Friday, May 31, 2013
mealy macro on: macro model choice for policy makers
a story
"It is sometime in 2005/6. Consumption is very strong, and savings are low, and asset prices are high. You have good reason to think asset prices may be following a bubble. Your DSGE model has a consumption function based on an Euler equation, in which asset prices do not appear. It says a bursting house price bubble will have minimal effect. You ask your DSGE modellers if they are sure about this, and they admit they are not, and promise to come back in three years time with a model incorporating collateral effects. Your SEM modeller has a quick look at the data, and says there does seem to be some link between house prices and consumption, and promises to adjust the model equation and redo the forecast within a week. Now choose as a policy maker which type of model you would rather rely on."
more firm based modeling of cross border trade
" The size of the welfare gains from trade and the mechanisms through which these occur are central to policy debates about trade liberalisation. These include both multilateral trade negotiations such as the WTO Doha Round and regional integration decisions such as the Transatlantic Trade and Investment Partnership. Over the last 20 years, trade economists have uncovered heterogeneous firm-level responses to trade liberalisation, which in turn inspired the development of new theories of international trade."
Blah
"Evidence of these heterogeneous firm-level responses comes from numerous empirical studies of disaggregated (firm- or plant-level) datasets following Bernard and Jensen (1995):
•A minority of firms participate in international markets, whether through exports, imports or multinational activity. Often 10% of a nation’s firms account for over 80% of all exports.
•These firms are larger, more productive, more capital intensive, more skill intensive and pay higher wages than domestic firms within the same industry.
•While most firms that trade supply few products to a handful of destination markets, a small number of traders account for the vast majority of the value of exports and imports.
Trade liberalisation reforms are found to induce intra-industry reallocations of resources, as low productivity firms exit and more productive firms expand to serve export markets. In turn, these reallocations towards more productive firms generate an increase in average industry productivity."
"A new survey of the new new trade theory
In our recent handbook chapter, we review the theories developed to capture these features of the data (Melitz and Redding 2013a). The basic elements of these models are simple:
•New entrants in an industry face uncertainty about their future productivity (or product quality appeal).
•Productivity/quality is revealed after a sunk entry cost is incurred.
•At this point, some firms realise that they cannot earn positive operating profits and exit the industry.
•The remaining firms continue to produce and those with high productivity or quality attain larger market shares and earn higher profits.
•The firms that select into exporting as well as selling locally are naturally the most productive since exporting involves additional costs.
When trade costs fall, export profits rise and a new logic leads to changes that raise average industry productivity:
•Some new firms become exporters (the most productive among those that did not previously export), while existing exporters increase their export sales (and hence their overall production levels).
•The higher export profits also induce additional entry into the domestic industry (as the returns to high productivity/quality increase).
•Non-exporters lose market share because of both increased import competition and the additional entry and hence shrink.
•This forces some of the least productive firms to exit, while some more productive firms expand.
These within-industry reallocations in response to trade liberalisation generate higher industry productivity – and represent a new potential source of gains from trade.
Do these heterogeneous firm responses matter for aggregate welfare?
While these new theories of heterogeneous firms in differentiated product markets have been extremely successful in accounting for features of disaggregated trade data, Arkolakis, Costinot and Rodriguez-Clare (2012) ask whether these new insights for micro-level data have altered our understanding of the aggregate welfare gains from trade.
They show that there exists a class of trade models (with and without firm-level differences across producers) in which a country’s domestic trade share (expenditure on its own goods relative to GDP) and the elasticity of trade with respect to trade costs (the percentage increase in trade from a 1% decrease in trade cost) are sufficient statistics for the aggregate welfare gains from trade. Under these circumstances, calculating the welfare gains from trade does not require knowledge of disaggregated features of international trade data. All one requires is aggregate data on trade shares and the trade elasticity (the sensitivity of aggregate trade to changes in trade costs). If two different models within this class are calibrated to deliver the same trade share and trade elasticity, then they also deliver the same welfare gains from trade – regardless of their different implications for the firm-level responses to trade.
Based on this result, the authors summarise the contribution of new theories of heterogeneous firms to our understanding of the aggregate welfare implications of trade as “So far, not much.”
A new source of gains from trade
In Melitz and Redding (2013b), we show that firm-level responses to trade that generate higher productivity do in fact represent a new source of gains from trade.
•We start with a model with heterogeneous firms, then compare it to a variant where we eliminate firm differences in productivity while keeping overall industry productivity constant.
We also keep all other model parameters (such as those governing trade costs and demand conditions) constant.
•This 'straw man' model has no reallocations across firms as a result of trade and hence features no productivity response to trade.
Yet it is constructed so as to deliver the same welfare prior to trade liberalisation. We then show that, for any given reduction in trade costs, the model with firm heterogeneity generates higher aggregate welfare gains from trade because it features an additional adjustment margin (the productivity response to trade via reallocations). We also show that these differences are quantitatively substantial, representing up to a few percentage points of GDP. We thus conclude that firm-level responses to trade and the associated productivity changes have important consequences for the aggregate welfare gains from trade.
Reconciling these findings
How can these findings be reconciled with the results obtained by Arkolakis, Costinot, and Rodriguez-Clare (2012)? Their approach compares models that are calibrated to deliver the same domestic trade share and trade elasticity (the sensitivity of aggregate trade to changes in trade costs). In so doing, this approach implicitly makes different assumptions about demand and trade costs conditions across the models that are under comparison (Simonovska and Waugh 2012). By assuming different levels of product differentiation across the models, and assuming different levels of trade costs, it is possible to have the different models predict the same gains from trade – even though they feature different firm-level responses. In contrast, our approach keeps all these 'structural' demand and cost conditions constant, and changes only the degree of firm heterogeneity (Melitz and Redding 2013b). This leads to different predictions for the welfare gains from trade.
One potential criticism of our approach is that one can estimate the trade elasticity (the sensitivity of aggregate trade to changes in trade costs) using aggregate trade data only – without requiring any specific assumptions about the firm-level responses to trade. Whatever assumptions are made about those firm-level responses (and the demand and trade-cost conditions), they should then be constructed so as to match that estimated aggregate elasticity. However, recent empirical work has shown that those underlying assumptions radically affect the measurement of the aggregate trade elasticity, and that this trade elasticity varies widely across sectors, countries, and the nature of the change in trade costs (see for example Helpman et al. 2008, Ossa 2012, and Simonovska and Waugh 2012). There is thus no single empirical trade-elasticity parameter that can be held constant across those different models.
Given the lack of a touchstone set of elasticities, we favour our approach to measuring the gains from trade arising from different models; one that maintains the same assumptions about demand and trade costs conditions across those models.
References
Arkolakis, C, A Costinot and A Rodriguez-Clare (2012) “New Trade Models, Same Old Gains,” The American Economic Review, 102(1), 94-130.
Bernard, A and J Bradford Jensen (1995) “Exporters, Jobs, and Wages in US Manufacturing: 1976-87,” Brookings Papers on Economic Activity: Microeconomics, 67-112.
Helpman, E, Melitz, M and Y Rubinstein (2008) “Estimating Trade Flows: Trading Partners and Trading Volumes,” Quarterly Journal of Economics, 123(2), 441-87.
Melitz, M and S Redding (2013a) “Heterogeneous Firms and Trade,” Handbook of International Economics, Volume 4, Elsevier: North Holland, forthcoming, 2013. NBER Working Paper, 18652.
Melitz, M and S Redding (2013b) “Firm Heterogeneity and Aggregate Welfare,” NBER Working Paper, 18919.
Ossa, Ralph (2012) “Why Trade Matters After All,” NBER Working Paper, 18113.
Simonovska, I and M Waugh (2012) “Different Trade Models, Different Trade Elasticities,” New York University, mimeograph.
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LTV deprived Delong faces a future flooded with robots without the withering away of " the delicate machine " that is the market place
"To create wealth, you need ideas about how to shape matter and energy, additional energy itself to carry out the shaping, and instrumentalities to control the shaping as it is accomplished. The Industrial Revolution brought ideas and energy to the table, but human brains remained the only effective instrumentalities of control. As ideas and energy became cheap, the human brains that were their complements became valuable."
"But"
" as we move into a future of artificial intelligence that and into a future of biotechnology that grows itself as biological systems do, won’t human brains cease to be the only valuable instrumentalities of control?"
"It is not necessarily the case that “unskilled” workers’ standards of living will fall in absolute terms: the same factors that make human brains less valuable may well be working equally effectively to reduce the costs of life’s necessities, conveniences, and luxuries."
" But"
" wealth is likely to flow to the owners of productive – or perhaps fashionable – ideas,"
" and to owners of things that can be imitated only with great difficulty and high cost even with
dirt-cheap instrumentalities of control, dirt-cheap energy, and plentiful ideas."
"The lesson is clear"
"the marketplace is not guaranteed by nature to produce a long-run future characterized by
a reasonable degree of wealth inequality and relative poverty."
" Unless and until we recognize this fully"
" we will remain at the mercy of Keynes’s poorly understood “delicate machine.”
Wednesday, May 29, 2013
Parrot modeling
Model Imitation of market dynamics:
The collection of bare data streams
From a few selected metrics from an economy
Similarly
" generated " by a mechanism. http://www.newyorkfed.org/research/staff_reports/sr618.pdf
Monday, May 27, 2013
Rogoff invoked the non linear rate response path
Street name:
The sudden spike
And where is the fed in all this Kenny ?
The image of an overwhelmed CB is a joke
The CB runs it's own currency market if and when it chooses to
Whatrevents the fed from buying up entire issues
Err
Other then the fed itself
The only think we have to fear is the fed itself !
Fiscal injections scotched by fed
Yes the fed can constrict Net credit flows
To counter fiscal thrust funded with borrowed money
But how can you set up a test of pure fiscal activism ?
What is the neutral policy the fed must take ?
The hicks model tells us nothing if the fiscal borrowing doesn't move the nominal rate off the floor
Or even if it does but that change leaves corporate and household spending " unimpacted"
And the dollar doesn't strengthen or export buyers spending is " unaffected"
by the forex change
Saturday, May 25, 2013
How does Aggregate "supply constraint " reduce system wide dynamic efficiency improvements ?
Maybe
I don't get it ...
You still have opportunity to increase your gain
By innovation process or product
or re purposing or switching sectors
Even if now
you operate entirely in the black
Maybe reducing the power of the credit system
to guide over all investment flows from the commanding heights
Increases co ordination
If the system is set to operate in aggregate
in the red
Survival in aggregate requires credit infusions
Sunday, May 19, 2013
PK narrates the spiraling 70's and lo and behold no colander MAP no pigou inflation tax
when the spiral of output prices driven by wages chasing COL
and profits maintaining margins ..got insufferable
the answer to "the spiral" was at hand
weintraub or lerner :
a pigou tax or a warrant market
but
instead we got Volcker
"In elite mythology, the origins of the crisis of the 70s, like the supposed origins of our current crisis, lay in excess: too much debt, too much coddling of those slovenly proles via a strong welfare state. The suffering of 1979-82 was necessary payback."
"None of that is remotely true."
well that's a relief eh comrades!
"There was no deficit problem: government debt was low and stable or falling as a share of GDP during the 70s. "
"Rising welfare rolls may have been a big political problem, but a runaway welfare state more broadly just wasn’t an issue — hey, these days right-wingers complaining about a nation of takers tend to use the low-dependency 70s as a baseline. "
okay nouigh spoonheading :
"What we did have was a wage-price spiral:"
" workers demanding large wage increases (those were the days when workers actually could make demands) because they expected lots of inflation, firms raising prices because of rising costs, all exacerbated by big oil shocks. It was mainly a case of self-fulfilling expectations"
" the problem was to break the cycle."
"So why did we need a terrible recession? "
"...simply as a way to cool the action. "
"Someone — I’m pretty sure it was Martin Baily — described the inflation problem as being like what happens when everyone at a football game stands up to see the action better, and the result is that everyone is uncomfortable but nobody actually gets a better view."
come the double camel clutch submission hold
aka: the volckerdammerung
," stopping the game until everyone was seated again."
"this timeout destroyed millions of jobs and wasted trillions of dollars."
"Was there a better way? "
"Ideally, we should have been able to get all the relevant parties in a room and say, look, this inflation has to stop; you workers, reduce your wage demands, you businesses, cancel your price increases, and for our part, we agree to stop printing money so the whole thing is over. That way, you’d get price stability without the recession. "
" America wasn’t like that, and the decision was made to do it the hard, brutal way."
" This was not a policy triumph! It was, in a way, a confession of despair."
.
"60-year-old men should remember that a decade after the Volcker disinflation we were still very much in a national funk"
Saturday, May 18, 2013
Thursday, May 16, 2013
brad pugsley forgets NAIRU taboo line
he's thrashing smug uber rodent
micky kinkajou
" Kinsley claims that: "the lessons of Paul Volcker" are that "the Great Stagflation of the late 1970s" was caused by fiscal "Stimulus" which "is strong medicine--an addictive drug--and you don’t give the patient more than you absolutely have to."
a fairly common narrative actually
the usual line about the original sin
prior to the reagan eviction of the job class from the eden
of post war
"fairly strong job markets "
"Was he not alive in the late 1970s and early 1980s? "
asks bradkins
"Does he not remember that the large fiscal deficits of the 1970s and 1980s
came not during the Great Stagflation of the 1970s, but in the 1980s
after the Volcker Disinflation?"
its YOU dear brad that isn't singing here
from the dominant hymn book
at thomatose:
anne said...
micky kinkajou
" Kinsley claims that: "the lessons of Paul Volcker" are that "the Great Stagflation of the late 1970s" was caused by fiscal "Stimulus" which "is strong medicine--an addictive drug--and you don’t give the patient more than you absolutely have to."
a fairly common narrative actually
the usual line about the original sin
prior to the reagan eviction of the job class from the eden
of post war
"fairly strong job markets "
"Was he not alive in the late 1970s and early 1980s? "
asks bradkins
"Does he not remember that the large fiscal deficits of the 1970s and 1980s
came not during the Great Stagflation of the 1970s, but in the 1980s
after the Volcker Disinflation?"
its YOU dear brad that isn't singing here
from the dominant hymn book
at thomatose:
anne said...
im1dc said...
ABC news is reporting
"Now Venezuela Is Running out of Toilet Paper"
By FABIOLA SANCHEZ and KARL RITTER
CARACAS, Venezuela... May 16, 2013... (AP)
"First milk, butter, coffee and cornmeal ran short. Now Venezuela is running out of the most basic of necessities — toilet paper.
Blaming political opponents for the shortfall, as it does for other shortages, the embattled socialist government says it will import 50 million rolls to boost supplies.
That was little comfort to consumers struggling to find toilet paper on Wednesday.
"This is the last straw," said Manuel Fagundes, a shopper hunting for tissue in downtown Caracas. "I'm 71 years old and this is the first time I've seen this."..."
========================================================
How embarrassing for the World Socialist Anti-America Haters.
"Now Venezuela Is Running out of Toilet Paper"
By FABIOLA SANCHEZ and KARL RITTER
CARACAS, Venezuela... May 16, 2013... (AP)
"First milk, butter, coffee and cornmeal ran short. Now Venezuela is running out of the most basic of necessities — toilet paper.
Blaming political opponents for the shortfall, as it does for other shortages, the embattled socialist government says it will import 50 million rolls to boost supplies.
That was little comfort to consumers struggling to find toilet paper on Wednesday.
"This is the last straw," said Manuel Fagundes, a shopper hunting for tissue in downtown Caracas. "I'm 71 years old and this is the first time I've seen this."..."
========================================================
How embarrassing for the World Socialist Anti-America Haters.
anne said...
How embarrassing for the World Socialist Anti-America Haters.
[ Notice the language of ceaseless slander, hatred and attempted intimidation. ]
[ Notice the language of ceaseless slander, hatred and attempted intimidation. ]
anne said...
http://krugman.blogs.nytimes.com/2013/05/16/the-sadomonetarists-of-basel/
May 16, 2013
The Sadomonetarists of Basel
By Paul Krugman
The Wall Street Journal highlights a speech by Jaime Caruana, general manager of the Bank for International Settlements, warning of the dangers of easy money and the need to raise rates now to avert … something or other. And his views matter, says the Journal:
"Mr. Caruana is no disgruntled outvoted hawk on a policy-setting council, trying desperately to set the record straight after being outvoted. Rather, he’s the mouthpiece for a global college of central bankers, almost all of whom find themselves under intense pressure from their national governments to keep things ticking over while they try to repair the economy.
"His views also matter for another reason: the BIS is one of the few international financial institutions (some say the only one) to see the financial crisis coming and to issue clear warnings ahead of time."
I guess we can check the record here and see just how prescient the BIS was. What I do recall, however — which the Journal apparently doesn’t — is that the BIS has spent years warning about the dangers of low interest rates. Except that a couple of years back it was telling a completely different story about why we needed to raise rates; you see, the big danger was of imminent inflation:
" 'Global inflation pressures are rising rapidly as commodity prices soar and as the global recovery runs into capacity
May 16, 2013
The Sadomonetarists of Basel
By Paul Krugman
The Wall Street Journal highlights a speech by Jaime Caruana, general manager of the Bank for International Settlements, warning of the dangers of easy money and the need to raise rates now to avert … something or other. And his views matter, says the Journal:
"Mr. Caruana is no disgruntled outvoted hawk on a policy-setting council, trying desperately to set the record straight after being outvoted. Rather, he’s the mouthpiece for a global college of central bankers, almost all of whom find themselves under intense pressure from their national governments to keep things ticking over while they try to repair the economy.
"His views also matter for another reason: the BIS is one of the few international financial institutions (some say the only one) to see the financial crisis coming and to issue clear warnings ahead of time."
I guess we can check the record here and see just how prescient the BIS was. What I do recall, however — which the Journal apparently doesn’t — is that the BIS has spent years warning about the dangers of low interest rates. Except that a couple of years back it was telling a completely different story about why we needed to raise rates; you see, the big danger was of imminent inflation:
" 'Global inflation pressures are rising rapidly as commodity prices soar and as the global recovery runs into capacity
paine said...
in the final analysis
pk blows the kalecki message
because he conceives of structural reforms entirely within the context of the present MNC sustaining system
implicitly he asks
"what will sustain and hopefully improve the present system'
hence his implicit observence of a NAIRU taboo line
debating whether that line is at 7 or 4 percent etc
is not the key
its the notion
to prevent
wage price spirals which are lethal
to the present system
we forgo higher output and employment
ie higher social mobilization for production
yes nairu as lethality
not
harbinger of the deeper structural "limitations"
of the present system
screaming at us
to sublate them
pk blows the kalecki message
because he conceives of structural reforms entirely within the context of the present MNC sustaining system
implicitly he asks
"what will sustain and hopefully improve the present system'
hence his implicit observence of a NAIRU taboo line
debating whether that line is at 7 or 4 percent etc
is not the key
its the notion
to prevent
wage price spirals which are lethal
to the present system
we forgo higher output and employment
ie higher social mobilization for production
yes nairu as lethality
not
harbinger of the deeper structural "limitations"
of the present system
screaming at us
to sublate them
pk on master K
"Two and a half years ago Mike Konczal reminded us of a classic 1943 (!) essay by Michal Kalecki"
MASTER K sez pk
" .. suggested that business interests hate Keynesian economics because they fear that it might work — and in so doing mean that politicians would no longer have to abase themselves before businessmen in the name of preserving confidence"
yup so far so good
but comes a zoink
." This is pretty close to the argument that we must have austerity, because stimulus might remove the incentive for structural reform"
what ?
pk drives to the gates of enlightenment
reads the sign there and..
drives back to hooterville
and to add piffle on puffle
" that, ...., gives businesses the confidence they need before deigning to produce recovery."
MASTER K sez pk
" .. suggested that business interests hate Keynesian economics because they fear that it might work — and in so doing mean that politicians would no longer have to abase themselves before businessmen in the name of preserving confidence"
yup so far so good
but comes a zoink
." This is pretty close to the argument that we must have austerity, because stimulus might remove the incentive for structural reform"
what ?
pk drives to the gates of enlightenment
reads the sign there and..
drives back to hooterville
and to add piffle on puffle
" that, ...., gives businesses the confidence they need before deigning to produce recovery."
Wednesday, May 15, 2013
pk recaps the just so story of the oecd stag path avec notes by OP
in media res...
"....statistical techniques suddenly made a remarkable number of prominent people look foolish.
The real mystery, however, was why Reinhart-Rogoff was ever taken seriously, let alone canonized"
"So why wasn’t there more caution?"
" The answer, both politics and psychology: the case for austerity was and is one that many powerful people want to believe, leading them to seize on anything that looks like a justification."
the game is already lost
"So was a second Great Depression about to unfold?"
" The good news was that we had, or thought we had, several big advantages over our grandfathers"
,On the structural side, probably the biggest advantage over the 1930s was the way taxes and social insurance programs—both much bigger than they were in 1929—acted as “automatic stabilizers.” Wages might fall, but overall income didn’t fall in proportion, both because tax collections plunged and because government checks continued to flow for Social Security, Medicare, unemployment benefits, and more. In effect, the existence of the modern welfare state put a floor on total spending, and therefore prevented the economy’s downward spiral from going too far."
a chance to generalize this sub systems capacity
not just as off set and floor maker
but as rapid automatic "re mobilizer"
blasting aside pk's nod
to friedman disciple gentle ben
"economists had learned from John Maynard Keynes that under depression conditions government spending can be an effective way to create jobs."
AND
"They had learned from FDR’s disastrous turn toward austerity in 1937 that abandoning monetary and fiscal stimulus too soon can be a very big mistake."
back to ben
"the Federal Reserve not only slashed interest rates, but stepped into the markets to buy everything from commercial paper to long-term government debt"
now keynes
" the Obama administration pushed through an $800 billion program of tax cuts and spending increases"
.
"Now, some economists..... warned from the beginning that these monetary and fiscal actions, although welcome, were too small given the severity of the economic shock."
" Indeed, by the end of 2009 it was clear that although the situation had stabilized,
the economic crisis was deeper than policymakers had acknowledged, and likely to prove more persistent than they had imagined."
pk what if a oecd stag
a yellow flag on the "first world "track
was good for "our" corporate global system of profit arbitrage ?
nope
" one might have expected "
he sez
"a second round of stimulus to deal with the economic shortfall"
why ?
.
What actually happened, however, was a sudden reversal.
How decisive was the turn in policy? Figure 1, which is taken from the IMF’s most recent World Economic Outlook, shows how real government spending behaved in this crisis compared with previous recessions; in the figure, year zero is the year before global recession (2007 in the current slump), and spending is compared with its level in that base year. What you see is that the widespread belief that we are experiencing runaway government spending is false—on the contrary, after a brief surge in 2009, government spending began falling in both Europe and the United States, and is now well below its normal trend. The turn to austerity was very real, and quite large.
On the face of it, this was a very strange turn for policy to take. Standard textbook economics says that slashing government spending reduces overall demand, which leads in turn to reduced output and employment. This may be a desirable thing if the economy is overheating and inflation is rising; alternatively, the adverse effects of reduced government spending can be offset. Central banks (the Fed, the European Central Bank, or their counterparts elsewhere) can cut interest rates, inducing more private spending. However, neither of these conditions applied in early 2010, or for that matter apply now. The major advanced economies were and are deeply depressed, with no hint of inflationary pressure. Meanwhile, short-term interest rates, which are more or less under the central bank’s control, are near zero, leaving little room for monetary policy to offset reduced government spending. So Economics 101 would seem to say that all the austerity we’ve seen is very premature, that it should wait until the economy is stronger.
The question, then, is why economic leaders were so ready to throw the textbook out the window.
One answer is that many of them never believed in that textbook stuff in the first place. The German political and intellectual establishment has never had much use for Keynesian economics; neither has much of the Republican Party in the United States. In the heat of an acute economic crisis—as in the autumn of 2008 and the winter of 2009—these dissenting voices could to some extent be shouted down; but once things had calmed they began pushing back hard.
A larger answer is the one we’ll get to later: the underlying political and psychological reasons why many influential figures hate the notions of deficit spending and easy money. Again, once the crisis became less acute, there was more room to indulge in these sentiments.
In addition to these underlying factors, however, were two more contingent aspects of the situation in early 2010: the new crisis in Greece, and the appearance of seemingly rigorous, high-quality economic research that supported the austerian position.
If Greece provided the obvious real-world cautionary tale, Reinhart and Rogoff seemed to provide the math. Their paper seemed to show not just that debt hurts growth, but that there is a “threshold,” a sort of trigger point, when debt crosses 90 percent of GDP. Go beyond that point, their numbers suggested, and economic growth stalls. Greece, of course, already had debt greater than the magic number. More to the point, major advanced countries, the United States included, were running large budget deficits and closing in on the threshold. Put Greece and Reinhart-Rogoff together, and there seemed to be a compelling case for a sharp, immediate turn toward austerity.
But wouldn’t such a turn toward austerity in an economy still depressed by private deleveraging have an immediate negative impact? Not to worry, said another remarkably influential academic paper, “Large Changes in Fiscal Policy: Taxes Versus Spending,” by Alberto Alesina and Silvia Ardagna.
One of the especially good things in Mark Blyth’s Austerity: The History of a Dangerous Idea is the way he traces the rise and fall of the idea of “expansionary austerity,” the proposition that cutting spending would actually lead to higher output. As he shows, this is very much a proposition associated with a group of Italian economists (whom he dubs “the Bocconi boys”) who made their case with a series of papers that grew more strident and less qualified over time, culminating in the 2009 analysis by Alesina and Ardagna.
In essence, Alesina and Ardagna made a full frontal assault on the Keynesian proposition that cutting spending in a weak economy produces further weakness. Like Reinhart and Rogoff, they marshaled historical evidence to make their case. According to Alesina and Ardagna, large spending cuts in advanced countries were, on average, followed by expansion rather than contraction. The reason, they suggested, was that decisive fiscal austerity created confidence in the private sector, and this increased confidence more than offset any direct drag from smaller government outlays.
As Mark Blyth documents, this idea spread like wildfire. Alesina and Ardagna made a special presentation in April 2010 to the Economic and Financial Affairs Council of the European Council of Ministers; the analysis quickly made its way into official pronouncements from the European Commission and the European Central Bank. Thus in June 2010 Jean-Claude Trichet, the then president of the ECB, dismissed concerns that austerity might hurt growth:
By the summer of 2010, then, a full-fledged austerity orthodoxy had taken shape, becoming dominant in European policy circles and influential on this side of the Atlantic. So how have things gone in the almost three years that have passed since?
The turn to austerity after 2010, however, was so drastic, particularly in European debtor nations, that the usual cautions lose most of their force. Greece imposed spending cuts and tax increases amounting to 15 percent of GDP; Ireland and Portugal rang in with around 6 percent; and unlike the half-hearted efforts at stimulus, these cuts were sustained and indeed intensified year after year. So how did austerity actually work?
The answer is that the results were disastrous—just about as one would have predicted from textbook macroeconomics. Figure 2, for example, shows what happened to a selection of European nations (each represented by a diamond-shaped symbol). The horizontal axis shows austerity measures—spending cuts and tax increases—as a share of GDP, as estimated by the International Monetary Fund. The vertical axis shows the actual percentage change in real GDP. As you can see, the countries forced into severe austerity experienced very severe downturns, and the downturns were more or less proportional to the degree of austerity.
There have been some attempts to explain away these results, notably at the European Commission. But the IMF, looking hard at the data, has not only concluded that austerity has had major adverse economic effects, it has issued what amounts to a mea culpa for having underestimated these adverse effects.*
But is there any alternative to austerity? What about the risks of excessive debt?
In early 2010, with the Greek disaster fresh in everyone’s mind, the risks of excessive debt seemed obvious; those risks seemed even greater by 2011, as Ireland, Spain, Portugal, and Italy joined the ranks of nations having to pay large interest rate premiums. But a funny thing happened to other countries with high debt levels, including Japan, the United States, and Britain: despite large deficits and rapidly rising debt, their borrowing costs remained very low. The crucial difference, as the Belgian economist Paul DeGrauwe pointed out, seemed to be whether countries had their own currencies, and borrowed in those currencies. Such countries can’t run out of money because they can print it if needed, and absent the risk of a cash squeeze, advanced nations are evidently able to carry quite high levels of debt without crisis.
Three years after the turn to austerity, then, both the hopes and the fears of the austerians appear to have been misplaced. Austerity did not lead to a surge in confidence; deficits did not lead to crisis. But wasn’t the austerity movement grounded in serious economic research? Actually, it turned out that it wasn’t—the research the austerians cited was deeply flawed.
First to go down was the notion of expansionary austerity. Even before the results of Europe’s austerity experiment were in, the Alesina-Ardagna paper was falling apart under scrutiny. Researchers at the Roosevelt Institute pointed out that none of the alleged examples of austerity leading to expansion of the economy actually took place in the midst of an economic slump; researchers at the IMF found that the Alesina-Ardagna measure of fiscal policy bore little relationship to actual policy changes. “By the middle of 2011,” Blyth writes, “empirical and theoretical support for expansionary austerity was slipping away.” Slowly, with little fanfare, the whole notion that austerity might actually boost economies slunk off the public stage.
Reinhart-Rogoff lasted longer, even though serious questions about their work were raised early on. As early as July 2010 Josh Bivens and John Irons of the Economic Policy Institute had identified both a clear mistake—a misinterpretation of US data immediately after World War II—and a severe conceptual problem. Reinhart and Rogoff, as they pointed out, offered no evidence that the correlation ran from high debt to low growth rather than the other way around, and other evidence suggested that the latter was more likely. But such criticisms had little impact; for austerians, one might say, Reinhart-Rogoff was a story too good to check.
So the revelations in April 2013 of the errors of Reinhart and Rogoff came as a shock. Despite their paper’s influence, Reinhart and Rogoff had not made their data widely available—and researchers working with seemingly comparable data hadn’t been able to reproduce their results. Finally, they made their spreadsheet available to Thomas Herndon, a graduate student at the University of Massachusetts, Amherst—and he found it very odd indeed. There was one actual coding error, although that made only a small contribution to their conclusions. More important, their data set failed to include the experience of several Allied nations—Canada, New Zealand, and Australia—that emerged from World War II with high debt but nonetheless posted solid growth. And they had used an odd weighting scheme in which each “episode” of high debt counted the same, whether it occurred during one year of bad growth or seventeen years of good growth.
Without these errors and oddities, there was still a negative correlation between debt and growth—but this could be, and probably was, mostly a matter of low growth leading to high debt, not the other way around. And the “threshold” at 90 percent vanished, undermining the scare stories being used to sell austerity.
Not surprisingly, Reinhart and Rogoff have tried to defend their work; but their responses have been weak at best, evasive at worst. Notably, they continue to write in a way that suggests, without stating outright, that debt at 90 percent of GDP is some kind of threshold at which bad things happen. In reality, even if one ignores the issue of causality—whether low growth causes high debt or the other way around—the apparent effects on growth of debt rising from, say, 85 to 95 percent of GDP are fairly small, and don’t justify the debt panic that has been such a powerful influence on policy.
At this point, then, austerity economics is in a very bad way. Its predictions have proved utterly wrong; its founding academic documents haven’t just lost their canonized status, they’ve become the objects of much ridicule. But as I’ve pointed out, none of this (except that Excel error) should have come as a surprise: basic macroeconomics should have told everyone to expect what did, in fact, happen, and the papers that have now fallen into disrepute were obviously flawed from the start.
This raises the obvious question: Why did austerity economics get such a powerful grip on elite opinion in the first place?
When applied to macroeconomics, this urge to find moral meaning creates in all of us a predisposition toward believing stories that attribute the pain of a slump to the excesses of the boom that precedes it—and, perhaps, also makes it natural to see the pain as necessary, part of an inevitable cleansing process. When Andrew Mellon told Herbert Hoover to let the Depression run its course, so as to “purge the rottenness” from the system, he was offering advice that, however bad it was as economics, resonated psychologically with many people (and still does).
By contrast, Keynesian economics rests fundamentally on the proposition that macroeconomics isn’t a morality play—that depressions are essentially a technical malfunction. As the Great Depression deepened, Keynes famously declared that “we have magneto trouble”—i.e., the economy’s troubles were like those of a car with a small but critical problem in its electrical system, and the job of the economist is to figure out how to repair that technical problem. Keynes’s masterwork, The General Theory of Employment, Interest and Money, is noteworthy—and revolutionary—for saying almost nothing about what happens in economic booms. Pre-Keynesian business cycle theorists loved to dwell on the lurid excesses that take place in good times, while having relatively little to say about exactly why these give rise to bad times or what you should do when they do. Keynes reversed this priority; almost all his focus was on how economies stay depressed, and what can be done to make them less depressed.
I’d argue that Keynes was overwhelmingly right in his approach, but there’s no question that it’s an approach many people find deeply unsatisfying as an emotional matter. And so we shouldn’t find it surprising that many popular interpretations of our current troubles return, whether the authors know it or not, to the instinctive, pre-Keynesian style of dwelling on the excesses of the boom rather than on the failures of the slump.
David Stockman’s The Great Deformation should be seen in this light. It’s an immensely long rant against excesses of various kinds, all of which, in Stockman’s vision, have culminated in our present crisis. History, to Stockman’s eyes, is a series of “sprees”: a “spree of unsustainable borrowing,” a “spree of interest rate repression,” a “spree of destructive financial engineering,” and, again and again, a “money-printing spree.” For in Stockman’s world, all economic evil stems from the original sin of leaving the gold standard. Any prosperity we may have thought we had since 1971, when Nixon abandoned the last link to gold, or maybe even since 1933, when FDR took us off gold for the first time, was an illusion doomed to end in tears. And of course, any policies aimed at alleviating the current slump will just make things worse.
In itself, Stockman’s book isn’t important. Aside from a few swipes at Republicans, it consists basically of standard goldbug bombast. But the attention the book has garnered, the ways it has struck a chord with many people, including even some liberals, suggest just how strong remains the urge to see economics as a morality play, three generations after Keynes tried to show us that it is nothing of the kind.
And powerful officials are by no means immune to that urge. In The Alchemists, Neil Irwin analyzes the motives of Jean-Claude Trichet, the president of the European Central Bank, in advocating harsh austerity policies:
So is the austerian impulse all a matter of psychology? No, there’s also a fair bit of self-interest involved. As many observers have noted, the turn away from fiscal and monetary stimulus can be interpreted, if you like, as giving creditors priority over workers. Inflation and low interest rates are bad for creditors even if they promote job creation; slashing government deficits in the face of mass unemployment may deepen a depression, but it increases the certainty of bondholders that they’ll be repaid in full. I don’t think someone like Trichet was consciously, cynically serving class interests at the expense of overall welfare; but it certainly didn’t hurt that his sense of economic morality dovetailed so perfectly with the priorities of creditors.
It’s also worth noting that while economic policy since the financial crisis looks like a dismal failure by most measures, it hasn’t been so bad for the wealthy. Profits have recovered strongly even as unprecedented long-term unemployment persists; stock indices on both sides of the Atlantic have rebounded to pre-crisis highs even as median income languishes. It might be too much to say that those in the top 1 percent actually benefit from a continuing depression, but they certainly aren’t feeling much pain, and that probably has something to do with policymakers’ willingness to stay the austerity course.
Four years ago, the mystery was how such a terrible financial crisis could have taken place, with so little forewarning. The harsh lessons we had to learn involved the fragility of modern finance, the folly of trusting banks to regulate themselves, and the dangers of assuming that fancy financial arrangements have eliminated or even reduced the age-old problems of risk.
I would argue, however—self-serving as it may sound (I warned about the housing bubble, but had no inkling of how widespread a collapse would follow when it burst)—that the failure to anticipate the crisis was a relatively minor sin. Economies are complicated, ever-changing entities; it was understandable that few economists realized the extent to which short-term lending and securitization of assets such as subprime mortgages had recreated the old risks that deposit insurance and bank regulation were created to control.
I’d argue that what happened next—the way policymakers turned their back on practically everything economists had learned about how to deal with depressions, the way elite opinion seized on anything that could be used to justify austerity—was a much greater sin. The financial crisis of 2008 was a surprise, and happened very fast; but we’ve been stuck in a regime of slow growth and desperately high unemployment for years now. And during all that time policymakers have been ignoring the lessons of theory and history.
It’s a terrible story, mainly because of the immense suffering that has resulted from these policy errors. It’s also deeply worrying for those who like to believe that knowledge can make a positive difference in the world. To the extent that policymakers and elite opinion in general have made use of economic analysis at all, they have, as the saying goes, done so the way a drunkard uses a lamppost: for support, not illumination. Papers and economists who told the elite what it wanted to hear were celebrated, despite plenty of evidence that they were wrong; critics were ignored, no matter how often they got it right.
The Reinhart-Rogoff debacle has raised some hopes among the critics that logic and evidence are finally beginning to matter. But the truth is that it’s too soon to tell whether the grip of austerity economics on policy will relax significantly in the face of these revelations. For now, the broader message of the past few years remains just how little good comes from understanding.
"....statistical techniques suddenly made a remarkable number of prominent people look foolish.
The real mystery, however, was why Reinhart-Rogoff was ever taken seriously, let alone canonized"
"So why wasn’t there more caution?"
" The answer, both politics and psychology: the case for austerity was and is one that many powerful people want to believe, leading them to seize on anything that looks like a justification."
the game is already lost
"in the beginning was the bubble... it burst "
"Students of economic history watched the process unfolding in 2008 and 2009 with a cold shiver of recognition, because it was very obviously the same kind of process that brought on the Great Depression.""So was a second Great Depression about to unfold?"
" The good news was that we had, or thought we had, several big advantages over our grandfathers"
,On the structural side, probably the biggest advantage over the 1930s was the way taxes and social insurance programs—both much bigger than they were in 1929—acted as “automatic stabilizers.” Wages might fall, but overall income didn’t fall in proportion, both because tax collections plunged and because government checks continued to flow for Social Security, Medicare, unemployment benefits, and more. In effect, the existence of the modern welfare state put a floor on total spending, and therefore prevented the economy’s downward spiral from going too far."
a chance to generalize this sub systems capacity
not just as off set and floor maker
but as rapid automatic "re mobilizer"
blasting aside pk's nod
to friedman disciple gentle ben
"economists had learned from John Maynard Keynes that under depression conditions government spending can be an effective way to create jobs."
AND
"They had learned from FDR’s disastrous turn toward austerity in 1937 that abandoning monetary and fiscal stimulus too soon can be a very big mistake."
back to ben
"the Federal Reserve not only slashed interest rates, but stepped into the markets to buy everything from commercial paper to long-term government debt"
now keynes
" the Obama administration pushed through an $800 billion program of tax cuts and spending increases"
.
"Now, some economists..... warned from the beginning that these monetary and fiscal actions, although welcome, were too small given the severity of the economic shock."
" Indeed, by the end of 2009 it was clear that although the situation had stabilized,
the economic crisis was deeper than policymakers had acknowledged, and likely to prove more persistent than they had imagined."
pk what if a oecd stag
a yellow flag on the "first world "track
was good for "our" corporate global system of profit arbitrage ?
nope
" one might have expected "
he sez
"a second round of stimulus to deal with the economic shortfall"
why ?
.
What actually happened, however, was a sudden reversal.
2.
Neil Irwin’s The Alchemists gives us a time and a place at which the major advanced countries abruptly pivoted from stimulus to austerity. The time was early February 2010; the place, somewhat bizarrely, was the remote Canadian Arctic settlement of Iqaluit, where the Group of Seven finance ministers held one of their regularly scheduled summits. Sometimes (often) such summits are little more than ceremonial occasions, and there was plenty of ceremony at this one too, including raw seal meat served at the last dinner (the foreign visitors all declined). But this time something substantive happened. “In the isolation of the Canadian wilderness,” Irwin writes, “the leaders of the world economy collectively agreed that their great challenge had shifted. The economy seemed to be healing; it was time for them to turn their attention away from boosting growth. No more stimulus.”On the face of it, this was a very strange turn for policy to take. Standard textbook economics says that slashing government spending reduces overall demand, which leads in turn to reduced output and employment. This may be a desirable thing if the economy is overheating and inflation is rising; alternatively, the adverse effects of reduced government spending can be offset. Central banks (the Fed, the European Central Bank, or their counterparts elsewhere) can cut interest rates, inducing more private spending. However, neither of these conditions applied in early 2010, or for that matter apply now. The major advanced economies were and are deeply depressed, with no hint of inflationary pressure. Meanwhile, short-term interest rates, which are more or less under the central bank’s control, are near zero, leaving little room for monetary policy to offset reduced government spending. So Economics 101 would seem to say that all the austerity we’ve seen is very premature, that it should wait until the economy is stronger.
The question, then, is why economic leaders were so ready to throw the textbook out the window.
One answer is that many of them never believed in that textbook stuff in the first place. The German political and intellectual establishment has never had much use for Keynesian economics; neither has much of the Republican Party in the United States. In the heat of an acute economic crisis—as in the autumn of 2008 and the winter of 2009—these dissenting voices could to some extent be shouted down; but once things had calmed they began pushing back hard.
A larger answer is the one we’ll get to later: the underlying political and psychological reasons why many influential figures hate the notions of deficit spending and easy money. Again, once the crisis became less acute, there was more room to indulge in these sentiments.
In addition to these underlying factors, however, were two more contingent aspects of the situation in early 2010: the new crisis in Greece, and the appearance of seemingly rigorous, high-quality economic research that supported the austerian position.
The Greek crisis came as a shock to almost everyone, not least the new Greek government that took office in October 2009. The incoming leadership knew it faced a budget deficit—but it was only after arriving that it learned that the previous government had been cooking the books, and that both the deficit and the accumulated stock of debt were far higher than anyone imagined. As the news sank in with investors, first Greece, then much of Europe, found itself in a new kind of crisis—one not of failing banks but of failing governments, unable to borrow on world markets.
It’s an ill wind that blows nobody good, and the Greek crisis was a godsend for anti-Keynesians. They had been warning about the dangers of deficit spending; the Greek debacle seemed to show just how dangerous fiscal profligacy can be. To this day, anyone arguing against fiscal austerity, let alone suggesting that we need another round of stimulus, can expect to be attacked as someone who will turn America (or Britain, as the case may be) into another Greece.If Greece provided the obvious real-world cautionary tale, Reinhart and Rogoff seemed to provide the math. Their paper seemed to show not just that debt hurts growth, but that there is a “threshold,” a sort of trigger point, when debt crosses 90 percent of GDP. Go beyond that point, their numbers suggested, and economic growth stalls. Greece, of course, already had debt greater than the magic number. More to the point, major advanced countries, the United States included, were running large budget deficits and closing in on the threshold. Put Greece and Reinhart-Rogoff together, and there seemed to be a compelling case for a sharp, immediate turn toward austerity.
But wouldn’t such a turn toward austerity in an economy still depressed by private deleveraging have an immediate negative impact? Not to worry, said another remarkably influential academic paper, “Large Changes in Fiscal Policy: Taxes Versus Spending,” by Alberto Alesina and Silvia Ardagna.
One of the especially good things in Mark Blyth’s Austerity: The History of a Dangerous Idea is the way he traces the rise and fall of the idea of “expansionary austerity,” the proposition that cutting spending would actually lead to higher output. As he shows, this is very much a proposition associated with a group of Italian economists (whom he dubs “the Bocconi boys”) who made their case with a series of papers that grew more strident and less qualified over time, culminating in the 2009 analysis by Alesina and Ardagna.
In essence, Alesina and Ardagna made a full frontal assault on the Keynesian proposition that cutting spending in a weak economy produces further weakness. Like Reinhart and Rogoff, they marshaled historical evidence to make their case. According to Alesina and Ardagna, large spending cuts in advanced countries were, on average, followed by expansion rather than contraction. The reason, they suggested, was that decisive fiscal austerity created confidence in the private sector, and this increased confidence more than offset any direct drag from smaller government outlays.
As Mark Blyth documents, this idea spread like wildfire. Alesina and Ardagna made a special presentation in April 2010 to the Economic and Financial Affairs Council of the European Council of Ministers; the analysis quickly made its way into official pronouncements from the European Commission and the European Central Bank. Thus in June 2010 Jean-Claude Trichet, the then president of the ECB, dismissed concerns that austerity might hurt growth:
As regards the economy, the idea that austerity measures could trigger stagnation is incorrect…. In fact, in these circumstances, everything that helps to increase the confidence of households, firms and investors in the sustainability of public finances is good for the consolidation of growth and job creation. I firmly believe that in the current circumstances confidence-inspiring policies will foster and not hamper economic recovery, because confidence is the key factor today.This was straight Alesina-Ardagna.
By the summer of 2010, then, a full-fledged austerity orthodoxy had taken shape, becoming dominant in European policy circles and influential on this side of the Atlantic. So how have things gone in the almost three years that have passed since?
3.
Clear evidence on the effects of economic policy is usually hard to come by. Governments generally change policies reluctantly, and it’s hard to distinguish the effects of the half-measures they undertake from all the other things going on in the world. The Obama stimulus, for example, was both temporary and fairly small compared with the size of the US economy, never amounting to much more than 2 percent of GDP, and it took effect in an economy whipsawed by the biggest financial crisis in three generations. How much of what took place in 2009–2011, good or bad, can be attributed to the stimulus? Nobody really knows.The turn to austerity after 2010, however, was so drastic, particularly in European debtor nations, that the usual cautions lose most of their force. Greece imposed spending cuts and tax increases amounting to 15 percent of GDP; Ireland and Portugal rang in with around 6 percent; and unlike the half-hearted efforts at stimulus, these cuts were sustained and indeed intensified year after year. So how did austerity actually work?
There have been some attempts to explain away these results, notably at the European Commission. But the IMF, looking hard at the data, has not only concluded that austerity has had major adverse economic effects, it has issued what amounts to a mea culpa for having underestimated these adverse effects.*
But is there any alternative to austerity? What about the risks of excessive debt?
In early 2010, with the Greek disaster fresh in everyone’s mind, the risks of excessive debt seemed obvious; those risks seemed even greater by 2011, as Ireland, Spain, Portugal, and Italy joined the ranks of nations having to pay large interest rate premiums. But a funny thing happened to other countries with high debt levels, including Japan, the United States, and Britain: despite large deficits and rapidly rising debt, their borrowing costs remained very low. The crucial difference, as the Belgian economist Paul DeGrauwe pointed out, seemed to be whether countries had their own currencies, and borrowed in those currencies. Such countries can’t run out of money because they can print it if needed, and absent the risk of a cash squeeze, advanced nations are evidently able to carry quite high levels of debt without crisis.
Three years after the turn to austerity, then, both the hopes and the fears of the austerians appear to have been misplaced. Austerity did not lead to a surge in confidence; deficits did not lead to crisis. But wasn’t the austerity movement grounded in serious economic research? Actually, it turned out that it wasn’t—the research the austerians cited was deeply flawed.
First to go down was the notion of expansionary austerity. Even before the results of Europe’s austerity experiment were in, the Alesina-Ardagna paper was falling apart under scrutiny. Researchers at the Roosevelt Institute pointed out that none of the alleged examples of austerity leading to expansion of the economy actually took place in the midst of an economic slump; researchers at the IMF found that the Alesina-Ardagna measure of fiscal policy bore little relationship to actual policy changes. “By the middle of 2011,” Blyth writes, “empirical and theoretical support for expansionary austerity was slipping away.” Slowly, with little fanfare, the whole notion that austerity might actually boost economies slunk off the public stage.
Reinhart-Rogoff lasted longer, even though serious questions about their work were raised early on. As early as July 2010 Josh Bivens and John Irons of the Economic Policy Institute had identified both a clear mistake—a misinterpretation of US data immediately after World War II—and a severe conceptual problem. Reinhart and Rogoff, as they pointed out, offered no evidence that the correlation ran from high debt to low growth rather than the other way around, and other evidence suggested that the latter was more likely. But such criticisms had little impact; for austerians, one might say, Reinhart-Rogoff was a story too good to check.
So the revelations in April 2013 of the errors of Reinhart and Rogoff came as a shock. Despite their paper’s influence, Reinhart and Rogoff had not made their data widely available—and researchers working with seemingly comparable data hadn’t been able to reproduce their results. Finally, they made their spreadsheet available to Thomas Herndon, a graduate student at the University of Massachusetts, Amherst—and he found it very odd indeed. There was one actual coding error, although that made only a small contribution to their conclusions. More important, their data set failed to include the experience of several Allied nations—Canada, New Zealand, and Australia—that emerged from World War II with high debt but nonetheless posted solid growth. And they had used an odd weighting scheme in which each “episode” of high debt counted the same, whether it occurred during one year of bad growth or seventeen years of good growth.
Without these errors and oddities, there was still a negative correlation between debt and growth—but this could be, and probably was, mostly a matter of low growth leading to high debt, not the other way around. And the “threshold” at 90 percent vanished, undermining the scare stories being used to sell austerity.
Not surprisingly, Reinhart and Rogoff have tried to defend their work; but their responses have been weak at best, evasive at worst. Notably, they continue to write in a way that suggests, without stating outright, that debt at 90 percent of GDP is some kind of threshold at which bad things happen. In reality, even if one ignores the issue of causality—whether low growth causes high debt or the other way around—the apparent effects on growth of debt rising from, say, 85 to 95 percent of GDP are fairly small, and don’t justify the debt panic that has been such a powerful influence on policy.
At this point, then, austerity economics is in a very bad way. Its predictions have proved utterly wrong; its founding academic documents haven’t just lost their canonized status, they’ve become the objects of much ridicule. But as I’ve pointed out, none of this (except that Excel error) should have come as a surprise: basic macroeconomics should have told everyone to expect what did, in fact, happen, and the papers that have now fallen into disrepute were obviously flawed from the start.
This raises the obvious question: Why did austerity economics get such a powerful grip on elite opinion in the first place?
4.
Everyone loves a morality play. “For the wages of sin is death” is a much more satisfying message than “Shit happens.” We all want events to have meaning.When applied to macroeconomics, this urge to find moral meaning creates in all of us a predisposition toward believing stories that attribute the pain of a slump to the excesses of the boom that precedes it—and, perhaps, also makes it natural to see the pain as necessary, part of an inevitable cleansing process. When Andrew Mellon told Herbert Hoover to let the Depression run its course, so as to “purge the rottenness” from the system, he was offering advice that, however bad it was as economics, resonated psychologically with many people (and still does).
By contrast, Keynesian economics rests fundamentally on the proposition that macroeconomics isn’t a morality play—that depressions are essentially a technical malfunction. As the Great Depression deepened, Keynes famously declared that “we have magneto trouble”—i.e., the economy’s troubles were like those of a car with a small but critical problem in its electrical system, and the job of the economist is to figure out how to repair that technical problem. Keynes’s masterwork, The General Theory of Employment, Interest and Money, is noteworthy—and revolutionary—for saying almost nothing about what happens in economic booms. Pre-Keynesian business cycle theorists loved to dwell on the lurid excesses that take place in good times, while having relatively little to say about exactly why these give rise to bad times or what you should do when they do. Keynes reversed this priority; almost all his focus was on how economies stay depressed, and what can be done to make them less depressed.
I’d argue that Keynes was overwhelmingly right in his approach, but there’s no question that it’s an approach many people find deeply unsatisfying as an emotional matter. And so we shouldn’t find it surprising that many popular interpretations of our current troubles return, whether the authors know it or not, to the instinctive, pre-Keynesian style of dwelling on the excesses of the boom rather than on the failures of the slump.
David Stockman’s The Great Deformation should be seen in this light. It’s an immensely long rant against excesses of various kinds, all of which, in Stockman’s vision, have culminated in our present crisis. History, to Stockman’s eyes, is a series of “sprees”: a “spree of unsustainable borrowing,” a “spree of interest rate repression,” a “spree of destructive financial engineering,” and, again and again, a “money-printing spree.” For in Stockman’s world, all economic evil stems from the original sin of leaving the gold standard. Any prosperity we may have thought we had since 1971, when Nixon abandoned the last link to gold, or maybe even since 1933, when FDR took us off gold for the first time, was an illusion doomed to end in tears. And of course, any policies aimed at alleviating the current slump will just make things worse.
In itself, Stockman’s book isn’t important. Aside from a few swipes at Republicans, it consists basically of standard goldbug bombast. But the attention the book has garnered, the ways it has struck a chord with many people, including even some liberals, suggest just how strong remains the urge to see economics as a morality play, three generations after Keynes tried to show us that it is nothing of the kind.
And powerful officials are by no means immune to that urge. In The Alchemists, Neil Irwin analyzes the motives of Jean-Claude Trichet, the president of the European Central Bank, in advocating harsh austerity policies:
Trichet embraced a view, especially common in Germany, that was rooted in a sort of moralism. Greece had spent too much and taken on too much debt. It must cut spending and reduce deficits. If it showed adequate courage and political resolve, markets would reward it with lower borrowing costs. He put a great deal of faith in the power of confidence….Given this sort of predisposition, is it any wonder that Keynesian economics got thrown out the window, while Alesina-Ardagna and Reinhart-Rogoff were instantly canonized?
So is the austerian impulse all a matter of psychology? No, there’s also a fair bit of self-interest involved. As many observers have noted, the turn away from fiscal and monetary stimulus can be interpreted, if you like, as giving creditors priority over workers. Inflation and low interest rates are bad for creditors even if they promote job creation; slashing government deficits in the face of mass unemployment may deepen a depression, but it increases the certainty of bondholders that they’ll be repaid in full. I don’t think someone like Trichet was consciously, cynically serving class interests at the expense of overall welfare; but it certainly didn’t hurt that his sense of economic morality dovetailed so perfectly with the priorities of creditors.
It’s also worth noting that while economic policy since the financial crisis looks like a dismal failure by most measures, it hasn’t been so bad for the wealthy. Profits have recovered strongly even as unprecedented long-term unemployment persists; stock indices on both sides of the Atlantic have rebounded to pre-crisis highs even as median income languishes. It might be too much to say that those in the top 1 percent actually benefit from a continuing depression, but they certainly aren’t feeling much pain, and that probably has something to do with policymakers’ willingness to stay the austerity course.
5.
How could this happen? That’s the question many people were asking four years ago; it’s still the question many are asking today. But the “this” has changed.Four years ago, the mystery was how such a terrible financial crisis could have taken place, with so little forewarning. The harsh lessons we had to learn involved the fragility of modern finance, the folly of trusting banks to regulate themselves, and the dangers of assuming that fancy financial arrangements have eliminated or even reduced the age-old problems of risk.
I would argue, however—self-serving as it may sound (I warned about the housing bubble, but had no inkling of how widespread a collapse would follow when it burst)—that the failure to anticipate the crisis was a relatively minor sin. Economies are complicated, ever-changing entities; it was understandable that few economists realized the extent to which short-term lending and securitization of assets such as subprime mortgages had recreated the old risks that deposit insurance and bank regulation were created to control.
I’d argue that what happened next—the way policymakers turned their back on practically everything economists had learned about how to deal with depressions, the way elite opinion seized on anything that could be used to justify austerity—was a much greater sin. The financial crisis of 2008 was a surprise, and happened very fast; but we’ve been stuck in a regime of slow growth and desperately high unemployment for years now. And during all that time policymakers have been ignoring the lessons of theory and history.
It’s a terrible story, mainly because of the immense suffering that has resulted from these policy errors. It’s also deeply worrying for those who like to believe that knowledge can make a positive difference in the world. To the extent that policymakers and elite opinion in general have made use of economic analysis at all, they have, as the saying goes, done so the way a drunkard uses a lamppost: for support, not illumination. Papers and economists who told the elite what it wanted to hear were celebrated, despite plenty of evidence that they were wrong; critics were ignored, no matter how often they got it right.
The Reinhart-Rogoff debacle has raised some hopes among the critics that logic and evidence are finally beginning to matter. But the truth is that it’s too soon to tell whether the grip of austerity economics on policy will relax significantly in the face of these revelations. For now, the broader message of the past few years remains just how little good comes from understanding.
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May 16, 2013
The Smith/Klein/Kalecki Theory of Austerity
By Paul Krugman
Noah Smith recently offered an interesting take * on the real reasons austerity garners so much support from elites, no matter hw badly it fails in practice. Elites, he argues, see economic distress as an opportunity to push through “reforms” — which basically means changes they want, which may or may not actually serve the interest of promoting economic growth — and oppose any policies that might mitigate crisis without the need for these changes:
"I conjecture that 'austerians' are concerned that anti-recessionary macro policy will allow a country to 'muddle through' a crisis without improving its institutions. In other words, they fear that a successful stimulus would be wasting a good crisis....
"If people really do think that the danger of stimulus is not that it might fail, but that it might succeed, they need to say so. Only then, I believe, can we have an optimal public discussion about costs and benefits."
As he notes, the day after he wrote that post, Steven Pearlstein of the Washington Post made exactly that argument for austerity.
What Smith didn’t note, somewhat surprisingly, is that his argument is very close to Naomi Klein’s "Shock Doctrine," with its argument that elites systematically exploit disasters to push through neoliberal policies even if these policies are essentially irrelevant to the sources of disaster. I have to admit that I was predisposed to dislike Klein’s book when it came out, probably out of professional turf-defending and whatever — but her thesis really helps explain a lot about what’s going on in Europe in particular.
And the lineage goes back even further. Two and a half years ago Mike Konczal ** reminded us of a classic 1943 (!) essay by Michal Kalecki, who suggested that business interests hate Keynesian economics because they fear that it might work — and in so doing mean that politicians would no longer have to abase themselves before businessmen in the name of preserving confidence. This is pretty close to the argument that we must have austerity, because stimulus might remove the incentive for structural reform that, you guessed it, gives businesses the confidence they need before deigning to produce recovery.
And sure enough, in my inbox this morning I see a piece more or less deploring the early signs of success for Abenomics: Abenomics is working — but it had better not work too well. Because if it works, how will we get structural reform?
So one way to see the drive for austerity is as an application of a sort of reverse Hippocratic oath: “First, do nothing to mitigate harm”. For the people must suffer if neoliberal reforms are to prosper.
* http://noahpinionblog.blogspot.com/2013/05/why-do-people-support-austerity.html
** http://rortybomb.wordpress.com/2011/01/21/kristol-kalecki-and-a-19th-century-economist-defending-patriarchy-all-on-political-macroeconomics/