The Phillips Machine

The Reserve Bank of New Zealand has a neat animation of Bill Phillips' famous hydraulic computer, which illustrates the stocks and flows of national income with tubes, tanks and gurgling noises. 

I've posted previously about the machine, and Phillips' (interesting) life.

In addition to the animation, the RBNZ has an actual working Phillips machine, which it demonstrates to the public every month (so that explains New Zealand's tourism boom!).

John Maynard Keynes

The Economist posts its beautiful 1946 obituary of John Maynard Keynes, which begins:

The sudden death of Lord Keynes on Easter morning has removed a great man. In turn civil servant, pamphleteer, don and college bursar, editor, company chairman, patron of the arts, government spokesman and adviser, member of the Upper House—he touched no career that he did not brilliantly adorn. More than any other man of his time he had the power to arouse informed opinion to the acceptance of novel proposals and if the public mind is better prepared in this country than in many others to face the problems of the period that is now opening, Keynes can claim far more than one man’s share of the credit. The story is told that when he was appointed a director of the Bank of England, he was accused by a friend of turning orthodox in his old age and replied, with his perfect self-assurance, “You are wrong. Orthodoxy has caught up with me.” What would have been conceit in another was the simple truth in his case. He had the gift that comes only to real leaders, of being well ahead of his generation and yet able to pull it along behind him. For this, more than intellect and more than lucidity are needed—though Keynes had both in plenty. He had also the integrity of the philosopher and, when he wished, the fervour of the prophet.

Cardiff Garcia brings my attention to Robert Skidelsky's memoir of writing his Keynes biography, which concludes:

"But, soon or late, it is ideas, not vested interests, which are dangerous for good or ill," Keynes wrote, in one of his most famous passages. I have often puzzled about the word "dangerous". Keynes was a most careful user of words. How can ideas be dangerous for good? A more obvious word would be "powerful"; the thought behind it being that ideas have a stronger influence on events, for good or bad, than have interests. And this is how the passage is usually interpreted. But the word "dangerous" adds a subtlety characteristic of Keynes: the thought that ignorance is dangerous, but that knowledge, too, is dangerous, because it tempts to hubris - the usurpation by men of divine powers - whose inevitable fruit is nemesis. That Keynes great revolutionary manifesto, The General Theory of Employment, Interest and Money should have ended on this oblique note of warning is striking testimony to a greatness that transcended economics. An intellect that could soar, seemingly without limit, accepted the discipline of earth- bound limits in the management of human affairs. This is the Keynes I love, and whose personality and achievements I have tried to convey.

Signs of a Supply Shock off Monterrey?

The Times reports:

Humpback whales, pelicans and sea lions are all common summer sights off the Monterey coast, with its nutrient-rich waters. But never that anyone remembers have there been this many or have they stayed so long, feeding well into November.

“It’s a very strange year,” said Baldo Marinovic, a research biologist with the Institute for Marine Sciences at the University of California, Santa Cruz. 

What has drawn the animals is a late bloom of anchovies so enormous that continuous, dense blankets of the diminutive fish are visible on depth sounders. The sea lions, sea birds and humpbacks (which eat an average of two tons of fish a day) appear to have hardly made a dent in the population. Last month, so many anchovies crowded into Santa Cruz harbor that the oxygen ran out, leading to a major die-off.

I immediately thought of the Phillips curve shifting down (as in a positive 'supply shock').  I've discussed why anchovies matter for inflation previously.  I'm not sure they really do (and in the long run its only the money supply that matters of course), but its a fun example for macro students.

Stagflation: The Final Frontier?

In my twitter feed this afternoon...

It's econ, Jim, but not as we know it RT @richdhw: OMG the UK Phillips Curve is the USS Enterprise pic.twitter.com/CnvofMyMVV

— Matthew C. Klein (@M_C_Klein) November 22, 2013

The Wrath of (Mervyn) King?

The Making of the CPI

The Washington Post's Emily Wax-Thibodeaux follows Caren Gaffney, one of the BLS' "Economic Assistants" who gather the raw data for the consumer price index:

On this recent day, Gaffney will be on the road for nearly eight hours in her beat-up 2003 Honda Pilot, driving across vast stretches of Virginia, from county to county, on a mission to hunt down prices of three American staples: gas, sugar and beer.
As Gaffney demonstrates at stop after stop, there’s more to price checking than tallying up numbers.
“A good EA is face to face with the product, is picking things up, is looking at every label,” she says. “The tiniest mistake can throw off the data. You have to be on your feet mentally.”
To ensure the integrity of the information, price checkers have to make sure they’re comparing not just apples with apples but also, for instance, organic Fuji apples with organic Fuji apples.

As the story notes, the process is labor-intensive (there are 428 economic assistants roaming the country) which means that the cost of constructing the CPI should rise over time relative to goods and services subject to more efficiency gains - i.e., Baumol's cost disease applies.  But good data is undoubtedly worth it.

Germany's Turn

The US Treasury:

Within the euro area, countries with large and persistent surpluses need to take action to boost domestic demand growth and shrink their surpluses. Germany has maintained a large current account surplus throughout the euro area financial crisis, and in 2012, Germany’s nominal current account surplus was larger than that of China. Germany’s anemic pace of domestic demand growth and dependence on exports have hampered rebalancing at a time when many other euro-area countries have been under severe pressure to curb demand and compress imports in order to promote adjustment. The net result has been a deflationary bias for the euro area, as well as for the world economy. 

That is from the semi-annual "Report to Congress on International Economic and Exchange Rate Policies" (pdf).

Typically the headline from such reports is about China, as the US criticizes its policy of intervening to keep the RMB undervalued to support a trade and current account surplus, but stops short of officially declaring it a "currency manipulator" which could trigger a conflict (which some, like Paul Krugman, have said the US should be willing to start).

The shift in focus to Germany is a sign the policy discussion is catching up to reality.  Although it is still intervening in the foreign exchange market, China has allowed a significant appreciation of the RMB (and even more in real terms) over the past several years and its current account surplus has narrowed.  That said, its "rebalancing" is still far from complete - consumption remains very low as a share of GDP; the decrease in the share of net exports seems to have been made up for by an increase in investment rather than consumption (with the usual caveat that the data are less than perfect..).

The biggest threat to the world economy now is a crisis in Europe, and while the ECB has managed to calm (for now at least) fears of a dramatic collapse, the Euro-area economy is still in lousy shape, which is a tragedy for the millions unemployed there, and a drag on economic activity in the rest of the world.

The Treasury is correct that Germany's current account surplus plays a role - stronger demand growth in Germany would help the suffering "periphery" of Europe (Spain, Italy, etc..) by creating more demand for their exports.  But Germany continues to be in denial, as Bloomberg reports:

Germany today reiterated its rejection of the Treasury report, saying it doesn’t merit criticism. “There are no imbalances in Germany which require a correction of our growth-friendly economic and fiscal policy,” Finance Ministry spokesman Martin Kotthaus told reporters in Berlin. 

The difficulty, in part, comes from the moralistic connotations of some of the language used to discuss international flows.  That is, Germany is running a current account "surplus" which results from a high level of "savings", and saving and having a surplus sound like the results of virtuous behavior (while having deficits and low savings connote profligacy).  So the idea that German economic policy is part of the problem is a hard sell to politicians, commentators and voters (and even some economists who should know better).  But it takes two to have an imbalance.  Or as Karl Whelan put it on Twitter:

See German politicians know that running surpluses shows they are good morally upright people. All countries should run surpluses. With Mars
— Karl Whelan (@WhelanKarl) November 1, 2013

Germany wants all countries in EZ to run surpluses. But then we also need hard money and a strong euro which makes that almost impossible.
— Karl Whelan (@WhelanKarl) November 1, 2013

One thing that is lost is that the current account surplus implies a lower standard of living for German citizens because it means they get to consume less of what they make.  In the second quarter of 2013, private consumption accounted for only 57% of Germany's GDP (via OECD), which is pretty low (in the US, which tends to be on the high side, its around 70%).  While exporting always seems to sound great to everyone, every BMW that is exported to the US is one less BMW that a German gets to drive (and the surplus implies that Germany is getting pieces of paper - not Mustangs - in return).  In the case of China, policies that led to a high share of exports could be defended as a development strategy - while this meant that the level of consumption was lower at any point in time, it may have generated a higher growth rate.  Its harder to apply such a rationale to a relatively high-income country like Germany.

However, though I don't agree with FT columnist Gideon Rachman's defense of Germany, he is correct that the Treasury's timing is poor (the report is required by law), coming on the heels of the reports that the US might have been spying on Angela Merkel, and that episodes like the debt ceiling wrangle seriously damage US economic policy credibility. 

The Economist's "Charlemagne" has a nice column this week on subject.

Update: See also Paul Krugman.

Some Econ Grad School Advice

Miles Kimball (Michigan) and Noah Smith (a recent Michigan PhD who's at Stony Brook) offer a useful "complete guide to getting into an Economics PhD program."  Michigan's Jeff Smith comments on it.  I generally concur, though like J. Smith, I have a slight disagreement with their emphasis on being a research assistant - I definitely think it can be useful, but programs aren't going to require applicants to have this experience.

My own advice is here.  I haven't updated it in a while, but I don't think much has changed.

When I next revise it, I might add some information from the NSF's survey of earned doctorates.  Of 1124 new PhDs from US institutions in 2011, 656 had definite employment, 90 were going on to postgraduate study, 218 were seeking employment and 23 were "other" (apparently not everyone completed that survey question).  I think that might give a misleadingly negative impression the job market for economists - while it may be that quite a few PhDs weren't employed when they completed the survey, economics PhDs generally are able to get jobs.  Of those with employment, 56.3% were going into academe, 14.9% to government and 16.8% to business, with the rest going to nonprofits (6.6%) and other/unknown (5.5%).  The cohort was 34.4% female and 38.2% were US citizens.  The median age of a PhD was 31.4 and the median time to completion was 7 years.

The American Economic Association also has some useful resources about Econ PhD programs.

The Publishing Game

Although I generally feel quite fortunate to be an academic economist, in my grumpier moods I might complain that the business of getting papers published in academic journals (which is the basis for how we're judged as scholars) can feel like a bit of a game (and frustrating one at that).

Now, it is a game.  The folks at Research Papers in Eonomics (RePEc) propose to bring us a "fantasy league" for armchair department chairs:

The IDEAS fantasy league allows you to pretend you are at the helm of an economics department. Your goal is to improve its ranking relative to other departments in the league. You can do this by trading economists and by choosing which ones to activate in your roster. 

In a blog post, Christian Zimmerman explains that it started as an April fools' joke.  At this point, it is still a proposal.

I would think that those who would play this game would be well-advised that their time might be better spent working on their research papers.  Of course, the same might be said of blogging.

On the Yellen Bandwagon

The quasi-campaign for the next Federal Reserve chair continues... Heidi Hartmann and Joyce Jacobsen (my office neighbor) have organized an open letter from economists in support of Janet Yellen, which concludes:

[W]e believe that Janet Yellen is an extremely effective leader who has demonstrated her capacity to work with the other FRB governors and to bring important perspectives of the American people to her leadership and decisions.  In our opinion, she is the best possible leader for the Federal Reserve Board at this critical time in our nation’s history.

The whole thing can be read here, and there is a link for economists who wish to add their names.

The letter has already been successful in attracting quite a few signatories, including some big names, like Michael Woodford (who Richard Clarida called "the leading monetary theorist on the planet right now" in this Bloomberg profile), Alan Blinder, Christina Romer, David Romer, Robert Shiller, Maurice Obstfeld, James Hamilton (who endorsed Yellen at Econbrowser), Mark Gertler, Menzie Chinn and Charles Engel.

In addition to having the support of economists, Yellen has also been endorsed by The Economist.

There has been quite an outpouring of commentary on this, though I don't think any of it has fundamentally changed the preference for Yellen over Summers I expressed in July after Ezra Klein's initial report that Summers was the front-runner (was that the worst trial balloon ever?).  However, Jared Bernstein, who worked with him in the White House, did argue persuasively that some of the vilification of Summers as a Wall Street stooge is off-base.  This story by Zachary Goldfarb details how and why President Obama became so enamored of Summers.  But as Steven Pearlstein argued (and so did Felix Salmon) that very closeness to the President is problematic from the standpoint of central bank independence.

One of the things I like about Yellen is that she appears to represent stylistic continuity with Bernanke, who has tried to de-personalize the making of monetary policy.  However, I think an argument could be made for a regime change in substance - a shift to a new monetary rule, like nominal GDP targeting as Christina Romer called for (and Scott Sumner persistently evangelizes for), or Laurence Ball's suggestion of a higher inflation target (which I also raised back in 2008), or Ken Rogoff's "sustained burst of moderate inflation."  A Fed chair openly advocating such a fundamental policy shift does not appear to be in the cards - certainly it would be problematic in the confirmation process, and there is no guarantee that the FOMC could be brought along anyway.  Of the options that are on the table now, Janet Yellen clearly seems the best to me.

Coming Soon: "Gung Ho 2"?

Reading stories like this in the Detroit papers in the 1980s may have planted a seed in the mind of a young man who would grow up to be an economist specializing in exchange rates:

Bill Ford, executive chairman, put it this way when I talked with him Tuesday:

“It’s all about fairness, really,” he said. “I think what this country went through to re-establish our manufacturing base when we almost lost it. … For us now to give that away in a bad trade agreement makes no sense to me.

“I think manufacturing in this country matters a lot,” Ford continued. “It matters to this area. We’re not only just getting back on our feet, but as you know, really hitting on all cylinders. We’re hiring lots of Americans for both blue-collar and white-collar jobs. But a bad trade agreement could jeopardize that, and we will not let that happen.”

Ford executives are rightly proud that their company — without a federal bailout — took steps to right-size itself, boost productivity, rebuild its credit rating and revamp its product lineup to be competitive with the world’s top automakers.

But then, since last November, they’ve watched as their company’s Japanese rivals got a huge boost from a drop of nearly 20% in the value of the Japanese yen compared to the U.S. dollar.

Oh, wait, that's not from the 1980s - its from last week.  What is going on?

Certainly the fall in the Yen is helpful for Japanese exporters.  According to the Washington Post's Neil Irwin:

It’s been a good year so far for automakers. And it’s been an even better year for Toyota. The company reported its second-quarter earnings Friday, which included this whopping number: Sales were up 14 percent over a year earlier. The company hiked its estimate for 2013 earnings by 8 percent. And operating profit rose 88 percent.

The results were enough to spark a 6 percent rise in Toyota’s U.S.-listed shares, and surely to strike fear in the hearts of Toyota’s competitors. As Bloomberg news points out, while Toyota was edged out by General Motors in number of cars and trucks sold, it recorded more than three times the profit....

Of the 272 billion yen in higher earnings that Toyota reported Friday, 260 billion are attributable to foreign exchange swings, according to Toyota’s own estimates. Toyota has taken advantage of costs that are now 25 percent lower on the global marketplace (at least for those cars and parts built in Japan, rather than in satellite plants elsewhere).

The yen has depreciated about 25% relative to the dollar in the past year:

(Note: the graph shows the yen price of a dollar, so a rise is a yen depreciation/dollar appreciation.)

Is this "currency manipulation" as some in Detroit and Washington would have it?  The most straightforward explanation of the yen's decline would be a more expansionary monetary policy under the new Bank of Japan Governor, Haruhiko Kuroda (appointed by the new government of Shinzo Abe).  One of the effects of expanding the quantity of money is to reduce the value of it, both domestically (inflation) and relative to others (depreciation), and since currencies are traded in financial markets, the effects of expansionary policies can show up quickly in exchange rates (indeed, markets are forward-looking, so only a change in expectations is needed).  In the case of Japan, which has suffered from deflationary sluggishness for a couple of decades now, a shift to a more expansionary policy regime seems appropriate.

Taking a longer view, the recent decline is partly retracing the yen's appreciation during the financial crisis (when, even more than the dollar, it was seen as a "safe haven") and afterwards, when the dollar was falling due to the Fed's "quantitative easing" expansionary policies.

"Manipulation" is a loaded term, and determining when it occurs is subjective (I think the term could reasonably be applied when governments intervene in foreign exchange markets - the evidence of this would be in official holdings of currency reserves).  But its common for trading partners to grumble when your currency falls, even if the depreciation results from a monetary policy appropriate for domestic conditions.  The US was on the other side of this type of criticism a few years ago when the Fed was being accused of stoking "currency wars."

Of course, even if one takes the view Japan is (unfairly) "manipulating" its currency, there isn't really a mechanism to do anything about it.  Mirroring the divide in the economics profession where "international trade" is studied by microeconomists and exchange rates ("international finance") is the province of macroeconomists, the world has separate institutions for dealing with "trade" problems and "monetary" ones.  If a country attempts to boost net exports with a tariff, its trading partners have recourse to the WTO (and, in many cases, provisions of preferential trading agreements as well).  Doing the same thing through currency depreciation, well... the institution that has purview over exchange rates, the IMF, doesn't really have any mechanisms to settle grievances, so government officials are left to hector each other, and, on rare occasion, agree to coordinated policies.

In the case of the relative lack of US presence in the Japanese auto market, which has been consistent throughout the ups and downs of the yen-dollar exchange rate, the culprit (to the extent its driven by policy, not consumer preferences) is more likely in "non-tariff barriers" (NTBs).  While tariffs are easy to see, analyze and bargain over, imports can be impeded in more subtle ways that are more difficult to identify and deal with.  Often, what some see as a non-tariff barrier can be defended as a safety or environmental regulation.  In his "proposal to level the playing field" this is how Sander Levin (D-MI; my old congressman) characterizes Japan's auto sector NTBs:

These barriers have included: a discriminatory system of taxes; onerous and costly vehicle certification procedures for imported automobiles; a complex and changing set of safety, noise, and pollution standards, many of which do not conform to international standards and add significant development and production costs for automobiles exported to Japan; an unwillingness by Japanese dealerships to carry foreign automobiles and insufficient enforcement of competition laws to address anti-competitive practices; zoning restrictions that make it difficult, if not impossible, to establish new dealerships in important markets; and exclusionary consumer preferences shaped by decades of government policies directed at promoting the national car companies. 

Of course, that's not exactly an unbiased source (methinks "exclusionary consumer preferences" a bit of a stretch).  The occasion for Levin's proposal is Japan's entry into the negotiations over the "Trans Pacific Partnership" (TPP) trade agreement.  Overall, these preferential trade agreements are somewhat of a mixed bag.  They represent a "deeper" form of integration than the WTO and, as such, tend to extend further into areas typically thought of as "domestic" policy and may include such things as harmonization of regulations.  Whatever else one may think of it, the TPP negotiations may therefore be a good vehicle for addressing NTBs.  The US Trade Representative's office is promising to work on it, and already claiming some progress:

On April 12th, Japan announced its unilateral decision to more than double the number of motor vehicles eligible for import under its Preferential Handling Procedure (PHP), a simpler and faster certification method often used by U.S. auto manufacturers to export to Japan. In the near term, U.S. auto producers will be allowed to export up to 5,000 vehicles annually of each vehicle “type” under the PHP program, compared with the current annual ceiling of 2,000 vehicles per vehicle type. The United States and Japan have agreed to address a broad range of non-tariff measures in Japan’s automotive sector –including those related to transparency in regulations, standards, certification, “green” and new technology vehicles, and distribution – in a bilateral negotiation parallel to the TPP talks. In addition, they agreed to negotiate a special motor vehicle safeguard provision, as well as a mechanism to “snap back” tariffs as a remedy in dispute settlement cases.

Moreover, it appears that the Abe government plans to use the TPP as a cudgel to overcome domestic resistance to various domestic "reforms" that it wants to achieve as part of the "third arrow" of Abenomics.

Nonetheless, I don't think the US automakers should expect a big increase in the number their products cruising the roads of Japan anytime soon.  Issues of "currency manipulation" and non-tarriff barriers are invariably sticky ones - separating currency manipulation from valid monetary policy is subjective, and distinguishing legitimate regulations from disguised trade barriers is often very tricky.  Voluntary export restraints, anyone?

The post title is a reference to this, from the 80s.

GDP: TNG

According to the BEA's first version (the "advance estimate") of the second-quarter GDP numbers, which were released this past week, the US economy grew at a lackluster 1.7% annual rate in April-June.  That's an acceleration from the first quarter (1.1%) and the last quarter of 2012 (0.1%). But its still pretty disappointing - a treading-water-ish growth rate at best when we need faster-than-normal growth to make meaningful progress towards something resembling "full employment".

Although the unemployment rate has been falling, other measures like the employment-population ratio highlight how the labor market is far from fully recovered from the 2008-09 recession, and a 1.7% growth rate isn't nearly fast enough to really help.

Second-quarter growth was boosted by investment, which increased at a 9% rate (including 13.4% growth rate in residential investment; inventory accumulation also contributed).  Net exports were a minus, with imports growing faster than exports (9.8% versus 5.4%).  Government expenditures were a small drag, falling 0.4% (the federal government was at -1.5%, while state and local grew 0.3%).  It was the third consecutive quarter that the federal government has made a negative contribution (though less so than in the previous two).

The interesting thing in the release was not the second-quarter numbers, but rather the "comprehensive revision" of all the past data that came with it.  The BEA does this about every 5 years to incorporate changes in definitions and methodology.  By its new reckoning, US GDP is about $550 billion (3.4%) larger.

This shows how much the revisions have added to GDP over time (the percent difference between the new and previous versions of the series, constructed using vintage data from Alfred):

The main changes are to treat research and development as well as the creation of movies, TV programs, books and music (which the BEA is calling "entertainment, literary and artistic originals") as forms of investment.  These appear in the tables as a new subcategory of investment called "intellectual property products" which also includes software (formerly part of "equipment and software"; now there's a separate "equipment" subcategory).

Slate's Matthew Yglesias had a nice explanation of rationale for the changes:

Government statisticians draw a distinction between money a company spends as the cost of doing business and money a company spends on investing for the future. When a moving company buys a new truck, that’s an investment. You expect the truck to last for years and generate an ongoing stream of income. The truck purchase is part of GDP. Each year the truck depreciates in value, with the depreciation subtracting from GDP as what’s known as “consumption of fixed capital.” When a moving company buys gasoline to fuel the truck, that’s just the cost of doing business. The expense incurred is subtracted from the company’s income when calculating how profitable it was in any given year.

Right now we treat filming a season of Game of Thrones or having researchers work on a new pharmaceutical as being similar to filling up the truck’s gas tank. The new method is to treat them as similar to buying the truck.

Conceptually, the new way is clearly correct. Game of Thrones is to HBO as a truck is to a moving company: part of its stock of capital. Accounting for artistic originals in that way will add about half a percentage point to the size of America’s overall economy. Doing the same for research and development spending will add slightly more than two percentage points. And here, too, the new system is more sound in theory. A drug company is going to own plenty of physical capital goods, but its most important investments are the ones it makes in researching new products.

At Econbrowser, James Hamilton used a "Robinson Crusoe" story to explain the changes, Dean Baker and Jared Bernstein used the occasion to consider some of the other limitations of GDP in a NYT op-ed.

Overall, the revisions do not significantly change the "macro" picture of the behavior of the US economy.  With the new series, the average growth rate is slightly faster: 3.16% versus 3.11% since 1947 (when the quarterly data begins) and 2.50% versus 2.42% since 1993.  The standard deviation of growth is a tiny bit lower in the new series, and inflation, measured by the GDP deflator, is reduced a smidge by the revisions.  The "extra" output added in the revision is acyclical for the 1947-2013 period as a whole - the correlation of the addition to GDP with the growth rate is -0.04 - but slightly pro-cyclical over the last 20 years, with a correlation between growth and the addition of 0.19.

The new series makes the 2008-09 recession look slightly less bad, and the subsequent expansion a little bit better, as can be seen looking at both series normalized to 100 at the previous business cycle peak of fourth-quarter 2007:

At his FT blog, Gavyn Davies puts the new numbers in the context of economic policy.

Another change was to treat traditional, defined-benefit pensions on an "accrual" basis, which means they will be counted as income as the obligations to workers rise, rather than when employers put money in their pension funds.  This boosts the measured saving rate, which the Washington Post's Jim Tankersley thinks is problematic:

That money isn’t necessarily real. The Bureau of Economic Analysis didn’t find hundreds of billions of dollars stuffed in Americans’ mattresses. It decided to start counting all pension promises as savings in the bank....

The promises that aren’t backed by an income stream are called unfunded liabilities, and by changing how it counts them, the government added almost $200 billion to the nation’s personal savings for 2012.

The catch is, what if those promises don’t come true? The accounting change was made shortly after Detroit became the largest U.S. city to file for bankruptcy, in part due to the unfunded liabilities in its pension plan, raising questions over whether pensioners will actually receive the benefits they’ve been promised. Signs point to more strains on state and local government pension funds down the road.

(It's worth noting that some, including Paul Krugman, argue that the hand-wringing about under-funded pensions is overblown).

Another change is that some expenses associated with property transfers like attorney's fees and title insurance are also going to be treated as investments (the idea is that when you pay for these, you're not consuming a service, but rather paying for something that generates a flow of services - keeping the rain off your head - over a period of time).

The BEA also moved the "base year" to 2009 - i.e., real GDP is now expressed at 2009 prices (before it was 2005).

The BEA has more information about the comprehensive revision here; I found this article from the March Survey of Current Business (pdf) particularly helpful.

The revised "second estimate" of second-quarter GDP is due on Aug. 29.

Of Summers, Discontent

Based on conversations with "plugged-in sources", Ezra Klein reports:

The word among Federal Reserve watchers right now is that the choice is down to Janet Yellen or Larry Summers as Ben Bernanke’s replacement. I can’t find anyone who really thinks it’ll be Roger Ferguson, Tim Geithner, Alan Blinder, or some other dark horse.

People dismissed Summers’s chances a month or two ago, but he’s increasingly viewed as the leading candidate today — and opinions on this, for reasons I don’t fully understand (though I suspect have to do with a bunch of elite trial balloons going up at the same time), have really hardened in the last 72 hours.

I'd thought the persistent reports that Summers was a leading candidate represented some wishful thinking among writers in need of a more interesting story; like Matt Yglesias, I thought Yellen over Summers a no-brainer.  Yellen's qualifications are beyond doubt - she has strong academic credentials and experience at high levels of the Fed.  From a political perspective, Summers seems to have obvious drawbacks - supposedly one of the reasons Obama appointed him CEA chair rather than Treasury Secretary at the beginning of his administration was to avoid a messy confirmation fight (the CEA position does not require Senate approval).

Moreover, as Bill McBride details, "Yellen has a much better track record of correctly analyzing the economic situation, while Summers has frequently been wrong (but never in doubt)" and Cardiff Garcia's endorsement of Yellen provides further evidence on that point.  Scott Sumner is also unimpressed with Summers' views (or lack thereof) on monetary policy.

Also, as Paul Krugman notes:

[Y]ou need someone who can be effective at bringing the rest of the Fed along — but that’s a bit of a mysterious quality. Ben Bernanke has been far better at that than one might have expected from an academic. Looking forward, which is better: someone who has already demonstrated an ability to get along with her Fed colleagues, or someone who has a reputation as a tough guy but also a reputation for raising hackles? 

As Richard Grossman explains, one of Bernanke's big achievements has been to move away from the "cult of personality" style of central banking that was one of the worst aspects of the Greenspan era.  In that respect, appointing someone with a reputation for being obnoxious "strong personality" like Summers would likely be a step backward.

Up to this point, I've refrained from mentioning the fact that an appointment of Yellen would be historic because she would be the first woman to lead the Fed.  Even without taking that into consideration, its clear that she is a strong candidate, and Summers a highly problematic one.  But breaking the "glass ceiling" that still seems to exist in the monetary policy world would be no small thing.

Ezra Klein recently argued in a column that there was an undercurrent of sexism in some of the arguments being made against Yellen (e.g., "She lacks 'toughness.' She’s short on 'gravitas.' Too 'soft-spoken' or 'passive.'").  He pointed out that

An interesting wrinkle is that the current chairman of the Federal Reserve doesn’t fit the default masculine leadership model himself. Bernanke is soft-spoken and conciliatory. He doesn’t pound the table in meetings or preen at conferences. When he took the job, there were concerns about his gravitas. He’s not a social or political force around Washington in the way his predecessor, Alan Greenspan, was. He leads by consensus, with none of the high-stakes showdowns that burnished the legend of former Fed chairman Paul Volcker. Yet Bernanke has managed to pull the Federal Reserve through an extraordinarily turbulent period.

Yellen’s background bears similarities to Bernanke’s, though she’s got more Washington and Fed experience than he did at the time of his appointment. 

Klein generally seems to know what he's talking about, and I believe him when he says his reporting is well-sourced.  His story lays out the reasons Obama is apparently leaning towards Summers, none of which I find very persuasive.  I hope he's wrong on this one.

See also: Noam Scheiber, who asks "can we at least talk it over first?"

Update (8/1): There has been quite an outpouring of commentary on this in the last week.  While much of it focuses on the perceived drawbacks of Summers (e.g., Paul Krugman), James Hamilton makes a case for Yellen.  The New York Times has editorialized in favor of Yellen, and President Obama defended Summers at a meeting with congressional Democrats (he also mentioned Don Kohn as a possibility for the Fed position).  This widespread, almost campaign-like debate is little uncomfortable for those who subscribe to the view that the Fed should be somewhat removed from politics.

Ezra Klein dug further into the administration's arguments for Summers, and Brad DeLong makes a (somewhat lonely) pro-Summers case (see also his blog post).

Bernanke Isn't Neutral on the Long-Run

When I first started teaching intermediate macroeconomics ten years ago, I decided to consider economic growth in the first part of the class.  Partly my reasoning was tactical - its the most mathematically challenging part of the class for many students, so I thought it was good to get them in the habit of working hard and taking it seriously at the start (and the competing claims on students' time tend to be less severe earlier in the semester).  The more important rationale was motivation - at the time we were in the midst of the "great moderation" and it was hard to get students who had never seen a serious recession in their lives excited about learning about things like how the Fed sets interest rates.  That, of course, has changed, and I think starting in with business cycles would be a good way to get the students "hooked" now - its tempting to change, but I've stuck with my strategy of emphasizing growth at the beginning of the semester.

As I noted in a recent post, long-run economic growth is the most important determinant of how living standards change from generation to generation, and why they vary so much from country to country.  The rise in incomes over decades is much bigger than the disruptions due to any business cycle downturn, even relatively large ones like the slump following the 2007-08 financial crisis.  Economic theory says that the main determinant of growth in the long run is technological progress, though we're still a little iffy on explaining how that technological change occurs.

Robert Lucas famously said: "Once you start thinking about economic growth, its hard to think about anything else."  Actually, that's pretty wrong - its very easy to be focused on short-run fluctuations and policy responses to them (and this is really important, and the negative consequences of recessions are understated by representative agent type models that Lucas tends to favor).

Ben Bernanke used his commencement address at Bard College at Simon's Rock as an opportunity to step back from his usual focus on managing short-run fluctuations and talk about economic growth.   His speech acts as a rebuttal of sorts to Robert Gordon and others who are worrying that the benefits of the information technology "revolution" for productivity growth are already petering out.  The core of his response is:

First, innovation, almost by definition, involves ideas that no one has yet had, which means that forecasts of future technological change can be, and often are, wildly wrong. A safe prediction, I think, is that human innovation and creativity will continue; it is part of our very nature. Another prediction, just as safe, is that people will nevertheless continue to forecast the end of innovation. The famous British economist John Maynard Keynes observed as much in the midst of the Great Depression more than 80 years ago. He wrote then, "We are suffering just now from a bad attack of economic pessimism. It is common to hear people say that the epoch of enormous economic progress which characterised the 19th century is over; that the rapid improvement in the standard of life is now going to slow down." Sound familiar? By the way, Keynes argued at that time that such a view was shortsighted and, in characterizing what he called "the economic possibilities for our grandchildren," he predicted that income per person, adjusted for inflation, could rise as much as four to eight times by 2030. His guess looks pretty good; income per person in the United States today is roughly six times what it was in 1930.

Second, not only are scientific and technical innovation themselves inherently hard to predict, so are the long-run practical consequences of innovation for our economy and our daily lives. Indeed, some would say that we are still in the early days of the IT revolution; after all, computing speeds and memory have increased many times over in the 30-plus years since the first personal computers came on the market, and fields like biotechnology are also advancing rapidly. Moreover, even as the basic technologies improve, the commercial applications of these technologies have arguably thus far only scratched the surface. Consider, for example, the potential for IT and biotechnology to improve health care, one of the largest and most important sectors of our economy. A strong case can be made that the modernization of health-care IT systems would lead to better-coordinated, more effective, and less costly patient care than we have today, including greater responsiveness of medical practice to the latest research findings.  Robots, lasers, and other advanced technologies are improving surgical outcomes, and artificial intelligence systems are being used to improve diagnoses and chart courses of treatment. Perhaps even more revolutionary is the trend toward so-called personalized medicine, which would tailor medical treatments for each patient based on information drawn from that individual's genetic code. Taken together, such advances could lead to another jump in life expectancy and improved health at older ages.

Other promising areas for the application of new technologies include the development of cleaner energy--for example, the harnessing of wind, wave, and solar power and the development of electric and hybrid vehicles--as well as potential further advances in communications and robotics. I'm sure that I can't imagine all of the possibilities, but historians of science have commented on our collective tendency to overestimate the short-term effects of new technologies while underestimating their longer-term potential.

Finally, pessimists may be paying too little attention to the strength of the underlying economic and social forces that generate innovation in the modern world. Invention was once the province of the isolated scientist or tinkerer. The transmission of new ideas and the adaptation of the best new insights to commercial uses were slow and erratic. But all of that is changing radically. We live on a planet that is becoming richer and more populous, and in which not only the most advanced economies but also large emerging market nations like China and India increasingly see their economic futures as tied to technological innovation. In that context, the number of trained scientists and engineers is increasing rapidly, as are the resources for research being provided by universities, governments, and the private sector. Moreover, because of the Internet and other advances in communications, collaboration and the exchange of ideas take place at high speed and with little regard for geographic distance. For example, research papers are now disseminated and critiqued almost instantaneously rather than after publication in a journal several years after they are written. And, importantly, as trade and globalization increase the size of the potential market for new products, the possible economic rewards for being first with an innovative product or process are growing rapidly.  In short, both humanity's capacity to innovate and the incentives to innovate are greater today than at any other time in history. 

In typical Bernanke fashion, the whole speech is very nicely done (he must be a fantastic professor).  Another thing I liked about it is that Bernanke also makes a case for liberal arts education:

Well, what does all this have to do with creativity and critical thinking, which is where I started? The history of technological innovation and economic development teaches us that change is the only constant. During your working lives, you will have to reinvent yourselves many times. Success and satisfaction will not come from mastering a fixed body of knowledge but from constant adaptation and creativity in a rapidly changing world. Engaging with and applying new technologies will be a crucial part of that adaptation. Your work here at Simon's Rock, and the intellectual skills, creativity, and imagination that that work has fostered, are the best possible preparation for these challenges. And while I have emphasized technological and scientific advances today, it is important to remember that the arts and humanities facilitate new and creative thinking as well, while helping us to draw meaning that goes beyond the purely material aspects of our lives. 

I'd been thinking of adding Robert Gordon's paper on the "headwinds" facing economic growth to the reading list for next year.  Bernanke's speech will be a nice counterpoint to go with it.

The speech is also discussed by the NYT's Binyamin Appelbaum and Washington Post's Neil Irwin.

China to Switch Sides (of the Trilemma)?

At Wonkblog, Neil Irwin rightly points out that China's announced intention to liberalize financial flows by making it easier to convert renminbi into foreign currency is a big deal.  He writes:

China is essentially weighing a trade-off.  A transition to a freer, more market-based financial system could pack many advantages, including a more efficient system of funneling savings into productive investment, more reliable savings vehicles available for its citizens, and advantages for Chinese companies as they do business across Asia and beyond.

But getting those advantages will come at a price. It means pivoting away from an export-led growth strategy that has been wildly successful over the last generation and has benefited from an artificially low yuan. It leaves China with greater risk of volatile capital flows that have created booms and busts, and bursts of inflation, in many other emerging economies over the years.  And most importantly, from the vantage point of the ruling Communist party, it will mean ceding some of the power now held by top party officials to the hard-to-corral whims of markets.

As Greg Mankiw explains, the international finance "trilemma" (or "impossible trinity" for those who think "trilemma" sounds too silly) implies that a country cannot simultaneously have (i) free capital mobility (financial flows) (ii) a fixed exchange rate and (iii) monetary policy autonomy.  That is, on this diagram, all countries must choose a side:

China's current policy puts it on the right-hand side; while the yuan is no longer pegged to the dollar, its value is heavily managed.  The capital controls come in by preventing foreigners from buying yuan when interest rates in China rise (which would otherwise cause the yuan to appreciate).  Allowing relatively free financial flows and letting the yuan float would put it on the left-hand side, which is where the US is.

There is likely a significant pent-up demand demand for yuan- denominated assets and the rest of the world would soon take advantage of the opportunity to diversify portfolios by investing in China.  Furthermore, free capital flows would help the yuan to gain status as a "reserve currency" held by governments (it isn't one now because nobody wants to hold reserves in a currency they can't freely exchange).  Purchases of Chinese assets by investors and governments would cause the yuan to appreciate (which would be partly offset by outflows as Chinese buy more foreign assets).  This would hurt Chinese exports but raise its wealth and increase its consumption, helping to "rebalance" its economy toward a more consumer-oriented model (currently, consumption is about 35% of China's GDP, versus roughly 70% in the US).

China's policy of intervening to keep the yuan undervalued (relative to what it would be under a free float) means that its been buying alot of dollar-denominated assets.  A reduction in this buying, as well as possibly lower demand for dollars from other countries if the yuan takes market share as a reserve currency, would mean a dollar depreciation.  This would boost US exports, while lowering the purchasing power of consumers, thus rebalancing the US economy in the opposite direction of China's.  In general, the financial inflows associated with the dollar's unique role have meant lower interest rates for the US - while this has been called our "exorbitant privilege", it is, at best, a mixed blessing, as it has distorted the US economy away from tradable goods production and helped fuel the previous decade's housing bubble.  Ceteris paribus, the changes discussed above imply higher interest rates for the US, but for the immediate future, one would expect the Fed to try to make offsetting adjustments.

Allowing the yuan to appreciate would also make exports from other developing countries more competitive, and reduce the pressure on them to keep their currencies undervalued.  That is, the biggest beneficiary of a shift by China might be Mexico.

Econ PhD Musings

Holder of a more recent vintage economics PhD than me, Noah Smith says "If you get a PhD, get an economics PhD".  His foremost reason is that job market conditions are much better for economics PhDs than in most other fields.  It's definitely worth a read if you're considering grad school, though I have some friendly amendments to offer:

On the positive side:
The benefits of having a stronger labor market than most other academic disciplines persist beyond the initial job placement.  If you end up in a place that isn't a "good fit", you have a reasonable chance of being able to move.  This is in contrast to some fields where anyone with an academic job must cling desperately to it knowing they have slim chances of finding another one, which makes them vulnerable to jerky administrators etc (fortunately my current institution generally seems to treat people well, even when they don't have to).  Moreover, this means that the tenure process is slightly less terrifying - the economists I know who've been denied tenure have generally landed on their feet.

On the negative side:
Noah neglects to mention that, while the job market for economists is relatively robust, its still a fairly thin one (at least compared to most 'normal' jobs), so, while PhDs generally get jobs, they don't usually have alot of choices.  This means is a problem to have strong preferences about exactly what type of job you want, or where you want to live.

I think he also understates the risk of failure.  Its true that, once you're through the preliminary exams, you're not likely to experience "failure" as a single, discrete event. However, dissertations are a real struggle - even in the best case - and its not uncommon for people to drift away without finishing.

I like Noah's enthusiasm about the potential for "intellectual fulfillment" - and he's right, its pretty great - and rare - to have a job where you have freedom to pursue different ideas and topics with nobody telling you what conclusions to come to.  And its neat to be around people who are are sharp thinkers and/or doing interesting research.  But, that said, academics don't just get to think - they have to have their work validated by publishing, and the process of getting papers published is a real grind, and, on a bad day, can feel like a bit of a game.

Also, he says, "as an econ grad student, you'll have a life. Or a chance at having a life, anyway."  Hmm... depends on what you mean by "life", and certainly not the first year (or really the second, either).

I think the big qualifier is "If you get a PhD" - while conditions for economists are much better than in many other fields, getting a PhD in economics still has a high cost.  Not only does it entail giving up income - both during the grad school years, but also by forgoing more lucrative career options - it also means narrowing the set of career choices (there really is such a thing as being "overqualified," so having a PhD is limiting).  I agree with Noah that the careers available to econ PhDs are generally desirable, but my advice to college juniors and seniors who aren't sure would be to try out working in the "real world" first - it may give you some perspective.

I've posted some general advice about economics grad school here.

The Trend of Things

Amid all our concern about financial crises, zero lower bounds, stimulus packages and the euro, its worth remembering that they are related to a short-term fluctuation (albeit a relatively large one) around a long-run trend, and it is the trend that ultimately determines how well-off people will be in the future.  Or,

The prevailing world depression, the enormous anomaly of unemployment in a world full of wants, the disastrous mistakes we have made, blind us to what is going on under the surface to the true interpretation of the trend of things. For I predict that both of the two opposed errors of pessimism which now make so much noise in the world will be proved wrong in our own time-the pessimism of the revolutionaries who think that things are so bad that nothing can save us but violent change, and the pessimism of the reactionaries who consider the balance of our economic and social life so precarious that we must risk no experiments. 

as J.M. Keynes wrote in "Economic Possibilities for Our Grandchildren" (1931).*

The rise in living standards over time - the long-run growth rate - depends on labor productivity (i.e., output per hour of work).  That, in turn, depends on capital per worker and technological progress (broadly defined as our ability to wring more output from a given amount of capital and labor).  Since capital has diminishing returns, it is really technological progress that ultimately matters.

At his Conversable Economist blog, Tim Taylor notes that growth in per capita real GDP over the past two centuries in the US has been remarkably consistent in the long run.  Using Measuring Worth's series, it looks like this:

[Note: plotting the logarithm means that the slope of the line is proportional to the percentage growth rate; the gridlines at 7.5, 9 and 10.5 correspond to $1800, $8100 and $36300, respectively]**

Technological progress essentially determines the slope, and a seemingly small rate of change, compounded over a few decades, is a big deal - a much bigger deal, measured in output, than the "great recession" (whether output is the right thing to count is another, more complicated, matter). So it may be cause for concern that productivity growth, after picking up in from the mid-1990's through the early 2000's, appears to have slowed again.

Average TFP growth rates, US Private Sector (source: BLS)

1948-73:      1.9%

1973-95:      0.4%

1995-2007:  1.4%

2007-11:      0.4%

The New Yorker's John Cassidy has some interesting musings on why that might be.  The alarming possibility is that the productivity resurgence associated with the internet is petering out already.  However, in the short-run, productivity measurements can be volatile and affected by business cycles, so its we may want to hold off on worrying that the trend has turned down.

*I'd actually started writing this and forgotten to finish it put it aside some time before Niall Ferguson's repellent remarks (that he quickly apologized for) about Keynes not caring about the future because he was childless; "Economic Possibilities" is not only evidence that Keynes cared about the long-run, but that he had considerable insight into the process of long-run growth which anticipated some of the implications of Robert Solow's work in the 1950's.  Though it should be admitted that  Keynes' essay also shows that he wasn't entirely above invoking offensive stereotypes himself.

**If anyone knows of a graphing program that easily does a nice job with log scales, I'd love to hear about it (the ones Excel makes don't come out very well and I'm repeatedly aggravated by trying).

Stiglitz on Singapore

Joseph Stiglitz writes:

Singapore has had the distinction of having prioritized social and economic equity while achieving very high rates of growth over the past 30 years — an example par excellence that inequality is not just a matter of social justice but of economic performance.

Finally, an example of a country that can walk and chew gum at the same time!  Oh, wait...

I'm not really that familiar with Singapore (aside from knowing you can't chew gum there), so I won't comment on the particulars, but its worth noting that the comparison Stiglitz makes of Singapore's growth record to that of the US is a little unfair because Singapore was once - not that long ago - a much poorer country than the US.  Standard growth theory predicts that low-income countries should "converge" (i.e., catch up) to higher income ones.  That means that they'll have higher growth rates.

(Data: World Bank)

That said, many low income countries haven't managed to converge, so Singapore does stand out as a successful example which may provide some useful lessons.

Is Euro-geddon Nigh?

 Brad DeLong writes on the value of studying economic history:

Ten years ago I thought that my curiosity about and interest in the Great Depression was an antiquarian diversion from my day job of understanding the interaction of economic institutions, economic policies, and economic outcomes. The fact that we had gone through the Great Depression, had learned lessons from it, and had incorporated those lessons into our institutions and policy processes meant that there was little practical use to going over it once again. Boy, was I wrong. History may not repeat itself, but it certainly does rhyme—and nothing made an economist better-prepared and better-positioned to understand what happened to the world economy between 2007 and 2013 than a deep and comprehensive knowledge of the history of the Great Depression.

One of the most basic lessons from the 1930's, as well as the semi-regular banking panics of the 19th century, is the importance of preventing bank runs.  This can be accomplished by providing a mechanism, such as deposit insurance, that makes depositors confident that they will always be able to get their money out - therefore they won't feel an urgent need to take it out at the first sign of trouble.

Even though its been evident for a while that Europe, or at least its "leaders", seem determined to forget (or ignore) the lessons of economic history, what they're doing with Cyprus is rather stunning.  Neil Irwin writes:

It is a bad day to have your money deposited in a bank in the Mediterranean island nation of Cyprus. And it may just mean some bad days ahead for the rest of us.

Early Saturday, the nation reached an agreement with international lenders for bailout help. Part of the agreement: Bank depositors with more than 100,000 euros ($131,000) in their accounts will take a 9.9 percent haircut. Even those with less in savings will see their accounts reduced by 6.75 percent. That’s right: Anyone with money in a Cypriot bank will have significantly less money when the banks open for business Tuesday than they did on Friday. Cypriots have reacted with this perfectly rational reaction: lining up at ATM machines to try to get as much money out in the form of cash before the money they have in their accounts is reduced.

The Economist's "Schumpeter" blog further explains some of the ways in which this move is problematic:

The bail-out appears to move Europe further away from the institutional reforms that are needed to resolve the crisis once and for all. Rather than using the European Stability Mechanism to recapitalise banks, and thereby weaken the link between banks and their governments, the euro zone continues to equate bank bail-outs with sovereign bail-outs. As for debt mutualisation, after imposing losses on local depositors, the price of support from the rest of Europe is arguably costlier now than it ever has been.

It is also hard to square this outcome with the ongoing overhaul of finance. The direction of efforts to improve banks’ liquidity position is to encourage them to hold more deposits; the aim of bail-in legislation planned to come into force by 2018 is to make senior debt absorb losses in the event of a bank failure. The logic behind both of these reform initiatives is that bank deposits have two, contradictory properties. They are both sticky, because they are insured; and they are flighty, because they can be pulled instantly. So deposits are a good source of funding provided they never run. The Cyprus bail-out makes this confidence trick harder to pull off.

Prophecies of impending Euro-doom over the past several years have repeatedly been wrong (or premature, at least), but this doesn't look good.  How many hours until banks open in Spain?

Update: According to the FT, it was the IMF that had been pushing the idea of "depositor haircuts" - I'd thought they were a little more enlightened, but apparently not...

See also: Karl Whelan,  Felix Salmon, David Beckworth, Paul Krugman.

The 'Woodford Period': A Bourbon for Bernanke?

The news release summarizing  St. Louis Fed President's James Bullard's recent speech on the "current stance of monetary policy" includes the following:

He stated that “the current St. Louis Fed forecast for the unemployment rate implies that the 6.5 percent threshold will be crossed in June 2014.” However, he noted, the policy rate implied jointly by the Taylor (1999) rule and the St. Louis Fed forecasts should increase in August 2013.  Thus, “The Committee’s thresholds imply a ‘Woodford period’ since the policy rate would be held at zero past the point where ordinary FOMC behavior would indicate an increase,” Bullard said.   

William McChesney Martin, who chaired the Fed in the 1950's and 60's once said it was the Fed's job "to take the punch bowl away just as the party gets going."  It sounds like the Fed's new corollary to Martin's rule involves leisurely sipping bourbon for a while when the economic slump is ending.  If the slump is the hangover from a financial crisis, maybe its kind of a "hair of the (monetary) dog" thing.

The release continues:

The period from August 2013 to June 2014 would be the “Woodford period,” which refers to Michael Woodford of Columbia University.  “According to received theory, this is a more stimulative monetary policy and possibly even an optimal monetary policy when the zero lower bound is constraining,” Bullard added.  

Oh, "Woodford" is the author of Interest and Prices, not Woodford Reserve bourbon whiskey.

Perhaps that's for the best... if distilleries expected the Fed to print money to buy bourbon we might expect to see them them start diluting it in anticipation.  Hmmm...

Stanley Fischer

At Wonkblog, an interesting profile of Stanley Fischer by Dylan Matthews, which mixes in a little recent history of economic thought, recounted with the help of one of Fischer's advisees at MIT:

“He was not fundamentally a rat-exian,” Bernanke said, invoking the derogatory slang that Keynesians used to describe Lucas and his theory of “rational expectations.” “He was basically a Keynesian in his instincts, so he got along just fine with Samuelson and [fellow MIT professor Robert] Solow.”

The fruit of Fischer’s effort to integrate the two approaches is known today as “New Keynesian” economics. It is the dominant approach in most leading economics departments, with Mankiw, Bernanke, IMF chief economist Olivier Blanchard and many others contributing to the movement.

But Fischer was arguably first out of the gate. He helped originate the argument that “sticky prices”— that is, practical impediments to changing prices for goods, such as the expense of printing a new restauarant menu — mean that even rational, self-interested businesses and consumers can make choices that add up to an economy much like the one Keynesians describe.

Fischer, Bernanke said, wrote “one of the very first papers that had both sticky prices and rational expectations in it.” By doing this, Fischer had in effect united the two sides of economics. “I still think Keynesian economics is extremely important, and if anybody didn’t think so, this crisis should have made them rethink,” Fischer said in an interview.

The profile includes some speculation that Fischer might succeed his student as Federal Reserve chair (Bernanke's term ends in Jan. 2014).  If he were nominated, it would be interesting to see whether the fact that he is from outside the US - he was born in Zambia (when it was Northern Rhodesia) and came to the US for grad school at Chicago - and served as head of another country's (Israel's) central bank would cause trouble during the Senate confirmation process.  It seems likely that some in the Senate would make trouble for whoever President Obama might nominate (which may be an argument for trying to keep Bernanke on), but I would guess opponents would be more likely to latch on to the fact that Fischer also held a high-ranking job at Citigroup for several years.

Update (2/17): David Warsh's Economic Principals also discussed Fischer as a potential Fed candidate a couple of weeks ago.

From 'The Economic Consequences of Mr. Churchill'

J.M. Keynes, "The Economic Consequences of Mr. Churchill" (1925):

The truth is that we stand mid-way between two theories of economic society.  The one theory maintains that wages should be fixed by reference to what is "fair" and "reasonable" as between classes.  The other theory - the theory of the economic Juggernaut - is that wages should be settled by economic pressure, otherwise called "hard facts," and that our vast machine should crash along, with regard only to its equilibrium as a whole, and without attention to the chance consequences of the journey to individual groups.

The gold standard, with its dependence on pure chance, its faith in "automatic adjustments," and its general regardlessness of social detail, is an essential emblem and idol of those who sit in the top tier of the machine.  I think that they are immensely rash in their regardlessness, in their vague optimism and comfortable belief that nothing really serious ever happens.  Nine times out of ten, nothing really serious does happen - merely a little distress to individuals or to groups.  But we run a risk of the tenth time (and are stupid into the bargain) if we continue to apply the principles of an Economics which was worked out on the hypotheses of laissez-faire and free competition to a society which is rapidly abandoning these hypotheses.

Basic economic theory typically ignores the role of social norms in labor markets.  To some degree, that's ok - we can't have everything in every model, and the basic models (i.e., intermediate micro) give some useful insights.  The danger comes when economists - and the consumers of economics - forget that the models are (over) simplifications.

The context for Keynes's essay was Britain's return to the gold standard at an overvalued level - Winston Churchill was the Chancellor of the Exchequer at the time - but much of it holds up well 88 years later as an essay on the danger of "internal devaluation" such as we're seeing now in Spain.