As I Faced the Fiscal Cliff, I Failed to Find Comfort in the Words of Winston Churchill

As I read in the Wall Street Journal about the failure to come to some agreement to resolve the fiscal cliff, I thought again about these words: 

We can always count on the Americans to do the right thing, after they have exhausted all the other possibilities.

I have often heard these words attributed to Winston Churchill. But a web search for the source took me to the quoteinvestigator.com article on this quotation, which indicates this is a folk quotation. Many people have had a hand in inventing it, but there is no evidence that Winston Churchill participated in that invention. Still, I hope it is true.

For the record, my proposal for dealing with the long-run budget issues that are the heart of the disagreements between Republicans and Democrats is the system of “public contributions” laid out in my post “No Tax Increase Without Recompense.” This public contribution system would help make sure that the poor and afflicted are taken care of while reducing the footprint of the government in society.

Q&A: How Can Electronic Money Eliminate Inflation?

Q: I’m not clear on how electronic money could eliminate inflation. Would you explain this to me? Thanks!

A: Electronic money eliminates the zero lower bound on the nominal interest rate. The reason central banks (Fed, ECB, …) have chosen 2% as their long run inflation target instead of zero is because they are worried about the zero lower bound.

The Twitter version of the answer stimulated some discussion, which you can find storified here. The opening monologue to that discussion is also copied out below:

  1. W or w/o depreciating currency, e-money eliminates the zero lower bound…
  2. The main reason many central banks (Fed, ECB …) have a long-run inflation target of 2% instead of 0 is b/c they’re worried about the ZLB.
  3. So if the zero lower bound is eliminated by electronic money, I predict central banks will choose a long-run inflation target of zero.
  4. With electronic money (think reserves, bank accounts, …) as the unit of account, depreciating paper currency makes the ZLB non-binding.
  5. Having the same central bank with authority to issue both e-money and currency means the exchange rate between them is fully defensible.
  6. So a central bank with the needed legal authority can announce a track for the exchange rate between e-money and paper money.
  7. Announcing a track for the e-money/paper money exchange rate that has paper money depreciating gives paper money a rate of return below zero
  8. Just choose a rate of depreciation of paper money relative to e-money that makes its ROR less than Fed funds target & interest on reserves.
  9. When the Fed funds rate target is positive, paper money can appreciate relative to e-money until it returns to par.
  10. If inflation is zero, to be able to continue to return to par, what is needed is for the real interest rate to be positive on average.
  11. Or say the health of the banking system required Fed funds rate to be at least 2% above the ROR of currency, avg r > 2% allows return to par

The Neomonetarist Perspective

In May 2000 I gave a series of three lectures on business cycle theory at Harvard’s Economics Department. In the first lecture, I presented a set of slides on “The Neomonetarist Perspective.” I have copied the contents of those slides below. Let me provide a few annotations. First, in the slides, I mention the concept of “real rigidity” introduced by Larry Ball and David Romer in 1990. Real rigidity makes prices adjust less even when firms have the chance to adjust their prices. My own treatment of real rigidity is in my 1995 paper “The Quantitative Analytics of the Basic Neomonetarist Model.”  Second, my views on the labor supply elasticity have shifted as a result of my 2008 paper with Matthew Shapiro: “Labor Supply: Are the Income and Substitution Effect Both Large or Both Small?” toward larger values since I wrote these slides. (However, the intensive Frisch labor supply elasticity of around 1 that Matthew and I find is still somewhat lower than that used in many real business cycle models.) Third, the qualitative analytics I mention are best illustrated by my working paper “Q-Theory and Real Business Cycle Analytics”–which also provides a methodological discussion consistent with “The Neomonetarist Perspective” below. Fourth, my textbook draft “Business Cycle Analytics” provides many illustrations of quantitative analytics. (Both of these are on my University of Michigan website.) 

Four Elements of the Neomonetarist Perspective

  1. Attributing the fluctuations at business cycle frequency primarily to the interaction of real and monetary shocks with sticky prices.
  2. Seeing the qualitative properties of “Real Business Cycle” models as descriptions of the decadal fluctuations of the economy rather than fluctuations at business cycle frequencies.
  3. Viewing with skepticism many of the parameter values, functional forms, and mechanisms that have become traditional in much of business cycle theory.
  4. Pursuing a research strategy that emphasizes detailed intuitive understanding and systematic analytical methods over purely numerical results.

Neomonetarist Modeling of Sticky Prices

(a) Background requirements for plausibility:

  • imperfect competition.
  • increasing returns to scale.
  • real rigidity.

(b) Macroeconomic effects of imperfect price flexibility lasting several years.

  • Price adjustment that is fast relative to adjustment of the capital stock, but slow relative to adjustment of output to demand. 
  • Overlapping price setting.  At any one time, only a small fraction of prices will be changed.
  • Leaning toward optimization.
  • Neoclassical, fully optimizing households.
  • Cost-Minimizing firms.
  • Price-setting modeled as optimization subject to important procedural constraints.
  • Variation in the actual markup as the link between the monetary, nominally sticky side of the model and the real equations of the model. 

The Argument for “Real Business Cycle Models” as Models of the Medium-Run Adjustment of the Capital Stock Rather than Models of Business Cycle Fluctuations:

(a) Basic “Real Business Cycle Models” are sophisticated versions of the “Solow Growth Model” of capital adjustment.

(b) With plausible parameter values, the endogenous rate of adjustment of the capital stock is on the order of ten years. 

(c ) Most shocks to total factor productivity (“technology”) should be essentially permanent; therefore, business cycle fluctuations must result from an endogenous business-cycle-frequency (about three-year) mechanism rather than from business-cycle-frequency movements in the driving variable of technology. 

(d) If the degree of imperfect competition and increasing returns to scale are relatively small–and prices adjust several times faster than the capital stock–“Real Business Cycle Models” are good models of the medium-run adjustment of the capital stock even when prices are sticky in the short run.

A New Take on Parameter Values and Functional Forms

(a) Prescott’s original strategy of calibrating models of economic fluctuations by looking at a wide range of micro-economic, partial equilibrium and long-run trend evidence and logic needs to be pursued with greater earnestness.  Prescott’s genuine contribution here is the approach, not the particular parameter values and functional forms he chooses.  Flexible functional forms should be preferred where possible; functional form restrictions need to be justified.  

(b) There is no microeconomic or partial equilibrium evidence of high labor supply elasticities.  The arguments of Rogerson and Hanson are not an adequate defense of high labor supply elasticities.  Effort-elicitation models of efficiency wages also do not justify high labor supply elasticities. 

(c ) There is no microeconomic or partial equilibrium evidence of a strong response of nondurable consumption to the real interest rate. 

(d) There is a great deal of microeconomic and long-run-trend evidence that the income and substitution effects of a permanent increase in the real wage approximately cancel.

Three Analytical Toolboxes

(a) Approximation theory.

  • The certainty equivalence approximation links the perfect foresight model to the corresponding stochastic model.
  • Writing down a discrete-time model and then taking a continuous-time limit yields the most insight into a model. 
  • The approximation of a hierarchy of adjustment speeds allows one to deal with more than one state variable in an intuitive way. 

(b) Qualitative analytics.

  • Analyzing the partial equilibrium pieces of a model with model-specific graphs and the principles of monotone comparative statics. 
  • Contemporaneous general equilibrium.
  • Dynamic general equilibrium on the phase diagram. 
  • Steady state comparative statics.

(c ) Quantitative analytics.

  • Steady-state relationships.
  • Log-linearization around the steady-state.
  • Calculation of the convergence rate and impulse responses.

Eliezer Yudkowsky: Evaporative Cooling of Group Beliefs →

Eliezer’s post “Evaporative Cooling of Group Beliefs” is a brilliant explanation of why failed prophecies can lead to a group with increased belief and fanaticism. What is more, this post hints at a possible future direction for mathematical sociology. This statistical mechanics perspective is also important for the economics of religion as an alternative explanatory principle.

Raj Chetty on Taxes and Redistribution

Several people have asked me where they could learn more about the economics of taxes. David Agrawal (a Michigan Ph.D. who is now at the University of Georgia) pointed out to me that Raj Chetty, one of the top experts in the world on the economics of taxes and redistribution, has put his lectures on taxes and redistribution online.

Here is the homepage for Raj Chetty’s lectures.

Here is a direct link to the videos on YouTube.

Neil Irwin: American Manufacturing is Coming Back. Manufacturing Jobs Aren't

Sometimes a sector of the economy has so much technological progress that over many decades, output in the sector increases while inputs into the sector–particularly the amount of labor used–decreases. Agriculture went through this transformation first. In more recent decades, manufacturing employment has been shrinking while manufacturing output has been growing. Just as we need only a few farmers to feed everyone, we are moving toward a world where we only need a few people to manufacture things, while almost everyone is employed in the service sector.

Neil Irwin describes this transformation in his post “American manufacturing is coming back. Manufacturing jobs aren’t.”

Marcelo Gleiser: "Astrotheology: Do Gods Need to Be Supernatural?" →

In my post “The Egocentric Illusion,” which gives my take on David Foster Wallace’s Kenyon College Commencement Address, I wrote:

Up until I was 39 or 40 years old, I genuinely believed in an afterlife, and like most people assumed my afterlife would be a pleasant one.  Then I decided I did not believe in God. I had always thought that an afterlife would require someone powerful to make it happen. So not believing in God meant I did not believe in an afterlife either. Realizing that most likely there was no afterlife was a big item of bad news for me. It made me less happy than I normally would have been for several years. That unhappiness caused me to think. Then and sometimes now, I tried to imagine the intelligent aliens who might be recording my consciousness digitally for later cybernetic resurrection, but I have lacked enough social support for that belief for it to be all that reassuring.

The link (embedded in the title of this post) to Marcelo’s Gleiser’s post, shows that social support for such a belief may not be totally lacking.

Steven Pinker on Straw Men

In his book The Stuff of Thought, (p. 89), Steven Pinker writes (bullets added):

The beauty of the straw man is that he can be used in so many ways.

  • The most hackneyed is the straw man boxing match, in which one replaces a formidable opponent with a defeatable simpleton. 
  • But there’s also the straw-man two-step: first set up the effigy, then acknowledge that he is not so fatuous after all, but frame his reasonableness as a capitulation to one’s devastating criticisms.
  • And then there is the sacrificial straw man, useful when one worries about being on the fringe of respectable opinion: set up a fanatical version of one’s theory, then distance oneself from it as proof of one’s moderation.

Judging the Nations: Wealth and Happiness Are Not Enough

blog.supplysideliberal.com tumblr_mejabdMaDi1r57lmx.png

Here is a link to my 8th column on Quartz: “Emotional Indicator: Obama the libertarian? Americans say they’d be happy if government got out of their way.”

The title of this post is the original working title of the column. 

In early drafts, I related what I say in the Quartz column to Jonathan Haidt’s six moral tastes in his book The Righteous Mind: Why Good People Are Divided by Politics and Religion. Here is a New York Times book review by William Saletan, and here is a good passage from Jonathan Haidt summarizing his theory, chosen by Bill Vallicella, in Bill’s post “Jonathan Haidt on Why Working Class People Vote Conservative.”

There is a key chunk of text making the link to Jonathan Haidt’s theory that was appropriately cut for being too wonkish, but that I think you might find valuable

  1. for making that connection and 
  2. for more carefully stating the key findings about people’s preferences in hypothetical policy choices from my paper with Daniel Benjamin, Ori Heffetz and Nichole Szembrot. 

Here it is:

The most important boon people want for the nation as a whole is freedom. In the words we used for the choices we gave them, the #1, #2, #10, #13, #18 and #23 things people want for the nation are

  • freedom from injustice, corruption, and abuse of power in your nation
  • people having many options and possibilities in their lives and the freedom to choose among them;
  • freedom of speech and people’s ability to take part in the political process and community life;
  • the amount of freedom in society;
  • people’s ability to dream and pursue their dreams; and
  • people’s freedom from emotional abuse or harassment.

The next most important boons people want for the nation are goodness, truth, loyalty, respect and justice. On our list, the #3, #6, #8, #17, #19 and #21 most highly-valued aspects of the good society are

  • people being good, moral people and living according to their personal values;
  • people’s freedom from being lied to, deceived or betrayed
  • the morality, ethics, and goodness of other people in your nation; and
  • people having people around them who think well of them and treat them with respect
  • the quality of people’s family relationships
  • your nation being a just society.

The exact picture of “goodness” and “justice” might differ from one person to the next, but it is clear that they represent more than just money and happiness.  University of Virginia psychologist Jonathan Haidt,  in his brilliant book The Righteous Mind: Why Good People Are Divided by Politics and Religion argues that morality comes in six flavors (“The righteous mind is like a tongue with six tastes.”):

  1. liberty vs. oppression,
  2. fairness vs, cheating,
  3. sanctity vs. degradation,
  4. loyalty vs. betrayal,
  5. authority vs subversion, and 
  6. care vs. harm.

The first five of Haidt’s flavors of morality are well represented above.  The fourth flavor of morality, care vs. harm, is the one many authors focus on, to the exclusion of the others. It is the bread and butter aspects of people’s lives. In our findings, care vs. harm is reflected in 11 of the top 25 (numbers 4, 7, 9, 11, 12, 13, 16, 18, 22, 24, 25), including “the overall well-being of people and their families” in your nation, people’s health, financial security, and freedom from pain; “people having people they can turn to in time of need” and a “sense of security about life and the future in general” and balance, as reflected in the items “people’s mental health and emotional stability,” “how much people enjoy their lives” and “how peaceful, calm and harmonious people’s lives are.”

In addition to all of these, people want meaning, as reflected by #5 and #14 on our list: “people’s sense that they are making a difference, actively contributing to the well-being of other people, and making the world a better place, and “people’s sense that their lives are meaningful and have value.”  In addition to his discussion of key dimensions of morality, in The Righteous Mind: Why Good People Are Divided by Politics and Religion, Jonathan Haidt emphasizes the importance of meaning—in particular, the importance of feeling one is a part of a larger whole. One of his central metaphors is “We are 90 percent chimp and 10 percent bee.” That is, Haidt believes that perhaps 90% of the time we are out for ourselves, however gently, but perhaps 10% of the time we are out for a higher cause (like the general good of everyone in our group) to the deepest level of our beings. A sense of “meaning” often comes from making that connection to something greater than ourselves.  

You can see my other posts on happiness in the happiness sub-blog linked at my sidebar, and here:

http://blog.supplysideliberal.com/tagged/happiness

Joshua Hausman: More Historical Evidence for What Federal Lines of Credit Would Do

This is the second guest post by Joshua Hausman on supplysideliberal.com.

An excellent historical analogy to Miles’s Federal Lines of Credit proposal are the 1931 loans to World War I veterans that I discussed in a guest blog post in August. As I described then, in 1924, Congress promised to pay World War I veterans a large bonus in 1945. When the Depression threw many out of work, veterans lobbied for early payment of the bonus. Congress acquiesced in 1931 by allowing veterans to borrow up to 50 percent of the value of their bonus. The main chapter of my dissertation focuses on the larger payment to veterans that occurred in 1936. In this blog post, I summarize my paper and discuss its possible implications for the success of a Federal Lines of Credit program.

Background

Despite their ability to take loans after 1931, veterans continued to demand immediate cash payment of the entire, non-discounted, value of their bonus. Tens of thousands camped out in Washington, DC from May to July 1932 to lobby Congress and the President for immediate payment (see picture). Rather than agree to their demands, President Hoover allowed General Douglas MacArthur to use soldiers and tanks to evict the veterans from Washington. Soldiers burned down veterans’ shacks in Anacostia. This forcible eviction provoked a political reaction that helped propel Franklin Roosevelt to victory the next year. 

  • Although popular history often emphasizes Roosevelt’s New Deal spending, FDR was in fact a deficit hawk, who raised taxes as much as he increased spending. Consequently, Roosevelt opposed payment of the bonus. But eventually, in January 1936, widespread popular support led Congress to override Roosevelt’s veto and authorize payment.

In June 1936 the typical veteran received $550, more than annual per capita income and enough money to buy a new car. In aggregate, the Federal government issued 3.2 million veterans bonds worth $1.8 billion or 2% of GDP. As a share of the economy, bonus payments were roughly the same size as the American Recovery and Reinvestment Act (the Obama stimulus) in 2009.

This payment had a loan component analogous to a Federal Lines of Credit program since it allowed veterans access to money in 1936 that they were supposed to receive in 1945. Furthermore, taking the money as cash in 1936 came with an interest rate penalty: veterans were issued bonds in $50 denominations and could cash as many or as few of them as they desired. If they held the bonds, they would receive 3 percent interest every year until 1945. Just as one pays interest when one borrows money from a bank, veterans had to forgo interest if they chose to cash their bonus in 1936.

But the 1936 legislation also was an outright gift, since it increased the present value of veterans’ lifetime income. In particular the legislation forgave interest on loans that they had taken against the bonus, and gave veterans in 1936 the same nominal sum they had been supposed to receive in 1945. In my paper, I calculate that for the typical veteran roughly half the bonus amount received in June 1936 was an increase in present value lifetime income.

Effects of the bonus

Out of the $1.8 billion of bonds issued to veterans through June 30, 1936, $1.2 billion were cashed in June and July 1936. A further 200 million were redeemed in late summer and fall. Thus 80 percent of the dollar value of the bonds was cashed in 1936. This in itself suggests large effects from giving veterans access to cash; more generally, it suggests that a program giving individuals access to low interest rate loans, as Federal Lines of Credit would do, can be quite popular. 

My paper explores whether and how veterans spent this money. The primary source of evidence is a household consumption survey administered by the Works Progress Administration and the Bureau of Labor Statistics in 1935 and 1936. By exploiting variation in when households were surveyed and in the likelihood that a household included a veteran, I estimate a marginal propensity to consume (MPC) out of the bonus of 0.7, meaning that out of every dollar of bonus bonds received, the typical veteran spent 70 cents. This result is confirmed by other, independent, sources of evidence. 

Interestingly, an MPC of 0.7 is as large as that measured from the 2001 tax rebates and 2008 stimulus payments, programs that did not have a loan component. If veterans’ spending were only influenced by the part of the bonus that represented a change in the present value of their lifetime income, then it would be almost impossible to explain the amount of spending I observe. An MPC of 0.7 out of the total bonus implies a MPC out of the increment to lifetime income of about 1.4 (since the increment to lifetime income was roughly half the bonus amount). This is implausible. Instead, the much more likely explanation is that veterans’ spent more in 1936, not only because their lifetime income was higher, but because the bonus meant access to a low interest rate loan at a time when liquidity constraints were pervasive.

Further evidence on the bonus’s effects comes from differences in the proportion of the population made up of veterans across states and cities. This variation meant significant geographic variation in bonus payments received. The figure at the top of this post juxtaposes the change in new car purchases from 1935 to 1936 in a state against the number of veterans per capita as measured in the 1930 census in that state. The slope implies that for every additional veteran in a state, roughly 0.3 more new cars were sold in 1936. In the paper, I show that this result is robust to controlling for a variety of different possible confounding variables. 

A third source of evidence on veterans’ spending behavior is an unpublished survey by the American Legion that asked 42,500 veterans how they planned to use their bonus. Veterans told the American Legion that they planned to consume 40 cents out of every dollar and to spend an additional 25 cents out of every dollar on residential and business investment. Evidence from the 2001 and 2008 Bush tax rebates suggests that such ex ante surveys are likely to significantly understate the total cumulative spending response (see section 5 of my paper for more on this argument). Thus, the prospective MPC of 0.4 measured in the American Legion Survey is consistent with an actual MPC that was significantly higher. 

Aggregate time series are also consistent with a large spending response. GDP grew 13.1 percent in 1936, more rapidly than in any other year of the 1930s. In the paper, I estimate that the bonus contributed 2.5 to 3 percentage points to this growth.

Conclusion

My results are encouraging evidence for the efficacy of Federal Lines of Credit, since they suggest that even when a large portion of a transfer payment is a loan (roughly half in the case of the veterans’ bonus), the MPC can be high. 2012 is not 1936, of course, and particular features of the 1936 economy may have contributed to unusually high spending from the bonus, specifically on durables. Still, at a minimum, my results suggest that further research on the efficacy of Federal Lines of Credit is desirable. 

Sources

The Bonus March photo is from http://www.loc.gov/exhibits/treasures/images/at0058f2as.jpg

All other material is taken from my job market paper, with sources documented there. One other paper, Telser (2003), examines the 1936 bonus in detail. Telser studies a variety of time series and concludes that the bonus “brought a large measure of recovery to the economy’‘ (p. 240).

Tunku Varadarajan on the Backlash Against Winner-Take-All in Online Journalism

In his Daily Beast article “Schadenfareed,” Tunku Varadarajan has something interesting to say about a side-effect of the winner-take-all tendencies of online journalism:

It’s lonely at the top. As the traditional news media shrivel and other platforms proliferate, celebrity public intellectuals like Zakaria (think, also, of Tom Friedman and David Brooks) become the only bankable resource left. Recognizable across all the mediums, the branded few become mini-industries unto themselves. Simultaneously, a huge cloud of excluded people, regular civilians and workaday journalists alike, can now respond on the Internet, many of them resentful that their voices go unheard while the Zakarias loom ever larger. So they pick over every word.

Tunku is explicit about the envy of the many against the few big winners in the tournament as a motivating force for the heat Fareed got for his bit of plagiarism:

What one has seen in the past few days can only be described as a hideous manifestation of envy—Fareed Envy.

It occurs to me that, while college teaching has only recently had the technological potential for such dynamics of winner-take-all, coupled with envy, academic research has long has exactly these dynamics of winner-take-all plus envy. Although often unpleasant, those dynamics are part of what keep science honest, as those on their way up make their bones by finding flaws in the work of those who are already big guns.