2010 m. spalio 14 d., ketvirtadienis

Glaeser apie šių metų ekonomikos Nobelį

October 11, 2010
The Work Behind the Nobel Prize

Edward L. Glaeser is an economics professor at Harvard.

This year’s Nobel Memorial Prize in Economic Science (formally the Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel) was awarded today to Peter A. Diamond, Dale T. Mortensen and Christopher A. Pissarides for their research on “markets with search frictions,” which means any setting where buyers and sellers don’t automatically find each other. Search models are relevant in many settings, including dating, used cars and housing, but above all, these models help us make sense of unemployment.

As the United States unemployment rate has remained above 9.4 percent since May 2009, the prize manages both to honor timeless research on core economic questions and to highlight the ways in which economics addresses a most timely global problem.

The most traditional economic model of the labor market assumes a labor supply schedule, which reflects the number of workers willing to work at a given wage, and a labor demand schedule, which describes the number of workers that companies are willing to hire at a given wage. At some wage, supply equals demand and that’s the market equilibrium, which is where traditional economics predicts the world will end up. In markets with undifferentiated products — like copper or winter wheat — that model works pretty well, but it has some pretty obvious failings when it comes to labor or housing markets.

In particular, the Economics 101 model does an awful job explaining an American civilian labor force where nearly one-tenth say they want a job and can’t find one. Die-hard supporters of the basic model sometimes argue that wage floors, like the minimum wage, keep wages too high for the market to clear. But American minimum wages are low, and only a small fraction of jobs are affected by that barrier. Another attempt to save the old model is to argue that unemployed workers just value their time too highly to take a job at current market rates. But the view that the unemployed are just having a swell time hanging out watching cable is wildly at odds with the real world. New paradigms emerge when reality crashes against theory, and that’s what brought us the search theory of Professors Diamond, Mortensen and Pissarides.

Search models don’t just assume that buyers and sellers face a market-clearing price — they try to actually describe the process that determines that price. The ur-search paper, “The Economics of Information,” was published in 1961 by George Stigler (who won his Nobel in 1982). Professor Stigler modeled a product market where consumers kept searching for lower prices until the point where “the cost of search is equated to its expected marginal return,” in the form of lower prices. Professor Stigler then applied search theory to the labor market in 1962, focusing on the dispersion of wages, which he argued should be higher when search was more difficult. He said little about unemployment and didn’t really address the pricing behavior of companies.

Dale Mortensen’s 1970 paper on “Job Search, the Duration of Unemployment and the Philips Curve,” formalized and extended Professor Stigler’s ideas. In Professor Mortensen’s paper, companies offer jobs, each of which requires a certain amount of skill. Jobs with the same skill requirements offer the same wage. Workers then interview for jobs, and if they are qualified, they can either take the job or move along. More skilled workers will be qualified for more jobs, which perhaps explains why the unemployment rate among college graduates is about one-third the unemployment rate for high school dropouts, but they will also be pickier. Pickiness among the more skilled also leads to unemployment, as workers hold out for a better job. In a sense, unemployment does reflect the fact that workers have something better to do than accept a low-paying job. That something is searching for a better-paying job.

But Professor Mortensen’s 1970 paper was still pretty modest in its treatment of the company side of the problem, which Peter Diamond remedied in his 1971 search model, “A Model of Price Adjustment,” published in The Journal of Economic Theory. Professor Diamond began writing about information a few years later, with an article about the “role of the stock market,” in the transmission of knowledge. The 1971 search paper produces a somewhat surprising result: if there are a number of otherwise identical stores, which fix their prices, then competition can lead to high monopoly prices, not low competitive pricing or Stiglerian price dispersion. If consumers think that companies are all charging the same price, then they won’t bother searching. If consumers don’t bother searching, then the only reasonable thing for companies to do is to charge the monopoly price. This result, which is known as the Diamond Paradox, can be weakened if price-cutting companies are able to advertise, but it suggests the enormous ability of search frictions to distort markets.

In the late 1970s, Professors Diamond, Mortensen and Pissarides all turned to the public policy implications of search models. In a 1977 article “Unemployment Insurance and Job Search Decisions,” Professor Mortensen examined the implication of unemployment benefits for unemployment rates. He concluded that the effects were more ambiguous than previously thought, because workers who aren’t currently receiving unemployment insurance benefits will be more likely to take on a low-wage, risky job if they know they can get unemployment insurance if the job doesn’t work out.

The core of Professor Diamond’s work on search models appeared in a three-year window between 1979 and 1982. His work was distinguished both by elegant modeling — building the theoretical tools needed to make sense of labor turnover—and important insights. Perhaps the key idea is the “search externality,” the idea that each “additional worker makes it easier for vacancies to find workers and harder for other workers to find jobs.” In a sense, a flood of unemployed workers can congest the labor market just as a flood of extra drivers can congest a highway. Whenever one worker passes up a job, that worker makes finding a job easier for other workers. This insight led to Professor Diamond’s conclusion that higher levels of unemployment insurance could improve the workings of the labor market by making some workers pass up marginal jobs.

Professor Pissarides had also begun working on job search models in the late 1970s, but he published his masterpiece “Job Creation and Job Destruction in the Theory of Unemployment,” together with Professor Mortensen, in The Review of Economic Studies in 1994. In this model, workers make decisions about searching for jobs. Companies make decisions about creating job openings. When they meet, a worker is hired if both parties benefit from the match. There is an implied negative relationship between the level of vacancies (the number of jobs needing to be filled) and the level of unemployment, which is called the Beveridge Curve. Most importantly, a cyclical downturn can cause the system to go seriously haywire, at least for a while, as the number of jobs destroyed soars and the number of jobs created drops.

The work of these economists does not tell us how to fix our current high unemployment levels, but it does help us to make some sense of our current distress. Their models tell us that common wisdom — like the belief that higher unemployment benefits always increase unemployment — may be wrong and that policies that improve matching may have great value. Rarely has the prize committee been better able to match the honored work with the moment.

2010 m. spalio 13 d., trečiadienis

Woodford siūlymas Bernankei

Bernanke needs inflation for QE2 to set sail
By Michael Woodford
Published: October 11 2010 22:34 | Last updated: October 11 2010 22:34

Debate is raging within the Federal Reserve about whether to do more to stimulate the US economy. It seems many of its leading figures would like to, and the minutes of their last Federal Open Market Committee meeting, released Tuesday, will be read carefully for hints. Yet Ben Bernanke, Fed chairman, knows that a cut in rates, his usual tool, is currently infeasible. Therefore, speculation has turned to a return to quantitative easing (QE2), or large purchases of long-term Treasury bonds.

This would be a dramatic move. But we must not kid ourselves. It would have at best a modest effect in a large, liquid market such as Treasury bonds and, therefore, is unlikely to dig the US economy out of its current hole. There is, however, another option: for the Fed to clarify its “exit strategy” from its current, unconventional monetary stance. This would mean making clear that the Fed has no plans to tighten policy through increases in the federal funds rate, even if inflation temporarily exceeds the rate regarded as consistent with the Fed’s mandate. In short, the Fed should allow a one-time-only inflation increase, with a plan to control it once the target level of prices has been reached.

Such a move would be controversial within the Fed. But such a statement would merely be designed to help reduce expectations regarding both the path of short-term interest rates over the next few years and to increase the expected rate of inflation. Changes in these expectations would stimulate current spending: an expectation that low short-term rates will last for longer will lower long-term interest rates and an expectation of higher inflation should also reduce the perceived real rate of interest. Both of these steps would increase current expenditure by households and firms, giving the US economy a much-needed boost.

This proposal is different from that made in some quarters (and rejected by Fed officials) for an increase in the Fed’s inflation target. In order to obtain the benefits just cited, it is not necessary to make people expect a continuing high rate of inflation. Indeed, that would be counterproductive. To the extent that expectations of a permanently higher inflation rate would create uncertainty about the value of the dollar, for instance, they could easily make long-run real bond yields higher, rather than lower.

Instead, as suggested in a recent speech by William Dudley of the Federal Reserve Bank of New York, the Fed should commit to make up for current “inflation shortfalls” due to its inability to cut interest rates. If, for example, inflation was predicted to run half a percentage point below the Fed’s target for the next two years, the Fed could announce plans to offset this by allowing an additional one per cent rise in prices after that. Once the shortfall has been made up, the Fed would return to its previous, lower target.

Critics will say this will undermine the Fed’s credibility on price stability. They are wrong because the price increases allowed under this “catch-up” policy would be limited in advance. Catch-up inflation would simply put prices back on the path they would have followed had the Fed been able to cut interest rates earlier.

Others argue the opposite case: that a modest increase in prices would have too small an effect to boost the recovery. But the true value of such a commitment would be precluding a disinflationary spiral, in which expectations of disinflation without any possibility of offsetting interest-rate cuts lead to further economic contraction and hence to further declines in inflation. A commitment subsequently to offset any inflation deficit would allow higher future inflation to be anticipated in step with the size of the current inflation shortfall. This in turn would automatically limit the degree of disinflation that can occur.

The instinct of policymakers such as Mr Bernanke is to say less about future policy during a time of economic turmoil, on the grounds that the future seems especially difficult to predict at such times. Yet it is precisely when policymakers face unprecedented conditions that it is most difficult to assume that the public will be able to form correct expectations without explicit guidance. At times like the present, uncertainty about the future is one of the greatest impediments to faster recovery.

The writer is a professor at Columbia University and author of “Interest and Prices: Foundations of a Theory of Monetary Policy”

2010 m. spalio 11 d., pirmadienis

Paul Krugman apie fiskalinio stimulo iliuzijas JAV

Hey, Small Spender
2010.10.10, www.nytimes.com

Here’s the narrative you hear everywhere: President Obama has presided over a huge expansion of government, but unemployment has remained high. And this proves that government spending can’t create jobs.

Here’s what you need to know: The whole story is a myth. There never was a big expansion of government spending. In fact, that has been the key problem with economic policy in the Obama years: we never had the kind of fiscal expansion that might have created the millions of jobs we need.

Ask yourself: What major new federal programs have started up since Mr. Obama took office? Health care reform, for the most part, hasn’t kicked in yet, so that can’t be it. So are there giant infrastructure projects under way? No. Are there huge new benefits for low-income workers or the poor? No. Where’s all that spending we keep hearing about? It never happened.

To be fair, spending on safety-net programs, mainly unemployment insurance and Medicaid, has risen — because, in case you haven’t noticed, there has been a surge in the number of Americans without jobs and badly in need of help. And there were also substantial outlays to rescue troubled financial institutions, although it appears that the government will get most of its money back. But when people denounce big government, they usually have in mind the creation of big bureaucracies and major new programs. And that just hasn’t taken place.

Consider, in particular, one fact that might surprise you: The total number of government workers in America has been falling, not rising, under Mr. Obama. A small increase in federal employment was swamped by sharp declines at the state and local level — most notably, by layoffs of schoolteachers. Total government payrolls have fallen by more than 350,000 since January 2009.

Now, direct employment isn’t a perfect measure of the government’s size, since the government also employs workers indirectly when it buys goods and services from the private sector. And government purchases of goods and services have gone up. But adjusted for inflation, they rose only 3 percent over the last two years — a pace slower than that of the previous two years, and slower than the economy’s normal rate of growth.

So as I said, the big government expansion everyone talks about never happened. This fact, however, raises two questions. First, we know that Congress enacted a stimulus bill in early 2009; why didn’t that translate into a big rise in government spending? Second, if the expansion never happened, why does everyone think it did?

Part of the answer to the first question is that the stimulus wasn’t actually all that big compared with the size of the economy. Furthermore, it wasn’t mainly focused on increasing government spending. Of the roughly $600 billion cost of the Recovery Act in 2009 and 2010, more than 40 percent came from tax cuts, while another large chunk consisted of aid to state and local governments. Only the remainder involved direct federal spending.

And federal aid to state and local governments wasn’t enough to make up for plunging tax receipts in the face of the economic slump. So states and cities, which can’t run large deficits, were forced into drastic spending cuts, more than offsetting the modest increase at the federal level.

The answer to the second question — why there’s a widespread perception that government spending has surged, when it hasn’t — is that there has been a disinformation campaign from the right, based on the usual combination of fact-free assertions and cooked numbers. And this campaign has been effective in part because the Obama administration hasn’t offered an effective reply.

Actually, the administration has had a messaging problem on economic policy ever since its first months in office, when it went for a stimulus plan that many of us warned from the beginning was inadequate given the size of the economy’s troubles. You can argue that Mr. Obama got all he could — that a larger plan wouldn’t have made it through Congress (which is questionable), and that an inadequate stimulus was much better than none at all (which it was). But that’s not an argument the administration ever made. Instead, it has insisted throughout that its original plan was just right, a position that has become increasingly awkward as the recovery stalls.

And a side consequence of this awkward positioning is that officials can’t easily offer the obvious rebuttal to claims that big spending failed to fix the economy — namely, that thanks to the inadequate scale of the Recovery Act, big spending never happened in the first place.

But if they won’t say it, I will: if job-creating government spending has failed to bring down unemployment in the Obama era, it’s not because it doesn’t work; it’s because it wasn’t tried.

2010 m. spalio 10 d., sekmadienis

Požiūris į nelygybę JAV

"Wealth and an American Paradox"
Why are Americans mostly opposed to redistribution?:
Sunday, October 03, 2010

Wealth and an American paradox, by Claude Fischer, Berkeley Blog: The liberal blogosphere is currently atwitter over a new study produced by Michael Norton and Dan Ariely (pdf) showing how much Americans underestimate economic inequality in America.

A 2005 on-line survey asked thousands of respondents to estimate what proportion of all the total wealth in the country was owned by the richest one-fifth of Americans, the next richest one-fifth and so on. On average, the respondents guessed that the richest one-fifth owned about three-fifths of the nation’s wealth; in reality the richest one-fifth own over four-fifths of it. The survey also asked respondents for their ideal distribution; on average, they preferred a society in which the richest one-fifth owned about one-third of the national wealth. (Although dramatic, these findings are not surprising. ... Americans generally cannot provide accurate statistical descriptions of America. ...)

According to the new study, then, Americans not only think that wealth is much more equally distributed than it really is, they want an America that is much more equal than they imagine it is today. And yet, Americans are notably opposed to the government doing anything to move the distribution of wealth in that direction. Why the contradiction?

America the Unequal

The United States has the greatest inequality of income and wealth among affluent western nations. And that inequality has been increasing pretty steadily since about 1970 — more so than in other western nations – with a slowdown in the late 1990s and a few short-term fluctuations in wealth inequality due to swings in the stock market. This is pretty much understood by serious scholars (with a few outlying voices in dissent). It looks like Americans have been sensing rising inequality, too. ...

Hands Off

And yet, Americans, studies have shown, are more opposed to having the government do anything about this inequality than are citizens of other western nations. (And, of course, the United States in fact does less than other western nations to address inequality.) ... Surveys asking whether the government should do something major (on the order of what European nations do) show continuing opposition from many, if not most, Americans. ...


So, it appears that Americans have noticed growing inequality, but they haven’t really changed their general opposition to the government doing anything dramatically different about it (beyond perhaps financing “shovel-ready” projects). Why?

One implication of the Norton-Ariely paper cited above is that, were most Americans to appreciate how unequal their society is and how much greater that inequality is than their ideal, their political views would shift.

Perhaps, but perhaps not. The other evidence suggests that increasingly many Americans have been aware of growing inequality, but that has not changed their resistance to explicit economic “leveling.” ...

Versions of this paradox have perplexed social scientists for decades. (See also this earlier post.) Here are a handful of plausible explanations forwarded by scholars:

“Anti-statism.” Americans have been historically suspicious of and hostile to government (although they have accepted many pragmatic programs, like Medicare). Therefore, they may wish that inequality was much less than it is, but they will not empower the government to do something serious about it.

Opportunity, not outcome. Survey data show that many Americans generally do support government actions that widen opportunities for economic advancement, especially through education. Most Americans may believe, then, that in a society of equal opportunity, unequal outcomes can be reduced or at least tolerated. (Unfortunately, the belief that the U.S. is particularly open to upward mobility is empirically incorrect.)

Race trumps: In the U.S., issues of economic inequality have been tangled up with issues of race, because blacks have disproportionately been poor and the likeliest recipients of government assistance. Research suggests that this prospect leads whites to resist government action, even action that might benefit themselves.

Ideology of self-reliance: Americans have been historically committed to emphasizing individual independence and self-reliance; increased government action threatens to create dreaded “dependency.” In practice, Americans have comprised that ideology when conditions demanded – in the Great Depression, for example; or in accepting disaster relief. But these values make for deep resistance to any major new initiatives.

Constricted horizons: Some have argued that political discussions here are so narrowly bounded that Americans may see and resent great inequality but cannot really imagine that things could be (and are elsewhere) different. When, for example, the free-enterprise Obama health plan is seen by so many as an extreme, socialistic program, when our tax rates on the wealthy are described as confiscatory, or when Sweden is depicted as some sort of totalitarian state, it would seem that Americans are operating with blinders on.
The latest Norton-Ariely paper provides a vivid picture of just how unaware Americans are of how unequally distributed wealth has become in the United States. It still leaves us with the puzzle of why most Americans, even when they are aware of that imbalance, oppose major efforts to rebalance it.

The best I can do is related to the "race trumps" explanation, but it's more about the individual and everyone else than race. That is, I think people do feel they get a raw deal, that they are not paid according to what they contribute to society due to one thing or another working against them ("the system" generally). They feel they deserve more. That would be fair. So they would and do favor policies that clearly correct the inequities that they feel.

However, when the typical household does the calculation for most policies that are proposed, or that have been implemented in the past, they conclude, rightly or wrongly, that on net it won't end up favoring them. They will, yet again, be asked to pay the bills and then end up with even less to show for it. When the middle class hears redistribution they don't think it will be from the wealthy to them, or from the wealthy to the poor, but rather from them to the poor. These programs never end up working in their favor, and they don't think it's fair that their hard-earned money, money that is needed to make it to the end of the month, ought to be given to people who don't share their commitment to hard work (I want to be clear that I am speculating about what others think, not giving my own view). Things like the bailout of the financial crisis tell them that the wealthy and powerful always find ways to come out on top -- when the applecart is upset they end up with more apples than everyone else -- and attempts to make them pay more inevitably end up, one way or another, as a new burden on the middle class. They are told that the taxes for these programs will only fall on the wealthy -- who don't always deserve what they have -- but when it's time to actually pay for the programs, somehow the taxes for the middle class always seem to go up. They always end up paying the largest part of the bill. So why even try if, in the end, it will only make the middle class worse off? Why give their hard earned money to people who are less-deserving, people who don't even try and instead simply live off "the system."

And that is the misperception that I think is a big part of this, that the poor deserve their fate because of the choices that they have made. The system didn't oppress them or hold them back, it wasn't where they grew up, it wasn't the schools they went to, etc., etc. It was their own choices and lack of ability and hey, while life isn't easy for those of us in the middle class, we get up every day and go to work and do what needs to be done. Why should our hard earned money go to help those who are unwilling to do these things? I think it's this misperception, that the poor are poor largely due to their own poor choices, and that it's unfair to take from the hard-working middle class to give them help, that creates resistance to redistribution.

I think the whole debate over "what is rich" reflects this -- it says don't take my money, I'm a hard-working stiff just trying to have enough to pay the bills at the end of the month just like the rest of you, if anything I deserve more -- so keep your hands out of my pockets

2010 m. spalio 8 d., penktadienis

Stiglitz siūlo nurašyti dalį būsto paskolų

Fixing America’s Broken Housing Market
Joseph E. Stiglitz
www.project-syndicate.org, 2010-09-08

NEW YORK – A sure sign of a dysfunctional market economy is the persistence of unemployment. In the United States today, one out of six workers who would like a full-time job can’t find one. It is an economy with huge unmet needs and yet vast idle resources.

The housing market is another US anomaly: there are hundreds of thousands of homeless people (more than 1.5 million Americans spent at least one night in a shelter in 2009), while hundreds of thousands of houses sit vacant.

Indeed, the foreclosure rate is increasing. Two million Americans lost their homes in 2008, and 2.8 million more in 2009, but the numbers are expected to be even higher in 2010. Our financial markets performed dismally – well-performing, “rational” markets do not lend to people who cannot or will not repay – and yet those running these markets were rewarded as if they were financial geniuses.

None of this is news. What is news is the Obama administration’s reluctant and belated recognition that its efforts to get the housing and mortgage markets working again have largely failed. Curiously, there is a growing consensus on both the left and the right that the government will have to continue propping up the housing market for the foreseeable future. This stance is perplexing and possibly dangerous.

It is perplexing because in conventional analyses of which activities should be in the public domain, running the national mortgage market is never mentioned. Mastering the specific information related to assessing creditworthiness and monitoring the performance of loans is precisely the kind of thing at which the private sector is supposed to excel.

It is, however, an understandable position: both US political parties supported policies that encouraged excessive investment in housing and excessive leverage, while free-market ideology dissuaded regulators from intervening to stop reckless lending. If the government were to walk away now, real-estate prices would fall even further, banks would come under even greater financial stress, and the economy’s short-run prospects would become bleaker.

But that is precisely why a government-managed mortgage market is dangerous. Distorted interest rates, official guarantees, and tax subsidies encourage continued investment in real estate, when what the economy needs is investment in, say, technology and clean energy.

Moreover, continuing investment in real estate makes it all the more difficult to wean the economy off its real-estate addiction, and the real-estate market off its addiction to government support. Supporting further real-estate investment would make the sector’s value even more dependent on government policies, ensuring that future policymakers face greater political pressure from interests groups like real-estate developers and bonds holders.

Current US policy is befuddled, to say the least. The Federal Reserve Board is no longer the lender of last resort, but the lender of first resort. Credit risk in the mortgage market is being assumed by the government, and market risk by the Fed. No one should be surprised at what has now happened: the private market has essentially disappeared.

The government has announced that these measures, which work (if they do work) by lowering interest rates, are temporary. But that means that when intervention comes to an end, interest rates will rise – and any holder of mortgage-backed bonds would experience a capital loss – potentially a large one.

No private party would buy such an asset. By contrast, the Fed doesn’t have to recognize the loss; while free-market advocates might talk about the virtues of market pricing and “price discovery,” the Fed can pretend that nothing has happened.

With the government assuming credit risk, mortgages become as safe as government bonds of comparable maturity. Hence, the Fed’s intervention in the housing market is really an intervention in the government bond market; the purported “switch” from buying mortgages to buying government bonds is of little significance. The Fed is engaged in the difficult task of trying to set not just the short-term interest rate, but longer-term rates as well.

Resuscitating the housing market is all the more difficult for two reasons. First, the banks that used to do conventional mortgage lending are in bad financial shape. Second, the securitization model is badly broken and not likely to be replaced anytime soon. Unfortunately, neither the Obama administration nor the Fed seems willing to face these realities.

Securitization – putting large numbers of mortgages together to be sold to pension funds and investors around the world – worked only because there were rating agencies that were trusted to ensure that mortgage loans were given to people who would repay them. Today, no one will or should trust the rating agencies, or the investment banks that purveyed flawed products (sometimes designing them to lose money).

In short, government policies to support the housing market not only have failed to fix the problem, but are prolonging the deleveraging process and creating the conditions for Japanese-style malaise. Avoiding this dismal “new normal” will be difficult, but there are alternative policies with far better prospects of returning the US and the global economy to prosperity.

Corporations have learned how to take bad news in stride, write down losses, and move on, but our governments have not. For one out of four US mortgages, the debt exceeds the home’s value. Evictions merely create more homeless people and more vacant homes. What is needed is a quick write-down of the value of the mortgages. Banks will have to recognize the losses and, if necessary, find the additional capital to meet reserve requirements.

This, of course, will be painful for banks, but their pain will be nothing in comparison to the suffering they have inflicted on people throughout the rest of the global economy.

Kamščių išoriniai efektai

Manhattano pavyzdžiu.

2010 m. spalio 6 d., trečiadienis

Skirtingi to kas vyksta modeliai

Model Mayhem: Its Not in the Math Ezra
October 5th, 2010 by Karl Smith

Ezra Klein apparently asks for the difference between the models that Krugman and Delong use and the models that their opponents use.

So first there are some different Schools out there. I’ll give a rough and ready estimate of what I think they are.

Real Business Cycle

I think there are still some people who essentially believe that Real Business Cycles are correct. I assume Casey Mulligan is in this camp. I think Cochrane and Fama are implicitly in this camp though I don’t know if they have stated as much.

In this world markets always clear, government spending must reduce private spending and running up the deficit always leads to lower investment and growth.

For these guys recessions represent people for various reasons deciding not to work. It might be a productivity shock. It might be government disincentives.

If you want a nice little nerd rundown you can check this out:



There are some people, I am thinking Arnold Kling here, who believe in what I might call a neo-Austrian view. I don’t think there are any formal models here and I might be mistaken but I think many in this camp eschew formal models. What there is, is a basic sense that markets work as an evolutionary process.

Within that process transitional pains are to be expected and recessions are just a big version of that. Arnold is currently the most vocal intellectual in this School but if you had to nail down what the Peter Schiffs of the world are thinking, its probably closest to something like Recalculation.

If anyone says that the government caused a bunch of people to buy houses they couldn’t afford and now we are working through the pains of that, they are effectively a Recalculationist.

In summary, for these guys recessions are caused by mistakes which take time to be corrected. There is no treatise as such but you can try:



There are some people who think that the problem is matching the right workers with the right jobs. Kocherlakota and Stephen Williams are in this camp.

For them a recession is basically a giant shift in priorities. What makes them different from recalculationist is that there need be no “mistake.”

There might have been mistakes but that’s not the key. The key is that the economy is shifting. Some will say that the recession is just an inflection point in a long trend. Some will cite the housing bubble but not make a big deal out of it being an error, just that priorities have changed.

For the super nerd version check out


New Keynesians

Then there is basically everyone else who is some version of a New Keynesian. This literature is much bigger than I am but the bedtime story that we are told in graduate school is that the modern models began with this guy. You might have heard of him.


For these guys recessions are about an excess demand for some type of financial instrument.

Some people see it as explicitly bonds. This means everyone is trying to save at the same time but this is impossible.

Some people see it as explicitly money. This means everyone is trying to build up cash reserves at the same time but this is impossible.

Some people see it as explicitly high credit instruments. This means everyone is trying to run away from risky investments at the same time but this leads to a cascade that makes moderately risky investments very risky, which in turn makes mildly risky investments very risky and so forth.

I tend to think that all three work together as an agglomeration because of a host of transaction cost and principle-agent problems. But that is beyond the scope of this post.

For the most part the central issue in this line of thinking is: how can swapping around financial instruments which are in some sense just pieces of paper have these huge effects on the real economy? For this to work the connection between the real economy and the financial economy has got to be sticky in some way. The bedtime story is that Greg offered one of the first consistent reasons why.

By and large most economists are working with some type of New Keynesian model. The difference is the focus or the details. In terms of policy, however, I think political economy concerns dominate.

My thoughts tend this way: look this all about money (or bonds or credit) and so the focus of everything is the Fed.

I was a stimulus skeptic. I could see the reasoning but I thought it better to focus all of our attention on monetary policy. I also suggested then and now that if fiscal stimulus must be done, that it should consist entirely of tax cuts or increases in direct assistance to the poor.

However, this was for political economy reasons. Not model reasons. If someone asked whether I thought GDP was higher or lower as a result of the Obama stimulus, I would answer: higher.

On the other hand, Brad and Paul like to focus on spending. I suspect this is in no small part because they think government spending is too low anyway. Why not kill two birds with one stone: build some roads and get some jobs.

A lot of the spending guys like to focus on the higher multiplier of spending when compared to tax cuts. I think this is to some extent a red-herring. We get more bang for the buck with spending but we can also move more bucks with tax cuts. For example, a complete payroll tax holiday in 2009 would have resulted in something like 900B in stimulus in a single year. With ARRA I think we got something like 300B and even then much of that was from the tax cut portion. Spending money just takes time.

At the end of the day, your choice of New Keynesian instruments: monetary policy, government spending or tax cuts depends mostly on political economy concerns. That is, your view of the fundamental relationship between the government and the economy.

Additional Readings: Two simple but powerful pieces that are worth reading in my mind.

Barro’s Critique of all things Keynesian:


Mankiw’s Defense of the Basic Keynesian Observation:


2010 m. spalio 1 d., penktadienis

Jim Skea mintys labai tinka Lietuvai

A practical guide to decarbonising the global economy
by Jim Skea
Summer 2010, www.europesworld.org

Sorting fact from fiction is becoming central to the climate change debate. In the aftermath of Copenhagen and with Cancun looming ahead, Jim Skea distinguished what can be done and what must be done

There are two approaches to meeting the challenge of climate change. One way is to ask how quickly we can de-carbonise the global economy if dangerous climate change is to be avoided, the other is how quickly we must do so.

How much common ground is there between the two? If they were two hands reaching out to each other, no one would say they are clasped in a firm handshake, but at least the fingertips are touching.

Last December’s Copenhagen Accord aims to keep global temperature increases below 2OC, and is commonly associated with reducing all greenhouse gas (GHG) emissions around the world by around 50% by 2050, and those from developed countries by around 80%. Yet the scientific truth is that keeping temperature increase below 2OC cannot be guaranteed. Probabilistic modelling work shows that if we can assume global emissions peak in 2016 and fall by 4% a year thereafter, there is still a 50% chance that the 2OC threshold will be exceeded. If emissions fall at only 1.5% per year that probability rises to 80%.

There are also compromises on the “can” side of the debate. Among the stream of recent studies is one from the European Climate Foundation that shows it would be technically and economically feasible to reduce emissions by 80% at an affordable cost less than 1-2% of GDP. It is also often noted that 80% reduction targets are feasible, but require step changes in the delivery of policy, and thus the exercise of political will.

The term “challenging” is often used in the debate on how to tackle climate change, so it's worth exploring what is meant by this euphemism. There are two key elements; the first is that governments are orchestrators of societal action, but they are not the agents of practical change. It is the role of the private sector and citizens that is critical to investing in and driving forward low carbon solutions. Given the urgency and scale of action required, establishing trust between private and public sectors and as well as a shared understanding of the way forward is fundamental. For governments, this translates into a need for clear, stable, long-term policy signals that are developed with buy-in from the private sector.

The second key element is social consent. All the low-carbon scenarios so far involve investment in energy supply and infrastructure that will impinge on citizens, and also the assumption that people will choose different technologies for use in the home or on their travels, and so will to some extent modify their own behaviour. It is certainly true that people will be paying more for energy, but there is also strong sense that the consensus about climate change among Europe’s elites is not yet shared by public opinion at large. Two things could prevent the broadening of that consensus; the assault on climate science that has tarnished the reputation of the International Panel in Climate Change (IPCC), and fall-out from the banking crisis.

But the only basis for public-private trust and social consent to more determined policies is an honest dialogue. In Europe this means a clearer picture of which interventions are the most effective, and what the costs will be. The EU’s emissions trading scheme (ETS) is widely presented as the cornerstone of its strategy for reducing GHG emissions. Yet, this is simply not true; no framework that is delivering a CO2 price of €16 a tonne can be the cornerstone of a credible climate strategy. To reach an 80% reduction in GHG emissions by 2050 will require us to implement measures that will cost more than €100 a tonne, perhaps much more. The truth is that low carbon electricity, the key to a low carbon economy, depends on other policy interventions, notably those taken by national governments to meet their obligations under the EU’s Renewable Energy Directive. The CO2 price implicit in such measures as feed-in tariffs and renewables obligations provides a much more realistic account of the effort needed to mitigate climate change.

Equally, the current CO2 price will not by itself support more controversial technologies like carbon capture and storage (CCS) or nuclear power. There is no reason why the ETS could not in principle be the cornerstone of the EU’s climate strategy, but that would mean biting the bullet and allocating far fewer emission allowances than the EU currently does so as to drive up prices and incentivise serious mitigation efforts. At €16 a tonne, all Europe can hope to do is fine-tune the operational balance between coal and gas and influence the purchase of international emissions credits. Not a cent’s worth of investment will be stimulated.

So far, the burden of increasing investment in low carbon energy is largely borne by Europe’s energy consumers via their electricity bills. The recession has already had a real impact on their incomes, with perhaps worse to come, so the spotlight is sure to fall on the resources for climate change mitigation. Even if only 1-2% of GDP needs to be spent in it over the next 40 years, politics will be driven by the here and now.

It is incumbent on policymakers to ensure that consumers’ contributions towards a low carbon society are cost-effective. It’s still not certain that the balance is right between renewable energy support, energy efficiency incentives and support for emerging technologies such as carbon capture and storage. There are also other rationales than low carbon for investing in emerging technologies. There is a systemic market failure in relation to innovation as much as there is in relation to the externalities associated with GHG emissions. Public sector intervention in support of new technologies is perfectly legitimate, but some existing choices also need to be questioned. In Britain, for instance, does it make sense to offer private householders a financial inducement to generate photovoltaic electricity when much more cost-effective measures like home insulation and double glazing set nothing comparable in support?

The EU can only be part of a wider global process of de-carbonisation. The EU should continue to play a leading in this process, but by leading do we mean simply setting the most ambitious targets, or something more? The brutal truth is that the actions of China and the U.S. will not be tightly coupled to the targets by we Europeans. China’s approach is likely to be determined by a cool assessment of the advantages and disadvantages of climate mitigation, but whatever it chooses to do, its low carbon investment will be staggering. Last year China accounted for the global majority of new wind energy installations. By contrast, the U.S. approach will be the result of messy internal politics.

The main contribution Europe can make is to press ahead with climate measures that make sense, and these are many. One of Europe’s widely perceived weaknesses is to set ambitious targets and then fail to deliver results, so closing this implementation gap is essential. A host of vigorously implemented measures, like de-carbonisation of electricity supply, enhanced use of renewables, aggressive energy efficiency and the gradual extension of electricity into heating and transport, could bring greater energy security. Europe’s economic structure would change, but would not be disadvantaged as long as cost-effective balanced policies are pursued.

On the international stage, this would send a strong signal to smaller economic players other than China and the U.S. that Europe is taking a leading role. Securing their support has obvious advantages in terms of fostering new industries with global potential. While not perhaps changing the internal debate in China and the U.S., it would give others confidence that the measures they take will be in line with global best practice.

TVF apie fiskalinės konsolidacijos kaštus/naudą

Budget Cuts and Growth: Short-term Pain, Long-term Gain
IMF Survey online, www.imf.org

September 30, 2010

* Most advanced economies will have to make difficult budget cuts
* Results tend to be painful in the short term
* In the long term, reducing government debt is beneficial

Almost all advanced economies will need to cut deficits and raise taxes to put their fiscal positions back on a sustainable footing in the coming years.

Analysis in a chapter of the IMF’s latest World Economic Outlook shows that initially fiscal retrenchment typically has contractionary short-term effects on economic activity, with lower output and higher unemployment.

But it is likely to be beneficial over the longer term. “In particular, lower debt is likely to reduce real interest rates and the burden of interest payments, allowing for future cuts to distortionary taxes,” the authors say. By boosting private investment, this increases output in the long term.

Will it hurt?

In the chapter titled “Will It Hurt? Macroeconomic Effects of Fiscal Consolidation,” the authors find that within two years of cutting the budget deficit by 1 percent of GDP, domestic demand—consumption and investment—is about 1 percent lower, and the unemployment rate is about ⅓ percentage point higher. Because net exports––exports minus imports––tend to rise when budget deficits are cut, the overall impact on GDP is a decline of ½ percent.

A number of factors usually soften the short-term impact of fiscal consolidation. Using a new data set, the authors show that central banks usually cut interest rates and the currency falls in value. This helps cushion the impact on consumption and investment, and boosts exports.

Second, fiscal consolidation is less costly when markets are more concerned about fiscal sustainability. Third, consolidations based on spending cuts are less painful than those based on tax hikes. This is largely because central banks cut interest rates more after spending cuts.

Today’s environment

The findings suggest that in today’s environment, fiscal consolidation is likely to have more negative short-term effects than usual.

In many economies, central banks can only provide a limited monetary stimulus because interest rates are already near zero. Moreover, if many countries adjust simultaneously, the output costs are likely to be greater—since not all countries can reduce the value of their currency and increase net exports at the same time. Fiscal retrenchment is also likely to be more costly for members of a monetary union where scope for a fall in the value of their currency is reduced.

The simulations suggest that the contraction in output may be more than twice as large as the IMF’s baseline estimate when central banks cannot cut interest rates, and when the adjustment is synchronized across all countries. But for economies considered at high risk of sovereign default, short-term negative effects are likely to be smaller.

There are a number of ways to reduce the impact of needed fiscal consolidation on the recovery. Measures that are legislated now but only reduce deficits in the future—when the recovery is more robust—would be particularly helpful. Examples include linking statutory retirement ages to life expectancy and improving the efficiency of entitlement programs.

Brad DeLong išaiškina "pinigų paklausos" problemą

What Is This "Demand for Money" of Which You Speak?

If our big macroeconomic problem of deficient demand for currently-produced goods and services were the result of a deficient supply of liquid cash money--the stuff you keep in your pockets and use for clearing and functions as a medium of exchange--then the prices of all alternatives to money would be very low: people would be trying to dump their holdings of other assets to build up their stocks of liquid cash money, and only very low prices of and very high expected rates of return on those alternatives could check that desire. Thus we would expect a downturn caused by a shortage of liquid cash money to be accompanied by very high interest rates on, say, government bonds--which share the safety characteristics of money and serve also as savings vehicles to carry purchasing power forward into the future, but which are not liquid cash media of exchange.

Nevertheless, David Beckworth writes:

Macro and Other Market Musings: Martin Wolf, the Paradox of Thrift, and the Excess Demand for Money: Martin Wolf concludes more borrowing may be just what the economy currently needs.... [His] paradox of thrift idea is really nothing more than another way of saying there is a monetary disequilibrium created by an excess demand for money. And, of course, an excess demand for money is best solved by increasing the quantity of money. The painful alternative is to let the excess money demand lead to a decline in total current dollar spending and deflation until money demand equals money supply... the paradox of thrift requires the Fed to be asleep on the job.

Let me explain why the Paradox of Thrift is really just an excess demand for money problem.... [I]ndividual households can save... by cutting back on consumer spending and hoarding money... by spending income on stocks, bonds, or real estate and... by paying down debt.... [I]ncreas[ing] their holdings of money by cutting back on expenditures... will create an excess demand for it and a painful adjustment process will occur. If, on the other hand, the Fed adjusts the money supply to match the increased money demand then the painful adjustment is avoided.... In the latter two cases where assets are bought and debt is paid down the money is passed on to the seller of the assets or to the creditor. Here, the only way to generate the painful adjustment is for the seller or creditor--or any other party down the money exchange line--to hoard the money. If the creditor or seller does not hoard the money then it continues to support spending and price stability. All is well. Increased austerity, then, only becomes an economy-wide problem when it leads to an excess demand for money.... The fundamental proposition of monetary theory is that an individual household can adjust its money stock to the amount demanded, but the economy as a whole cannot...

The hole in David's argument is, I think, where he says "the Fed adjusts the money supply" without saying how. Suppose that we have a situation--like we have today--where people are trying to cut back on their expenditure on currently-produced goods and services in order to build up their stocks of safe assets: places where they can park their wealth and be confident it will not melt away when their back is turned. They switch spending away from currently-produced goods and services and try to build up their stocks of safe assets--extremely senior and well-collateralized private bonds, government securities, and liquid cash money. Now suppose that the Federal Reserve increases the money supply by buying government securities for cash. It has altered the supply of money, yes. But it interest rates are already very low on short-term government paper--if the value of money comes not from its liquidity but from its safety--then households and businesses will still feel themselves short of safe assets and still cut back on their spending on currently-produced goods and services and the expansion of the money supply will have no effect on anything. The rise in the money stock will be offset by a fall in velocity. The transactions-fueling balances of the economy will not change because the extra money created by the Federal Reserve will be sopped up by an additional precautionary demand for money induced by the fall in the stock of the other safe assets that households and businesses wanted to hold.

So, yes, Beckworth is right in saying that there is an excess demand for money. But he is wrong in saying that the Federal Reserve can resolve it easily by merely "adjust[ing] the money supply. The problem is that--when the underlying problem is that the full-employment planned demand for safe assets is greater than the supply--each increase in the money supply created by open-market operations is offset by an equal increase in money demand as people who used to hold government bonds as their safe assets find that they have been taken away and increase their demand for liquid cash money to hold as a safe asset instead.

Increasing the money supply can help--but only if the Federal Reserve does it without its policies keeping the supply of safe assets constant. Print up some extra cash and have the government spend it. Drop extra cash from helicopters. Have the government spend and. by borrowing to finance it, create additional safe assets in the form of additional government debt. Guarantee private bonds and make them safe. Conduct open market operations not in short-term safe Treasuries but in other, risky assets and so have your open market operations not hold the economy's stock of safe assets constant but increase it instead.

These are all ways of increasing the money supply or of decreasing the effective demand for money by shifting some of the precautionary demand for money-not-as-liquid-but-as-safe-asset over to newly-created other safe assets.

These are all ways that ought to work, the Lord willing and the creek don't rise.

But to say that the problem is an excess demand for money is, I think, misleading, for it suggests that the standard way of increasing the money stock--open market operations that swap liquid cash for other assets while holding the total stock of safe assets in the economy constant--will also work. And by this point I think we have a bunch of evidence that it does not.

And to describe these other policy moves--printing up some extra cash and having the government spend it; dropping extra cash from helicopters; having the government spend and. by borrowing to finance it, create additional safe assets in the form of additional government debt; guaranteeing private bonds and making them safe; conducting open market operations not in short-term safe Treasuries but in other, risky assets and so having your open market operations not hold the economy's stock of safe assets constant but increase it instead--as "monetary policy" seems likely to me to add to the general confusion. When the excess demand for liquid cash money is itself the result of a spillover from a more fundamental excess of (planned) savings over investment or of (planned) safe asset holdings over supply, standard open market operations that are designed to hold the stock of safe assets and the stock of savings vehicles constant are unlikely to work. And when Federal Reserve monetary expansions do work, it is likely to be because they not only increased the supply of money but more important increased the supply of safe assets or increased the supply of savings vehicles.

The point, I think, is that liquid cash money is not only a medium of exchange but it is also a store of value--a savings vehicle--and a hedge--a place of safety that you hold in your portfolio to satisfy your precautionary demand, and so the transactions demand for money is only part of the whole. But because other assets are stores of value and hedges a well, to focus exclusively on the supply and demand for money is to miss much of the action in times like these.

I am still frustrated that all of this seems so clear to me and is to opaque to so many other smart people. Personally, I blame Olivier Blanchard for making us spend three weeks on Lloyd Metzler's "Wealth, Saving, and the Rate of Interest" in my first year of graduate school...