Recently in General Economics Category

Christian Zimmerman has set up a new blog aggregator for academic economics, called Econ Academics. Looks very good.

That reminds me I need to update my blogroll. Just need to get all my changes together and do it all at once.

Via Tim Schilling, we find this excellent piece from Rick Mattoon of the Chicago Fed.

He starts with the basics...

From a conceptual viewpoint of our economy, natural disasters impact our economic well-being in two basic ways. First, they destroy what we have produced in the past—our “capital stock”—including lives, homes, commercial buildings, public infrastructure and property. Second, they often interrupt normal commercial activity and production. Transportation and deliveries do not take place, people cannot get to work and work places become dysfunctional until normalcy is restored.

...

... Following the 1993 floods, estimates for the third quarter reduced personal income by $9 billion and forecasted uninsured losses to be $2 billion. Losses to proprietors’ incomes were estimated at another $1 billion.

Remarkably, such initial losses soon appear to translate into economic gains as business and households rebuild. The rise in construction activity and the resumption of business activity often boost gross domestic product (GDP) estimates for future quarters, as households and businesses attempt to rebuild their physical capital and, in the case of businesses, to fill order backlogs. For example, following Hurricane Andrew, annualized GDP growth hit 5.7% in the fourth quarter of 1992, spurred by rebuilding activities.

But take heed, gentle reader...

However, such rebuilding does not reflect an actual economic gain in the broad long-term perspective. In most cases the rebuilding merely replaces lost capital stock—meaning that, in the long term, the nation’s product will not exceed what would have been produced without the disaster. While the immediate burst of economic activity is quite evident, the losses from the foregone output of interrupted and diminished business activity may go largely undetected because the diminished growth takes place in small amounts spread over many years.

The last sentence is so true, yet so often forgotten.

Most of the rest of the article goes on to estimate the actual losses. Mattoon finds that the aggregate losses will likely be smaller this year than in 1993, in part because the geographical footprint of the flooded area is smaller.

He finishes with another comparison--one of which I know something from my western Minnesota roots--the Red River flood of 1997 which devastated Grand Forks, ND.

For business, the greatest disruption was for restaurants, bars, hotels and any business where discretionary spending is important. Many of these businesses had to lay off workers. Other businesses such as banks, health care and manufacturing suffered lost sales but did not suffer drastic employment declines. In fact given the gains in construction jobs, employment in Grand Forks rebounded to its pre-flood level in five months. To some observers, the newly rebuilt Grand Forks with its improved infrastructure and new capital stock is better positioned for growth than before the flood, but this is only true because of significant government subsidies and 10 years of hard work. And of course, it is not true for every household and business impacted by the flood, as many chose to leave Grand Forks.

Well said.

I'd sum it up this way. Natural disasters are not a net benefit for the economy. They result in arbitrary transfers of wealth and temporary changes (both positive and negative) in spending and income. The resulting equilibrium (new capital stock and all) is not a Pareto improvement.

Let me state it even more plainly. Anything a natural disaster can do could also be done by a government through the use of forced relocation, bulldozers, and other people's tax dollars.

With no major meltdowns in the financial markets in the last couple weeks, I have been trying to catch up on other things. Trying.

But here are a couple of things that caught my attention lately.

Tim Schilling writes a nice essay on the economic way of thinking about Romeo and Juliet. This post is just about Act I. Looking forward to the rest.

Professors who teach principles of micro... bookmark these articles for the next time you do supply and demand. Both the NY Times and WSJ describe how farmers will be planting less corn and more soybeans this year. Cost increases and relative price changes are the reasons given. The exam questions practically write themselves.

Sticking with the agricultural theme, this article on the lack of convergence in futures and spot prices is beyond the principles level. Give it to your grad students.

Give this one to your students who are going on the market soon. The FDIC is hiring. No need to guess why.

David Tufte links to this interview with Ed Begley Jr. At about the same time that this came out, Begley visited WIU and gave the same message.

It's a busy week ahead. The final push to the end of the semester is about to begin.

Lawrence White explains why the gold standard may not be such a bad idea. It's a Cato podcast... with a briefing paper to go along with it.

Tim Duy gets frustrated with people comparing our current problems with Japan in the 1990s. Me too. He also gives his take on Plosser's speech and more.

Jeff Frankel is blogging. Go. Read. Now.

Andrew Samwick is disappointed with congress over the stimulus package.

Every so often, you see a paper that just reaches out and grabs your attention by its sheer size and comprehensiveness. This is one of those papers.

"A Quantitative Theory of Unsecured Consumer Credit with Risk of Default" by Satyajit Chatterjee, Dean Corbae, Makoto Nakajima, and Jose-Victor Rios-Rull (Econometrica vol. 75 no. 6, Nov. 2007 pages 1525-1589.)

Non-gated version here. Homework assignment (!) based on the paper here.

I was Dean's TA for the graduate macro class at Iowa back in the day. I think he was already working on the seeds of this paper at that time (a dozen years ago or so). According to the note at the end of the paper, almost 5 years elapsed during the review process. This paper has a theoretical model with all of the requisite proofs befitting a lead article in Econometrica as well as a computer simulation of the calibrated model. They conduct a policy experiment similar to the recent change in bankruptcy laws. Their model predicts a significant increase in average consumption.

At first glance, the welfare gains they find are surprisingly large. I wonder how sensitive the welfare effects are to the parameters. This is a difficult question in any model with a complicated simulation (this I know from experience in my own papers), and their paper is already 65 pages long. So that question will probably need to be explored further in another paper. This paper will be of most interest to specialists who deal with quantitative macro models of heterogeneous agents. It's probably not destined for first year reading lists. But if you do any kind of work with these models or have an interest in the frontier of macro research on bankruptcy issues, then you should look at this impressive paper.

This interview was conducted in October 2005 but not released until now. Hat tip to Greg Mankiw.

Edward Nelson and Anna Schwartz of the St. Louis Fed and NBER respectively have published a working paper which responds to Paul Krugman's essay in the New York Review of Books, "Who Was Milton Friedman?"

The paper is titled: The Impact of Milton Friedman on Modern Monetary Economics: Setting the Record Straight on Paul Krugman’s “Who Was Milton Friedman?”

The abstract:

Paul Krugman’s essay “Who Was Milton Friedman?” seriously mischaracterizes Friedman’s economics and his legacy. In this paper we provide a rejoinder to Krugman on these issues. In the course of setting the record straight, we provide a self-contained guide to Milton Friedman’s impact on modern monetary economics and on today’s central banks. We also refute the conclusions that Krugman draws about monetary policy from the experiences of the United States in the 1930s and of Japan in the 1990s.

Hat tip: RGE Monitor

Now we tax based on intent. A scary thought for your Halloween. You can't make this stuff up. The Tax Foundation quotes from the Iowa Department of Revenue. Yes, my beloved Iowa has taken it upon itself to engage in this kind of silliness.

The Department recently refined its position on whether pumpkins are subject to Iowa sales tax to more closely match what we believe to be their predominant use.

In the past, pumpkins were exempt from sales tax as a food (edible squash), even if they were to be later made into jack-o'-lanterns or used as decorations.

Our position now is that pumpkins are taxable if:

1. They are advertised to be used as jack-o'-lanterns/decorations, or

2. It is understood that they will be used as jack-o'-lanterns/decorations

Pumpkins are exempt in the following circumstances:

* The buyer completes a sales tax exemption certificate stating they will be used as food, or

* The pumpkins are a specific variety used to make pumpkin pies and are advertised in that way, or

* They are purchased with Food Stamps.

Retailers who sell pumpkins should keep these guidelines in mind and make any necessary changes to their tax treatment of pumpkin sales.

I predict a surge in sales of pumpkins for pie making.

Hat tip to King at SCSU Scholars

My economist readers probably are familiar with RePEc. Christian Zimmerman has added a blog to the impressive list of resources over there. Here's what he says under the heading "about this blog".

We, the RePEc team, discuss here the workings of RePEc and seek input from the community on how we can improve. We also want to give more volunteers opportunity to be part of this project and provide valuable services to the profession. Finally, we also discuss issues about the dissemination of research on Economics.

Here's what he means by addressing the dissemination of research. On the topic of peer review...

We can think completely differently. Think of this blog. I rant on a topic, and then others can comment on it and openly declare whether this rant was valuable or not. Why not do this with academic work? An early attempt was done with WoPEc. This was the first RePEc service, similar to IDEAS and EconPapers today, which offered for some time on each paper’s abstract page a discussion section. Participation was minimal and there was very little value added (see an example, I could not find one that actually had comments). This aspect of WoPEc was finally abandoned. A second attempt was organized by SOLE (Society of Labor Economists), that would post every two weeks a new paper to discuss. Again, participation was small, and the project was finally abandoned.

The latest attempt is the Economics E-Journal, which allows registered users to rate and comment on discussion papers. Once the editors find that a paper has generated sufficient interest, it is promoted to the journal, where it can still be discussed. This initiative started this year, so the jury is still out whether it will be successful in the end. So far, it looks very promising.

From time to time, members of the RePEc team are approached and asked whether a discussion section could be added to our services. Given the past experience with WoPEc and the large monitoring costs involved, we are not enthusiastic. Of course if other volunteers are interested in working on this, we may think about it. But first we need to understand whether there is really a demand for this. Maybe RePEc is now too large for this and such initiative should be left to field specific initiatives (SOLE again?).

RePEc is a quality operation. Zimmerman has been one of the driving forces for the site in recent years. Though there is a long history going back to the now-defunct WoPEc as he mentions. (The site still exists but is no longer updated.) One could also trace its lineage back to the working paper site (EconWPA) at Wash U started by Bob Parks. Bill Goffe's Resources for Economics also came out of those early years. Zimmerman also had a quantitative macro and RBC site that is now part of RePEc that goes back to 1995 according to the copyright. (It's a trip down memory lane thinking about all those early sites.) That sounds about right. That was about the time that I was starting grad school and was pretty early in "Internet Time." The RePEc blog might be a good way to get more people involved, and that would be positive for the site and the profession.

Hat tip to Greg Mankiw.

A footnote: The Wash U connection to all those early internet archives is everywhere. As a minor in computer science in college, I remember well the freeware archive at Wash U. It was probably the first internet address that I memorized... wuarchive.wustl.edu. If you were a CS student in the early to mid '90s, you used it. Sadly, this too is defunct. Does anyone else remember wuarchive?

King Banaian gets it. Responding to Rodrik's discussion starter, he writes,

Because I read more now, I think research is improved too.

I'll second that. And...

I worry about the lemons problem only insofar as one thinks econoblogging is about spreading the word of what's on the cutting edge of economics research or the policy debates. I have never concerned myself with the former, and as to the latter, I'm not terribly convinced that the best policy analysis comes from the economists with the longest c.v.'s. Again, that might be about where I'm from and what I do, a personal bias.

Since I, like Banaian, am on the faculty of a "Non-Flagship State U" we share a similar perspective. I agree that excellent policy analysis can come from economists without a long c.v. So if you can't judge a blog's quality relative to the market solely on the basis of the academic prestige of the author or his/her institution, does that lead to a breakdown of the market? No. Links are the currency of the realm here, and they are the way that information gets passed along. Suppose a brand new blog reader drops in on the economic corner of the blogosphere tonight. After how many minutes of clicking around will he or she figure out who the heavy hitters are? It probably wouldn't take long to get the lay of the land. A lot of those readers will never pick up a copy of the American Economic Review, much less Econometrica. And yet, they will figure out whose blogs are worth reading (and probably figure out who's got the best academic pedigrees as well). Whether their list of favorites would put their c.v.'s in rank order or not, well... de gustibus non est disputandum.

The blogosphere, even just the economics corner, is a big place with room for many styles and approaches. Rodrik seems to have come around on the question that kicked off this whole discussion as well. We'll gladly give him a mulligan on this one. In the world of blogging, that happens, and that's one of the things that makes all this interesting...and valuable.

Wow. Check these out. Here are some of the names: Arrow, Fischer, Krugman, Sen, Chari, Schelling, Samuelson, Fudenberg. If it's more than you'll have time for this weekend, download them now and savor them one at a time.

Dani Rodrik notes Greg Mankiw's recent post announcing the end of comments on his blog and wonders, "Is the econ-blogosphere sustainable?"

At this rate, in any case?

Two things happened in the last twenty-four hours which made me wonder if some of the best economics blogs may be on their way out. First, an economist with a very high-quality blog told me that he was not sure if he had made the right decision by starting it. He said he worried about coming up with new content on a daily basis, and that he may run out of energy at some point. Then, Greg Mankiw declares that he is too busy to be reading and filtering all the comments he gets on his site and turns off the comments section. In a long post, he says the whole blog thing is taking too much of his time, and intimates that he may not be doing this for ever.

So if economists with high opportunity costs of time start to get out, shall we have a lemons problem on our hands? Will eventually the only prolific bloggers remain the ones that are not worth reading?

It is ironic that this post comes in a rather slow period in my own blogging. My excuse? Working on getting a conference paper out. Not to mention the fact that conferences aside, as late October rolls around a lot of us in the academic community find ourselves in a pretty busy time. It's what I call the rhythm of the semester. In my case, a lot more is hitting right now than would be usual even for late October. Opportunity cost, baby!

But to call this a "lemons" problem is to imply that there is some information asymmetry in the market. In other words, when there are a lot of blogs out there, it is harder for people to tell which ones are the "good" ones and which ones are the lemons. Unable to command a price to cover their opportunity cost, the "good" bloggers exit and you're left with lemons.

Nah.

Finding a good blog is a lot easier than finding a good used car, and the commitment factor is a lot less of an issue. If you buy a lemon used car you're stuck. If you find you're reading a sub-par blog, you can move on. Information is passed in the form of links that tie us all together. Yes, there can be a bit of an echo chamber in some corners, but particularly in the economics wing of the blogosphere there is also a lot of cross-traffic between writers of different ideological persuasions. I mean, I comment at Angry Bear once in a while. They haven't kicked me out yet. My comments and their responses there and here build a stock of information about our blogs that makes it way around the network of readers. That helps people make decisions about who to read. So while I wouldn't say that the econ-blogosphere is a picture of a perfect market of ideas, it's got a lot of things going for it. I don't think the lemons issue is much of a problem.

I have a feeling that the stable long run equilibrium will have some of the better blogs that feature mostly economics and less of the daily political bloodsport will post better items less frequently. Also, blogs by academics will be subject to bursts of activity and periods of relative quiet. Readers who become familiar with that rhythm will accept it the same way that TV viewers are accustomed to sweeps week and summer reruns.

In other words, the death of the econ-blogosphere has been greatly exaggerated. It seems much more likely to me that the medium is simply entering another stage in its development.

Here is the press release from the Nobel Foundation:

Adam Smith's classical metaphor of the invisible hand refers to how the market, under ideal conditions, ensures an efficient allocation of scarce resources. But in practice conditions are usually not ideal; for example, competition is not completely free, consumers are not perfectly informed and privately desirable production and consumption may generate social costs and benefits. Furthermore, many transactions do not take place in open markets but within firms, in bargaining between individuals or interest groups and under a host of other institutional arrangements. How well do different such institutions, or allocation mechanisms, perform? What is the optimal mechanism to reach a certain goal, such as social welfare or private profit? Is government regulation called for, and if so, how is it best designed?

These questions are difficult, particularly since information about individual preferences and available production technologies is usually dispersed among many actors who may use their private information to further their own interests. Mechanism design theory, initiated by Leonid Hurwicz and further developed by Eric Maskin and Roger Myerson, has greatly enhanced our understanding of the properties of optimal allocation mechanisms in such situations, accounting for individuals' incentives and private information. The theory allows us to distinguish situations in which markets work well from those in which they do not. It has helped economists identify efficient trading mechanisms, regulation schemes and voting procedures. Today, mechanism design theory plays a central role in many areas of economics and parts of political science.

Here is the scientific background paper. Arnold Kling calls it a "Nobel Prize in abstraction". Marginal Revolution provides a translation as well as links about Leonid Hurwicz, Roger Myerson, and Eric Maskin. Mark Thoma lists some other media links as well.

In this post, Tyler Cowen muses about the practicality of their research, asking "Did these guys get at the real reasons why we don't organize the entire economy as a second-price auction?" That's a fair question. But the seminal contributions of these three to the theory of mechanism design are already central to the study of auctions, regulation, and social choice. Those are precisely the sort of things that the Nobel Committee likes to reward. For laying the foundations of this work, Hurwicz was a great choice. Maskin and Myerson are a little on the young side for an economics Nobel, but very appropriate choices to complement Hurwicz.

After hearing about this, I was having flashbacks to my Ph.D. micro courses all morning. Despite what you might think, that's not entirely a bad thing. I remember well the days and nights I spent poring over the work of these three prize winners. I learned a lot from their papers, and I'm happy to see them get the prize.

The previous post reminds us that The Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel will be announced on Monday. Any picks? For years, I've been thinking that Jagdish Bhagwati would be a very good choice. Oliver Hart, Bengt Holmstrom, and Oliver Williamson would make a good trio of winners in the area of the theory of the firm. At the moment, Gene Grossman and Elhanan Helpman are the front-runners on the Thomson Scientific poll. Eugene Fama is also a possibility.

But never underestimate the committee's ability to surprise us. Edmund Phelps was not on a lot of short lists last year. Perhaps this year's will also be unexpected. Nonetheless, all of those mentioned above are deserving and will probably have their day eventually.

Comments are welcome.

www.friedmanlegacy.org

Baseball, Free Markets, and Milton Friedman (Mackinac Center for Public Policy)

Wall Street Journal Op-ed by Thomas F. Siems

PGL at Angry Bear points us to this TPMCafe piece by Jared Bernstein. They both reference the Barry Schwartz piece I discussed here in my last post.

Bernstein uses the Schwartz article as a springboard for detailing the shortcomings of the economics profession, including forecasting (thus the title of this post). Two of his critiques stand out:

2. Economists are reductionists.... the world doesn’t work like the textbooks say it should.

...

3. And one reason for that is, as the NYT oped argues, we misunderstand incentives. To be specific, we exaggerate them.

I have frequently argued (e.g. in this recent post about Iranian gasoline) that the textbook model is not perfect but still useful. In my discussion of the Schwartz op-ed, I conclude that monetary incentives can have nonstandard effects in certain circumstances. We don't completely understand those circumstances and therefore more work is needed. I'm not ashamed to admit that perhaps a little more humility is also needed when considering the possibility of these non-standard effects. But it still remains that the incentive story that drives most economic models is mostly right. The question of whether we exaggerate the magnitude of these effects in our rhetoric (even when we are correct about their existence) is another matter, and I'd be more comfortable if Bernstein didn't lump them together.

I should note also that I have responded to PGL's post in the comments over there. This whole issue of responding to incentives and the usefulness of textbook economics is a worthwhile topic and generates some of the more interesting conversations on the blog. I hope to flesh out some more ideas on this over time.

Bruce Bartlett on why blogging is like a seminar...only better.

Yep, in the grand accounting scheme of the intellectual debate, I'd say that blogging is on the plus side of the ledger.

Via Mark Thoma.

Roll the tape.... from Tuesday:

...I would be wary of a government managed plan for universal broadband access. My fear would be that they would adopt a 20th century solution to a 21st century problem.

Broadband technology (particularly the new wireless broadband) is still evolving. Once you make it a government program, you introduce a lot of rigidity. Better to keep some flexibility until we see which technology is superior. We can, I believe, afford to do that in this case because wireless is a low fixed cost operation compared to high fixed cost utilities such as the electrical grid, the copper wire laid down by Ma Bell, and even cable TV. There will be competition just as there is for wireless phone service--speaking of an industry that went from high class luxury to practically universal access in about a decade.

Friday's Wall Street Journal editorial has this to say:

Much of this [telecommunications sector] growth has been fueled by increased broadband deployment, which makes high-speed Internet services possible. The latest government data show that broadband connections increased by 26% in the first six months of 2006 and by 52% for the full year ending in June 2006.

Also noteworthy, notes telecom analyst Scott Cleland of the Precursor Group, is that of the 11 million broadband additions in the first half of last year, 15% were cable modems, 23% were digital-subscriber lines (DSL) and 58% were of the wireless variety. Between June 2005 and June 2006, wireless broadband subscriptions grew to 11 million from 380,000.

This gives the lie to claims that some sort of cable/DSL duopoly has hampered competition among broadband providers and limited consumer options. That's the charge of those who want "network neutrality" rules that would allow the government to dictate what companies like Verizon and AT&T can charge users of their networks. But the reality is that the telecom industry has taken advantage of this deregulatory environment to provide consumers with more choices at lower prices. Verizon's capital investments since 2000 exceed $100 billion, and such competitors as Cingular, T-Mobile and Sprint are following suit. So are the cable companies.

Memo to Congress: Don't mess this up.

John Tierney writes in the NY Times:

Five years ago, Dr. [Martin] Rees posted this prediction: “By 2020, bioterror or bioerror will lead to one million casualties in a single event.” He reasoned that “by 2020 there will be thousands — even millions — of people with the capability to cause a catastrophic biological disaster. My concern is not only organized terrorist groups, but individual weirdos with the mindset of the people who now design computer viruses.”

He didn’t get any takers on LongBets.org, which seems to me a missed opportunity. So I’ve posted an offer there to bet him $200 — not a huge sum, but enough to put both our reputations on the line. I realize that betting on disaster may sound ghoulish, but neither of us will personally profit (if I win, the money goes to the International Red Cross). And I think bets like this serve a purpose.

This jogged my memory. In August 2005, he proposed a bet with Matthew Simmons concerning the price of oil. Simmons predicts we will see $200 per barrel by 2010. Here's what I said:

I'm sure someone has already told them that they should get their bet on the record for all to see at longbets.org. If not, I just did.

I e-mailed Tierney as well. Whether it was me or someone else who got him to check out longbets.org, he appears to have latched on to the concept.

Oh, and I hope Tierney wins this one too.

Today is Milton Friedman Day. I urge everyone to watch the documentary The Power of Choice on PBS tonight (check your local listings). If you want to see the old Free to Choose series, go to IdeaChannel.tv.

Many economists credit Friedman in some way with inspiring them--either directly as his students (we should all have been so fortunate) or indirectly through reading his books and articles or watching Free to Choose. As a beginning student, I found Friedman's popular articles extremely compelling and fun to read. Capitalism and Freedom was an early favorite of mine. His essay arguing that the social responsibility was to increase profits also caught my attention as a college sophomore. At that time, most college macro texts had not fully embraced rational expectations. In the macro texts at the time, there was still a lot of discussion of Keynesianism vs. Monetarism. I found all that to be very interesting, and I sided with Friedman for a lot of it. But to try to be fair, I also read a lot of Keynes's work. This I did on my own on a number of evenings in the library--especially when working on my senior honors thesis. It was worth it.

While my graduate school years were filled with rational expectations and dynamic programming, I never forgot those early days of hanging out in the library clandestinely reading those Friedman articles that we were never assigned in class. I even managed to eke out some time for those readings in grad school. Some of them were even assigned readings.

On this day dedicated to remembering Milton Friedman, I would like to encourage today's students to take a little time to browse the library for the works of the masters--Friedman in particular. You don't have to become a scholar of the history of thought, but you should be familiar with some of the ideas that changed the discipline. You might even get hooked on some of those ideas. I firmly believe that students should find something in their discipline that inspires them, and many people would tell you that Milton Friedman's work is fertile ground for those ideas.

In the NY Times, Ben Stein ably defends capitalism but correctly recognizes the glue that holds the system together--trust.

When I see what the top dogs at all too many corporations are now doing to that trust, I feel queasy. Outrageous — yes, obscene — pay. Greedy backdating of stock options, which in my opinion is straight-up theft. Managers buying assets from their trustors, the stockholders, at pennies on the dollar, then forestalling competing bids with lockups and insane breakup fees.

These misdeeds and many, many more are hammer blows at the granite foundation of trust we built in the 1940s and ’50s. How long democratic capitalism can survive these blows before it gives in and gives birth to revolution or to an out-and-out aristocracy, I am not sure.

As I have repeatedly pointed out, capitalism is not a no-holds-barred "greed is good" system as it is often portrayed. The success of capitalism depends on the rule of law, enforcement of property rights, and, yes, trust.

As we approach Milton Friedman Day, it is fitting that we remember that when he said that the social responsibility of business was to increase profits, he added the qualifier,

...so long as it stays within the rules of the game, which is to say, engages in open and free competition without deception or fraud.

David Warsh places Richard Musgrave's work in the context of one of the more interesting discussions in economics. Economists are increasingly speaking of goods being either rival or nonrival rather than public or private. The distiction between rival and nonrival deals essentially with the question of whether the good can be enjoyed by more than one person at once. The pen in my pocket is rival. The movie I saw on the screen in the theater a couple weeks ago was nonrival. Musgrave originated the use of that terminology, but it took a while for it to enter general use.

Go read it at Warsh's site, Economic Principals. A Week, Long Ago, in Biarritz

Today, the Wall Street Journal publishes an interview of Milton Friedman conducted via e-mail last July.

Hope everyone had a great New Year's holiday. I have been trying to catch up on things. Unfortunately blogging has suffered. Now I'm off to the ASSA meetings, so blogging will be light for a couple more days and then return to a more normal schedule.

In Economic Principals, Warsh reviews Duncan Foley's new book, Adam's Fallacy: A Guide to Economic Theology. (hat tip to Mark Thoma):

Foley dwells entirely on what economists have managed to make so far of The Wealth of Nations, and gives short shrift to Smith's other book, The Theory of Moral Sentiments, and to the relationship of the one to the other.

He wouldn't be the first. Nor, I fear, the last.

As they say, read the whole thing. Also, Mark Thoma links to these Brad DeLong posts which include a rejoinder from Foley.

That is to say, it's easy over very short time horizons and almost impossible over longer horizons. In Monday's Wall Street Journal, E.S. Browning continues the chronicle of the widening disconnect between the Fed and the market.

The Fed is expected to leave target interest rates unchanged, fueling hopes that it will start cutting rates some time next year, which would be good news for stocks and bonds.

But worries are spreading that, longer-term, investor hopes for interest rates may have gotten a little out of hand. If so, stocks and bonds both could be in for some rough waters in the coming months.

Later in the article, his interview subject expresses thoughts that should be familiar to any reader of this blog.

"Inflation is the key here," says Ethan Harris, chief U.S. economist at Lehman Brothers. "Inflation is the enemy of all markets. If you get serious inflation, if the Fed's fears materialize, then you will have the Fed hiking instead of cutting, pushing growth weaker. That is a lousy environment for both" the stock and bond markets.

Mr. Harris isn't forecasting a resurgence in inflation. He thinks it could remain more or less steady.

But, like the Fed, he doesn't think that is a sure thing, and he thinks investors could be making a mistake to assume that inflation is dying....

Sorry. No "one armed economists" here. On the one hand inflation could be under control. On the other hand the battle may not yet be over.

Some people find a certain irony in all this.

Now, Mr. [Jim] Bianco [of Bianco Research in Chicago] notes, "the guy that is holding the Fed back from easing is Helicopter Ben. We got him all wrong, at least for his first 10 months" in office.

It is really hard not to say, "I told you so."

Anyway, while we sit here and think about the implications of what the Fed may or may not do, Ed Prescott reminds us in a Wall Street Journal op-ed today that it may not matter all that much. The op-ed is titled "Five Macroeconomic Myths" and is sure to provoke a response from people who, for example, think that the national debt is too large (it's #4 on his list). Read the whole thing. Here's part of myth #1 that monetary policy causes booms and busts.

Between 1975 and 1980, the inflation-corrected federal funds rate was low; at the same time, output trended upward until late 1978. So far, things look somewhat promising for the mythmakers. But looking closer at the data we see that output began its downward trend in late 1979 while monetary policy was still easy through most of 1980. Also, output continued its decline through 1982, when it began to climb at a time when monetary policy remained tight.

These facts do not square with conventional wisdom. Our obsession with monetary policy in the conduct of the real economy is misplaced.

Where monetary policy's effect on output is concerned, expectations matter. That is a fact which is not lost on Mr. Bernanke, especially these days.

The mint is taking another run at making a dollar coin people will use. In reality, it sounds like a dollar coin that people will want to collect. (NY Times)

The United States Mint is unveiling four designs for one-dollar coins today, featuring likenesses of the first four presidents. They begin a series that is to last a decade and portray every deceased president.

The United States Mint is planning a series of one-dollar coins to feature every deceased president, with the date stamped into the edge.

The first coin, displaying George Washington on one side and the Statue of Liberty on the other, will go into circulation in mid-February, in time for Presidents’ Day. After that, coins with John Adams, Thomas Jefferson and James Madison will be issued at three-month intervals.

...

The size, color and metal content of the $1 coins will be identical to those of the current Sacagawea dollars, but their luster should last longer because of a new anti-tarnishing compound that will be applied to blank coins between the time they are annealed, or softened by heating, and struck with the design.

The date and some inscriptions will be stamped into the edge, airing out the designs.

The director of the Mint, Edmund C. Moy, said the number of each presidential dollar coin issued would depend on circulation demands forecast by the Federal Reserve, regardless of how well known a president was. “This could be a renaissance for some of our lesser-known presidents,” Mr. Moy said in an interview.

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Hopes are that the new dollars will be as popular as the state quarters, many of which have been taken out of circulation by collectors. The government has earned $4 billion to $5 billion on the state-quarter series since 1999.

I like dollar coins. We really should emulate Canada with both $1 and $2 coins. Count me in as collecting this series. I also love the quote from the director of the Mint. The number issued will be determined by circulation demand, not the popularity of the president. Be prepared to observe Gresham's Law in action. Andrew Johnson coins might circulate at face value while collectors hoard all the Jeffersons.

Here's the announcement from the U.S. Mint. Note that Grover Cleveland gets two coins for his non-consecutive terms.

Paul at Truck and Barter has done heroic work in putting so many links together.

OpinionJournal has a sampling of Friedman's many pieces written for the Wall Street Journal. Thomas Sowell has a tribute piece as well.

Lawrence Summers shows his class in his NY Times op-ed.

UPDATE: Robert Frank suggests a way to expand the earned income tax credit to be more like what Friedman envisioned while also getting the incentives right. Not an easy assignment, but worth discussing.

Relatively few of us live to age 94. Fewer are still professionally active at that age. Even among academics, who are noted for their ability to continue the intellectual enterprise under the title "emeritus", 94 years is an extraordinary age for a public intellectual.

Milton Friedman certainly was extraordinary in more than just this respect.

His scholarly accomplishments are being lauded widely today, and there is a lot to praise. But it was more than just the papers that he authored that made him so influential. It was that his ideas were infused into the very heart of the discipline. Ideas that he, his students, and his followers advanced have become the standard currency of the realm. Pick up a journal containing macroeconomic research today. You will be looking at his legacy. And what a legacy it is.

I never met the man, but I'm sure many of you would agree that after watching so many hours of his television interviews and specials over the years it was hard not to feel like you knew him. I so enjoyed and admired the way that he conducted himself in the public eye. In those interviews he had a twinkle in his eye that only comes from true passion for the ideas he advanced. He made no apologies for his position. He was staunch and steadfast but at the same time a consummate gentleman.

Whether you agreed with him or not, he forced you to think. As Bill Conerly wrote on his blog (Businomics) today, he did not tolerate sloppy economics. He didn't tolerate sloppy arguments of any kind. He made short work of many a question by an interviewer, sometimes in a way that made you feel for the person who just got put in their place. But there was no malice. He wanted to win people over not by browbeating them, but by convincing them with the strength of his argument. However his quickness could catch even a great interviewer off guard. He came up with the perfect answer right away whereas us ordinary folks would have taken some time to ponder the theory or plumb our memory for an example. It was as if he was one step ahead all the time.

But then he was extraordinary.

What gives me the greatest sorrow today is that there will never be another of those interviews for us to enjoy. No longer will we be able to hear his insight on the momentous economic events of our time. Even at age 94, he had so much more to give, as this op-ed in the Wall Street Journal (dated Friday) illustrates. He was as sharp as ever, right up to the end.

Over the upcoming Thanksgiving break, I plan to re-read parts of Two Lucky People and Capitalism and Freedom. The latter was an inspiration for me as I began my study of economics (by no means was my experience unique). Though I do not fully endorse every single idea in the book, I find it to be so engaging and thought provoking that it inspires new ideas in me no matter how many times I read it. Reading the words of Friedman, like reading the other true giants of the discipline regardless of their position on the political spectrum, sharpens your mind and refines your arguments.

His and Rose's memoir, Two Lucky People is special to me because it came out in paperback right about the time that I proposed to the woman who would become my wife. I told her about Milton and Rose, what a beautiful marriage they had, and what an inspiration he was to me professionally. The more I read about Milton and Rose, the more they became an inspiration to me personally. My future wife agreed and gave me the book as a gift. We celebrate our sixth anniversary on Saturday. That's not even one-tenth as long as Milton and Rose spent together. My wife and I hope and pray that we can enjoy that kind of longevity as a couple. The word "extraordinary" falls short of fully describing it.

In the coming days and weeks, I will offer some additional thoughts on Friedman's contributions and what we can still learn from his ideas, even those that have met with less success than others. Tonight, however, my thoughts tonight are for his family.

NY Times Obituary
WSJ Obituary

UPDATE: Paul at Truck and Barter has an extensive listing of links, including a link to David Friedman's blog.

This month's fedgazette from the Minneapolis Fed features poverty as its theme. There are a number of interesting articles that are worth your attention. In this post, I call your attention to one in particular on income mobility--the ability of individuals and households to move through the income distribution over time.

Income mobility is one of those things that we like to talk about and make claims about. We like to hear stories of "rags to riches", but how often does it really happen? It turns out that we understand relatively little about mobility from a statistical standpoint. Ronald Wirtz writes in the fedgazette article,

Bhashkar Mazumder, an economist at the Federal Reserve Bank of Chicago, has authored several mobility studies in recent years. He said, also via e-mail, that prevailing mobility research throws water on the common notion that U.S. income is highly mobile and more mobile than other countries. More recent studies, like his own, have used much richer longitudinal data that track income over longer periods of time, giving a more accurate reading of lifetime incomes in the United States. Research over the past decade and a half shows that “mobility is relatively low in the U.S. and lower than we thought,” said Mazumder.

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Nathan Grawe has also done research on income mobility as an economics professor at Carleton College in Minnesota. In his estimation, the four best studies done to date on intergenerational mobility have both positive and negative findings, and most results were not statistically significant; in other words, the findings aren't particularly trustworthy. “All told,” Grawe said via e-mail, “I'd say we have no evidence of change.”

Part of the problem is that studies done before about 1990—which generally concluded that the United States had high mobility—are widely discredited today as faulty, mostly because they relied on very small windows of income data, often just a few years or less. In 1992, Solon published one of the first papers suggesting that U.S. mobility was not as high as everyone thought.

Mazumder's research comes to the same conclusion. But his most recent effort with Daniel Aaronson (also of the Chicago Fed) might have something of a silver lining. They found that current mobility might simply be returning to its historical trend line after experiencing an uptick in the 1970s. In other words, mobility might be worse compared to the 1970s, but it might well be in line with the country's historical average.

Obviously, a lack of longitudinal data going way back will remain a problem. Maybe in fifty years we'll be able to put the current period in historical perspective. Too long for some. You know what Keynes said about the long run. While the evidence here is conflicting and the conclusions not quite conclusive, the situation is better than that concerning the question of how much mobility is optimal.

The notion of perfect mobility—an equal chance for any outcome, regardless of where you start—has a hint of social and economic chaos, by virtue of the fact that it implies a lack of predictability in outcomes regardless of the very things that families and societies tend to value: effort, ability, education and other human capital investment, and parenting.

Economists believe incentives motivate behavior. Grawe, from Carleton College, noted that mobility research was often written “in ways which suggest more mobility is better.” But a society with no obvious determinants for income “would clearly have all sorts of incentive problems.”

For example, parents' attempts to offer certain advantages to their kids—reading to them, sending them to better schools, saving for college, transmitting certain values—might be for naught in a world where these things have no lasting economic effect. In a 2002 working paper on the notion of perfect mobility, sociologist Adam Swift of the University of Oxford wrote, “Even those that regard current mobility patterns as evidence of morally unacceptable unfairness should acknowledge that some mechanisms by which parents transmit advantage—or disadvantage—to their children are unobjectionable and would exist even in an altogether just society.”

In other words, there is no clear guidance at all on how much mobility is optimal or even what we mean by optimal mobility. One cannot escape the fact that mobility requires an appeal to long run incentives, but people do not always behave in accordance with those long run incentives. Hence, a divergence between opportunity and outcomes is assured. This is the world in which we live. And this is why the solution to the problem of income inequality is more difficult than many people realize.

As the last couple of paychecks of the year approach, many people get a temporary pay raise, as Ron Lieber of the Wall Street Journal explains:

By now, many of the 8.9 million Americans who earn more than $100,000 annually have already hit six figures; scores more will do so in the next few weeks. Here's what they may miss if they don't watch their paycheck carefully: A nice-sized raise that appears without warning, then vanishes just as quietly on Jan. 1.

Sound odd? It's a function of tax rules. Most workers have their paychecks docked 6.2% to f