Non-Satiation

Brad DeLong revisits "Economic Possibilities for our Grandchildren" -

Nearly eighty years ago, John Maynard Keynes did the math on economic growth and concluded that within a few generations—by the time his peers' great-grandchildren came of age in, say, the 2000's—the persistent economic problem of too-scarce resources and too-few goods would no longer bedevil a substantial portion of humanity. He was right—even in the midst of our current hard times, he is right.

The current recession may turn into a small depression, and may push global living standards down by five percent for one or two or (we hope not) five years, but that does not erase the gulf between those of us in the globe's middle and upper classes and all human existence prior to the Industrial Revolution. We have reached the frontier of mass material comfort—where we have enough food that we are not painfully hungry, enough clothing that we are not shiveringly cold, enough shelter that we are not distressingly wet, even enough entertainment that we are not bored. We—at least those lucky enough to be in the global middle and upper classes who still cluster around the North Atlantic—have lots and lots of stuff. Our machines and factories have given us the power to get more and more stuff by getting more and more stuff—a self-perpetuating cycle of consumption.

Our goods are not only plentiful but cheap. I am a book addict. Yet even I am fighting hard to spend as great a share of my income on books as Adam Smith did in his day. Back on March 9, 1776 Adam Smith's Inquiry into the Nature and Causes of the Wealth of Nations went on sale for the price of 1.8 pounds sterling at a time when the median family made perhaps 30 pounds a year. That one book (admittedly a big book and an expensive one) cost six percent of the median family's annual income. In the United States today, median family income is $50,000 a year and Smith's Wealth of Nations costs $7.95 at Amazon (in the Bantam Classics edition). The 18th Century British family could buy 17 copies of the Wealth of Nations out of its annual income. The American family in 2009 can buy 6,000 copies: a multiplication factor of 350.

Keynes was right about growth, despite predating the Solow growth model by a quarter-century. Some of his speculations about the social and cultural change that would follow in the wake of the end of scarcity have not panned out (so far, at least). DeLong believes we will never run out of things that we want:

Keynes thought that by today we would have reached a realm of plenty where "We shall once more value ends above means and prefer the good to the useful. We shall honour those who can teach us how to pluck the hour and the day virtuously and well, the delightful people who are capable of taking direct enjoyment in things, the lilies of the field who toil not, neither do they spin."

But no dice. I look around, and all I can say is: not yet, not for a long time to come, and perhaps never. I'm convinced that everyone I know can easily imagine how to spend up to three times their current income usefully and productively. (It is only beyond three times your current spending that people judge others' spending as absurd and wasteful.) And everybody I know finds it very difficult to imagine how people can survive on less than one-third of what they spend—never mind that all of our pre-industrial ancestors did so all the time. There is a point at which we say "enough!" to more oat porridge. But all evidence suggests Keynes was wrong: We are simply not built to ever say "enough!" to stuff in general.

In the Times, a while back, Bob Frank came to a similar conclusion.

A Case for the Stimulus

When I was in college, a female classmate once told me I reminded her of George Will. At the time, I took that as a complement, but my capacity for self-deception has since diminished... In any case, some years later, I have indeed landed on a newspaper opinion page. In today's Cincinnati Enquirer, I argue for the fiscal stimulus bill:

The Obama administration's plan, which includes $550 billion in spending and $275 billion in tax cuts, will provide a badly needed "shove" to help get the economy moving in the right direction. Trimming the size of the proposal or shifting the emphasis to tax cuts, as some have called for, would reduce its effectiveness.

The current recession is mainly the result of households cutting back on spending because two important sources of wealth, the value of homes and retirement savings, have taken a big hit. Moreover, in the face of uncertainty and rising unemployment, people have become more cautious about spending. While this behavior makes sense on an individual basis, when everybody is cutting back, the entire economy suffers....

Tax cuts only work to the extent that households spend them. This is why a broad-based reduction in income taxes would not be very effective as stimulus - many households would save the additional money. The main tax provision in the proposal, a credit of $500 for individuals and $1,000 for couples, will be more effective than a rate cut because more of the benefits go to lower- and middle-income households. Many of these families are struggling to meet their everyday needs, which means they are more likely to spend additional disposable income.

The spending elements include investments in transportation infrastructure and schools, improvements to the electricity grid and information technology upgrades for our healthcare system. Some in Washington reflexively attach the word "wasteful" to any government spending, and they have begun to attack the proposal. Those criticisms are irrelevant. For the immediate purpose of boosting economic demand, it doesn't much matter exactly how the money is spent - even "bridges to nowhere" work as fiscal stimulus.

The proposals also include federal grants to state governments, which will be a significant, immediate help. Because most states are limited by their constitutions from borrowing, they are forced to cut back when economic downturns reduce tax revenue. We are seeing this already in Ohio. In the absence of federal help, even more cuts in state services will be necessary.

While we must take seriously the need to reduce the deficit after the recovery takes hold, limiting the size of the stimulus now for the sake of "fiscal responsibility" would be self-defeating and might prolong the recession.

Incidentally, responsibility for the lame headline lies with the editors, not me. They also lopped off this point: "much of the proposed spending addresses longstanding needs and will have economic benefits that outlast the recession."

Fundamental Psychological Laws?

One of the building blocks of the Keynesian economic model is the consumption function, asserted by Keynes:

The fundamental psychological law, upon which we are entitled to depend with great confidence both a priori from our knowledge of human nature and from the detailed facts of experience, is that men are disposed, as a rule and on the average, to increase their consumption as their income increases, but not by as much as the increase in their income.

This turned out to be one of the weakest parts of the Keynesian edifice, as Modigliani and Brumberg's Life-Cycle Hypothesis and Friedman's Permanent Income Hypothesis showed in the 1950's. However, the modern view that has evolved from Friedman of rational, forward-looking agents choosing their consumption to maximize expected lifetime utility is also a bit hard to swallow.

The truth may lie somewhere in the middle, but exactly how consumption decisions are made has significant implications for the effectiveness of policies like the tax cuts in the fiscal stimulus package. The New Yorker's James Surowiecki reports on the implications of some research in behavioral economics, which is making a more serious go at uncovering the "psychological laws" that govern our behavior. Their findings imply that the stimulus will be more effective if it comes to us in small pieces, he writes:

The permanent-income hypothesis is elegant, but studies have shown that it’s not always an accurate description of the way people decide how to spend and save. A more compelling explanation for why rebates haven’t worked very well is that they have been handed out as lump sums. You might think that handing people a big chunk of change is a perfect way to get them to spend it. But it isn’t, because people don’t treat all windfalls as found money. Instead, in the words of the behavioral economist Richard Thaler, people put different windfalls in different “mental accounts,” which in turn influences what they do with the money...

The key factor in these kinds of distinctions, Thaler’s work suggests, is whether people think of a windfall as wealth or as income. If they think of it as wealth, they’re more likely to save it, and if they think of it as income they’re more likely to spend it. That’s because many people tend to base their spending not on their long-term earning potential or on their assets but on what they think of as their current income, an amount best defined by what’s in their regular paycheck. When that number goes up, so does people’s spending. In Thaler’s words, “People tend to consume from income and leave perceived ‘wealth’ alone.”

So what does this mean for making a rebate work? If you want people to spend the money, you don’t want to give them one big check, because that makes it more likely that they’ll think of it as an increase in their wealth and save it. Instead, you want to give them small amounts over time. And you want the rebate to show up as an increase in people’s take-home pay, because an increase in steady income is more likely to translate into an increase in spending. What can accomplish both of these goals? Reducing people’s withholding payments.

Methodenstreit!

Brad DeLong and Paul Krugman have vigorously criticized some prominent economists - particularly Eugene Fama and John Cochrane - who have offered apparently pre-Keynesian interpretations of the current economic mess. In particular, both seem to suggest that "Say's Law" holds, and therefore, fiscal policy cannot only reallocate - but not increase - output, an argument we thought Keynes had demolished in 1936. Krugman writes:

So how is it possible that distinguished professors believe otherwise?

The answer, I think, is that we’re living in a Dark Age of macroeconomics. Remember, what defined the Dark Ages wasn’t the fact that they were primitive — the Bronze Age was primitive, too. What made the Dark Ages dark was the fact that so much knowledge had been lost, that so much known to the Greeks and Romans had been forgotten by the barbarian kingdoms that followed.

And that’s what seems to have happened to macroeconomics in much of the economics profession. The knowledge that S=I doesn’t imply the Treasury view — the general understanding that macroeconomics is more than supply and demand plus the quantity equation — somehow got lost in much of the profession. I’m tempted to go on and say something about being overrun by barbarians in the grip of an obscurantist faith, but I guess I won’t. Oh wait, I guess I just did.

Or, as he said to Mark Thoma, economists who "have spent their entire careers on equilibrium business cycle theory are now discovering that, in effect, they invested their savings with Bernie Madoff." By "equilibrium business cycle theory," he means the modern incarnation of classical economics, where markets clear and economic fluctuations arise from the behavior of rational, optimizing agents. Greg Mankiw offers a more charitable interpretation:

It is funny. I have a similar pedigree as Paul. Both of us have PhDs from MIT, and we learned a lot of our macro there. Both of us see the world through the lens of the Keynesian framework (by which I mean the IS-LM model, etc.) But we have very different perspectives on the equilibrium business cycle theorists.

The difference may reflect our research paths. Most of Paul's research has been in international economics, and throughout his career, he could easily ignore equilibrium business cycle theory. By contrast, I have done a lot of work on "new Keynesian economics," which tries to fix the flaws in the Keynesian model that the equilibrium business cycle theorists pointed out. Perhaps that work has given me more appreciation for their contribution, as well as for the defects in the Keynesian worldview.

Here is DeLong on Fama, and on Cochrane.

More Stimulus Guesstimates

The stimulus has passed the House and is now cooling in the senatorial saucer. The CBO has estimated its effects:

According to CBO’s estimates, with enactment of H.R. 1, the number of jobs would be between 0.8 million and 2.1 million higher at the end of this year, 1.2 million to 3.6 million higher at the end of next year, and 0.7 million to 2.1 million higher at the end of 2011 than under current law.

As this Times analysis nicely explains, the components vary in their speed and effectiveness - the spending has a higher multiplier than the tax cuts, but some of the spending will take longer to implement. The Tax Policy Center has graded the effectiveness of the tax provisions; they give a B+ to the centerpiece "making work pay" refundable tax credit of $500 for individuals and $1000 for couples, while the corporate tax breaks mostly get lower grades. At Econbrowser, Menzie Chinn plots the CBO's estimate of spending over time (bear in mind that the CBO's estimates are for the federal government's fiscal years, which begin in October, not January, so we're almost half way through FY 09).

A detailed outline of the bill has been posted by Speaker Pelosi's office.

The Roquefort Files

The Washington Post reports:

In its final days, the Bush administration imposed a 300 percent duty on Roquefort, in effect closing off the U.S. market. Americans, it declared, will no longer get to taste the creamy concoction that, in its authentic, most glorious form, comes with an odor of wet sheep and veins of blue mold that go perfectly with rye bread and coarse red wine.

The measure, announced Jan. 13 by U.S. Trade Representative Susan C. Schwab as she headed out the door, was designed as retaliation for a European Union ban on imports of U.S. beef containing hormones. Tit for tat, and all perfectly legal under World Trade Organization rules, U.S. officials explained.

Is it just me, or does this smell like a parting shot at cheese-eating surrender monkeys?

Update (2/1): The Economist's Free Exchange says: "Yes, while Europeans will be relishing delicious bleu cheese, Americans can eat hormone-injected beef with a side of stale freedom fries."

Old School

From Davos, of all places, the Times reports:Don't forget to include their running-dog lackeys.

Keynes and FDR

From an interesting Times article on the lessons of the depression:

In 1934, the British economist John Maynard Keynes visited Roosevelt in the White House to make his case for more deficit spending. But Roosevelt, it seems, was either unimpressed or uncomprehending. “He left a whole rigmarole of figures,” Roosevelt complained to his labor secretary, Frances Perkins, according to her memoir. “He must be a mathematician rather than a political economist.”

Keynes left equally disenchanted, telling Ms. Perkins that he had “supposed the president was more literate, economically speaking.”

A Crisis of Animal Spirits

In the WSJ, Yale's Robert Shiller argues for the relevance of the Keynes beyond the "textbook" Keynesian model:

The term "animal spirits," popularized by John Maynard Keynes in his 1936 book "The General Theory of Employment, Interest and Money," is related to consumer or business confidence, but it means more than that. It refers also to the sense of trust we have in each other, our sense of fairness in economic dealings, and our sense of the extent of corruption and bad faith. When animal spirits are on ebb, consumers do not want to spend and businesses do not want to make capital expenditures or hire people...

But lost in the economics textbooks, and all but lost in the thousands of pages of the technical economics literature, is this other message of Keynes regarding why the economy fluctuates as much as it does. Animal spirits offer an explanation for why we get into recessions in the first place -- for why the economy fluctuates as it does. It also gives some hints regarding what we need to do now to get out of the current crisis...

The famous phrase comes from this passage in chapter 12 of the General Theory:

Even apart from the instability due to speculation, there is the instability due to the characteristic of human nature that a large proportion of our positive activities depend on spontaneous optimism rather than on a mathematical expectation, whether moral or hedonistic or economic. Most, probably, of our decisions to do something positive, the full consequences of which will be drawn out over many days to come, can only be taken as a result of animal spirits - of a spontaneous urge to action rather than inaction, and not as the outcome of a weighted average of quantitative benefits multiplied by quantitative probabilities. Enterprise only pretends to itself to be mainly actuated by the statements in its own prospectus, however candid and sincere. Only a little more than an expedition to the South Pole, is it based on an exact calculation of benefits to come. Thus if the animal spirits are dimmed and the spontaneous optimism falters, leaving us to depend on nothing but a mathematical expectation, enterprise will fade and die; - though fears of loss may have a basis no more reasonable than hopes of profit had before.

Krugman Debunks Stimulus Skeptics

In his Times column, Paul Krugman provides a useful rebuttal of some of the arguments being made against the stimulus proposal, including:

First, there’s the bogus talking point that the Obama plan will cost $275,000 per job created. Why is it bogus? Because it involves taking the cost of a plan that will extend over several years, creating millions of jobs each year, and dividing it by the jobs created in just one of those years.

It’s as if an opponent of the school lunch program were to take an estimate of the cost of that program over the next five years, then divide it by the number of lunches provided in just one of those years, and assert that the program was hugely wasteful, because it cost $13 per lunch. (The actual cost of a free school lunch, by the way, is $2.57.)

The true cost per job of the Obama plan will probably be closer to $100,000 than $275,000 — and the net cost will be as little as $60,000 once you take into account the fact that a stronger economy means higher tax receipts.