Now Ron Paul wants to debase the currency?

 

Oh dear sweet Jehovah.

First Republicans, after spending years warning about the danger of a debt default, decide to not only recommend a U.S. sovereign default, but actively push for one in Congress.

Now, after Republicans spent years warning us about the (then nonexistent) possibility of hyperinflation, Ron Paul comes out and suggests a policy that would be a huge step toward hyperinflation.

Specifically, Ron Paul wants to have the Fed destroy its holdings of U.S. Treasury bonds. This would be retroactive seigniorage; it would mean that the money that the Fed printed in the past to buy those Treasury bonds was actually printed to pay off the U.S.'s sovereign debt.

As any Econ 101 student knows, large-scale sustained seigniorage is what causes hyperinflation. Now, the Fed doing a one-off round of retroactive seigniorage would not be enough by itself to push us into Weimar Republic territory - in particular, because the money has already been printed. But it would also send a signal that the Fed is no longer an independent central bank, and that Congress feels free to strong-arm the Fed into paying off U.S. sovereign debt with printed money at any time in the future. That would be a signal that much more seignorage is on the way, which would push us into hyperinflation. (Tyler Cowen sees this possibility, but rather euphemistically labels the future seigniorage "QEIII".)

So what the heck is Ron Paul thinking? Paul is a well-known supporter of the gold standard, which policy-wise is the exact opposite of hyperinflation. Is he simply betting that we'd decide to go back on the gold standard after we got tired of pushing around wheelbarrows full of billion-dollar bills? Or does he just know absolutely nothing about economics?

More generally, what is with the Republicans trying to push us into the very doomsday scenarios that they've always warned us about? Hyperinflation and sovereign default are basically THE worst self-inflicted disasters that we have ever seen befall a modern rich economy. And the only reason that there is any worry, whatsoever, that either of these things might happen to the U.S. is that the Republican Party seems to be flirting with the idea of intentionally causing them. The GOP seems to no longer be the "party of business", but a mad-dog populist gang that is running around chucking sticks of dynamite in all directions.


Update: Greg Mankiw agrees that Paul's idea is crazy, but is actually less worried than I am about the signal of future seigniorage that would be sent by revoking the Fed's independence in order to pay off our debt. Dean Baker actually likes the idea, and thinks we could deal with any inflationary effects by raising reserve requirements. So he's really cavalier about revoking central bank independence.

Update 2: A bunch of people (including Greg Mankiw and Andy Harless) are saying "But the Ron Paul plan just transfers money from one part of the government to another, and hence would be harmless." I tried to explain above why I don't think that's the case, but let me try again. Yes, having the Fed destroy a bunch of government bonds would be harmless if we only did it once, and if people believed we were only going to do it once. If we did it again and again as a regular policy, we would have to get the Fed to keep printing more and more money so that we could destroy U.S. Treasuries again and again. That would cause hyperinflation. But suppose we only do it just this once. Could we convince people that it was only a one-time thing? I doubt it. First of all, doing the Ron Paul plan even once requires revoking the independence of the Fed, which tells people that Congress is now willing to use the Fed to implement fiscal policy. That by itself is a huge policy change. Second of all, if the Ron Paul plan achieved results that pleased lawmakers (i.e. reducing headline federal debt), that would tend to make the lawmakers want to do it again. And again. So there is every reason to think that the Ron Paul plan would lead to popular expectations of large-scale seigniorage...and hence to hyperinflation. In any case, it's an absolutely enormous risk. To take that risk, for the sole purpose of reducing headline debt (while leaving net debt unchanged), is, as Greg Mankiw says, crazy.

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Taylor seems to agree with the Keynesians, but claims he doesn't

 

John Taylor has what I consider to be a pretty good post about the stimulus. He points out that if we evaluate the stimulus' impact using the same models that we used to predict its impact, we don't gain a lot of added value from the backward-looking part of the analysis. That is very true. He then points out the extreme difficulty of evaluating the stimulus (or other policy interventions) without basically assuming your conclusion through the choice of the model used to construct the counterfactual. This is also true.

He then presents a paper that he has written that attempts to evaluate the ARRA. According to Taylor, he has clear evidence that the stimulus didn't work.

This, of course, sent alarm bells ringing through my head. According to my Efficient Marketplace-of-Ideas Hypothesis, if there were an easy way to show convincingly that the stimulus failed, somebody would already have shown it. Previous studies purporting to show the failure of stimulus have been less than convincing. So I went into this paper expecting to find serious problems.

But instead I found Taylor pretty much agreeing with the Keynesians...

Taylor evaluates the ARRA by looking at changes in specific components of output - federal government purchases, state government purchases, and private consumption. According to Keynesian theory, if stimulus works it should work by raising either G (in the case of a rise in government purchases) or C (in the case of tax refunds or increased transfers). So Taylor just looks to see the degree to which this actually happened.

First, he shows that personal consumption doesn't appear to have been much affected by the tax rebates and transfer payments that made up a big chunk of the stimulus:

This graph looks convincing; you see bumps in stimulus income, but no bumps in consumption. Of course, Taylor is assuming a particular lag structure for his model; it's quite possible that the rise in spending due to tax rebates and transfers didn't occur immediately, but were spread out over the next few quarters, so that you wouldn't expect to see contemporaneous bumps. Similarly, when Taylor generates counterfactuals to show that consumption didn't rise, he picks a specific lag structure. Maybe he tried alternate specifications and didn't report them because they showed the same thing? Or maybe not.

Anyway, the arbitrary lag specification means that this model is not in any way conclusive. But it is still suggestive. And what it suggests is that tax rebates and transfer payments don't make for particularly good stimulus, because in a balance-sheet recession people will just use the money to pay down their debts. Helping people pay down debts may be good in its own right; but this is a reason why Keynesians often argue that government spending is a better approach to stimulus than tax rebates.

On that note, Taylor notes that federal expenditures didn't rise by very much due to the ARRA:

The most striking finding in Figure 3 is that only a small part of ARRA went to purchases of goods and services by the federal government. Measured as a percentage of GDP the amounts were immaterial: At the maximum effect, which occurred in the third quarter of 2010, federal government purchases due to ARRA reached only 0.21 percent of GDP and federal infrastructure only 0.05 percent of GDP.

These amounts are too small for the stimulus package to have had a significant effect on the overall economy. In this case the debate over the size of the government purchases multiplier is largely moot because the government purchases multiplier had virtually nothing to multiply at the federal level.

This precisely echoes the complaints that Keynesians had about the ARRA: not enough federal government purchases, not enough infrastructure spending.

Finally, Taylor looks at state-level spending, and concludes that the ARRA grants mainly replaced state borrowing with federal borrowing:

Figure 6 shows that in the absence of the 2009 stimulus grants, net borrowing by state and local governments would have been greater than it was with the grants. This is consistent with the view that state and local governments tried to smooth their expenditures in the face of temporary changes in income, much as households without borrowing constraints did...State and local governments used the stimulus grants to reduce their net borrowing (largely by acquiring more financial assets) rather than to increase expenditures[.]

This analysis is subject to the same caveat about lag structure as the earlier consumption analysis. But it also seems basically plausible to me, and highly suggestive that states mainly pocketed their ARRA grants instead of spending them on building roads and such.

Finally, Taylor presents a hypothesis that ARRA grants actually made states shift their spending from purchases to transfer payments, which (if this indeed happened) would have actually reduced GDP.

So to sum up, Taylor's paper says that ARRA didn't increase GDP because it didn't increase government purchases, and even hurt GDP to the extent that it reduced government purchases. This sounds exactly like a Keynesian critique of the stimulus bill - government purchases are good medicine for recessions, and we didn't do nearly enough of them! But somehow Taylor interprets his pro-Keynesian assumptions as an anti-Keynesian conclusion:

More generally, the results from the 2000s experience raise considerable doubts about the efficacy of temporary discretionary countercyclical fiscal policy in practice. In this regard the experience with the stimulus packages of the 2000s adds more weight to the position reached more than 30 years ago by Lucas and Sargent (1978) and Gramlich (1978, 1979).

What? But Lucas, Sargent, etc. thought that government purchases wouldn't raise GDP. That runs counter to Taylor's entire critique, which is that ARRA didn't raise government purchases enough!

Readers may go through this paper with a finer-toothed comb than I used, and may find significant methodological flaws that I overlooked. Please be my guest. But that won't change the larger point that Taylor is being a lot more Keynesian than he seems to think he's being.

So this makes two prominent conservative economists who have criticized Democrats for not being Keynesian enough (the other being Martin Feldstein). Is it possible that what these guys don't like is really just...well...Democrats?

Update: Mark Thoma points out that this is not the first time John Taylor has criticized the ARRA for not including enough government purchases.

Update 2: Paul Krugman concurs. John Taylor responds:

Now, I know that Krugman...would like a stimulus package with higher proportions going to...government purchases...But experiences from the 1970s raise serious doubts about the political and operational feasibility of such discretionary fiscal policy. So do recent experiences in many other countries...In a simple Keynesian model, all the government has to do to combat a recession is quickly increase government purchases, but the difficulty with doing so in practice is one of the classic arguments against discretionary fiscal policy.

So Taylor is arguing that the type of Keynesian policy that Keynes himself suggested, and which modern-day Keynesians want, is simply politically infeasible. Fine. I myself am quite receptive to that argument, actually. But then there's the China example, which Taylor himself cites as an example of a rapid increase in government purchases in response to a recession. How does Taylor explain that? Is it autocracy, or maybe some kind of central planning, that is supposed to make real stimulus politically feasible in China but not here? And then there's another question: even if (real) stimulus turns out not to be politically feasible, does that mean that economists shouldn't recommend it, if it would be the best policy? I mean, the fact that Medicare privatization is politically infeasible hasn't stopped John Taylor from urging us to do it.

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Is space exploration over?

The Economist has an article about how the age of space exploration is over. They are a little late on this announcement, as the peak distance that any human has traveled from Earth was reached about 40 years ago. The first age of space exploration has been over for a while.

But does that mean that our adventures in the Final Frontier are over forever? I'm not so sure. After all, think about maritime exploration. For thousands of years after the first canoe was launched, the high seas remained basically empty of human ships. Once we got the technology to conquer the seas, however, we quickly did so.

What technology would be needed to conquer space? It's clear that what we use now is too expensive for large-scale use. To reduce launch costs from Earth, we need either mass drivers, laser propulsion, or something of similar energy savings (a "space elevator", sadly, will probably never exist).

But we need more than that, because even with cheaper launch systems, manned space exploration is extremely expensive, especially given the radiation shielding and other add-ons that we'll need for interplanetary travel. What we need is a bigger, better energy source. With the Earth energy-constrained as it is, there are no fossil fuels to spare for Mars missions, and we'll be lucky if we get renewables to the point where they save us from backsliding to the iron age. That means that we need nuclear fusion.

But in addition to the means, we need a reason to go. What is in space that we can use? Well, if fusion becomes a power source, we might want to mine tritium from other planets. And with fusion, terraforming of Mars might one day be possible (fusion is really that good as an energy source!).

As for interstellar travel, that is really and truly off the table without technological breakthroughs so advanced that we currently can barely imagine what they are.

So basically, no fusion, no space adventures. But if we do invent fusion, then the whole equation changes, not just for space travel, but for every conceivable human activity. Hence, we should focus our engineering efforts not on manned space travel, but on fusion power. And if we ever succeed, then the Second Age of space exploration may begin, and the Economist's article may come to look as silly as those medieval assertions that the Atlantic could never be crossed.

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Is education a public good?

 

In response to my "Tamerlane" post, commenter Josh writes:

How are schools public goods?

Good question. I will give you the answer that I gave in my Public Finance field course.

Schools are public goods because of their function as jails. Young boys who are not closely supervised by their parents will tend to form violent gangs; the violence perpetrated by these gangs imposes costs that spill over into every segment of society and the economy (go watch the movie City of God for a demonstration of how this works). By forcing boys into a structured environment for most of the day, public schools keep them off the street, creating huge spillover benefits for third parties. Schools are therefore a public good. Incidentally, this is why your junior high probably felt like a state prison - it was one.

BUT, the public good-ness of schools is not why we spend a lot of government money on them. We spend government money on schools because of an incomplete markets problem.

Human capital is extremely valuable. Some people estimate the return to human capital investment as being around 15% (good luck getting that return from your retirement account!). But human capital suffers from an incomplete markets problem, because the crucial time frame for the purchasing of human capital (i.e. childhood) comes at a time when the owner and main beneficiary of the capital (i.e. the child) is not legally empowered to make his or her own investment decisions. Since as a toddler you can't possibly pay to educate yourself, anyone who does end up footing the bill for your education will probably end up not seeing a positive return on their investment. So if education is purely private, we will probably end up with a lot less human capital investment than is optimal (or than your grown-up self will wish you'd received as a toddler).

Note that this incomplete markets problem, though not a public goods problem in the classic Lindahl-Samuelson sense, nevertheless looks a lot like one. The transaction between whoever pays for your early childhood education (the govt., your parents, the Catholic Church, etc.) and whoever provides the education (teachers) has very important benefits to a third party (you). So it's a similar kind of issue.

What are the solutions to this incomplete markets problem? Well, we could solve it the Coasian way, by giving some older person(s) - e.g. your parents - the right to the proceeds from your future labor. But this would mean you would be born into slavery. It is therefore a solution that society, and also a large number of libertarians, will be unwilling to accept. (Note for all you sci-fi economists out there; when "superbaby" technology comes around, parental rights will be a much bigger and more uncomfortable issue!)

The modern solution to the incomplete markets problem has been to have government step in and buy little kids an education. We've fixed an arbitrary cutoff for legal adulthood (albeit one that we now know is loosely supported by science), and we've decided that before that cutoff, the government will invest in your human capital. So far, the system of universal public education has been a resounding success, and has probably been a huge factor in the development of rich modern economies. It's not hard to see why. Before universal public education, there were some private schools, but most parents opted to keep their kids around the house to do labor for the family. It was a perfectly rational equilibrium. Socialization of education solved the incomplete markets problem and created the vast literate workforces that undergird every moden nation's prosperity.

So I hope that answers the question.

As a final note, I want to point out that this is just one more reason to be wary of the modern American libertarian movement. The philosophy has never had a good answer to the question of children's rights. And yet the question of whether or not the government  and/or or your parents can make you go to school is of crucial importance to the wealth of nations...and hence of crucial importance to our ability to guard our future liberty against Tamerlane.


Update: Lots of EconLog love today. Arnold Kling asks why government needs to provide education instead of just subsidize it. My answer: No reason in principle, but in practice government contractors seem quite hard to monitor. David Henderson says that innocent kids shouldn't be sent to prison/school. My 12-year-old self certainly agreed with him...but society fears gangs more than it loves perfect child liberty. Henderson also asks why people are more willing to vote for public schools than they are to pay for them. The answer to this is simple: people gain a lot from other people's kids being educated, since systemic underinvestment in education makes the country as a whole much poorer (and thus lowers parents' real wages). So they agree to pay taxes to have their kids educated, as long as everyone else does so as well, and the net benefit they receive is far more than if only they themselves were paying to have their own kids educated. So government solves a coordination problem, similarly to the public goods case.

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When has stimulus ever been politically feasible?

Brad DeLong says that he and everyone he knows were taken aback by our government's inability to prevent the financial crisis from turning into a protracted recession:

In order to have successfully predicted that we would be where we are now, you would have to have predicted a large number of things:

1. That a global savings glut and a period of low interest rates would produce a housing boom.
2. That the housing boom would turn into a housing bubble.
3. That the housing bubble would lead to a collapse of mortgage underwriting standards.
4. That risk management practices on Wall Street would have been nonexistent.
5. That the Federal Reserve would not be able to construct its usual firewall between finance and the real economy.
6. That the Federal Reserve would not feel itself empowered to take the emergency steps to stabilize demand needed during and in the immediate aftermath of the financial crisis.
7. That the incoming Obama administration would come out of the gate with too small an economic recovery package.
8. That politics would prevent the Obama administration from being able to take a second bite at the apple.
9. That the Obama administration would then give up on pushing the envelope of its powers to try to generate a strong recovery.
10. That the intellectual victory of Keynesian approaches on the level of reality--forecasting and accounting for the course of the Little Depression--would be accompanied by a non-intellectual defeat of Keynesian approaches on the level of politics.

Get all of those 10 right, and you are a wizard.

But I know of nobody who did.

The smart people I know--there imagination failed after number five or so.

Numbers 5-10 on this list deal with the inability of the American government to enact effective countercyclical policy. I have to say that I am not surprised by this at all...and I think that even without the benefit of hindsight, I would not have been surprised (and indeed, I always believed that the government's response would be inadequate). Why? Because we've never really implemented effective countercyclical policy in the past!

First, take the Fed's ability to construct its "usual firewall" between finance and the real economy. What usual firewall? Can you name a systemic financial crisis in our history that was not followed by a protracted economic slump? I am not sure I can. (Caveat: this does not establish that financial crises cause recessions, though I happen to believe that they do.) I suppose the Panic of 1907, but there was no Fed then. Maybe the LTCM collapse?

Now take the Fed's inability/refusal to stabilize nominal GDP growth after the crisis. At the zero lower bound, Fed action pretty much means QE. And when have we (or any country) ever implemented large-scale QE in the absence of out-and-out deflation? I can't think of any example.

Finally, let's consider the political feasibility of stimulus. Has the United States ever purposefully enacted a large countercyclical fiscal stimulus in the past? There's the New Deal, but as DeLong himself has mentioned, it was actually pretty small beer. Clinton's 1993 stimulus bill died a quiet death by filibuster. In fact, the only real example of fiscal stimulus that I can think of was Reagan's military buildup...but that was hardly sold as a stimulus.

So history would seem to indicate that the U.S. government is not very good at protecting the economy from financial crises or implementing countercyclical policy in really deep or prolonged slumps. I suspect, therefore, that Brad's belief in the government's abilities was really more hope than fear, and his reaction to our failure was more disgust than surprise. In other words, he was an optimist regarding the U.S. political economy. Sad to say, that is something I have never been.


Update: Mark Thoma points out that automatic stabilizers are generally politically feasible. That is certainly true.

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Libertarianism and the Tamerlane Principle

Still in Japan and working hard, so expect posting to be infrequent...

Anyway, I encourage everyone to read this excellent article by Stephen Metcalf. It's about Robert Nozick and the birth of modern American libertarianism. The piece does a great job of critiquing libertarianism from the standard "social welfare"/"institutions" point of view.

I want to be clear: I think that if the only thing wrong with libertarianism were that it rejects social welfare and ignores real-world institutions, that would be more than enough to allow me to oppose the dogma in good conscience. But I tend to criticize libertarian thought from a very different angle.

My problem with libertarianism is something I call the "Tamerlane Principle." Before I explain it, consider this account of the conquests of the 14th Century Central Asian warlord and conqueror Timur the Lame, commonly known as Tamerlane:

At the news of the [up]rising, [Tamerlane] stayed his march into the mountains, and took a terrible vengeance...he showed himself to be a "hurricane of annihilation"...[H]e commanded cruelty and devastation such as made people shudder even in those cruel days...When he stormed the rebellious city of Sabzevar...he had 2,000 persons walled up alive, as a tower of horror "for a warning for all who should dare to revolt and as an indication of Tamerlane's vengeance"...The sword of the executioner made an end of the dynasty of Herat; the towns of the Sserbedars became heaps of ruin...The mountain cities, which defended themselves valiantly, were crowned with pyramids of skulls; and in the capital city...the inhabitants were put to the sword by the conqueror, "even to the centenarians, and to the baby in the cradle." Then the soldiers carried off everything "down to the nails from the doors"; and whatever was combustible went up in flames. City after city, fortress after fortress, fell into the hands of the conquerors, "until there were no more enemies left in these provinces, and no one who did not obey Tamerlane."

Delightful, isn't it? But this was something that really happened. The truth is, this sort of conquest and destruction was a regular feature of human history for thousands of years. 

What would Robert Nozick say if he read that passage? He probably wouldn't see a strong connection between the conquests of Tamerlane and the question of government intervention in a modern capitalist economy. But I do. The connection is this: 

Tamerlane is always over the horizon, waiting to strike. There will always be conquerors waiting for the chance to conquer and pillage the soft civilized nations of the world. If you think Tamerlane is ancient history, just look up Pol Pot, Joseph Kony, Hitler, etc. This is a recurrent phenomenon. The only thing that can protect people against the Tamerlanes of the world is a strong, economically prosperous, well-organized nation state. And the only way you get a strong, economically prosperous, well-organized nation state is to have a strong, centralized government that provides lots of public goods. Roads, ports, schools, technological R&D. You need these things because everything we know about economic development says that these things are absolutely essential for a nation to have a high GDP. And a high GDP is necessary for a nation to win wars with hypothetical Tamerlanes.

This is why modern American libertarianism is so very, very flawed. The ideology professes to value liberty above all else, but it ignores the dynamic aspect. There is liberty today, and there is liberty tomorrow. Sometimes violations of liberty today (such as an income tax) are necessary to protect the body politic from far, far, far more heinous violations of liberty tomorrow.

Most libertarians recognize this, and freely admit that defense is an exception to the "small government" rule. But an army is not going to be a very effective Tamerlane repellant without a large GDP and advanced technology to back it up. And what modern American libertarians either fail to understand, or refuse to accept, is that public goods are essential for a high GDP. 

Stephen Metcalf declares that Nozick "was able to separate out a normative claim (that liberty is the fundamental value of values, and should be maximized) from an empirical claim (that the most efficient method for allocating goods and services is a market economy)." I wish that this were true, but it is not. Nozick, and his present-day acolytes, make an argument for unfettered capitalism that relies fundamentally on the empirical claim that public goods are not necessary for a strong economy. If public goods are necessary for a strong economy, then maximizing liberty requires that a government tax and spend.

Robert Nozick's radical prescription for a laissez-faire economy, if followed to the extreme, would put us in a position to be overrun by the first Tamerlane that wandered by and noticed our amber waves of grain. If you think this is a silly, alarmist statement, just observe how our recent neglect of public goods, along with our refusal to tax ourselves, is forcing us to make defense cuts (and will soon force us to make many more). This is where decades of trust in Nozick has gotten us. It's not a civilizational crisis yet, but it's not pretty.


Update: Wow, Metcalf's essay really seems to have touched a nerve. Will Wilkinson: "If only a levee separated polite discourse from the sort of ax-grinding indifference to fairness and truth Mr Metcalf displays in his essay." Reihan Salam: "Alas, I have just had the distinct displeasure of reading a critique of Nozick that is, I’m sorry to say, neither provocative nor intelligent. I wish I could get those minutes of my life back." Tyler Cowen: "I agree with Reihan that the recent web critique of Nozick, which I will not link to, was just awful." And here's Jason Kuznicki with an actual rebuttal. But so far, no libertarian bloggers, to my knowledge, have answered the Tamerlane Critique. Can I have been the first person to think of this idea? It seems highly unlikely.

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In Japan.

I am in Japan until the end of  summer 2011, doing research at Osaka University and Aoyama Gakuin University. Posting will be sporadic this summer...

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