The goal of an RE model is to establish the universality (or lack thereof) of a specified problem.

From Marginal Revolution:

"Why it's worth defending rational expectations theory

RSuleiman, a commentator over at Ezra Klein, writes:

Having just finished reading the paper, it seems very much of a piece with Professor Cowen's other post-crash writings, and yes, it does seem to be designed as a defense of the rational markets hypothesis.

He is referring to my piece on the crash. Suleiman's is a common response but it is neglecting why rational expectations (RE) models are so powerful and also, at least among economists, so popular. Economists try to fit various phenomena into RE models to show that the mechanisms underlying those phenomena are general and not relying on some very specific set of assumptions about expectations. The goal is not to convince everyone that expectations, or markets, are indeed rational. They're not, at least not always.

The goal of an RE model is to establish the universality (or lack thereof) of a specified problem.

There are people who misuse rational expectations techniques, but don't let those mistakes mislead you. Krugman and Stiglitz also have used RE a lot as a modeling device, although they are (properly) willing to abandon it as a descriptive assumption in many cases. A market failure argument with RE is often more powerful than a market failure argument without RE.

Posted by Tyler Cowen on June 9, 2009"

Me:

Although I often disagree with you, I generally find your views useful and clear. In fact, even when I generally disagree with you, as in this paper, I understand your point and am, in a certain basic sense, sympathetic to it. I feel the same way about Richard Posner. Even as I disagree with him, I tend to feel some common ground.

In the last few years, some people sold their houses and most of their stocks, and ended up largely in, say, CDs. They did this because they saw that we were in a housing bubble, and stocks had risen quite a bit after the tech bubble burst. Also, the Bush Administration had run up such a huge debt in a short amount of time, that, if a crisis hit, the government's responses would be hindered. What did these people know?

I don't think that some of these people knew anything for sure, but they had a motley list of rules, nostrums, and life experiences ( very important ), that translated into a careful, prudential, manner of dealing with money. When I read Taleb's works, I basically find that he simply produces such a list in the end. Possibly these people are followers of Benjamin Graham, for example. In any case, these people had a manner of dealing with money that helped them weather this crisis. Prudentially, beforehand, they had bought houses and some stocks and mutual funds. This doesn't mean that they became rich, just better off than they would have been.

In real life, such people, seeing the riskiest buyers buying houses at the top of the market,could make no sense of this event. It's not that the buyers were poor. Presumably, in a different market, these people could afford a house. But, in this market, they couldn't.

If you're such a conservative person with money, you might find the explanations being given by people for their actions more like excuses. That doesn't mean that you have to be unsympathetic, but you are more likely to want to know what the assumptions and presuppositions of these people were, at all levels. In many cases it will come down to trust. However, depending upon the relationship, trust can mean fiduciary responsibility and professional ethics. All this needs to be investigated. There's no a priori way to determine the exact causes of this crisis.

In that sense, saying that people trust other people, follow advice, get greedy, get scared ( want to buy a house as an investment for retirement), isn't much of a theory. It's helpful to remind ourselves of these truisms, but that's all that they are. In that sense, I actually like Black's methods and ideas:

"At bottom, the financial
crisis has been a story of how poorly suited we are
at handling unexpected systemic risks, especially
those that stem from the so-called real economy."

To me, it's more a question of how and why people made decisions that they suspected were dubious.

"Again, this
conclusion follows from Black’s insistence that a
business cycle is essentially a set of sectoral shifts,
and those shifts do not always occur easily."

People's views about many issues will change because of this crisis. The shift will not be easy because many people don't yet know where they want to go, or, when they do, how to get there.

"But we
do not yet know how to get investors out of T-bills
and back into riskier assets."

On the contrary, we have some decent ideas, and we're trying them. The stimulus, which could include tax cuts, infrastructure spending, automatic stabilizers, has some merit. What we don't know, and, from my point of view, never will know, is exactly which of these moves will be responsible for getting us out of this mess. That's why we're trying them. And, because human beings are involved, it's quite possible that the mix that will work this time, didn't work the last time, and won't work the next time.

Posted by: Don the libertarian Democrat

Like many economists he has decided to call "The Efficient Markets Hypothesis", "Rational Expectations."

TO BE NOTED: From Angry Bear:

"Shrill

Robert Waldmann

I usually try to be semi polite. I especially don't usually deliberately write rude things about smart economists. However, here goes. Evidently Tyler Cowen* wrote

In a strict rational expectations model, we might expect some people to overtrust others and one view of rational expectations is that investors’ errors will cancel one another out in each market period. Another view of rational expectations is that investors’ errors will cancel one another out over longer stretches of time but that the aggregate weight of the forecasts in any particular period can be quite biased owing to common entrepreneurial misunderstandings of observed recent history. In the latter case, entrepreneurial errors magnify one another rather than cancel one another out. That is one simple way to account for a widespread financial crisis without doing violence to the rational expectations assumption or denying the mathematical elegance of the law of large numbers.

After the jump an argument which might be of some interest (added as an update) and a rant.

* Update: spelling error corrected.



Update: I just noticed something odd about the paragraph by Cowen. Like many economists he has decided to call "The Efficient Markets Hypothesis", "Rational Expectations." So before his redefinition (which I think must be absolutely condemned as I do below) he wrote "one view of rational expectations is that investors’ errors will cancel one another out in each market period." If by "errors" he means avoidable errors, then that would be the efficient markets hypothesis. However, it would not amount to rational expectations.

When the rational expectations assumption is used, it is used to mean "the things we care about have the same values they would have if everyone were rational." In particular, inferences about welfare which some people actually take seriously, are derived from models including the rational expectations hypothesis.

Then somehow, when it is tested it changes to a quite different hypothesis. "aggregate variables which we can measure have the same values they would have if everyone were rational." So, in finance, it becomes a statement about asset prices. However, for the use of the assumption in contributions to the policy debate to be defensible, one would need a model in which welfare is what it would be if everyone were rational. I am fairly confident that you can't do this unless you assume people are risk neutral, that is make an assumption which is overwhelmingly rejected by the data.

If aggregates act as if people are rational and they make irrational mistakes which cancel out then they will bear more risk than they would if they were rational. Welfare will be lower. The amount of irrational risk bearing can be influenced by policy. The optimal policy is laissez faire *if* people are rational. If they are not rational yet aggregates behave as if they were rational, then the optimal policy will not be laissez faire.

Before moving on to discuss Cowen's effort to dodge data by redefining terms,
I note that it does *not* become a statement about asset prices and trading volume for the simple reason that no one can write down a model with the rational expectations hypothesis which isn't overwhelmingly rejected by the data. I believe that there are simply no models of trading volume including the rational expectations assumption in the literature. For more than 20 years agents who trade with no motive described in the model have been present in (as far as I know) all models of market microstructure. Now it may be hinted that there might be some rational reason for noise traders to trade as they do. However, no one (as far as I know and I am ignorant) has presented such a model, because the volume of trading that could be rationalized is a tiny tiny tiny fraction of observed trading volume.

My original rant is below. 5 minutes after posting, I stand by it, but I think the objection above is actually of some potential interest, while the shrillness below is, of course, something that has been said and written many many times.



Cowen has chosen to redefine the rational expectations hypothesis. He has also defined it so that it is meaningless, unfalsifiable, and not a hypothesis.

His intellectual accomplishment can be reproduced in other fields. If I redefine "The Ptolomaic model" to mean "The hypothesis that the earth orbits the sun" then I can save it from its recent difficulties.

I think he could have made his point more clearly if he decided to redefine "the rational expectations hypothesis" to be the hypothesis that 2+2=4. Oh and while he's at it he could define "the law of large numbers" to mean large numbers are larger than small numbers."

His use of the phrase "law of large numbers" shows that he is absolutely unwilling to consider the actual statement of any actual theorem. Oh and that he doesn't know the difference between mathematics and science.

I think a refutation of Cowen's argument which is just as valid as his argument is "I am Tyler Cowen and I retract abjure and reject my argument". Technically, I am not Tyeler Cowen, but if he can redefine the rational expectations hypothesis as he pleases then why can't I redefine "Tyler Cowen" to mean "Robert Waldmann."

Posted by Robert"

Tyler Cowen and I, last Thursday, spent very little time deciding that Jasper Johns and Gerhard Richter were #1 and #2 respectively

FROM REUTERS:

"Felix Salmon

nonrival, nonexcludable

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June 8th, 2009

The top living artists

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Posted by: Felix Salmon

Tags: art

What’s the wisdom of crowds when it comes to the greatest-living-artist question? After 1.4 million votes cast, mainly in the UK (so an English bias is unavoidable), the consensus seems to be:

1. Jasper Johns
2. Bruce Nauman
3. Lucian Freud
4. Richard Serra
5. David Hockney
6. Cy Twombly
7. Cindy Sherman
8. Jeff Koons
9. Tracy Emin
10. Damien Hirst

Tyler Cowen and I, last Thursday, spent very little time deciding that Jasper Johns and Gerhard Richter were #1 and #2 respectively; it didn’t take much longer to decide that Nauman was #3. So how come Richter doesn’t even crack the top ten on the Times/Saatchi list? Do people — even English people — really believe that Tracy Emin is a significantly better artist than Gerhard Richter?

Then again, the same poll puts Martin Kippenberger in the top 20 artists of the 20th Century, while Joseph Beuys languishes at #68, somewhere below Chaim Soutine. And Ed Ruscha — an easy top-10 on the living-artist list for both Tyler and me — doesn’t even crack the top 100 on this list; compare that to Hockney, at #33.

The other thing worth noting is the reputational market of Damien Murakoons. While Hirst and Koons are right next to each other in the low 50s on the list, Takashi Murakami is right at the bottom, at #190. (Warhol is at #8.) My guess is that the main difference here is how they did at auction — even if the pricetag on something like this is just as high as anything Hirst or Koons can command."

Me:
The greatest living artist is, without a doubt, Botero, since all of his people look like me. Actually, he is my favorite. - Posted by Don the libertarian Democrat

Legacy Loans Program: Being Gamed Or Avoided?

From Marginal Revolution:

"Is the Geithner plan dying a natural death?

Via Ezra Klein, we learn from the WSJ:

A government program designed to rid banks of bad loans, part of a broader effort once viewed as central to tackling the financial crisis, is stalling and may soon be put on hold, according to people familiar with the matter.

Ezra comments:

...the reasons appear to be twofold. First, few investors or banks want to work with the government. And second -- and maybe more importantly -- few investors and banks now think they'll have to. The banks, in particular, are apparently enthused by their ability to raise private capital, and now think they can wait out the market turmoil and sell their toxic assets in a few years, when they'll be worth more money.

And then:

Recently, I asked an administration official which government program we'd remember as making the most difference in averting catastrophe. Where will the history books place the credit?

"It'll be the Federal Reserve," he replied. "It'll be their decision to increase the size of their balance sheet from whatever it was before the crisis to whatever it is now."

Posted by Tyler Cowen"

Me:

So let's see:

"The WSJ reports:

Banking trade groups are lobbying the Federal Deposit Insurance Corp. for permission to bid on the same assets that the banks would put up for sale as part of the government's Public Private Investment Program.

PPIP was hatched by the Obama administration as a way for banks to sell hard-to-value loans and securities to private investors, who would get financial aid as an enticement to help them unclog bank balance sheets. The program, expected to start this summer, will get as much as $100 billion in taxpayer-funded capital. That could increase to more than $500 billion in purchasing power with participation from private investors and FDIC financing.

The lobbying push is aimed at the Legacy Loans Program( NB DON ), which will use about half of the government's overall PPIP infusion to facilitate the sale of whole loans such as residential and commercial mortgages.

Federal officials haven't specified whether banks will be allowed to both buy and sell loans, but a list released by the FDIC and Treasury Department of the types of financial firms likely to be buyers made no mention of banks.

Allowing banks to have it both ways would give them added incentive to sell assets at low prices, even at a loss, the banks contend. They claim it also would free up capital by moving the assets off balance sheets, spurring more lending.

"Banks may be more willing to accept a lower initial price if they and their shareholders have a meaningful opportunity to share in the upside," Norman R. Nelson, general counsel of the Clearing House Association LLC, wrote in a letter to the FDIC last month."

And:

"U.S. plan to buy banks' bad loans stalls: report
Wed May 27, 2009 10:39pm EDT

NEW YORK (Reuters) - A U.S. government plan to rid banks of bad loans is stalling and may soon be put on hold, the Wall Street Journal reported on Wednesday, citing people familiar with the matter.

The Legacy Loans Program ( NB DON ), which is being crafted by the Federal Deposit Insurance Corp, is part of the $1 trillion Public Private Investment Program the government announced in March to encourage banks to sell securities and loans weighing on their balance sheets to willing investors.

Prospective buyers and sellers have expressed reluctance to the FDIC about participating for fear the program's rules will change in a political atmosphere hostile to Wall Street, the Journal reported. It also said that some banks that might have sold troubled loans into the program earlier in the year have become less eager as they regained a sense of stability.

FDIC spokesmen were not immediately available for comment."

So, the banks are lobbying for something that they have no intention of taking part in. Makes sense.

Posted by: Don the libertarian Democrat "

I think they made a big mistake by not bailing out Lehman Brothers, I think they recognized that two days later

From Marginal Revolution:

"Interview with Robert Barro, on the New Deal and Great Depression

From The Browser, here is one bit:

It’s clear that a lot of the policies that were put into place were negative, but as to sorting out how important they were, that’s a much more challenging question. And I think Roosevelt at the time recognized ex-post that some of the things he tried were failures and then his attitude was “OK, it’s a failure I’ll stop doing it.” Which is actually pretty positive. For example, some of the things he did was try to organize labor unions and also businesses essentially promoting monopoly – I don’t think that was a plus. He was trying really hard to keep wages and prices from falling with direct influence and that was a negative. The effect of the expenditure programs is less clear. In the mid-1930s with the New Deal there was an unusual amount of infrastructure-type of expenditures. But it’s not actually big enough to sort out in a statistical sense -- to figure out how much it mattered in terms of the recovery after the trough in 1932-33. I don’t think we know that that was a mistake, but it’s not clear that it was all that important.

Barro also offers a reading list on the topic.

Posted by Tyler Cowen"

Me:

Three good points:

"1)The New Deal is part of my research, and it’s bigger than the other non-defense expenditure in terms of stimulus, but it’s not enough to really sort it out.

So I don’t think you can reliably say what the effect is.

2) Well Bernanke was thinking that way even a year ago. I remember talking to him at the time, in April, just after the Bear Stearns initial intervention. I got a chance to ask him a question about why they were so aggressive at that time when things didn’t look so bad. And his response was that basically he was worrying about a Depression-type scenario – and trying to act early to nip that in the bud.

3) Since the Lehman disaster – I think they made a big mistake by not bailing out Lehman Brothers, I think they recognized that two days later. I think that was Paulson’s individual fault and responsibility from what I can gather."

My main disagreement is that it's not clear what he means by stimulus. I'm assuming that he's for Automatic Stabilizers, so is he simply talking about infrastructure and other spending. As well, I though that he backed what he called 'incentives', like tax cuts. By the way, my choice, a sales tax decrease, is working in the UK with the VAT decrease.

"I think the stimulus package was very stupid; it was awful. It’s just a tremendous waste of money and it’s going to cause some trouble in terms of a bigger public debt, it’s just wasting resources. But the more important thing is the financial system, and somewhat the housing related aspects. So on that, despite a lot of floundering around, mostly I think what they were doing is in the right direction."

I think I agree. It's just that the spending is part of the political floundering around. I don't think that calling it stupid or awful is really called for. Isn't humility an obvious byproduct of this crisis? I do think that a placebo and investment case can be made for infrastructure spending, and Shiller is correct in believing that a massive stimulus would do the trick. However, like Barro, I don't that that we can afford to chance the massive debt.

Posted by: Don the libertarian Democrat | May 03, 2009 at 06:19 PM

He argues that there's "a big hole" in the Obama administration's proposals to reform financial regulation

TO BE NOTED: From The Economics Of Contempt:

"Tyler Cowen Is Very Wrong

Tyler Cowen has a truly bizarre column in this morning's New York Times. He argues that there's "a big hole" in the Obama administration's proposals to reform financial regulation: "the new proposals immunize the creditors and counterparties of [firms like AIG] by protecting them from their own lending and trading mistakes." He goes on at length about how the administration's proposals "neutraliz[e] creditors," and thus risk "creating a class of institutions whose borrowing is, in effect, guaranteed by the government."

This is 100% untrue.

The Treasury's proposals specifically included a proposed resolution authority for systematically significant finanancial companies like AIG, modelled on the FDIC's resolution authority. And like the FDIC's resolution authority for insured banks and thrifts, the Treasury's proposal gives the FDIC the power to impose pain on creditors—which is exactly what Cowen criticizes the Obama administration for failing to propose! Specifically, the FDIC would have its traditional powers of avoidance, as well as the power to repudiate "burdensome" contracts.

This undercuts Cowen's entire column. I honestly don't know how he could have missed this—the proposed resolution authority was the most talked about aspect of Treasury's proposed financial regulations. What's even more amazing is that the NYT's editors let Cowen's column go to press. I guess they don't read their own paper.

Posted by Economics of Contempt"

guarantees that keep them whole even if, a priori, they had declared they wouldn't in order to avoid the negative fallout from such runs

TO BE NOTED: From the Economist's View:

"Why Creditors should Suffer Too"

Tyler Cowen:

Why Creditors Should Suffer, Too, by Tyler Cowen, Economic View, NY Times: The Obama administration’s proposals to reform financial regulation sound ambitious enough as they aim to bring companies like A.I.G. under a broader umbrella of government rule-making and scrutiny.

But there is a big hole in these proposals,... the new proposals immunize the creditors and counterparties of such firms by protecting them from their own lending and trading mistakes.

This pattern has been evident for months, with the government aiding creditors and counterparties every step of the way. Yet this has not been explained openly to the American public.

In truth, it’s not the shareholders of the American International Group who benefited most from its bailout; they were mostly wiped out. The great beneficiaries have been the creditors and counterparties at the other end of A.I.G.’s derivatives deals — firms like Goldman Sachs, Merrill Lynch, Deutsche Bank, Société Générale, Barclays and UBS.

These firms engaged in deals that A.I.G. could not make good on. The bailout, and the regulatory regime outlined by Timothy F. Geithner..., would give firms like these every incentive to make similar deals down the road. ...

What the banking system needs is creditors who monitor risk and cut their exposure when that risk is too high. Unlike regulators, creditors and counterparties know the details of a deal and have their own money on the line. ...

A simple but unworkable alternative is to let major creditors make their claims in the bankruptcy courts, as was done with Lehman Brothers. But that is costly for the economy and, after the fallout from the Lehman failure, politically impossible now. Instead, the key to effective regulatory reform is to find a credible means of imposing some pain on creditors.

Here is one possibility. The government has restricted executive pay at A.I.G. and banks receiving government funds, but this move fails to recognize that the richest bailout benefits go to creditors. Restricting compensation at these creditor firms would have more force — if it is done transparently, in advance and in accordance with the rule of law. A simple rule would be that some percentage of bailout funds should be extracted from the bonuses of executives on the credit or counterparty side of transactions.

Such a rule would make lenders more conservative, which would generally be a good thing. ...

Here is another option..., credit agreements should provide for the possibility of a future, prepackaged bankruptcy. Those agreements should require that the creditors themselves would suffer some of the damage — even if the government stepped in to bail out the afflicted firm.

There is a risk that these sacrifices will not be extracted when the time comes, but the prospect might still check the worst excesses of leverage. ...

This poses a very difficult public relations problem for the government, because the Federal Reserve and the Treasury do not want to discuss the importance of the creditors too publicly right now. ... The challenge isn’t easy, and we can’t start on it today, but one way or another a new regulatory plan has to move some risk back to creditors.

These seem like good ideas, but I'm not so sure that these options pose a threat that is credible enough to "check the worst excesses of leverage" as much as is needed. Given the propensity for bank runs in both the traditional and non-traditional banking sectors when depositors/creditors are threatened - they will want to get their money out of institutions that look to be headed for trouble, i.e. to stop being creditors, before the firm is declared insolvent and these restrictions cause them to incur losses that they would be protected from otherwise - would the government step in with guarantees that keep them whole even if, a priori, they had declared they wouldn't in order to avoid the negative fallout from such runs?

The possibility that the government would keep its word and enforce the losses, along with the possibility of being unable to get money out in time and then coming under the regulatory restrictions, ought to check behavior to some degree. But to get substantial effects we need to have a substantial probability that the government will keep its word about imposing losses. However, I'm not so sure that the belief that the government will keep its word is as widely held as is needed, particularly if too large to fail, politically powerful institutions are allowed to persist."

implementing the net-liberty-enhancing policies that a real libertarian would favor if he or she were truly a decisive agent

TO BE NOTED: From Marginal Revolution:

"Words of wisdom

From Matt Yglesias:

The question here is what would Adam Posen have done if he had Tim Geithner’s job? And based on Posen’s analysis, I think the only conclusion you can reach is that he’d have done more-or-less the same thing. Talking about a different issue last week, I heard Tyler Cowen forcefully make the point that you have to think of the political constraints as a real policy consideration. Suppose Geithner had asked Congress to appropriate $1 trillion to implement a program of bank nationalization, asset writedowns, and loan guarantees—what would that have accomplished? It certainly wouldn’t have gotten Congress to appropriate $1 trillion to implement a program of bank nationalization, asset writedowns, and loan guarantees. It might have derailed the budget and thrown the political momentum on the Hill to proponents of a neo-Hooverite spending freeze program. It might have caused panic. And it certainly would have undermined the credibility of the inevitable effort by Geithner to do the most he can with the authority he already has.

One thing I like about Bryan Caplan's book is an interpretation which he will probably hate. The truly decisive actors are people directly in the political process. Maybe the "libertarians" who are or have been in politics are not just "sell outs." Rather they are implementing the net-liberty-enhancing policies that a real libertarian would favor if he or she were truly a decisive agent.

Posted by Tyler Cowen"

Acting Now To End World Poverty

TO BE NOTED: From Bloggingheads:

Acting Now To End World Poverty

Peter’s new book, “The Life You Can Save” (03:08)
What is the most effective way to end poverty? (06:45)
Genetically reprogramming humans to be more generous (05:35)
What charities does Peter give to? (06:27)
Advice for a young utilitarian (04:49)
How to achieve a higher happiness (03:17)

	Play entire diavlog

Does fiction weaken your grasp of reality? (06:52)

From Marginal Revolution:

"BloggingFrozenHeads.TV with Robin Hanson

You'll find it here. Robin is awesome, as usual, and that is why I am grinning throughout. The topics are (among others):

Agreeing to Disagree

Tyler vs. Robin on the merits of cryonics (12:23)
Does fiction weaken your grasp of reality? (06:52)
Are economists evil? (12:10)
How to estimate the value of a person’s life (06:04)
Will prediction markets ever really take off? (08:06)
Has fame made Tyler boring? (02:27)

Addendum: Robin and his readers comment here.

Posted by Tyler Cowen on March 15, 2009 at 05:17 PM "

Me:

Is signaling like Conspicuous Consumption? Where can I read about it? By the way, my brother is a graduate of MIT, getting his PhD in Cognitive Linguistics, but he was also an officer on an attack sub. I ask him questions about being on a sub because I'm going to write a novel, if I live long enough, about a writer who served on a sub. Anyway, according to my brother and friends of his who served on his sub, Battlestar Gallactica is much more realistic about what it's like to be on a sub than so-called "realistic" shows that show life on a submarine.

Posted by: Don the libertarian Democrat | Mar 15, 2009 at 06:15 PM

Greg Mankiw points us to this article by Sachs,

From Marginal Revolution:

"I agree with Jeffrey Sachs

Greg Mankiw points us to this article by Sachs, excerpt:

President Barack Obama’s economic team is now calling for an unprecedented stimulus of large budget deficits and zero interest rates to counteract the recession. These policies may work in the short term but they threaten to produce still greater crises within a few years. Our recovery will be faster if short-term policies are put within a medium-term framework in which the budget credibly comes back to balance and interest rates come back to moderate sustainable levels....

We need to avoid reckless short-term swings in policy. Massive deficits and zero interest rates might temporarily perk up spending but at the risk of a collapsing currency, loss of confidence in the government and growing anxieties about the government’s ability to pay its debts. That outcome could frustrate rather than speed the recovery of private consumption and investment. Deficit spending in a recession makes sense, but the deficits should remain limited (less than 5 percent of GNP) and our interest rates should be kept far enough above zero to avoid wild future swings.

Posted by Tyler Cowen on February 23, 2009 at 08:09 AM in Economics | Permalink"

Me:

"Conservatives are aghast. The bail-out of the auto industry was hard enough to swallow. Government investments in infrastructure and research and development are viewed with scorn, compared with the tried and true (if disastrously failed) tax cuts of the Bush era. Rightwing pundits bemoan the evident intention of Obama and team to "tell us what kind of car to drive". Yet that is exactly what they intend to do (at least with regard to the power source under the hood), and rightly so. Free-market ideology is an anachronism in an era of climate change, water stress, food scarcity and energy insecurity. Public-private efforts to steer the economy to a safe technological harbour will be the order of the new era.

There is plenty of room for blunders, to be sure. Government activism can founder on the shoals of massive budget deficits, tax-cutting populism pushed by the right, politically motivated investments such as corn-based ethanol rather than science-based public investments, and more. Yet Obama is absolutely correct that we have no choice but to try.

John F Kennedy used to tell the Irish tale of the boys who would throw their hats over the high wall, to ensure that they would make the heroic efforts to surmount it. Obama is throwing the hat over the wall of environmental crisis, and asking us to surmount it together. This is a new era of public action, with the US back in the lead, and we will all find a new economy and new opportunities on the other side of the wall."

Is this the same person?

http://www.guardian.co.uk/commentisfree/2009/jan/28/obama-policy-technology

Posted by: Don the libertarian Democrat at Feb 23, 2009 3:08:09 PM

and the desire to pursue even a small chance of avoiding nationalization, are signs of wisdom, not cowardice

From Marginal Revolution:

"Banks vs. bank holding companies

I continue to see many bloggers suggesting that bank nationalization is a fait accompli and that anyone who isn't on board right now is in denial. It is far less common that bloggers give serious consideration to the difference between a bank and a bank holding company. In fact I usually don't see that critical distinction mentioned at all.

If the government nationalized (or "pre-privatized"...whatever) Citibank, Citicorp would go bankrupt and we would be back at a Lehman Brothers scenario again. So the government would have to take over Citicorp too. That goes way, way beyond anything the Swedes did or for that matter it goes well beyond WaMu. Shall I turn the mike over to Wikipedia?

Citigroup was formed from one of the world's largest mergers in history by combining the banking giant Citicorp and financial conglomerate Travelers Group on April 7, 1998. Citigroup Inc. has the world's largest financial services network, spanning 107 countries with approximately 12,000 offices worldwide. The company employs approximately 300,000 staff around the world, and holds over 200 million customer accounts in more than 100 countries. It is the world's largest bank by revenues as of 2008.

You can read about Travelers Group here.

Thinking through the implications of said nationalization for the counterparty positions of a bank holding company, or its role in the commercial paper market, is mind-boggling. Neither the FDIC (which generally does an OK job) nor any other government agency is in any way prepared for this kind of management task. It has very little to do with standard FDIC procedures. All I hear about is "bank" this, "bank" that, etc. but again little or no talk of the bank holding company.

Of course this is only a problem for the five or six biggest financial institutions but those are precisely the issue at hand.

On nationalization, Bernanke is very much on the ball. He said this:

Federal Reserve Chairman Ben Bernanke said this week, is “that you tend to lose the franchise value, that the counterparties and others don’t want to deal with you because they don’t know your future.”

I usually don't like to speak so negatively, but it's the advocates of nationalization who are in denial. There is a belief that Obama, Bernanke, and/or Geithner are somehow spineless or in the pocket of the banking lobby. The sadder truth is that they understand just how ill-prepared the U.S. government, or the Fed, would be to run such an enterprise.

I do understand that if all the water runs out of the sink, as it may, nationalization will come in some form or another, however disastrous that may be. But the desire to postpone it until the last possible moment, and the desire to pursue even a small chance of avoiding nationalization, are signs of wisdom, not cowardice.

When you read about nationalization, and see only the word "bank," and not "bank holding company," be very afraid of the advice on tap.

Addendum: Here is a different but related piece on banks vs. bank holding companies.

Posted by Tyler Cowen on February 21, 2009 at 07:43 AM in Economics | Permalink

Me:

This is amazing. Many of us have been urging a version of the Swedish plan since September. At that time, I had no idea if or how many banks might have to be seized. No one was giddily crying for nationalization as an end in itself or for the hell of it. The point was to put in place a modus operandi that could seize the major banks if it were to be necessary. That's what Sweden did. The argument was that is was a plan, model, map, that could help us maneuver through this crisis, just as the Swedish Plan was influenced by the RTC. The alternatives, doing nothing, for those of us worried about Fisher's Debt-Deflation, seemed a poor choice, as did a hybrid government/banking sector plan, which would have any number of serious problems. To see if those of us who were worried about the Hybrid Model were even near correct, simply read the GAO report on TARP.

We will obviously need to adapt the Swedish Plan to our needs. No one was claiming that we have to follow their plan blindly. That would be silly. We also saw that simply using normal FDIC swooping procedures might not work in the case of the big banks, which is why you either had to create a particular FDIC entity for these big banks or, better yet, set up a separate procedure from them. In other words, a version of the Swedish Plan.

I'm already taking up to much space, but you're also ignoring the criticisms of the alternatives, which I believe have been spot on. In seeing the flaws of TARP in its various guises beforehand, we also feel that our fears of a costly and messy response have largely come true, although they have done some good.

Finally, this report via Real Time Economics makes some good points:

http://www.clevelandfed.org/Research/commentary/2009/0209.cfm?DCS.pr=20090212

Posted by: Don the libertarian Democrat at Feb 21, 2009 12:02:15 PM

And, possibly not posted:

http://www.reuters.com/article/mnaNewsIndustryMaterialsAndUtilities/idUSN1248357020090112?sp=true

(For more Reuters DEALTALKs, click [DEALTALK/])

By Paritosh Bansal

NEW YORK, Jan 12 (Reuters) - Citigroup Inc (C.N) may explore further asset sales after divesting its Smith Barney retail brokerage unit to Morgan Stanley (MS.N), but the banking giant is likely to have a tough time finding buyers.

Chief Executive Vikram Pandit is trying to shed hundreds of billions of dollars of assets and reduce risk after Citigroup suffered $20.3 billion of losses in the year ended Sept. 30. The bank is expected to post another loss for the 2008 fourth quarter when it reports results this month.

Citigroup has considered selling its Banamex Mexican banking unit and Primerica Financial Services, people close to the matter have said. The Wall Street Journal reported on Monday that CitiFinancial, international retail-brokerage operations and the private-label credit-card businesses may also be put on the block. The bank declined to comment.

But Citigroup may not find it easy to sell other assets, and like insurer American International Group Inc (AIG.N), it could run into problems disposing of units amid the financial crisis, investment bankers said. Few would-be buyers have enough cash, stocks are down, financing is not easily available, and the quality of financial assets is often suspect.

"They may quietly explore what's available. I just don't think that they can do very many deals in the near-term," said Marshall Sonenshine, chairman of New York-based investment bank Sonenshine Partners. "But over the next couple of years, they will sell a lot of those businesses, and so will AIG."

CONSUMER CREDIT

Citigroup tried to sell life insurance unit Primerica over the summer, but its plans were set back as the financial crisis took over.

Selling consumer lending businesses such as private label credit cards and CitiFinancial, which provides loans for home improvement, debt consolidation and tuition, is also likely to prove difficult in an economic downturn as consumers suffer.

In September, General Electric Co (GE.N) shelved plans to sell its $30 billion U.S. private-label credit card business, saying it was a challenging time to find someone who wanted to take responsibility for more than $30 billion of assets.

"Anything that has credit sensitivity to it, like a credit card business in this market -- Citi will be crazy to try to sell something like that," a financial services investment banker said.

"There are no strategic buyers, no financial buyers. There's no leverage," the banker said. "You are going to sell an asset that has consumer credit risk to it? Good luck."

AT WHAT PRICE?

Still, as it faces pressure to put its house in order, Citigroup may want to try, and some of its assets could lure potential buyers. But the bank will then have to deal with the problem of negotiating a good price.

"Someone's going to be interested in them at a certain price -- maybe an unappealing price to Citi's shareholders," another financial services investment banker said. "They may not get the prices they want, but you can sell things."

In some cases, uncertainty about asset quality can be addressed by a deal's structuring.

The agreement for the sale of Chevy Chase Bank to Capital One Financial Corp (COF.N) has a clause that would have Capital One pay more if the acquired bank's assets perform better than expected.

So questions about the quality of Citigroup's private-label credit card portfolio in a declining economy, for instance, could potentially be addressed by structuring a transaction where payments are made over time, with the amount depending on defaults, the banker said.

"Whether Citigroup will be better off accepting prices today or deferring sales remains to be seen," Sonenshine said. "In both cases, AIG and Citi, we are looking at the slow but inevitable disaggregation of overextended financial services companies that have demonstrated an inability to manage risk."( NB ) (Additional reporting by Dan Wilchins; editing by John Wallace) (For more M&A news and our DealZone blog, go to www.reuters.com/deals) "

The point is that we are paying to keep them alive until they can sell these businesses. We know what a Holding Company is.Listen to Liddy:

http://www.pbs.org/nbr/site/onair/gharib/081110_gharib/

"GHARIB: Mr. Liddy, make a case why American taxpayers should feel good about this latest rescue plan.

LIDDY: The taxpayer in this case is being very well cared for. People use this term bailout and it's got kind of a negative implication. But the reality is on the equity that we're getting from the Federal government, we're going to pay $4 billion a year to the taxpayer for that. The debt carries a full market rate of interest. Right now we'll have about $20 billion outstanding, $21 billion. It carries interest at 5 or 6 percent. That's a billion too. The government is going to have an interest in upside in the two asset entities that were two financing entities that we're setting up. The taxpayer is being well cared for and well provided here.

GHARIB: You have a lot of financial issues that you have to deal with over the next couple of months and years. How are you going to pay off these billions of dollars of government loans?

LIDDY: We're going do it by selling some our very best assets. This company has been built over about a 99 year period of time. We have some assets around the globe that are the envy of the world. They couldn't be duplicated. They couldn't be recreated today. The proceeds from those asset sales will pay down that $60 billion. And if we do really well maybe even give us enough money left over that we can call some of the preferred stock.

GHARIB: How difficult is it to find buyers in this down economy?

LIDDY: We probably have 75 to 100 companies that are seriously looking at various of our companies. These are very complicated businesses. In many cases they operate in multiple countries or in multiple positions around the United States. So getting everything just right is really important to us. I think we will be successful in this endeavor. "

Why you think that a government agency couldn't do better than these idiots is beyond me. Talk about rewarding incompetence.In any case, you must believe that this is a good strategy. At least then listen to the opinion of some people with some credentials. That's all I ask:

http://www.ocnus.net/artman2/publish/Business_1/Geithner_s_AIG_Strategy.shtml

Geithner’s AIG Strategy
By Pietro Veronesi, Luigi Zingales, City Journal 19/2/09
Feb 19, 2009 - 9:21:59 AM

"Judging by Geithner’s past behavior as chairman of the Federal Reserve Bank of New York—where he helped lead bailout deals for Bear Stearns, Citigroup, and others last year—it’s likely that the Treasury will try to attract investors by using government guarantees to cap their possible losses. On the face of it, this seems like a smart way for the government to stop the financial industry’s meltdown without incurring astronomical costs. By covering some potential losses, the thinking goes, the government can calm investors’ fears and lure them back into buying mortgage-related and similar securities from banks. If the government guarantee is large enough, investors can even pay for the securities at close to the value on the banks’ books—sparing banks the burden of recognizing additional losses, which could push many of them into official insolvency. Last but not least, the plan minimizes the amount of money that the government must request from Congress.

To understand the problems lurking beneath this idea, though, let’s analyze a similar deal: the guarantee that the federal government provided to Citigroup in November 2008. For a $306 billion pool of Citigroup assets “consisting of loans and securities backed by residential real estate and commercial real estate,” the government committed to providing something like an insurance policy with a deductible. Citigroup would absorb the first $39.5 billion of losses on the loans and other securities, with the government picking up 90 percent of the additional losses and Citigroup just 10 percent. The government ingeniously divided its responsibility among the Treasury (the first $5 billion), the Federal Deposit Insurance Corporation (the next $10 billion), and the Federal Reserve (all the rest). In this way, the Treasury committed only $5 billion of the finite TARP bailout money to the deal.

The real value of the guarantee (and thus its potential cost to taxpayers) should include not only the TARP funds but also these other commitments—and it is massive. We estimate that if the government were held to the same accounting standards as private companies, the expected liability it would have to report for the Citigroup guarantee would be $66 billion. Nobody knows the true value of the volatile loans and securities underlying the deal—meaning that nobody knows the true extent of potential losses. And even the $66 billion estimate assumes that the assets comprise an average pool of residential-backed securities. Since Citigroup has a strong incentive to put the worst, most overpriced assets in the pool, the government’s actual liability could easily be $78 billion or more.

Geithner’s plan suggests that the government might be applying similar sleight of hand to the entire financial system. We estimate that to restore the solvency of the top 10 banks to their pre-crisis level, the banking system needs at least $4.5 trillion in purchases of its toxic securities. (That’s why former Treasury secretary Henry Paulson abandoned the Bush administration’s idea simply to buy up all the toxic assets—he knew that the government couldn’t afford it.) Based on the Citigroup example, we calculate that Geithner would have to commit $75 billion of TARP money to attract enough private capital for the plan. But just as with the Citigroup case, that initial commitment wouldn’t tell the whole story. Under proper accounting standards, and taking the entire government’s commitments into consideration, the strategy would actually impose a cost of around $1.2 trillion on taxpayers."

Check out this as well:

http://faculty.chicagobooth.edu/luigi.zingales/research/papers/from_awful_to_merely_bad.pdf

In short, it would have been very bad but not the end of the world economy or democratic capitalism.

From Marginal Revolution:

"Did the world almost come to an end Sept. 18th?

I've had so many of you write me and ask me what I think of this blog post. The main claim is taken from Paul Kanjorski:

On Thursday (Sept 18), at 11am the Federal Reserve noticed a tremendous draw-down of money market accounts in the U.S., to the tune of $550 billion was being drawn out in the matter of an hour or two. The Treasury opened up its window to help and pumped a $105 billion in the system and quickly realized that they could not stem the tide. We were having an electronic run on the banks. They decided to close the operation, close down the money accounts and announce a guarantee of $250,000 per account so there wouldn't be further panic out there.

If they had not done that, their estimation is that by 2pm that afternoon, $5.5 trillion would have been drawn out of the money market system of the U.S., would have collapsed the entire economy of the U.S., and within 24 hours the world economy would have collapsed. It would have been the end of our economic system and our political system as we know it.

The second paragraph is very much overstated (and I wonder about the exact numbers in the first paragraph). My personal guess -- and guess is the right word -- is that if nothing had been done on this day, a disaster would have resulted, though not on the scale postulated here. In my view there would have been an immediate bank holiday, partly improvised, plus complete insolvency for some very large financial institutions, followed by rapid nationalization. There would have been a much tougher whack to the commercial paper market than what we saw. Many businesses would have had problems meeting short-term payroll requirements. The downturn in the real sector would have been much steeper than it has been. In short, it would have been very bad but not the end of the world economy or democratic capitalism.

Posted by Tyler Cowen on February 16, 2009 at 07:21 AM in History | Permalink

Me:

I think that the Aleph Blog has a good point about what occurred:

http://alephblog.com/2009/02/15/the-story-not-told/

I'll simply repeat me view that I posted there: There was definitely a threat to pull out of money market funds. The threat was to test the strength of the government's guarantees in this crisis. When the government essentially guaranteed money market funds, the threat ended.

Posted by: Don the libertarian Democrat at Feb 16, 2009 11:35:30 AM

Sweden looks like a good model.

From Tyler Cowen:

"Barack Obama on Sweden

Read this post; here is Obama speaking:

Sweden, on the other hand, had a problem like this. They took over the banks, nationalized them, got rid of the bad assets, resold the banks and, a couple years later, they were going again. So you'd think looking at it, Sweden looks like a good model. Here's the problem; Sweden had like five banks. [LAUGHS] We've got thousands of banks. You know, the scale of the U.S. economy and the capital markets are so vast and the problems in terms of managing and overseeing anything of that scale, I think, would -- our assessment was that it wouldn't make sense. And we also have different traditions in this country.

Here is a short movie by Ingmar Bergman. Here is a Carl Milles sculpture. Here is some cabbage with your pizza.

Posted by Tyler Cowen on February 11, 2009 at 07:41 AM in Political Science | Permalink"

Me:

"Sweden looks like a good model"

Here's the deal: It's a model. That means:

1) It worked
2) It can be assessed as you're implementing it
3) It's harder to lobby against
4) It's moral hazard that the bankers fear
5) It will be easier to get out of

TARP is a hybrid. The interests of the banks and taxpayers are not the same. The GAO couldn't even assess it. You can believe that this mess and expense is worth it to avoid actually taking over a few banks, but you're fooling yourself. These banks are wards of the state, and the money we're spending is taxpayer money. We were talking recently about using the stimulus to fool people into thinking things are better than they are or that government is on the case. TARP is fooling everyone into believing that we're preserving some sacred free market principles. Maybe the stimulus will work, even if it is a placebo.

Posted by: Don the libertarian Democrat at Feb 11, 2009 9:52:49 AM

Hybrid example for today:

http://www.nytimes.com/2009/02/11/business/economy/11react.html?hp

"Washington Hopes ‘Vulture’ Investors Will Buy Bad Assets"

"Another big issue is the price at which the troubled assets would be valued by the banks. While potential investors want to buy as cheaply as possible, the banks might have to take debilitating write-downs if they sold at fire-sale prices. Such an outcome might not be in the government’s — or taxpayers’ — interests.

But competing interests are bound to bedevil this kind of deal, said Campbell R. Harvey, a professor at the Fuqua School of Business at Duke University.

“Given the conflicting objectives, I’m not sure I’d be interested in this kind of altruistic investing,” he said.

And the potential political costs, money managers said, are real. Some managers said that if they did their job well, they could earn double-digit returns and, with them, public scorn.

“We can’t really win,” one private equity executive said. “When we made money, people criticized us. This year, we lost money, and people are criticizing us.”

Posted by: Don the libertarian Democrat at Feb 11, 2009 10:37:36 AM

Good comment on a Tyler Cowen post at Marginal Revolution wherein Cowen unearths an ancient Keynes letter providing some support for tax cuts.

From Paul Kedrosky:

"Negative Externalities and Dueling Economists

Good comment on a Tyler Cowen post at Marginal Revolution wherein Cowen unearths an ancient Keynes letter providing some support for tax cuts. More fuel for my take that skepticism-verging-on-nihilism is the right answer when faced by economists splitting along party lines.

….negative externalities accrue when we disparage poor expert consensus in a way that doesn't clearly lead to advocating for better expert consensus.

As for unearthing an old Keynes letter, I understand it may be fighting fire with fire, but really, I think the economics and legal profession should move away the pre-rational human tendency to want to derive policy wisdom from interpreting the texts of ancestors. Let's leave that to religious fundamentalism.

I'm more intrigued by the empirical work of folks like Romer and Barro and others, than the dueling sacred texts of Keynes and Mises."

Me:

It depends upon how you view Economics. To me, it produces some theories and models that are more or less useful in helping us to understand the economy. The really important action exists in Political Economy. Keynes and Mises are of continuing interest because they studied Political Economy. Although I did read a couple of books by Barro that qualify, they were not great, but good. I haven't read books by Romer.

However, it is a bizarre claim that Political Economy can't use the classics. That's like saying that sociologists can't use Durkheim. After all, we still use Newtonian Mechanics. If you think that Economics is more like physics than a human science, I can understand this position, sort of. If not, it's strange.

Since we're not sure what to do, and the economic theories are of limited use, we naturally look to the past for help. Isn't a lot of economics based on comparing different historical examples and trying to derive some useful ideas? Keynes is useful because his theories are widely thought to have been of help in ending the depression. As well, he was a very good writer. He provides us a set of ideas which we can use as a guide in considering current ideas, and, quite frankly, a hopeful narrative of how we might get out of this mess. I consider narrative thinking to be very important for politics and political economy. Others don't, I suppose.

Merely appealing to Keynes is an example of the fallacy called the appeal to authority. I don't think that Cowen is doing this, since he believes, as I do, that a payroll tax cut is a good thing. The Keynes letter also gives some reasons for his views, which you can agree with or not. But, since there are reasons given, it is not simply the argument from authority. It is valid, in my opinion, to want to know what Keynes thought about this issue, because he was a brilliant. That's all.

However, just calling on Barro and Romer is also the argument from authority. I've been reading Romer and Barro. In fact, yesterday, their ideas were both on blogs. Barro called for tax cuts as incentives, without offering anything specific. Romer, if I've got the right Romer, advocated giving the FDIC more power to collapse banks and concerns like Lehman I believe, which, from my perspective, is just nationalization under a different rubric. I'm fine with it, but it qualifies as a government takeover.

So, it's fine to quote whomever you want, assuming that you can explain what they said, and give reasons why you do or don't agree. I don't take that for granted, by the way. I know that it's hard to do for all of us.

Does anyone share my feeling that your slogan, “Small steps toward a much better world,” is odd?

From Tyler Cowen:

"Small steps toward a much better world"

James Hudson, a philosopher and a loyal MR reader (it turns out I already know and admire his work), emails me the following observations:

Does anyone share my feeling that your slogan, “Small steps toward a much better world,” is odd?

But now it is long and so it goes under the fold...

First, better than what? I suppose it’s better than the world we have now; but then the “world” of the slogan is not a whole possible world, which would persist throughout time, but rather a temporal segment or slice of a possible world. We don’t now “have” a whole world; what we have is the present time-slice of the world. Or you might say that what we have is the whole past-and-present--the temporal segment of the world from the Beginning to Now; but this would be less suitable for comparison with what you are striving toward, so I will assume that the present time-slice or “state-of-affairs” is the intended standard of comparison.

Then the target is a better (momentary) state-of-affairs rather than a better whole possible world, or a better whole future. Now, the latter, not the former, should be your ultimate or most basic objective; but, admittedly, it might be acceptable tactically to aim at the former. That is, in order to maximize the value of the whole future--which should be the aim--you might aim for “a much better (momentary) state-of-affairs,”to come into being at some point in the future.

And what point might that be; when is the much better state-of-affairs supposed to come into existence? That is being left indefinite (though,presumably, sooner is better than later).

I interpret “steps toward a (particular) state-of-affairs” as actions (perhaps mere “speech acts”) that make that state-of-affairs more probable. But these actions may also have other effects that ought to be considered, such as making some other state-of-affairs--perhaps quite a bad one--more probable. This points up a serious deficiency: the slogan is blind to risk, failing to incorporate hedging. The circumstance that a certain step that is “toward” a better state-of-affairs (i.e., that makes it more probable) is at the same time also “toward” a worse one should dampen your enthusiasm for taking the step; this is not reflected in the slogan.

There are probably infinitely many possible states-of-affairs, but for expository purposes let me pretend that the number is finite--say, a million. Let us rank these by value. The best will be S1, the worst S1,000,000 (I’ll ignore ties); the actual present state-of-affairs is somewhere in between--say, S100,000. {As you can see, this email program is incapable of representing the numbers as subscripts.}

There is, for each of these possible states-of-affairs, some probability that it will eventually become actual, given what we have now. The slogan endorses actions that will increase the probability of one of these states-of-affairs--call it ‘Sn’. But this favored possible state-of-affairs is not specified as S1, the best of them. Indeed, I assume n ≠ 1, since the slogan says “much better” rather than “best.” Since Sn is to be better than S100,000, we have 1 < n < 100,000, and since it is much better it must be closer to 1 than to 100,000; let us say 1 < n < 30,000. But beyond this it is completely obscure what n is or how it was selected. If n is, say, 10,189, you are aiming to make the eventual occurrence of S10,189 more probable. But the motivation for doing precisely this is hardly evident.

Finally, the “small steps” phrase is, presumably, intended as an expression of modesty. But why limit yourself to small steps? If you can take big steps to improve matters, do it! On the other hand, why restrict yourself to optimism? If you can make the world better, of course, do it; but maybe things appear likely to get worse, no matter what you do. You might even find yourself in a situation where there are no steps you can take “toward” Sn for any n < 100,000, perhaps because Prob (Sn/A) = 0, for any n < 100,000 and any possible action A (given that we are in S100,000). It would be well to cover this possibility, too, by presenting yourself as stepping toward the best (in this case, least bad) possible future.

My proposal for reform, then, is simply to advertise yourselves as intending to act in ways that promote maximum expected value throughout the future; in short: “Acting to maximize expected future value.” (If that’s not your intention, why not?)

The bottom line: I believe that James is a kindred spirit and that he indeed lives "Small steps toward a much better world."

Me:

Since you're alive, the best way to determine what you meant to say is to ask you. Of course, if the person asking you is someone like Socrates, you might want to save yourself a lot of grief and not answer.

Posted by: Don the libertarian Democrat at Feb 5, 2009 10:26:33 AM

Again, I don't have faith in these models and I believe agnosticism is the correct stance.

From Tyler Cowen:

"Permanent vs. temporary increases in government consumption

Paul Krugman writes:

...he [Brad DeLong] fails to note that it’s not just wrong, it’s 180 degrees wrong: a temporary increase in government spending should have a larger impact on demand than a permanent increase, not a smaller impact.

I intend my comments as the most boring blog post I have written, so it goes beneath the fold...

Perhaps Krugman is drawing from Barro's 1981 JPE paper on government purchases, which does indeed derive the stated result, but that is no longer the dominant approach. Circa 1990, Aiyagari, Christiano, and Eichenbaum note:

First, we demonstrate analytically that -- under standard assumptions spelled out in section 2 below -- the employment and output effects of permanent increases in government consumption always exceed those of temporary increases.

On pp.4-5 they explain why Barro is incomplete.

Overall I find these debates confusing. I wonder for instance if Krugman's blog example is actually comparing tax finance to debt finance, rather than temporary vs. permanent spending shocks. (Note also that Krugman is making a claim about demand or effective "stimulus" rather than output and employment, although I am taking the latter as what matter.)

Those of you with lots of time on your hands can ponder whether the "permanent vs. temporary" debates compare "$100 billion this year vs. $100 billion for each year to come" and/or "$100 billion this year vs. the present value of $100 billion spread out over time, in perpetuity," and whether all cited articles and blog posts are making exactly the same comparisons.

Results in this area usually can be modified by further assumptions. I think of this as the central paper, published in the JME 1999. Admittedly it is for a small open economy but the key result is:

Moreover, permanent increases in government expenditures have larger positive labor supply and output effects than temporary fiscal policies.

Again, I don't have faith in these models and I believe agnosticism is the correct stance. The point is not about who is wrong and who is right but rather how treacherous these analytical waters can be. Beware!

In any case there is hardly an overwhelming brief in favor of the stimulative powers of the temporary spending increase. The best case for the temporary boost is I think the public choice argument that it is better to get it over with more quickly, so as to limit corruption of the government.

Addendum: Megan McArdle adds comments on her contribution to the debate."

And I argue:

Previewing your Comment

"On pp.4-5 they explain why Barro is incomplete."

I would say less useful. The very fact that the model is being improved leads one to believe that the model is useful, but not a complete description, or even causal, of the real world. In our circumstances, it might turn out to be of limited use.

But the same can be said of the multiplier. It seems unreasonable to put so much faith in the precision of any multiplier in this situation, or to simply plug in a consumption figure which needs to be filled.

To me, both approaches seem useful, but not persuasive. The one person I agree with, Shiller, wants us to spend a massive amount of money. I agree that would work, but it could also cause serious inflation, causing us to induce another shock. As well, spending massive amounts of money can influence behavior, but that influence might not all be benign.

And that's my problem with your NY Times post: In order for behavior to be changed in a meaningful way, the influence upon it must be large and long lasting. I think that you underplay the possible social changes that could go with such a shift. They worry me more than this downturn.

Finally, the actual bill. Here was my plan:
1) $100 Billion Infrastructure Investment
2) $200 Billion Sales Tax Cut or Payroll Tax Cut
3) $100 Billion Tax Cut for Investment
4) Social Safety Net and State Aid ( $ ? )

This is different than the bill, but, if I were the Republicans, I would have asked for something similar to my plan and split the difference, for reasons of Political Economy. It would be better that we have an agreed upon plan, precisely because the social changes going forward could be so unpleasant.

Here, I echo Burke:

"All government, indeed every human benefit and enjoyment, every virtue, and every prudent act, is founded on compromise and barter. "

I think that Burke is someone we should keep in mind during a crisis.

Posted by: Don the libertarian Democrat | Feb 01, 2009 at 02:08 PM

Being a head of state is not like being in a restaurant. I have to have time to think about it.

From Tyler Cowen:

"Africa's World War

The subtitle is Congo, The Rwandan Genocide, and the Making of a Continental Catastrophe and yes the book truly explains all of these things or at least gives it a noble try. The author is Gérard Prunier. I've been stunned by how much I've learned from this book, which is clear without denying the underlying complexities. I rate it as one of the two excellent books of the year so far, the other being Ted Gioia's book on the history of the blues.

You'll find a very critical review of the book here but I was more impressed by the book than by the review. I liked this excerpt:

Interviewer: What model of democracy do you see as suitable?

Kabila: I cannot say now, you are asking too much. Being a head of state is not like being in a restaurant. I have to have time to think about it.

Me:

I'd like to recommend a few blogs:

http://stopthewarinnorthkivu.wordpress.com/

http://blogs.lesoir.be/colette-braeckman/

http://blogs.reuters.com/africa/

Posted by: Don the libertarian Democrat at Jan 31, 2009 5:01:03 PM

I AGREE with Olivier Blanchard that fear and lack of confidence are major problems behind the current economic downturn.

From Free Exchange:

"Blanchard roundtable: The economy needs a placebo

Posted by:

Tyler Cowen

Categories:

Blanchard roundtable

Tyler Cowen is Professor of Economics at George Mason University. He co-writes the popular economics blog Marginal Revolution. This discussion can be followed in its entirety here.

I AGREE with Olivier Blanchard that fear and lack of confidence are major problems behind the current economic downturn. I also agree that the banking sector requires recapitalisation and that this is hard to do. But I dissent from his analysis in a few key regards.

First, to the extent the real problem is fear, this militates in favour of placebo policies. By that I mean initiatives which appear bold and have great symbolic value, but which don't necessarily cost us very much. I haven't seen us make a major attempt to identify such proposals, but it is unlikely that an $800 billion stimulus fits the bill. I would sooner beef up automatic stabilisers, and aid to state and local governments, and claim that this, along with some regulatory changes, will help the economy. Unorthodox monetary policy, as the Fed is intent on pursuing, should be presented in this guise as well. The reality is that we don't actually know what will work, precisely because the problem goes beyond just stimulating aggregate demand.

I'm not opposed to the idea of “ring fencing” the bad assets on bank balance sheets, but that alone doesn't solve any problems. If the assets are to be bought, the question is at what price. Buying at a low price doesn't help any. Buying at a high price means a giveaway to the banks. Such giveaways might be necessary at this point but they could cost trillions. Today the key problem is that we don't know how to turn zombie banks into real banks.

I'm not sure we should be encouraging consumers to spend so much more. We need to make the painful adjustment to lower levels of spending and debt. Consumers have to spend less at some point and I believe that point is now, however painful the results may be. Mr Blanchard focuses on insufficient spending as a key problem but I am more likely to see the economy as needing to adjust to real shocks. We need to reallocate resources out of construction, finance, and debt-financed consumption. Boosting aggregate demand could make that adjustment harder rather than easier. Mr Blanchard never tells us when he thinks that consumer spending should fall.

Most generally, we all need to keep in mind that trying to restore public confidence is tricky. If you try hard, and fail, confidence then plummets and it is even harder next time around. This is a potential problem with both the stimulus approach and the placebo approach.

Most of all, I don't think we are paying enough attention to the placebo idea. It is well known in the medical literature that sometimes placebos work as well as the drugs themselves.

(Photo credit: George Mason University)"

Me:

Don the libertarian Democrat wrote:

"First, to the extent the real problem is fear, this militates in favour of placebo policies. By that I mean initiatives which appear bold and have great symbolic value, but which don't necessarily cost us very much. I haven't seen us make a major attempt to identify such proposals, but it is unlikely that an $800 billion stimulus fits the bill."

I believe that the purpose of the stimulus is to show confidence that we will come out of this by investing in the future. In that sense, I agree that it is largely symbolic. However, investing in infrastructure can have positive benefits going forward if it is spent wisely. In that sense, it is not a placebo.

"and aid to state and local governments"

Over $100 Billion seems to be for this.

"Unorthodox monetary policy, as the Fed is intent on pursuing, should be presented in this guise as well."

I agree with this, but it is separate from the stimulus.

"The reality is that we don't actually know what will work, precisely because the problem goes beyond just stimulating aggregate demand."

This is true, which is why the bill includes incentives for investment to attack the fear and aversion to risk.

"Such giveaways might be necessary at this point but they could cost trillions. Today the key problem is that we don't know how to turn zombie banks into real banks."

They are not. We can nationalize the banks, and then return them to the private sector. Or, if that bothers us, spend a huge amount of money for nothing in return. It's our choice.

"I'm not sure we should be encouraging consumers to spend so much more."

That's not the intent of the tax cuts. It's to stop a savings spree, which would contribute to a Debt-Deflation Spiral. If you don't see that as a possibility, then I understand your point. I believe that it is a serious possibility.

The bill includes social safety net spending as well. It seems like a compromise plan, which has a decent pragmatic approach.

I would have preferred:
1) $100 Billion in infrastructure investment
2) $100 Billion in incentives for investing
3) $200 Billion in a sales tax cut or payroll tax cut
4) Social safety net spending.
The administration's approach is not far from this. Other than doing nothing like this list, what exactly are you proposing?

I like to quote Burke on politics:

"All government, indeed every human benefit and enjoyment, every virtue, and every prudent act, is founded on compromise and barter. "

Sadly, the GOP counts zero Burkeans in their midst. Of course, Burke was a Whig.

1/30/2009 1:51 AM GST"

"Sadly, that's about as scientific as we've been able to get."

From Tyler Cowen:

"The best argument I've read *for* the stimulus

It comes not from a professional economist but from Warren Buffet, here goes:

SG: But there is debate about whether there should be fiscal stimulus, whether tax cuts work or not. There is all of this academic debate among economists. What do you think? Is that the right way to go with stimulus and tax cuts?

WB: The answer is nobody knows( TRUE ). The economists don’t know( TRUE ). All you know is you throw everything at it( TRUE ) and whether it’s more effective if you’re fighting a fire to be concentrating the water flow on this part or that part. You’re going to use every weapon you have in fighting it. And people, they do not know exactly what the effects are( TRUE ). Economists like to talk about it, but in the end they’ve been very, very wrong and most of them in recent years on this. We don’t know the perfect answers on it. What we do know is to stand by and do nothing is a terrible mistake( I AGREE ) or to follow Hoover-like policies would be a mistake and we don’t know how effective in the short run we don’t know how effective this will be and how quickly things will right themselves. We do know over time the American machine works wonderfully and it will work wonderfully again.

Sadly, that's about as scientific as we've been able to get."

I agree. I simply see this as being human. I wish people would remember that.