Why do people dislike inflation?

Matt Yglesias thinks that if people knew that wages were the biggest component of the price level, they wouldn't be as freaked out by inflation:

[T]he most important price in the economy is the price of labor and the price of labor is equal to workers' incomes, so a general increase in the nominal price level is necessarily a general increase in nominal incomes. But nobody seems to believe that. Instead people are convinced that gasoline and milk are the main prices in the economy, and that a general increase in the nominal price level is necessarily a general decline in real incomes.

This is a pretty common idea: People dislike inflation because of money illusion. They mistake their nominal incomes for real incomes, and mistake consumer prices for the real cost of living. Seems plausible. And it provides a parsimonious explanation for other phenomena, such as downward nominal wage stickiness.

Except that I see a problem with this explanation. Money illusion explains why people dislike hypothetical or prospective inflation, but it does not explain why people are unhappy when inflation actually happens. Suppose real prices and real wages are unchanged, but inflation spikes to 10%. People who suffer from money illusion will tend to be upset when consumer prices rise, but happy when their nominal wages rise. So in this scenario, it seems that their elation at rising "incomes" would at least mostly cancel out their dismay at rising "costs of living". Instead, it seems that actual inflation causes a lot more dismay than elation.

Here's an alternative explanation: Maybe people think that inflation lowers their real wages. Why would they think that? Well, because inflation tends to correlate with lower real wages! Check out this graph, courtesy of Pau Rabana of NYU, which shows the historically observed correlation between inflation and real wages in the U.S.:

This graph clearly shows that when inflation goes up (at time 0), real wages tend to go down over the next few months. That means that inflation really is correlated with an increase in the cost of living for the average American.

Now, of course, correlation does not equal causation, but mistaking correlation for causation seems like a lot easier of an error to make than money illusion. If people see a spike in inflation, they are logically justified in saying "Oh no, here comes an increase in my cost of living!" They are not necessarily justified in saying "If we had taken steps to prevent that inflation, my cost of living wouldn't have gone up." But it is a very short leap of illogic to go from the first statement to the second. 

It's easy to to see how the correlation in this graph could be misleading. People instinctively think that causes precede effects in time, but this is not always the case. For example, what if expected inflation leads actual inflation, and a spike in expected inflation causes real wages to rise, through a forward-looking Phillips Curve kind of effect? 

But on the other hand, maybe inflation really does cause real wages to fall. How would this work? I don't know, because the wage bargaining process is not well-understood. There are a lot of puzzles and mysteries. One possibility, just off the top of my head, is that inflation allows employers to cut real wages more easily without violating implicit contracts. That could be caused by money illusion too, or it could be caused by people thinking that their coworkers might have money illusion. Anyway, that's just a conjecture.

The basic point is: Maybe people don't dislike inflation because they're stupid. Maybe people dislike inflation because they know it's correlated with falling real wages.

reade more... Résuméabuiyad

Government investment: timing vs. levels

Tyler Cowen is skeptical of the argument low interest rates mean we should boost government investment: 

It is often claimed that the governments of the United States, the UK, and Germany should spend more money because they can borrow at low rates, thus raising the present expected return on the investment considered as a whole. 

Maybe, but keep in mind that the interest rates on quality government debt are down, in part, because the risk premium is up...You might think the government investments are “low hanging fruit” in terms of quality.  Maybe yes, maybe no, but the low real interest rate doesn’t signal that, rather it signals merely that people expect to be repaid. 

In this argument for more government investment, the notion of government investments as low hanging fruit is doing a lot of the work.

I think that Tyler may be conflating an argument about levels of investment with an argument about the timing of investment.

Suppose the optimal level of government investment over the next decade is $2.2T over the next 5 years (Note: I did not make this number up). That still leaves open the question of timing. Should we do all $2.2T next year and then zero over the following 4 years? Or should we space it out evenly? Because capital (which you create by investment) is durable, we have a lot of flexibility in choosing when to make investments, even if how much investment we need is fixed.

The correct timing depends on the interest rate. Remember, in a world where government capital is not a perfect substitute for private capital, government bonds are net wealth, and there is no Ricardian Equivalence. So it's best to do your investing when government capital is cheap. In other words, when the interest rate on government debt is low. For the purposes of timing, it doesn't matter why the interest rate is low. If the interest rate is low because of risk premia, that's fine. It's still a great time to do whatever investing that you need to do. This is true even if the current average level of public investment is just right (or even if it's slightly too high!).

So the interest rate argument for government investment is all about timing, not levels. "More investment right now" does not necessarily mean "more investment overall". If you need to make some hay, the correct time to make it is when the sun is shining.

Update: Tyler writes to point out that rates are expected to stay low for quite some time, weakening the case for shifting investment forward. This is true, but I think there are good reasons to believe that rates will not go any lower; even if the yield curve is pretty flat right now, the low level of interest rates probably limits the downside risk.

reade more... Résuméabuiyad

Economists who don't do it with models

"Economists do it with models. But those models are generally either really old or really ugly." - Noah Smith, attempting to be witty

Scott Sumner says: Formal models? Economists don't need no steenkin' formal models!

There are basically two types of demand-side models, both of which are nearly useless: 

1.  Some general equilibrium models are used to find which stabilization policy regime is optimal from a welfare perspective.  Most of these models assume some sort of wage/price stickiness...The problem is that...You can get pretty much whatever policy implication you want with the right set of assumptions.  Unfortunately, macroeconomists aren’t able to prove which model is best... 

2.  A second type of model tries to show how to best implement a specific type of policy regime, like inflation targeting...Unfortunately, these “implementation models” conflict with the EMH—it’s not clear why the central bank wouldn’t just peg the price of a futures contract linked to the goal variable... 

To summarize, despite all the advances in modern macro, there is no model that anyone can point to that “proves” any particular policy target is superior to NGDPLT.  There might be a superior target (indeed I suspect a nominal wage target would be superior.)  But it can’t be shown with a model.  All we can do is construct a model that has that superiority built in by design... 

Models are toys to show our students.  When we face serious real world dilemmas it’s time to put away the toys and get real[.]

Sumner essentially restates my big critique of modern macro: How do we know which model to use at any given time? There are a ton of macro models but no commonly accepted scientific standard for validating/rejecting them. So what we (the profession, the Econ Hive Mind, whatever) end up doing is choosing a model based on how plausible we think its assumptions are. We go with our intuition, gut feeling, or politics instead of data. Models are "stories", and we choose the story that sort of sounds the best.

But what should we do instead? Here is where Scott and I part ways. Scott basically says: Why constrain your story with math when you can just tell the story? And I say: Sure, but you're still just telling stories.

There are advantages to telling your stories in English instead of in Math. One is that you can be more flexible - you can add stuff to your story, or be ecumenical in your view of the world, without being worried about pesky internal contradictions. The other advantage is that you can explain your ideas to a wider class of people, who either don't understand Math or can't be bothered to read through it.

Of course, there are disadvantages as well. One is that you can't give quantitative predictions: If we deviate from NGDP Level Targeting by X%, how much will our incomes go down? And so forth. This problem can be solved by using simple "ad-hoc" or aggregate-only models, which are fairly easy for most people to grasp and can be modified without much effort. Then there's the second disadvantage of English storytelling, which is internal consistency. Formal models rely on their assumptions, but once you choose your assumptions, your conclusion is forced by the Math. With English storytelling, you can state conclusions that don't follow from your own assumptions, and often no one will be the wiser.

But I feel like this list of advantages and disadvantages ignores the elephant in the room: How do we know if the story is right? (For you George Box-quoting jerks, what I mean is: How do we know how usefully this story can be applied in a given situation?) Whether you tell your story in complex Math, simple Math, or English, it is still desirable to have a way to evaluate the story.

How do I know that NGDP Level Targeting (Scott Sumner's cause celebre) is a good policy? It hasn't been tried before. So to evaluate how good of a policy it would be, we need to know a lot about how the economy works. Scott Sumner has some ideas (informal models) about how the economy works. How well do these ideas match reality? I'm not sure. And more importantly, I don't know how I'm supposed to be sure. If Sumner used formal models, I could at least go and do a statistical test of the model (for example, a Full Information Maximum Likelihood test) against the available macro data. Sure, no one would pay attention if the test rejected the model - the data are crappy and the econ profession lacks generally agreed standards for scientific disproof - but at least I could do it. But since Scott's stories about the economy's inner workings are not quantitative and thus not subject to data, I don't even know how to evaluate them.

I mean, sure, I can think of some extreme stylized facts that, if true, would put the lie to Scott's basic story - for example, if inflation tended always to rise in recessions - but to require such a huge, glaring discrepancy in order to invalidate a model is setting the bar for your theory pretty low (in the language of econometrics, it's "protecting the null hypothesis").

In other words, the basic, fundamental problem with macro, as things stand, is that it's not scientific. Making it less formalized, or less mathematical, doesn't get around that problem. And it seems pretty likely to me that if macro ever does come up with a way to tell if models are right, it's going to require that those models be of the formal mathematical type.

Update: Though, come to think of it, biology models are not mostly math. If you give a description of how the liver works, the description won't rely on equations, and in fact will be more useful than one that does rely on equations. So maybe macroeconomic science won't rely on math; maybe it'll rely on qualitative descriptions of the function of key components of the economy. I'm really not sure. But in any case, we need some standard of model evaluation...

Update 2: Scott Sumner gets model-icious!

reade more... Résuméabuiyad

Believe in yourself, for my benefit.

In his Stanford CS183 class on tech startups, Peter Thiel asks the age-old question: Do entrepreneurs succeed because of skill, or because of luck?

He also gives the correct answer: Since every new company is different, we can't do statistical analysis to predict a startup's success or failure from past data (in econometrics jargon, startup success is non-ergodic). We know for sure that some skill is involved in the mix; we also know for sure that some luck is involved in the mix. How much skill and how much luck, though, is something we'll never really know.

So here's the question: Should a prospective entrepreneur believe in skill, or luck? And my answer is: Depends on who's asking! From an individual standpoint, it could go either way. But there are reasons to think that even if belief in skill is wrong, it might benefit society! Here's why.

If you believe in skill, you're more likely to be an entrepreneur, because you'll be more convinced that you can beat the market. Which is to say, a person who believes she is more skilled than the average will only bet on that belief if she thinks skill matters. If you think entrepreneurial success is mostly just down to luck, then what you should do (as Thiel points out) is to diversify your portfolio and manage your risk. Go get a nice stable high-income job and put your savings into index funds. I.e., don't be an entrepreneur at all.

This fits with economic theory. Economist Frank Knight famously described a difference between "risk" and "uncertainty". Risk is when you don't know the outcome, but you know the probabilities of the outcomes (e.g. flipping a coin). Uncertainty is when you don't even know the probabilities of success and failure (e.g. starting the first social-networking company). Entrepreneurs, he said, must accept not just risk, but also true uncertainty, since no one really knows how likely a new business is to succeed. This is especially true of tech entrepreneurs.

If you believe in skill (and if you have skill), you are more likely to accept true uncertainty, because you probably think that your guess regarding your probability of success is better than other people's guess. In other words, you believe that your knowledge of your own skill is inside information, so instead of diversifying your portfolio (i.e. insuring against risk), you concentrate your investments in one big bet on your inside info.

So will believing in skill be good or bad for you? It's tough to know. In some eras, there are lots of good opportunities just out there for the taking (e.g. when the internet was just being invented), but in other eras, the available ideas are more scarce, and you just never know which era you're in (it also differs by sector).

But some people argue that even when believing in your own skill is a bad bet from an individual standpoint, it might be good for society to have lots of people who believe (even irrationally!) in their own skill. The reason, essentially, is this: There is always new stuff out there, and if society is going to progress, somebody needs to discover it. If nobody is confident in their own skill, nobody will try any new stuff; each person will limit her exposure to true uncertainty, but society will suffer. In other words, there is a positive externality to exposing oneself to true uncertainty.

Blogger and CTO Matt Sherman puts it this way:

The process of going from nothing to something...is inherently irrational...To embark on it is to leave the world of economic modeling...[P]rogress requires madness, that is, the freedom to pursue choices whose rationality can’t be measured.

Economists Antonio Bernardo and Ivo Welch actually have a model that describes how this could happen. From the abstract to their paper:

By ignoring the herd, the actions of overconfident individuals ("entrepreneurs") convey their private information. However, entrepreneurs make mistakes and thus die more frequently. The socially optimal proportion of entrepreneurs trades off the positive information externality against high attrition rates of entrepreneurs[.]

Same basic idea!

So there are theoretical reasons to believe that overconfident entrepreneurs are more likely to benefit society than they are to benefit themselves. If you try to be the next Mark Zuckerberg, chances are you're taking on a lot more risk than you would take if you weren't such an overconfident nut. But without overconfident nuts like you, our economy will be poorer and our society will be more stagnant.

So, by all means, young entrepreneur, believe in skill! Believe that you, not the person sitting next to you, will be the next tech billionaire. You're probably wrong. But the chance that you might be right is enough to make your quixotic madcap adventure worth it for the rest of us.

reade more... Résuméabuiyad

On grumpy grandparents

My grand-advisor, Greg Mankiw, is not known to be a big fan of the Democratic party, presumably because they want to raise taxes on the rich, opposing which is one of Greg's causes celebres. However, I wonder if his anti-tax sentiment has bled over into his analysis of other policies undertaken by Democratic politicians.

Here's one example: Today, Greg links approvingly to this Marc Thiessen column in the Washington Post. Thiessen, a Republican operative who is most famous for mounting a spirited defense of government torture, lists a bunch of companies that have received loans or loan guarantees from the Obama administration and have subsequently gone bust. But, as Mankiw must surely know, this list is cherry-picked. There is no similar list of companies that have received such loans or guarantees and have subsequently thrived. Without that other list, how can we evaluate whether Obama has been a "good venture capitalist"? (This is setting aside the issue of whether the government has the same objectives as a venture capitalist in the first place.)

In fact, the evidence shows that the government is pretty good at estimating how many of the companies it supports are going to go bust. In other words, Thiessen's list of failures is about as long as the Obama administration expected the list to be. So Thiessen hasn't really proven much at all.

Here's another example: in a post earlier this week, Greg wrote the following:

[I]t is worth remembering that the Clinton boom was in large measure driven by the dot-com bubble[.]

Really? The dot-com bubble caused 90s growth? Remember, Greg Mankiw is a macroeconomist - perhaps the pre-eminent business cycle theorist of our time. Upon what is he basing this claim? To my knowledge, none of Mankiw's well-known business cycle models rely on the idea that asset price fluctuations drive the real economy. Also, to my knowledge, none of Mankiw's well-known business cycle models rely on the idea that sectoral malinvestment drives business cycles.

So not only can I not tell what exactly my grand-advisor means by saying that a "bubble" drove the economy, but it doesn't appear to be something that he claims in his published research.

Furthermore, the claim is far from obvious when you look at history. The robust growth of the 90s began well before tech stocks became overpriced (measured relative to ex post earnings). And productivity, which one assumes is not driven by "bubbles", accelerated strongly starting in the early 1990s. Note that I'm not necessarily crediting Clinton with the 90s boom, I'm just saying that the boom was no illusion.

So to Greg I say: Just because Democrats want to tax the rich doesn't mean that everything they do is a mistake and every Democratic administration is a failure.

reade more... Résuméabuiyad

In defense of private equity: Japan.

Taking a short break from my blogging break here, to wade into the controversy over private equity.

In general, I am a supporter of private equity, so first a disclaimer. There appears to be a real and genuine problem with the private equity industry in the U.S.: our tax code encourages private equity companies to load their acquisitions up with too much debt. That is a relatively recent problem, and one that seems fixable.

Anyway, I generally support private equity. Why? Because of Japan.

Fact 1: In Japan, there is no big private equity industry, because it is very difficult to do a leveraged buyout of a company. The Japanese government allows companies to defend themselves from takeovers in ways that are illegal in America. Also, Japanese companies often hold each other's shares, a practice known as "cross-shareholding", which tends to prevent hostile takeovers. Cross-shareholding creates huge financial risks; however, many of the Japanese companies that engage in cross-shareholding are big banks that are backed by the government (much as ours are here in the U.S., but more explicitly), so this risk is assumed by the Japanese taxpayer. For a comprehensive primer on Japanese corporate governance, see here.

Upshot: In Japan, private-equity firms cannot buy companies and force them to restructure.

Fact 2: Japan has a productivity problem. We think of Japan as being super-productive, and in fact some industries (and most export-oriented factories) are. But overall, Japanese productivity kind of stinks. Since at least the 90s, Japan's Total Factor Productivity has lagged far behind that of the U.S. Nor is this due (as Ed Prescott has tried to claim) to a slowdown in technology; it appears to be a function of how resources are allocated within and between Japanese companies.

Although it's hard to measure white-collar productivity, anecdotally, it is horrendous in Japan. Employees sit idly in front of their computers waiting for the boss to leave so they can go home, or make busy-work for themselves, copying electronic records onto paper (yes, this is real!). Unproductive workers are kept on the payrolls because of lifetime employment, with high salaries guaranteed by the system of seniority pay. To this, add endless meetings, each of which must be exhaustively prepared for in advance. Layer upon layer of bureaucracy with poorly defined accountability. Pay based entirely on tenure rather than merit.

I have seen a little of this with my own eyes, but if I had to work full-time for a Japanese company for any extended period of time, I would probably quit and join the yakuza. It is baaad. Like, Brazil-the-movie-bad.

Would private equity shake up this insane little world? I think it would. In the U.S., Steven Davis, Josh Lerner, and their co-authors found that private equity firms have a positive impact on the productivity of the companies they buy out. Here is a survey of other research on the topic; basically it all agrees that productivity gets a boost when a firm gets acquired.

It is my opinion that Japan desperately needs this sort of productivity boost.

Now, the knock against private equity (besides the debt problem I mentioned at the beginning of this post) is that it screws over the workers of the companies it buys. In fact, it does seem to be the case that private equity firms achieve most of their productivity gains by firing people. The stereotypes are true. So private equity's detractors say: Workers may not be shareholders, but they are stakeholders. When workers sign on to work for a company, and thus sacrifice their mobility and outside options, they enter into an implicit contract with a company, that says, essentially, "This company will try to live as long as possible." When private equity companies chop up and sell a company, this implicit contract is violated, and the worker-stakeholders lose out. (Note: Just to pat myself on the back, I thought of the "implicit contract" thing before reading this Larry Summers paper! But it says basically the same thing.)

And I agree with that. And I think it is a real cost of letting private equity do its thing. But I don't think it's as big a cost as people make it out to be. Again, the reason is Japan. In Japan, the implicit contract between worker and firm is far more important than in the U.S.; companies there view workers as very, very important stakeholders. This is, in fact, why the government makes it so hard to take over companies; Japan is a Bain-basher's dream land.

But - and here I venture into the realm of anecdotes and intuition - I do not think that Japanese workers are happier than American workers. First of all, the low-productivity office environment I described takes its toll. Long wasted overtime hours separate men from their families. Squelched individual initiative creates feelings of frustration and stasis. The impossibility of switching companies, the lack of merit pay, and the pre-determined nature of promotions leave few career goals to strive for. And, most importantly, the binding of employees to their employers creates a pervasive feeling of powerlessness (無力感) and fear; if bad decisions or market shifts force a company to lay off workers, those workers have basically no hope of finding a similar job elsewhere. No wonder the suicide rate in Japan is so astronomically high. The bulk of those suicides are men of working age.

And I didn't even mention women. Anyone who knows Japan knows how poorly Japanese women are utilized (and how poorly they are treated) at many Japanese companies. It is disgusting, and it is harming Japan's economy big-time. One reason is the impossibility of winning discrimination lawsuits in Japan's hidebound legal system. But I think a bigger reason is related to corporate governance; since there is no pressure on these zombie companies to boost productivity, there is no reason for them to hire more women or make better use of the women they already have. Private equity would change that, I think. What private equity does is force companies to cut labor costs; one big way of cutting costs is to replace your existing workers with workers who are of similar quality but are paid less. In a country with a big gender pay gap, those alternative workers are known as women.

So I say: Japan should let the corporate raiders raid. Sic the pirates on the zombies.

And although American critics of private equity have valid points, I think they should look to Japan before they denounce the role that Bain Capital and company have played in our economic and social development. By all means, change the tax code to discourage private equity companies from over-leveraging their acquisitions. Close the carried interest loophole. Create re-employment services to help the workers laid off in restructuring. But for pete's sake, don't wish that our corporate culture was like Japan's. You wouldn't like it.


Update: Paul Krugman chimes in, with a claim that the rise of buyout firms increased inequality. Sorry, maybe it's true, but I don't see the proof here. Correlation does not equal causation, and a lot of other stuff was going on at the time, in particular globalization, the death of unions, and changes in technology.

Update 2: Some people have been asking "Well, maybe private equity boosts productivity in the short term, but doesn't it reduce investment in the long term?" I was curious so I did a little Googling. Here is a paper by Jarrad Harford and Adam Kolasinski purporting to show that private equity firms generally create more long-term value than they destroy. Here is a private study showing that firms bought by private equity tend to increase, not decrease, their investment rates in the medium-term. Here is a paper by Josh Lerner and others showing that companies bought by private equity maintain about the same rate of research and development. But on the other hand, Josh Kosman's new book purports to show that companies bought by private equity tend to go bankrupt. And the overleveraging thing appears to have become a lot more common recently; this may mean that private equity has been more destructive recently than in the 80s, but the long-term data isn't in yet. My tentative conclusion: If done right, private equity creates value and improves productivity, but we need to close the interest tax deduction loophole that encourages overleveraging.

Update 3: Here's a recent news story about just the kind of low white-collar productivity that I'm talking about...

reade more... Résuméabuiyad

Beware the deflationary forces at work in the worldwide economy

I'm not an economist by training, but that won't keep me from advancing a hypothesis or two about the worldwide economy.

My main thesis is that there are signifcant deflationary forces at work today (mostly new in the last six months), which could have unexpected consequences in the months ahead.

Not all parts of any economy are deflationary. Some are inflationary. But it's important to recognize what the deflationary forces are.

Deflation is (colloquially, at least) a situation in which too little money is chasing too many goods. Ultimately this leads to a surplus of goods and lowered prices on them, with a corresponding strengthening of currencies.

One of the great examples of deflation cited in textbooks is the deflation that occurred from the period of 1870 to 1900 as the dramatic productivity gains of the Industrial Revolution (combined with relatively modest increases is wages) resulted in cheap goods with few buyers. I think we are living a replay of this situation today. Gains in computing power (with Moore's law) combined with the application of technology to production (resulting in historic high productivity), combined with the devaluing of ordinary items of consumption via competition on the Internet (e.g., Amazon), combined with declining earning power (in real terms) for most workers, has led to a phantom deflationary economy that runs in parallel with an inflationary economy. 

The evidence for deflation, today, comes from many sources.

1. Petroleum has been declining in price (significantly) recently.

2. Natural gas (a feedstock for plastics, as well as an energy source) is at historic low prices.

3. Base metals (steel, aluminum, copper, etc.) are sinking in price.

4. Precious metals have been on a downtrend since February 2012.

5. Soft commodities (e.g., agriculturals) have been on a steady decline since February.

6. There is a glut of unsold real estate in the U.S., depressing prices. In China, home prices have declined 15% or more in the past year.

Cash hoarding is known to be deflationary, and we have seen plenty of that, not only on the part of banks, but also the very wealthy, who have not been spending the majority of their cash (neither to create jobs, nor invest).

Participation in the stock market by individual investors has shrunk markedly over the past two years.

Unemployment has the effect of decreasing consumer spending. In the U.S., real unemployment (including the discouraged, and those who have left the workforce) is running around 15%. These are people who are barely spending any money.

The rate of new family formation (in the U.S.) is down substantially. This puts downward pressure on the housing market and leads to less spending, generally.

U.S. corporations are carrying record amounts of cash on their books. This is a form of cash hoarding.

Banks are not making as many loans as they used to. Again, cash hoarding.

Government austerity programs are aimed at cutting government spending, which is a form of cash conservation (hoarding).

Lately, because of the banking crisis in Europe, there has been a run on the U.S. dollar, increasing its relative value. This is delflationary in the sense that dollar-denominated assets are now dropping in price.

The short-term effects of deflation are positive for businesses whose margins are dramatically affected by raw-supply costs. If aluminum, steel, and rubber are cheap, car makers can enjoy increased margins. If restaurants see the cost of food go down, this means margins increase.

Longer-term, the effects of deflation are not so salutary. Inventories pile up. Consumers who are hoarding cash (or don't have much cash to begin with) will stop buying big-ticket items (houses, cars) and inventories of those items will increase.

Also, consumers will be less likely to buy items on credit, because if you take a loan out to buy a high-ticket item, you are promising to pay in future dollars that are worth more than current dollars. In essence, you are paying more for an item than the interest rate would indicate.

The Internet has been a huge deflationary influence. Think of all the items on Amazon that have been cut in price to a fraction of pre-Internet pricing. Multiply that by all the other companies on the Web who have been able to "eliminate the middleman," bringing you goods at historic low prices.

Where it gets complicated is in separating out deflationary aspects of the economy from inflationary aspects. This is no longer largely a goods-based economy. It's a service-based economy, more and more. And services are not going down in price. The prime example of this is health care costs. In the U.S., health care costs are one of the fastest rising cost centers in the economy. The same is true of the cost of higher education. Colleges have been increasing their tuition rates much faster than the overall rate of inflation.

Bottom line, not all aspects of the economy are experiencing deflation. Some aspects are experiencing significant inflation. Thus, the Consumer Price Index is positive, still. But it may not be, for long.

What does it all mean? You can probably expect that housing prices will stay low (given the huge amount of unsold inventory). Also, you can expect to buy a new car at a much lower price later this year than right now. The U.S. is on track to produce 15 million new vehicles in 2012, which is more than a 10 percent increase over last year. This will lead to a glut of unsold vehicles come late fall. If you're in the market for a new car, you'd be well advised to wait until late in the year to purchase a new car. Dealers will be overstocked and anxious to cut deals.

Ironically, this may be one of the best times in history for governments to print more money and boost inflation. Rather than encouraging austerity, governments should be spending more on social programs and paying for them with printed money that will be worth less in the future than now.

And the stock market? That's a complicated question. If there's a flight to the dollar, the dollar will increase in value and everything dollar-denominated (including U.S. stock prices) will inevitably go down, unless the Fed acts to increase the money supply. But to do that, they would practically be forced to charge negative interest rates to banks. That's never happened before.

The banking crisis in Europe is putting new focus on all these questions. Every Greek (and Spanish and Italian and Irish) citizen knows instinctively that cash is king. Local currencies could be devalued severely in any country that leaves the Eurozone.

Time to prepare for deflation. Not inflation. It requires quite a mind-shift. Are you thinking about it now?

Comments? Suggestions? Kudos? Brickbats? Leave your feedback below.

reade more... Résuméabuiyad

Importing JSON data into a Java Content Repository

This is a handy tip for anyone who might be wondering if there's an easy way (a RESTful way) to push hierarchical data into a Java Content Repository, making use of JSON. The good news: There is, indeed, an easy way to accomplish this.

The key is to use the :operation selector (set to a value of "import"), in conjunction with the :contentType selector (set to a value of "json").

Let's take a simple example. Suppose you have a JSON object that looks like:

{ 'jcr:primaryType': 'nt:unstructured',

  'propOne' : 'propOneValue',

  'childOne' : { 'childPropOne' : true }

}

You want this data to show up under /content in the repository tree, with a node of type nt:unstructured. You would simply create a form element in your HTML page and set it up like this:

<form method="POST" action="/content" enctype="multipart/form-data">

   <input type="hidden" name=":operation" value="import" />

   <input type="hidden" name=":contentType" value="json" />

  <input type="hidden" name=":nameHint" value="sample" />

   <input type="text" name=":content"

     value="{ 'jcr:primaryType': 'nt:unstructured', 'propOne' : 'propOneValue', 'childOne' : { 'childPropOne' : true } }" />

   <input type="Submit" />

</form>

Once the user clicks "Submit," the JSON data gets pushed into the repository exaxtly where and how you want it.

Other tips for pushing data to a Java Content Repository can be found here.

If you want to play with this using Adobe's CRX repository (otherwise known as the Experience Server product), you can download a copy of it, along with a free developer license, right here. CRX is the foundational piece of repository infrastructure underlying Adobe CQ and other Adobe enterprise products. It's a JCR-compliant repository (based on Apache Sling) with a lot of great administrative tools and other UIs (including a built-in IDE) included, ready to use. Installation is as simple as double-clicking the (single) downloadable JAR.

Give CRX a try. It's about as straightforward and easy to use as an enterprise-grade content repository gets.

reade more... Résuméabuiyad

Another blogging hiatus

Work has temporarily eaten my life, so very little blogging for a while. In the meantime, feel free to amuse yourself with this video of a human vacuuming a cat.

reade more... Résuméabuiyad

A pro-fossil industrial policy?

Two items of news caught my eye today. The first is that Republicans in Congress are trying to stop the U.S. military from using biofuels:

In its report on next year’s Pentagon budget, the House Armed Services Committee banned the Defense Department from making or buying an alternative fuel that costs more than a “traditional fossil fuel.”...if the measure becomes law, it would make it all-but-impossible for the Pentagon to buy the renewable fuels. It would likely scuttle one of the top priorities of Navy Secretary Ray Mabus. And it might very well suffocate the gasping biofuel industry, which was looking to the Pentagon to help it survive.

Now, this sounds like a fairly straightforward narrative: cost-conscious Republicans versus free-spending Democrats who want to push a "green" agenda and protect favored industries. But a moment's thought will reveal that it's not so simple. The "cost" of a fuel source is not entirely reflected in its spot price. Here are purely economic reasons why the military might want to buy some biofuel:

1. Research and development. If the cost of biofuel can be brought below the cost of fossil fuels, not just the U.S. military but the entire human race will massively benefit. However, energy technology must be embodied in actual economic activity - it probably takes a lot of large-scale investment and trial-and-error to advance the state of the technology. Therefore, what looks like expensive biofuel might actually be cheap to a very patient monopsonist. Already, the cost of algae-based biofuel purchased by the U.S. Navy has fallen by a factor of 16 in two years!

2. Idiosyncratic risk. The U.S. Military faces different risks than other fuel buyers. For one thing, the military's budget changes very slowly, so spikes and dips in the price of fuel can interrupt military operations. This provides an incentive for the military to diversify its fuel sources. Also, a successful operation by an enemy military power to temporaily block the international flow of fossil fuels during a war would be annoying for a business, but devastating for our military.

In fact, the Secretary of the Navy made basically these arguments:

Mabus and his allies countered that...Of course relatively small batches of a new fuel are going to be expensive — just like the original, 5GB iPod cost $400 and held fewer songs than today’s $129 model, which holds 8 GB. That’s the nature of research and development. With development time and big enough purchases, the costs of biofuels will come down; already, the price has dropped in half since 2009... 

What’s more, Mabus added, there’s a value in a more stable, domestic supply of fuel; every time the price of oil goes up by a dollar per barrel, it costs the Navy $31 million. “We simply buy too much fossil fuels from places that are either actually or potentially volatile, from places that may or may not have our best interests at heart,” he said... 

None of those arguments managed to sway House Republicans[.] (emphasis mine)

So do Republicans just have a weak grasp of some of the more subtle points of economics? Or do they have some vested interest in blocking the adoption of non-fossil energy sources?

The other news story that caught my eye may provide some insight into that question. It's about a new campaign by conservative think tanks to block the adoption of solar and wind power:

A number of rightwing organisations, including Americans for Prosperity, which is funded by the billionaire Koch brothers, are attacking Obama for his support for solar and wind power. The American Legislative Exchange Council (Alec), which also has financial links to the Kochs, has drafted bills to overturn state laws promoting wind energy. 

Now a confidential strategy memo seen by the Guardian advises using "subversion" to build a national movement of wind farm protesters... 

It suggests setting up "dummy businesses" to buy anti-wind billboards, and creating a "counter-intelligence branch" to track the wind energy industry. It also calls for spending $750,000 to create an organisation with paid staff and tax-exempt status dedicated to building public opposition to state and federal government policies encouraging the wind energy industry... 

ATI [the think tank coordinating the campaign] is part of a loose coalition of ultra-conservative thinktanks and networks united by their efforts to discredit climate science and their close connections to the oil and gas industry, including the Koch family. Those groups include the Heartland Institute, the John Locke Foundation, and Americans for Prosperity, the organising arm of the Tea Party movement.

Is this a case of the oil industry working to fight industrial policies that bias markets against their products? Or is it a case of the oil industry working to create/perpetuate industrial policies that bias markets in favor of their products? The answer to this question depends on whether the "right" prices for fossil fuels and non-fossil fuels are represented by their spot prices.

As in the case of the military, state governments deciding which energy source to buy face a problem that is not a simple static cost minimization problem. Here are some additional considerations a local government should consider:

1. Long-term investments. Our existing energy infrastructure is oriented toward fossil fuels. If non-fossil fuel spot prices will eventually fall below fossil fuel spot prices, it makes sense to start building the new infrastructure well in advance of that time. A private company is (mostly) not responsible for building new infrastructure. A government is. Therefore a government may have an incentive to switch to non-fossil fuels before it would make sense for a company to do so.

2. Environmental costs. I think that the environmental costs of fossil fuel use are much lower than members of the Pigou Club think. This is not because global warming isn't real (it is!), or because it isn't dangerous (it is!), but because fossil fuels are pretty fungible, meaning they can be sold on world markets; if the U.S. burns less, China will simply burn what we don't burn (this is not always true, especially in the case of coal). But there are some carbon costs all the same.

Also, there is the research aspect, again.

In addition, this campaign by conservative think-tanks seeks to raise costs for the wind industry by using local government to block wind farm construction. That has nothing to do with halting industrial policy, and everything to do with using government regulation to overrule the logic of the market.

It seems to me overwhelmingly reasonable to assume that the U.S. fossil fuel industry, led by oil barons like the Koch brothers, would try to push for government policies that favor their industry at the expense of potential future competitors, irrespective of actual market logic. It also seems obvious to me that the U.S. fossil fuel industry is a key backer of the Republican party and a key backer of conservative think tanks and opinion-making organizations. Are these two facts sufficient to prove that the conservative campaign against alternative energy runs counter to economic efficiency? No. It may still be true that government adoption of non-fossil energy sources is a misguided, ideological initiative. But as non-fossil energy costs fall and fall, that position will become harder and harder to defend.

Update: Fred Kaplan backs me up in this excellent article at Slate.

reade more... Résuméabuiyad

New features in Adobe CQ 5.5

Last time, I gave a high-level overview of the some of the flashier new changes in Adobe CQ 5.5 (Adobe's Web Experience Management solution). This time, I'd like to dig a little deeper and shed light on a few less-visible (yet still noteworthy) changes in the product.

A change to the repository infrastructure that I think is very much under-rated is the transition to a pure OSGi runtime based on Apache Felix. The repository has leveraged OSGi for some time, actually, but with 5.5, every Java process runs in the OSGi framework (everything is an OSGi service).

OSGi is a powerful framework for development of Composite Content Applications, because it provides:

• Modularity and Code Reuse ―OSGi is ideal for this. Developing with OSGi means deploying code and resources as bundles, which is OSGI's fundamental unit of modularity. Bundles hide their internals from each other, communicating through well-defined APIs. The high degree of encapsulation provided by bundles means improved granularity and compositionality, robust dependency resolution, improved control over visibility (superior to Java's native “package” system), among other benefits.


• Dynamism ― The OSGI framework is highly dynamic. Bundles can be indepedently installed, started, stopped, updated, and/or uninstalled at any time, without taking the system down.


• Flexible Versioning Support ― It's often been said that OSGi technology solves JAR hell, which is the problem that library A works with library B-version-1, but library C can only work with B-version-2. In standard Java, this is a difficult problem. In OSGI, all bundles are explicitly versioned and can be mapped to multiple versions of the same library.


• Simplicity ― The core OSGI API comprises only one package with a few dozen classes.


• Lightweight ― The OSGI Framework is small and efficient, and allows runtime to be relatively small, itself, and run in a reasonable amount of memory.

Some other miscellaneous new features that have been brought into Adobe CQ 5.5 include:

• An OpenSocial container, in the form of Apache Shindig.
• Integration with Creative Suite 5 and 5.5 using Adobe Drive.
• Faceted Search in DAM Admin.
• More detailed Context Cloud UI.
• InDesign content extraction via integration into InDesign Server. This allows direct repurposing of content from InDesign files hosted in the DAM.
• Service and workflow task to write XMP meta data back into the original binary. Until now DAM could only extract XMP but not write back. This is essential for full round-trip Creative Suite integration.
• The use of HTML5 (instead of Flash) to upload assets to DAM/Image/Download Component.
• Improved Campaign Manager UI to manage teasers and brand pages.
• XLIFF import/export tools for better translation process integration.
• Update built-in Apache PDFBox to version 1.6 for improved PDF extraction and preview.
• RMI connectivity to repository (for use by, e.g., connectors).
• A number of updates to libraries (e.g., jQuery and ExtJS) for better/broader browser support.

These are just some of the under-the-covers enhancements included in CQ 5.5. For more information on the product, be sure to consult the Adobe CQ product page, the CQ developer page, and the CQ Community page.

reade more... Résuméabuiyad

Cyclicalists should start talking about structural issues too.

I could count on my fingers the number of times Paul Krugman has obviously been wrong about something, and still have enough fingers left to type 60 words per minute. But if there's one thing I've learned in my years of arguing with people, it's that if you're not in math or the natural sciences, being right on the merits is never good enough to win an argument. You have got to win hearts and minds.

Krugman has convinced a huge chunk of the populace that there is something seriously wrong with macroeconomics. That is good. But he seems not to have made much headway in garnering intellectual support for more active countercyclical policy. As an illustration of this, consider the recent push for "structural" explanations of our current high unemployment rate. Raghuram Rajan, David Brooks, and Tyler Cowen are all confidently asserting that our problems are structural, not cyclical. This point of view is seconded by Greg Mankiw and John Cochrane and echoes recent comments by Jim Bullard.

Now, it is true that these "structuralists" (to use Brooks' term) are in some sense just the usual suspects. For these people to support, say, quantitative easing would be to go against their political instincts. But in 2009 you did not hear these people arguing nearly as strongly or loudly that everything was structural, because in 2009 this point of view was far less credible. The fact that no one now feels ashamed of making structuralist claims shows that the winds of public opinion are starting to shift against Krugman and the "cyclicalists".

In response, Krugman has rebutted the structuralist argument with data (see here, here, and here). He is joined by Scott Sumner, Karl Smith, Mike Konczal, Ezra Klein, and other cyclicalists. On the merits, their case is very strong. It is much stronger than the case of the structuralists, which seems mostly based on assertion and repetition, and includes a fair bit of confusion (for example, Cowen claims that we have a drought of government investment, and then claims that there is somehow a tradeoff between government investment and fiscal stimulus; Cochrane seems to think that Keynesians believe that negative AD shocks move the economy to a slower long-term growth path). If economic policy arguments were settled on the basis of logic, the cyclicalists would be winning. 

And yet they are not winning. They are slowly losing. The battle for fiscal stimulus in America has been lost, the battle for more quantitative easing in America has been lost for now, and the battle against European austerity is not going well. My guess is that this coincides with an increasing acceptance of structuralist ideas on both sides of the Atlantic.

Why? I suggest several reasons:

1. People intuitively understand structuralist ideas, which is to say they intuitively understand long-run supply. They do not intuitively understand aggregate demand. Anyone who has taught undergrad macro knows this fact. And though intuition and common sense are not a good substitute for scientific expertise, it is not certain who constitutes an expert, and when trillions of dollars are on the line, people have a tendency to go with their gut rather than listen to some smart guy with a confusing theory.

2. Many people just don't care about business cycles, and assume that even without help, the economy will recover in a few years.

3. Many people want (quite reasonably!) to use the ongoing economic troubles as an opportunity to win political backing for their favorite structural reforms - as the saying goes, "never letting a good crisis go to waste".

4. Many people are worried about structural problems anyway, regardless of where we are in the business cycle.

5. Many people think that economists understand optimal structural policy much better than they understand optimal cyclical policy, and that we should focus on making suggestions that we understand better.

So if I'm right, Krugman and the cyclicalists can unload as many pretty graphs and impressive numbers and inventive models and carefully argued paragraphs as they like, and it will make very little difference to what most people think. A new rhetorical approach is needed.

For this new approach, I suggest that Krugman and others start talking about structural policy ideas.

I do not mean that cyclicalists should stop recommending things like quantitative easing. I mean that they should start also throwing out ideas about how to improve our economic performance in the long run. They should do this for two reasons. 

The first reason is that many policymakers and members of the public currently think that there is a tradeoff between cyclical policy and structural policy. In general, contra Tyler Cowen, this is not true. If you think that deregulation is what we need to grow more in the long run, then you should realize that there is no tradeoff between deregulation and quantitative easing, or deregulation and stimulus. Ditto for free trade. Ditto for corporate tax cuts (as long as income taxes are raised to keep revenue the same). Ditto for policies to improve education. Ditto for policies to improve labor search and matching. In the case of the government investment that Tyler Cowen says we need more of, good structural policy also makes good countercylical policy! In fact, the only "structuralist" policies - if you can call them that and keep a straight face - that conflict with countercyclical policy are austerity and hard money.

Krugman and some of the cyclicalists have focused the vast majority of their attention on cyclical issues. But this reinforces the (mistaken, misleading) claim of the structuralists that there is a tradeoff between the short term and the long term. One more Krugman blog post is not going to convince anyone to support stimulus, QE, etc. But one more Krugman blog post dedicated to discussing long-term issues will do a lot to convince readers that there is no policy trade-off. In other words, the marginal value of Krugman devoting more time to cyclical issues is negative.

The second reason for cyclicalists to discuss structural policy is political. The people advocating "structuralist" policies are, right now, mostly conservatives. Their ideas about long-term growth policy are basically more tax cuts and more deregulation. Only occasionally, if ever, do these "structuralists" call for repairs to our disintegrating infrastructure, or increased spending on research, or ending the dollar's reserve currency status. And the conservative "structuralists" have ideas about education, health care, and occasionally immigration that strongly diverge from what liberal "cyclicalists" would be promoting if they bothered to talk about structural policy more often. 

In other words, while liberals throw all their energy into a losing rearguard action against austerity, conservatives are winning the future.

This is why I call for a balance between discussions of cyclical policy and discussions of structural policy. Yes, it would still be good if we got more QE. Yes, European-style austerity is a real danger. But continuing to hammer home these points with logic and reason is yielding diminishing returns. Logic and reason are good things to have, but by themselves they do not win arguments. If I have a choice between proving I'm right and winning, I'll pick winning every time...


Update: Here is a good example of what I'm calling for!

reade more... Résuméabuiyad

Leadership (or lack thereof) begins at the top

Yahoo! CEO (and liar) Scott Thompson.

On May 3, activist shareholder Dan Loeb pointed out that Yahoo! CEO Scott Thompson never obtained a degree in computer science, despite what his official Yahoo! bio claims. (The bio has since been altered.)

Apparently, Thompson has been lying about his credentials for at least ten years. When Thompson worked for eBay (as CTO of the PayPal division), his bio contained the statement: "Scott received a bachelor’s in accounting and computer science from Stonehill College." There's only one problem. Stonehill did not begin awarding computer-science degrees until four years after Thomspon graduated.

Thompson's bachelor's degree is actually in business administration.

Less-often reported is the fact that Yahoo! board member Patti Hart (who vetted Thompson's hiring) doctored her bio, also, to show a degree in "economics and marketing." In actual fact, Hart's degree (like Thompson's) is in business administration.

Yahoo! issued a statement calling Thompson's out-and-out lie "an inadvertent error." Which is, itself, a lie.

Yahoo! Board Member Patti Hart

So lying is endemic at the highest levels of Yahoo.Which ought to be quite demoralizing to Yahoo! employees. And apparently it is.

Interestingly, Yahoo's own code of ethics, which you can download here if you're interested, requires employees to (among other things) "Make sure information we disclose about our company is clear, truthful, and accurate." It also cautions employees to "avoid exaggerating."

Apparently, Yahoo's code of ethics means absolutely nothing, since board members and executive officers don't obey it.

Ordinary employees at Yahoo! now must come to grips with the fact that there are two standards of behavior at Yahoo!, one of which applies to them, the other of which applies to bigwigs at the top.If any ordinary employee did what Thompson and Hart have done, he or she would be fired in an instant. But CEO Thompson hasn't been fired. And even if he is, he'll leave with millions of dollars in severance.

The whole episode (including Yahoo's unbelievable lack of urgency in dealing with the situation) sends a bad message not only about Yahoo! but about corporate America. It says that corporate codes of ethics needn't mean anything, and lying (in both corporate bios and SEC statements) is 100% acceptable at the level of CEOs and board members.

We'll see, soon enough, if at also means you get paid big bucks on the way out the door.

reade more... Résuméabuiyad

The macro Overton window

The "Overton window" is basically the range of positions on a certain question that are considered reasonable. In macroeconomic policy discussions in the United States, certain positions are, for whatever reason, outside the Overton window - Marxist ideas, mercantilist ideas, the gold standard, etc. Whatever your position is in an argument, you want it to be in the middle of the Overton window instead of at the edge. You do not want to be seen as someone who is on the borderline between serious and kook. 

In the debate over the causes of, and proper responses to, the current recession, the Overton window matters. If one edge of the window corresponds to Old Keynesianism and the other edge corresponds to the policy status quo, it's likely that what will end up happening will be something in between those two extremes, e.g. more quantitative easing. But if the rightmost edge of the window corresponds to the idea that demand shocks don't affect output at all, then what will end up happening will probably look more like the status quo.

Hence it makes practical sense for economists who favor less countercyclical policy to try to yank the Overton window toward the right, even if their objective analyses admit the possibility that Keynesians might be right. Or even if conservative economists don't do this intentionally, it certainly helps their cause when someone does it.

For example of arguments that shift the Overton window rightward, here is Garrett Jones suggesting that we pay attention to RBC models:

One of the major schools of thought in macroeconomics rarely makes it into mainstream discussions: Real Business Cycle Theory...[A]s long as big ideas come in waves, as long as energy supplies depend on the vagaries of global politics, and as long as politicians enact policies that weaken confidence in the health of a nation's economic institutions, RBC will matter. 

Notice that the "technology shock" that Jones hints is responsible for our current recession is just the supposed leftist policies of the Obama administration.

For another example, here's John Cochrane:

A logical possibility of course is that drawn-out recessions following financial crises...reflect particularly ham-handed policies followed by governments after financial crises.  Financial crises are followed by  bailouts, propping up zombie banks, stimulus, heavy regulation, generous unemployment and disability benefits, mortgage interventions, debt crises and high distortionary taxation (European "Austerity" consists largely of taxes that say "don't start a business here") and so on...It is certainly possible that these, rather than "financial crisis" are the cause of slow recovery, and thus that slow recovery is a self-inflicted wound rather than an inevitable fate.   

The similar policy mix in the Great Depression is now accused by a strand of scholarship as the prime cause of that depression's extraordinary length, not valiant but sadly insufficient fixes. (For example, see Lee Ohanian; for some more popular summaries see Jim Powell or Amity Shlaes.)

Amity Shlaes? Really?

Note that both Jones and Cochrane make almost explicit reference to the Overton window. Jones says RBC "rarely makes it into mainstream discussions," while Cochrane says "It's certainly possible" that Obama is behind the slow recovery. They aren't claiming that this extreme view is true. They merely wanted it included in the discussion. They want the Overton window to include it.

Is the idea - that Obama's policies have caused our slow recovery - plausible? Well, I guess so, in a generalized, I'm-open-minded-and-willing-to-consider-any-proposition sort of way. But by that standard, quite a lot of things are plausible that no one is talking about nowadays. If you're going to argue that aggregate demand doesn't affect output, you're going to have a very difficult time explaining the initial steep plunge of GDP in 2008-9, before Obama had had a chance to do anything (and you're going to have a very hard time explaining what happened to the price level during that time).

reade more... Résuméabuiyad

What is a "financial crisis"? (reply to John Cochrane)

The conventional wisdom says that recessions that follow financial crises last longer than other recessions. In a recent blog post, John Cochrane challenges the conventional wisdom:

Financial crises certainly don't always and inevitably lead to long recessions, as the factoid suggests... 

In a nice article for the Atlanta Fed, Gerald Dwyer and James Lothian went back to the 1800s, and find no difference between recessions with financial crises and those without. Some, like the Great depression and now, last a long time. The others don't.   

Michael Bordo and Joseph Haubrich wrote a somewhat more detailed study of US history, (which I found through John Taylor's blog) concluding 

recessions associated with financial crises are generally followed by rapid recoveries. We find three exceptions to this pattern: the recovery from the Great Contraction in the 1930s; the recovery after the recession of the early 1990s and the present recovery. ... 

In contrast to much conventional wisdom, the stylized fact that deep contractions breed strong recoveries is particularly true when there is a financial crisis. In fact, on average, it is cycles without a financial crisis that show the weakest relation between contraction depth and recovery strength 

This had pretty much been the "stylized facts" when I went to grad school: US output has (so far) returned to trend after recessions. The further it falls, the quicker it rises (growth). Financial crises give sharper and deeper recessions, followed by sharper recoveries, but not, on average, longer ones. This "recovery" is in fact quite unusual, looking more like the Great Depression but unlike the usual pattern.  

As I did minor searches for the facts however, it's clear there is an explosion of work on this subject, so it's hardly the last word.  

When I read this, the first question that popped into my mind was "OK, but how are they defining financial crises?" It turns out that the two sources Cochrane cites disagree on this point. The article by Dwyer and Lothian says:

No U.S. recession since World War II [other than the current recession] has been associated with a financial crisis. 

While the paper by Bordo and Haubrich says:

Consequently, the recessions we associate with a financial crisis are those that start in 1882, 1892, 1907, 1912, 1929, 1973, 1981, and 1990.

That's a big difference! Three post-WW2 financial crises versus zero?

The problem, of course, is that it's difficult to define a financial crisis. Many people seem to use the term to mean "a large drop in asset prices" (this is the definition that leads to the claims that economic models can't forecast financial crises). But there are other possible meanings of the term. For example, "financial crisis" could also mean:

• A large number of bank runs, leading to a liquidity crisis

• A solvency crisis, in which most large financial institutions are found to be insolvent

It seems to me that this third definition - the simultaneous insolvency of most large financial institutions - is the kind of "financial crisis" that most people would casually associate with long recessions and slow recoveries. Note that a steep fall in asset prices is neither necessary nor sufficient to generate a solvency crisis, since firms may have different degrees of leverage.

If we define financial crises as asset price drops, it seems pretty obvious that "financial crises" will be associated with most recessions. This is because asset prices are forward-looking and quick to react to events; any shock that will cause a recession over the next year will cause an asset price almost as soon as the shock is realized. I strongly suspect that Bordo and Haubrich are using this definition, since they claim that a financial crisis happened just before the 1981 recession. Stock prices would obviously fall in reaction to an interest rate hike by the Fed (which most people believe caused the recession in '81).

Dwyer and Lothian seem to be using a different definition of "financial crisis". I'm not sure what their definition is, but my guess is that it is a liquidity crisis or solvency crisis type of definition.

Now, both of Cochrane's sources reach the same conclusion, which is mainly based on pre-WW2 data. I don't know much about pre-WW2 economic history, so I'm not really qualified to evaluate their claims. But I think that the confusion over definitions merits a long hard look into exactly what happened in and before all of those pre-WW2 recessions.

Two more points:

1. Actually, my intuition says that financial crises are not the cause of slow recoveries. My intuition is basically the "balance sheet recession" story, which is about a sudden regime change in people's behavior toward debt and consumption after a long build-up in debt. My intuition says that people's sudden shift to a "balance sheet rebuilding" regime will tend to cause both a long recession and a financial crisis. But then again, this is just my intuition...As Cochrane says, there is lots of research being done on the subject.

2. Cochrane definitely does do a good job of rebutting a factoid tossed off by Bill Clinton, which is that recessions after financial crises last "5 to 10 years". Cochrane cites evidence from Reinhart and Rogoff that shows that the international average has been just under 5 years for recent crises. Although I'm not sure I believe the Reinhart/Rogoff numbers (the Great Depression lasted only 4 years??), it is definitely the case that countries such as Sweden, Finland, and Korea have managed quick recoveries after financial crises. I think we should look at what they did, and see if maybe we can replicate their best practices.

reade more... Résuméabuiyad

Riled by the wrongness of Raghuram Rajan

Once more, it's time for me to take advantage of the large number of R's in Raghuram Rajan's name to create a catchy blog post title, for once more, the eminent finance professor has written an article that I believe to contain a substantial quantity of Wrong. Rajan's article in Foreign Affairs, titled "The True Lessons of the Recession," is a call for austerity, pro-growth structural reforms, and other Stuff Conservatives Like. The piece has already sparked controversy in the econ blogosphere - Tyler Cowen says "every paragraph of [the] piece is excellent", while Karl Smith calls it "nonsense on stilts". As you may guess, I agree more with the other Smith. Though Rajan gets some things right and some things wrong, I have three major problems with his analysis: 1. His reading of economic history appears to fall victim to several common misconceptions, 2. His focus on structural reform doesn't make a lot of sense for the U.S., and 3. His conclusion that "the West can't borrow and spend its way to recovery" seems to just come out of nowhere.

Much of Rajan's article is devoted to a sort of folk history of the global economy since World War 2. Most of this I have no problem with. But some of it is appallingly false. For example, how many times has this narrative been dissected and rejected?

[S]tarting in the early 1990s, U.S. leaders encouraged the financial sector to lend more to households, especially lower-middle class ones...Such policies helped money flow to lower-middle-class households and raised their spending...

Cynical as it may seem, easy credit was used as a palliative by successive administrations unable or unwilling to directly address the deeper problems with the economy or the anxieties of the middle class...

Bankers obviously deserve a large share of the blame for the crisis. Some of the financial sector’s activities were clearly predatory, if not outright criminal. But the role that the politically induced expansion of credit played cannot be ignored; it is the main reason the usual checks and balances on financial risk taking broke down. (emphasis mine)

The idea that U.S. housing policies caused the housing bubble and the financial crisis remains a part of the conventional wisdom only because Republicans keep saying it over and over. The evidence is strongly against this interpretation of events. I could rattle off a million links to back this up, but why bother? Everyone with two eyes can see that the rise in securitization, not any federal policy, is what increased the demand for risky housing loans. Rajan does not even mention securitization.

Or take this nugget of bad CW:

Some countries focused on making themselves more competitive. Fiscally conservative Germany, for example, reduced unemployment benefits even while reducing worker protections....[O]ther European countries, such as Greece and Italy, had little incentive to reform[.]

"Fiscally conservative" Germany? But Germany's government debt is 83% of GDP; for most of the period Rajan is discussing, Germany ran deficits as big or bigger than the countries Rajan castigates.

To sum up, it seems to me that ideological conservatives, Republican partisans, and European "austerians" have managed to repeat certain fictions long enough and vehemently enough that these fictions have seeped into the worldviews of conservative-leaning economists like Rajan. But fictions they are.

Now on to Rajan's prescriptions for improving the economic situation. Rajan says that "pro-growth" structural reforms are the answer for the South European states:

[T]he best short term policy response is to focus on long-term sustainable growth...Countries that don’t have the option of running higher deficits, such as Greece, Italy, and Spain,should shrink the size of their governments and improve their tax collection. They must allow freer entry into such professions as accounting, law, and pharmaceuticals, while exposing sectors such as transportation to more competition, and they should reduce employment protections...

OK, assume for the moment that Rajan is right - suppose these countries "don't have the option of running higher deficits", and suppose that these structural reforms are obviously good ideas, and that these reforms would make a big difference.

Now, what about the United States?

The United States, not being part of the EU or the euro, has plenty of scope to both borrow money and engage in looser monetary policy. But Rajan takes his prescription for South Europe and applies it to the United States in an almost cut-and-paste fashion:

The United States must improve the capabilities of its work force, preserve an environment for innovation, and regulate finance better so as to prevent excess.

He then lists a number of reforms that he thinks would benefit the U.S. Actually, I agree with most of these ideas! What I don't agree with is Rajan's conviction that such reforms would make a big difference.

See, back in the 80s, the U.S. already did a lot of the reforms that Rajan recommends for Europe. Rajan himself points this out. Therefore, the U.S., though it is now facing the same high unemployment levels suffered by Europe, has far less scope for easy reform. That's the problem with trying to use structural reform as countercyclical recession-fighting policy; eventually you run out of reforms!

Karl Smith puts this rather more colorfully:

Is this some kind of sick joke? 

Is there an area in which our policy initiatives have more consistently failed than in producing long term sustainable growth? Do we even have a consensus on how long term growth got started in the first place? Do we have a solid story to explain growth differentials today?... 

[E]fforts to increase TFP or educational effectiveness...[are] what folks have been desperate for my entire life. If we knew how to get it, we would.

Finally, let's talk about Rajan's big conclusion. The subheading of Rajan's article is "The West Can’t Borrow and Spend Its Way to Recovery". But Rajan seems to draw this conclusion out of thin air. He offers no reason why fiscal stimulus won't work in the United States. Maybe such reasons exist. Maybe Rajan has them in his head. But he doesn't say what they are; he just asserts this claim as if it follows from the rest of his article, when in fact he never makes the case. Even when talking about Europe, he just states that countries like Spain "don't have the option of running higher deficits", when in fact Spain has considerably less debt than Germany.

To sum up, this article is full of dubious or unsubstantiated claims. The claim that U.S. government housing policy caused the financial crisis is highly dubious. The claim that Germany is "fiscally conservative" is highly dubious. The claim that structural reform is the key to a U.S. recovery is highly dubious. And the claim that fiscal stimulus will not benefit the United States is unsubstantiated.

I don't like this. When well-respected people like Raghuram Rajan repeat these claims over and over in the popular press, they become a part of the conventional wisdom, and give ammunition to vested political groups (e.g. Republicans) looking for intellectual cover for their narrow interests.

And I just generally dislike this trend of substituting conservative harrumph-ing for thoughtful economic analysis. Harrumph, austerity is healthy and stimulus is waste! Harrumph, government attempts to help the poor must be at the root of any market failure! Harrumph, North Europeans work harder and save more than South Europeans! Etc. etc. Yes, I realize that macroeconomics is really hard, and that we just don't understand the vast majority of what is going on. But I think that makes it all the more important to ignore the sweet seductive siren song of one's own politico-cultural biases.

reade more... Résuméabuiyad