John Cochrane on Keynesianism

I'm not sure how to link soley to John Cochrane's contribution to the Delong v. Zingales debate, so I'll just reprint it here:

Nobody is Keynesian now, really. Keynes distrusted investment and did not think about growth. Now, we all understand that growth, fuelled by higher productivity, is the key to prosperity. Keynes and his followers famously did not understand inflation, leading to the stagflation of the 1970s. We now understand the links between money and inflation, and the natural rate of unemployment below which inflation will rise. A few months before his death in 1946 Keynes declared:1 “I find myself more and more relying for a solution of our problems on the invisible hand [of the market] which I tried to eject from economics twenty years ago.” His ejection attempt failed. We all now understand the inescapable need for markets and price signals, and the sclerosis induced by high marginal tax rates, especially on investment. Keynes recommended that Britain pay for the second world war with taxes. We now understand that it is best to finance wars by borrowing, so as to spread the disincentive effects of taxes more broadly over time.

Really, the only remaining Keynesian question is a resurrection of fiscal stimulus, the idea that governments should borrow trillions of dollars and spend them quickly to address our current economic problems. We professional economists  are certainly not all in favour. For example, several hundred economists quickly signed the CATO Institute's letter2opposing fiscal stimulus. 

Why not? Most of all, modern economics gives very little reason to believe that fiscal stimulus will do much to raise output or lower unemployment. How can borrowing money from A and giving it to B do anything? Every dollar that B spends is a dollar that A does not spend.3 The basic Keynesian analysis of this question is simply wrong. Professional economists abandoned it 30 years ago when Bob Lucas, Tom Sargent and Ed Prescott pointed out its logical inconsistencies. It has not appeared in graduate programmes or professional journals since. Policy simulations from Keynesian models disappeared as well, and even authors who call themselves Keynesian authors do not believe explicit models enough to use them. New Keynesian economics produces an interesting analysis of monetary policy focused on interest rate rules, not a resurrection of fiscal stimulus. 

Our situation is remarkable. Imagine that an august group of Nobel-prize-winning scientists and government advisers on climate change were to say: “Yes, global warming has been all the rage for 30 years, but all these whippersnappers with their fancy computer models, satellite measurements and stacks of publications in unintelligible academic journals have lost touch with the real world. We still believe the world is headed for an ice age, just as we were taught as undergraduates back in the 1960s.” Who would seem out of touch in that debate? Yet this is exactly where we stand with fiscal stimulus. 

Robert Barro's Ricardian equivalence theorem was one nail in the coffin. This theorem says that stimulus cannot work because people know their taxes must rise in the future. Now, one can argue with that result. Perhaps more people ignore the fact that taxes will go up than overestimate those tax increases. But once enlightened, we cannot ignore this central question. We cannot return to mechanically adding up today's consumption, investment and export demands, and prescribe the government demand necessary to attain some desired level of output. Every economist now knows that to get stimulus to work, at a minimum, government must fool people into forgetting about future taxes, an issue Keynes and Keynesians never thought of. It also raises the fascinating question of why our Keynesian government is so loudly announcing large and distortionary tax increases if it wants stimulus to work.
There is little empirical evidence to suggest that stimulus will work either. Empirical work without a plausible mechanism is always suspect, and work here suffers desperately from the correlation problem. Quack medicine seems to work, because people take it when they are sick. We do know three things. First, countries that borrow a lot and spend a lot do not grow quickly. Second, we have had credit crunches periodically for centuries, and most have passed quickly without stimulus. Whether the long duration of the great depression was caused or helped by stimulus is still hotly debated. Third, many crises have been precipitated by too much government borrowing. 

Neither fiscal stimulus nor conventional monetary policy (exchanging government debt for more cash) diagnoses or addresses the central problem: frozen credit markets. Policy needs first of all to focus on the credit crunch. Rebuilding credit markets does not lend itself to quick fixes that sound sexy in a short op-ed or a speech, but that is the problem, so that is what we should focus on fixing. 

The government can also help by not causing more harm. The credit markets are partly paralysed by the fear of what great plan will come next. Why buy bank stock knowing that the next rescue plan will surely wipe you out, and all the legal rights that defend the value of your investment could easily be trampled on? And the government needs to keep its fiscal powder dry. When the crisis passes, our governments will have to try to soak up vast quantities of debt without causing inflation. The more debt there is, the harder that will be.

Of course we are not all Keynesians now. Economics is, or at least tries to be, a science, not a religion. Economic understanding does not lie in a return to eternal verities written down in long , convoluted old books, or in the wisdom of fondly remembered sages, whether Keynes, Friedman or even Smith himself. Economics is a live and active discipline, and it is no disrespect to Keynes to say that we have learned a lot in 70 years. Let us stop talking about labels and appealing to long dead authorities. Let us instead apply the best of modern economics to talk about what has a chance of working in the present situation and why. 

Here is some Keynesian wisdom I think we should accept. 

“The difficulty lies, not in the new ideas, but in escaping the old ones, which ramify, for those brought up as most of us have been, into every corner of our minds.”

“How can I accept the doctrine, which sets up as its bible, above and beyond criticism, an obsolete textbook which I know not only to be scientifically erroneous but without interest or application to the modern world?”

“Practical men, who believe themselves to be quite exempt from any intellectual influences, are usually the slaves of some defunct economist.”

I think Cochrane is right about bizarre denialist flavor of the recent vogue for undead Keynesianism and — about  most other stuff, too. But I'd also like to see him acknowledge the limits of post-Lucas macro modeling as well. I think the lesson for the economics profession is now pretty clear. Macroeconomics that is useful for policymaking needs to (1) include a lot more political economy and (2) work from more empirically-grounded behavioral assumptions. That is to say, it would be nice to see more top-flight economists like Cochrane acknowledging that macro policy is politics and that people act like people. I suppose doing this would make the math seem impossible, but nobody ever said science was easy.

The Opportunity Cost of the Bailouts

Richard Florida offers some insight

The bailouts and stimulus, while they may help at the margins, also pose an enormous opportunity costs.  One the one hand, they impede necessary and long-deferred economic adjustments. The auto and auto-related industries suffer from massive over-capacity and must shrink.  The housing bubble not only helped spur the financial crisis, it also produced an enormous mis-allocation of resources. Housing prices must come a lot further down before we can reset the economy – and consumer demand – for a new round of growth. The financial and banking sector grew massively bloated – in terms of employment, share of GDP and wages, as the detailed research of NYU's Thomas Phillipon has shown – and likewise have to come back to earth.

On the other hand,  there is the classic question: What better and more effective things might have been done with these trillions?  That’s for historians to ponder and decide. But the combination of the massively misallocated resources produced by the bubble (plus the costs of military adventures)  combined with humongous bailout spending puts the US behind the economic eight-ball in a way it has not been in more than the century. Having hold on the reserve currency helps, but it cannot absolve all these compounded sins.  Sooner or later the money will run out; bills will come due.

That creates a wide open structural opportunity to accelerate what Fareed Zakaria has dubbed the “rise of the rest” to accelerate.  Crises are periods where the relative position of nations and regions can and do  change dramatically.   (Do I think the US will lose its hegemonic position: Of course not.  My hunch is that the US is in the same position structurally as England at the onset of the Long Depression of 1873.  It was not until the next major crisis – the Great Depression of 1929 and the onset of WWII that it lost its position  [to] the United States. So worst case: The US has one more long-cycle at the top of the heap).   But, just think of all the ways the trillions of bailout money could be used to build the economy of the future. And while you’re doing that imagine that some other places … that have been patiently building and conserving their resources may start to figure out how to do just that.

I don't give a fig about the U.S.'s relative position, but I do care about the absolute level of welfare and thus the absolute level of innovation and it is here that I worry about the costs of American decline.

The Revenge of Tucker Carlson

I'm with Tucker Carlson on Jon Stewart:

Cynics might assume that the fury [behind the excoriation of Cramer] was a pose. Humor requires ironic detachment, and nobody as funny and sophisticated as Jon Stewart could possibly be getting that mad on TV over something so abstract. A fair assumption, but wrong. Stewart really was enraged. It was all entirely, strangely real.

I know this from my own run-in with Stewart, on CNN’s Crossfire a few weeks before the 2004 election. Stewart spent a couple of segments lecturing Paul Begala and me about how we were somehow “helping the politicians and the corporations,” a charge that baffled me then (I’ve never particularly liked either one), as it does now.

Unlike most guests after an uncomfortable show, Stewart didn’t flee once it was over, but lingered backstage to press his point. With the cameras off, he dropped the sarcasm and the nastiness, but not the intensity. I can still picture him standing outside the makeup room, gesticulating as the rest of us tried to figure out what he was talking about. It was one of the weirdest things I have ever seen.

Finally, I had to leave to make a dinner. Stewart shook my hand with what seemed like friendly sincerity and continued to lecture our staff. An hour later, one of my producers called me, sounding desperate. Stewart was still there, and still talking.

No one this earnest can remain an effective satirist, and at times Stewart seems like less a comedian than a courtier to the establishment. In August 2004, a week before the Republican convention, Stewart got an interview with then-candidate John Kerry. At the time, reporters covering Kerry couldn’t get closer than the rope line, so the interview qualified as a booking coup.

Stewart squandered it embarrassingly. His first question (after, “How are you holding up?”) was: “Is it a difficult thing not to take it personally” when your opponents are mean?

“You know what it is, Jon?” Kerry replied. “It’s disappointing.”

Four years later, Stewart had become, if anything, even softer. Over the course of a reverential eight-and-a-half minute interview with Barack Obama six days before the election, Stewart failed to ask a single substantive question, much less venture into policy (though, as with Kerry, he did open with, “How are you holding up?”). Instead, like the cable-news morons that he often criticizes, Stewart stuck strictly to the horserace, at one point even resorting to a sports metaphor.

Here's what I said about Stewart way back in 2004 after his Crossfire soapboxing:

You know what? I’m just gonna say it: I’m bored bored bored of John Stewart. The Crossfire thing was the final straw, the shark jumping. He’s permanently tainted, and from here on out we can only look forward to the long slide into “Remember when that guy was funny.” Sanctimony is death to satire. The last thing I need is the fake news guy thinking he’s King Shit protector of the public interest. Yes, Tucker Carlson is a dick. But we all have eyes. Damn, John. You used to be cool.

My feelings haven't much changed. The long slide has taken rather longer than I expected, however. At least there's Colbert!

(Yes, I know it's 'Jon'.)

Journalistic Capture

Glenn Greenwald makes the main point I wanted to make about the last episode of Stewart v. Cramer. There is nothing special about Cramer and there is nothing special about CNBC. The point Greenwald doesn't make, but which I will, is that Cramer, like thousands of others, gives investment advice, and like thousands of others failed to call the collapse and therefore gave a ton of terrible advice. Greenwald's point is that CNBC, like basically every other news outlet, has been captured to some extent or other by the high-placed sources that it has so fastidiously cultivated. Greenwald rightly points out that this is exactly how the New York Times and other elite media outlets talked the country into the war in Iraq.

The point that can't be emphasized enough is that this isn't a matter of past history.   Unlike Cramer — who at least admitted fault last night and said he was “chastized” — most establishment journalists won't acknowledge that there was anything wrong with the behavior of the press corps during the Bush years.  The most they'll acknowledge is that it was confined to a couple of bad apples — The Judy Miller Defense.  But the Cramer-like journalistic behavior during that period that was so widespread and did so much damage is behavior that our press corps, to this day, believes is proper and justified.

And here's something I'd like Jon Stewart to grasp. In some important sense, Timothy Geithner faces the same assymetrical information quandry Cramer did. The government is so incredibly dependent on Wall Street for much of the information it needs that it is almost inconceivable that the government (and thus the taxpayer) is not being gamed. Somehow I'd never thought much before about the similarity between regulatory capture and a journalist's becoming a tool of her sources, but it's a pretty striking similarity.

New at Cato Unbound: Lott Replies to Loury

John Lott is unimpressed with Loury's argument. The gist:

Charges of racism flow freely in Professor Loury’s recent book and this essay.  He makes it seem that we lock up blacks because whites are afraid of them or that we simply dislike them and want to keep them locked up and away from the rest of society.  But Loury forgets an important fact: for violent and property crime there is always an individual victim who gets hurt — for black criminals that victim is overwhelmingly black.  Nor does he recognize how extremely progressive criminal penalties are. He also neglects acknowledging that we can’t determine if the number of people in prison is “too high” without discussing the benefit from prison — without discussing how many crimes were deterred.

Many blacks have their lives disrupted by the criminal justice system, but the lives and property of many blacks are also protected by that same system.  Looking at only the cost of imprisonment seems a very strange way to answer the question of whether we should change the current system.

I'm really lookin forward to the rest of the replies, and to the subsequent blog chat. I find myself fairly sympathetic both to Loury and Lott, which gives me the sense that many elements of their positions are not mutually exclusive.

Christina Romer's Six Lessons

David Frum's new column for The Week nicely lays out what the chair of the White House Council of Economic Advisors really thinks of the administration's economic policy: 

Invited by a reporter Monday to criticize President Obama’s economic plans, the chair of the White House Council of Economic Advisers, Christina Romer, naturally brushed the question aside. “You want me to tell you what's wrong with the fiscal stimulus package?” she said. “SO not going to do that!” 
Too late! As it happens, the lecture Romer had just finished delivering at the Brookings Institute on Monday afternoon was criticism enough. 
An expert on the Great Depression, Romer organized her lecture around six lessons distilled from the era. The administration she serves seems to be disregarding every one of them. 

Read the rest for the lessons.

Hello? Excuse Me! Brrrring… Anybody Home?

Anatole Kaletsky today argues at length what I yesterday argued very briefly on Marketplace:

Which brings us to the greatest risk facing the world economy: Mr Obama's failure to present a credible response to the financial crisis or even to assemble a proper economic policy team. After the British Government's leaked messages of despair about nobody answering the phone at the US Treasury in the preparations for the G20, everybody is now aware that Mr Obama has nominated only two out of 18 deputy and assistant Treasury secretaries. What is less widely recognised is that this decision-making vacuum reflects a deeply worrying feature of US economic policy.

American politicians simply don't seem to understand the existential threat that their economy is now facing. Instead of uniting to deal with a national emergency far more threatening to their way of life than the terrorist attacks of 9/11, they have responded by dividing more sharply than ever into hostile partisan camps.

Efforts to revive economic activity and to stabilise the financial system that are clearly indispensable on the basis of any economic analysis, whether Keynesian or monetarist or plain business-sense, have been denounced on the Right for interfering with free markets and on the Left for feather-bedding bankers. Instead of rallying around in a moment of crisis, many Americans are openly expressing their hope that the new President will fail and the economy collapse. Candidates for key Treasury posts have been viciously attacked in the media and Congress for trivial tax and administrative infractions inadvertently committed many years ago or simply for having once worked on Wall Street. As a result, these jobs have become almost impossible to fill.

Mr Obama himself seems to have attached a surprisingly low priority to dealing with the financial crisis. He had, for example, selected key State Department officials, from Hillary Clinton downwards even before his inauguration. He has managed to get dozens of these confirmed by Congress in the past two months and immediately put his personal stamp on US foreign policy. Yet there has been no similar focus on creating a properly functioning economic team or launching a coherent new response to the financial crisis.

The lack of urgency, of focus and of national unity in America's response to the financial crisis is the most surprising – and most dangerous – threat to our chances of recovery.

Kaletsky's right that conservatives are being stupidly obstructionist, especially about necessary political appointments. But as time goes on, the inattention of the administration to the truly urgent problem facing the country and the world is flabbergasting. The economic crisis does present a window of political opportunity big enough to drive a truck through, and so it's easy to understand why Democrats have been gleefully loading up the truck with everything they've ever wanted ever. But it's really the height of irresponsibility when the circumstances demand that efforts be devoted to ensuring the window doesn't widen to the point that the house collapses on the truck. (What is a truck doing in the house? Can you drive a truck through a window? Where is the truck going? Another house? I can haz Tom Friedman!) If Obama does not luck out (and he is nothing if not lucky) and things get a good deal worse, this early episode of rather terrifying mismanagement will not be forgotten.

Those who think this is a mere partisan talking point and amounts to the idiotic claim that it is not possible to simultaneously walk and chew gum need to back away from their own partisanship and get a little perspective. Also, they should reflect on why Obama, despite his undisputed excellence in gum-chewing, has so far done such an embarrassing job of walking.


The blogs are a twitter with Ross Douthat's ascension to the thone of opinionating at the New York Times. I think the Times made a terrific choice and I'm thrilled for Ross. Oh, it seems like only yesterday when I first met Ross at a reading of Privelege at the Court House Olson Books in Arlington. I attended at the invitation of Ross' longtime housemate and frequent collaborator Reihan Salam, who knows everybody. I've always thought of Reihan as the manic near-omniscient yin to Ross's sober besweatered yang. Not to take anything away from Ross, but I've always seen Reihan as the ideas man in the Ross 'n Reihan operation. Reihan will drop more ideas in ten minutes of conversation than many people will entertain in a lifetime. I've always thought the carnival of erudition that is Reihan's mind deserves a more prominent showcase, which is why I dearly hope the Atlantic will do the natural thing and hand Ross's blog over to Reihan. The blog would be sort of the same but completely different all at the same time.

Hungry for Howley? Try Slate's XX Factor!

If you've been missing your daily dose of the withering wit of Kerry Howley ever since she stopped blogging at Hit & Run, have I got good news for you! You can now satisfy your hankering for your favorite cosmotarian feminist at Slate's XX Factor blog (one X beyond superpowered mutants, one X short of hardcore porn), where Kerry is now a regular contributor. Today, Kerry tells Michele Obama where to stuff her nutrition facts.

Let's Keep Our Eye On the Ball

Here's my Marketplace commentary for this morning.