Keynes!

The FT profiles the "Man in the News: John Maynard Keynes." Ed Crooks writes:

The key to Keynes was his commitment to preserving the market economy by making it work. He was dismissive of Marxism but believed the market economy could survive only if it earned the support of the public by raising living standards.

The role of the economist, he believed, was to be the guardian of “the possibility of civilisation”, and no economist has ever been more suited for that role.

In the Washington Post, Keynes' biographer Robert Skidelsky writes "We Forgot Everything Keynes Taught Us" -

No one has bettered Keynes in his understanding of the psychology of financial markets. "Most . . . of our decisions to do something positive . . . can only be taken as a result of animal spirits . . . If animal spirits are dimmed . . . enterprise will fade and die" is one famous remark. "Speculators may do no harm as bubbles on a steady stream of enterprise. But the position is serious when enterprise becomes the bubble on a whirlpool of speculation. When the capital development of a country becomes a by-product of the activities of a casino, the job is likely to be ill-done" is another. Professional investment, he wrote, is like "a game of Snap, of Old Maid, of Musical Chairs," whose object is to pass on the Old Maid -- the toxic debt -- to one's neighbor before the music stops. What makes the game toxic is not greed, which is universal, but uncertainty masquerading as certainty.

"The outstanding fact is the extreme precariousness of the basis of knowledge on which our estimates of prospective yield have to be made," Keynes wrote in his great book "The General Theory of Employment, Interest, and Money" in 1936. We disguise this uncertainty from ourselves by assuming that the future will be like the past, that existing opinion correctly sums up future prospects, and by copying what everyone else is doing. But any view of the future based on "so flimsy a foundation" is liable to "sudden and violent changes. The practice of calmness and immobility, of certainty and security suddenly breaks down. New fears and hopes will, without warning, take charge of human conduct . . . the market will be subject to waves of optimistic and pessimistic sentiment, which are unreasoning yet in a sense legitimate where no solid basis exists for a reasonable calculation." Keynes accused economics of being itself "one of these pretty, polite techniques which tries to deal with the present by abstracting from the fact that we know very little about the future."

While Skidelsky is right that Keynes' discussion of the psychology of investment booms and busts is too often neglected - it has been left out of the "Keynesian" economic models in our textbooks - I woudn't go so far as to say that we've forgotten everything Keynes taught us. A number of people have lately been invoking another important Keynesian lesson, the role of government in propping up "effective demand" through fiscal policy.

In the Guardian, Brad DeLong explains how policymakers dealing with the financial crisis have gone from Plan A through Plan F. Next up:

If Plan F fails, we move to Plan G: we pull the Keynesian fire alarm and begin an enormous government infrastructure building programme in the whole North Atlantic to keep away depression.

Paul Krugman is ready to break the glass:

[R]ight now, increased government spending is just what the doctor ordered, and concerns about the budget deficit should be put on hold...

[T]here’s not much Ben Bernanke can do for the economy. He can and should cut interest rates even more — but nobody expects this to do more than provide a slight economic boost.

On the other hand, there’s a lot the federal government can do for the economy. It can provide extended benefits to the unemployed, which will both help distressed families cope and put money in the hands of people likely to spend it. It can provide emergency aid to state and local governments, so that they aren’t forced into steep spending cuts that both degrade public services and destroy jobs. It can buy up mortgages (but not at face value, as John McCain has proposed) and restructure the terms to help families stay in their homes.

And this is also a good time to engage in some serious infrastructure spending, which the country badly needs in any case. The usual argument against public works as economic stimulus is that they take too long: by the time you get around to repairing that bridge and upgrading that rail line, the slump is over and the stimulus isn’t needed. Well, that argument has no force now, since the chances that this slump will be over anytime soon are virtually nil. So let’s get those projects rolling.

Waiting on a Recovery

"I'm confident in the long run, that this economy will come back." - Pres. Bush

"In the long run, we are all dead." - J.M. Keynes

Update (10/19): Paul Krugman has the long version of the Keynes quote.

Encroachment of Ideas

The Treasury's apparent shift towards using its $700 billion war chest for recapitalization instead of asset purchases suggests they are coming around to a view that many academic types have held all along. The Journal reports:

Many economists believed that the heart of the government's initial plan to pay $700 billion for toxic assets was aimed at the wrong target. Purchasing mortgage securities from banks wouldn't do anything to kick-start lending and get credit flowing again, they said. Rather, banks would use the proceeds they got from the Treasury to pay off debtors, and those debtors would use the proceeds to buy safe assets.

They said a wiser course -- the one the Treasury now seems to have come around to -- was for government to rebuild the badly depleted cash levels on bank balance sheets. That would cushion institutions against future losses, giving them the wherewithal to lend again. Other hitches in the original plan include coming up with a price for mortgage securities that is above the "fire sale" level they would draw on the open market, but not so high that taxpayers end up getting taken for a ride.

The Treasury move is a sign of how, as international efforts to contain the crisis continue this weekend at meetings of the International Monetary Fund and World Bank, economists' ideas for solutions are influencing policy and entering the public discourse.

Hat tip (not surprisingly) to Mankiw, who says "score one for the ivory tower."

Near the end of the General Theory, Keynes wrote: "Madmen in authority, who hear voices in the air, are distilling their frenzy from some academic scribbler of a few years back." Perhaps we should make that: "blogger of a few days back."

That's the sentence immediately after the one I cited in this recent post, noting that the Congressional modifications to the proposal included opening the window for an equity component which Paulson is now jumping through (nice work, Senator Dodd).

Here's the quote in context, which closes the General Theory:

At the present moment people are unusually expectant of a more fundamental diagnosis; more particularly ready to receive it; eager to try it out if it should be even plausible. But apart from this contemporary mood, the ideas of economists and political philosophers, both when they are right and when they are wrong, are more powerful than is commonly understood. Indeed the world is ruled by little else. Practical men, who believe themselves to be quite exempt from any intellectual influences, are usually the slaves of some defunct economist. Madmen in authority, who hear voices in the air, are distilling their frenzy from some academic scribbler of a few years back. I am sure that the power of vested interests is vastly exaggerated with the gradual encroachment of ideas. Not, indeed, immediately, but after a certain interval; for in the field of economic and political philosophy there are not many who are influenced by new theories after they are twenty-five or thirty years of age, so the ideas which civil servants and politicians and even agitators apply to current events are not likely to be the newest. But, soon or late, it is ideas, not vested interests, which are dangerous, for good or evil.

Keynes continues to be very relevant.

The Failure of Supply-Side Tax Policies

Writing in the Times' Economix blog, Princeton's Uwe Reinhardt makes the case against the argument - now standard boilerplate "supply side" Republican rhetoric - that tax cuts lead to higher investment and GDP:

From a macroeconomic perspective, however, changes in tax rates are but one of many factors that drive the time path of gross domestic product (G.D.P.), savings, investment, employment and other such variables. By itself, changing tax rates steers the economy about as much as would tapping an elephant on the leg with a chopstick. There may be some effect, but typically it is small and dwarfed by other effects.

He provides a chart showing that the share of investment in GDP fell during the Reagan/Bush years (i.e., in the wake of the 1981 tax cuts), rose in the Clinton years (i.e., following the 1993 tax increase), and has fallen again since the 2001 and 2003 tax cuts. A point he doesn't make: this pattern would be consistent with the hypothesis that "crowding out" prevails - i.e., that government borrowing, which ballooned in the Reagan and (to a lesser extent) G.W. Bush administrations, displaces private investment.

Nonetheless, some economists are still apparently on board, as this statement released by the McCain campaign shows. Jonathan Chait writes:

First, 100 economists is not actually all that many, given the number of economists in our country. Second, the list of signatories actually has only 90 economists on it. (Count for yourself.) This trouble with basic arithmetic might explain the McCain campaign's stated beliefs in such fallacies as tax hikes always cause revenues to fall.

Was the campaign unable to find 100 economists? The list certainly does not suggest excessive discrimination about credentials. It's heavily larded with GOP apparatchiks now residing in the right-wing think tank world (my favorite is "economist" George Schultz of the Hoover Institution), as well as two signatories who list their affiliation as "McCain-Palin 2008." The takeaway here is that, even with the most generous standards, the campaign couldn't find 100 economists in the country to badmouth Obama's proposals, let alone endorse their own.

I'd disagree slightly: some of the signatories do actually have pretty strong academic credentials. But we do know that most economists support Obama; I'm sure if his campaign tried, they could gather a more impressive list.

Hmm... back in July, McCain had an endorsement from 300 economists... have 210 of them jumped ship?

Professor Obama

Noam Scheiber says that Barack Obama's experience as a professor gave him the edge in last night's debate:

Obama really benefitted from his years as a law professor. He was fluent and very much at ease walking and talking at the same time. He had a professor's knack for making eye contact and maintaining it while he walked a questioner through a multi-step response. And his answers were much more concrete and intuitive than I'd ever heard them. It's as though it took fielding questions from ordinary people to remind him of this latent professorial talents.

I have found that such talents, unfortunately, do not come automatically with being a professor.

Furnish an Elastic Currency

One of the main reasons for establishing the Fed was to create a "lender of last resort." The Federal Reserve Act passed in 1913:

To provide for the establishment of Federal reserve banks, to furnish an elastic currency, to afford means of rediscounting commercial paper, to establish a more effective supervision of banking in the United States, and for other purposes.

Over time, this function of the Fed has receded into the background, but it is now again front and center, as the Fed continues to step up its lending activity, and is now even planning to buy commerical paper. Econbrowser offers an excellent summary of the action, so far, on the Fed's balance sheet.

On the Times' new economics blog, David Leonhardt has praise for Bernanke.

The Economist Asks Some Economists

The Economist has surveyed economists' opinions about McCain and Obama. The results are overwhelmingly in Obama's favor:They didn't just ask any economists - the survey was sent to 683 NBER research associates, an elite subset of academic economists, of which 142 responded. A somewhat broader sample of American Economic Association members (a less elite group - even I am in it) surveyed by Scott Adams also favored Obama, though less overwhelmingly (see this earlier post).

Bailout: Gone With the Windbags?

In reading CBO Director Peter Orszag's useful statement to the House Budget Committee about the bailout, I notice that the official name of the thing is the Troubled Asset Relief Act. Yes, its called TARA (a tribute to Ben Bernanke's southern roots, perhaps?).

And now, it looks like the House Republicans are burning down Tara. Don't they realize that some people still haven't gotten over the last time?

Paul Krugman and Steven Pearlstein gallantly defend Tara, but is it a lost cause? Hopefully things won't get this bad:Update (9/29): In its latest incarnation, the bill is the Emergency Economic Stabilization Act of 2008, which establishes a "Troubled Assets Relief Program" or TARP.

Some Rough Bailout Arithmetic

Large numbers are being thrown around, which is confusing....

So, if the government borrows $700 billion for the bailout, let's say at 4.25% interest (a rate currently between the 10- and 30-year Treasury yield), taxpayers are on the hook for about $30 billion per year in interest. That adds roughly 1.1% to total federal spending, and is about $100 per person per year.

The bailout shouldn't actually cost $700 billion - the Treasury will be buying assets that are presumably worth something. Exactly how much they will ultimately be worth is a matter of great uncertainty, and we don't know yet how exactly, in practice, the Treasury will determine what it is willing to pay (i.e., how hard it will try to get a good deal). So, the $700 billion is an upper bound on the cost (unless, of course, they ask for more....).

That is about 5% of GDP. If we guesstimate (conservatively, I hope) that the full $700 billion is spent, and the Treasury loses 50%, we're talking 2.5% of GDP. So, the question is: in the absence of a bailout, would the additional, credit crunch-induced loss of output be larger than 2.5% of a year's GDP?

Palin on the Bailout, et cetera

As a professor, I have some empathy for those who babble incoherently in front of a visibly skeptical, irritated audience. But I don't think my students have ever had it quite as bad as Katie Couric does here, when she asks Sarah Palin about the bailout:
Hat tip to Ezra Klein, who says: "The question was simple. The answer came from some dreamscape I've never visited."