whereas historical oil price shocks were primarily caused by physical disruptions of supply, the price
run-up of 2007-08 was caused by strong demand confronting stagnating world production. Although
the causes were different, the consequences for the economy appear to have been very similar to those
observed in earlier episodes, with significant effects on overall consumption spending and purchases
of domestic automobiles in particular. In the absence of those declines, it is unlikely that we would
have characterized the period 2007:Q4 to 2008:Q3 as one of economic recession for the U.S. The
experience of 2007-08 should thus be added to the list of recessions to which oil prices appear to have
made a material contribution.

But wait, didn't the housing crash cause the recession? Hamilton writes:

That last claim seems hard to believe, since Blanchard and Galí are doubtless correct
that there has been some decrease in the effects of oil prices as the economy has become
less manufacturing-based and more flexible, and since the housing downturn surely made
a critical contribution to the recession of 2007-08. Nevertheless, a few points about the
respective contributions of housing and the oil shock deserve mentioning. I would note first
that housing had been exerting a significant drag on the economy before the oil shock, despite
which economic growth continued. Residential fixed investment subtracted an average
of 0.94% from the average annual GDP growth rate over 2006:Q4-07:Q3, when the economy
was not in a recession, but subtracted only 0.89% over 2007:Q4-2008:Q3, when the recession
began. At a minimum it is clear that something other than housing deteriorated to turn
slow growth into a recession. That something, in my mind, includes the collapse in automobile
purchases, slowdown in overall consumption spending, and deteriorating consumer
sentiment, in which the oil shock was indisputably a contributing factor.

Second, there is an interaction effect between the oil shock and the problems in housing.
Cortright (2008) noted that in the Los Angeles, Tampa, Pittsburgh, Chicago, and Portland-
Vancouver Metropolitan Statistical Areas, house prices in 2007 were likely to rise slightly
in the zip codes closest to the central urban areas but fall significantly in zip codes with
longer average commuting distances. Foreclosure rates also rose with distance from the
center. And certainly to the extent that the oil shock made a direct contribution to lower
income and higher unemployment, that would also depress housing demand. For example,
the estimates in Hamilton (2008) imply that a 1% reduction in real GDP growth translates
into a 2.6% reduction in the demand for new houses.

Eventually, the declines in income and house prices set mortgage delinquency rates beyond
a threshold at which the overall solvency of the financial system itself came to be
questioned, and the modest recession of 2007:Q4-2008:Q3 turned into a ferocious downturn
in 2008:Q4. Whether we would have avoided those events if the economy had not gone
into recession, or instead would have merely postponed them, is a matter of conjecture.
Regardless of how we answer that question, the evidence to me is persuasive that, if there
had there been no oil shock, we would have described the U.S. economy in 2007:Q4-2008:Q3
as growing slowly, but not in a recession.

Food for thought. Then there's Roger Farmer, "Fiscal Policy Can Reduce Unemployment: But There is a Less Costly and More Effective Alternative," NBER Working Paper No. 15021.

This paper uses a model with a continuum of equilibrium unemployment rates to explore the effectiveness
of fiscal policy. The existence of multiple steady state unemployment rates is explained by the absence
of markets for the inputs to a search technology for matching unemployed workers with vacant jobs.
I explain the current financial crisis as a shift to a high unemployment equilibrium, induced by the
self-fulfilling beliefs of market participants about asset prices. Using this model, I ask two questions.
1) Can fiscal policy help us out of the crisis? 2) Is there an alternative to fiscal policy that is less costly
and more effective? The answer to both questions is yes.

Specifically, his more effective alternative is for the government to guarantee the prices of private sector assets, notably housing and stocks. In the case of the stock market, it could do this simply by standing ready to buy, say, S&P 500 index funds at 800 or whatever the acceptable minimum is judged to be. Months ago I proposed that the government start buying up stocks. This proves that what I need is fewer nonresearch responsibilities, some graduate research assistants, and a bigger brain so that I can translate these nuggets of insight into publishable papers. (In the same vein, a couple of months ago I thought someone could make a gajillion dollars by creating an iPod "app" that is a field guide to birds, complete with recordings of bird songs. Then, lo and behold...)