President Obama, send Charles Evans some help now!

Brad DeLong links to FRB Chicago president Charles Evans calling for more aggressive monetary policy actions to reduce unemployment - including letting inflation rise above the Fed's 2 percent target in the near term. Apparently the FOMC is sharply divided between the "doves" like Charles Evans and the "hawks" like Naryana Kocherlakota who believe that a more expansionary monetary policy would let loose the dogs of inflation. There are two vacant seats on the Board of Governors. President Obama, fill them with economists who think like Charles Evans!

The tragic fate of a slow-footed, dim-witted macroeconomist with a heavy teaching load

The paper I planned on writing eventually, "Monetary Policy Rules, Fiscal Policy Drools," has already been written, by Eric Leeper, under the title "Monetary Science, Fiscal Alchemy". His paper is excellent but I like my title better.

Good reads

This paper by Christiano, Ilut, Motto and Rostagno from last year's Symposium (back when Fed economists seemed to care about whether they could do anything to help pull the world out of recession) is very interesting. Cliffs Notes version: Contrary to conventional wisdom, stock market booms are generally associated with low inflation. This is because anticipated increases in productivity which fuel stock market booms (think the internet bubble) also imply reduction in costs for producers, meaning lower future inflation. Forward-looking price-setters will put off price increases or cut prices today in anticipation of lower future prices. If the Federal Reserve conducts monetary policy using an inflation target (as is its current practice), it will lower interest rates when it sees inflation fall. This causes the economy to accelerate and exacerbates the stock market boom, destabilizing the economy. Instead the Fed should raise interest rates when expected productivity increases spark stock market booms. The optimal policy can be approximated by including a measure of credit in the Federal Reserve's monetary policy reaction function (that is, the Fed raises rates when unemployment falls, inflation rises, or total credit rises). Christiano et al. demonstrate this elegantly in a standard New Keynesian model.

Paul Krugman and others are skeptical that inflation could ever be a problem with the economy in as deep a recession as we currently are, and therefore are very critical of the Federal Reserve's reluctance to get more expansionary in light of recent increases in inflation. The Christiano et al. paper sheds a little light on this argument. Flip the paper's logic around. An anticipated decrease in productivity - could be due to anything, but let's say concerns about excessive government regulation, higher taxes, or deterioration of skills among the long-term unemployed - causes asset prices to fall. It also causes firms to anticipate higher inflation in the future. They therefore start increasing prices now, causing inflation to rise. Boom - standard economic theory (which one should acknowledge Krugman is not wild about) suggests you can have inflation even during a deep recession.

However, standard economic theory, articulated in Christiano et al., also says that the Fed should lower, not raise interest rates in response to this upward pressure on inflation. The Fed should be setting the market interest rate to track the natural rate, which falls when productivity falls. Krugman's wrong that there is no coherent argument that inflation can rise during a severe recession, but correct in his criticism of the Fed's monetary policy.

Bernanke and the Symposium

I didn't think that in his speech at the Jackson Hole Symposium Bernanke would drop any hints about more aggressive monetary policy actions to come, and in that sense he did not disappoint. I am nonetheless awestruck that with the unemployment rate stuck above 9 percent for two years now, GDP at a standstill, financial markets in panic, and evidence of renewed contraction in manufacturing and housing, the Federal Reserve seems content to sit on its hands. People, if you believe that further monetary policy action would be ineffective, tell us so and maybe also tell us what nonmonetary policies might be helpful. If you believe that a more expansionary monetary policy would help spur the economy, and nevertheless do not plan on undertaking such policy, then tell us what freakin' objective function your policy is designed to maximize. What does the weight on the inflation parameter have to be to justify doing nothing when the unemployment rate is 9 percent and inflation is 2.5 percent? Is that weight consistent with the preferences of the typical American?

The program for the Symposium is similarly disheartening. Papers on long-run growth in emerging markets, managing natural resources, and so on. Nothing on the sputtering economy. Didn't someone think to organize the conference around questions like "what's next for monetary policy" or "can we have growth and fiscal contraction at the same time" or "the dangers of excessive sovereign debt" or "can Europe survive"? I get the sense that they're all just too exhausted from their efforts at putting out the fires of the last four years and have decided to pretend that the flames that are consuming the world economy just don't exist.

A-List

Here are the economists and policymakers attending this year's Jackson Hole Economic Policy Symposium. Not enough bloggers - how are we ever going to get the inside skinny on what everyone's saying behind closed doors?

[Oops, that's last year's list. Still, it's interesting to see who central bankers are listening to.]

Finally, interesting conservative ideas on health care

David Frum says the way to reduce health costs is to exploit the market power of insurance companies. Regulate insurance companies at the federal level to prevent insurers from reducing the quality of insurance through lifetime limits and so on; eliminate state-level barriers to allow consolidation of the insurance industry on a national level; rely on the resulting small number of large companies to force cost reductions by health providers.

One way this differs from Obama's system is that under ACA the federal government tries to reform health care delivery practices whereas under Frumcare that job is done by large companies in competition with each other. There's a chance that Frum is right here - I'd guess that the government would do a poorer job of reducing costs of household items than Walmart.

I don't see how Frumcare could be implemented without an individual mandate or some other guarantee of universal access however. The same adverse selection problem would apply: if insurers can't discriminate against people with pre-existing conditions then they can't prevent healthy people from opting out of the system and opting in only when they get (expensively) sick.

I don't know if Frum's idea is preferable to ACA, but I appreciate that it is an actual idea from an actual conservative. I will start reading FrumForum more regularly.

Earthquake blogging

Can't seem to get this song out of my mind (unfortunately).

Why people hate the Wall Street Journal

Because they consistently print opinion pieces that they must know are total nonsense. Jonathan Chait takes down today's piece by Stephen Moore. To add to what Chait says, first the truly crazy part of Moore's article:

The grand pursuit of economics is to overcome scarcity and increase the production of goods and services. Keynesians believe that the economic problem is abundance: too much production and goods on the shelf and too few consumers. Consumers lined up for blocks to buy things in empty stores in communist Russia, but that never sparked production.

Mr. Moore: the Soviet Union was a communist, centrally-planned, non-market economy! Keynesian theory is a theory of market economies such as ours. The Keynesian argument says that firms respond to incentives, so when they see customers lining up they increase production in order to get more profits. That obviously wasn't going to happen in the Soviet Union since the central planners didn't really give a rat's a** about customers standing in line. It is equally true that lines of shoppers in the Soviet Union did not cause prices to increase - does this disprove neoclassical economics?

Now the merely ignorant:

Or consider the biggest whopper: Mr. Obama's thoroughly discredited $830 billion stimulus bill. We were promised $1.50 or even up to $3 of economic benefit—the mythical "multiplier"—from every dollar the government spent. There was never any acknowledgment that for the government to spend a dollar, it has to take it from the private economy that is then supposed to create jobs. The multiplier theory only works if you believe there's a fairy passing out free dollars.

But ignorant in a big way. Moore is basically dusting off the British Treasury view of the 1930s and employing it as if Keynes had not decisively demolished it in the General Theory. Ok, here's the logic. Suppose I decide to spend $10,000 to have a new roof put on my house. That creates a job for the roofer, does it not? Why wouldn't it?

- Well, maybe the roofer was booked solid so that to do my roof he has to cancel a job for another customer. In that case there's no employment effect.

- Or perhaps to buy the roof I had to cancel my plans to buy a car. In that case the roofer's employment is offset by unemployment in the auto industry.

- Or (and this is a little convoluted) perhaps when I took money out of the bank to pay for the roof, that caused the bank to be somewhat short of cash to lend out, so it raised the interest rates on loans and my neighbor who wanted to borrow to buy a car decided it was too expensive; there again unemployment in the auto industry offsets the new job for the roofer.

In a recession, none of those caveats apply. The roofer is not booked solid - he's spending long hours at home waiting for the phone to ring, and my job crowds out his time spent watching Nascar rather than someone else's roof job. I didn't have plans to spend the money on a car; in a recession people hoard money rather than spend it, so the money comes from savings rather than from spending on other goods. The bank didn't have to raise the interest rate on loans because the Federal Reserve is keeping interest rates fixed at near zero; the bank can acquire reserves from the Fed in essentially unlimited quantities to make all the loans it wants to at that rate.

Or as Keynes put it, the resources for the purchase of the roof come from idle savings and idle labor. No fairy is required: with 20 million or so people unemployed or underemployed, there are plenty of free resources to be drawn upon to finance purchases of whatever the government wants to buy. So it should do so.

Class warfare

John Stewart says much smarter things about the budget battles than I ever could. Please Republicans, PLEASE make raising taxes on the 50 percent of Americans who don't earn enough to pay federal income taxes a centerpiece of your platform in 2012!

Privatize the liquor stores!

This Forbes article about opposition to the bill moving through the Pennsylvania legislature to private the state liquor stores was reprinted in the Gettysburg Times this morning. I'm a well-known card-carrying liberal (except during my primary challenge to Todd Platts), but I'm enough of an economist to know BS when I see it. To whit:

A proposal to turn over Pennsylvania's state-controlled sale of liquor and wine to private business would drive up prices, limit the selection of products and leave many rural residents without a nearby liquor store, critics warned lawmakers Thursday.

The effect on prices and selection will come as news to the hundreds of people in the Gettysburg area who regularly drive down to Maryland to buy their wine and liquor.

Conti said a standard state store carries nearly 2,500 types of liquor and wine, and that the board maintains stores in rural areas, even when they are not profitable, as a matter of fairness for consumers, which may not be the case under privatization.

"The bill cannot force a grocery store to bid for a license," said Dale Horst, the PLCB's director of retail operations. "If the PLCB can't make any money because the sales volume is simply not there, these areas may not be served at all."

Please. By that logic the state should also run grocery stores, Walmarts and movie theaters. Look, the benefit of living in an isolated rural hamlet is the pastoral beauty and ability to escape the hurly-burly of city life. The cost is that you have to drive a ways to buy groceries and liquor.

I don't know enough about the details of the Turzai bill (but I'm going to start reading Lew Bryson's blog regularly for all my liquor privatization news), but here's my vision for Pennsylvania:

- I get to buy beer, wine and liquor in grocery stores, pharmacies, WalMart, wherever.
- I can buy my beer by the bottle, case, or six pack - I do not have to buy an entire case every time!
- There are no restrictions on the varieties of beer, wine and liquor available to me; any retailer in Pennsylvania can order any brand from any supplier anywhere in the world
- Alcoholic beverages are taxed at a reasonable rate, comparable to the rate charged by other states, that provides the state with a decent amount of revenue
- Workers at the establishments that sell alcohol are free to join a union and earn a decent living.

Ta-Nehisi Coates visits Gettysburg

He dreads his visit:

At this point, I've toured quite a few battlefields -- the Wilderness, Petersburg, Shiloh, Fort Donelson. I have, for several reasons, been dreading a trip to Gettysburg. I should say a return to Gettysburg, because I came here in middle school on a field trip. I remember liking it a great deal, but having no deliberate sense of the Civil War in relationship to slavery, or Gettysburg in relationship to slavery. I certainly didn't know that Confederate Armies had kidnapped free blacks during the campaign. Of course, once you understand that the South seceded to preserve an economy built on enslaved black people, the act doesn't seem that shocking.

but in the end sees that we're not all that bad after all:

I can't go much further, because I risk giving up my article. But the point I'm driving at it's very tough to consider Gettysburg, as its commonly rendered in the American imagination, when you're black. And yet in point of fact, perhaps more than any other battlefield in the country, the folks at Gettysburg have done a really good job in making clear that the war was about slavery. What struck me more than anything was the film in the visitor center. It was narrated by Morgan Freeman. There were quotes from Frederick Douglass. You really couldn't watch it and think the Civil War was about anything else.

and he's still here!

And yet still, I had that weird feeling. I never feel more "outside" than when I'm visiting battlefields. I have one more day here, and a lot more to think about.

I wish he'd stopped by the College to say "hey" and to find out how we overwhelmingly liberal overwhelmingly northerners get by in a town that fetishizes the gallantry of the Confederate invaders. Maybe he did stop by but nobody told me. Where are you now Ta-Nehisi? Wanna get a beer?

London's burning

The riots are the result of a lot of different factors, but surely the global economic crisis has something to do with it. Small signs of the unraveling of our society under economic pressures brings John Maynard Keynes' 1938 essay My Early Beliefs to mind. In it Keynes reflected on how poorly his and his cohort's pre-war beliefs held up against the reality of World War I, the Great Depression, the rise of Communism, Nazism, and lesser Fascisms, and the looming menace of World War II:

"We were the last of the Utopians, or meliorists as they are sometimes called, who believe in a continuing moral progress by virtue of which the human race already consists of reliable, rational, decent people, influenced by truth and objective standards, who can be safely released from the outward restraints of convention and traditional standards and inflexible rules of conduct, and left, from now onwards, to their own sensible devices, pure motives and reliable intuitions of the good...

"In short, we repudiated all versions of the doctrine of original sin, of their being insane and irrational springs of wickedness in most men. We were not aware that civilisation was a thin and precarious crust erected by the personality and the will of a very few, and only maintained by rules and conventions skilfully put across and guilefully preserved. We had no respect for traditional wisdom or the restraints of custom. We lacked reverence, as [D.H.] Lawrence observed and as Ludwig [Wittgenstein] with justice also used to say - for everything and everyone. It did not occur to us to respect the extraordinary accomplishment of our predecessors in the ordering of life (as it now seems to me to have been) or the elaborate framework which they had devised to protect this order... As cause and consequence of our general state of mind we completely misunderstood human nature, including our own...

"And as the years wore on towards 1914, the thinness and superficiality, as well as the falsity, of our view of man's heart became, as it now seems to me, more obvious....

"If, therefore, I altogether ignore our merits - our charm, our intelligence, our unworldiness, our affection - I can see us as water-spiders, gracefully skimming, as light and reasonable as air, the surface of the stream without any contact at all with the eddies and currents underneath. And if I imagine us as coming under the observation of Lawrence's ignorant, jealous, irritable, hostile eyes, what a combination of qualities we offered to arouse his passionate distaste; this thin rationalism skipping on the crust of the lava, ignoring both the reality and the value of the vulgar passions, joined to a libertinism and comprehensive irreverence, too clever by half for such an earthy character as Bunny [David Garnett], seducing with its intellectual chic such a portent as [Lady] Ottoline [Morrell], a regular skin-poison. All this was very unfair to poor, silly, well-meaning us. But that is why I say that there may have been just a grain of truth when Lawrence said in 1914 that we were 'done for.'"

We could use a few good people skilfully to put across some rules and conventions and guilefully to preserve them right about now. More broadly (and somewhat apart from Keynes' point in this particular essay, but consistent with his other writings): Managing the economy is important. We need growth and economic opportunity to keep our social structure from becoming unhinged. Expect more of what we're seeing in the UK as long as this economic crisis continues.

It's a government recession

It started out as a construction / financial / manufacturing recession. Now employment in every sector of the economy is stagnant or growing. Only the government is shedding jobs. Here's the net change in employment by sector, July 2010 - July 2011, from the BLS:

Total nonfarm: +1.258 million
Total private: +1.805 million
Mining and logging: +89,000
Construction: +32,000
Manufacturing: +165,000
Trade, Transportation and Utilities: +342,000
Information: -23,000
Financial activities: -15,000
Professional and Business Services: +512,000
Education and Health Services: +405,000
Leisure and hospitality: +212,000
Other services: +86,000
Government: -547,000
Federal: -207,000
State: -90,000
Local: -250,000

Since March 2010, when overall employment started rising, nonfarm payroll employment has increased by an average of 109,000 per month - an anemic rate that is a bit under the level necessary to keep the unemployment rate steady. Hence the unemployment rate has increased a smidge. If government employment had increased by 18,000 per month during that period, the average rate of increase under the Bush administration, the average monthly increase in payroll employment would have been 158,000 - too low but not totally disheartening - and the unemployment rate would be drifting down slowly. Had government employment grown at its Bush-era rate, total employment would be 776,000 greater right now. And that is not taking the multiplier effect of government employment into account.

Faced with these facts, what are policymakers doing? Trying as hard as they can to reduce government employment at the federal, state, and local level. Brilliant!

And the Fed's response to the slowdown?

The Fed today took the minimum possible step toward a more expansive policy, changing the wording of its statement to stress that it will maintain interest rates near zero "at least through mid-2013" rather than "for an extended period". It also says it will monitor the size of its asset holdings and consider the full range of policy options in case the economy weakens further.

I think this statement should have been made about three months ago, and today's action should have been to actually announce another round of asset purchases. But like last year, it looks like the Fed is going to be about six months late (and perhaps several trillion dollars short) with its policy response.

Note: I don't like to read too much into stock price movements, but it looks like the market was rallying this morning on rumors that the Fed was going to take some action. The Dow has fallen about 200 points since the Fed released its statement at about 2:18 and is now back to where it was at the beginning of the day. Nice job guys!

Update: Dow is up 429 for the day and Treasury yields are down. Looks like the stock market liked the Fed's statement after all. But I still think it's too weak.

A plan to reinvigorate the economy

I approve of Joe Gagnon's approach:

- The Fed launches a new $2 trillion round of quantitative easing with a commitment to further action if the economy remains weak

- The Fed lowers the interest paid on reserves to zero

- The Obama Administration instructs Fannie Mae and Freddie Mac to allow all homeowners current on their mortgage payments to refinance regardless of loan-to-value ratio

- The Obama Administration makes a strong effort for mortgage modifications for distressed mortgage borrowers

- The Treasury renounces its "strong dollar" policy, allowing a broad-based depreciation.

I endorse Paul Krugman's caveat: the Fed should not reassure markets that it will switch course if inflation rises above 3 percent. In fact, the Fed should promise that it will continue to make purchases as long as inflation is below 3 percent for a few years.

I also support the establishment of an infrastructure bank in legislation attached to the highway bill that is under consideration in Congress, and an extension of the payroll tax holiday and unemployment compensation.

Everything but the last three proposals can be done by the Obama Administration and Fed alone, without having to go through Congress. For the last three, Obama needs to be much more specific and forceful than he was in his speech yesterday. The message ought to be, if Congress does not act on jobs, it - not he - will be held responsible for continued high unemployment in 2012. If you can't get the legislation, take the issue.

Outsourcing grading

From the Chronicle:

Professors Cede Grading Power to Outsiders—Even Computers
By Jeffrey R. Young

The best way to eliminate grade inflation is to take professors out of the grading process: Replace them with professional evaluators who never meet the students, and who don't worry that students will punish harsh grades with poor reviews. That's the argument made by leaders of Western Governors University, which has hired 300 adjunct professors who do nothing but grade student work.

"They think like assessors, not professors," says Diane Johnson, who is in charge of the university's cadre of graders. "The evaluators have no contact with the students at all. They don't know them. They don't know what color they are, what they look like, or where they live. Because of that, there is no temptation to skew results in any way other than to judge the students' work."

Western Governors is not the only institution reassessing grading. A few others, including the University of Central Florida, now outsource the scoring of some essay tests to computers. Their software can grade essays thanks to improvements in artificial-intelligence techniques. Software has no emotional biases, either, and one Florida instructor says machines have proved more fair and balanced in grading than humans have...

Better still, grading could be outsourced to countries like India or Turkey that have large numbers of excellent academics willing to work for lower salaries than US instructors. Some of my colleagues have elaborate grading rubrics that they use to efficiently plow through 30 term papers a semester. But if the rubric is that good, surely it could be used by a contract worker instead of the instructor! For that matter, why do I write my own exams? I could download the final exam from some past intermediate macro class at an Ivy League university and send it to India to be graded - think of the time savings!

The debt deal

Paul Krugman is apocalyptic this morning. "Disaster," "catastrophe," "abject surrender." I think we need to keep a few points in mind.

1. One way or another there needs to be spending reductions over the next ten years. I don't have the exact figures on me, but at the current pace of spending the federal government will spend something like 45 trillion dollars over the next decade. The promised cuts (relative to that baseline) are about $2.5 trillion, or just under 5 percent. Significant but not catastrophic.

2. the first round of cuts supposedly consists of programs identified by the Biden group that were uncontroversial. If we're talking about ethanol subsidies and other agricultural subsidies and the like, then liberals have nothing to complain about here.

3. The cuts don't start happening until 2013 (I believe; we don't have all the details), so they don't do significant damage to the economy right now. Hopefully the economy will be stronger by then and able to absorb the cuts with little pain.

4. It's unlikely that the Congressional commission that is supposed to propose further deficit reductions in November will propose significant tax increases. However, as I understand it the commission will use "current law" as the baseline for it's recommendations. Current law is that all of the Bush tax cuts expire at the end of 2012, increasing revenue by $3.5 trillion or so over the next decade. So if the commission fails to make any recommendations for tax increases, revenues will rise by that amount, more than the total amount of spending cuts. Theoretically the Commission could propose keeping the tax cuts at the low end but letting the high end cuts expire (liberals' preferred outcome) and this would be scored as a tax cut by the Commission!

5. So I don't think the agreement is terrible. The worst that can be said about it is that it does not include any tax cuts or spending increases to create jobs this year. Obama indicated in his speech that he is still committed to pushing a continuation of the payroll tax cuts imposed in December and an infrastructure bank, legislation for which is working it's way through Congress. I don't know how the agreement affects those efforts, but if we can now turn our attention to jobs, that's a good thing.