Leveling Up: Making the Transition from Poor Country to Rich Country

A Home in Jakarta, Indonesia (at the intermediate levels of development)

Deirdre McCloskey posted her wonderful essay “Factual Free-Market Fairness” on bleedingheartlibertarians.com a few days ago.  In it, she focuses on the follies of government.  Her essay has generated a huge debate: 193 comments so far.  These are central issues being debated. For example,  here are Noah Smith’s comments.  Noah points out that governments have also done good things and that some of the most successful economies in the world have high tax rates and high levels of government spending. 

I have several reactions (which I will put here rather than in Deirdre’s comment thread where you would have trouble finding them in the thick forest of surrounding comments). First, regulation is much like distortionary taxation in its costs, only worse.  In particular, by mandating a particular way of doing things, regulation often tends to stifle innovation in a way that distortionary taxation doesn’t.  But regulation, like distortionary taxation, typically has benefits as well as (often fearsome) costs.  One of Deirdre’s key points is that the costs can often outweigh the benefits even for the intended beneficiaries of a regulation.

One of the biggest questions in all of the social sciences is why some countries are rich and some countries are poor, with per capita incomes differing by more than a 100 times from poorest to richest.  (The richest countries have per capita incomes above $40,000 per year; the poorest countries have per capita incomes below $400 per year.)  Let me give you my view on that question in a nutshell. 

The entry levels in the quest to become a rich country are the hardest.  The basic problem is that any government strong enough to stop people from stealing from each other, deceiving each other, and threatening each other with violence, is itself strong enough to steal, deceive, and threaten with violence.  Designing strong but limited government that will prevent theft, deceipt, and threats of violence, without perpetrating theft, deceipt, and threats of violence at a horrific level is quite a difficult trick that most countries throughout history have not managed to perform.  To see how difficult this is, think of how strong a temptation it is for a sovereign to simply take someone’s accumulated wealth. As long as the rulers of a country regularly succumb to this temptation, no one in that country will work very hard to accumulate wealth unless he or she has some form of special protection from such takings.  Also think of how difficult it is to have a strong enough military to avoid falling prey to the next country over, without having the military take over and run one’s country for its own benefit.

The intermediate levels in the quest to become a rich country are somewhat easier: establishing the rule of law and stamping out corruption.  If unchecked, corruption and the arbitrary decisions that are the antithesis of the rule of law act like huge tax distortions that discourage commerce and industry. 

In comparison to the earlier levels, the advanced levels in the quest to become a rich country are a piece of cake: keeping tax rates reasonable while providing key public goods such as roads and other public works, getting monetary policy right, encouraging education and science, and fostering the environmental amenities that are part of what should be counted as “being rich” even though environmental amenities don’t happen to be counted in GDP.  Most of the economic policy issues I am addressing on this blog are at this advanced level.  Even governments of countries at these advanced levels that get the balance of taxing and spending wrong are still doing very well by having in place the basics of preventingtheft, deception and threats of violence; perpetrating only a little theft, deception and threats of violence (except perhaps internationally); maintaining the rule of law and keeping down corruption.  When looking at an advanced country that has very high tax rates, the right question is not “Is it still rich even with high tax rates?” but “Would it be even richer if it had lower marginal tax rates and less regulation?"  There are some European countries that might have what it takes to be much richer countries than the United States if only they liberalized their economies by cutting marginal tax rates and loosened regulations that make it hard for new firms to get started. 

Note: Much of what I am saying here comes from my reading of my favorite economics textbook: David Weil’s book Economic Growth.  Any reader of this blog would learn a lot by sitting down to read this book.

Mike Konczal: What Constrains the Federal Reserve? An Interview with Joseph Gagnon

Thayer Hall at Harvard

Anyone who has been following the monetary policy debates on this blog will be interested in this interview with Joseph Gagnon. Joseph was an insider at the Fed, but now works at the Peterson Institute for International Economics: thus he can speak freely. 

Here is one exchange in the interview:

Mike Konczal: Let’s start with the basics. Does a random person – not at the highest levels, but among those who make up most of the researchers and workers – at the Federal Reserve think that the Fed is “out of ammo”? What are their opinions on how well previous expansionary monetary policy at the zero bound, like QE2 and Operation Twist, have worked to bolster the economy?

Joseph Gagnon: Let me start by linking to a blog post from a former classmate at his new blog, Miles Kimball’s Balance Sheet Monetary Policy: A Primer, that spells out what the Fed could do and why it would work. However, he ignores some of the legal restrictions on what the Fed can do. (See below.)

Joseph goes on to detail exactly what legal restrictions the Fed faces on what assets it is allowed to purchase.  Though there may be some legal interpretation here, I can tell you that it matches the view of legal restrictions facing the Fed that I heard from Fed staffers when I visited the Fed as detailed in my second post, Getting the Biggest Bang for the Buck in Fiscal Policy.“ I will refer to this interview in the future as a source for understanding the legal restrictions facing the Fed. 

Joseph was my undergraduate classmate: our dorm rooms were only a few steps away from each other freshman year in Thayer Hall on the Yard.  I am delighted to be in contact with him again through the blogosphere.

Going Negative: The Virtual Fed Funds Rate Target

Note: This post is about quantitative easing (QE). Don’t miss my posts on negative interest rate policy proper. I have the links to those posts and to my related academic papers in “How and Why to Eliminate the Zero Lower Bound: A Reader’s Guide.”

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Balance sheet monetary policy presents what the folks at the Fed call a “communications” problem.

This “communications” problem matters because balance sheet monetary policy is, as it should be, the Fed’s primary tool once the fed funds rate (

the very short-term interest rate at which banks lend to each other overnight

) has already been brought down to essentially zero.

Take what the press called QE2 (Quantitative Easing, Round 2) for example: the Fed announced in November 2010 that it would buy $600 billion dollars worth of long-term government bonds.Because many (though not all) of the households and firms from whom the Fed bought these long-term government bonds were reasonably content to switch into holding short-term government bonds or close substitutes to cash instead, much of the effect of the $600 billion dollar purchase was neutralized and QE2 had more or less the modest positive effect that the Fed had expected it to have.As I discussed in my post “Trillions and Trillions: Getting Used to Balance Sheet Monetary Policy,” large headline numbers for asset purchases, associated with modest effects, are typical of balance sheet monetary policy.Aside from“communications,” this is not a serious difficulty for monetary policy, since the Fed is perfectly capable of printing money and purchasing trillions of dollars worth of assets if it needs to.And it is perfectly capable of focusing its purchases on assets with interest rates that are still above zero and can be pulled down closer to zero. But the public can be forgiven for getting scared when it sees massive asset purchases and only modest effects.

So what should the Fed do?I know this is an area where the Fed will carefully listen to and at least consider advice, so I feel a duty to do my best to come up with a constructive suggestion before tomorrow’s monetary policy setting meeting of the Federal Open Market Committee (FOMC).  Because my suggestion is very specific, in the rest of this post, I will use the more precise “FOMC” instead of its approximate synonym “the Fed” that I have used when talking about monetary policy in other posts.  Let me first say what I think the FOMC shouldn’t do in communicating balance sheet monetary policy intentions.  Here is what the FOMC said in its official statement in November 2010:

To promote a stronger pace of economic recovery and to help ensure that inflation, over time, is at levels consistent with its mandate, the Committee decided today to expand its holdings of securities. The Committee will maintain its existing policy of reinvesting principal payments from its securities holdings. In addition, the Committee intends to purchase a further $600 billion of longer-term Treasury securities by the end of the second quarter of 2011, a pace of about $75 billion per month.

This FOMC statement led to front page newspaper articles prominently featuring the $600 billion figure. Later on, newspaper articles appeared saying that the Fed had done this large amount of asset purchases with little subsequent effect.  So I worry that having the large dollar figure in people’s minds causes many to doubt the efficacy of balance sheet monetary policy–something that I think is dangerous given the importance of expectations and confidence.  Highlighting the large dollar figure for asset purchases also causes others, including those in high places, to think that the Fed is doing too much, despite the action having only modest aggregate demand effects. I worry that facing such ill-informed criticism could lead the FOMC to do less than it would otherwise judge that it should. 

So what can be done instead to accurately convey the FOMC’s intentions?  Since balance sheet monetary policy leads to relatively modest interest rate movements for a given amount of asset purchases, my argument is that it would give the public a more accurate idea of the Fed’s intended effects if the FOMC’s decision could be stated in interest rate terms rather than in terms of asset quantities.  That is what the FOMC usually does in normal times when the fed funds rate is above zero: it announces how much it is going to raise or lower the fed funds rate. The way the fed funds rate is raised or lowered in normal times is primarily by having the New York Federal Reserve Bank sell or buy some quantity of 3-month Treasury bills.  But the quantity of 3-month Treasury bills the New York Fed is going to sell or buy is not emphasized.   

One could imagine having the FOMC statement focus on some other particular interest rate, say the rate on 2-year Treasury notes.  But this faces two related objections.   As I pointed out in my post “Balance Sheet Monetary Policy: A Primer”:

It is logically possible that sellers might sell all of a particular asset to   the Fed before its interest rate gets down to zero.

This logical possibility is most likely to actually occur for something such as 2-year Treasury notes that have many very close substitutes.  (For example, among the many close substitutes for the newly issued 2-year Treasury notes that define the 2-year interest rate are the 2-year Treasury notes issued last month, which now have a remaining maturity of 23 months.)  This presents two problems.  First, since people are worried about the Fed “monetizing the debt”–that is, taking on the inherently inflationary role of trying to fund the Federal Government–it creates another type of “communications” problem if the Fed owns all of the Federal Government’s debt, even if only at one specific maturity.  The second problem is that the New York Fed may not be able to meet a specific interest rate target on that particular asset, since it may have purchased all of the asset before that interest rate target is reached.  And it is a very big communications problem if the New York Fed can’t do what the FOMC says it is going to do.  This would hurt the credibility of the FOMC, which is its most precious asset. 

What I propose is that the FOMC say something like this when it feels that monetary policy should be more expansionary than a fed funds rate of zero alone will provide:

In addition to keeping the federal funds rate at 0 to ¼ percent, the Committee will undertake purchases of other securities in amounts estimated to provide an effect on aggregate demand equivalent to what a reduction in the federal funds rate target of 2 percent would normally provide.  

(Of course, they should substitute the correct number where I have put “2%.”) This could be followed by some guidance about what mix of asset purchases would be involved–say 50% long-term government bonds, 50% Fannie Mae securities–without saying exactly what quantities would be purchased.  The financial markets and the press would eventually figure out what kinds of quantities were involved, but these numbers would be more likely to be reported in the middle of a newspaper article, and might not even make it to the front page. 

The “virtual fed funds rate target” of my title is my suggestion for how the press could report this action by the FOMC:

The Federal Reserve today set a virtual fed funds rate target of -2%.  Since the fed funds rate is already close to zero, the Fed is slated to buy various assets (including long-term government bonds and mortgage-backed securities from Fannie Mae) in order to achieve the same stimulus that reducing the fed funds rate by 2% normally would accomplish. 

And here is the headline:

FED SETS VIRTUAL FUNDS TARGET AT -2%

To me, this sounds much less inflammatory than

FED SET TO BUY $600 BILLION OF BONDS

Another plus. In addition to the advantages I have emphasized of avoiding misunderstanding by the public, the virtual fed funds rate target will also help avoid another type of misunderstanding by those who watch monetary policy closely.  In its most recent statement, the FOMC said 

In particular, the Committee decided today to keep the target range for the federal funds rate at 0 to ¼ percent and currently anticipates that economic conditions–including low rates of resource utilization and a subdued outlook for inflation over the medium run–are likely to warrant exceptionally low levels for the federal funds rate at least through late 2014.

In saying that the federal funds rate is likely to stay low through late 2014, I think the FOMC is simply informing people about its thinking by making a prediction about what it is going to do in the future, emphasizing that what it will actually do depends on future conditions.  But despite the clarity of its words, some people read into this something more: they think the FOMC is saying that it is promising to keep the fed funds rate in the future lower than it otherwise would in order to stimulate the economy now.  The reason they think this is that in formal models that exhibit Wallace neutrality,  the only way to get more oomph from monetary policy once the fed funds rate is at zero is by promising to overstimulate the economy in the future when the fed funds rate will no longer be at zero. (On Wallace neutrality, see my crowd-sourcing post “Is Monetary Policy Thinking in Thrall to Wallace Neutrality?” and its comment thread, as well as “Trillions and Trillions: Getting Used to Balance Sheet Monetary Policy,” and Noah Smith’s post “Does Steve Williamson Think Printing Money Can’t Cause Inflation?”)  I will save for another post a rundown of some of those (especially those in the blogosphere) who believe in the implication of Wallace neutrality that I have bolded and italicized above.  For now I simply want to recommend that the FOMC distance itself from this view.  If the FOMC believes that balance sheet monetary policy works, as I think it does, there is no need to promise to overstimulate the economy in the future (when the fed funds rate is above zero) in order to stimulate it now (when the fed funds rate is zero).  And even more, I hope that the FOMC doesn’t in the future feel that it has made such a promise to overstimulate the economy that it must then follow through on.

The beauty of the virtual fed funds rate target is that it communicates the idea that it is likely to be a while before the FOMC raises the fed funds rate above zero without any danger of being misconstrued as a promise.  It is natural for the fed funds rate target–including the virtual fed funds rate target–to evolve gradually over time as information about the state of the economy comes in.  (More on that in a future post.)  If, say, the virtual fed funds rate target were currently at -2%, it would be a reasonable inference that the fed funds rate target was not likely to get above zero for some time, unless there was dramatic new information about economic activity or inflation.  So the virtual funds rate target communicates the likelihood that a near-zero fed funds rate is likely to continue for some time, without any appearance of tying the FOMC’s hands. 

Of all the policy proposals I have made so far in this blog, this is the only one that I think can be implemented immediately.  There is no reason the FOMC couldn’t use this idea in its statement tomorrow or Wednesday.  I strongly urge any of the Federal Reserve System’s staff economists who read this post and agree with this idea, or who simply think it deserves consideration, to forward a link to others in the Federal Reserve System–and of course to take advantage of opportunities to communicate this idea to members of the FOMC itself.

Avoiding Fiscal Armageddon

I believe the continued existence of our species is of great value.  Therefore it is worth paying a great price to reduce the chances of a nuclear Armageddon by even a little bit.  There is reason to believe that if Iran gets nuclear weapons, it will significantly raise the chances of further nuclear proliferation–which in turn will raise the chances of nuclear war further down the road.  Thus, to my mind, preventing Iran from getting nuclear weapons trumps any other foreign policy or economic goal right now.  Though we should fervently hope that through diplomacy the price is lower, we should be willing to pay whatever price is required, even if that price includes literal battle deaths as well as the figurative body blow of higher oil prices to an already ailing world economy. 

The surface of what was once called “our sister planet” Venus is not a pleasant place for human beings.  Scientists believe that Venus became so hot because of a runaway greenhouse effect.  We don´t know how likely it is that the Earth will go down this road, but the possibility is terrifying.  All of the other possible harms from increasing the atmospheric concentration of carbon dioxide–such as floods, hurricanes, famines, extinctions of many plant and animal species–pale in insignificance compared to even small increases in the chances of a runaway greenhouse effect that would truly transform Earth into Venus´s sister planet.  To my mind, the scientific and popular discussion about global warming should focus more on what we know about the possibility of a climate change Armageddon in the form of going down the Venus road and how we can know more, thanon the lesser horsemen of floods, hurricanes, famines, extinctions of plants and animals, and so on.

This graph of government spending as a percentage of GDP (from Jim Bianco) isn´t as scary as the other two pictures, but it only includes Federal spending, and absent decisive action, the worst is yet to come.  The reason the worst is yet to come is simple: the U.S. population is getting older as birth rates drop and the Baby Boomers (from an earlier era of high birth rates) reach retirement age.  Other than defending our country and acting as the world´s policeman, the big expenses of the Federal government are the programs intended to take care of older Americans: Social Security, Medicare, and the part of Medicaid that goes to pay for nursing-home costs of people who have used up their own resources.  Everything else the Federal government does pales in comparison to Defense and taking care of older Americans (although Obamacare could add a large enough government responsibility for the medical care of younger Americans to compete in this contest).  Thus, more older Americans means more expenses of the Federal Government.

As I have only begun to explain in my posts “What is a Supply-Side Liberal?”“Can Taxes Raise GDP?” and my current favorite post “Why Taxes are Bad,” the taxes needed to support high levels of government spending come at serious cost.  This is likely to continue to be true even if we try to be very clever (as we should try to be) at raising revenue with the least possible distortion.   (On one way to raise some revenue while actually reducing distortion, see “A Supply-Side Liberal Joins the Pigou Club” and “Henry George and the Carbon Tax.”)  So at the end of the day, after all our efforts to raise revenues in ways that are not too harmful to the many important objectives we put under the label “the economy,” there will be a limit to how large a fraction of GDP should be devoted to government spending.  

For the sake of argument, let´s suppose we decide that–except in temporary emergencies–that Federal, State and Local governments combined should spend no more than half of GDP.  How can we set up constitutional limits to achieve such a goal?  It won´t be easy.  As I wrote in “Leading States in the Fiscal Two-Step”:

… fiscal discipline is hard for governments—so hard that most governments are not capable of fiscal discipline without balanced budget requirements that are so inflexible they cannot easily handle economic emergencies.Given the unpredictability of real-world events, it is not possible to fully define what constitutes an economic emergency in advance as flexibly as would be desirable, but in the absence of hard and fast, but inflexible rules, governments have a temptation to chronically declare economic emergencies.

It´s hard, and maybe impossible.  But let´s try.  A balanced budget amendment won´t do it, since it would still be possible to tax and spend a large fraction of the (possibly smaller) GDP pie.   A limit on taxes won´t do it, since the Federal Government is good at deficit spending.   What we need is a rule that goes directly toward the goal: a direct limit on the fraction of GDP that is allowed to go to government spending. 

There are complications.  In particular, we need to (1) be able to get the rule passed, (2) make it hard to wiggle around the rule once it is in place, (3) be able to deal with emergencies and (4) avoid tempting the government to skimp on investing for the future.

(1) Getting the spending ceiling passed.  The Republicans have been successful at making a big deal of the periodic need to raise the ceiling on the national debt.  Suppose that the next time the debt ceiling needs to be raised, they said “We are willing to make increases in the debt ceiling automatic.  All we want in return is immediate legislation and passage by Congress of a matching constitutional amendment that limits government spending by all levels of government to less than half of GDP."  I think that the Democrats would lose politically by opposing this; if they opposed it, they would be admitting that in the future they planned to take more than half of GDP for government purposes.

(2) Making the spending ceiling stick.  My idea here is simple.  If government spending at all levels (Federal, State and Local) is more than 49% of GDP (according to a modified formula discussed below), the President of the United States has full power to cut Federal spending of any type in any way that he or she chooses down to the level that makes total government spending 49% of GDP.  If government spending at all levels is more than 50% of GDP, the President of the United States is required to cut Federal spending to bring total government spending down to less than 50% of GDP–and of course is allowed to go further down to 49% if he or she chooses. Since the members of Congress value their own power, they would be unlikely to actually pass a spending bill that went above the 49% level, since that gives away a lot of their power to the President.  So the likely outcome is that budget negotiations would proceed much as they do now, but Congress would never propose anything that pushed total government spending above 49% of GDP according to the formula.  The one exception is if they thought they didn´t have the self-discipline to do what needed to be done and wanted the President to take the political burden from them.  One reason to leave the President full flexibility on how to cut is that he or she would only be in that situation if Congress had given up on trying to control spending even though not trying to control spending themselves meant giving away a big chunk of their power to the President. 

3. Designing a formula that allows for emergencies.  Designing a rule that can deal with recessions, wars and other emergencies is complicated, but I think can be done.  The first step is to use five-year averages for a number of quantities that tend to go up and down with the business cycle.  I am going to give a list of things I would use five-year averages for.  These are going to be things that can move around even if Congress hasn´t done anything in terms of regular budget legislation.  The list: GDP, government spending on unemployment insurance and welfare, spending by state and local governments, interest payments on the debt (which are counted as spending), and military spending.  The five-year average for military spending would include only a cobbling-together of the most recent 60 months that were not during a period of declared war.  The five-year average for unemployment insurance and welfare and state and local spending would include only a cobbling-together of the most recent 60 months that were not during a period when the 3-month Treasury bill rate was below a .25% annual rate, which is meant to leave out periods of such great economic emergency that the Fed has already gone to its limit on reducing short-term government interest rates.   The five-year average for GDP would be the greater of (a) the average over the last five years and (b) a cobbling-together of the most recent 60 months when the 3-month T-bill rate was above .25%.   

There are several points to make about this formula.  In a recession (according to a standard story) having unemployment insurance payments and welfare payments go up somewhat helps to stabilize the economy.  These increases in spending are given some leeway by not being counted fully right away.  Also, I am hoping that previously putting in place a Federal Medicaid Contribution Prepayment and Escrowing program–as proposed in my post "Leading States in the Fiscal Two-Step”–would make state government spending go up in recessions.  This too would be given extra leeway by not being counted fully right away.  And unemployment insurance spending, welfare spending, and state and local spending during periods when the Fed had already brought interest rates down to near zero would be fully exempted from the calculation.  Similarly, a military spending spike in a given year would only be partially counted in that year, and not counted at all in the formula if during a period of declared war.  And the spending limit would be in relation to GDP as it was before a serious recession.  Finally, using the five-year average for interest payments on the Federal debt cushions the effect of any change in interest rates on how tight the spending ceiling is. 

Looking at the other side of the ledger–the possibility of having the purpose of the rule subverted–there are several points to make:

• It is not that easy to wiggle around the rule in the long run using the 5-year average since spending more in one year then tightens the effective limits in each of the following 4 years. 
• A period of economic emergency is effectively determined by the Fed (by having interest rates very low), not Congress or the President, so that does not present too much temptation.
• I think formal declarations of war are taken very seriously.  

There is one other feature that may not be obvious but is also important in providing discipline.  I am proposing to have the GDP numbers and the spending numbers be nominal amounts, which means that there is no inflation adjustment that Congress could tinker with.  Doing the five-year moving averages for all of GDP but for only some types of spending means that the spending ceiling would effectively be tighter if inflation is higher.  So this spending ceiling actually provides some discipline against Congress pushing the Fed toward too much inflation.  (I don´t think the Fed acting on its own would try to cause extra inflation just to tighten the spending ceiling.)   

One last issue with the formula is that one might worry that State and Local government spending will trend up so much that the Federal government can´t do its job.  The answer to that is simple: if that becomes a big problem, the Federal Government has the power under its authority to regulate interstate commerce to limit State and Local spending to some reasonable maximum. 

4. Capital Budgeting.  Having roads and bridges in key places is important for economic growth.  I don´t see a big problem with allowing the Federal Government to do the same kind of thing as local governments do with millages.  If a ten-year bond is issued to pay for a road that lasts longer than that, it is OK to count just the annual payments on that ten-year bond as government spending for the purposes of the spending ceiling.  The reason to go to the trouble to set up capital budgeting rules is to avoid giving Congress an incentive to neglect important investments.  But note that the spending ceiling still bites.  In each of ten years the money being paid for the road would mean the Federal Government is required to spend less on other things.  To avoid chicanery, I would make ten years the longest payment period allowed for capital budgeting, even for things that might last longer.  

Something that doesn´t require explicit capital budgeting, but is somewhat similar, is the way that Federal Lines of Credit (as proposed in my post “Getting the Biggest Bang for the Buck in Fiscal Policy”) would interact with the spending.  The key is to make clear in the rule that Federal loans (which Federal Lines of Credit provide to individuals in order to stimulate the economy) are only counted as spending when repayment of those loans is behind schedule.  Any loan that was being paid off on schedule would not be counted as government spending.  And a loan that fell behind in a previous year but got back on schedule this year would be netted out against other loans that fell behind.  

Though I know the word “bailout” has a bad odor these days, if bailing out banks ever again became necessary to stabilize the financial system, bail-out loans could be treated similarly: only counting loans in actual arrears on payments as having been government spending.  The risk that loans might not pay off in the future would not be counted as government spending. Even if the loans are ultimately going to go bad, the key here is to spread out when the government´s losses are counted as government spending, so that the government can do the bailouts if absolutely necessary.  There should be a big debate about bailouts, but I don´t want to tie the governments hands in a true emergency, so the spending ceiling I am proposing does not attempt to stop bailouts. 

Without decisive action, I fear that we will end up with government spending more than half of GDP.  I think it will be much easier to get a spending ceiling like this enacted while it still seems shocking to think of running more than half of our economy in one way or another through the government.  Avoiding fiscal Armageddon will not be easy in any case, but it will be easier if we set up good rules now to limit a possible torrent of spending in the future.

@mileskimball on Twitter

I consider my activity on Twitter to be an integral part of this blog.  I strongly encourage everyone who subscribes with an RSS feed or on Tumblr, or who comes to this website frequently, to follow @mileskimball on Twitter as well.  For those of you who are already Twitter users, just click the “Follow” button at the sidebar.  If you are not yet a Twitter user, you might find it easier to start by clicking the link labeled

On Twitter: @mileskimball

This link makes it easy to follow my tweets from a regular computer without needing to use the full power of Twitter.  Try it and see!  

My only objective with my tweets is to enhance the experience readers have with this blog—and to reinforce and extend the points I am trying to make on this blog. It will be quite unusual for me to do more than a few tweets a day, so I won’t overwhelm you with tweets.  Here are some of the things I will do with my tweets:

1. Advertise when I have published an important post (including posts that are important despite being brief).
2. Give insight into which articles I think are especially interesting in my reading of the Wall Street Journal and other newspapers and periodicals.  
3. Tell in qualitative terms about the blog schedule.
4. Describe topics I have in mind for upcoming posts.  
5. Periodically report blog statistics. 
6. Recommend books, articles, blog posts and tweets by others.
7. Give more biographical background that will help you understand where I am coming from.
8. Do the equivalent of a blog post if what I have to say is so short that it can fit into a tweet or two.

Notice of Revocable Permission to Reproduce Content from this Blog—SUPERSEDED BY THE NOTICE THIS TITLE LINKS TO →

Update: this legal notice has been superseded by the later legal notice dated 8/3/2012 linked at my sidebar and here.  What you see below is null and void after November 1, 2012. Because I allowed 90 days for people to see the link to the updated legal notice at my sidebar, what you see has some legal effect until then, but its meaning is already greatly limited by the later, superseding legal notice dated 8/3/2012.  On August 3, 2012, I hereby invoke the following clauses:

I reserve the right to revoke this blanket permission at any time

Anyone wishing to continue relying on this permission for additional reproductions or uses is required to check this blog at least once every ninety days and carefully read all legal notices linked to at the sidebar, even if they have previously read one or more of these notices.  

Everything below the row of asterisks remains unaltered from the way this notice has appeared since June 15, 2012, two days after the post was originally published.  

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Joe Bruns says this in a comment about my post “Balance Sheet Monetary Policy: A Primer”:

Great article.  May I use this in my economics class?  The concept of creating money from nothing is foreign to freshmen in HS.  This completes the circle explaining why this concept is important.

I would be delighted to have any of my posts used to teach economics classes. 

More generally:

Though I reserve the right to revoke this blanket permission at any time, until further notice on this blog, with two exceptions noted below, I (Miles Spencer Kimball) hereby give anyone the right to freely reproduce and use any of the material on this blog to which I hold copyright as long as he or she properly credits this blog (including noting the web address of this blog) and properly recognizes my copyright on any and all reproductions and uses.  Anyone wishing to continue relying on this permission for additional reproductions or uses is required to check this blog at least once every ninety days and carefully read all legal notices linked to at the sidebar, even if they have previously read one or more of these notices.

EXCEPTION 1: This permission does NOT extend to anything I write or otherwise create that appears on any other website. It only applies to content taken directly from this website. That is, you must be able to see the content you want to reproduce or use at a web address that begins with the characters     http://blog.supplysideliberal.com   in order for the permission above to apply.

EXCEPTION 2: This permission does NOT extend to any post appearing on this website (including any content in the comments to that post to which I hold copyright) if the post has a notice of exception at the top of the post (above other content but below the title). 

Several notes:

1. For students, I think it would be especially valuable to send them to this blog itself, because they might click on some economics beyond what is assigned and learn even more!
2. The situation in which I can imagine revoking this blanket permission is if some part of the content of this blog is packaged for sale at some point.  I don´t currently have any plans along those lines, but I want to be legally careful. 
3. Anyone can freely link to anything in the blog and make “fair use” even apart from this permission.
4. Exception 1 means that if I take something down from the website, this permission no longer applies, since you have to be able to take it directly from the most recent version of the website.  Also, in the much more common case of a post that has had some revisions, it means that you need to use the most recent, updated version of a post, taken directly from the current version of the website at the time you need to download.     
5. A link to this notice appears on the sidebar.  If you are using this permission, you should click on that link at least every ninety days to see if the text of this permission has been changed in any material way.  For example, I just added the two exceptions and changed “quarterly” to “ninety days."  These modifications are included under the revocation clause.  The latest version of this notice applies.  The sidebar is currently on the right. 

Diana Kimball: Recording Skype Conversations on a Mac →

My daughter Diana spent two years working in Silicon Valley before starting business school and has been very helpful with information technology issues I have faced.  For the cognoscenti, as further warrant of her tech-cred, it is also worth noting that Diana was co-founder of ROFLCon and has been on the program of major tech conferences. 

So by the wonders of reblogging, I am going to conscript her as the occasional IT columnist for this blog when I think one of her posts would be useful to readers. This post seemed useful since coauthors collaborating by Skype (as I do frequently with my coauthors) might find it valuable to record their Skype conversations.

Diana Kimball on the Beginnings of supplysideliberal.com →

My dad’s an Economics professor, and Confessions of a Supply-Side Liberal is his new blog—and I’m crazy about it. Not just because I’m crazy about him (I am), and not just because I helped him set it up (I did…on Tumblr, even!), but because I truly believe he’s found his medium. ”I think I’ve always thought in hypertext,” he told me a few days in. Read his first post and check out his Twitter account at @mileskimball, and see what you think. I’m beyond happy he’s doing this.

First shared in the latest letter.

Leading States in the Fiscal Two-Step

[Note on the cartoon:  My technical and blog etiquette expert Diana Kimball tells me it is proper etiquette to acknowledge the origin of photos by linking to the source.  I won’t go back and do that on all of my earlier posts, but I wanted to give you the link to this one because I found it early on, and then was frustrated that I couldn’t find it when it came time to post “Leading States in the Fiscal Two-Step."  I love this cartoon.  It is much better than the cartoon I previously had of Uncle Sam dancing with Lady Liberty.  Here is the link.  From the site, it looks as if you can ask people online to draw pictures for you pro bono–something useful for every blogger to know.  Has anyone had any experience with this?]

In his article "The Federal Reserve Turns Left,” Bill Greider tells how the Fed is currently one of the institutions arguing most strongly that the Federal Government should spend more now.  Since the Fed has not departed from its long-term recommendation that the Federal Government spend less in the future, this amounts to recommending that the U.S. Federal Government execute what I will call a “fiscal two-step”: spending more now, while promising to spend less later.

I have serious misgivings about this recommendation.First and foremost, I think it is politically very hard for a sovereign nation to do this:temporarily higher spending is likely to get built into the baseline.Second, even if such a fiscal two-step as usually envisioned is executed as intended, it will lead to a path for the national debt that is considerably higher over a substantial length of time (with all the risks that entails) than an alternative policy I have put forward on this blog of Federal Lines of Credit (FLOC’s) now combined with National Rainy Day Accounts (NRDA’s) down the road.

The combination of FLOC’s and NRDA’s effectively encourages people to do the individual version of the fiscal two-step.By providing lines of credit, people are encouraged to spend now if spending now is attractive to them.Later as part of the FLOC program they are required to repay this debt, and later still, they are required to save a modest amount each month by payroll deduction (or for the self-employed, in their quarterly estimated taxes) to go into their National Rainy Day Accounts–money that they are only allowed touse in the wake of a recession or other declared economic emergency or in case of a bona fide, documentable personal financial emergency of high order.With the combination of FLOC’s now and NRDA’s later, the FLOC’s now would provide stimulus now; while later on, in recessions down the road, stimulus would be provided by releasing some of the accumulated funds in the National Rainy Day Accounts.(If this combination of policies is followed, and it is a long time before the next recession, FLOC’s might only be needed once, since releasing funds from National Rainy Day Accounts could provide the needed stimulus in the future.But an additional round of FLOC’s would always be available as a backup policy.)

To give an idea of the possible magnitudes in National Rainy Day Accounts, suppose each adult were required to set aside $20 per month in NRDA’s.Then if it was five years between the institution of NRDA’s and the next recession, compound interest would mean that each adult would then have a warchest of more than $1200 in their NRDA , minus the amount that went to take care ofdocumentable personal financial emergencies.That amount would be available for release to fight that future recession.

Why am I repeating all of this, when I said it already?I am recapping all of this as background for a corresponding policy proposal for the states, which has a non-obvious name: Federal Medicaid Contribution Prepayment and Escrowing. The idea is to have the Federal Governmentgive the states more money now, while in effect requiring them to repay it later, then to build up a balance that would legally belong to the states, but remain in escrow until a recession, when some or all of the funds would be released.(Also, in situations where under current policies, a state might be bailed out–or otherwise rescued–with Federal money, the money in a state’s Medicaid Escrow Account could be released, so that at least the state was being bailed out or rescued with its own money.)

Interest would be assessed on the prepaid amount and earned by a state on the escrowed amount at the 3-month Treasury bill rate.Up to some target maximum for the Medicaid Escrow Accounts (specified in the original legislation), the interest would be paid as an addition to escrowed funds, but if a state’s account reached its target maximum, the interest would be paid to that state as unencumbered funds that the state could spend at will.The reason for insisting that the Federal Government pay the states interest in an unencumbered way once some predefined target maximumis reached is to reaffirm the states’ property rights in their Medicaid Escrow Accounts.Without ongoing reaffirmation of the states’ property rights in these Medicaid Escrow Accounts, the Federal Government would be very strongly tempted to confiscate the money at some future time in order to deal with its own fiscal problems.The Federal Government could always unilaterally cut its transfers to the states, but it is important that it be discouraged from penalizing a state for being especially thrifty with its Medicaid Escrow Account or for being slow to beg for a bailout or rescue.

Let me say with the utmost clarity that there is no real connection between this program and the purposes of Medicaid itself.I am imagining the rules of the Medicaid program itself to be totally unchanged.The only thing that would change is the timing of when the Federal Government pays its share, as defined under current law.

The main reason I am envisioning this program happening as a modification to the existing flows of Medicaid money from the Federal government to the state governments is simply for the sake of political plausibility.I think it is much more likely, politically, that the Federal Government would change the timing of its Medicaid contributions than that the Federal Government would explicitly set up the equivalent of FLOC’s and NRDA’s for the states.

The second reason for working through a modification of the existing system of Federal Medicaid Contributions is that this approach makes it easier to work around the balanced budget requirements in state constitutions.I do believe that macroeconomic stabilization is an appropriate use of the Federal Government’s power to regulate interstate commerce, and the Supremacy clause in the Constitution of the United States should allow the Federal government to override balanced budget requirements in state constitutions in any case.But with a policy of Federal Medicaid Contribution Prepayment and Escrowing, this can be handled simply by saying in the legislation

“This change in the timing of Federal contributions for Medicaid shall not be construed as borrowing or as saving when any State or Federal court interprets balanced budget requirements that states impose upon themselves.”

Thus, the policy would actually have the effect of tightening existing state balanced budget requirements in non-recessionary times, while loosening those requirements during recessions.

Along these lines, let me emphasize one more time the importance of the Federal Medicaid Contribution Escrowing down the line, as well as the Federal Medicaid Contribution Prepayment now.It is important for states to have the funds in those Medicaid Escrow Accounts to fight future recessions.And it is just as important to keep the states from overspending in good years as it is to encourage them to spend in bad years.

Why do I think the fiscal two-step will work for states, when I don’t think it will work for the Federal Government? Because fiscal discipline is hard for governments—so hard that most governments are not capable of fiscal discipline without balanced budget requirements that are so inflexible they cannot easily handle economic emergencies.Given the unpredictability of real-world events, it is not possible to fully define what constitutes an economic emergency in advance as flexibly as would be desirable, but in the absence of hard and fast, but inflexible rules, governments have a temptation to chronically declare economic emergencies.

The solution I am proposing here is to let a higher government(facing different political incentives) enforce the fiscal discipline in a way flexible enough to deal with recessions or other genuine economic emergencies. I think a government can lead in a fiscal two-step, and I think a government can follow in a fiscal two-step.  (Though they may do so clumsily, stepping on each other’s toes.)  But it takes two to tango, and two to dance the fiscal two-step.Almost no government can lead itself in such an intricate dance.

A Proposal for the supplysideliberal Community's First Public Service Project: a wikipedia Entry on "Wallace Neutrality"

Although I plan to keep tight editorial–and for the most part, authorial–control over this blog itself, in a broader sense I view supplysideliberal as a collective enterprise.  I hope readers of this blog will gel into an online community that goes beyond this blog.  This will be a community of thoughtful people who do not all think alike; they need not be “Supply-Side Liberals” by the definition given in my first post “What is a Supply-Side Liberal?  Anyone who comes to this website frequently belongs to the supplysideliberal community (which means, for example, that the 535 people who have put this blog on their RSS feeds automatically qualify). 

It is my hope that in some way, the supplysideliberal community becomes something more than just this blog.  But it is good to take things in small steps, even if the small steps follow each other in quick succession.  So I have a proposal for a medium-sized undertaking as our first collective project outside of this blog: bringing into existence a wikipedia entry on "Wallace Neutrality.”

If you think this is a good idea, the key step will be to get the entry started, which I think can be done based on Noah Smith´s post “Does Steve Williamson Think Printing Money Can´t Cause Inflation?” and the comments on my post“Is Monetary Policy Thinking in Thrall to Wallace Neutrality?” Once the entry is started, it can be revised in the light of further comments on this blog, reading of one or more of Wallace´s papers, etc. Because of the importance of highlighting the assumption of Wallace Neutrality behind much of the discussion of monetary policy during our current economic troubles, I believe this would be a great service to the world.

Could one of you take the lead on this?

I definitely can´t do it all myself.  In terms of my personal priorities in relation to monetary policy, in the next while I will be writing about how people’s views on Wallace neutrality inform their views on current monetary policy debates, and what I think should be done given my belief in departures from Wallace neutrality.  In setting out the nature of Wallace neutrality itself, I need help.  I think a wikipedia entry would be a great way to collate our collective wisdom on this. And I think it would be a great start toward our becoming something more than just this blog.

supplysideliberal.com Takes on a Math Columnist: Gary Cornell on the Financial Crisis

Mathematics is a crucial tool for economics.  In my view, it is good for all economists to try to understand better what is going on in mathematics.  So I have decided to host an occasional math column in this blog.  

Those of you who have been following this blog closely have seen the very interesting posts based on Gary Cornell’s emails to me.  Gary has agreed to be this blog’s math columnist!  For now, the math column will always be headed by a title that begins “Gary Cornell on …”  or a title that has the word “math” or “mathematics” somewhere in it.  

Here is Gary’s post for today:

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One thing I noticed when I was watching the whole financial crisis at work which I never saw mentioned in the econ blogs was this. Consider the following model for a financial firm. You work for a firm on wall street worth 50 billion dollars. Your part of the business actually consists of once a year spinning a roulette wheel with 100 numbers marked zero to 99.  If 1-99 comes up you get a 1 million dollar bonus and your firm makes 10 million from some third party.  If the 0 comes up your firm goes bankrupt wiping out 50 billion dollars in its market cap.

Question:  How many spins before there is even a 50% chance of my company blowing up?

The elementary probability calculation needed for the answer in turn leads to the problem that while the expected value is hugely negative, the most likely scenario is that I and all my bosses and their bosses will be long since retired and very rich before my company goes under, so I would have to be a fool not to play.

Is Monetary Policy Thinking in Thrall to Wallace Neutrality?

Economics (or even just the combination of stabilization policy and macro public finance that I laid out as a core focus for this blog in its original Prospectus, “What is a Supply-Side Liberal?”) is too vast for me to have the crystallized intelligence necessary to do this blog with the care it deserves on my own.  So I need your help.  And I spent some time yesterday working with my daughter Diana Kimball to set up comments with disqus to get your help directly on this blog.  

Currently, I am trying to prepare for more posts on monetary policy.  Following @justinwolfers and @tylercowen on twitter yesterday, including clicking on Brad DeLong’s post A Fragment on the Interaction of Expansionary Monetary and Fiscal Policy at the Zero Nominal Lower Bound to Interest Rates, I was struck again by how dominant the view is that Wallace neutrality as defined by Noah Smith is descriptive of the real world.  Let me try setting out a definition of Wallace neutrality to see if you think the definition is a fair one.  Also, I want to see if you think Wallace neutrality is an appropriate name.

Wallace neutrality:  a property of monetary economic models in which differences in the government’s overall balance sheet at moments in time when the nominal interest rate is zero have no general equilibrium effect on interest rates, prices, or non-financial economic activity, as long as the pattern of government purchases and marginal tax rates is held fixed.  

The first question I am asking readers of this blog is “Do you see a flaw in this definition?”

As Noah points out in his post Does Steve Williamson think printing money can’t cause inflation? the blogosphere has been calling Wallace neutrality the Modigliani-Miller theorem.  And there is no question that it is a Modigliani-Miller-like result, since the proof relies on private agents adjusting their portfolios in a way that counteracts any change in the government’s balance sheet.  But I think it will clarify things a great deal to follow Noah (subliminal message alert) in calling this Wallace neutrality.  

One reason I think that Wallace neutrality deserves its own name is that we find it useful to call Ricardian neutrality “Ricardian neutrality” instead of “the Modigliani-Miller theorem” even though (I think) Ricardian neutrality is more or less an application of the Modigliani-Miller theorem.  In Ricardian neutrality results, the government is typically exchanging bonds (a receive-interest-payments-and-principal-later asset) for cash on the one hand and exchanging an implicit receive-tax-payments-now asset for a receive-tax-payments-later asset.  So it seems like an application of the Modigliani-Miller theorem to me.  

With that definition of Wallace neutrality in hand, or with whatever modified definition you think is the right one, here are my other questions:

• Is it correct to say that Ben Bernanke does not believe that Wallace neutrality is a good description of the real world?
• Aside from Ben Bernanke, Noah Smith, and yours truly, who else does not seem to believe that Wallace neutrality is an adequate description of the real world to guide the conduct of monetary policy in our current situation?  
• What do you think are the best monetary models out there (where “best” includes both technical virtues and real-world plausibility of mechanisms) that exhibit departures from Wallace neutrality that could be used to get oomph from monetary policy in the current economic situation?  When I say “get oomph from monetary policy in the current situation” I mean the kind of thing I was talking about in my posts “Balance Sheet Monetary Policy: A Primer” and “Trillions and Trillions: Getting Used to Balance Sheet Monetary Policy.”
• Is it accurate to say that almost all of the formal models of optimal monetary policy by Michael Woodford and Lars Svensson and their students exhibit Wallace neutrality?   What are the exceptions?  What about formal models of optimal monetary policy by other authors?

Use the comment window at the bottom of this post to reply if you feel you have an answer to one of these questions.   (It will not show up on the blog right away because I need to approve comments for them to appear.)  I appreciate the help.  3696 heads are smarter than one.

Comments on supplysideliberal.com

Update, April 21, 2013: I want to encourage more commentary on my blog. I need to approve each comment unless you are whitelisted. But if you send me a tweet to let me know you need a comment approved, I will get to it quicker, and normally approve it and whitelist you. I do try to enforce a certain level of civility and decorum (including a language filter), but on substance, I want a robust debate. For Quartz columns, the link I post on my blog (usually the day after the column appears) is a good place to make comments. 

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I appreciate all of you who are reading my blog.  Let me remind you that I have a companion twitter site @mileskimball.   

I am going to experiment with having tightly moderated comments on this blog.  The way I have comments set up using disqus, I can see all comments, but you will only be able to see the comments that I approve.  I am going to handle comments as a newspaper or magazine would handle letters to the editor.   But so far, comments have been of very high quality, so I have approved them all.  

I will have some posts in which I will pose a question and actively invite comments in order to take advantage of the collective wisdom of my readers.  On those posts, I will be especially diligent about checking out all of the comments, and I will publish more of the comments.  The first such crowd-sourcing post is my post “Is Monetary Policy Thinking in Thrall to Wallace Neutrality?”  The high level of the collective wisdom of my readers is apparent from the comments to this post.  

Two notes:

1. If you want to see comments, you have to go to the post itself.  You can’t see them on the home page of the blog.  
2. I have to approve each comment individually in disqus for it to appear, so if I am away from my computer or from internet access (as I often am for substantial periods of time), there may be a significant delay before your comment appears.

Gary Cornell on Intergenerational Mobility

Mathematician Gary Cornell has a theory I like about perceptions of intergenerational mobility in different countries and an empirical question the theory depends on.  Please send replies to him at gary@thecornells.com . I will find out from him what answers he got.  Here is his email I reprint with his permission with his theory and question:

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Hi Miles, thanks for the post.

I wonder if you know anything about the following conjecture of mine:

The background is that I’ve long puzzled about people believe that America is the land of opportunity even though intergenerational mobility  is actually lower here than in many other countries. I  have a conjecture  that seems to have some  evidence to sustain it. (Basically I scanned the equivalent of the Forbes rich lists here and in other countries).

Namely:  While moving from upwards from one quintile to another  is less likely in the united states, moving  to the top .01% of wealth (assets of about $30 million roughly) is far more likely in the United States than in other countries or even moving into the top .1% (about 7 million in assets)  (For these people think of the first 1,000 people hired at Google or the first few hundred at Facebook  for example… )  In other countries I am pretty sure that the probability  that someone born  middle class or even upper middle class can become really really rich is a small fraction of what it is here.  So more precisely my conjecture is that, for example, because the ratio:

P(getting rich in the US)/P(getting rich in Europe)  

is so large people (and the media) tend to believe and the media tends to report that America is a land of opportunity compared to other countries and to forget that

P(getting really  rich in the US)

is almost vanishingly small in absolute terms… (If you look at the equivalent of the Forbes list in other countries it sure looks like the american list has fewer examples of people getting their place through the lucky sperm derby than in England, France. Or Germany.) Do you know of any papers on this?

Miles's Curriculum Vitae →

My personal website is a mess.  I am having technical problems uploading anything to it.  I will work on some basic improvements later on this Summer.  In the meantime, I wanted to give you a link to my updated CV.  

Gary Cornell on Andrew Wiles

With Gary Cornell’s permission, I reprint here an email he sent me with a correction to the wikipedia  quotation in my post “Trillions and Trillions: Getting Used to Balance Sheet Monetary Policy.”

By the way, Gary was alluding to Alan Blinder’s book Hard Heads, Soft Hearts: Tough-Minded Economics for a Just Society, which in fact has been a book that influenced my thinking about economic policy.  Because Alan Blinder was Greg Mankiw’s professor when Greg was an undergraduate at Princeton doing graduate-level work, I think of Alan as my grand-advisor.   

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Dear Miles,

Ihave very much enjoyed your recent blog entries which I was turned on to by the continuously interesting posts of your students Noah Smith. (Having such a brilliant student must be quite a lot of fun!) Anyway, I am glad you have started blogging because we definitely need more economists with “soft hearts and hard heads” like you seem to have.  

That having been said, in one of your recent posts you quoted the Wikipedia article on Wileswhich said this:

“Starting in the summer of 1986, based on successive progress of the previous few years of Gerhard Frey, Jean-Pierre Serre and Ken Ribet, Wiles realized that a proof of a limited form of the modularity theorem might then be in reach.”

Since I actually helped organize the  big conference on the proof that Wiles for example spoke at, I remember the time very well!  And unfortunately this sentence is, I believe subtly but still quite wrong and so gives the wrong idea of what was going on at the time and I dare say of what Wiles himself was thinking when he took the leap into the unknown. As I read it, it says Wiles thought the that the work done on proving the amazing  implication (what we call Ribet’s theorem now) that: “Modularity (Shimura-Taniyama-Weil)  for semi stable elliptic curves implies Fermat” led Wiles to think that modularity was in reach. My understanding, based on what Wiles has said numerous times and also because of what was being done in the field of modular forms at that time (such as the then relatively recent proof of the main conjecture etc.) was rather that Wiles was willing to try so hard to prove modularity, even though nobody thought it was possible at the time *because* of Ribet’s theorem. In other words, he was willing to make the effort because Ribet’s theorem told him Fermat would fall *if* he could prove modularity. And since nobody really thought modularity was in reach at the time, it was truly amazing that Wiles believed he could prove even a special case of it and his willingness to basically risk all on the attempt remains so amazing. (Wiles himself is often quoted as saying that proving Fermat was a lifelong dream of his from the time he was a young student and thus provided the motivation once Ribet had shown the implication.)

Anyway if I was going to rewrite the Wikipedia article, here’s what I think it should say:

“Starting in the summer of 1986, based on the work of the previous few years including Gerhard Frey’s on the importance of what is now called the Frey curve, Jean-Pierre Serre who showed that the properties of the Frey curve plus what became known as the epsilon conjecture would contradict a weak form of the modularity conjecture and then finally Ken Ribet with his deep and difficult proof of the epsilon conjecture, everyone now knew  that a proof of a limited form of the modularity theorem meantFermat would fall. Of course, at that point even a weakened form of the modularity conjecture was thought of as being totally beyond reach, so Ribet’s theorem was thought of as simply being a really cool result and hey maybe in a hundred years or so we would finally knew enough to prove modularity, and therefore Fermat itself would be a corollary! Somehow, Wiles started to believe that by combining many of the techniques developed in the 70’s and 80’s in Modular Forms specifically and Arithmetic Geometry more generally, along with techniques that he had only glimmerings of at that point, maybe, just maybe he could prove modularity and thus his lifelong dream of proving Fermat might actually be possible. So he was willing to devote all his efforts for so many years to the proof of the modularity conjecture.”

Finally, for those who want to go further into the details of the proof we turned that conference into what has become one of the more practical ways to “get into the proof” – well  “practical” if you have two or three years of graduate math courses of course.

http://www.amazon.com/Modular-Forms-Fermats-Last-Theorem/dp/0387989986/ref=sr_1_5?s=books&ie=UTF8&qid=1338802037&sr=1-5

Otherwise, I strongly recommend

http://www.amazon.com/Fearless-Symmetry-Exposing-Patterns-Numbers/dp/0691138710/ref=sr_1_3?s=books&ie=UTF8&qid=1338896372&sr=1-3

as the best possible treatment of the circle of ideas around Wiles work for  a mathematically literate reader-any grad student in economics should have enough background to read this I think.

Best regards,

Gary Cornell

Miles's Tweets →

Among other things, I’ll use twitter to expand on the bio you see on the sidebar. 

Henry George and the Carbon Tax: A Quick Response to Noah Smith →

The title is a link to Noah Smith’s post “Carbon Taxes Won’t Work.  Here’s What Will.”  

I have to be quick because I have proofs to read for my new AER paper with Dan Benjamin, Ori Heffetz and Alex Rees-Jones.  One downside of blogging is that your coauthors know what you are doing instead of working on your joint paper with them.  

Forgive me, Noah, if I am missing something in only skimming your post, but I wanted to say that a carbon tax or a gasoline tax isn’t just about global warming.  I like the national security argument for lowering the price of oil that, say, Iran gets, as well as the global warming argument.  I second you in advocating scientific research as the most effective way to address global warming.  But the revenue from the carbon tax can help pay for this research and other important government functions.    

To the extent that oil or coal in the ground is in inelastic supply, increasing taxes on oil and coal in many countries around the world at the same time is somewhat like Henry George’s land tax that came up in the conversation when Clive Crook told Michael Kinsley about this blog, as reported in Clive Crook’s post “Supply-Side Liberals.”  Note that if oil or coal is in inelastic supply like this, the before-tax price of oil and coal might go down so much that the after-tax price of oil and coal doesn’t change that much.  If so, the quantity used might not change that much either.*  So the direct benefit on the global warming front of a carbon tax might be small.  But the benefit in raising revenue to pay for research to solve the global warming problem could be huge.  

Overall, relative ineffectiveness at slowing global warming would lead to a smaller optimal level of a carbon tax, but the revenue side alone is pretty favorable, as long as the government doesn’t give away all of the potential revenue by using “Cap and Trade.”

*Note:  I have to give credit where it is due for this idea that worldwide carbon taxes will push down the price of oil or coal enough that there might not be much effect on use.  When I was a visitor at the Center for Economic Studies in Munich last Summer, I learned this at lunch from one of the other visitors there, who was unsuccessfully (I think) trying to persuade one of the graduate students in Munich to work on it.  I hope that someone has worked on this idea or plans to work on it.

A Supply-Side Liberal Joins the Pigou Club

I try not to oversimplify in my posts, but I confess to oversimplifying on occasion in the titles of my posts.  The number of words it is reasonable to put into a title–and a title’s function of intriguing people enough that they might actually read a post–make me willing to make that compromise.  

In the title to my last post “Why Taxes are Bad,” I am referring to income, earnings and consumption taxes.  There is a big exception to the rule that most taxes have bad side-effects: Pigou taxes.  Pigou taxes are taxes that discourage people from doing too much of things that have bad consequences for the world that don’t fall entirely on the person making the decision.  Pigou taxes are one of the closest things there is to a free lunch in economic policy: a way to finance the many important things the government does–including enabling the government to defend our country and help the poor, build roads and bridges and foster scientific research–while discouraging things that should be discouraged (at least discouraged a little bit).   

The most important Pigou tax on the table (at least among economists) is a carbon tax.  Because one of the big benefits of Pigou taxes is to finance important government functions without causing harmful distortions, I am unwilling to consider “Cap and Trade” as an equivalent to a Pigou tax on carbon emissions.   In theory, if the carbon emissions rights in “Cap and Trade” were auctioned off, it would be equivalent to a carbon tax at some level (though I think less likely to be at the right level than if the carbon tax rate is set directly), but in practice, most of the potential government revenue would be given away to carbon-emitting companies.  That would mean either that important government functions would suffer, or that we would have to use distortionary taxes–with all the attendant costs detailed in "Why Taxes are Bad“–in order to finance those government functions.  The best can be the enemy of the good, but for now I am holding out for an actual carbon tax.  (If a comprehensive carbon tax is not politically possible, an increase in the gasoline tax would be a reasonable start, but I am not at all convinced that an increase in the gasoline tax is any easier politically than a comprehensive carbon tax.)   

In any case, I am hereby officially joining the Pigou Club.  For more about the Pigou Club and the logic behind Pigou taxes, see Greg Mankiw’s post ”The Pigou Club Manifesto.“    

Why Taxes are Bad

In “Miles Kimball, the Supply-Side Liberal,” Noah Smith summarizes my post “Can Taxes Raise GDP?” with this passage:

Many people are familiar with the fact that people work about the same  amount whether taxes are low (as in the 2000s) or high (as in the 1960s). Miles agrees with this, but points out that high taxes hurt people in a different way, by making them feel so poor that they have to work more, and thus depriving them of leisure.

This makes it clear to me that I didn’t get some of my point across in “Can Taxes Raise GDP?” since what Noah is saying only applies to the case when the government is wasting the money.  What if the government isn't wasting the money?  Let’s take the case of the government redistributing money from the rich to the poor (which is a big element of what is going on in Medicaid and Medicare, for example).  The first thing that happens, as Karl Smith emphasizes in “Welcome Miles Kimball: Now Set the Record Straight on Taxes” is that the poor receiving the money work less:

benefits lead people to work less, a point I have long tried to make. 

This is a big effect.  And if it means that fathers and mothers don’t have to work second jobs to make ends meet and can spend more time with their children, this is a good thing, even though it makes GDP go down.  (One of the many problems with using GDP as if it were the measure of how well a society is doing is that child-rearing by parents doesn’t get counted in GDP.)

So far so good, but what about the side effects of taking the money from the rich to give to the poor?  The “Occupy Wall Street” movement and its spinoffs paint a picture of rich people who got rich by some kind of chicanery or evil–a picture embedded in the negative connotation now carried by the phrase “the 1%.”  But the typical case is someone who got rich–or whose parents got rich–by providing a useful service.  And I am not just talking about the wonderful services provided by someone like Steve Jobs or Oprah Winfrey. For vividness I need to use famous people as examples, but before their current fame, in the relative anonymity that most rich people live in, Duchess Kate’s parents rose to become part of the “the 1%” in England by providing people with party supplies and decorations.   There were many parties that were better because Carole and Michael Middleton provided these supplies and decorations.  Aside from the rare cases (think Bernie Madoff) in which someone gets rich by pretending to provide a service they are not really providing, or by means of some other evil–we all benefit from having the rich work hard to provide us with those services. Also, many of the rich provide jobs to employees.  

Now let’s look at the bad side-effects of tax distortions. To do this, we need to compare distortionary taxes (such as income taxes, labor earnings taxes or consumption taxes) to taxes on the rich that do not depend on the level of their income, earnings or consumption.  If we could tax the rich in a way that did not depend on their income, earnings or consumption, they would fulfill their obligation to contribute toward helping the poor in part by working harder to make more money to pay the taxes.  This would benefit all of the people who receive the services they provide.   And they might hire additional employees to work with them in the extra time they are devoting to work.  

By contrast, distortionary taxes such as income, earnings or consumption taxes push the rich toward getting the money to pay their taxes out of their existing income rather than in part by raising their before-tax income to soften some of the hit to their after-tax income.  We are all then worse off as a result: the rich because they would rather work harder than take the tax hit entirely as a reduction in after-tax income, and everyone else who would have benefitted as a customer or employee from the extra services and jobs they would have provided.  

So why don’t we use non-distortionary taxes that don’t depend on income, earnings or consumption to raise the taxes to help the poor?  It is because it is not easy to tell the rich and the poor apart without looking at income, earnings or consumption.  

In principle, if we could look at genes, say, to figure out who is inherently blessed with the talents to be rich, we could avoid distortions.  This approach raises a host of troubling philosophical issues.  But it is taken seriously in the academic literature.  See for example my University of Michigan colleague Joel Slemrod’s paper with Kyle Logue: Genes as Tags: The Tax Implications of Widely Available Genetic Information.  At this point, I am not willing to recommend such a gene-based approach.  But without some new approach, we are stuck with identifying who is rich by looking at income, earnings or consumption.  So we use taxes that depend on income, earnings or consumption, with all their attendant distortions. 

My overall message in this post is given well by Noah’s summary of my first post “What is a Supply-Side Liberal”:

Taxes bad, redistribution good.  

Some messages are worth repeating.