Debt and the burden on future generations, Part MMMVIII

I don't want to bore people, but once again this question has come up (see here, here, here, here, here, here, and here for the whole battle royale) , and I thought I'd blog about it, because hey, every econ blog should occasionally do some little "thought experiment" type stuff, even if it doesn't quite as much traffic as does making fun of commenters.

The question, once again, is: "Does government debt impose a burden on future generations?" I took a crack at this question back in January, and my answer is still the same, but I'd like to phrase it more concretely.

Here's how I like to think about this question. In my mind, to "impose a burden on future generations" means  "to decrease the consumption possibilities of future generations". So the question is really whether or not the size of today's stock of government debt reduces the total consumption possibilities of people not currently born. In other words, if government debt is $1,000,000,000 today, does that mean that the consumption of future people must be lower than if government debt were $1 today?

Let's assume a closed economy. In that case, the economy's maximum potential consumption at any point in time is determined by the productive capacity of the economy at that time. Productive capacity is determined by the size of the capital stock, the labor force, the availability of natural resources, and the level of production technology. (For convenience, I'm defining the "capital stock" as including all consumer durables, and defining "consumption" as including the flow of services from those durables.) Now let's assume that the technology level, the labor force, and the amount of natural resources are all completely exogenous, so that the government cannot affect these things (this may not be realistic but we could always drop that assumption later). So the productive capacity of the economy at any point in time is just a monotonic function of the economy's capital stock - more capital at time T means more potential consumption at time T.

Now let's define "burden on future generations". That means that at some time T > 0 (t=0 being today), the potential consumption of the economy will be lower. Since the potential consumption of the economy at any time t is determined entirely by the size of the capital stock at time t, what we are really asking is whether or not the following proposition is true:

∀{D_t},{C_t} ∃T>0 s.t. K_T = f(D_0), where f'(D_0) < 0 

Here K is the capital stock, D is government debt, f is some function, t=0 is today, D_0 is today's stock of government debt, {D_t} is the path of government debt between t=0 and t=T, and {C_t} is the path of consumption between t=0 and t=T. If this proposition is true, then no matter what anybody does in the future, higher debt today necessarily means a smaller capital stock at some point in the future. 

Note that this proposition is not stated as formally as it could be or really should be, for which I apologize.

So now, let's think about what determines the capital stock at a future time T. This is determined by the sequences of consumption and investment from t=0 to t=T-1. In order for K_T to be constrained to be lower than it would otherwise be, it must be the case that K_T-1 is lower than it would otherwise be (this follows easily from the assumption that the production function is monotonic in the level of the capital stock). By backwards induction, the above proposition can only hold if the following proposition holds:

K_1 = f(D_0), where f'(D_0) < 0 

Remember, t=1 means tomorrow. In other words, only if tomorrow's capital stock depends in a negative way on today's stock of government debt can it be true that a higher D_0 forces K_T to be lower at some point in time.

Tomorrow's capital stock depends entirely on today's level of investment (today's level of production is fixed, because today's capital stock is fixed). So our question now reduces to:

Question: If I_0 = g(D_0), where I_0 is today's investment and g is some function, what is the sign of g'(D_0)? 

If g'(D_0) is positive, then a higher government debt stock today means that the economy will invest more today; this means that government debt will impose no burden on future generations.

So is it possible that g'(D_0) > 0? In other words, given two societies that are identical in all respects except that Society 1 has a higher stock of government debt than Society 2, is it possible that Society 1 will invest more today (and consume less today) than Society 2?

Of course it's possible. The investment/consumption choice is entirely behavioral. And when I say "behavioral" I am including the behavior of the government. If Society 1's government chooses to cut welfare and use the money to build a bunch of roads, for example, it could easily invest more and consume less today than Society 2; the high level of D_0 in Society 1 would not prevent it from being able to do this.

So government debt need not be a burden on future generations. It all depends on how economy-wide consumption/savings decisions react to the size of the stock of government debt. And that is heavily dependent on the behavioral model one chooses. Might a higher stock of government debt outstanding induce a society to invest less and consume more (which would constrain future consumption to be lower under certain additional assumptions)? Sure.

So the answer to the question is: It depends. What does it depend on? It depends on how consumption/savings decisions react to the size of the stock of government debt, which depends on the behavior of the government, firms, and households. Modeling that behavior is a major challenge.

Also, note that this does not answer the question of "Does government borrowing impose a debt on future generations?" This is because the economy's consumption-savings choices may respond differently to changes in debt than to levels of debt. But in general, the answer will have the same form.

So to sum up:

• Must higher government debt today lead to lower potential consumption sometime in the future? No.

• Does higher government debt today lead to lower potential consumption sometime in the future? Maybe; I don't know.

• Does higher government debt today lead to lower actual consumption sometime in the future? Maybe; I don't know.

• Must higher government borrowing today lead to lower potential consumption sometime in the future? No.

• Does higher government borrowing today lead to lower potential consumption sometime in the future? Maybe; I don't know.

• Does higher government borrowing today lead to lower actual consumption sometime in the future? Maybe; I don't know.

(Just in case you were wondering: The example Nick Rowe creates here is a case of higher government borrowing today leading to lower actual consumption in the future. He uses a "fruit-tree economy" with no capital (or if you prefer, with K fixed), so potential consumption in each period is fixed. In that sort of economy, it is impossible for anything to "impose a burden" on any cohort, using my definition of "imposing a burden".) 

Update: More interesting conversation between me and Nick over at his blog, as well as in the comment section of this post. We look deeper into the issue and get some more interesting results.

Update 2: Nick and I have been discussing the issue. I think we agree on everything now, and a number of interesting conclusions have emerged. Let me see if I can translate them into plain English...

The "Burden" Result: It is possible that the existence of past government transfers can ensure that either currently living people or as-yet-unborn (or both) must get screwed, relative to the baseline in which no transfers occurred. These past government transfers can be accomplished by government borrowing and spending; in that case, the past government transfers will affect the value of today's government debt. This is the upshot of Nick's model.

The "No Future Burden" Result: However, no matter what transfers happened in the past or how much government debt we have today, then given some simple assumptions, it is always possible to get away with only screwing people who are currently alive (and yes, you can quote me on that!). This is the upshot of my proof.

Note that these two results are not incompatible at all. So Nick and I don't disagree.

The "Dues Paid" Result: Given some more simple assumptions, it is always possible to limit the total amount of screwage (in consumption terms, not utility terms) to the amount of consumption that was, in the past, transferred away from people who are currently alive. In other words, the total amount of screwage never has to be bigger than the total "dues" already paid by currently living people. This is something I realized while talking to Nick over at his blog. I think it's kind of interesting.

The "Debt Does Not Equal Burden" Result: This means that the govt. debt number may not equal the burden number (and in general does not). The size of the current stock of government debt may be much larger than the total amount of the aforementioned screwage. In other words, govt. debt may be $10,000,000,000 today, but the total amount of necessary screwage might be much smaller, or might even be zero. This can happen, for example, if the government spends money on the same people it taxes, or if people leave government bonds to their children in a certain way. So debt is not a book-keeping device that faithfully records the amount of necessary future screwage.

(Note that this means that government debt's effect on society is very different from the effect of one household's debt on that household. If I borrow $10,000 and spend it today, I'm going to need to take a $10,000 hit in the future in order to pay it back. But if the government borrows $10,000 today, it's quite possible that nobody ever has to take a hit at all. I am not sure, but I think that this might be Paul Krugman's main point.)

(Update: Antonio Fatas thinks that this last result should be the main takeaway from the debate.)

In conclusion: When you ask "Does debt impose a burden on future generations?", you have to be very careful about exactly what you mean when you ask that question. But if you are careful - if you use math in your explanation, state all definitions and assumptions clearly, and above all think clearly and don't get mad - then the truth will out.

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Will econ blogging hurt your career?

Many people ask me this. Short answer: It's impossible to know.

Reason 1: The number of bloggers is small, and blogging is new. In terms of econ grad student bloggers, there has been me, Steve Randy Waldman, Adam Ozimek, Daniel Kuehn, Kevin Bryan, JW Mason, and maybe one or two others. That's not a statistically large sample, and there are lots of confounding factors (research quality, blog subject matter, etc.). So it's basically impossible to do any kind of quantitative analysis to answer the question.

Reason 2: Very few of the people you annoy will actually inform you of the fact. For example, I've criticized modern macro a lot. Maybe that has annoyed tons of macroeconomists, to the point where they wouldn't consider working with me, hiring me, or allowing my papers into a journal that they refereed. But if so, they're not going to write me emails and say "Hey, I think you're a jerk." They're just going to quietly decide that I'm a jerk, and I'll never know why my paper really got rejected.

So basically, nobody will know for a long time how blogging impacts people's careers. Those of us who have tried it are basically just very tolerant of Knightian uncertainty. In fact, I love uncertainty. In many situations I'd rather try something just to see what happens. I'm the character that gets killed first in every horror movie, but that's fine with me, since life is not generally like a horror movie.

But here are a few reasons to think that blogging won't be as bad for your career as many people fear:

Reason 1: Blogging is great for meeting people. Through blogging, I've met awesome people like Richard Thaler, Eric Brynjolfsson, George Akerlof, James Heckman, Betsy Stevenson, and Roger Farmer, not to mention fellow blogger/economists like Mark Thoma, Tyler Cowen, Alex Tabarrok, Justin Wolfers, Brad DeLong, John Cochrane, Greg Mankiw, Robert Waldmann, Scott Sumner, Steve Williamson, David Andolfatto, and others (I still haven't met Paul Krugman, in case you were wondering). That doesn't mean those people think I'm an elite researcher just because I blog, or will do me any personal career-related favors. Blogs are not a good-ol'-boy network. But it's very helpful to meet this sort of people, to get ideas and perspective, learn how to think about things, and see what's going on in the world of economics. Not to mention networking; senior people advise younger people, and younger people are potential co-authors.

Reason 2: Blogging really doesn't take up much time. It's like any other hobby; it may put a crimp in your social life, but work will still come first. Heavy blogging will require 2 hours a day, but I would say I spend an average of only 20-30 minutes a day on it. And I never feel pressured to post more. Blogging is not a job, so it's not an obligation.

Reason 3: Blogging helps you think. It helps to get things down on paper. Sometimes you have an idea, and then when you start to write it down you realize how vague and/or implausible and/or illogical it is. Writing an idea clarifies the idea, and it helps you practice communicating your idea to others. This will help with writing papers. Even the "blog-fights" help with logical thinking and being able to dissect arguments.

Reason 4: Name recognition is somewhat important in economics, and there is a bit of evidence that blogging helps to build name recognition. This evidence should be taken with several grains of salt, of course, for reasons discussed above.

So there are reasons that blogging might be good for one's career. But these should be viewed simply as mitigating the (unknowable) risks of blogging, not as reasons to start blogging in the first place. The real reason to blog is to affect the national conversation, to get involved with policy and national affairs in some small way, and simply for the sheer joy of thinking about stuff. In other words, the same reasons that people should go into academia in the first place. If your main goal is to make money and wear a suit and have a swank office - and there's absolutely nothing wrong with that - go find a nice safe job in a bank!

Update: In the comments, Steve Williamson adds:

Here's an old blogger perspective. There is risk associated with getting into anything you have not tried before. When you're young you have to take risks, otherwise you never get anywhere. There is risk in blogging just as there is risk in anything else we do. You can say foolish things in a blog post. You can say foolish things when you present a paper at a conference. In the first case you reveal your foolishness to more people, but they are more forgetful. Tomorrow they will move on to another idiot. Old economists who have had some success in the profession and have tenure can coast - they don't have to take risks. But coasting is no fun, and rust never sleeps. If you have tenure, you can use it to your advantage. Offend a few people. Speak your mind. Maybe it matters.

Sounds like great advice to me...

Update 2: In the comments, Frances Woolley adds:

Academic publishing is becoming increasingly dysfunctional. People have to publish to get tenure/promotions/government or other funding, so everyone wants to get stuff out, but no one wants to referee for journals or read their contents (except for a dozen or so top journals).  

As academic journals lose relevance, conferences, high profile working paper series like the NBER, and blogs are gaining. I get way more eyeballs - and way more ideas out there into the public domain - by blogging than I would by publishing stuff in mid-ranked journals.

Interesting...

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Acemoglu and Robinson versus the blogs

Daron Acemoglu and James Robinson have a paper out (with Thierry Verdier) about different "flavors" of capitalism and how these  flavors could affect innovation. Specifically, they compare the "cuddly" capitalism of Europe to the "cutthroat" capitalism of America. First they make a simple mathematical model to show how more socialist "cuddly" countries like Sweden can act as parasites, leeching off of the innovations produced by the freewheeling "cutthroat" nations. Then they "test" their model by showing that the U.S. patents more stuff than Scandinavian countries.

This paper drew criticism from a number of bloggers. For example, here Lane Kenworthy asked: 1. What about alternate measures of innovation in which Scandinavian countries score close to the U.S.?, and 2. Wasn't the U.S. more "cuddly" back in the 70s, and weren't we just as innovative back then? And here, Matt Yglesias alleged that patents are a crummy measure of innovation.

Acemoglu and Robinson then defended themselves on their blog. After suggesting that criticism of their paper was motivated by politics (buncha commie bloggers!), Acemoglu and Robinson discuss what they believe to be the differing roles of blogs and academic research:

[There is a] divide between what the academic research in economics does — or is supposed to do — and the general commentary on economics in newspapers or in the blogosphere. When one writes a blog, a newspaper column or a general commentary on economic and policy matters, this often distills well-understood and broadly-accepted notions in economics and draws its implications for a particular topic. In original academic research (especially theoretical research), the point is not so much to apply already accepted notions in a slightly different context or draw their implications for recent policy debates, but to draw new parallels between apparently disparate topics or propositions, and potentially ask new questions in a way that changes some part of an academic debate. For this reason, simplified models that lead to “counterintuitive” (read unexpected) conclusions are particularly valuable; they sometimes make both the writer and the reader think about the problem in a total of different manner (of course the qualifier “sometimes” is important here; sometimes they just fall flat on their face).

Well, first of all, I disagree with the idea that counterintuitiveness is inherently good when evaluating academic research; growing up, I argued this point at length with my dad, who is a cognitive psychologist. But this is neither the time nor the place for that argument.

Instead, I want to make two points.

First, I want to point out that Acemoglu and Robinson's theoretical result is not very counterintuitive. The notion that there is a tradeoff between innovation and redistribution is quite a commonly-held belief. In Acemoglu and Robinson's theoretical model, this ideas is a built-in assumption; is is not the result of the model, it is the model's starting point. To see this, just check out Section 2.2 on "Reward Structures". The authors assume that the reward to entrepreneurship (entrepreneurs are the same as innovators in their model) depends on the degree to which a country lets winners win and lets losers lose. The entrepreneurs decide how much effort to put out - if they try harder, they have a bigger chance of succeeding.

To my knowledge - and if I am wrong, please correct me! - this reward structure and this "return to effort", are not taken from any microeconomic study of entrepreneurial behavior; they are just something the authors wrote down.

Why did they write them down? A cynic would say: "Because these assumptions made the model work out the way the authors wanted it to", but I am not such a cynic. Instead, it seems to me that they wrote down these assumptions because they were intuitively plausible. It makes intuitive sense that the bigger the risk from losing, the more people will try hard not to end up being losers. And it makes intuitive sense that the harder someone tries, the better they do.

Given these assumptions, the result of the model is not hard to predict - when you let losers lose and winners win, innovators try harder. Not exactly a shocker, given the assumptions.

So is this model counterintuitive? I argue: No. Instead, it is intuitive. It seems to have been built using intuition, and its results confirm commonly-held beliefs about the difference between "cutthroat" and "cuddly" capitalism. So I don't think it makes much sense for Acemoglu and Robinson to defend their research from the bloggers by saying that the purpose of academic research is to be counterintuitive.

OK, time for my second point. Mark Thoma wondered why Acemoglu, Robinson, and Verdier get the result they get. Isn't it true that entrepreneurs have to take a lot of risk? And doesn't that mean that social insurance, which reduces risk, should encourage entrepreneurs to take more risk, not less? How is it that Acemoglu et al.'s model avoids this effect?

Here is the answer: it's built into the math. The authors assume that the only cost of entrepreneurship is effort. From the paper:

We assume that workers can simultaneously work as entrepreneurs (so that there is no occupational choice). This implies that each individual receives wage income in addition to income from entrepreneurship[.]

In other words, the authors have assumed away much of the risk of entrepreneurship! A failed entrepreneur gets paid exactly the same wage income as a worker who doesn't try to be an entrepreneur at all! This automatic wage income reduces the risk of entrepreneurship substantially, and makes social insurance much less necessary for reducing risk. 

How realistic is that assumption? Well, in the real world, entrepreneurs in rich countries have limited liability, and can pay themselves wages out of their start-up capital. This means that many entrepreneurs can earn a wage even as they work to start businesses. But this wage is often much less than they could have earned otherwise, and if their business fails (a statistically likely event), they will be unemployed. So the "no occupational choice" assumption probably reduces the risk of entrepreneurship, relative to the real world. 

Also, the authors assume that entrepreneurs do not put up any of their own wealth as startup capital for their ventures, and they assume no heterogeneity between worker/entrepreneurs. This means that it is just as easy - and no more risky - for a poor person to start a successful company as for a rich person to do so.

So to sum up my second point, Acemoglu, Robinson, and Verdier have assumed a model in which:

• Entrepreneurship is low-risk,
• Rich people have no advantage over poor people when it comes to starting companies, and
• Your probability of success depends entirely on how hard you work.

(No wonder liberals were not happy about this model, eh?)

So to combine my two points: When it comes to this kind of modeling, what you get out is pretty much what you put in. If you start off with the intuition that success is a function of how hard you work, and how hard you work is a function of how much the government will let you keep your hard-earned gains - in other words, if you start off with the intuition of pretty much every middle-aged conservative guy in America - then your model will probably spit out the result that countries face a tradeoff between redistribution and innovation...again, fitting perfectly with the intuition of pretty much every middle-aged conservative guy in America.

So the model is not counterintuitive. But is it a good model? Does it help us understand the world? Here we have to turn to the data. The data tell us that America issues more patents than Scandinavian countries. Is that good enough? Even if patents are a good measure of innovation (i.e., if Matt Yglesias is wrong), and even if cross-country comparisons are valid, and even if such a small sample were enough to make a statistical inference, I'd still say we have a problem here. Why? Because Acemoglu, Robinson, and Verdier were almost certainly aware of the patents data before they wrote their paper. It is quite probable that the patenting disparity between the U.S. and Scandinavia is what inspired their paper. And one cardinal rule of scientific theorizing is that your model should be tested on data other than the data used to construct the model.

In other words, Acemoglu et al. have not yet succeeded in explaining anything about the world. They have looked at the world, and then used plausible sounding assumptions to create a model whose results fit what they observed. But they have not yet tested whether that model can be used to predict things other than the original observation. Until they do that (or someone else does it), their theory should not be believed.

Anyway, I think I'm done talking about this paper. I am NOT trying to say that Acemoglu and Robinson are wrong, or that they have made any mistakes in their research. What I am trying to do is to illustrate the usefulness of blogs. Even if I've made some mistakes about the particulars (and I may have!), I hope I've shown that blogs, while not a substitute for academic research, do have something to contribute to the academic discussion - by pointing out assumptions, identifying relationships between assumptions and conclusions, discussing alternative assumptions, and evaluating the current status of the research. This is much more than just "distilling well-understood and broadly-accepted notions", which Acemoglu and Robinson claim to be the purpose of blogging.

Update: Some people apparently have been thinking that I'm accusing Acemoglu et al. of political bias. I am doing no such thing. Acemoglu et al. almost certainly just want to demonstrate a neat idea they had (the "asymmetric equilibrium" between "cutthroat" and "cuddly" countries). Demonstrating that, though, requires a model whose assumptions are bound not to be very pleasing to liberals...although again, that's not necessarily the only reason that liberal bloggers criticized the paper. In econ, a lot of accusations and counter-accusations of political bias are always flying around, but I like to keep those to a minimum.

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How many economists are monetarists?

Reading the econ blogosphere and talking to macroeconomists, you would think that the monetarists have triumphed. With the coming of QE3, the hard-money faction has suffered a decisive defeat in the policy arena. Mike Woodford is being hailed as a hero for our times, and the notable resemblance of QE3 to NGDP targeting has won Scott Sumner many accolades as well. Monetarism - broadly, the notion that economic fluctuations should be stabilized entirely through the monetary policy of an independent central bank - appears in the ascendance.

Except that the rest of the economics profession has apparently not gotten the message. The Economist has conducted a survey of economists from various walks of life - the NBER, business economists, and "independents". The question: What has been holding back America's recovery from the Great Recession? And here, in two pretty graphs, are the answers:

Basically, we see the following facts:

1. Most of these economists believe that slow recoveries are a natural result of financial crises.

2. The "policy uncertainty" trope has a good number of followers, despite the fact that there is probably substantial (and entirely political/partisan) disagreement as to what sort of policies people are worried about (socialist Obamacare, crazy Republican debt brinksmanship, or just a general failure of America's political institutions?).

3. A lot of economists seem to believe in fiscal stimulus.

4. Most economists do not think that monetary policy has been a big factor in the slow recovery.

All of these results are interesting, but to me, the last one is huge. Milton Friedman claimed that the Fed caused the Great Depression by keeping monetary policy too tight. Ben Bernanke agreed with this view. This survey shows that most economists (or, at least, most of those surveyed; it was not a random sample of the profession) now think that Milton Friedman was utterly wrong. 

This seems like a big deal to me because it signals a general lack of confidence in macroeconomics as a field. In recent years, most mainstream academic macro has modeled recessions as being due to demand shocks, and has focused on monetary policy as the most appropriate - or indeed the only - policy countermeasure. Fiscal stimulus is such a distant second that it might as well be running in a different race. Monetary policy - optimal rules, targets, expectations management - was and is considered the..er...gold standard of what macro has to offer the world in terms of practical, applicable engineering. What this survey shows is that many economists believe that our best macroeconomic policy engineers are unable to build any sort of useful machine.

How would I respond if I took this survey? Basically, I agree that there is probably some force that holds back recoveries after financial crises (and we don't entirely understand what that force is, though many think it's related to gross indebtedness). And I think that uncertainty about external shocks is a huge deal - I wouldn't be surprised if there were "ringing" or "boomerang" effects as the crisis filtered slowly around the world and back. Also, I think we could have given the economy a much bigger boost by doing a lot more road and bridge repair. So except for the "policy uncertainty" part, I agree with the majority or surveyed economists.

And monetary policy? It's hard to say. It's not a topic I understand well, despite having taken classes on it and read a fair number of papers. I'm not sure it's a topic that more than a handful of people understand well, given the propensity of respected monetary policymakers to say such odd things (and such different things over time). I'm still open to the idea that better monetary policy could have had us back on our feet in a jiffy after 2009, but I'm definitely far from convinced...

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Hard money and the gerontocracy

There is a huge divide between economists and the rest of the populace when it comes to inflation. Economists generally focus purely on the efficiency/growth effects of inflation - whether monetary easing can boost output, etc. Most normal people ignore this issue entirely, and mistakenly equate "inflation" with "falling real wages" (which is absurd, but 99% of people seem to make this mistake). But then there are lots of people who seem to care about the redistributive effects of inflation. These effects are real, and potentially big, and economists often ignore them.

Who loses from inflation? "Net nominal lenders". These are people who own a lot of non-inflation-adjusted bonds, and not a lot of stocks, and who get less of their income from wages. Who are these people? They are old people.

Owning lots of bonds, and not much stock, is the wise thing to do when you're old. Stocks are riskier than bonds, and old people can't afford to take as much risk - this is the core idea of "life-cycle investing". Also, obviously, old people have a lot of savings (and hence a lot of income from investments), and not much in the way of wage income. So old people tend to be hurt by unanticipated inflation, while young people are generally helped.

That is the basic idea behind this new paper by Jim Bullard, Carlos Garriga, and Christopher Waller of the St. Louis Fed. they make a model (basically, a variant on the simple old "overlapping generations" model) in which the government wants to please its citizens, but can't enact Social Security or other methods of income transfer. Instead, the government uses inflation to help whichever group has the heftiest demographic weight. If the country's population is tilted toward the elderly, deflation is used to maximize social welfare; if there's a baby boom on, inflation is the most utilitarian policy.

OK, so how does this toy model connect to the real world? In the real world, we are perfectly able to do things like Social Security, so we don't need to use inflation/deflation to redistribute between the young and the old. But in the real world, different age groups may use the political process to skew monetary policy anyway. Or as Bullard et al. put it:

When the old have more influence over this redistributive policy, the economy has...a lower or negative rate of inflation. By contrast, when the young have more influence...wages are relatively high and [there is] a relatively high inflation rate... 

In this paper, we have allowed [our math model] to “stand in ”for the political processes that society uses to make decisions concerning redistributional policy... 

[S]ociety could use other [policies] to achieve similar goals, so we interpret the …findings here as...taking the existing distortionary tax system as fixed and immutable.

Furthermore, they contend, the broad patterns of inflation and deflation seem to follow the age structures of developed countries. Consider the cases of the U.S. and Japan:

It certainly looks like there's a correlation.

Now, for this to be what's really going on, old people must exert some sort of control over the Fed. We typically think of the Fed as independent, apolitical, and technocratic - not the type of institution that would be swayed by the selfish desires of one cohort of the population to extract rents from its descendants. But who knows; maybe the legendary political strength of the elderly somehow filters through to the brain of the Fed chairman.

And if that's true, it means that elderly countries will have a much harder time fighting recessions. If old people's desire for the redistributive benefits of low inflation overwhelms the need for the Fed to boost growth, then we're going to have a much tougher time ending our current stagnation...to say nothing of Japan, where hard money is much more of a cult even than here in the States, and which has been mired in near-deflation for decades.

So next time you throw up your hands and wonder why the Fed isn't doing more to boost the economy, remember Jim Bullard's paper...it might be all Grandma and Grandpa's fault!

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New Atlantic column: the Alternative Asia Plan

I have a new column up at the Atlantic, about the benefits of large-scale immigration from Asia. Key excerpts:

For most of its history, America was the "Alternative Europe"..."Alternative Europe" was a winning strategy for us. But that strategy is mostly played out...The United States still needs people...But we're not going to get our new people from Europe... 

East Asia, South Asia, and Southeast Asia together have over half the world's population, but Asians make up only 5% of the United States. If our ethnic makeup was a portfolio of stocks, we would be severely underweight Asia. 

Asia is important not just because it is huge, but because it is growing rapidly...Geopolitics, too, will be centered on Asia... 

Adding diversity to our melting pot will speed up America's inevitable and necessary transition from a "nation of all European races" to a "nation of all races." The sooner that happens - the sooner people realize that America's multi-racialization is a done deal - the quicker our political debate can shed its current ethnic overtones and go back to being about the issues... 

But we need to act now, because the window of opportunity for large-scale Asian immigration will not stay open for much longer...We probably have only two more decades in which to transplant large numbers of Asians to our shores. (This is in contrast to Africa, whose high fertility levels will make sure it remains a plentiful source of immigrants for at least another century.)... 

This, then, is the "Alternative Asia Plan." America began as a nation of Europeans and Africans; it is now a nation of Europeans, Africans, and Latin Americans. It must become a nation of Asians as well.

Basically, the reasons for immediate large-scale targeting of Asian immigration is three-fold:

1. Immigration from Europe and Latin america has trickled off, while immigration from Africa will be available essentially indefinitely; the window for Asian immigration is short, and is now.

2. Strong ties with Asia are important for geopolitics.

3. Asian immigration will make our cultural and racial mix more representative of the globe.

20 or 30 years from now, expect to see me writing about the "Alternate Africa Plan"...

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A monetary policy pop quiz

I freely admit that I don't understand monetary policy incredibly well. Sure, I solved some New Keynesian models in my field classes. I remember what happens in equilibrium. And I taught intro macroeconomics a few times, and learned all the standard kiddie models - money demand, loanable funds, AD-AS, long-run and short-run Phillips curves. I saw the "Friedman Rule" derived a couple times. But there is much about monetary policy I don't understand. First, I don't understand all of the particulars of how monetary policy is actually conducted. Second, I don't have much intuition for what happens far away from the equilibria in most models, especially if the equations that define the equilibrium are not linearized. Finally, I do not understand what would happen if this or that assumption of the models I know were dropped, or how plausible alternative, non-mainstream models are. All I know, really, are: A) the linearized equilibria of New Keynesian sticky-price models, similar models like Mankiw's "sticky information" models, B) some "New Classical" models like the Lucas Islands and RBC models, and C) some heuristics and hand-wavey ideas from the age of Milton Friedman and Paul Samuelson.

So I'm really not sure what to think when I read things like this pronouncement from two years ago by Narayana Kocherlakota:

[I]f the FOMC maintains the fed funds rate at its current level of 0-25 basis points for too long, both anticipated and actual inflation have to become negative. Why? It’s simple arithmetic. Let’s say that the real rate of return on safe investments is 1 percent and we need to add an amount of anticipated inflation that will result in a fed funds rate of 0.25 percent. The only way to get that is to add a negative number—in this case, –0.75 percent. 

To sum up, over the long run, a low fed funds rate must lead to consistent—but low—levels of deflation.

Is this right? Do permanently low interest rates eventually lead to permanent deflation? My instincts say that this cannot be true. My instincts say that printing more money cannot lead to deflation at long time scales - if you wait long enough, an increase in the supply of money will decrease money's value.

So what would happen if the Fed kept interest rates at zero forever? Would inflation rise to a new, higher average level and stay there, or would it keep accelerating until hyperinflation resulted and the real interest rate plunged to negative infinity? I'm not sure.

OK, so let's think about the opposite policy. What if the Fed tried to keep the nominal interest rate at, say, 50% forever? First of all, could it do that, or would it empty out its balance sheet and have to give up, like an emerging market trying to maintain a currency peg? And if a 50% real interest rate caused deflation - which seems like it would certainly happen - then the real interest rate would be above 50%. That would make govt. bonds a much more attractive proposition than the stock market or any other private asset, so it seems like everyone would abandon the real economy and stampede into govt. bonds. with the whole country earning >50% real rates of return, we'd all get rich really quick...this seems physically impossible to sustain for very long.

OK, so you see my problem. I just don't understand the extremes of monetary policy. So instead of making any pronouncements, I want to conduct a pop quiz. This quiz has two short-answer problems. Please answer in the comments, as concisely and succinctly as possible.

Problem 1

Suppose that the Fed targets only one interest rate, a short-term nominal interest rate, and that its only tool is Open Market Operations (it cannot provide any "forward guidance" or communicate with the public at all). Suppose that at date T, the Fed decides to keep the interest rate at zero in perpetuity, and remains unwaveringly committed to this decision for all time > T.

a) Describe the time path of the price level (or inflation/deflation), starting at time T, and going forward to infinity (or until the policy ends).

b) Describe the sequence of Open Market Operations that the Fed will conduct.


Problem 2


Suppose that the Fed targets only one interest rate, a short-term nominal interest rate, and that its only tool is Open Market Operations (it cannot provide any "forward guidance" or communicate with the public at all). Suppose that at date T, the Fed decides to keep the interest rate at 50% in perpetuity, and remains unwaveringly committed to this decision for all time > T.

a) Describe the time path of the price level (or inflation/deflation), starting at time T, and going forward to infinity (or until the policy ends).

b) Describe the sequence of Open Market Operations that the Fed will conduct.


I'm looking forward to reading your answers...


Update 1: Answers are coming in...keep em coming! Mark Thoma sends this video of George Evans explaining a New Keynesian model.

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